EXHIBIT 13
The Bear Stearns Companies Inc.
SELECTED FINANCIAL DATA
FISCAL YEAR ENDED
June 30, June 30, June 30, June 30, June 30,
In thousands, except share and employee data 1997 1996 1995 1994 1993
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OPERATING RESULTS
Revenues $ 6,077,278 $ 4,963,863 $ 3,753,572 $ 3,440,638 $ 2,853,185
Interest expense 2,551,364 1,981,171 1,678,515 1,023,866 710,086
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Revenues, net of interest expense 3,525,914 2,982,692 2,075,057 2,416,772 2,143,099
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Non-interest expenses
Employee compensation and benefits 1,726,931 1,469,448 1,080,487 1,227,061 1,037,099
Other 785,293 678,318 606,488 546,912 491,602
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Total non-interest expenses 2,512,224 2,147,766 1,686,975 1,773,973 1,528,701
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Income before provision for income taxes 1,013,690 834,926 388,082 642,799 614,398
Provision for income taxes 400,360 344,288 147,471 255,834 251,951
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Net income $ 613,330 $ 490,638 $ 240,611 $ 386,965 $ 362,447
====================================================================================================================================
Net income applicable to common shares $ 589,497 $ 466,145 $ 215,474 $ 362,592 $ 355,696
====================================================================================================================================
FINANCIAL POSITION
Total assets $121,433,535 $92,085,157 $ 74,597,160 $ 67,392,018 $ 57,439,505
Long-term borrowings $ 8,120,328 $ 6,043,614 $ 4,059,944 $ 3,408,096 $ 1,883,123
Stockholders' equity $ 3,626,371(1,2) $ 2,895,414(1) $ 2,502,461(1) $ 2,316,566(1) $ 1,776,530
Common shares outstanding (3) 151,561,465 151,274,714 151,465,966 149,208,420 149,353,528
====================================================================================================================================
PER SHARE DATA
Earnings per share (3,4) $ 4.20 $ 3.27 $ 1.54 $ 2.50 $ 2.47
Cash dividends declared per common share $ 0.60 $ 0.60 $ 0.60 $ 0.60 $ 0.60
Book value per common share (3) $ 19.56 $ 16.03 $ 13.34 $ 12.31 $ 10.32
====================================================================================================================================
OTHER DATA
Return on average common equity 27.9% 25.6% 13.5% 23.3% 28.8%
Profit margin (5) 28.7% 28.0% 18.7% 26.6% 28.7%
Employees 8,309 7,749 7,481 7,321 6,306
====================================================================================================================================
<FN>
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1. Includes $150 million 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. Includes $200 million of Guaranteed Preferred Beneficial Interests in Company
Subordinated Debt Securities which were issued by a subsidiary of the
Company. See Note 8 of Notes to Consolidated Financial Statements.
3. Adjusted to reflect stock dividends.
4. See Note 1 of Notes to Consolidated Financial Statements.
5. Represents the ratio of income before provision for income taxes to revenues,
net of interest expense.
</FN>
6
The Bear Stearns Companies Inc.
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, in particular, volatile trading markets and fluctuations in the
volume of market activity. Consequently, the Company's net income and revenues
in the past have been, and are likely to continue to be, subject to wide
fluctuations, reflecting the impact of many factors, including securities market
conditions, the level and volatility of interest rates, competitive conditions,
and the size and timing of transactions. Certain statements contained in this
discussion are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks and uncertainties, including those previously
mentioned.
BUSINESS ENVIRONMENT
The business environment during fiscal 1997 was generally characterized by a
stable economy and low levels of inflation. This economic backdrop resulted in
improved financial market conditions and heightened investor activity. The
financial markets were characterized by rising domestic equity markets on strong
investor volume, active fixed income markets and increased underwriting and
merger and acquisition activity. The result of these conditions was reflected in
the Company's improved commissions, principal transactions and investment
banking revenues.
US bond markets experienced volatility throughout fiscal 1997. A
strong rally in the US bond market during the first six months of the year was
characterized by heavy trading and decreasing interest rates which resulted from
moderate economic growth and benign inflation levels. At the outset of the third
quarter, the market experienced a general rise in interest rates due to
inflationary concerns.
Equity markets were characterized by record flows of capital into
equity funds, with the major indices reaching record levels. The Dow Jones
Industrial Average surged over 2,000 points, reaching 7,672 by the end of the
fiscal year. The Standard & Poor's 500 Index climbed 32% and the New York Stock
Exchange average daily trading volume rose 21%.
The global market environment during fiscal 1997 reflected improved
conditions over the prior year. The Company continued to develop global
distribution in equity and fixed income areas, resulting in significant
increases in international commissions for fiscal year 1997 versus fiscal year
1996. The Company also increased its international base by expanding its
securities lending expertise to Europe and Asia.
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, and interest rates fell to their lowest levels of the last
three years. The New York Stock Exchange and the NASDAQ average daily trading
volumes reached new levels in fiscal year 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. Additionally, the favorable environment created by
rising stock prices and falling interest rates provided a strong investment
banking backdrop. These improved financial conditions led to increased investor
activity, resulting in strong commissions and trading revenues.
35
MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
The Company reported net income of $613.3 million, or $4.20 per
share, in fiscal 1997, which represented an increase of 25.0% from $490.6
million, or $3.27 per share, in fiscal 1996. The Company reported net income of
$240.6 million, or $1.54 per share, in fiscal 1995.
Revenues, net of interest expense ("net revenues"), increased 18.2% to
$3.5 billion in fiscal 1997 from $3.0 billion in fiscal 1996, reflecting
increases in all revenue categories. Net revenues in fiscal 1995 amounted to
$2.1 billion.
Commission revenues in fiscal 1997 increased 6.7% to $732.3 million,
from $686.5 million in fiscal 1996. 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 1996 commission revenues improved 25.5% from $546.9 million in fiscal
1995, reflecting higher levels of activity and continued growth of the
Company's securities clearance client base.
Revenues from principal transactions in fiscal 1997 increased 26.8% to
$1.6 billion from $1.2 billion in fiscal 1996, reflecting increases in revenues
from the Company's fixed income activities, particularly in the mortgage-backed
securities, high yield and corporate bond 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
international equity trading and over-the-counter market-making areas.
Additionally, revenues from the Company's derivatives activities increased as
the number of transactions increased from the prior year. Fiscal 1996 principal
transaction revenues increased 47.1% from $842.6 million in fiscal 1995,
reflecting increases in revenues from the Company's fixed income and equity
trading activities.
Investment banking revenues in fiscal 1997 increased 9.2% to $663.2
million from $607.3 million in fiscal 1996. Underwriting revenues increased due
to increases in volume, most notably from emerging markets, investment-grade
debt and common equity issuances. Merger and acquisition fees also increased,
reflecting increased activity. Fiscal 1996 investment banking revenues increased
74.1% from $348.9 million in fiscal 1995, reflecting increases in underwriting
revenues due to higher new issue volume and increases in merger and acquisition
fees.
Net interest and dividends (revenues from interest and net dividends
less interest expense) in fiscal 1997 increased 23.1% to $507.1 million, from
$412.1 million in fiscal 1996, principally due to record levels of customer
margin debt and short account balances. Average interest-bearing margin debt
balances were $30.6 billion and reached $38.1 billion at June 30, 1997, up from
$25.6 billion at June 30, 1996. Average free-credit balances were $7.6 billion
and reached $8.9 billion at June 30, 1997, up from $6.8 billion at June 30,
1996. The Company also experienced significant growth in its customer securities
lending activities attributable to increased customer short selling. Average
customer short account balances were $40.3 billion and reached $51.3 billion at
June 30, 1997, up from $32.3 billion at June 30, 1996. Net interest and
dividends in fiscal 1996 increased 33.5% from $308.8 million in fiscal 1995,
principally due to the large increase in customer margin debt and growth in
securities lending activities associated with the Company's securities clearance
client base.
Employee compensation and benefits in fiscal 1997 increased 17.5% to
$1.7 billion, from $1.5 billion in fiscal 1996. The increase was principally
attributable to increased incentive and discretionary bonuses associated with
the increase in net revenues and earnings in fiscal 1997. Employee compensation
and benefits, as a percentage of net revenues, decreased to 49.0% for fiscal
1997, from 49.3% in fiscal 1996. Employee compensation and benefits in fiscal
1996 increased 36.0%, from $1.1 billion in fiscal 1995, reflecting increased
incentive and discretionary bonuses associated with the increase in net revenues
and earnings in fiscal 1996.
Other non-interest expenses in fiscal 1997 increased 15.8% to $785.3
million, from $678.3 million in fiscal 1996. Floor brokerage, exchange and
clearance fees increased 9.0% in fiscal 1997, reflecting the increase in the
volume of securities transactions processed during the fiscal year. The balance
of other non-interest expenses increased 17.4% in fiscal 1997, reflecting
increases in depreciation and amortization, communications expense and
professional fees. These increases are primarily the result of the Company's
continued investment in technological upgrades. Other non-interest expenses in
fiscal 1996 increased 11.8% from $606.5 million in fiscal 1995, principally
reflecting expansion of the Company's business activities.
The decrease in the Company's effective tax rate to 39.5% in fiscal
1997, from 41.2% in fiscal 1996, was principally attributable to higher levels
of tax preference items. The effective tax rate in fiscal 1996 increased from
38.0% in fiscal 1995, due to increases in state and local taxes.
36
MANAGEMENT'S DISCUSSION AND ANALYSIS
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, results 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, 1997 increased to $121.4
billion, from $92.1 billion at June 30, 1996. The increase was primarily
attributable to the growth in financial instruments owned, securities borrowed,
and securities purchased under agreements to resell. 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 margin or
overcollateralization, 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 1997 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 and 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 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.
37
MANAGEMENT'S DISCUSSION AND ANALYSIS
The Company also 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, the facility provides
for defined margin levels on a wide range of eligible financial instruments that
may be pledged under the secured portion of the facility. There were no
borrowings outstanding under the facility at June 30, 1997.
Capital Resources
The Company conducts a substantial portion 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 these broker dealer subsidiaries. The Company regularly monitors the
nature and significance of 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 1997, the Company expanded its long-term borrowing base
to $8.1 billion through the issuance of $3.1 billion of long-term debt, which
along with the growth in retained earnings and the issuance of $200 million of
Guaranteed Preferred Beneficial Interests in Company Subordinated Debt
Securities, increased total capital to $11.7 billion from $8.9 billion in fiscal
1996. 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. Long-term debt of
$6.5 billion and $5.1 billion had maturities beyond one year at June 30, 1997
and June 30, 1996, respectively.
At June 30, 1997, the Company's long-term debt ratings were as
follows:
- --------------------------------------------------------------------------------
Moody's Investors Service A2
Standard & Poor's Rating Group A
IBCA Inc. A+
Thomson BankWatch AA-
- --------------------------------------------------------------------------------
In September 1997, the Company entered into a 99-year ground lease at 383
Madison Avenue, New York City. The Company expects to develop and build an
office tower on this site which will serve as its new world headquarters. The
new facility will be completed by the expiration of the current lease at 245
Park Avenue in 2002. The Company expects to fund the construction of the new
building through a combination of internally generated funds and long-term debt.
The new facility will allow the Company to consolidate its New York City real
estate requirements into one facility and will allow expansion related to future
growth.
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, 1997, the Company repurchased a total of 7,230,103 shares of
Common Stock through open market transactions at a cost of approximately $187.1
million. During the year ended June 30, 1997, the participants of the CAP Plan
had approximately $246.9 million of fiscal 1997 compensation deferrals and
earnings on previous deferrals. This amount was credited to participants'
deferred compensation accounts in the form of 7,494,518 shares at a cost of
approximately $196.1 million, and the remaining balance of $50.8 million was
credited to the participants' deferred compensation cash accounts. The Company
intends, subject to market conditions, to continue to purchase in future periods
a sufficient number of shares of Common Stock in the open market to enable the
Company to issue shares with respect to all compensation deferred and any
additional amounts allocated to participants under the CAP Plan.
During the fiscal year ended June 30, 1997, the Company adopted 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 September 3, 1997, there have been no purchases under the
Repurchase Plan.
38
MANAGEMENT'S DISCUSSION AND ANALYSIS
Cash Flows
Cash and cash equivalents increased to $1.2 billion at the end of fiscal 1997,
from $127.8 million at the end of fiscal 1996, an increase of $1.1 billion.
Fiscal 1996 year-end cash and cash equivalents decreased $572.7 million from
$700.5 million at the end of fiscal 1995. Fiscal 1995 year-end cash and cash
equivalents increased $405.9 million from $294.6 million at the end of fiscal
1994. Cash provided from financing activities was primarily used to support the
growth in operating activities in each of the last three fiscal years.
Cash used in operating activities in fiscal 1997 was $5.4 billion. The
usage was primarily attributable to increases in financial instruments owned of
$12.2 billion, securities borrowed of $11.1 billion and securities purchased
under agreements to resell of $3.8 billion. This increase was partially offset
by increases in customer payables of $8.0 billion, financial instruments sold,
but not yet purchased of $6.9 billion, and securities sold under agreements to
repurchase of $6.1 billion.
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 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 provided by financing activities in each of the three fiscal
years ended June 30, 1997, 1996 and 1995 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 1997 used $230.2 million primarily for
purchases of property, equipment and leasehold improvements of $137.3 million
and purchases of investment securities and other assets of $108.5 million.
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.
Regulated Subsidiaries
As registered broker dealers, Bear Stearns and BSSC are subject to the net
capital requirements of the Securities Exchange Act of 1934, the New York Stock
Exchange, 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. 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.
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, 1997, the
Company held direct equity investments in ten leveraged transactions with an
aggregate carrying value of approximately $36.2 million. The Company did not
make any significant direct investments in leveraged acquisitions during fiscal
1997.
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, 1997 and 1996, the Company held high yield securities
of $1.6 billion and $1.1 billion, respectively, in long inventory, and $0.3
billion and $0.1 billion, respectively, in short inventory. These investments
generally involve greater risk than investment-grade debt securities due to
credit considerations, liquidity of secondary trading markets, and vulnerability
to general economic conditions. The level of the Company's high yield securities
inventories, and the impact of
39
MANAGEMENT'S DISCUSSION AND ANALYSIS
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 counterparties with the choice of either a termination or
continuation structure.
As of June 30, 1997 and 1996, the Company had notional/ contract
amounts of $353.0 billion and $288.2 billion, respectively, of derivative
financial instruments, of which $62.0 billion and $69.2 billion, respectively,
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
either are used to 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 are 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, using interest rate swaps, generally based on LIBOR. 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 $29.4 million, $15.9
million and $21.1 million during fiscal years 1997, 1996 and 1995, respectively.
40
MANAGEMENT'S DISCUSSION AND ANALYSIS
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
In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," effective for
transactions occurring after December 31, 1996. Certain provisions of this
statement relating to repurchase agreements, securities lending transactions and
similar transactions have been deferred by SFAS 127 and will become effective
after December 31, 1997.
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. The effective provisions of SFAS 125 have not
had a material impact on the financial condition or operations of the
Company; however, the Company has not yet determined the effect upon the
financial condition or operations of the Company relating to the deferred
provisions.
In February 1997, the FASB issued SFAS 128, "Earnings Per Share,"
which will be effective for financial statements issued for periods ending after
December 15, 1997, including interim periods. Under this standard, the Company
will replace its disclosure of "primary" earnings per share with "basic"
earnings per share. Basic earnings per share excludes dilution and is computed
by dividing net income available to common stockholders by the weighted average
number of common shares outstanding for the period. Prior period amounts must be
restated. The impact on previously reported primary earnings per share will be
immaterial. Diluted earnings per share, as required under the new standard, is
computed similarly to fully diluted earnings per share under existing accounting
principles.
In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive
Income," which requires businesses to disclose comprehensive income and its
components in a prominent position on the face of the financial statements. The
effect of SFAS 130 will not be material to the Company's financial statement
disclosure.
In June 1997, the FASB issued SFAS 131, "Disclosures about Segments of
an Enterprise and Related Information," which will be effective for the Company
beginning January 1, 1998. SFAS 131 redefines how operating segments are
determined and requires disclosure of certain financial and descriptive
information about a company's operating segments. The Company believes that the
segment information required to be disclosed under SFAS 131 will be more
comprehensive than previously provided, including expanded disclosure of income
statement and balance sheet items for each of its reportable operating segments.
However, the Company has not yet determined the impact of this statement on the
Company's financial statement disclosure.
41
The Bear Stearns Companies Inc.
RISK MANAGEMENT
Overall
The Company's principal business activities by their nature engender significant
market and credit risks. Managing these risks is critical to the success and
stability of the Company. As a result, comprehensive risk management policies
and procedures have been established to identify, control and monitor each of
these major risks. Additionally, the Company's diverse portfolio of business
activities helps to reduce the impact that volatility in any particular market
may have on its net revenues. In addition to market risk, the Company is also
subject to credit risk, operating risk and funding risk. Funding risk is
discussed in the Liquidity and Capital Resources section of Management's
Discussion and Analysis.
Managing risk at the Company begins first and foremost with the
expertise and experience of trading department management. Senior Managing
Directors in each trading department have extensive knowledge of the markets and
activities in which they do business. Their experience and insight are
supplemented by risk management policies and procedures intended to monitor and
evaluate the Company's risk profile.
The cornerstone of the Company's risk management practices is constant
communication between trading department management and senior management
concerning inventory positions and market risk profile. This process, which
occurs on a daily basis, culminates each week with the trading departments
making formal reports of positions, profits and losses and trading strategies to
Bear Stearns' Risk Committee (the "Risk Committee"). The Risk Committee,
comprised of Senior Managing Directors from each of the various trading
departments, is chaired by Alan C. Greenberg, Chairman of the Board of the
Company and of Bear Stearns. The Risk Committee meets weekly and has overall
responsibility for oversight of the trading departments and their related
trading strategies.
The risk management process encompasses many units, including the
Controller's Department, Operations and the Risk Management Department, and is
intended to support and enforce the Company's policies and procedures with
respect to market risk. As part of its daily risk management procedures the
Company marks all of its inventory to market and the Controller's Department
provides to senior management daily profit and loss statements covering all
trading departments. The Controller's Department and Operations monitor position
and balance sheet information through reconciliation procedures.
The Risk Management Department, which was formed in 1988, is
independent of all trading areas and reports directly to the Risk Committee. The
goals of the department are to understand the risk profile of each trading area,
to articulate large trading or position risks to senior management, to provide
traders with perspectives on their positions and to ensure accurate
mark-to-market pricing. The department's staffing and responsibilities have
grown with the Company's trading activities.
The Risk Management Department, together with trading department
management, reviews the age and composition of the 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.
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 comprised of
Senior Managing Directors who are generally 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 of customers seeking repurchase and resale agreement
facilities, derivative financial instruments and other forms of secured and
unsecured credit.
42
RISK MANAGEMENT
Market Risk
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument as a result of
fluctuations in interest and currency exchange rates and in equity and commodity
prices. Market risk is inherent to both derivative and non-derivative financial
instruments, and accordingly, the scope of the Company's market risk management
procedures extends beyond derivatives to include all market risk sensitive
financial instruments. The Company's exposure to market risk is directly related
to its role as a financial intermediary in customer-related transactions and to
its proprietary trading and arbitrage activities.
The Company makes dealer markets in investment-grade corporate debt,
non-investment-grade corporate ("high yield") debt, US government securities,
sovereign debt, mortgages and mortgage-backed securities, and municipal bonds.
The Company is also an active market-maker and conducts block trading activities
in both the listed and over-the-counter equity markets. In connection with these
activities, the Company may be required to maintain significant inventories in
order to ensure availability and to facilitate customer order flow. The Company
is also engaged as a dealer in over-the-counter derivatives, and accordingly
enters into transactions such as interest rate and cross-currency swaps,
over-the-counter swaps and options on foreign currencies and equity swaps and
options as part of its customer and proprietary trading activities. In
connection with these activities the Company attempts to mitigate its exposure
to such market risk by entering into hedging transactions which may include
over-the-counter derivative contracts or the purchase or sale of securities,
financial futures, options on futures or forward contracts.
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 options transactions, which seek to capture differences between the
expected and actual volatility of the underlying instrument. The Company
attempts to mitigate its exposure to market risk with respect to these
activities by entering into hedging transactions.
Following is a discussion of the Company's primary market risk
exposures as of June 30, 1997, including a discussion of how those exposures are
currently managed.
Interest Rate Risk
Interest rate risk is a consequence of maintaining inventory positions and
trading in interest rate sensitive financial instruments. In connection with the
Company's dealer and arbitrage activities, including market-making in
over-the-counter derivative contracts, the Company exposes itself to interest
rate risk, arising from changes in the level or volatility of interest rates,
mortgage prepayment speeds or the shape and slope of the yield curve. The
Company's corporate bond activities also expose it to the risk of loss related
to changes in credit spreads. Credit spread risk arises from the potential that
changes in an issuer's credit rating or credit perception affect the value of
financial instruments. Credit risk resulting from default on counterparty
obligations is discussed in the credit risk section. The Company attempts to
hedge its exposure to interest rate risk by entering into transactions such as
interest rate swaps, options, eurodollar and US government securities and
futures and forward contracts designed to reduce the Company's risk profile.
Foreign Exchange Rate Risk
Foreign exchange rate risk arises from the possibility that changes in foreign
exchange rates will impact the value of financial instruments. When the Company
buys or sells a foreign currency or a financial instrument denominated in a
currency other than US dollars, exposure exists from a net open currency
position. Until the position is covered by selling or buying an equivalent
amount of the same currency or by entering into a financing arrangement
denominated in the same currency, the Company is exposed to a risk that the
exchange rate may move against it. The principal currencies creating foreign
currency risk for the Company were the German deutsche mark and the Japanese
yen. The Company hedges the risk arising from its foreign exchange activities
primarily through the use of currency swaps, options, forwards and futures.
Equity Price Risk
The Company is exposed to equity price risk as a consequence of making markets
in equity securities and equity derivatives. Equity price risk results from
changes in the level or volatility of equity prices which affect the value of
equity securities or instruments that derive their value from a particular
stock, a basket of stocks or a stock index. The Company attempts to reduce the
risk of loss inherent in its inventory in equity securities by entering into
hedging transactions, including equity options, designed to mitigate the
Company's market risk profile.
43
RISK MANAGEMENT
Value at Risk
The estimation of potential losses that could arise from changes in market
conditions is typically accomplished through the use of statistical models which
seek to predict risk of loss based on historical price and volatility patterns.
Such statistical models are commonly known as value at risk. Value at risk is
used to describe a probabilistic approach to measuring the exposure to market
risk. This approach utilizes statistical concepts to estimate the probability of
the value of a financial instrument falling above or below a specified amount.
The calculation utilizes the standard deviation of historical changes in value
of the market risk sensitive financial instruments (i.e., volatility) to
estimate the amount of change in the current value that could occur at a
specified probability level.
Measuring market risk using statistical risk management models has
recently become the main focus of risk management efforts by many companies
whose earnings are significantly exposed to changes in the fair value of
financial instruments. The Company believes that statistical models alone do not
provide a reliable method of monitoring and controlling risk. While value at
risk models are relatively sophisticated, the quantitative risk information
generated is limited by the parameters established in creating the related
models. The financial instruments being evaluated may have features which may
trigger a potential loss in excess of the amounts previously disclosed if the
changes in market rates or prices exceed the confidence level of the model used.
Therefore, such models do not substitute for the experience or judgment of
senior management and traders, who have extensive knowledge of the markets and
adjust positions and revise strategies as they deem necessary. The Company uses
these models only as a supplement to other risk management tools.
For purposes of new Securities and Exchange Commission disclosure
requirements, the Company has performed an entity-wide value at risk analysis of
virtually all of the Company's financial assets and liabilities, including all
reported financial instruments owned and sold, repurchase and resale agreements,
and funding assets and liabilities. The value at risk related to non-trading
financial instruments has been included in this analysis and not reported
separately because the amounts were not material. The calculation is based on a
methodology which uses a one-day interval and a 95% confidence level. Interest
rate and foreign exchange rate risk use a Monte Carlo value at risk approach.
For interest rates, each country's yield curve has five factors which describe
possible curve movements. These were generated from principal component
analysis. In addition, volatility and spread risk factors were used, where
appropriate. Inter-country correlations were also used. Equity price risk was
measured using a historical value at risk. Equity derivatives were treated as
correlated with various indices, of which the Company used forty. Parameter
estimates, such as volatilities and correlations, were based on daily tests
through June 30, 1997.
This table illustrates the value at risk for each component of market
risk as of June 30, 1997:
In millions
-------------------------------------------------------
Market Risk
Interest rate $ 11.6
Currency 3.2
Equity 8.9
-------------------------------------------------------
44
RISK MANAGEMENT
As previously discussed, the Company utilizes a wide variety of market risk
management methods, including: limits for each trading activity; marking all
positions to market on a daily basis; daily profit and loss statements; position
reports; aged inventory position reports; and independent verification of all
inventory pricing. Additionally, trading department management reports
positions, profits and losses, and trading strategies to the Risk Committee on a
weekly basis. The Company believes that these procedures, which stress timely
communication between trading department management and senior management, are
the most important elements of the risk management process.
Efforts to further strengthen the Company's management of market risk
are continuous, and the enhancement of risk management systems is a priority of
the Company. This includes the development of quantitative methods, profit and
loss and variance reports, and the review and approval of pricing models.
The chart below represents a summary of the daily revenues generated
by the Company's trading departments and reflects a combination of trading
revenues, net interest revenues for certain trading areas and other revenues for
the year ended June 30, 1997. This chart represents a historical summary of the
results generated by the Company's trading departments, as opposed to the
probability approach used by the value at risk model. The average daily trading
profit was $6.2 million for fiscal 1997. The range of daily trading profit
volatility reflects the Company's historical ability to manage its exposure to
market risk and the diversified nature of its trading activities.
DAILY TRADING PROFIT FREQUENCY DISTRIBUTION
[The following is a tabular version of a bar graph included in the
paper version of the Annual Report]
FREQUENCY INTERVALS
(Number of Days) (Daily Trading Profit Volatility)
---------------- ---------------------------------
0 (5,000,000)
0 (4,000,000)
1 (3,000,000)
0 (2,000,000)
2 (1,000,000)
6 0
2 1,000,000
13 2,000,000
16 3,000,000
21 4,000,000
30 5,000,000
20 6,000,000
18 7,000,000
28 8,000,000
22 9,000,000
15 10,000,000
9 11,000,000
13 12,000,000
7 13,000,000
5 14,000,000
6 15,000,000
7 16,000,000
5 17,000,000
0 18,000,000
0 19,000,000
7 greater than or equal to 20,000,000
45
RISK MANAGEMENT
Credit Risk
Credit risk arises from the potential inability of counterparties to perform on
an obligation in accordance with the terms of the contract. The Company is
exposed to credit risk in various capacities: as counterparty in financial
contracts; as direct lender; as holder of securities; and as member of exchanges
and clearing organizations. The Company accepts credit risk whenever a
counterparty is obligated to perform under a contract. As a lender, the Company
is exposed to the risk of nonpayment of interest or principal by the borrower.
As a holder of securities, the Company is exposed to default by the issuer or to
the possibility of market price deterioration. The Company has established
policies and procedures to manage credit risk.
The Credit Policy Committee has full authority to rule on all credit
issues. The Credit Policy Committee establishes credit limits for the Global
Credit Committee and Global Credit Department, approves exposure measurement
standards and sets documentation and credit support policies. The Global Credit
Committee implements the policies established by the Credit Policy Committee on
an individual counterparty level. The credit risk management functions of the
Company are administered in four departments: Global Credit; Margin; Risk
Management and Correspondent Clearing (Specialist Clearance).
The Global Credit Department is responsible for approving, monitoring
and controlling extensions of credit to counterparties of the Company. The
department's function is to assess the creditworthiness of the Company's
counterparties, to assign credit limits and credit requirements, to assess the
quality and acceptability of collateral, to monitor compliance with these credit
limits, to obtain adequate legal documentation and to carry out the directives
of the Global Credit Committee.
The Company measures and monitors credit risk depending upon the
nature of the financial instrument creating the credit exposure. For products
other than derivatives, credit risk is controlled by the Global Credit
Department on the basis of notional amounts and the terms of the contract. The
Global Credit Department's oversight of the credit risk associated with
derivative products includes the measurement of the replacement cost of the
position in addition to any estimates of potential future exposure as a result
of market changes. The gross replacement cost of a derivative position is the
positive mark-to-market value of the transaction without taking into account the
effects of netting or collateralized arrangements.
Master netting agreements and various enhancements such as collateral
are used to reduce counterparty credit risk. The credit exposures reflect these
risk-reducing features to the extent they are legally enforceable. The Company's
net replacement cost of derivative contracts in a gain position at June 30, 1997
and 1996 was $540.8 million and $276.8 million, respectively. Exchange-traded
financial instruments are guaranteed by the clearing organization and have
minimal credit risk due to margin requirements.
The Global Credit Department establishes three classes of derivatives
credit limits: unsecured, mark-to-market and initial margin. Derivatives
operations monitors the counterparty's designated credit requirements.
Unsecured credit limits are available to certain investment-grade
quality clients who will post no collateral to support their derivatives
contracts. The Company measures credit risk arising from derivative contracts
with unsecured counterparties using a value at risk approach. A statistical
estimate of potential exposure is applied against unsecured derivatives credit
limits. The statistical models used by the Company project the highest
replacement cost during the life of the contracts all but 2.3% of the time. The
Global Credit Department's determination of the size and tenor of a
counterparty's credit line includes an assessment of credit ratings and tangible
equity amounts. The Global Credit Department establishes internal ratings for
unrated counterparties based on the quality and size of the counterparty as well
as the countries in which they operate, among other criteria.
46
RISK MANAGEMENT
Mark-to-market derivatives credit limits are for clients posting no
initial margin but posting collateral once the replacement cost of the contract
reaches a specified threshold of either potential exposure estimates or
replacement costs which trigger calls for collateral by the Company. Exposure
thresholds are based on the investment grade of the counterparty.
Initial margin credit limits are for those posting collateral at the
onset of the contract in addition to marking-to-market as the replacement cost
changes, subject to a minimum call level. Since potential exposures net of
posted collateral are minimal, the Company monitors risk based on the amount of
collateral required from the counterparty.
The Margin Department is responsible for evaluating the risk of
extending to the Company's customers loans secured by certain marketable
securities. The Margin Department evaluates the creditworthiness of the borrower
as well as the acceptability of collateral.
The Risk Management Department is responsible for monitoring the
market risk of the Company's proprietary positions. As part of its duties, the
group evaluates the credit quality of securities positions held in inventory in
order to quantify and limit the risk to the Company of issuer default or changes
in credit spreads.
The Risk Department of the Specialist Clearance function is
responsible for extensions of credit to correspondents (broker dealers and other
professional investors) and their customers. The department uses sophisticated
computer simulations to project adverse moves in the value of certain
correspondents' or their customers' assets held by the Company on an individual
security basis and portfolio basis. These daily simulations value the positions
assuming a minimum adverse move for portfolios of 20% and individual securities
of 25%. In some cases, these percentages are considerably higher depending on a
portfolio's or instrument's market value, volatility and liquidity.
Operating Risk
Operating risk is the potential for loss arising from limitations in the
Company's financial systems and controls, deficiencies in legal documentation
and the execution of legal and fiduciary responsibilities, deficiencies in
technology and the risk of loss attributable to operational problems. These
risks are less direct than credit and market risk, but managing them is
critical, particularly in a rapidly changing environment with increasing
transaction volumes. In order to reduce or mitigate these risks, the Company has
established and maintains an effective internal control environment which
incorporates various control mechanisms at different levels throughout the
organization and within such departments as Finance and Accounting, Operations,
Legal and Internal Audit. These control mechanisms are designed to ensure that
operational policies and procedures are being followed and that the Company's
various businesses are operating within established corporate policies and
limits.
Management has established and maintains an effective internal control
structure over financial reporting, the primary goal of which is to ensure that
policies and procedures have been established regarding authorization, access to
assets and asset accountability. This provides a high degree of assurance that
assets are acquired and safeguarded, and that liabilities are incurred and
discharged, in accordance with management's decisions. In addition, an effective
internal control structure ensures that financial information is accurately
maintained on the books. The Company also has effective risk controls in place
to ensure that operational functions such as transaction initiation, transaction
processing and settlement/clearance are functioning properly.
The Company has invested heavily in technology over the years in order
to have the ability to gather and process information efficiently and to handle
the wide variety of products and services the Company offers. In addition, our
investment in technology allows us to communicate information efficiently and
securely to our customers and to groups within the Company.
The Company has policies and procedures in place related to contract
administration, which includes ensuring that contract files are properly
maintained and that International Swap Dealers Association master netting
agreements, which provide protection in the event of counterparty default, are
obtained.
The Operations Committee, together with the Management and
Compensation Committee, has oversight responsibilities for all operational and
other matters that affect the Company's day-to-day activities. These committees
also review new products/businesses and ensure that policies and procedures are
established and in place prior to doing business.
47
The Bear Stearns Companies Inc.
CONSOLIDATED STATEMENTS OF INCOME
Fiscal Year Ended Fiscal Year Ended Fiscal Year Ended
June 30, June 30, June 30,
In thousands, except share data 1997 1996 1995
===========================================================================================================================
REVENUES
Commissions $ 732,343 $ 686,548 $ 546,939
Principal transactions 1,571,332 1,239,697 842,575
Investment banking 663,249 607,338 348,886
Interest and dividends 3,058,452 2,393,266 1,987,297
Other income 51,902 37,014 27,875
-------------------------------------------------------------------------------------------------------------------
Total revenues 6,077,278 4,963,863 3,753,572
Interest expense 2,551,364 1,981,171 1,678,515
-------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 3,525,914 2,982,692 2,075,057
-------------------------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSES
Employee compensation and benefits 1,726,931 1,469,448 1,080,487
Floor brokerage, exchange and clearance fees 141,211 129,509 109,040
Communications 102,926 92,827 85,711
Occupancy 88,419 85,899 83,247
Depreciation and amortization 89,719 69,878 59,274
Advertising and market development 69,765 56,797 57,036
Data processing 36,620 34,305 33,650
Other expenses 256,633 209,103 178,530
-------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 2,512,224 2,147,766 1,686,975
-------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 1,013,690 834,926 388,082
Provision for income taxes 400,360 344,288 147,471
-------------------------------------------------------------------------------------------------------------------
Net income $ 613,330 $ 490,638 $ 240,611
===================================================================================================================
Net income applicable to common shares $ 589,497 $ 466,145 $ 215,474
===================================================================================================================
Earnings per share $ 4.20 $ 3.27 $ 1.54
===================================================================================================================
Weighted average common and
common equivalent shares outstanding 147,847,885 148,855,048 147,755,982
===========================================================================================================================
See Notes to Consolidated Financial Statements.
48
The Bear Stearns Companies Inc.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, June 30,
In thousands, except share data 1997 1996
===========================================================================================================================
ASSETS
Cash and cash equivalents $ 1,249,132 $ 127,847
Cash and securities deposited with clearing organizations
or segregated in compliance with federal regulations 1,448,814 1,702,124
Securities purchased under agreements to resell 28,340,599 24,517,275
Securities borrowed 40,711,280 29,611,207
Receivables:
Customers 8,572,521 7,976,373
Brokers, dealers and others 1,227,947 811,391
Interest and dividends 405,892 305,725
Financial instruments owned, at fair value 38,437,280 26,222,134
Property, equipment and leasehold improvements, net of accumulated
depreciation and amortization of $415,681 and $318,657
in 1997 and 1996, respectively 379,533 331,924
Other assets 660,537 479,157
-------------------------------------------------------------------------------------------------------------------
Total Assets $ 121,433,535 $ 92,085,157
===================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings $ 14,416,671 $ 9,867,619
Securities sold under agreements to repurchase 39,431,216 33,353,899
Payables:
Customers 29,921,386 21,905,015
Brokers, dealers and others 2,808,359 1,847,599
Interest and dividends 452,662 448,121
Financial instruments sold, but not yet purchased, at fair value 20,784,796 13,916,581
Accrued employee compensation and benefits 907,337 712,962
Other liabilities and accrued expenses 964,409 1,094,333
-------------------------------------------------------------------------------------------------------------------
109,686,836 83,146,129
-------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Long-term borrowings 8,120,328 6,043,614
-------------------------------------------------------------------------------------------------------------------
Guaranteed Preferred Beneficial Interests in Company Subordinated
Debt Securities 200,000
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;
167,784,941 shares and 159,803,764 shares issued in 1997 and 1996,
respectively 167,785 159,804
Paid-in capital 1,874,016 1,696,217
Retained earnings 1,031,736 694,108
Capital Accumulation Plan 655,007 471,191
Treasury Stock, at cost
Adjustable Rate Cumulative Preferred Stock, Series A:
2,520,750 shares and 2,341,350 shares in 1997 and 1996,
respectively (103,421) (95,389)
Common Stock: 50,191,531 shares and 41,664,729 shares in 1997
and 1996, respectively (772,551) (598,217)
Note receivable from ESOP trust (13,701) (19,800)
-------------------------------------------------------------------------------------------------------------------
Total Stockholders' Equity 3,276,371 2,745,414
-------------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 121,433,535 $ 92,085,157
===================================================================================================================
See Notes to Consolidated Financial Statements.
49
The Bear Stearns Companies Inc.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Treasury Stock
--------------------------
Adjustable Rate
Cumulative
Preferred Stock, Note
Common Capital Series A-$50 Common Receivable
In thousands, Preferred Stock Paid-In Retained Accumulation Liquidation Stock from ESOP
except share data Stock $1 Par Value Capital Earnings Plan Preference $1 Par Value Trust
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1994 $ 437,500 $ 144,965 $1,447,066 $ 388,685 $ 275,415 $ (85,507) $(410,882) $ (30,676)
Net income 240,611
Cash dividends declared
Common ($0.60 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
Allocation under Capital
Accumulation Plan 87,560
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1995 437,500 152,203 1,557,237 430,330 344,338 (85,507) (458,193) (25,447)
Net income 490,638
Cash dividends declared
Common ($0.60 per share) (70,293)
Preferred (24,493)
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
Allocation under Capital
Accumulation Plan 181,702
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1996 $ 437,500 $ 159,804 $1,696,217 $ 694,108 $ 471,191 $ (95,389) $ (598,217) $ (19,800)
- ------------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
50
Treasury Stock
--------------------------
Adjustable Rate
Cumulative
Preferred Stock, Note
Common Capital Series A-$50 Common Receivable
In thousands, Preferred Stock Paid-In Retained Accumulation Liquidation Stock from ESOP
except share data Stock $1 Par Value Capital Earnings Plan Preference $1 Par Value Trust
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1996 $ 437,500 $ 159,804 $1,696,217 $694,108 $ 471,191 $ (95,389) $(598,217) $ (19,800)
Net income 613,330
Cash dividends declared
Common ($0.60 per share) (69,928)
Preferred (23,890)
Purchase of Treasury Stock
Adjustable Rate Cumulative
Preferred Stock, Series A
(179,400 shares) (8,032)
Common Stock
(7,230,103 shares) (186,742)
Common Stock issued out
of treasury (745,399 shares) 350 (12,298) 12,408
Income tax benefits attributable
to Common Stock issued
out of treasury 3,546
5% stock dividend
(7,981,177 shares) 7,981 173,903 (181,884)
Note repayment from ESOP Trust 6,099
Allocation under Capital
Accumulation Plan 196,114
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1997 $ 437,500 $ 167,785 $1,874,016 $1,031,736 $ 655,007 $(103,421) $(772,551) $ (13,701)
====================================================================================================================================
See Notes to Consolidated Financial Statements.
51
The Bear Stearns Companies Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Year Ended Fiscal Year Ended Fiscal Year Ended
June 30, June 30, June 30,
In thousands 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 613,330 $ 490,638 $ 240,611
Adjustments to reconcile net income to cash used in operating
activities:
Depreciation and amortization 89,719 69,878 59,274
Deferred income taxes (101,859) (189) (11,488)
Other 73,699 61,474 28,351
Decreases (increases) in operating receivables:
Cash and securities deposited with clearing organizations or
segregated in compliance with federal regulations 253,310 (392,551) 1,680,375
Securities purchased under agreements to resell (3,823,324) (5,576,531) 575,020
Securities borrowed (11,100,073) (4,979,119) (3,558,880)
Receivables:
Customers (596,148) (1,982,601) 1,272,837
Brokers, dealers and others (416,556) (232,715) 401,776
Financial instruments owned (12,215,146) (4,712,636) (7,065,580)
Other assets (80,975) (67,439) (85,858)
Increases (decreases) in operating payables:
Securities sold under agreements to repurchase 6,077,317 3,769,175 2,721,602
Payables:
Customers 8,016,371 5,668,404 (151,321)
Brokers, dealers and others 968,282 675,016 330,678
Financial instruments sold, but not yet purchased 6,868,215 2,675,463 2,889,860
Accrued employee compensation and benefits 137,967 207,023 (146,346)
Other liabilities and accrued expenses (138,288) 773,208 (3,964)
-------------------------------------------------------------------------------------------------------------------
Cash used in operating activities (5,374,159) (3,553,502) (823,053)
-------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from short-term borrowings 4,549,052 1,296,842 710,466
Issuance of long-term borrowings 3,129,439 2,654,134 1,040,090
Net proceeds from issuance of subsidiary securities 199,884
Capital Accumulation Plan 196,114 181,702 87,560
Common Stock distributions 4,006 6,497 18,088
Note repayment from ESOP trust 6,099 5,647 5,229
Payments for:
Retirement of Senior Notes (1,062,844) (674,000) (400,300)
Treasury Stock purchases (202,296) (191,474) (70,373)
Cash dividends paid (93,784) (95,001) (92,642)
-------------------------------------------------------------------------------------------------------------------
Cash provided by financing activities 6,725,670 3,184,347 1,298,118
-------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold improvements (137,328) (88,935) (100,334)
Purchases of investment securities and other assets (108,480) (134,321) (1,172)
Proceeds from sale of investment securities and other assets 15,582 19,757 32,338
-------------------------------------------------------------------------------------------------------------------
Cash used in investing activities (230,226) (203,499) (69,168)
-------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 1,121,285 (572,654) 405,897
-------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, beginning of year 127,847 700,501 294,604
-------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 1,249,132 $ 127,847 $ 700,501
===================================================================================================================
Non-cash financing activities totaled $0, $7,522 and $2,250, for the
years ended June 30, 1997, 1996 and 1995, respectively.
See Notes to Consolidated Financial Statements.
52
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 consolidated financial statements at their
initial cost until such time as 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 to 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.
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 the
accrued interest thereon 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 allowing
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 to retrieve excess collateral from counterparties,
when deemed appropriate.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Securities borrowed and securities loaned are recorded based upon the
amount of cash collateral advanced or received. Securities borrowed transactions
facilitate the settlement process and 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
collateral. 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 excess collateral 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 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 subsidiaries file a consolidated federal income
tax return. The Company accounts for income taxes under the provisions of
Statement of Financial Accounting Standards ("SFAS") 109, "Accounting for Income
Taxes." 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 Stock and
Common Stock Equivalents outstanding during each period presented. Common Stock
Equivalents 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 Stock 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,
1997, 1996 and 1995. Income taxes paid totaled $478.4 million, $279.0 million
and $125.6 million for the fiscal years 1997, 1996 and 1995, respectively.
2 - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS 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 99.5% 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 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 such
as 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 and short-term maturities, in many cases overnight, and, accordingly, are
not materially affected by changes in interest rates.
The estimated fair value of the Company's long-term borrowings, based
upon market rates of interest available to the Company at June 30, 1997 for debt
obligations of similar maturity, was approximately $8.1 billion, which was less
than the aggregate carrying value by approximately $7.7 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
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.
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3 - FINANCIAL INSTRUMENTS
Financial instruments owned and financial instruments sold, but not yet
purchased consisting of the Company's proprietary trading and investment
accounts, at fair value, as of June 30, were as follows:
In thousands 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
FINANCIAL INSTRUMENTS OWNED:
US government and agency $ 13,275,828 $ 8,258,074
Other sovereign governments 1,847,691 656,699
Corporate equity 8,351,399 5,225,171
Convertible debt 2,928,800 3,267,399
Corporate debt 4,961,737 4,739,512
Derivative financial instruments 2,780,231 1,855,617
Mortgages and other mortgage-backed securities 3,745,779 1,796,322
Other 545,815 423,340
---------------------------------------------------------------------------------------------------------------
$ 38,437,280 $ 26,222,134
===============================================================================================================
- ----------------------------------------------------------------------------------------------------------------------
FINANCIAL INSTRUMENTS SOLD, BUT NOT YET PURCHASED:
US government and agency $ 8,695,621 $ 5,502,459
Other sovereign governments 1,479,278 964,808
Corporate equity 4,976,169 4,469,425
Corporate debt 1,099,700 877,576
Derivative financial instruments 4,412,986 2,088,621
Other 121,042 13,692
---------------------------------------------------------------------------------------------------------------
$ 20,784,796 $ 13,916,581
===============================================================================================================
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.
55
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.
Borrowings made under the Company's commercial paper programs were
$7.8 billion and $4.3 billion at June 30, 1997 and 1996, respectively. During
the fiscal years 1997 and 1996, the weighted average interest rates on such
borrowings were 5.47% and 5.66%, respectively. The weighted average rates at
June 30, 1997 and 1996 were 5.59% and 5.33%, respectively.
At June 30, 1997 and 1996, the Company had outstanding $5.7 billion
and $4.9 billion, respectively, principal amount of Medium-Term Notes maturing
from six to 18 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 fiscal years 1997 and 1996, the weighted average interest
rates on the Medium-Term Notes were 5.63% and 5.85%, respectively. The weighted
average rates at June 30, 1997 and 1996 were 5.84% and 5.55%, respectively.
At June 30, 1997 and 1996, the Company had outstanding $39.4 billion
and $33.4 billion of repurchase agreements. During the fiscal years 1997 and
1996, the weighted average interest rates on the repurchase agreements were
5.30% and 5.41%, respectively. The weighted average rates at June 30, 1997 and
1996 were 5.44% and 5.15%, respectively.
Short-term borrowings at June 30, 1997 and 1996 included $920.5
million and $651.1 million, respectively, of bank loans. During the fiscal years
1997 and 1996, the weighted average interest rates on such bank loans were 5.36%
and 5.40%, respectively. The weighted average rates at June 30, 1997 and 1996
were 4.56 % and 5.33%, respectively.
5 - LONG-TERM BORROWINGS
Long-term borrowings at June 30 consisted of the following:
In thousands 1997 1996
- ---------------------------------------------------------------------------------------------------------------
Floating-Rate Notes due 1998 to 2030 $ 1,122,461 $ 924,129
Fixed-Rate Senior Notes due 1998 to 2005;
interest rates ranging from 53\4% to 93\8% 3,068,453 2,568,696
Medium-Term Notes & Other 3,929,414 2,550,789
----------------------------------------------------------------------------------------------------------
Total long-term borrowings $ 8,120,328 $ 6,043,614
==========================================================================================================
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, 1997 and 1996, the weighted average effective
interest rates on the Floating-Rate Notes were 5.88% and 6.29%, respectively.
The weighted average effective interest rates on the Floating-Rate Notes at June
30, 1997 and 1996 were 6.06% and 5.85%, respectively.
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
Fixed-Rate Senior Notes during the fiscal years 1997 and 1996 were 6.21% and
6.45%, respectively. The weighted average effective interest rates on the
Company's Senior Notes at June 30, 1997 and 1996 were 6.22% and 6.01%,
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 fiscal years 1997 and 1996,
the weighted average interest rates on the Medium-Term Notes were 5.85% and
6.11%, respectively. The weighted average interest rates on the Company's
Medium-Term Notes at June 30, 1997 and 1996 were 6.02% and 5.81%, respectively.
Maturities of long-term borrowings at June 30, 1997 consisted of the following:
In thousands
- --------------------------------------------------------
FISCAL YEAR AMOUNT
----------- ------
1998 $1,576,734
1999 1,532,869
2000 1,059,431
2001 1,336,409
2002 532,074
Thereafter 2,082,811
---------------------------------------------
$8,120,328
========================================================
Instruments governing certain indebtedness of the Company contain
various covenants, the most restrictive of which require the maintenance of
minimum levels of stockholders' equity by the Company and Bear Stearns. At June
30, 1997, the Company and Bear Stearns 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 the following:
In thousands 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------
Current:
Federal $ 326,359 $ 212,686 $ 103,944
State and local 139,676 108,652 40,681
Foreign 36,184 23,139 14,334
---------------------------------------------------------------------------------------------------------------
Total current $ 502,219 $ 344,477 $ 158,959
---------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Deferred:
Federal $ (74,346) $ 2,596 $ (8,322)
State and local (27,513) (2,785) (3,166)
Total deferred (101,859) (189) (11,488)
---------------------------------------------------------------------------------------------------------------
Total provision for income taxes $ 400,360 $ 344,288 $ 147,471
===============================================================================================================
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Significant components of the Company's deferred tax assets (liabilities) as of
June 30 were as follows:
In thousands 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Deferred compensation $ 304,238 $ 214,484 $ 153,564
Valuation reserves 15,304 19,848 14,491
Liability reserves 93,631 57,199 23,663
Other 25,398 13,264 5,833
--------------------------------------------------------------------------------------------------------
Total deferred tax assets $ 438,571 $ 304,795 $ 197,551
--------------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Partnerships $(106,379) $ (82,314) $ (60,893)
Unrealized appreciation (117,616) (98,787) (4,864)
Depreciation (15,261) (19,026) (19,266)
Other (7,467) (14,679) (22,728)
--------------------------------------------------------------------------------------------------------
Total deferred tax liabilities $(246,723) $(214,806) $(107,751)
--------------------------------------------------------------------------------------------------------
Net deferred tax asset $ 191,848 $ 89,989 $ 89,800
========================================================================================================
A reconciliation of the statutory federal income tax rates and the Company's
effective tax rates for the fiscal years ended June 30 were as follows:
1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------------------
Statutory rate 35.0% 35.0% 35.0%
State and local income taxes, net of federal benefit 6.9 8.5 6.3
Dividend exclusion (1.8) (1.9) (3.6)
Other, net (0.6) (0.4) 0.3
----------------------------------------------------------------------------------------------------------------------------
Effective tax rate 39.5% 41.2% 38.0%
============================================================================================================================
Not included in the reconciliation table reflected above are
approximately $3.5 million, $5.3 million and $4.7 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 1997, 1996 and 1995, respectively.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7 - REGULATORY REQUIREMENTS
Bear Stearns and BSSC, a subsidiary of Bear Stearns, are registered broker
dealers and, accordingly, are subject to Rule 15c3-1 under the Securities
Exchange Act of 1934 (the "Net Capital Rule") and the capital rules of the New
York Stock Exchange, Inc. ("NYSE") and other principal exchanges of which Bear
Stearns and BSSC are members. 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, 1997, Bear Stearns' net capital, as
defined, of $1.43 billion exceeded the minimum requirement by $1.40 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.
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, 1997, approximately $1.9 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 5.63% during the year ended June 30, 1997.
During the year ended June 30, 1997, the Company repurchased 179,400 shares at a
cost of approximately $8.0 million. At June 30, 1997, the Company held 2,520,750
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 Subsidiaries
Bear Stearns Finance LLC ("BSF"), a wholly owned subsidiary of the Company, has
outstanding $150.0 million 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 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.
In January 1997, Bear Stearns Capital Trust I (the "Trust"), a wholly
owned subsidiary of the Company, issued $200.0 million of Guaranteed Preferred
Beneficial Interests in Company Subordinated Debt Securities (the "Capital
Securities"). The Capital Securities are fixed/adjustable rate capital
securities which have a liquidation value of $1,000 per capital security.
Holders of the Capital Securities are entitled to receive semi-annual
preferential cumulative cash distributions at an annual rate of 7% through
January 2002. Thereafter the distributions will be at a variable rate
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
based on three-month LIBOR plus a margin of 1.75%. The proceeds of the issuance
of the Capital Securities were used to purchase fixed/adjustable rate junior
subordinated deferrable interest debentures (the "Subordinated Debentures")
issued by the Company. The Subordinated Debentures are the sole assets of the
Trust. The Subordinated Debentures will mature on January 15, 2007. The interest
rate on the Subordinated Debentures is the same as the rate on the Capital
Securities. The Company's guarantee of the Capital Securities, considered
together with the other obligations of the Company with respect to Capital
Securities, constitutes a full and unconditional guarantee by the Company of the
Trust's obligation under the Capital Securities issued by the Trust.
9 - EMPLOYEE BENEFIT PLANS
The Company has a qualified non-contributory 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, 1997, 1996 and 1995 was $12.5 million, $11.1
million, and $4.5 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, 1997, 1996 and 1995 was $9.4 million, $7.2 million and $4.5
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, 1997, 1996 and 1995 was
$5.9 million, $6.2 million and $6.0 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, 1997, 1996 and 1995, participants
deferred compensation of approximately $191.8 million, $139.7 million and $71.8
million, respectively. During the years ended June 30, 1997, 1996 and 1995, the
Company recognized expense of approximately $56.4 million, $36.7 million and
$20.9 million, respectively, attributable to CAP Units or cash credited to
participants' deferred compensation accounts with respect to earnings
adjustments. As of July 1, 1997, pursuant to the terms of the CAP Plan,
7,494,518 CAP Units were credited to participants' deferred compensation
accounts with respect to the deferrals and earnings made during fiscal year
1997. In addition, $50.8 million which represented the balance of the deferral
was credited to the participants' deferred compensation cash accounts. The
aggregate number of shares of Common Stock distributable pursuant to the
Company's obligation for CAP Units at June 30, 1997, 1996 and 1995 was
approximately 34.0 million, 27.2 million and 22.2 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.
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 risk, which
includes interest rate, exchange rate, equity price and commodity price risk.
SFAS 119, "Disclosure about Derivative Financial Instruments and Fair Value of
Financial Instruments," defines a derivative as a future, forward, swap or
option contract, or other financial instrument with similar characteristics such
as caps, floors and collars. Generally these financial instruments represent
future commitments to exchange interest payment streams or currencies or to
purchase or 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 by reporting categories, including
derivatives, for the fiscal years ended June 30, were as follows:
In thousands 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------
Fixed income $ 919,604 $ 677,475 $ 473,704
Equity 393,875 389,898 306,326
Foreign exchange and other derivative
financial instruments 257,853 172,324 62,545
---------------------------------------------------------------------------------------------------------------
Total principal transactions $ 1,571,332 $ 1,239,697 $ 842,575
===============================================================================================================
61
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 generally are not
actually paid or received, with the exception of currency swaps and foreign
exchange and mortgage-backed securities forwards. The notional/contract amounts
of financial instruments that give rise to off-balance-sheet market risk are
indicative only of the extent of involvement in the particular class of
financial instrument and are not necessarily an indication of overall market
risk.
The following table represents the notional/contract amounts of the Company's
outstanding derivative financial instruments as of June 30:
In billions 1997 1996
- -----------------------------------------------------------------------------------------------------------------
Interest Rate:
-----------------------------------------------------------------------------------------------------------
Swap agreements, including options, swaptions, caps, collars and floors $ 208.3 $ 175.2
Futures contracts 34.3 60.5
Options held 4.0 3.0
Options written 0.7 3.1
Foreign Exchange:
Futures contracts 19.9 2.3
Forward contracts 13.6 7.9
Options held 10.0 3.2
Options written 9.4 3.3
Mortgage-Backed Securities:
Forward contracts 40.5 23.0
Equity:
Swap agreements 6.0 3.8
Futures contracts 0.6 0.5
Options held 2.8 1.1
Options written 2.9 1.3
-----------------------------------------------------------------------------------------------------------
62
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 recorded at fair value on a daily basis with
the resulting unrealized gains or losses recorded in the Consolidated Statements
of Financial Condition and the related income or loss reflected in revenues
derived from principal transactions.
The fair values of derivative financial instruments held or issued for trading
purposes as of June 30 were as follows:
1997 1996
---------------------------------- -------------------------------
In millions Assets Liabilities Assets Liabilities
- -----------------------------------------------------------------------------------------------------------------------------------
Swap agreements $ 730 $ 1,250 $ 678 $ 846
Futures and forward contracts 172 248 280 307
Options held 1,880 897
Options written 2,927 968
The average monthly fair values of the derivative financial instruments for the
fiscal years ended June 30 were as follows:
1997 1996
------------------------------- --------------------------------
In millions Assets Liabilities Assets Liabilities
- -----------------------------------------------------------------------------------------------------------------------------------
Swap agreements $ 734 $ 1,029 $ 611 $ 698
Futures and forward contracts 245 218 286 275
Options held 1,120 704
Options written 1,657 795
The majority of the Company's transactions with off-balance-sheet risk are
short-term in duration with a weighted average maturity of approximately 2.99
years and 2.22 years at June 30, 1997 and 1996, respectively. The maturities for
notional/contract amounts outstanding for derivative financial instruments as of
June 30, 1997 were as follows:
Less than 1 to 3 3 to 5 Greater than
In billions 1 Year Years Years 5 Years Total
- -----------------------------------------------------------------------------------------------------------------------------------
Swap agreements $ 43.3 $ 65.4 $ 53.4 $ 52.2 $ 214.3
Futures contracts 42.7 10.3 1.7 0.1 54.8
Forward contracts 54.1 54.1
Options held 14.6 0.2 1.7 0.3 16.8
Options written 10.9 0.1 1.7 0.3 13.0
-------------------------------------------------------------------------------------------------------------------
Total $ 165.6 $ 76.0 $ 58.5 $ 52.9 $ 353.0
Percent of total 46.9% 21.5% 16.6% 15.0% 100%
===================================================================================================================
63
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.
The following table summarizes the credit quality of the Company's
trading-related derivatives by showing counterparty credit ratings for the
replacement cost of contracts in a gain position, net of $462.1 million and
$414.8 million of collateral, respectively, at June 30, 1997 and 1996:
In millions 1997 1996
- ---------------------------------------------------------------------
RATING(1) NET REPLACEMENT COST
AAA $ 92.4 $ 48.0
AA 201.7 86.1
A 152.9 93.2
BBB 40.6 25.6
BB and Lower 16.5 2.6
Non-rated 36.7 21.3
- ---------------------------------------------------------------------
(1) Rating Agency Equivalent
Customer Activities
The Company's clearance activities for both clearing clients and customers
involve the execution, settlement and financing of customers' securities and
commodities transactions. Customers' securities activities are transacted on
either a cash or margin basis, while customers' commodities transactions are
generally transacted on a margin basis subject to individual exchange
regulations. In connection with these activities, the Company executes and
clears customers' transactions involving the sale of borrowed securities
("short sales") and the writing of option contracts. These transactions may
expose the Company to off-balance-sheet risk in the event that customers are
unable to fulfill their contractual obligations and customers' margin deposits
are insufficient to fully cover their losses. In the event the customers fail to
satisfy their obligations, the Company may be required to purchase or sell
financial instruments at prevailing market prices in order to fulfill the
customers' obligations.
The Company seeks to control the risks associated with its customers'
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, may require customers to
deposit additional cash or collateral, or to reduce positions, when deemed
necessary. The Company also establishes credit limits for customers engaged in
commodity activities that are monitored daily. Additionally, with respect to
the Company's correspondent clearing activities, introducing correspondent firms
are required to guarantee the contractual obligations of their customers.
The Company's customer-financing and securities-settlement activities
may require the Company to pledge customers' securities as collateral to satisfy
exchange margin deposit requirements or to support various secured-financing
sources such as bank loans, securities loaned and repurchase agreements. In the
event the counterparties are unable to meet their contractual obligations 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 customers' obligations. The Company seeks to control this risk by
monitoring the market value of securities pledged on a daily basis and by
requiring adjustments of collateral levels in the event of excess market
exposure. Moreover, the Company establishes credit limits for such activities
and monitors credit compliance daily.
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Concentrations of Credit Risk
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 individual and institutional investors. A
substantial portion of the Company's transactions are collateralized and are
executed with, or made 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 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 customers' ability to satisfy their obligations to the Company. The
Company attempts to minimize credit risk associated with these activities by
monitoring customers' credit exposure and collateral values on a daily basis and
by requiring additional collateral to be deposited with or returned to the
Company. A significant portion of the Company's securities processing activities
includes clearing transactions for hedge funds, specialists, market-makers, risk
arbitrageurs and other professional traders. Due to the nature of their
operations, which may include a significant level of margin activity, short
selling and option writing, the Company may have significant credit exposure
should these customers be unable 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. Additional collateral
is requested when necessary. To further control this risk, the Company has
developed computerized risk control systems which analyze customers' sensitivity
to major market movements. When deemed necessary, the Company will require the
customers to deposit additional margin collateral, or reduce positions, if it is
determined that the customers' 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 primarily based on LIBOR, in order to convert
fixed-rate interest payments on its debt obligations into variable-rate
payments. 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, 1997 and 1996, the Company had outstanding interest rate
and currency swap agreements with a notional principal amount of $7.9 billion
and $6.0 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 $29.4 million, $15.9 million and $21.1 million for the fiscal
years ended June 30, 1997, 1996 and 1995, 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. In addition, in September 1997, the Company entered into a 99-year ground
lease at 383 Madison Avenue, New York City, pursuant to which an office tower
will be developed and built. The site will serve as the new worldwide
headquarters and will be completed by the expiration of the current lease at 245
Park Avenue. At June 30, 1997, future minimum aggregate annual rentals payable
under these noncancelable leases (net of subleases), including 383 Madison
Avenue, were as follows:
In thousands
-----------------------------------------------------
FISCAL YEAR
-----------
1998 65,069
1999 62,519
2000 143,823
2001 54,477
2002 52,162
Aggregate amount thereafter 238,615
-----------------------------------------------------
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The various leases contain provisions for periodic escalations to the
extent of increased operating and other costs. Rental expense, including
escalations, under these leases was $79.5 million, $77.0 million, and $73.8
million, for the years ended June 30, 1997, 1996 and 1995, respectively.
Letters of Credit
At June 30, 1997, the Company was contingently liable for unsecured letters of
credit of $2.5 billion and letters of credit of $78.0 million secured by
financial instruments which are principally used as deposits for securities
borrowed and for satisfying margin deposits at option and commodity exchanges.
Borrow Versus Pledge
At June 30, 1997, US government and agency securities with a market value of
approximately $5.7 billion had been pledged against borrowed securities with an
approximate market value of $5.6 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 lawsuits 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
SFAS 14. Information regarding the Company's operations for the fiscal years
ended June 30 is as follows:
In thousands 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
Foreign revenues $ 535,275 $ 460,055 $ 252,825
Domestic revenues 5,542,003 4,503,808 3,500,747
------------------------------------------------------------------------------------------------------------------
Consolidated revenues $ 6,077,278 $ 4,963,863 $ 3,753,572
==================================================================================================================
Foreign income before provision for income taxes $ 28,790 $ 53,470 $ 3,147
Domestic income before provision for income taxes 984,900 781,456 384,935
------------------------------------------------------------------------------------------------------------------
Consolidated income before provision for income taxes $ 1,013,690 $ 834,926 $ 388,082
==================================================================================================================
Foreign assets $ 22,148,655 $ 17,219,879 $ 10,428,506
Domestic assets 99,284,880 74,865,278 64,168,654
------------------------------------------------------------------------------------------------------------------
Consolidated assets $ 121,433,535 $ 92,085,157 $ 74,597,160
==================================================================================================================
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.
66
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, 1997
Revenues $ 1,236,153 $ 1,556,530 $ 1,511,301 $ 1,773,294 $ 6,077,278
------------------------------------------------------------------------------------------------------------------
Interest expense 547,469 616,396 576,836 810,663 2,551,364
------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 688,684 940,134 934,465 962,631 3,525,914
Non-interest expenses
Employee compensation and benefits 344,372 456,825 464,596 461,138 1,726,931
Other 165,795 192,754 194,094 232,650 785,293
------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 510,167 649,579 658,690 693,788 2,512,224
------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 178,517 290,555 275,775 268,843 1,013,690
Provision for income taxes 70,068 114,043 110,294 105,955 400,360
------------------------------------------------------------------------------------------------------------------
Net income $ 108,449 $ 176,512 $ 165,481 $ 162,888 $ 613,330
==================================================================================================================
Earnings per share $ 0.70 $ 1.21 $ 1.14 $ 1.15 $ 4.20
==================================================================================================================
Cash dividends declared per common share $ 0.15 $ 0.15 $ 0.15 $ 0.15 $ 0.60
==================================================================================================================
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 $ 0.60 $ 0.69 $ 0.86 $ 1.12 $ 3.27
==================================================================================================================
Cash dividends declared per common share $ 0.15 $ 0.15 $ 0.15 $ 0.15 $ 0.60
==================================================================================================================
67
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, 1997 and
1996, 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,
1997. 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, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 1997 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
New York, New York
SEPTEMBER 2, 1997
68
The Bear Stearns Companies Inc.
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 February 28, 1997, and the cash
dividends declared on the Common Stock.
As of September 3, 1997, there were 3,085 holders of record of the
Company's Common Stock. On September 3, 1997, the last reported sales price
of the Company's Common Stock was $42 1\8.
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 under the caption "Regulatory Requirements" for a further
description.
Cash Dividends
Declared Per
High Low Common Share
====================================================================================================================
FISCAL YEAR ENDED JUNE 30, 1997
First Quarter (through September 27, 1996) $ 23 1\4 $ 19 3\4 $ 0.15
Second Quarter (through December 31, 1996) 26 7\8 22 0.15
Third Quarter (through March 27, 1997) 32 3\8 25 5\8 0.15
Fourth Quarter (through June 30, 1997) 35 5\8 26 1\4 0.15
----------------------------------------------------------------------------------------------------
Cash Dividends
Declared Per
High Low Common Share
====================================================================================================================
FISCAL YEAR ENDED JUNE 30, 1996
First Quarter (through September 29, 1995) $ 20 7\8 $ 17 3\4 $ 0.15
Second Quarter (through December 31, 1995) 19 7\8 17 1\2 0.15
Third Quarter (through March 29, 1996) 23 17 1\4 0.15
Fourth Quarter (through June 30, 1996) 23 3\8 20 3\4 0.15
----------------------------------------------------------------------------------------------------
71