SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended August 25, 2000
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _____________ to ______________
Commission File Number 1-8989
THE BEAR STEARNS COMPANIES INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3286161
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
245 Park Avenue, New York, New York 10167
---------------------------------------------------
(Address of principal executive offices) (Zip Code)
(212) 272-2000
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of October 5, 2000, the latest practicable date, there were 106,722,503
shares of Common Stock, $1 par value, outstanding.
TABLE OF CONTENTS
-----------------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition at August 25, 2000
(Unaudited) and November 26, 1999 (Audited)
Consolidated Statements of Income (Unaudited) for the three-month
and nine-month periods ended August 25, 2000 and August 27, 1999
Consolidated Statements of Cash Flows (Unaudited) for the nine-month
periods ended August 25, 2000 and August 27, 1999
Notes to Consolidated Financial Statements (Unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
Signature
2
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
----------------------------------------------
ASSETS
AUGUST 25, NOVEMBER 26,
2000 1999
------------- -------------
(UNAUDITED)
(IN THOUSANDS)
Cash and cash equivalents $ 1,350,753 $ 1,570,483
Cash and securities deposited
with clearing organizations
or segregated in compliance
with federal regulations 1,154,615 1,188,788
Securities purchased under
agreements to resell 36,313,163 35,999,998
Receivable for securities
provided as collateral 1,702,219 2,571,404
Securities borrowed 63,382,318 60,429,297
Receivables:
Customers 21,075,549 16,839,040
Brokers, dealers and others 781,173 542,038
Interest and dividends 475,733 422,402
Financial instruments owned, at
fair value 45,513,097 40,764,802
Property, equipment and leasehold
improvements, net of accumulated
depreciation and amortization 530,956 504,040
Other assets 2,572,942 1,205,670
------------- -------------
Total Assets $ 174,852,518 $ 162,037,962
============= =============
See Notes to Consolidated Financial Statements.
3
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
----------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
AUGUST 25, NOVEMBER 26,
2000 1999
------------- -------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
Short-term borrowings $ 18,206,039 $ 13,424,201
Securities sold under
agreements to repurchase 62,228,387 53,323,109
Obligation to return
securities received as
collateral 2,620,720 3,999,229
Payables:
Customers 39,563,261 42,843,757
Brokers, dealers and others 4,141,223 5,596,577
Interest and dividends 652,633 532,023
Financial instruments sold,
but not yet purchased,
at fair value 20,473,903 19,704,921
Accrued employee compensation
and benefits 1,562,149 733,241
Other liabilities and accrued
expenses 635,730 527,565
------------- -------------
150,084,045 140,684,623
------------- -------------
Commitments and contingencies
Long-term borrowings 19,356,873 15,911,392
------------- -------------
Guaranteed Preferred Beneficial
Interests in Company
Subordinated Debt Securities 500,000 500,000
------------- -------------
Stockholders' Equity
Preferred Stock 800,000 800,000
Common Stock, $1.00 par value;
200,000,000 shares authorized;
184,805,848 shares issued at
August 25, 2000 and
November 26, 1999 184,806 184,806
Paid-in capital 2,520,714 2,509,801
Retained earnings 2,430,727 1,916,516
Capital Accumulation Plan 1,136,732 1,179,101
Treasury stock, at cost
Adjustable Rate Cumulative Preferred
Stock, Series A - 2,520,750 shares (103,421) (103,421)
Common Stock - 78,047,575 shares and
66,367,276 shares at August 25,
2000 and November 26, 1999,
respectively (2,057,958) (1,544,856)
------------- -------------
Total Stockholders' Equity 4,911,600 4,941,947
------------- -------------
Total Liabilities and Stockholders' Equity $ 174,852,518 $ 162,037,962
============= =============
See Notes to Consolidated Financial Statements.
4
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
---------------------------------
THREE-MONTHS ENDED NINE-MONTHS ENDED
---------------------------------- ----------------------------------
AUGUST 25, AUGUST 27, AUGUST 25, AUGUST 27,
2000 1999 2000 1999
---------------- --------------- --------------- ---------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Revenues
Commissions $ 262,042 $ 238,665 $ 894,143 $ 757,329
Principal transactions 528,202 496,549 1,689,737 1,778,636
Investment banking 236,897 266,031 780,945 746,464
Interest and dividends 1,353,628 1,011,518 4,138,265 2,894,846
Other income 35,236 29,255 104,632 74,246
---------------- --------------- --------------- ---------------
Total Revenues 2,416,005 2,042,018 7,607,722 6,251,521
Interest expense 1,144,527 846,429 3,508,872 2,416,272
---------------- --------------- --------------- ---------------
Revenues, net of interest expense 1,271,478 1,195,589 4,098,850 3,835,249
---------------- --------------- --------------- ---------------
Non-interest expenses
Employee compensation and benefits 663,999 602,200 2,087,182 1,905,947
Floor brokerage, exchange and clearance fees 35,820 37,019 111,690 111,870
Communications 39,931 37,237 125,047 110,904
Depreciation and amortization 37,472 36,213 112,978 103,455
Occupancy 26,909 26,804 79,441 83,009
Advertising and market development 32,531 23,814 91,779 72,148
Data processing and equipment 22,843 19,503 71,284 54,810
Other expenses 142,390 107,237 530,244 395,030
---------------- --------------- --------------- ---------------
Total non-interest expenses 1,001,895 890,027 3,209,645 2,837,173
---------------- --------------- --------------- ---------------
Income before provision for income taxes 269,583 305,562 889,205 998,076
Provision for income taxes 88,147 113,277 311,211 377,025
---------------- --------------- --------------- ---------------
Net income $ 181,436 $ 192,285 $ 577,994 (3) $ 621,051
================ =============== =============== ===============
Net income applicable to common shares $ 171,658 $ 182,507 $ 548,659 $ 591,716
================ =============== =============== ===============
Basic earnings per share (1) (2) $ 1.33 $ 1.19 $ 4.00 $ 4.02
================ =============== =============== ===============
Diluted earnings per share (1) (2) $ 1.32 $ 1.19 $ 4.00 $ 4.02
================ =============== =============== ===============
Weighted average common and common
equivalent shares outstanding (2):
Basic 148,816,237 165,365,835 152,967,377 164,796,954
================ =============== =============== ===============
Diluted 149,242,192 165,365,835 153,169,316 164,796,954
================ =============== =============== ===============
Cash dividends declared
per common share (2) $ 0.15 $ 0.14 $ 0.40(4) $ 0.43
================ =============== =============== ===============
<FN>
(1) Earnings per share is calculated based on net income reduced for preferred stock dividends and increased for costs related to
the Capital Accumulation Plan (the "CAP Plan"). The costs related to the CAP Plan are added back as the shares related to the CAP
Plan are included in weighted average common and common equivalent shares outstanding.
(2) Reflects all stock dividends declared through October 29, 1999.
(3) These results include an after tax-charge of $96.0 million, or 63 cents per share, attributable to increased litigation reserves
following the jury verdict in the Henryk de Kwiatkowski litigation.
(4) This cash dividend relates to the quarter ended December 31, 1999 ($.15), the two-month period ended February 25, 2000 ($.10,
declared to coincide with the Company's new quarterly periods resulting from the Company's change in fiscal year-end) and the
quarter ended May 26, 2000 ($.15).
</FN>
See Notes to Consolidated Financial Statements.
5
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
-------------------------------------
NINE-MONTHS ENDED
------------------------------------
AUGUST 25, AUGUST 27,
2000 1999
-------------- -------------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 577,994 $ 621,051
Adjustments to reconcile net income to
cash used in operating activities:
Depreciation and amortization 112,978 103,455
Deferred income taxes (165,837) (184,861)
Other (1,153) 124,921
(Increases) decreases in operating assets:
Cash and securities deposited with
clearing organizations or
segregated in compliance with
federal regulations 34,173 2,193,718
Securities purchased under agreements
to resell (313,165) (1,816,185)
Securities borrowed (2,953,021) (2,406,516)
Receivables:
Customers (4,236,509) (3,571,947)
Brokers, dealers and others (239,135) (116,234)
Financial instruments owned (5,257,619) 4,028,129
Other assets (1,038,877) 88,525
Increases (decreases) in operating
liabilities:
Securities sold under agreements to
repurchase 8,905,278 2,773
Payables:
Customers (3,280,496) (6,615,293)
Brokers, dealers and others (1,455,354) (190,602)
Financial instruments sold, but not
yet purchased 768,982 3,326,408
Accrued employee compensation and
benefits 717,508 (178,320)
Other liabilities and accrued expenses 260,149 (875,356)
------------- -------------
Cash used in operating activities (7,564,104) (5,466,334)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from short-term borrowings 4,781,838 1,131,452
Net proceeds from issuance of long-term
borrowings 7,444,453 4,213,179
Net proceeds from issuance of subsidiary
securities - 290,550
Redemption of Preferred Stock - (150,000)
Capital Accumulation Plan - 329,475
Tax benefit of Common Stock distributions 12,285 91,840
Note repayment from ESOP Trust - 7,114
Payments for:
Retirement of long-term borrowings (4,036,861) (1,992,164)
Treasury stock purchases (555,867) (358,346)
Cash dividends paid (73,562) (81,254)
------------- -------------
Cash provided by financing activities 7,572,286 3,481,846
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and
leasehold improvements (139,894) (127,418)
Purchases of investment securities and
other assets (142,012) (61,396)
Proceeds from sales of investment
securities and other assets 53,994 119,084
------------- -------------
Cash used in investing activities (227,912) (69,730)
------------- -------------
Net decrease in cash and cash equivalents (219,730) (2,054,218)
Cash and cash equivalents, beginning of
period 1,570,483 3,495,900
------------- -------------
Cash and cash equivalents, end of period $ 1,350,753 $ 1,441,682
============= =============
Statement of Financial Accounting Standards No. 125 requires balance sheet
recognition of collateral related to certain secured financing transactions,
which are non-cash activities and did not impact the Consolidated Statements of
Cash Flows.
See Notes to Consolidated Financial Statements.
6
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
------------------------------------------
1. BASIS OF PRESENTATION AND ACCOUNTING DEVELOPMENTS
The accompanying consolidated financial statements include the accounts of
The Bear Stearns Companies Inc. and its subsidiaries (the "Company"). All
material intercompany transactions and balances have been eliminated. The
Board of Directors declared 5% stock dividends on the Company's Common Stock
in January 1999 and October 1999. Earnings per share data for all periods
included in the consolidated financial statements reflect such 5% stock
dividends. Additionally, all information in the Notes to Consolidated
Financial Statements related to the five-month period ended November 26,
1999 is audited.
The consolidated financial statements reflect all adjustments which, in the
opinion of management, are normal and recurring and are necessary for a fair
statement of the results for the interim periods presented. The consolidated
financial statements are prepared in conformity with generally accepted
accounting principles which require management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates. The nature of the Company's business is such that the results of
any interim period may not be indicative of the results to be expected for
an entire fiscal year.
Accounting Changes and Developments
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities," which establishes
standards for accounting and reporting of derivative instruments, including
certain derivative instruments embedded in other contracts, and hedging
activities. SFAS No. 133 requires that all derivative instruments be
recorded on the balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as
part of a hedge transaction and, if it is, the type of hedge transaction.
For fair-value hedge transactions of assets, liabilities or firm
commitments, changes in the fair value of the derivative will generally be
offset by changes in fair value of the related hedged item. For cash-flow
hedge transactions, in which the Company is hedging the variability of cash
flows related to a variable-rate asset, liability, or a forecasted
transaction, changes in the fair value of the derivative instrument will be
reported in other comprehensive income. The gains and losses on the
derivative instrument that are reported in other comprehensive income will
be reclassified as earnings in the periods in which earnings are impacted by
the variability of the cash flows of the hedged item. The ineffective
portion of all hedges will be recognized in current-period earnings. In June
1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments
and Hedging Activities - Deferral of the Effective Date of FASB Statement
No. 133." SFAS No. 137 defers the effective date of SFAS No. 133 for one
7
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
------------------------------------------
1. BASIS OF PRESENTATION AND ACCOUNTING DEVELOPMENTS
(CONTINUED)
year to fiscal years beginning after June 15, 2000. In June 2000, the FASB
issued SFAS No. 138, "Accounting for Certain Derivative Instruments and
Certain Hedging Activities - an amendment of FASB Statement No. 133."
The Company expects to adopt SFAS No. 133, as amended by SFAS No. 138, when
required in the first quarter of fiscal 2001 and is continuing to assess the
potential impact on the Company's accounting for such activities. The
Company does not currently expect that adoption of this statement will have
a material effect on the Consolidated Financial Statements.
2. FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial instruments owned and financial instruments sold, but not yet
purchased, consist of the Company's proprietary trading and investment
accounts, at fair value, as follows:
August 25, November 26,
In thousands 2000 1999
- -----------------------------------------------------------------------------------------------------
Financial instruments owned:
US government and agency $11,814,491 $7,662,482
Other sovereign governments 2,985,855 2,785,025
Corporate equity and convertible debt 8,270,711 9,421,251
Corporate debt 3,562,190 4,835,056
Derivative financial instruments 5,377,888 4,734,149
Mortgages and other mortgage-backed securities 12,869,983 10,911,528
Other 631,979 415,311
----------- ----------
$45,513,097 $40,764,802
=========== ===========
Financial instruments sold, but not yet purchased:
US government and agency $6,796,363 $4,074,379
Other sovereign governments 1,941,275 2,116,448
Corporate equity 7,360,428 7,665,516
Corporate debt 377,808 1,228,338
Derivative financial instruments 3,996,455 4,599,592
Other 1,574 20,648
----------- ----------
$20,473,903 $19,704,921
=========== ===========
8
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
------------------------------------------
3. COMMITMENTS AND CONTINGENCIES
At August 25, 2000, the Company was contingently liable for unsecured
letters of credit of approximately $2.3 billion and letters of credit
secured by financial instruments of approximately $118.6 million, both of
which are principally used as deposits for securities borrowed or to satisfy
margin deposits at option and commodity exchanges.
In the normal course of business, the Company has been named as a defendant
in several lawsuits, which involve claims for substantial amounts.
Additionally, the Company is involved from time to time in investigations
and proceedings by governmental agencies and self-regulatory organizations.
Although the ultimate outcome of these matters cannot be ascertained at this
time, it is the opinion of management, after consultation with counsel, that
the resolution of such matters will not have a material adverse effect on
the results of operations or the financial condition of the Company, taken
as a whole.
4. REGULATORY REQUIREMENTS
Bear Stearns and BSSC, wholly-owned subsidiaries of the Company, 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. Included in the
computation of net capital of Bear Stearns is $1.2 billion which is net
capital of BSSC in excess of 5% of aggregate debit items arising from
customer transactions, as defined. At August 25, 2000, Bear Stearns' net
capital, as defined, of $2.32 billion exceeded the minimum requirement by
$2.27 billion.
Bear, Stearns International Limited ("BSIL") and Bear Stearns International
Trading Limited ("BSIT"), London-based broker-dealer subsidiaries, which are
indirectly wholly owned by the Company, are subject to regulatory capital
requirements of the Securities and Futures Authority, a self-regulatory
organization established pursuant to the United Kingdom Financial Services
Act of 1986.
Bear Stearns Bank plc ("BSB"), which is indirectly wholly owned by the
Company, is incorporated in Dublin and is subject to the regulatory capital
requirements of the Central Bank of Ireland.
At August 25, 2000, Bear Stearns, BSSC, BSIL, BSIT and BSB were in
compliance with their respective regulatory capital requirements.
9
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
------------------------------------------
5. EARNINGS PER SHARE
Earnings per share ("EPS") is computed by dividing net income applicable to
common shares adjusted for costs related to the Capital Accumulation Plan
by the weighted average number of common shares and common share equivalents
outstanding during each period presented. Weighted average shares used to
calculate diluted EPS include the effect of stock options. Common shares
include the assumed distribution of shares of common stock issuable under
various employee benefit plans, including certain of the Company's deferred
compensation arrangements.
6. CASH FLOW INFORMATION
Cash payments for interest approximated interest expense for the nine-months
ended August 25, 2000 and August 27, 1999. Income taxes paid totaled $632.8
million and $165.6 million for the nine-months ended August 25, 2000 and
August 27, 1999, respectively.
10
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
------------------------------------------
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company, in its capacity as a dealer in over-the-counter derivative
financial instruments and in connection with its proprietary market-making
and trading activities, enters into transactions in a variety of cash and
derivative financial instruments in order to reduce its exposure to credit
risk and to market risk, which includes interest rate, exchange rate and
equity price risk. SFAS No. 119, "Disclosure about Derivative Financial
Instruments and Fair Value of Financial Instruments," defines a derivative
as a future, forward, swap, or option contract, or other financial
instrument with similar characteristics such as caps, floors and collars.
Generally, these financial instruments represent future commitments to
exchange interest payment streams or currencies or to purchase or sell other
financial instruments at specific terms at specified future dates. Option
contracts provide the holder with the right, but not the obligation, to
purchase or sell a financial instrument at a specific price on or before an
established date. These financial instruments may have market and/or credit
risk in excess of amounts recorded in the Consolidated Statements of
Financial Condition.
In order to measure derivative activity, notional or contract amounts are
frequently used. Notional/contract amounts, which are not included on the
balance sheet, are used to calculate contractual cash flows to be exchanged
and are generally not actually paid or received, with the exception of
currency swaps and 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.
11
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
------------------------------------------
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (CONTINUED)
The following table represents the notional/contract amounts of the
Company's outstanding derivative financial instruments as of August 25, 2000
and November 26, 1999:
August 25, November 26,
In billions 2000 1999
- --------------------------------------------------------------------------------
Interest Rate:
Swap agreements, including options,
swaptions, caps, collars, and floors $392.6 $371.4
Futures contracts 48.5 47.3
Options held 19.0 43.8
Options written 3.9 18.4
Foreign Exchange:
Futures contracts 20.4 39.9
Forward contracts 12.3 10.0
Options held 3.1 5.5
Options written 3.1 4.1
Mortgage-Backed Securities -
Forward contracts 63.7 51.9
Equity:
Swap agreements 27.1 15.1
Futures contracts 4.1 2.1
Options held 7.1 6.5
Options written 5.7 6.3
The derivative financial instruments used in the Company's trading and dealer
activities are recorded at fair value with the resulting unrealized gains or
losses recorded in the Consolidated Statements of Financial Condition and the
related income or loss reflected in revenues derived from principal
transactions.
12
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
------------------------------------------
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (CONTINUED)
The fair values of derivative financial instruments held or issued for
trading and hedging purposes as of August 25, 2000 and November 26, 1999,
were as follows:
August 25, November 26,
2000 1999
----------------------------------------------------
In millions Assets Liabilities Assets Liabilities
- --------------------------------------------------------------------------------
Swap agreements $3,453 $2,108 $3,016 $2,952
Futures and forward
contracts 219 304 264 158
Options held 1,706 1,454
Options written 1,584 1,490
The average monthly fair values of the derivative financial instruments for
the three-months ended August 25, 2000 and November 26, 1999 were as
follows:
August 25, November 26,
2000 1999
----------------------------------------------------
In millions Assets Liabilities Assets Liabilities
- --------------------------------------------------------------------------------
Swap agreements $3,677 $3,173 $2,421 $2,625
Futures and forward
contracts 331 328 244 287
Options held 1,550 1,178
Options written 1,340 1,577
The notional/contract amounts of these instruments do not represent the
Company's potential risk of loss due to counterparty nonperformance. Credit
risk arises from the potential inability of counterparties to perform in
accordance with the terms of the contract. The Company's exposure to credit
risk associated with counterparty nonperformance is limited to the net
replacement cost of over-the-counter contracts, which are recognized as
assets in the Company's Consolidated Statements of Financial Condition.
Exchange-traded financial instruments, such as futures and options,
generally do not give rise to significant counterparty exposure due to the
margin requirements of the individual exchanges. Generally, options written
do not give rise to counterparty credit risk since they obligate the Company
(not its counterparty) to perform. The Company has controls in place to
monitor credit exposures by limiting transactions with specific
counterparties and assessing the creditworthiness of counterparties. The
Company also seeks to control credit risk by following an established credit
approval process, monitoring credit limits and requiring collateral where
appropriate.
13
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
------------------------------------------
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
(CONTINUED)
The following table summarizes the credit quality of the Company's
over-the-counter derivatives by showing counterparty credit ratings for the
replacement cost of contracts in a gain position, net of $2.8 billion and
$1.7 billion of collateral as of August 25, 2000 and November 26, 1999,
respectively:
August 25, November 26,
In millions 2000 1999
----------------------------------------------------------------
RATING(1) NET REPLACEMENT COST
AAA $ 228.0 $ 192.3
AA 713.2 597.1
A 495.0 600.7
BBB 43.3 79.8
BB and Lower 40.6 56.9
Non-rated 0.1 -
(1) Internal designations of counterparty credit quality are based
on actual ratings made by external ratings agencies or
comparable ratings established and utilized by the Company's
Credit Department.
8. SEGMENT DATA
The Company operates in three principal segments: Capital Markets, Execution
Services and Wealth Management. These segments are strategic business units
that offer an array of products and services. They are managed separately as
different levels and types of expertise are required to effectively manage
the segments' transactions.
The Capital Markets segment is comprised of Equities, Fixed Income and
Investment Banking areas. Equities combines the efforts of sales, trading
and research in such areas as block trading, convertible bonds,
over-the-counter equities, equity derivatives and risk arbitrage. Fixed
Income includes the efforts of sales, trading and research for institutional
clients in a variety of products such as mortgage-backed and asset-backed
securities, corporate and government bonds, municipal securities and high
yield instruments and foreign exchange and derivatives. Investment Banking
provides capabilities in capital raising, strategic advisory, mergers and
acquisitions and merchant banking.
14
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
------------------------------------------
8. SEGMENT DATA (CONTINUED)
The Execution Services segment is comprised of clearance and
commission-related areas, including institutional equity sales,
institutional futures sales and specialist activities. Clearance provides
clearing, margin lending and securities borrowing to facilitate customer
short sales to approximately 2,900 clearing clients worldwide. The
commission-related areas provide research and execution capabilities in US
equity securities and financial futures to our institutional clients.
The Wealth Management segment is comprised of the Private Client Services
("PCS") and Asset Management areas. PCS provides high-net-worth individuals
with an institutional level of service including access to the Company's
resources and professionals. Asset Management serves the diverse investment
needs of corporations, municipal governments, multi-employer plans,
foundations, endowments, family groups and high-net-worth individuals and,
in turn, earns management and/or performance fees on the institutional and
high-net-worth products it offers.
The three business segments are comprised of the many business areas with
interactions among each as they serve the needs of similar clients. Revenues
and expenses reflected below include those which are directly related to
each segment. Revenues from inter-segment transactions are credited based
upon specific criteria or agreed upon rates with such amounts eliminated in
consolidation. Individual segments also include revenues and expenses
relating to various items including corporate overhead and interest which
are internally allocated by the Company primarily based on balance sheet
usage or expense levels. The Company generally evaluates performance of the
segments based on net revenues and profit or loss before provision for
income taxes.
15
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
------------------------------------------
8. SEGMENT DATA (CONTINUED)
For the three-months ended August 25, 2000:
(in thousands) Net Revenues Pre-Tax Income (Loss) Segment Assets
- ----------------------------------- ---------------------- -------------------------- -------------------------
Capital Markets $ 682,862 $ 141,868 $ 116,250,869
Execution Services 366,710 138,693 61,313,073
Wealth Management 157,316 22,556 3,012,818
Other (a) 64,590 (33,534) (5,724,242)
- ----------------------------------- ---------------------- -------------------------- -------------------------
Total $ 1,271,478 $ 269,583 $ 174,852,518
=================================== ====================== ========================== =========================
For the three-months ended August 27, 1999:
(in thousands) Net Revenues Pre-Tax Income (Loss) Segment Assets
- ----------------------------------- ---------------------- -------------------------- -------------------------
Capital Markets $ 685,083 $ 225,399 $ 112,664,283
Execution Services 337,514 123,898 51,844,752
Wealth Management 139,840 14,073 3,103,576
Other (a) 33,152 (57,808) (3,530,382)
- ----------------------------------- ---------------------- -------------------------- -------------------------
Total $ 1,195,589 $ 305,562 $ 164,082,229
=================================== ====================== ========================== =========================
For the nine-months ended August 25, 2000:
(in thousands) Net Revenues Pre-Tax Income (Loss) Segment Assets
- ----------------------------------- ---------------------- -------------------------- -------------------------
Capital Markets $ 2,135,096 $ 547,555 $ 116,250,869
Execution Services 1,202,550 462,285 61,313,073
Wealth Management 542,285 91,539 3,012,818
Other (a) 218,919 (212,174) (5,724,242)
- ----------------------------------- ---------------------- -------------------------- -------------------------
Total $ 4,098,850 $ 889,205 $ 174,852,518
=================================== ====================== ========================== =========================
For the nine-months ended August 27, 1999:
(in thousands) Net Revenues Pre-Tax Income (Loss) Segment Assets
- ----------------------------------- ---------------------- -------------------------- -------------------------
Capital Markets $ 2,267,246 $ 838,154 $ 112,664,283
Execution Services 982,875 363,488 51,844,752
Wealth Management 448,882 77,685 3,103,576
Other (a) 136,246 (281,251) (3,530,382)
- ----------------------------------- ---------------------- -------------------------- -------------------------
Total $ 3,835,249 $ 998,076 $ 164,082,229
=================================== ====================== ========================== =========================
(a) Other is comprised of consolidation/elimination entries, unallocated
revenues (predominantly interest), corporate administrative functions,
including the accrual related to the Henryk de Kwiatkowski litigation
(for the nine-months ended August 25, 2000), and costs related to the
Capital Accumulation Plan (the "CAP Plan").
16
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
------------------------------------------------
Certain statements contained in this discussion are "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements are subject to risks and uncertainties, which could
cause actual results to differ materially from those discussed in the
forward-looking statements.
The Company's principal business activities, investment banking, securities
trading and brokerage, are, by their nature, highly competitive and subject to
various risks, in particular volatile trading markets and fluctuations in the
volume of market activity. Consequently, the Company's net income and revenues
in the past have been, and are likely to continue to be, subject to wide
fluctuations, reflecting the impact of many factors, including securities market
conditions, the level and volatility of interest rates, competitive conditions,
liquidity of global markets, international and regional political events,
regulatory developments and the size and timing of transactions.
For a description of the Company's business, including its trading in cash
instruments and derivative products, its underwriting and trading policies, and
their respective risks, and the Company's risk management policies and
procedures, see the Company's Current Report on Form 8-K for the five-month
period ended November 26, 1999 ("Transition Period").
Business Environment
- --------------------
The business environment during the Company's third quarter ended August 25,
2000 was characterized by moderate US economic growth and modest inflation.
Several economic reports showed that the US economy continued to expand but at a
slower pace than in previous quarters while inflation remained modest despite
increasing oil prices. The Fed met twice during the quarter and left interest
rates unchanged but maintained its inflation bias and noted that inflation
remained the most significant risk to the economy. Optimism that the Fed would
not raise rates at its October 3, 2000 meeting, the last Fed meeting before the
November presidential elections, and that short term rates would not be raised
for the remainder of the year, was somewhat offset by worries that a slower
economy would bring more modest growth in corporate earnings. While this
contributed to volatility in the equity markets during the quarter, overall
interest in domestic stocks was strong. During the quarter ended August 25,
2000, the Dow Jones Industrial Average ("DJIA") and the Standard & Poor's 500
Index ("S&P") increased 8.7% and 9.3%, respectively. The technology-heavy NASDAQ
increased 26.1% during the 2000 quarter, resulting from increased demand for
technology and telecommunications issues which resulted in increased equity
trading revenues compared to the prior year period. Weakness in certain of the
Company's fixed income businesses during the quarter ended August 25, 2000,
related to weak fixed income markets due to the continued inverted yield curve
and widening of corporate spreads, resulted in decreases in fixed income trading
and underwriting activity.
The business environment during the three-months ended August 27, 1999 was
characterized by active markets and growth in both NYSE and NASDAQ trading
volume. Volatility in the fixed income markets increased due to credit spreads
widening. The Fed met twice during the period and at each meeting raised the
federal funds rate by 25 basis points. While concerns over inflation and the
anticipation of further increases in the overnight lending rate by the Fed
contributed to some volatility in the financial markets during the 1999 period,
overall economic trends, including higher levels of consumer confidence and low
unemployment, were generally positive. Equity markets continued to be fueled by
strong interest in internet and technology issues. For the three-month period
ended August 27, 1999 the DJIA and S&P increased 5.0% and 3.5%, respectively,
while the NASDAQ increased 11.7%. In the fixed income markets, conditions were
generally positive, which benefited the Company's underwriting and trading
activities, specifically the mortgage-backed securities, high yield and
corporate bond areas.
17
Results of Operations
- ---------------------
Three-Months Ended August 25, 2000
Compared to Three-Months Ended August 27, 1999
- ----------------------------------------------
Net income from operations for the third quarter ended August 25, 2000 was
$181.4 million, a decrease of 5.6% from $192.3 for the comparable prior year
period. Earnings per diluted share was $1.32, up 10.9% from $1.19 per share for
the same period a year ago.
Revenues, net of interest expense, for the 2000 quarter were $1.3 billion, a
6.3% increase from $1.2 billion for the comparable prior year period. The
results for the quarter reflect increases in commissions, net interest revenues
and principal transactions, partially offset by a decrease in investment banking
revenues.
Commission revenues increased 9.8% in the 2000 quarter to $262.0 million from
$238.7 million in the comparable 1999 period. This increase was attributable to
strong performances in the institutional, clearance and private client services
areas driven by higher equity transaction volumes, partially offset by a
decrease in futures commissions.
The Company's principal transactions revenues by reporting categories, including
derivatives, are as follows (in thousands):
Three-Months Ended Three-Months Ended
August 25, 2000 August 27, 1999
--------------- ---------------
Fixed Income $ 179,719 $ 242,272
Equity 190,763 154,918
Derivative Financial Instruments
including Foreign Exchange 157,720 99,359
---------- -----------
$ 528,202 $ 496,549
========== ===========
Revenues from principal transactions increased 6.4% in the 2000 quarter to
$528.2 million from $496.5 million in the comparable 1999 period. The increase
reflects an increase in derivatives, particularly in the equity derivatives area
which had a record performance in the 2000 quarter. Additionally, results
reflect increases in equity activities, particularly in the over-the-counter,
specialist and international equity trading areas. The equity markets were
strong during the 2000 quarter driven by increased trading volumes in the
technology and telecommunication sectors which contributed to the increase in
these business areas. This increase was partially offset by a decrease in
revenues derived from fixed income activities, particularly in the
mortgage-backed and high yield areas. Reduced customer volumes and the widening
of high yield spreads contributed to the declines in these business areas.
18
Investment banking revenues decreased 11.0% to $236.9 million in the 2000
quarter from $266.0 million in the comparable 1999 period. The decrease reflects
a decline in equity underwriting activity due to lower new issue volume in the
technology and telecommunications sectors during the 2000 quarter as well as a
decline in fixed income underwriting activity, particularly in the high yield
area. The decline was partially offset by the increase in merchant banking
revenues to $34.3 million in the 2000 quarter from $7.6 million in the
comparable 1999 period.
Net interest and dividend revenues were $209.1 million in the 2000 quarter, an
increase of 26.7% from $165.1 million in the comparable 1999 period. The
increase was attributable to increased levels of customer shorts and increased
levels of customer margin debt. For the quarter ended August 25, 2000, average
customer margin debt increased to $56.4 billion, up from $43.1 billion in the
comparable 1999 period, and was $56.0 billion at August 25, 2000. Average
customer shorts increased to $59.8 billion, up from $56.7 billion in the
comparable 1999 period and was $60.0 billion at August 25, 2000. Average free
credit balances increased to $14.8 billion in the 2000 quarter from $12.5
billion in the comparable 1999 period.
Other income increased 20.4% to $35.2 million in the 2000 quarter from $29.3
million in the comparable 1999 period primarily due to an increase in management
and incentive-based fees earned by the Company's Asset Management area. The
Asset Management area increased assets under management to $16.6 billion at
August 25, 2000, which reflects a 39.5% increase over the comparable 1999 date.
Strong net inflows and market appreciation led to the growth in assets under
management during the 2000 quarter. The largest components of the increase in
assets were attributable to mutual funds and alternative investment products.
Mutual funds grew 163.6% to $3.9 billion at August 25, 2000 from $1.5 billion at
August 27, 1999 while alternative investment products grew 48.9% to $2.8 billion
at August 25, 2000 from $1.9 billion at August 27, 1999.
Employment compensation and benefits increased 10.3% to $664.0 million in the
2000 quarter from $602.2 million in the comparable 1999 period. Employee
compensation and benefits, as a percentage of net revenues, increased to 52.2%
in the 2000 quarter from 50.4% in the comparable 1999 period. The Company's
compensation as a percentage of net revenues was 50.7% for the 14 month period
ended August 25, 2000. The increase in compensation to net revenues during the
quarter principally reflects the Company's development of its investment banking
and equity businesses, both domestically and in Europe.
Non-compensation related expenses increased 17.4% to $337.9 million in the 2000
quarter from $287.8 million in the comparable 1999 period primarily due to costs
associated with increased business activity and global expansion. CAP Plan
expense increased $19.4 million to $45.7 million in the 2000 quarter from $26.3
million in the comparable 1999 period. Employment agency and professional fees
and advertising and market development increased $10.2 million and $8.7 million,
respectively in the 2000 quarter compared to the 1999 period. Communications,
data processing and depreciation also contributed to the increase in
non-compensation related expenses.
19
The Company's quarterly tax rate decreased to 32.7% in the 2000 quarter from
37.1% in the comparable 1999 period. This adjusts the Company's effective tax
rate for the nine-months ended August 25, 2000 to 35.0% which is primarily due
to a higher level of earnings in lower tax jurisdictions.
Nine-Months Ended August 25, 2000
Compared to Nine-Months Ended August 27, 1999
- ---------------------------------------------
Net income from operations for the nine-months ended August 25, 2000 was $578.0
million or $4.00 per diluted share, a decrease of 6.9% from $621.1 million or
$4.02 per diluted share for the comparable prior year period. These results
include an after-tax charge of $96.0 million or $0.63 per share, attributable to
increased litigation reserves following the jury verdict in the Henryk de
Kwiatkowski litigation.
Revenues, net of interest expense, increased 6.9% to $4.1 billion in the 2000
period from $3.8 billion in the comparable 1999 period. The results reflect
increases in net interest revenues, commissions, investment banking revenues and
other income, partially offset by a decrease in principal transactions revenues.
Commission revenues increased 18.1% in the 2000 period to $894.1 million from
$757.3 million in the comparable 1999 period. This increase was primarily
attributable to strong performances in the institutional, clearance and private
client services areas driven by higher equity transaction volumes. The NYSE
average daily volume increased by 28.9% in the 2000 period compared to the 1999
period.
The Company's principal transactions revenues by reporting categories, including
derivatives, are as follows (in thousands):
Nine-Months Ended Nine-Months Ended
August 25, 2000 August 27, 1999
--------------- ---------------
Fixed Income $ 569,845 $ 947,760
Equity 641,317 485,398
Derivative Financial Instruments
including Foreign Exchange 478,575 345,478
----------- ------------
$ 1,689,737 $ 1,778,636
=========== ============
20
Revenues from principal transactions decreased 5.0% in the 2000 period to $1.7
billion from $1.8 billion in the comparable 1999 period. The decrease reflects a
decline in the Company's fixed income activities, particularly in
mortgage-backed securities, high yield and emerging markets trading. The
secondary fixed income markets were weaker due to rising interest rates and
reduced customer volumes, which contributed to the decline in these business
areas. Revenues derived from equity activities increased, reflecting strong
performances from the over-the-counter, international equity trading and sales,
specialist and arbitrage activities. These increases were driven by increased
trading volumes particularly in the technology and telecommunications sectors as
well as an increase in mergers and acquisitions activity. The increase in
foreign exchange and other derivative financial instruments revenues is
principally due to increased equity derivatives revenues.
Investment banking revenues increased 4.6% to $780.9 million in the 2000 period
from $746.5 million in the comparable 1999 period. This increase reflects higher
mergers and acquisitions advisory fees and merchant banking revenues as well as
higher equity underwriting revenues in the 2000 period. These increases were
partially offset by a decrease in fixed income underwriting, particularly in the
high yield and corporate debt areas.
Net interest and dividends increased 31.5% to $629.4 million in the 2000 period
from $478.6 million in the comparable 1999 period. The increase was attributable
to increased levels of customer margin debt and customer shorts. Average
customer margin debt increased to $57.6 billion in the 2000 period from $40.5
billion in the comparable 1999 period. Average customer shorts increased to
$62.2 billion in the 2000 period from $57.4 billion in the comparable 1999
period. Average free credit balances increased to $15.0 billion in the 2000
period from $12.1 billion in the comparable 1999 period. The increase in net
interest profit was partially offset by higher funding costs incurred during the
first quarter as the Company had extended short-term maturities over the 1999
(Y2K) year-end.
Other income increased 40.9% to $104.6 million in the 2000 period from $74.2
million in the comparable 1999 period. This increase was primarily attributable
to an increase in performance-based and management fees earned by the Company's
Asset Management area. The Asset Management area increased assets under
management to $16.6 billion at August 25, 2000, which reflected a 39.5% increase
over $11.9 billion in assets under management at the comparable 1999 date. The
largest components of the increase in assets were attributable to mutual funds
and alternative investments as discussed above.
21
Employee compensation and benefits increased 9.5% to $2.1 billion in the 2000
period from $1.9 billion in the comparable 1999 period. The increase in employee
compensation and benefits was primarily attributable to an increase in headcount
as well as an increase in incentive and discretionary bonus accruals in the 2000
period and an increase in salesmen's commissions related to increased commission
revenues. Employee compensation and benefits, as a percentage of net revenues,
increased to 50.9% in the 2000 period from 49.7% in the comparable 1999 period.
The Company's compensation as a percentage of net revenues was 50.7% for the 14
month period ended August 25, 2000.
Non-compensation related expenses increased 20.5% to $1.1 billion in the 2000
period from $931.2 million in the comparable 1999 period. Legal expenses
increased by $124.2 million in the 2000 period primarily due to an increase in
litigation reserves related to the Henryk de Kwiatkowski litigation. CAP Plan
expense decreased by $15.1 million to $111.4 million in the 2000 period from
$126.5 million in the comparable 1999 period, reflecting lower pre-tax earnings.
Data processing, communications and depreciation increased $40.1 million or
14.9% in the 2000 period as a result of both the upgrading of existing
communication and computer systems throughout the firm and increased usage of
information services. Advertising and market development increased by $19.6
million in the 2000 period as a result of increased air travel and marketing
costs associated with business expansion.
The Company's effective tax rate decreased to 35.0% in the 2000 period compared
to 37.8% in the comparable 1999 period primarily due to higher levels of
earnings in lower tax jurisdictions.
Business Segments
- -----------------
The Company is primarily engaged in business as a securities broker and dealer
operating in three principal segments: Capital Markets, Execution Services and
Wealth Management. These segments are strategic business units analyzed
separately due to the distinct nature of the products they provide and the
clients they serve. Certain Capital Markets products are distributed by the
Wealth Management and Execution Services distribution network with the related
revenues of such intersegment services allocated to the respective segments
through transfer pricing.
The following segment operating results exclude certain unallocated revenues
(predominantly interest) as well as, corporate administrative functions
including items such as certain legal costs and costs related to the CAP Plan.
Three-Months Ended August 25, 2000
Compared to Three-Months Ended August 27, 1999
- ----------------------------------------------
Capital Markets
---------------
- ------------------------- -------------------------- -------------------------
Three-Months Ended Three-Months Ended
In thousands August 25, 2000 August 27, 1999
- ------------------------- -------------------------- -------------------------
Net revenues $ 682,862 $ 685,083
Pre-tax income $ 141,868 $ 225,399
- ------------------------- -------------------------- -------------------------
22
Net revenues for Capital Markets were $682.9 million in the 2000 quarter, down
slightly from $685.1 million in the comparable 1999 period. Pre-tax income for
Capital Markets was $141.9 million in the 2000 quarter, down from $225.4 million
in the comparable 1999 period. Fixed income results in the 2000 quarter were
lower compared to the 1999 period as difficult market conditions and lower
customer volumes resulted in decreases in the Company's mortgage-backed
securities, high yield and fixed income sales operations, partially offset by an
increase in the fixed income derivatives area. Equity results were strong in the
2000 quarter compared to the 1999 period as active equity markets and strong
deal flow resulted in a record performance from equity derivatives, as well as
strong performances in the over-the-counter and specialist areas. Investment
banking revenues decreased in the 2000 quarter reflecting a decline in equity
and fixed income underwriting activity offset by higher merchant banking
revenues. Pre-tax profit margin in the 2000 quarter was 20.8% compared to 32.9%
in the comparable 1999 period due to lower levels of profitability from the
fixed income and investment banking areas.
Execution Services
------------------
- ----------------------------- ------------------------- ------------------------
Three-Months Ended Three-Months Ended
In thousands August 25, 2000 August 27, 1999
- ----------------------------- ------------------------- ------------------------
Net revenues $ 366,710 $ 337,514
Pre-tax income $ 138,693 $ 123,898
- ----------------------------- ------------------------- ------------------------
At August 25, 2000, the Company provided securities clearance services to
approximately 2,900 clearing clients worldwide. Such clients include
approximately 2,500 prime brokerage clients including hedge funds and clients of
money managers, short sellers, arbitrageurs and other professional investors and
approximately 400 fully disclosed clients, who engage in either the retail or
institutional brokerage business. The Company processed an average of more than
238,000 trades per day during the 2000 quarter versus approximately 164,600
trades per day in the comparable 1999 period.
23
Net revenues for Execution Services approximated $366.7 million in the 2000
quarter, up 8.7% from $337.5 million in the comparable 1999 period. Pre-tax
income for Execution Services was $138.7 million in the 2000 quarter, up 11.9%
from $123.9 million in the comparable 1999 period. Results reflect increased
levels of customer margin balances, increased customer short sales and increased
transaction volumes, which benefited the Company's clearance and specialist
activities. Pre-tax profit margin in the 2000 quarter was 37.8% compared to
36.7% in the comparable 1999 period.
Wealth Management
-----------------
- ---------------------------- --------------------------- -----------------------
Three-Months Ended Three-Months Ended
In thousands August 25, 2000 August 27, 1999
- ---------------------------- --------------------------- ----------------------
Net revenues $ 157,316 $ 139,840
Pre-tax income $ 22,556 $ 14,073
- ---------------------------- --------------------------- -----------------------
The Wealth Management segment is comprised of the Private Client Services
("PCS") and Asset Management areas. PCS provides high-net worth individuals with
an institutional level of service, including access to the Company's resources
and professionals. PCS maintains a select team of approximately 500 account
executives in seven regional offices.
The Asset Management area, through Bear Stearns Asset Management Inc. ("BSAM")
had approximately $16.6 billion in assets under management at August 25, 2000
which reflected a 39.5% increase over $11.9 billion in assets under management
at August 27, 1999. Strong net inflows and market appreciation led to the growth
in assets under management in the 2000 quarter. The largest components of the
increase in assets were attributable to mutual funds and alternative investment
products. Mutual funds grew 163.6% to $3.9 billion at August 25, 2000 from $1.5
billion at August 27, 1999 while alternative investment products grew 48.9% to
$2.8 billion at August 25, 2000 from $1.9 billion at August 27, 1999.
Net revenues for Wealth Management were $157.3 million in the 2000 quarter, up
12.5% from $139.8 million in the comparable 1999 period. Pre-tax income for
Wealth Management was $22.6 million in the 2000 quarter, up 60.3% from $14.1
million in the comparable 1999 period. The increase was attributable to an
increase in management and performance-based fees earned by the Asset Management
areas as well as increased revenues and net interest profits from the private
client activities which were driven by active equity markets and strong customer
volumes. Pre-tax profit margin in the 2000 quarter was 14.3% compared to 10.1%
in the comparable 1999 period.
24
Nine-Months Ended August 25, 2000
Compared to Nine-Months Ended August 27, 1999
- ---------------------------------------------
Capital Markets
---------------
- --------------------------- -------------------------- -------------------------
Nine-Months Ended Nine-Months Ended
In thousands August 25, 2000 August 27, 1999
- --------------------------- -------------------------- -------------------------
Net revenues $ 2,135,096 $ 2,267,246
Pre-tax income $ 547,555 $ 838,154
- --------------------------- -------------------------- -------------------------
Net revenues for Capital Markets were $2.1 billion in the 2000 period, down from
$2.3 billion in the comparable 1999 period. Pre-tax income for Capital Markets
was $547.6 million in the 2000 period, down from $838.2 million in the
comparable 1999 period. Fixed income results in the 2000 period were lower
compared to the 1999 period as rising interest rates and lower customer volumes
resulted in decreases in the Company's mortgage-backed securities, fixed income
sales, high yield operations and corporate bond trading. Equity results were
strong in the 2000 period as active markets and strong deal flow resulted in
strong performances from equity derivatives, over-the-counter, international
equity trading, emerging markets equity trading and risk arbitrage. Investment
banking revenues increased in the 2000 period reflecting increased levels of
mergers and acquisitions and equity underwriting activity as well as an increase
in merchant banking revenues, partially offset by decreased levels of fixed
income underwriting. Pre-tax profit margin in the 2000 quarter was 25.6%
compared to 37.0% in the comparable 1999 period due to lower levels of
profitability from the fixed income and investment banking areas.
Execution Services
------------------
- --------------------------- ------------------------- --------------------------
Nine-Months Ended Nine-Months Ended
In thousands August 25, 2000 August 27, 1999
- --------------------------- ------------------------- --------------------------
Net revenues $ 1,202,550 $ 982,875
Pre-tax income $ 462,285 $ 363,488
- --------------------------- ------------------------- --------------------------
25
Net revenues for Execution Services approximated $1.2 billion in the 2000
period, up 22.4% from $982.9 million in the comparable 1999 period. Pre-tax
income for Execution Services was $462.3 million in the 2000 period, up 27.2%
from $363.5 million in the comparable 1999 period. Results reflect increased
levels of customer margin debt, short balances and higher transaction volumes,
which benefited the Company's clearance revenues and specialist operations and
improved domestic and European sales volume, which benefited the Company's
institutional equity business. Pre-tax profit margin in the 2000 quarter was
38.4% compared to 37.0% in the comparable 1999 period.
Wealth Management
-----------------
- --------------------------- ------------------------- --------------------------
Nine-Months Ended Nine-Months Ended
In thousands August 25, 2000 August 27, 1999
- --------------------------- ------------------------- --------------------------
Net revenues $ 542,285 $ 448,882
Pre-tax income $ 91,539 77,685
- --------------------------- ------------------------- --------------------------
Net revenues for Wealth Management were $542.3 million in the 2000 period, up
20.8% from $448.9 million in the comparable 1999 period. Pre-tax income for
Wealth Management was $91.5 million in the 2000 period, up 17.8% from $77.7
million in the comparable 1999 period. Active equity markets, strong customer
volumes and growth in assets under management resulted in increased revenues and
net interest profits from private client activities and increased management
fees in the 2000 period. In addition, strong performances by certain of the
Company's managed funds led to increases in performance-based fees during the
period. Pre-tax profit margin in the 2000 quarter was 16.9% compared to 17.3% in
the comparable 1999 period.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Financial Leverage
The Company maintains a highly liquid balance sheet with a majority of the
Company's assets consisting of marketable investments, which are
marked-to-market daily, and collateralized receivables arising from
customer-related and proprietary securities transactions.
26
Collateralized receivables consist of resale agreements secured predominantly by
US government and agency securities, customer margin loans and securities
borrowed, which are typically secured by marketable corporate debt and equity
securities. The 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. 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 August 25, 2000 increased to $174.9 billion from
$162.0 billion at November 26, 1999. The increase is primarily attributable to
an increase in financial instruments owned and receivables from customers
resulting from increased levels of margin debt and securities borrowed.
The Company's ability to support increases in total assets is a function of its
ability to obtain short-term secured and unsecured funding and its access to
sources of long-term capital in the form of long-term borrowings and equity,
which together form its capital base. The Company continuously monitors the
adequacy of its capital base, which is a function of asset quality and
liquidity. Highly liquid assets, such as US government and agency securities,
typically are funded by the use of repurchase agreements, which require very low
levels of margin. In contrast, assets of lower quality or liquidity require
higher levels of margin or overcollateralization and consequently increased
levels of capital. Accordingly, the mix of assets being held by the Company
significantly influences the amount of leverage the Company can employ and the
adequacy of its capital base.
Funding Strategy
- ----------------
The Company's general funding strategy provides for the diversification of its
short-term funding sources in order to maximize liquidity. Sources of short-term
funding consist principally of collateralized borrowings, including repurchase
transactions and securities lending arrangements, customer free credit balances,
unsecured commercial paper, medium-term notes and bank borrowings generally
having maturities from overnight to one year.
Repurchase transactions, whereby the Company sells securities with an agreement
to repurchase at a future date, represent the dominant component of secured
short-term funding.
In addition to short-term funding sources, the Company utilizes long-term debt,
including medium-term notes, as a longer-term source of unsecured financing.
During the nine-months ended August 25, 2000, the Company received proceeds
approximating $7.4 billion from the issuance of long-term debt which, net of
retirements, served to increase long-term debt to $19.4 billion at August 25,
2000 from $15.9 billion at November 26, 1999.
27
The Company maintains an alternative funding strategy focused on the liquidity
and self-funding ability of the underlying assets. The objective of the strategy
is to maintain sufficient sources of alternative funding to enable the Company
to fund debt obligations without issuing any new unsecured debt, including
commercial paper. The most significant source of alternative funding is the
Company's ability to hypothecate or pledge its unencumbered assets as collateral
for short-term funding.
As part of the Company's alternative funding strategy, the Company regularly
monitors and analyzes the size, composition, and liquidity characteristics of
the assets being financed and evaluates its liquidity needs in light of current
market conditions and available funding alternatives. 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 each asset category 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 this analysis, the Company can continuously evaluate the adequacy of its
equity base and the schedule of maturing term-debt supporting its present asset
levels. The Company can then seek to adjust its maturity schedule, in light of
market conditions and funding alternatives.
The Company has in place a committed revolving-credit facility (the "facility")
totaling $3.225 billion, which permits borrowing on a secured basis by Bear,
Stearns & Co. Inc. ("Bear Stearns"), Bear, Stearns Securities Corp. ("BSSC") and
certain affiliates. The facility also provides that the Company may borrow up to
$1.6125 billion of the facility on an unsecured basis. Secured borrowings can be
collateralized by both investment-grade and non-investment-grade financial
instruments. In addition, the facility provides for defined margin levels on a
wide range of eligible financial instruments that may be pledged under the
secured portion of the facility. The facility terminates in October 2000 with
all loans outstanding at that date payable no later than October 2001. The
Company expects to renew such facility. There were no borrowings outstanding
under the facility at November 26, 1999.
In August 2000, the Company established a $1.25 billion committed revolving
securities repo facility (the "repo facility") which permits borrowings, under a
repurchase arrangement, by Bear, Stearns International Limited ("BSIL"), Bear
Stearns International Trading Limited ("BSIT") and Bear Stearns Bank plc
("BSB"). The repo facility terminates in August 2001 with all repos outstanding
at that date payable no later than August 2002.
28
Capital Resources
- -----------------
The Company conducts a substantial portion of its operating activities within
its regulated subsidiaries Bear Stearns, BSSC, BSIL, BSIT and BSB. In connection
therewith, a substantial portion of the Company's long-term borrowings and
equity have been used to fund investments in, and advances to, these regulated
subsidiaries. The Company regularly monitors the nature and significance of
assets or activities conducted outside the regulated subsidiaries and attempts
to fund such assets with either capital or borrowings having maturities
consistent with the nature and liquidity of the assets being financed.
The Company's CAP Plan allows participants to defer portions of their annual
compensation in exchange for the future receipt of shares of the Company's
Common Stock. During the nine-months ended August 25, 2000 the Company
repurchased a total of 6,437,382 shares of Common Stock through open market
transactions in connection with the CAP Plan at a cost of approximately $268.3
million. The Company intends, subject to market conditions, to continue to
purchase, in future periods, a sufficient number of shares of Common Stock in
the open market to enable the Company to issue shares with respect to all
compensation deferred and any additional amounts allocated to participants under
the CAP Plan.
On October 28, 1999, the stockholders of the Company approved the Company's
Stock Award Plan (the "Stock Award Plan"). The purpose of the Stock Award Plan
is to secure for the Company and its stockholders the benefits of the additional
incentive, inherent in the ownership of the Company's stock, by selected key
employees of the Company who are important to the success and growth of the
business.
Separately, on January 18, 2000, the Board of Directors of the Company approved
an amendment to the Stock Repurchase Program (the "Repurchase Program") to allow
the Company to purchase (in addition to any shares purchased under a previous
repurchase authorization) up to $500 million in aggregate cost of Common Stock.
Purchases under the Repurchase Program may be made periodically in fiscal year
2000 or beyond either in the open market or through privately negotiated
transactions. During the nine-months ended August 25, 2000, the Company
purchased, under the previous and current repurchase authorizations, a total of
6,912,971 shares of Common Stock through open market transactions at a cost of
approximately $286.6 million. At August 25, 2000, an additional $310.4 million
of Common Stock may be purchased pursuant to the Repurchase Program. Purchases
of Common Stock pursuant to the CAP Plan are not made pursuant to the Repurchase
Program and are not included in calculating the remaining number of shares of
Common Stock that the Company may purchase under such program.
29
Cash Flows
- ----------
Cash and cash equivalents decreased by $219.7 million during the nine-months
ended August 25, 2000. Cash used in operating activities during the nine-months
ended August 25, 2000 was $7.6 billion, primarily due to increases in financial
instruments owned and customer receivables and a decrease in customer payables,
partially offset by an increase in securities sold under agreements to
repurchase. Financing activities provided cash of $7.6 billion, primarily
derived from net proceeds from the issuance of long-term borrowings and the
increase in short-term borrowings, partially offset by payments for retirement
of long-term borrowings. Investing activities during the nine-months ended
August 25, 2000 used $227.9 million for purchases of property, equipment and
leasehold improvements of $139.9 million and net purchases of investment
securities and other assets of $88.0 million.
Regulated Subsidiaries
- ----------------------
As registered broker-dealers, Bear Stearns and BSSC are subject to the net
capital requirements of the Securities Exchange Act of 1934, as amended, the
NYSE, and the Commodity Futures Trading Commission, which are designed to
measure the general financial soundness and liquidity of broker-dealers. BSIL
and BSIT, London-based broker-dealer subsidiaries, are subject to the regulatory
capital requirements of the Securities and Futures Authority, a self-regulatory
organization established pursuant to the United Kingdom Financial Services Act
1986. Additionally, BSB is subject to the regulatory capital requirements of the
Central Bank of Ireland. At August 25, 2000 Bear Stearns, BSSC, BSIL, BSIT, and
BSB were in compliance with their respective regulatory capital requirements.
Merchant Banking and High Yield Securities
- ------------------------------------------
As part of the Company's merchant banking activities, it participates from time
to time in principal investments in leveraged acquisitions. As part of these
activities, the Company originates, structures and invests in merger,
acquisition, restructuring, and leveraged capital transactions, including
leveraged buyouts. The Company's principal investments in these transactions are
generally made in the form of equity investments, equity-related investments or
subordinated loans, and have not historically required significant levels of
capital investment. At August 25, 2000, the Company held investments in twenty-
four leveraged transactions with an aggregate value of approximately $290.0
million.
As part of the Company's fixed-income securities activities, the Company
participates in the trading and sale of high yield, non-investment-grade debt
securities, non-investment-grade mortgage loans, non-investment-grade commercial
loans and securities of companies that are the subject of pending bankruptcy
proceedings (collectively "high yield investments"). Non-investment-grade
mortgage loans are principally secured by residential properties and include
both non-performing loans and real estate owned. At August 25, 2000, the Company
held high yield instruments of $1.9 billion owned and $0.5 billion sold short,
as compared to $1.5 billion owned and $0.3 billion sold short as of November 26,
1999.
30
These investments generally involve greater risk than investment-grade debt
securities due to credit considerations, illiquidity of secondary trading
markets, and increased vulnerability to general economic conditions.
The level of the Company's high yield investment inventories, and the impact of
such activities upon the Company's results of operations, can fluctuate from
period to period as a result of customer demand and economic and market
considerations. The Company's Risk Committee monitors exposure to market and
credit risk with respect to high yield investment inventories and establishes
limits with respect to overall market exposure and concentrations of risk by
both individual issuer and industry group.
Accounting Changes and Developments
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes standards for accounting
and reporting of derivative instruments, including certain derivative
instruments embedded in other contracts, and hedging activities. SFAS No. 133
requires that all derivative instruments be recorded on the balance sheet at
their fair value. Changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the type
of hedge transaction. For fair-value hedge transactions of assets, liabilities
or firm commitments, changes in the fair value of the derivative will generally
be offset by changes in fair value of the related hedged item. For cash-flow
hedge transactions, in which the Company is hedging the variability of cash
flows related to a variable-rate asset, liability, or a forecasted transaction,
changes in the fair value of the derivative instrument will be reported in other
comprehensive income. The gains and losses on the derivative instrument that are
reported in other comprehensive income will be reclassified as earnings in the
periods in which earnings are impacted by the variability of the cash flows of
the hedged item. The ineffective portion of all hedges will be recognized in
current-period earnings. In June 1999, the FASB issued SFAS No. 137, "Accounting
for Derivative Instruments and Hedging Activities - Deferral of the Effective
Date of FASB Statement No. 133." SFAS No. 137 defers the effective date of SFAS
No. 133 for one year to fiscal years beginning after June 15, 2000. In June
2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities - an amendment of FASB Statement No.
133."
The Company expects to adopt SFAS No. 133, as amended by SFAS No. 138, when
required in the first quarter of fiscal 2001 and is continuing to assess the
potential impact on the Company's accounting for such activities. The Company
does not currently expect that adoption of this statement will have a material
effect on the Consolidated Financial Statements.
31
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
The Company's principal business activities by their nature engender significant
market and credit risks. In addition, the Company is also subject to operating
risk and funding risk. Managing these risks is critical to the success and
stability of the Company. As a result, comprehensive risk management policies
and procedures have been established to identify, control and monitor each of
these major risks. Additionally, the Company's diverse portfolio of business
activities helps to reduce the impact that volatility in any particular market
may have on its net revenues.
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument as a result of
fluctuations in interest and currency exchange rates, equity and futures prices,
changes in the implied volatility of interest rate, foreign exchange rate,
equity and futures prices and also changes in the credit ratings of either the
issuer or its related country of origin. Market risk is inherent to both
derivative and non-derivative financial instruments, and accordingly, the scope
of the Company's market risk management procedures includes all market
risk-sensitive financial instruments. The Company's exposure to market risk is
directly related to its role as a financial intermediary in customer-related
transactions and to its proprietary trading and arbitrage activities. For a
discussion of the Company's primary market risk exposures, which include
interest rate risk, foreign exchange rate risk, and equity price risk, and a
discussion of how those exposures are managed, see the Company's Current Report
on Form 8-K for the five-month period ended November 26, 1999.
Value at Risk
- -------------
The estimation of potential losses that could arise from changes in market
conditions is typically accomplished through the use of statistical models,
which seek to predict risk of loss based on historical price and volatility
patterns. The output of such statistical models is commonly referred to as value
at risk. Value at risk is used to describe a probabilistic approach to measuring
the exposure to market risk. This approach utilizes statistical concepts to
estimate the probability of the value of a financial instrument rising above or
falling below a specified amount. The calculation utilizes the standard
deviation of historical changes in value (i.e., volatility) of the market risk
sensitive financial instruments to estimate the amount of change in the current
value that could occur at a specified probability level.
Measuring market risk using statistical risk management models has been the main
focus of risk management efforts by many companies whose earnings are
significantly exposed to changes in the fair value of financial instruments.
The Company believes that statistical models alone do not provide a reliable
method of monitoring and controlling risk. While value at risk models are
relatively sophisticated, the quantitative risk information generated is limited
by the parameters established in creating the related models. The financial
instruments being evaluated, in some cases, have features which may trigger a
potential loss in excess of the amounts previously disclosed if the changes in
market rates or prices exceed the confidence level of the model used. Therefore,
such models do not substitute for the experience or judgment of senior
management and traders, who have extensive knowledge of the markets and adjust
positions and revise strategies, as they deem necessary. The Company uses these
models only as a supplement to other risk management tools. Additionally, the
Company continuously evaluates and enhances such value at risk models in an
effort to more accurately measure risk of loss based on historical price and
volatility patterns.
32
For purposes of Securities and Exchange Commission disclosure requirements, the
Company has performed an entity-wide value at risk analysis of virtually all of
the Company's financial assets and liabilities, including all reported financial
instruments owned and sold, repurchase and resale agreements, and funding assets
and liabilities. The value at risk related to non-trading financial instruments
has been included in this analysis and not reported separately because the
amounts were not material. The calculation is based on a methodology, which uses
a one-day interval and a 95% confidence level. Interest rate and foreign
exchange rate risk use a "Monte Carlo" value at risk approach. Monte Carlo
simulation involves the generation of price movements in a portfolio using a
random number generator. The generation of random numbers is based on the
statistical properties of the securities in the portfolio. For interest rates,
each country's yield curve has five factors that describe possible curve
movements. These were generated from principal component analysis. In addition,
volatility and spread risk factors were used, where appropriate. Intercountry
correlations were also used. Equity price risk was measured using a combination
of historical and Monte Carlo value at risk approaches.
Equity derivatives were treated as correlated with various indexes, of which the
Company used approximately fifty. Parameter estimates, such as volatilities and
correlations, were based on daily tests through August 25, 2000. The total value
at risk presented below is less than the sum of the individual components (i.e.
Interest Rate Risk, Foreign Exchange Rate Risk, Equity Risk) due to the benefit
of diversification among the risks.
The following table illustrates the Company's value at risk for each component
of market risk as of August 25, 2000 and November 26, 1999:
August 25, November 26,
In millions 2000 1999
- ----------- ---- ----
MARKET RISK
Interest $ 9.0 $ 11.9
Currency 1.1 1.2
Equity 10.1 12.6
Diversification benefit (6.6) (8.4)
------ ------
Total $ 13.6 $ 17.3
====== ======
33
As previously discussed, the Company utilizes a wide variety of market risk
management methods, including: limits for each trading activity; marking all
positions to market on a daily basis; daily profit and loss statements; position
reports; aged inventory position reports; and independent verification of
inventory pricing. Additionally, management of each trading department reports
positions, profits and losses, and trading strategies to the Risk Committee on a
weekly basis. The Company believes that these procedures, which stress timely
communication between trading department management and senior management, are
the most important elements of the risk management process.
34
Part II - Other Information
Item 1. Legal Proceedings
Refer to Legal Proceedings Item 3. of the Company's Current Report on Form 8-K
filed with the Securities and Exchange Commission on September 28, 2000. There
have been no significant changes in legal proceedings since that filing.
35
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(11) Statement Re Computation of Per Share Earnings
(12) Statement Re Computation of Ratio of Earnings to Fixed
Charges
(27) Financial Data Schedule
(b) Reports on Form 8-K
During the quarter, the Company filed the following Current
Reports on Form 8-K.
(i) A Current Report on Form 8-K dated June 14, 2000 and
filed on June 15, 2000, pertaining to the Company's results
of operations for the three-months ended May 26, 2000.
(ii) A Current Report on Form 8-K dated July 14, 2000 and
filed on July 21, 2000, pertaining to an opinion of
Cadwalader, Wickersham & Taft as to the legality of the
Floating Rate Global Notes due 2005 ("Global Notes") issued
by the Company, certain federal income tax consequences
described in the Prospectus Supplement dated July 14, 2000,
and a consent in connection with the offering of the Global
Notes.
(iii) A Current Report on Form 8-K dated August 10, 2000 and
filed on August 17, 2000, pertaining to an opinion of
Cadwalader, Wickersham & Taft as to the legality of the
7.80% Global Notes due 2007 ("7.8% Global Notes") issued by
the Company, certain federal income tax consequences
described in the Prospectus Supplement dated August 10,
2000, and a consent in connection with the offering of the
7.8% Global Notes.
36
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
The Bear Stearns Companies Inc.
-------------------------------
(Registrant)
Date: October 10, 2000 By: /s/ Marshall J Levinson
---------------------------
Marshall J Levinson
Controller
(Principal Accounting Officer)
37
THE BEAR STEARNS COMPANIES INC.
FORM 10-Q
EXHIBIT INDEX
-------------
EXHIBIT NO. DESCRIPTION PAGE
- ----------- ----------- ----
(11) Statement Re Computation of Per Share Earnings 39
(12) Statement Re Computation of Earnings to Fixed Charges 40
(27) Financial Data Schedule 41
38