Exhibit 13
2002 ANNUAL REPORT TO STOCKHOLDERS
page 2
THE BEAR STEARNS COMPANIES INC.
SELECTED FINANCIAL DATA
-----------------
FISCAL YEAR ENDED Fiscal year ended Fiscal year ended
NOVEMBER 30, 2002 November 30, 2001 November 30, 2000
- ----------------------------------------------------------------------------------------------------------
(in thousands, except share and other data)
- ----------------------------------------------------------------------------------------------------------
OPERATING RESULTS
Revenues, net of interest expense $ 5,128,236 $ 4,907,035 $ 5,475,678
Employee compensation and benefits 2,508,197 2,528,852 2,788,638
Non-compensation expenses 1,309,076 1,443,739 1,515,517
Total expenses 3,817,273 3,972,591 4,304,155
Income before provision for income taxes 1,310,963 934,444 1,171,523
Provision for income taxes 432,618 309,479 398,340
Income before cumulative effect of change
in accounting principle 878,345 624,965 773,183
Cumulative effect of change in
accounting principle, net of tax -- (6,273) --
Net income $ 878,345 $ 618,692 $ 773,183
Net income applicable to common shares $ 842,739 $ 579,579 $ 734,070
- ----------------------------------------------------------------------------------------------------------
FINANCIAL POSITION
Total assets $184,854,423 $ 185,530,228 $168,631,602
Long-term borrowings $ 23,681,399 $ 23,429,054 $ 20,095,888
Guaranteed Preferred Beneficial
Interests in Company Subordinated
Debt Securities(1) $ 562,500 $ 762,500 $ 500,000
Stockholders' equity $ 6,382,083 $ 5,628,527 $ 5,654,288
- ----------------------------------------------------------------------------------------------------------
COMMON SHARE DATA
Basic earnings per share(2) $ 7.00 $ 4.49 $ 5.37
Diluted earnings per share(2) $ 6.47 $ 4.27 $ 5.35
Cash dividends declared per common share(2) $ 0.62 $ 0.60 $ 0.55
Book value per common share(2) $ 39.94 $ 33.84 $ 31.51
Common shares outstanding(2)(3) 145,591,496 146,465,210 158,039,960
- ----------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Return on average common equity 18.1% 13.7% 19.1%
Profit margin(4) 25.6% 19.0% 21.4%
- ----------------------------------------------------------------------------------------------------------
OTHER DATA (in billions, except employees)
Margin debt balances, average for period $ 34.1 $ 39.3 $ 56.4
Customer short balances, average for period $ 54.6 $ 56.9 $ 64.5
Stock borrowed, average for period $ 44.1 $ 46.9 $ 52.1
Free credit balances, average for period $ 19.3 $ 18.7 $ 15.0
Assets under management, at period end $ 24.0 $ 24.2 $ 19.5
Employees 10,574 10,452 11,201
==========================================================================================================
Five months ended Fiscal year ended Fiscal year ended
November 26, 1999* June 30, 1999 June 30, 1998
- ------------------------------------------------------------------------------------------------------------
(in thousands, except share and other data)
- ------------------------------------------------------------------------------------------------------------
OPERATING RESULTS
Revenues, net of interest expense $ 1,938,503 $ 4,502,124 $ 4,341,423
Employee compensation and benefits 964,529 2,265,830 2,094,679
Non-compensation expenses 520,382 1,172,186 1,183,252
Total expenses 1,484,911 3,438,016 3,277,931
Income before provision for income taxes 453,592 1,064,108 1,063,492
Provision for income taxes 167,778 391,060 403,063
Income before cumulative effect of change
in accounting principle 285,814 673,048 660,429
Cumulative effect of change in
accounting principle, net of tax -- -- --
Net income $ 285,814 $ 673,048 $ 660,429
Net income applicable to common shares $ 269,517 $ 633,618 $ 629,417
- ------------------------------------------------------------------------------------------------------------
FINANCIAL POSITION
Total assets $162,037,962 $153,894,340 $154,495,895
Long-term borrowings $ 15,911,392 $ 14,647,092 $ 13,295,952
Guaranteed Preferred Beneficial
Interests in Company Subordinated
Debt Securities(1) $ 500,000 $ 500,000 $ 350,000
Stockholders' equity $ 4,941,947 $ 4,955,509 $ 4,291,533
- ------------------------------------------------------------------------------------------------------------
COMMON SHARE DATA
Basic earnings per share(2) $ 1.78 $ 4.26 $ 4.17
Diluted earnings per share(2) $ 1.78 $ 4.26 $ 4.17
Cash dividends declared per common share(2) $ 0.29 $ 0.56 $ 0.54
Book value per common share(2) $ 26.93 $ 25.60 $ 21.64
Common shares outstanding(2)(3) 165,956,810 167,265,996 167,173,826
- ------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Return on average common equity 16.6% 18.8% 21.7%
Profit margin(4) 23.4% 23.6% 24.5%
- ------------------------------------------------------------------------------------------------------------
OTHER DATA (in billions, except employees)
Margin debt balances, average for period $ 43.8 $ 40.6 $ 45.8
Customer short balances, average for period $ 58.6 $ 60.7 $ 59.4
Stock borrowed, average for period $ 46.8 $ 45.3 $ 42.2
Free credit balances, average for period $ 13.0 $ 12.3 $ 10.1
Assets under management, at period end $ 13.0 $ 12.2 $ 9.8
Employees 10,081 9,808 9,180
============================================================================================================
* On January 18, 2000, the Company's Board of Directors elected to change
its fiscal year end to November 30 from June 30, effective with the fiscal year
beginning November 27, 1999.
(1) As of November 30, 2002, Guaranteed Preferred Beneficial Interests in
Company Subordinated Debt Securities consists of $300 million of Preferred
Securities issued by Bear Stearns Capital Trust II and $262.5 million of
Preferred Securities issued by Bear Stearns Capital Trust III. As of
November 30, 2001, Guaranteed Preferred Beneficial Interests in Company
Subordinated Debt Securities consists of $200 million of Capital
Securities issued by Bear Stearns Capital Trust I, $300 million of
Preferred Securities issued by Bear Stearns Capital Trust II and $262.5
million of Preferred Securities issued by Bear Stearns Capital Trust III.
As of November 30, 2000, November 26, 1999 and June 30, 1999, Guaranteed
Preferred Beneficial Interests in Company Subordinated Debt Securities
consists of $200 million of Capital Securities issued by Bear Stearns
Capital Trust I and $300 million of Preferred Securities issued by Bear
Stearns Capital Trust II. As of June 30, 1998, Guaranteed Preferred
Beneficial Interests in Company Subordinated Debt Securities consists of
$150 million of Exchangeable Preferred Income Cumulative Shares, which
were issued by one of our subsidiaries, and $200 million of Capital
Securities issued by Bear Stearns Capital Trust I. Each of the trusts is a
wholly owned subsidiary of the Company and holds certain of our
subordinated debentures as its sole asset.
(2) Reflects all stock dividends prior to November 30, 2002.
(3) Common shares outstanding include units issued under certain stock
compensation plans which will be distributed as shares of common stock.
(4) Represents the ratio of income before provision for income taxes to
revenues, net of interest expense.
Note: Certain reclassifications have been made to prior period amounts to
conform to the current year's presentation.
page 24
THE BEAR STEARNS COMPANIES INC.
FINANCIAL REPORT
25 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
44 RISK MANAGEMENT
52 CONSOLIDATED STATEMENTS OF INCOME
53 CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
54 CONSOLIDATED STATEMENTS OF CASH FLOWS
55 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
81 INDEPENDENT AUDITORS' REPORT
THE BEAR STEARNS COMPANIES INC.
page 25
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
and derivatives sales and trading, clearance and brokerage -- are, by their
nature, highly competitive and subject to various risks, including volatile
trading markets and fluctuations in the volume of market activity. Consequently,
the Company's net income and revenues have been, and are likely to continue to
be, subject to wide fluctuations, reflecting the effect of many factors,
including general economic conditions, securities market conditions, the level
and volatility of interest rates and equity prices, competitive conditions,
liquidity of global markets, international and regional political conditions,
regulatory developments, monetary and fiscal policy, investor sentiment,
availability and cost of capital, technological changes and events, and the
size, volume 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 CONCERNING MANAGEMENT'S EXPECTATIONS, STRATEGIC
OBJECTIVES, BUSINESS PROSPECTS, ANTICIPATED ECONOMIC PERFORMANCE AND FINANCIAL
CONDITION AND OTHER SIMILAR MATTERS ARE SUBJECT TO RISKS AND UNCERTAINTIES,
INCLUDING THOSE DESCRIBED IN THE PRIOR PARAGRAPH, WHICH COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE DISCUSSED IN THE FORWARD-LOOKING
STATEMENTS. FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE OF THE DOCUMENT
IN WHICH THEY ARE MADE. WE DISCLAIM ANY OBLIGATION OR UNDERTAKING TO PROVIDE ANY
UPDATES OR REVISIONS TO ANY FORWARD-LOOKING STATEMENT TO REFLECT ANY CHANGE IN
OUR EXPECTATIONS OR ANY CHANGE IN EVENTS, CONDITIONS OR CIRCUMSTANCES ON WHICH
THE FORWARD-LOOKING STATEMENT IS BASED.
CRITICAL ACCOUNTING POLICIES
The consolidated financial statements of the Company are prepared in conformity
with accounting principles generally accepted in the United States of America.
These principles require management to make certain estimates and assumptions
which could materially affect reported amounts in the financial statements (see
Note 1, "Summary of Significant Accounting Policies," in the Notes to
Consolidated Financial Statements). Critical accounting policies are those
policies that are the most important to the financial statements and/or those
that require significant management judgment related to matters that are
uncertain.
VALUATION OF FINANCIAL INSTRUMENTS
The Company has identified the valuation of financial instruments as a critical
accounting policy due to the complex nature of certain of its products, the
degree of judgment required to appropriately value these products and the
pervasive impact of such valuation on the financial condition and earnings of
the Company.
The Company's financial instruments can be aggregated in three broad categories:
(1) those valued based on quoted market prices or for which the Company has
independent external valuations, (2) those whose fair value is determined based
on readily observable price levels for similar instruments and/or models or
methodologies that employ data that are observable from objective sources, and
(3) those whose fair value is estimated based on internally developed models or
methodologies utilizing significant assumptions or other data that are generally
less readily observable from objective sources.
(1) Financial Instruments Valued Based on Quoted Market Prices or for Which the
Company Has Independent External Valuations
The Company's valuation policy is to use quoted market prices from securities
and derivatives exchanges where they are available and reliable. Financial
instruments valued based on quoted market prices are primarily exchange-traded
derivatives and listed equities. Financial instruments that are most typically
valued via alternative approaches but for which the Company typically receives
independent external valuation information include US treasuries, most
mortgage-backed securities and corporate, emerging market, high yield and
municipal bonds. Unlike most equities, which tend to be traded on exchanges, the
vast majority of fixed income trading (including US treasuries) occurs in
over-the-counter markets, and, accordingly, the Company's valuation policy is
based on its best estimate of the prices at which these financial instruments
trade in those markets. The Company is an active dealer in most of the
over-the-counter markets for these financial instruments, and typically has
considerable insight into the trading level of financial instruments held in
inventory and/or related financial instruments that it uses as a basis for its
valuation.
(2) Financial Instruments Whose Fair Value is Determined Based on Internally
Developed Models or Methodologies That Employ Data That Are Readily Observable
from Objective Sources
The second broad category consists of financial instruments for which the
Company does not receive quoted prices; therefore, models or other methodologies
are utilized to value these financial instruments. Such models are primarily
industry-standard models that consider various
THE BEAR STEARNS COMPANIES INC.
page 26
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
assumptions, including time value, yield curve, volatility factors, prepayment
speeds, default rates, loss severity, current market and contractual prices for
the underlying financial instruments, as well as other relevant economic
measures. Substantially all these assumptions are observable in the marketplace,
can be derived from observable data or are supported by observable levels at
which transactions are executed in the marketplace. A degree of subjectivity is
required to determine appropriate models or methodologies as well as appropriate
underlying assumptions. This subjectivity makes these valuations inherently less
reliable than quoted market prices. Financial instruments in this category
include non-exchange-traded derivatives such as interest rate swaps, certain
mortgage-backed securities and certain other cash instruments. For an indication
of the Company's involvement in derivatives, including maturity terms, see the
table setting forth notional/contract amounts outstanding in the "Derivative
Financial Instruments" section.
(3) Financial Instruments Whose Fair Value is Estimated Based on Internally
Developed Models or Methodologies Utilizing Significant Assumptions or Other
Data That Are Generally Less Readily Observable from Objective Sources
Certain complex financial instruments and other investments have significant
data inputs that cannot be validated by reference to readily observable data.
These instruments are typically illiquid, long-dated or unique in nature and
therefore engender considerable judgment by traders and their management, who,
as dealers in many of these instruments, have the appropriate knowledge to
estimate data inputs that are less readily observable. For certain instruments,
extrapolation or other methods are applied to observed market or other data to
estimate assumptions that are not observable. At November 30, 2002, such
positions (primarily fixed income cash positions) aggregated approximately $3.1
billion in "Financial Instruments Owned" and $328 million in "Financial
Instruments Sold, But Not Yet Purchased" in the Consolidated Statements of
Financial Condition.
As part of the Company's fixed income activities, the Company participates in
the underwriting, securitization and trading of non-performing mortgage-related
assets, real estate assets and certain residuals. In addition, the Company has a
portfolio of Chapter 13 and other credit card receivables from individuals.
Certain of these high yield positions have limited price observability. In these
instances, fair values are determined by statistical analysis of historical cash
flows, default probabilities, recovery rates, time value of money and discount
rates considered appropriate given the level of risk in the instrument and
associated investor yield requirements.
As a major dealer in derivatives, the Company is engaged in structuring and
acting as principal in complex derivative transactions. Complex derivatives
include certain long-dated equity derivatives, certain credit and municipal
derivatives and other exotic derivative structures. These non-exchange-traded
instruments may have immature or limited markets and, by their nature, involve
complex valuation methodologies and models, which are often refined to correlate
with the market risk of these instruments.
In recognition of the importance the Company places on the accuracy of its
valuation of financial instruments as described in the three categories above,
the Company engages in an ongoing internal review of its valuations. Members of
the Controllers and Risk Management Departments perform analysis of internal
valuations, typically on a monthly basis but often on an intra-month basis as
well. These departments are independent of the trading areas responsible for
valuing the positions. Results of the monthly validation process are reported to
the Mark-to-Market (MTM) Committee, which is composed of senior managing
directors from the Risk Management and Controllers Departments. The MTM
Committee is responsible for ensuring that the approaches used to independently
validate the Company's valuations are robust, comprehensive and effective.
Typical approaches include valuation comparisons with external sources,
comparisons with observed trading, independent comparisons of key model
valuation inputs, independent trade modeling and a variety of other techniques.
Merchant Banking
As part of its merchant banking activities, the Company participates from time
to time in principal investments in leveraged transactions. 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.
Equity securities acquired as a result of leveraged acquisition transactions are
reflected in the consolidated financial statements at their initial cost until
significant transactions or developments indicate that a change in the carrying
value of the securities is appropriate. Generally, the carrying values of these
securities will be increased only in those instances where market values are
readily ascertainable by reference to substantial transactions occurring in the
marketplace or
THE BEAR STEARNS COMPANIES INC.
page 27
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
quoted market prices. 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 (see "Merchant Banking Investments" for
additional details).
See Note 1, "Summary of Significant Accounting Policies," in the Notes to
Consolidated Financial Statements for a more comprehensive listing of
significant accounting policies.
RECENT DEVELOPMENTS
On December 20, 2002, Bear, Stearns & Co. Inc. ("Bear Stearns") reached an
agreement in principle with the United States Securities and Exchange
Commission; the National Association of Securities Dealers; the New York Stock
Exchange, Inc.; the Offices of the Attorneys General of New York, New Jersey,
Delaware, Vermont and Hawaii; and the North American Securities Administrators
Association on behalf of all the remaining states to resolve their
investigations of Bear Stearns relating to research analyst independence.
Pursuant to the agreement in principle, Bear Stearns agreed, among other things,
to: (1) pay $50 million in retrospective relief; (2) adopt internal, structural
and operational reforms that will further augment the steps it has already taken
to ensure research analyst independence and promote investor confidence; (3)
contribute $25 million spread over five years to provide independent,
third-party research to clients; (4) contribute $5 million for investor
education programs; and (5) in connection with the agreement in principle, adopt
restrictions on the allocation of shares in initial public offerings to
corporate executives and directors of public companies. This agreement is not
expected to have a material effect on the future results of operations.
BUSINESS ENVIRONMENT
The business environment during fiscal 2002 continued to be characterized by
economic uncertainty and challenging market conditions. During the first half of
fiscal 2002, several negative factors affected the business environment,
including concerns regarding the accuracy of reported financial results and the
reliability of corporate accounting practices, weakness in capital spending and
unemployment at eight-year highs. Despite these factors, there was growing
sentiment that the economy and corporate profits were strengthening and, as a
result, consumer confidence increased steadily during this period. However,
concerns pertaining to corporate accountability, along with high unemployment,
continued into the second half of fiscal 2002 as businesses adjusted their
workforces to reflect slow growth in the US economy. In addition, the WorldCom,
Inc. difficulties in the third quarter led to significant widening of corporate
credit spreads as the reliability of corporate reporting came into question.
These factors, together with the emergence of heightened geopolitical risks,
resulted in a steady decline in consumer confidence and significant volatility
in the equity markets during the second half of fiscal 2002. The Dow Jones
Industrial Average ("DJIA") and Standard & Poor's 500 Index ("S&P 500") declined
26.6% and 27.2%, respectively, from the beginning of the second half of the
fiscal year through mid-October amid a selloff in stocks. However, over the
balance of the fiscal year, the equity markets recovered from their October lows
as economic reports provided an indication of stability in the economy.
With inflation well contained, the Federal Reserve Board ("Fed") cut the federal
funds rate twice in fiscal 2002, for a total of 75 basis points to 1.25%, in an
effort to stimulate the economy. During the year, the Fed's economic bias
changed three times, fluctuating between weakness and neutral.
During fiscal 2002, the average daily trading volume on the New York Stock
Exchange, Inc. ("NYSE") increased 16.3%, while the average daily trading volume
on the Nasdaq decreased 7.7% from fiscal 2001. The major equity indices suffered
declines for the third straight year. During fiscal 2002, the DJIA declined 9.7%
to close at 8,896 at November 30, 2002, while the S&P 500 and Nasdaq Composite
Index ("NASDAQ") declined 17.8% and 23.4%, respectively. Equity capital markets
activities continued to be adversely affected by the impact of difficult global
economic conditions, reflecting continued lack of investor demand. Global- and
US-announced mergers and acquisitions volumes remained at low levels.
Domestic-completed mergers and acquisitions activity dropped 53.8%, reflecting
unstable market conditions compared with fiscal 2001. However, the economic and
interest rate environment provided favorable conditions for fixed income
activities in fiscal 2002. The Fed rate cuts, combined with a steep yield curve,
created strong demand for domestic debt issuances and strong secondary market
activities. As a result, the Company experienced strong results in its fixed
income activities, particularly in the mortgage- and asset-backed areas.
THE BEAR STEARNS COMPANIES INC.
page 28
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
The business environment during fiscal 2001 was characterized by a generally
weak US economy attributable to several factors, including a slowdown in
consumer spending, a decline in capital spending and an increase in
unemployment. The Fed cut the federal funds rate 10 times, for a total of 450
basis points, to 2%. US equity indices were volatile during fiscal 2001 as the
market responded to numerous economic reports, corporate earnings reports and
profit warnings. During fiscal 2001, the average daily trading volume on the
NYSE and Nasdaq rose 21.7% and 16.8%, respectively. The DJIA, S&P 500 and Nasdaq
declined 5.4%, 13.4% and 25.7%, respectively. The terrorist attacks of September
11, 2001 resulted in the US markets being closed for four consecutive business
days and, in the aftermath, unemployment reached its highest level in five years
and consumer confidence plunged. The combination of a weak economy, a declining
stock market and the terrorist attacks resulted in an extremely challenging year
for the securities industry. Global stock issuance volumes declined, reflecting
falling stock prices and lack of investor demand. Global- and US-announced
mergers and acquisitions volumes dropped dramatically during fiscal 2001,
reflecting unstable equity market conditions. However, the economic and interest
rate environment provided favorable conditions for fixed income activities in
fiscal 2001. The Fed rate cuts, together with a steepening yield curve, created
strong demand for domestic debt issuances and refinancings. As a result,
investment-grade debt and mortgage-backed securities new issue volumes increased
significantly.
RESULTS OF OPERATIONS
In the discussion to follow, results for the fiscal year ended November 30, 2002
("fiscal 2002") will be compared with the results for the fiscal year ended
November 30, 2001 ("fiscal 2001"), and the results for fiscal 2001 will be
compared with the results for the fiscal year ended November 30, 2000 ("fiscal
2000").
The Company reported net income of $878.3 million, or $6.47 per share (diluted),
for fiscal 2002, which represented an increase of 42.0% from $618.7 million, or
$4.27 per share (diluted), for fiscal 2001. Results for fiscal 2002 include a
merchant banking gain of $226.9 million, included in investment banking
revenues, from an investment in and initial public offering of Aeropostale, Inc.
Excluding the impact of this gain, earnings per share (diluted) was $5.57 for
fiscal 2002, an increase of 30.4% from fiscal 2001. The Company reported net
income of $773.2 million, or $5.35 per share (diluted), in fiscal 2000.
Fiscal 2002 versus Fiscal 2001 Revenues, net of interest expense ("net
revenues"), increased 4.5% to $5.1 billion in fiscal 2002 from $4.9 billion in
fiscal 2001. Net revenues, excluding the merchant banking gain, were $4.9
billion, unchanged from fiscal 2001.
Commission revenues in fiscal 2002 were virtually unchanged from fiscal 2001 at
$1.1 billion. Weak economic conditions led to a reduction in clearance and
retail commission revenues, which declined a combined 10.7% to $496.8 million in
fiscal 2002 from $556.6 million in fiscal 2001. This decline was offset by
increases in institutional commissions due to increased volume. Market share
increased significantly for both listed and over-the-counter institutional
volume. In addition, a new industry-wide commission-based pricing structure
(commission equivalents) for executing transactions on the Nasdaq resulted in an
increase in institutional commissions. Previously, the Company did not charge
explicit fees in this business, but rather earned market-making revenues based
generally on the difference between bid and ask prices. Such revenues were
previously recorded in principal transactions revenues.
The Company's principal transactions revenues by reporting categories for the
fiscal years ended November 30 were as follows:
----------
2002 2001 2000
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
Fixed income $1,662,952 $1,325,588 $ 881,494
Equity 410,052 549,199 767,051
Derivative financial instruments 464,795 408,010 576,473
- --------------------------------------------------------------------------------
Total principal transactions $2,537,799 $2,282,797 $2,225,018
================================================================================
Revenues from principal transactions in fiscal 2002 increased 11.2% to $2.5
billion from $2.3 billion in fiscal 2001, reflecting strong results from the
Company's fixed income activities, particularly in the mortgage- and
asset-backed securities, distressed debt and government bonds areas. These
business areas benefited from a favorable interest rate environment,
characterized by a low level of short-term interest rates, a steep yield curve
and increased customer order flow. The increase in revenues derived from fixed
income activities was partially offset by a decrease in revenues derived from
equity activities, particularly in the over-the-counter, convertible arbitrage
and risk arbitrage areas. Derivative financial instruments increased 13.9% to
$464.8 million from $408.0 million in fiscal 2001, reflecting increased equity
and interest rate derivatives revenues due to increased customer activity.
THE BEAR STEARNS COMPANIES INC.
page 29
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
Investment banking revenues increased 7.9% to $833.5 million in fiscal 2002 from
$772.1 million in fiscal 2001. Investment banking net revenues include
underwriting, merchant banking and advisory services revenues. Merchant banking
revenues were $238.3 million in fiscal 2002, including the gain on Aeropostale,
Inc. of $226.9 million, up from $77.4 million in fiscal 2001. Without the
merchant banking gain for Aeropostale, Inc., investment banking revenues
decreased 21.4% to $606.6 million in fiscal 2002. Underwriting revenues
increased 7.3% to $405.1 million in fiscal 2002 from $377.6 million in fiscal
2001, reflecting increased new issue activity. Advisory services revenues
decreased 40.1% to $190.1 million from $317.1 million in fiscal 2001 as the
level of completed mergers and acquisitions activity continued to decline.
Net interest revenues, interest and dividend revenue less interest expense, was
$469.6 million in fiscal 2002, a 13.9% decline from $545.3 million for fiscal
2001. The decrease in net interest revenues was primarily attributable to lower
levels of customer margin debt from prime brokerage clients. Difficult equity
market conditions experienced throughout fiscal 2002 continued to cause
professional investors to employ generally lower levels of leverage. Average
margin debit balances fell 13.2% to $34.1 billion in fiscal 2002 from $39.3
billion in fiscal 2001.
Fiscal 2001 versus Fiscal 2000 Net revenues decreased 10.4% to $4.9 billion in
fiscal 2001 from $5.5 billion in fiscal 2000. The decrease in net revenues
reflects a decrease in net interest revenues, investment banking revenues and
commissions. Lower levels of customer margin debt balances from professional and
retail investors in fiscal 2001 resulted in reduced net interest revenues. In
addition, challenging economic conditions and weakness in the US equity markets
resulted in reduced revenue levels from the Company's equity underwriting and
mergers and acquisitions activities.
Commission revenues decreased 7.5% to $1.1 billion in fiscal 2001 from $1.2
billion in fiscal 2000. Clearance and retail commissions declined a combined
21.4% to $556.6 million in fiscal 2001 from $708.5 million in fiscal 2000.
Difficult equity market conditions significantly reduced retail and fully
disclosed clearance customer activity. Partially offsetting the decline in
clearance and retail commissions was an increase in both institutional and
futures commissions.
Revenues from principal transactions in fiscal 2001 increased 2.6% to $2.3
billion from $2.2 billion in fiscal 2000, reflecting increases in revenues from
the Company's fixed income activities, particularly in the mortgage-backed
securities and distressed debt areas. These increases reflected a favorable
interest rate environment and increased customer demand. The increase in
revenues derived from fixed income activities was offset by a decrease in
revenues derived from equity activities, particularly the risk arbitrage and
over-the-counter market-making areas. In addition, derivatives revenues
declined, reflecting reduced equity derivatives revenues due to less favorable
market conditions and reduced customer activity.
Investment banking revenues decreased 24.4% to $772.1 million from $1.0 billion
in fiscal 2000. Industry-wide weakness in equity underwriting and completed
mergers and acquisitions led to the decline. Underwriting revenues decreased
5.4% to $377.6 million from $399.0 million in fiscal 2000, reflecting
industry-wide weakness in new issue volume. Advisory services revenues decreased
to $317.1 million, or 38.4% from $515.0 million in fiscal 2000.
Net interest revenues decreased 37.3% to $545.3 million in fiscal 2001, from
$870.1 million in fiscal 2000. The decrease in net interest revenues was
primarily attributable to lower levels of margin debt financing employed by both
prime brokerage and fully disclosed clearance clients. As a result of difficult
equity market conditions, clients employed significantly lower levels of
leverage in their portfolios. Average margin debt balances declined 30.3% to
$39.3 billion in fiscal 2001 from $56.4 billion in fiscal 2000.
NON-INTEREST EXPENSES
----------
2002 2001 2000
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
Employee compensation
and benefits $2,508,197 $2,528,852 $2,788,638
Floor brokerage, exchange
and clearance fees 197,266 161,363 158,940
Communications and
technology 382,857 453,261 449,691
Occupancy 152,523 146,620 134,596
Advertising and market
development 102,984 126,669 125,153
Professional fees 132,927 175,249 190,871
Other expenses 340,519 380,577 456,266
- --------------------------------------------------------------------------------
Total non-interest expenses $3,817,273 $3,972,591 $4,304,155
================================================================================
THE BEAR STEARNS COMPANIES INC.
page 30
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
Fiscal 2002 versus Fiscal 2001 Employee compensation and benefits for fiscal
2002 were $2.51 billion, down 0.8% when compared with $2.53 billion in fiscal
2001. Employee compensation and benefits as a percentage of net revenues was
48.9% for fiscal 2002, compared with 51.5% for fiscal 2001. Excluding the effect
of the merchant banking gain related to the Company's investment in Aeropostale,
Inc., compensation as a percentage of net revenues was 50.9% for the fiscal year
ended November 30, 2002. The decline in compensation as a percentage of net
revenues was principally attributable to the full-year-effect of workforce
reductions completed over the course of fiscal 2001. Full-time employees
increased slightly to 10,574 at November 30, 2002 from 10,452 at November 30,
2001.
Non-compensation expenses were $1.31 billion for fiscal 2002, a decrease of 9.3%
from $1.44 billion in fiscal 2001. Non-compensation expenses excluding the
merchant banking gain were $1.29 billion, a decrease of 10.9% from fiscal 2001.
Non-compensation expenses as a percentage of net revenues for fiscal 2002
declined to 25.5%, compared with 29.4% in fiscal 2001. Excluding the merchant
banking gain, non-compensation expenses as a percentage of net revenues was
26.3% for fiscal 2002. The decrease in non-compensation expenses was primarily
due to decreases in communications and technology costs, severance-related costs
and professional fees, reflecting expense control measures taken during fiscal
2001 and continuing in fiscal 2002, as further described below.
The decline in communications and technology costs was attributable to the
Company's relocation of its corporate headquarters to 383 Madison Avenue during
fiscal 2001 and a significant reduction in the use of information technology
consultants. Professional fees decreased as a result of decreases in employment
agency fees and consulting fees not related to information technology. Other
expenses also decreased due to decreases in litigation expenses and
severance-related costs, partially offset by an increase in the Capital
Accumulation Plan for Senior Managing Directors, as amended ("CAP Plan")
expenses. Severance-related costs during fiscal 2002 totaled $25.6 million,
compared with $84.2 million during fiscal 2001. These decreases were partially
offset by an increase in floor brokerage, exchange and clearance fees, which
increased 22.2% to $197.3 million from $161.4 million for fiscal 2001. These
fees resulted from increased trading volume in futures and options and the use
of electronic platforms. Expenses for the CAP Plan were $154.0 million for
fiscal 2002, a $31.0 million increase from $123.0 million in fiscal 2001,
reflecting the higher level of earnings in fiscal 2002 as compared with fiscal
2001. The expense control measures enabled the Company to achieve a pre-tax
profit margin of 25.6% for fiscal 2002. Excluding the merchant banking gain, the
pre-tax profit margin was 22.9% for fiscal 2002, compared with 19.0% for fiscal
2001.
The Company's effective tax rate was 33.0% in fiscal 2002 and 2001.
Fiscal 2001 versus Fiscal 2000 Employee compensation and benefits in fiscal 2001
decreased 9.3% to $2.5 billion from $2.8 billion in fiscal 2000. The decrease
was attributable to a decrease in incentive and discretionary bonuses associated
with a decrease in net revenues, a decrease in the number of employees and a
decrease in sales commissions in fiscal 2001. Employee compensation and benefits
as a percentage of net revenues increased to 51.5% in fiscal 2001 from 50.9% in
fiscal 2000. The generally weak operating environment experienced by many of the
Company's business areas adversely affected compensation as a percentage of net
revenues during fiscal 2001. Included in compensation for fiscal 2001 is
approximately $67 million in salaries and benefits related to employees who were
terminated during the year. Full-time employees decreased to 10,452 at November
30, 2001 from 11,201 at November 30, 2000.
In fiscal 2001, the Company launched a firmwide effort to reduce operating
expenses and increase efficiency. During that year, the Company reduced its
workforce by approximately 1,300 people. Non-compensation expense savings were
achieved in telecommunications, consulting and professional fees and in
occupancy costs related to relocation to the Company's new headquarters.
Non-compensation expenses for fiscal 2001 were $1.4 billion, a 4.7% decrease
from $1.5 billion in fiscal 2000. Fiscal 2001 expenses included severance costs
of $84.2 million and approximately $50.0 million of non-recurring accelerated
amortization costs of technology equipment and leasehold improvements, and
expenses incurred in connection with the Company's relocation to its new
headquarters. During fiscal 2000, expenses included an after-tax litigation
charge of $96.0 million ($150 million pre-tax recorded in "Other Expenses" in
the Consolidated Statements of Income). Expenses for the CAP Plan in fiscal 2001
were $123.0 million, down from $140.0 million in fiscal 2000, due to a lower
level of earnings. Professional fees decreased to $175.2 million from $190.9
million, primarily due to a decrease in employment agency fees in fiscal 2001.
THE BEAR STEARNS COMPANIES INC.
page 31
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
The Company's effective tax rate decreased to 33.0% in fiscal 2001, compared
with 34.0% in fiscal 2000, primarily due to higher relative levels of tax
preference items.
BUSINESS SEGMENTS
The remainder of "Results of Operations" is presented on a business segment
basis. The Company's three business segments -- Capital Markets, Global Clearing
Services and Wealth Management -- are 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 Global Clearing
Services distribution networks, with the related revenues of such intersegment
services allocated to the respective segments. Certain reclassifications have
been made to prior year amounts in the Capital Markets segment to conform to the
current year's presentation, including reclassification of certain revenues from
institutional equities to investment banking.
The following segment operating results exclude certain unallocated revenues
(predominantly interest) as well as certain corporate administrative functions,
such as certain legal costs and costs related to the CAP Plan.
CAPITAL MARKETS
----------
2002 2001 2000
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
Net revenues
Institutional equities $1,117,762 $1,131,124 $1,417,592
Fixed income 1,938,045 1,602,034 1,092,568
Investment banking 883,717 752,473 1,000,079
- --------------------------------------------------------------------------------
Total net revenues $3,939,524 $3,485,631 $3,510,239
================================================================================
Pre-tax income $1,343,912 $ 867,166 $ 899,101
================================================================================
The Capital Markets segment comprises the institutional equities, fixed income
and investment banking areas. The Capital Markets segment operates as a single
integrated unit that provides the sales, trading and origination effort for
various fixed income, equity and advisory products and services. Each of the
three businesses works in tandem to deliver these services to institutional and
corporate clients.
Institutional equities consists of sales, trading and research in areas such as
institutional domestic and international equity sales, block trading,
convertible bonds, over-the-counter equities, equity derivatives, risk and
convertible arbitrage and NYSE, American Stock Exchange, Inc. and International
Securities Exchange specialist activities. Fixed income includes sales, trading
and research for institutional clients in a variety of products such as
mortgage- and asset-backed securities, corporate and government bonds, municipal
and high yield products, foreign exchange and fixed income derivatives.
Investment banking provides services in capital raising, strategic advice,
mergers and acquisitions and merchant banking. Capital raising encompasses the
Company's underwriting of equity, investment-grade and high yield debt products.
Fiscal 2002 versus Fiscal 2001 Net revenues for Capital Markets were $3.9
billion in fiscal 2002, an increase of 13.0% from $3.5 billion in fiscal 2001.
Expenses decreased in fiscal 2002 from fiscal 2001 largely due to expense
reductions realized from the Company's margin improvement program. Pre-tax
income for Capital Markets was $1.3 billion in fiscal 2002, an increase of 55.0%
from $867.2 million in fiscal 2001. Without the gain on the merchant banking
transaction, net revenues for Capital Markets were $3.7 billion, an increase of
6.5% from fiscal 2001. Similarly, pre-tax income for Capital Markets was $1.2
billion, an increase of 33.2% from fiscal 2001.
Institutional equities net revenues for fiscal 2002 decreased 1.2% to $1.12
billion from $1.13 billion in fiscal 2001, primarily reflecting lower revenues
from the risk and convertible arbitrage areas. Risk arbitrage revenues continued
to be adversely affected by lower levels of announced mergers and acquisitions
activity, which consequently provided fewer risk arbitrage opportunities.
Declining volatility and widening credit spreads served to negatively affect
convertible arbitrage activity during fiscal 2002. These results were partially
offset by improved results in the equity derivatives and convertible securities
areas, which benefited from increased customer activity and improved market
conditions. Despite challenging market conditions, institutional equities sales
revenues were unchanged as compared with fiscal 2001, reflecting increased
market share in both listed and over-the-counter securities.
Fixed income net revenues increased to $1.9 billion in fiscal 2002, an increase
of 21.0% from $1.6 billion in fiscal 2001. The low level of short-term interest
rates and a steep yield curve resulted in increased levels of activity and net
revenues, particularly in the mortgage- and asset-backed securities, distressed
debt and government bonds areas, as well as interest rate derivatives. The
mortgage- and asset-backed area had record net
THE BEAR STEARNS COMPANIES INC.
page 32
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
revenues in fiscal 2002, reflecting favorable market conditions that served to
increase secondary trading activity and resulted in strong new issue volume.
Investment banking net revenues in fiscal 2002 increased 17.4% to $883.7 million
from $752.5 million in fiscal 2001. The fiscal 2002 results include realized and
unrealized gains of $226.9 million in an investment in Aeropostale, Inc.
Excluding the merchant banking gain, net revenues for fiscal 2002 were $656.8
million, down 12.7% from fiscal 2001. Investment banking net revenues include
those for underwriting, merchant banking and advisory services. Underwriting
revenues increased 18.3% to $488.6 million in fiscal 2002 from $412.9 million in
fiscal 2001, reflecting higher levels of municipal and equity underwriting
activity. Merchant banking revenues increased to $238.3 million in fiscal 2002,
including the gain from Aeropostale, Inc., as compared with $77.4 million in
fiscal 2001. However, advisory services revenues decreased to $156.8 million, or
40.2%, from $262.2 million in fiscal 2001 as the level of completed mergers and
acquisitions activity continued to decline in the unfavorable market
environment.
Fiscal 2001 versus Fiscal 2000 Net revenues for Capital Markets were $3.49
billion in fiscal 2001, a decrease of 0.7% compared with $3.51 billion in fiscal
2000. Pre-tax income for Capital Markets was $867.2 million in fiscal 2001, down
3.6% from $899.1 million in fiscal 2000.
Institutional equities net revenues for fiscal 2001 decreased 20.2% to $1.1
billion from $1.4 billion in fiscal 2000. A general downturn in the global
equities market resulted in lower levels of customer activity and reduced
revenues derived from equity derivatives, risk arbitrage and over-the-counter
market-making areas.
Fixed income net revenues in fiscal 2001 increased $509.5 million or 46.6%, from
$1.1 billion in fiscal 2000. The Fed eased policy in fiscal 2001, including 10
interest rate cuts totaling 450 basis points, which contributed to the strength
in the Company's fixed income businesses. Increased levels of mortgage-backed
securities, new issue volume and strong secondary customer activity contributed
to record revenues from the Company's mortgage-backed securities area.
Investment banking net revenues in fiscal 2001 decreased 24.8% to $752.5 million
from $1.0 billion in fiscal 2000. Underwriting revenues decreased 11.1% to
$412.9 million from $464.6 million in fiscal 2000, reflecting industry-wide
weakness in equity new issue volume. Advisory services revenues decreased to
$262.2 million, or 38.7%, from $427.5 million in fiscal 2000. The level of
announced US mergers and acquisitions activity declined significantly in fiscal
2001. The decrease in equity underwriting and advisory service revenues was
partially offset by an increase in high grade, high yield and municipal
underwriting revenues. Merchant banking revenues were $77.4 million and $108.0
million for fiscal 2001 and fiscal 2000, respectively.
GLOBAL CLEARING SERVICES
--------
2002 2001 2000
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
Net revenues $778,087 $810,601 $1,074,498
Pre-tax income $265,327 $249,754 $ 466,217
================================================================================
The Global Clearing Services segment provides execution, clearing, margin
lending and securities borrowing to facilitate customer short sales to clearing
clients worldwide. Prime brokerage clients include hedge funds and clients of
money managers, short sellers, arbitrageurs and other professional investors.
Fully disclosed clients engage in either the retail or institutional brokerage
business. At November 30, 2002, the Company held approximately $164 billion in
assets in Global Clearing Services client accounts.
Fiscal 2002 versus Fiscal 2001 Net revenues for Global Clearing Services
decreased 4.0% to $778.1 million in fiscal 2002, from $810.6 million in fiscal
2001. Lower prime brokerage and fully disclosed commissions were primarily
responsible for the decline in net revenues. Average margin balances declined
13.2% to $34.1 billion in fiscal 2002 from $39.3 billion in fiscal 2001.
Difficult equity market conditions characterized by unstable share prices
produced fewer investment opportunities and resulted in lower leverage levels
used by prime brokerage and fully disclosed customers. Expenses decreased in
fiscal 2002 from fiscal 2001, largely due to expense reductions realized from
reduced technology, research and administrative costs. As a result, pre-tax
income for Global Clearing Services was $265.3 million in fiscal 2002, an
increase of 6.2% from $249.8 million for fiscal 2001. Pre-tax profit margin was
34.1% for fiscal 2002 as compared with 30.8% for fiscal 2001.
Fiscal 2001 versus Fiscal 2000 Net revenues for Global Clearing Services were
$810.6 million in fiscal 2001, down 24.6% from $1.1
THE BEAR STEARNS COMPANIES INC.
page 33
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
billion in fiscal 2000. The decrease in net revenues was principally due to
reduced net interest revenues attributable to significantly lower levels of
customer margin debt balances and customer short balances. Difficult equity
market conditions characterized by unstable share prices produced fewer
investment opportunities and resulted in hedge fund clients deleveraging.
Average margin debt balances were $39.3 billion during fiscal 2001, compared
with $56.4 billion during fiscal 2000. Margin debt balances totaled $34.3
billion at November 30, 2001, compared with $41.9 billion at November 30, 2000.
Average customer short balances were $56.9 billion during fiscal 2001, compared
with $64.5 billion during fiscal 2000 and totaled $55.0 billion at November 30,
2001, down from $57.2 billion at November 30, 2000. Pre-tax income for Global
Clearing Services was $249.8 million in fiscal 2001, down 46.4% from $466.2
million for fiscal 2000.
WEALTH MANAGEMENT
--------
2002 2001 2000
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
Net revenues $498,411 $543,495 $683,791
Pre-tax income $ 11,616 $ 40,314 $127,856
================================================================================
The Wealth Management segment is composed of the Private Client Services ("PCS")
and asset management areas. PCS provides high-net-worth individuals with an
institutional level of investment service, including access to the Company's
resources and professionals. PCS maintains approximately 500 account executives
in its principal office and six regional offices. Asset management manages
equity, fixed income and alternative assets for leading corporate pension plans,
public systems, endowments, foundations, multi-employer plans, insurance
companies, corporations, families and high net-worth individuals in the US and
abroad.
Fiscal 2002 versus Fiscal 2001 Net revenues for Wealth Management were $498.4
million in fiscal 2002, a decrease of 8.3% from $543.5 million for fiscal 2001.
PCS revenues decreased 8.3% to $344.7 million in fiscal 2002, from $376.0
million in fiscal 2001, due to a reduction in retail trading volume resulting
from uncertain economic conditions and lower customer margin debt balances as
individual investors continued to retreat from the equity markets. Asset
management revenues decreased 8.3% to $153.7 million in fiscal 2002, from $167.5
million in fiscal 2001, due to lower levels of performance-based fees from
proprietary hedge funds. These results were partially offset by increased
management fees from mutual funds and wrap accounts. Pre-tax income for Wealth
Management was $11.6 million in fiscal 2002, a decrease of 71.2% from $40.3
million for fiscal 2001.
Assets under management were $24.0 billion at November 30, 2002, reflecting a
0.8% decrease from $24.2 billion in assets under management at November 30,
2001. The decrease in assets under management reflected declines in market
value, substantially offset by inflows in separate accounts.
Fiscal 2001 versus Fiscal 2000 Net revenues for Wealth Management were $543.5
million in fiscal 2001, down 20.5% from $683.8 million for fiscal 2000. The
decrease was attributable to a reduction in retail trading volume as a result of
uncertain economic conditions and volatile equity markets. Asset management
revenues increased, reflecting higher levels of management fees for the
Company's mutual fund and alternative investment products, partially offset by
reduced performance fees from alternative investment products. Pre-tax income
for Wealth Management was $40.3 million in fiscal 2001, down 68.5% from $127.9
million for fiscal 2000.
The asset management area had $24.2 billion in assets under management at
November 30, 2001, which reflected a 24.1% increase over $19.5 billion in assets
under management at November 30, 2000. Strong net inflows and performances from
certain investments in the funds led to the growth in assets under management.
Assets from alternative investment products grew sharply, up 37.8% to $6.2
billion under management at November 30, 2001, from $4.5 billion at November 30,
2000. Additionally, mutual funds under management rose 43.9% to $5.9 billion at
November 30, 2001, from $4.1 billion at November 30, 2000.
THE BEAR STEARNS COMPANIES INC.
page 34
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
LIQUIDITY AND CAPITAL RESOURCES
FINANCIAL LEVERAGE
The Company maintains a highly liquid balance sheet, with the vast majority of
the Company's assets consisting of cash, marketable securities inventories and
collateralized receivables arising from customer-related and proprietary
securities transactions. Collateralized receivables consist of resale agreements
secured predominantly by US government and agency securities, customer margin
loans and securities borrowed, which are typically secured by marketable
corporate debt and equity securities. The nature of the Company's business as a
securities dealer requires it to carry significant levels of securities
inventories 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 in
its clearance business, results in significant levels of customer-related
balances, including customer margin debt, securities borrowing and repurchase
activity. The Company's total assets and financial leverage can fluctuate,
depending largely on economic and market conditions, volume of activity and
customer demand. The Company's total assets at November 30, 2002 decreased to
$184.9 billion from $185.5 billion at November 30, 2001. The decrease was
primarily attributable to a decrease in securities purchased under agreements to
resell, substantially offset by an increase in financial instruments owned.
The Company's total capital base, which consists of long-term debt, preferred
equity issued by subsidiaries and total stockholders' equity, increased to $30.6
billion at November 30, 2002 from $29.8 billion at November 30, 2001. This
change was primarily due to an increase in equity growth from operations and a
net increase in long-term debt, partially offset by the redemption of $200.0
million in preferred securities issued by Bear Stearns Capital Trust I, a wholly
owned subsidiary of the Company, and the partial redemption and retirement of
the Company's Preferred Stock, Series E, F and G.
The amount of long-term debt, as well as total capital, that the Company
maintains is driven by its asset composition. The Company's ability to support
increases in total assets is a function of its ability to obtain short-term
secured and unsecured funding, as well as its access to longer-term sources of
capital (i.e., long-term debt and equity). The Company regularly measures and
monitors its total capital requirements, which are primarily a function of the
self-funding ability of its assets. The equity portion of total capital is
primarily a function of on- and off-balance-sheet risks (i.e., market, credit
and liquidity) and regulatory capital requirements. As such, the liquidity and
risk characteristics of assets being held are the primary determinants of both
total capital and the equity portion thereof, thus significantly influencing the
amount of leverage that the Company can employ.
Given the nature of the Company's market-making and customer-financing activity,
the overall size of the balance sheet fluctuates from time to time. The
Company's total assets at quarter end are frequently lower than would be
observed on an average basis. At quarter end, the Company typically uses excess
cash to finance high-quality, highly liquid securities inventory that otherwise
would be funded via the repurchase agreement market. In addition, the Company
reduces its matched book repurchase and reverse repurchase activities at quarter
end. Finally, the Company may reduce the aggregate level of inventories through
ordinary course, open market activities in the most liquid portions of the
balance sheet, which are principally US government and agency securities and
agency mortgage pass-through securities. At November 30, 2002, total assets of
$184.9 billion were approximately 13.3% lower than the average of the month-end
balances observed over the trailing 12-month period. Despite reduced total
assets at quarter end, the Company's overall market, credit and liquidity risk
profile is not changed materially, since the reduction in asset balances is
typically in highly liquid, short-term instruments that are financed on a
secured basis. This periodic reduction verifies the inherently liquid nature of
the balance sheet and provides consistency with respect to creditor
constituents' evaluation of the Company's financial condition.
The following table presents total assets, adjusted assets and net adjusted
assets with the resultant leverage ratios at November 30, 2002 and November 30,
2001. With respect to a comparative measure of financial risk and capital
adequacy, the Company believes that the low-risk collateralized nature of its
resale and securities borrowed assets renders net adjusted leverage as the most
relevant measure.
THE BEAR STEARNS COMPANIES INC.
page 35
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
-------
2002 2001
- --------------------------------------------------------------------------------
(in billions, except ratios)
- --------------------------------------------------------------------------------
Total assets $ 184.9 $ 185.5
Adjusted assets(1) $ 142.7 $ 140.7
Net adjusted assets(2) $ 89.6 $ 88.8
Leverage ratio(3) 26.6 29.0
Adjusted leverage ratio(4) 20.5 22.0
Net adjusted leverage ratio(5) 12.9 13.9
================================================================================
(1) Adjusted assets is Total assets less securities purchased under agreements
to resell and securities received as collateral.
(2) Net adjusted assets is Adjusted assets less securities borrowed.
(3) Leverage ratio equals Total assets divided by stockholders' equity and
preferred stock issued by subsidiaries.
(4) Adjusted leverage ratio equals Adjusted assets divided by stockholders'
equity and preferred stock issued by subsidiaries.
(5) Net adjusted leverage ratio equals Net adjusted assets divided by
stockholders' equity and preferred stock issued by subsidiaries.
FUNDING STRATEGY
The Company's general funding strategy seeks to ensure liquidity and diversity
of funding sources to meet the Company's financing needs at all times and in all
market environments. The Company attempts to finance its balance sheet by
maximizing, where economically competitive, its use of secured funding.
Short-term sources of cash consist principally of collateralized borrowings,
including repurchase transactions, sell/buy arrangements, securities lending
arrangements and customer free credit balances. In addition, with respect to
short-term, unsecured financing, the Company's emphasis on diversification by
product, geography, maturity and instrument results in prudent, moderate usage
of more credit-sensitive, potentially less stable funding. Short-term unsecured
funding includes commercial paper, medium-term notes and bank borrowings, which
generally have maturities ranging from overnight to one year. Due to the
collateralized nature of the borrowing, the Company views its secured funding as
inherently less credit sensitive and therefore a more stable source of funding.
The Company seeks to prudently manage its reliance on short-term unsecured
borrowings by maintaining an adequate total capital base and extensive use of
secured funding.
In addition to short-term funding sources, the Company utilizes equity and
long-term debt, including floating- and fixed-rate and medium-term notes as
longer-term sources of unsecured financing. The firm regularly monitors and
analyzes the size, composition and liquidity characteristics of its asset base
in the context of each asset's ability to be used to obtain secured financing.
This analysis results in a determination of the Company's aggregate need for
longer-term funding sources (i.e., long-term debt and equity). The Company views
long-term debt as a stable source of funding which effectively strengthens its
overall liquidity profile.
The Company maintains an alternative funding strategy focused on the liquidity
and self-funding ability of the underlying assets. The objective is to maintain
sufficient cash capital (i.e., equity plus long-term debt maturing in more than
12 months) and funding sources to enable the Company to refinance short-term,
unsecured borrowings with fully secured borrowings. The Company prepares an
analysis that focuses on a 12-month time period and assumes that the Company
does not liquidate assets and cannot issue any new unsecured debt, including
commercial paper. Within this context, the Company monitors its cash position
and the borrowing value of unencumbered, unhypothecated marketable securities in
relation to its unsecured debt maturing over the next 12 months, striving to
maintain the ratio of liquidity sources to maturing debt at 100% or greater.
Within this analytical framework, the Company also endeavors to maintain cash
capital in excess of that portion of its assets that cannot be funded on a
secured basis. These two measures, liquidity ratio and net cash capital, are
complementary and constitute the core elements of the Company's alternative
funding models and, consequently, its approach to funding and liquidity risk
management.
In addition, the Company monitors the maturity profile of its unsecured debt to
minimize refinancing risk, maintains relationships with a broad global base of
debt investors and bank creditors, establishes and adheres to strict short-term
debt investor concentration limits, and periodically tests its secured and
unsecured committed credit facilities. The Company also maintains available
sources of short-term funding that exceed actual utilization, thus allowing it
to endure changes in investor appetite and credit capacity to hold the Company's
debt obligations.
The Company has a committed revolving credit facility ("Facility") totaling
$3.030 billion, which permits borrowing on a secured basis by Bear Stearns,
Bear, Stearns Securities Corp. ("BSSC") and certain other subsidiaries. The
Facility also provides that The Bear Stearns Companies Inc. may borrow up to
$1.515 billion of the Facility on an unsecured basis. Secured borrowings can be
collateralized by both investment-grade and non-investment-grade financial
instruments as the Facility provides for defined margin levels on a wide range
of financial instruments eligible to be pledged. The Facility contains financial
covenants which require, among other things, maintenance of specified levels of
stockholders' equity of the Company and net capital of BSSC. The Company renewed
THE BEAR STEARNS COMPANIES INC.
page 36
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
the Facility in February 2003 with substantially the same terms. There were no
borrowings outstanding under the Facility at November 30, 2002.
The Company has a $1.25 billion committed revolving securities repo facility
("Repo Facility"), which permits borrowings secured by a broad range of
collateral, 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 contains financial covenants that
require, among other things, maintenance of specified levels of stockholders'
equity of the Company. The Repo Facility terminates in August 2003, with all
repos outstanding at that date payable no later than August 2004. There were no
borrowings outstanding under the Repo Facility at November 30, 2002.
The Company has a $500 million committed funding facility ("Funding Facility")
with a third-party lender, which permits secured borrowings to finance a
portfolio of primarily non-investment-grade loans. The Funding Facility
terminates in March 2003, with all amounts outstanding at that date payable no
later than March 2007. The Company expects to renew the Funding Facility on its
expiration in March 2003. At November 30, 2002, the amount outstanding under
this Funding Facility was $171.5 million.
At November 30, 2002, the Company had a $400 million committed revolving credit
facility ("Credit Facility"), which permits borrowing on a secured basis
collateralized by Japanese securities. The Credit Facility contains financial
covenants that require, among other things, maintenance of specified levels of
stockholders' equity of the Company and net capital of BSSC. In December 2002,
the Company renewed the Credit Facility at a $300 million committed level with
substantially the same terms. The Credit Facility, as renewed, terminates in
December 2003 with all loans outstanding at that date payable no later than
December 2004. There were no borrowings outstanding under the Credit Facility at
November 30, 2002.
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 has been used to fund investments in, and advances to, these regulated
subsidiaries, including subordinated debt advances. 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 self-funding
ability of the assets being financed.
Long-term debt totaling $18.8 billion and $19.7 billion had remaining maturities
beyond one year at November 30, 2002 and November 30, 2001, respectively. The
Company's access to external sources of financing, as well as the cost of that
financing, is dependent on various factors and could be adversely affected by a
deterioration of the Company's operating performance and/or the Company's long-
and short-term debt ratings.
At November 30, 2002, the Company's long-term/short-term debt ratings were as
follows:
Rating
- --------------------------------------------------------------------------------
Dominion Bond Rating Service Limited(1) A/R-1 (middle)
Fitch(2) A+/F1+
Moody's Investors Service(3) A2/P-1
Standard & Poor's(4) A/A-1
Rating & Investment Information, Inc. A+/nr
================================================================================
nr - does not assign a short-term rating
(1) On November 20, 2002, Dominion Bond Rating Service Limited confirmed the
above credit ratings with "stable" trends.
(2) On July 6, 2001, Fitch revised the outlook for the Company's long-term
debt ratings from "stable" to "negative," while simultaneously affirming
the Company's credit ratings.
(3) On February 6, 2003, Moody's Investors Service revised the outlook on the
Company's long-term debt ratings from "stable" to "positive," while
simultaneously affirming the Company's credit ratings.
(4) On October 5, 2000, Standard & Poor's revised the outlook for the
Company's long-term debt ratings from "stable" to "negative," while
simultaneously affirming the Company's credit ratings.
STOCK REPURCHASE PROGRAM
The Company has various employee stock compensation plans designed to increase
the emphasis on stock-based incentive compensation and align the compensation of
its key employees with the long-term interests of stockholders. Such plans
provide for annual grants of stock units and stock options. The Company intends
to offset the potentially dilutive impact of the annual grants by purchasing
common stock throughout the year in open market and private transactions. On
January 8, 2002, the Board of Directors of the Company approved an amendment to
the Stock Repurchase Program ("Repurchase Program") to replenish the previous
authorizations to allow the Company to purchase up to $1.2 billion of common
stock in fiscal 2002 or beyond. During the fiscal year ended November 30, 2002,
the Company
THE BEAR STEARNS COMPANIES INC.
page 37
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
purchased under the current and prior authorizations a total of 10,490,940
shares at a cost of approximately $627.5 million. Approximately $576.7 million
was available to be purchased under the current authorization as of November 30,
2002. On January 8, 2003, the Board of Directors of the Company approved an
amendment to the Repurchase Program to replenish the previous authorization to
allow the Company to purchase up to $1.0 billion of common stock in fiscal 2003
or beyond.
CASH FLOWS
Fiscal 2002 Cash and cash equivalents decreased $1.8 billion to $5.5 billion at
November 30, 2002 from $7.3 billion at November 30, 2001. Cash used in operating
activities was $1.4 billion, primarily attributable to a decrease in securities
sold under agreements to repurchase and an increase in financial instruments
owned, partially offset by decreases in securities purchased under agreements to
resell, cash and securities deposited with clearing organizations or segregated
in compliance with federal regulations and receivables from brokers, dealers and
others. Cash used in financing activities of $474.0 million primarily reflected
payments for the retirement of long-term borrowings and payments for treasury
stock purchases, partially offset by net proceeds from the issuance of long- and
short-term borrowings. Cash provided by investing activities of $29.8 million
reflected proceeds from net sales of investment securities and other assets,
partially offset by purchases of property, equipment and leasehold improvements.
Fiscal 2001 Cash and cash equivalents increased $5.0 billion to $7.3 billion at
November 30, 2001 from $2.3 billion at November 30, 2000. Cash provided by
operating activities was $7.1 billion, primarily attributable to a decrease in
securities borrowed, increases in customer payables and financial instruments
sold, but not yet purchased, partially offset by increases in securities
purchased under agreements to resell, cash and securities deposited with
clearing organizations or segregated in compliance with federal regulations, and
financial instruments owned. Cash used in financing activities of $1.5 billion
primarily reflected payments for the retirements of long-term borrowings and net
payments of short-term borrowings, partially offset by net proceeds from
issuances of long-term borrowings. Cash used in investing activities of $510.3
million reflected a business acquisition (see Note 17, "Business Acquisition,"
in the Notes to Consolidated Financial Statements), purchases of property,
equipment and leasehold improvements, as well as net purchases of investment
securities and other assets.
Fiscal 2000 Cash and cash equivalents increased $749.5 million to $2.3 billion
at November 30, 2000 from $1.6 billion at November 26, 1999. Cash used in
operating activities was $6.3 billion, primarily attributable to increases in
financial instruments owned and cash and securities deposited with clearing
organizations, partially offset by an increase in customer payables. Cash
provided by financing activities of $7.2 billion reflected increased net
borrowings to support the Company's operational growth while taking advantage of
favorable long-term financing opportunities. Cash used in investing activities
of $230.4 million reflected purchases of property, equipment and leasehold
improvements, as well as net purchases 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, 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 Financial Services Authority. Additionally, BSB is subject
to the regulatory capital requirements of the Central Bank of Ireland. At
November 30, 2002, Bear Stearns, BSSC, BSIL, BSIT and BSB were in compliance
with their respective regulatory capital requirements.
The Company's broker-dealer subsidiaries are subject to certain restrictions on
the payment of dividends, which could limit the Company's ability to withdraw
capital from such regulated subsidiaries, which in turn could limit the
Company's ability to pay dividends. See Note 7, "Regulatory Requirements," in
the Notes to Consolidated Financial Statements.
MERCHANT BANKING INVESTMENTS
At November 30, 2002, the Company held investments in 20 leveraged transactions
with an aggregate recorded value of approximately $163.2 million, reflected in
the Consolidated Statements of Financial Condition in "Other Assets." Sixteen
transactions are private principal investments aggregating $35.2 million at
November 30, 2002. Four transactions are principal investments in public
entities, aggregating $128.0 million at November 30, 2002, whereby the Company
may have large concentrated holdings, which are valued at a discount to the
quoted market value due to concentrations and/or restrictions on sale. Included
in these
THE BEAR STEARNS COMPANIES INC.
page 38
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
public principal investments is the Company's holding in Aeropostale, Inc. At
November 30, 2002, the Company retains an ownership interest of approximately
10.3 million shares in Aeropostale, Inc., representing approximately 29.2% of
its outstanding common shares. Also in connection with the Company's merchant
banking activities, the Company has investments in private equity-related
investment funds aggregating $172.7 million at November 30, 2002. In addition to
the various direct and indirect principal investments, the Company has made
commitments to participate in private investment funds that invest in leveraged
transactions (see the summary table under "Commitments").
HIGH YIELD POSITIONS
As part of the Company's fixed income activities, it participates in the
underwriting, securitization and trading of non-investment-grade debt
securities, non-performing mortgage-related assets, non-investment-grade
commercial and leveraged loans, and securities of companies that are the subject
of pending bankruptcy proceedings (collectively, "high yield positions"). Also
included in high yield positions is a portfolio of Chapter 13 and other credit
card receivables from individuals. Non-investment-grade debt securities have
been defined as non-investment-grade corporate debt, asset securitization
positions and emerging market debt rated BB+ or lower or equivalent ratings
recognized by credit rating agencies. At November 30, 2002 and November 30,
2001, the Company held high yield positions approximating $3.6 billion and $3.0
billion, respectively, substantially all of which are in "Financial Instruments
Owned" in the Consolidated Statements of Financial Condition, and $561.4 million
and $700.7 million, respectively, reflected in "Financial Instruments Sold, But
Not Yet Purchased" in the Consolidated Statements of Financial Condition.
Included in these amounts is a portfolio of non-performing mortgage-related
assets as well as a portfolio of Chapter 13 and other credit card receivables
aggregating $1.2 billion and $1.1 billion at November 30, 2002 and November 30,
2001, respectively.
Also included in the high yield positions are extensions of credit to highly
leveraged companies. At November 30, 2002 and November 30, 2001, the amount
outstanding to highly leveraged borrowers totaled $574.6 million (gross position
of $591.6 million less $17.0 million of associated hedges) and $413.1 million,
respectively. The largest industry concentration was to the telecommunications
industry, which approximated 18.0% and 26.7% of these high yield positions at
November 30, 2002 and November 30, 2001, respectively. Additionally, the Company
has lending commitments with these non-investment-grade borrowers (see the
summary table under "Commitments"). The Company also has exposure to
non-investment-grade counterparties through its trading-related derivative
activities. These amounts, net of collateral, were $192.0 million and $55.0
million at November 30, 2002 and November 30, 2001, respectively.
The Company's Risk Management Department and senior trading managers monitor
exposure to market and credit risk for high yield positions and establish limits
for overall market exposure and concentrations of risk by individual issuer.
High yield positions generally involve greater risk than investment-grade debt
securities due to credit considerations, liquidity of secondary trading markets
and increased vulnerability to changes in general economic conditions. The level
of the Company's high yield positions, and the impact of such activities on the
Company's results of operations, can fluctuate from period to period as a result
of customer demand and economic and market considerations.
SPECIALIST ACTIVITIES
At the close of business on April 20, 2001, the Company, through a joint
venture, completed an acquisition of the assets (including specialist rights)
and the assumption of certain liabilities of Wagner Stott Mercator. The Company
participates, together with its joint venture partner, in specialist activities
on the NYSE, AMEX and International Securities Exchange, through a limited
liability company in which the Company has just less than a 50% profit and loss
interest. For fiscal 2002 and 2001, net revenues from these specialist
activities are reflected in "Principal Transactions" revenues in the
Consolidated Statements of Income. The combination was accounted for under the
purchase method of accounting for business combinations. The purchase price
resulted in recordation of tangible and identifiable intangible assets acquired
and liabilities assumed based on their estimated fair values as of the effective
date of the combination.
THE BEAR STEARNS COMPANIES INC.
page 39
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
CONTRACTUAL OBLIGATIONS
The Company's contractual obligations, excluding derivative financial
instruments, as of November 30, 2002:
Payments Due by Period
- ------------------------------------------------------------------------------------------------------------------------------------
Fiscal Fiscal Fiscal
2003 2004-2005 2006-2007 Thereafter Total
- ------------------------------------------------------------------------------------------------------------------------------------
(in millions)
- ------------------------------------------------------------------------------------------------------------------------------------
Long-term borrowings(1) $4,889 $8,378 $5,763 $4,651 $23,681
Future minimum lease payments(2)(3) 55 97 79 106 337
Guaranteed indebtedness of a non-consolidated lessor(3)(4) 570 570
====================================================================================================================================
(1) Amounts include fair value adjustments in accordance with SFAS No. 133.
See Note 5, "Long-Term Borrowings," in the Notes to Consolidated Financial
Statements.
(2) Includes 383 Madison Avenue in New York City.
(3) See Note 15, "Commitments and Contingencies," in the Notes to Consolidated
Financial Statements.
(4) There was no deficiency as the fair value of the property was in excess of
the lessor's debt obligation at November 30, 2002. See 383 Madison Avenue
in Note 15, "Commitments and Contingencies," in the Notes to Consolidated
Financial Statements.
COMMITMENTS
The Company's commitments as of November 30, 2002:
Amount of Commitment Expiration Per Period
- ------------------------------------------------------------------------------------------------------------------------------------
Fiscal Fiscal Fiscal
2003 2004-2005 2006-2007 Thereafter Total
- ------------------------------------------------------------------------------------------------------------------------------------
(in millions)
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial loan commitments:(1)(2)
Investment-grade $1,396 $ 30 $ 461 $ -- $1,887
Non-investment-grade 300 112 245 211 868
Commitments to invest in private
equity-related investments
and partnerships(2)(3) 669
Underwriting commitments(2) 1,346 1,346
Letters of credit(2) 2,774 15 53 1 2,843
Other commercial commitments(2)(4) 548 99 695
====================================================================================================================================
(1) Commitments are shown gross of associated hedges of $695 million for
investment-grade borrowers.
(2) See Note 15, "Commitments and Contingencies," in the Notes to Consolidated
Financial Statements.
(3) At November 30, 2002, commitments to invest in private equity-related
investments and partnerships aggregated $669 million. These commitments
will be funded, if called, through the end of the respective investment
periods, primarily ending in 2011.
(4) Includes certain commitments with no stated maturity.
THE BEAR STEARNS COMPANIES INC.
page 40
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments are contractual commitments between
counterparties that derive their values from changes in an 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 index-referenced warrants, can be
traded on an exchange. Other derivatives, such as interest rate and currency
swaps, caps, floors, collars, 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 risks depending on the
nature of the contract.
The Company is 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 hedging transactions that
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 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, futures
contracts and US treasury positions to hedge its 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 its wholly owned subsidiary, Bear
Stearns Trading Risk Management Inc. ("BSTRM"). BSFP is a wholly owned
subsidiary of the Company. BSFP and BSTRM were established to provide clients
with a AAA-rated counterparty that offers a wide range of global derivative
products. BSFP is structured so that if a specified trigger event (including
certain credit rating downgrades of the Company) occurs, BSFP will perform on
all of its contracts to their original maturities with the assistance of an
independent derivatives portfolio manager who would assume the active management
of BSFP's portfolio ("Continuation Structure"). BSTRM is structured so that, on
the occurrence of a specified trigger event, it will cash-settle all outstanding
derivative contracts in a predetermined manner ("Termination Structure").
Clients can use either structure. The AAA/Aaa ratings that BSFP and BSTRM have
received are based on the ability to meet their respective obligations without
any additional capital from the Company. In the unlikely occurrence of a trigger
event, the Company does not expect any significant incremental impact on the
liquidity or financial condition of the Company. At November 30, 2002, the
potential cash settlement payable by BSTRM on the occurrence of a trigger event
was less than $20 million.
To measure derivative activity, notional or contract amounts are frequently
used. Notional/contract amounts are used to calculate contractual cash flows to
be exchanged and are generally not actually paid or received, with the exception
of currency swaps, foreign exchange forwards and mortgage-backed securities
forwards. The notional/contract amounts of financial instruments that give rise
to off-balance-sheet market risk are indicative only to the extent of
involvement in the particular class of financial instrument and are not
necessarily an indication of overall market risk.
As of November 30, 2002 and November 30, 2001, the Company had notional/contract
amounts of approximately $1.6 trillion and $1.1 trillion, respectively, of
derivative financial instruments, of which $421.1 billion and $285.4 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 outstanding, which either are used to hedge trading
positions, fixed-rate debt, or are part of its derivative dealer activities, are
marked to fair value.
The Company's derivatives have a weighted average maturity of approximately 3.9
years and 3.8 years at November 30, 2002 and November 30, 2001, respectively.
THE BEAR STEARNS COMPANIES INC.
page 41
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
The maturities of notional/contract amounts outstanding for derivative financial
instruments as of November 30, 2002 were as follows:
Less Than One to Three Three to Five Greater Than
One Year Years Years Five Years Total
- -------------------------------------------------------------------------------------------------------------------------
(in billions)
- -------------------------------------------------------------------------------------------------------------------------
Swap agreements, including options,
swaptions, caps, collars and floors $ 216.4 $ 261.6 $ 237.5 $ 331.5 $1,047.0
Futures contracts 151.0 52.6 31.2 4.3 239.1
Forward contracts 62.8 62.8
Options held 98.8 28.8 0.3 127.9
Options written 60.6 13.0 0.3 73.9
- -------------------------------------------------------------------------------------------------------------------------
Total $ 589.6 $ 356.0 $ 269.3 $ 335.8 $1,550.7
=========================================================================================================================
Percent of total 38.0% 23.0% 17.3% 21.7% 100.0%
=========================================================================================================================
THE BEAR STEARNS COMPANIES INC.
page 42
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
NEW ACCOUNTING PRONOUNCEMENTS
In October 2002, the Emerging Issues Task Force ("EITF") issued guidance on
Issue No. 02-3, "Issues Involved in Accounting for Derivative Contracts Held for
Trading Purposes and Contracts Involved in Energy Trading and Risk Management
Activities." This guidance would generally eliminate the practice of recognizing
profit at the inception of a derivative contract unless the fair value of the
derivative is obtained from a quoted market price in an active market or is
otherwise evidenced by comparison to other observable current market
transactions or based on a valuation technique that incorporates observable
market data. The guidance was effective for contracts entered into subsequent to
November 22, 2002 and did not materially impact the consolidated financial
statements. The effect in future financial statements is not currently
estimable.
In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation ("FIN") No. 45, "Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." FIN No. 45 requires a guarantor to recognize, at the inception of the
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. It also provides additional guidance on the disclosure of
guarantees. The recognition and measurement provisions are effective for
guarantees made or modified after December 31, 2002. The disclosure provisions
are effective for fiscal periods ending after December 15, 2002. The Company
will adopt FIN No. 45 as required in fiscal 2003 and does not expect a material
impact on the consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure," which amends SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS No. 148 provides three
alternative methods of transition for a voluntary change to fair value
accounting for stock-based compensation as permitted under SFAS No. 123. It also
requires prominent disclosures about the method of accounting for stock-based
compensation and its effect on reported results. The three alternatives are: 1)
the prospective method in which fair value expense would be recognized for all
awards granted in the year of adoption, but not previous awards, 2) the modified
prospective method in which fair value expense would be recognized for the
unvested portion of all prior stock options granted and those granted in the
year of adoption, and 3) the retroactive restatement method, which is similar to
the modified prospective method, except that all prior periods are restated. The
Company will adopt fair value accounting for stock-based compensation in fiscal
2003 using the prospective method provided by SFAS No. 148. As a result, the
Company will begin to expense the fair value of stock options issued to
employees over the related vesting period, starting with stock options granted
after November 30, 2002.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities -- an Interpretation of ARB No. 51." FIN No. 46 provides guidance on
the consolidation of certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support. Such entities are referred to as variable
interest entities ("VIEs"). FIN No. 46 requires the primary beneficiary of a VIE
to consolidate the entity. For existing entities, FIN No. 46 is effective for
fiscal periods beginning after June 15, 2003. For new entities, FIN No. 46 was
effective after January 31, 2003. The Company will adopt FIN No. 46 as required
in fiscal 2003 and is currently evaluating its impact on the consolidated
financial statements.
The transition provisions of FIN No. 46 require certain disclosures in financial
statements issued after January 31, 2003. Although the Company is still
evaluating the impact of FIN No. 46, it is reasonably possible that FIN No. 46
will require consolidation of, or additional disclosures related to, the
entities described below.
The Company acts as portfolio manager in several collateralized debt obligation
transactions. In these transactions, the Company establishes a trust that
purchases a portfolio of assets and issues trust certificates that represent
interests in the portfolio of assets. In addition to receiving variable
compensation for managing the portfolio, the Company also may retain certain
trust certificates. The assets in these trusts at November 30, 2002 approximated
$1.3 billion. The Company's maximum exposure to loss as a result of its
relationship with these trusts is approximately $11.9 million, which represents
the fair value of its interests.
The Company owns subordinated interests in several entities related to
collateralized debt obligation transactions in which it does not act as
portfolio manager. It may own these interests as a result of its underwriting
activities or by direct proprietary investment. These entities are likely to
qualify as VIEs. At November 30, 2002, the total assets of those entities in
which the Company owned significant variable interests
THE BEAR STEARNS COMPANIES INC.
page 43
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
approximates $1.6 billion. As owners of significant variable interests, the
Company may be required to make additional disclosures related to these
entities, but will not be required to consolidate them. The Company's maximum
exposure to loss related to these entities is approximately $14.5 million, which
represents the fair value of its interests at November 30, 2002.
The Company has entered into a lease arrangement for its world headquarters at
383 Madison Avenue with an entity that may be a VIE. The Company makes periodic
LIBOR-based payments to this entity and guarantees a portion of the value of the
building to the creditors of the entity. As a result of its involvement with
this entity, the Company's maximum exposure to loss is $570 million, which
represents the guarantee to the entity's creditors. The entity's sole asset is
the building, which was completed in 2002 at a cost of approximately $670
million.
In 1997, the Company established a program whereby it has created a series of
municipal securities trusts in which it has retained interests. These trusts
purchase fixed-rate, long-term, highly rated, insured or escrowed municipal
bonds financed by the issuance of trust certificates. Certain of the trust
certificates entitle the holder to receive future payments of principal and
variable interest and to tender such certificates at the option of the holder on
a periodic basis. The Company acts as placement agent for the trust certificates
and as liquidity provider to the trust. The purpose of the program is to allow
the Company's clients to purchase synthetic short-term, floating-rate municipal
debt that does not otherwise exist in the marketplace. In the Company's capacity
as liquidity provider to the trusts, the maximum exposure to loss at November
30, 2002 was approximately $2.7 billion, which represents the outstanding amount
of all trust certificates. This exposure to loss is mitigated by the underlying
municipal bonds. The underlying municipal bonds in the trusts are either AAA- or
AA-rated, insured or escrowed to maturity. Such bonds had a market value
approximating $2.7 billion at November 30, 2002.
At November 30, 2002, the Company had an approximate 40% equity interest in
Liquid Funding, Ltd. ("LFL"), a AAA-rated special purpose vehicle established to
participate in the repurchase agreement and total return swap markets. A
subsidiary of the Company acts as investment manager. The Company accounts for
such investment under the equity method of accounting. At November 30, 2002, the
total assets of this entity approximated $900 million. The Company's maximum
exposure to loss as a result of its investment in this entity is approximately
$5.0 million.
The Company regularly creates or transacts with entities that may be VIEs. These
entities are an essential part of its securitization, asset management and
structured finance businesses. In addition, the Company purchases and sells
instruments that may be variable interests. Given the short period of time from
the issuance of FIN No. 46 and its effective date, at this time, the Company
cannot definitively quantify the impact of FIN No. 46.
EFFECTS OF INFLATION
Since the Company's assets are primarily recorded at their current market value
and to a large extent are liquid in nature, they are not significantly affected
by inflation. However, the rate of inflation affects the Company's expenses,
such as employee compensation, office leasing costs, information technology 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 adverse 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.
THE BEAR STEARNS COMPANIES INC.
page 44
THE BEAR STEARNS COMPANIES INC.
RISK MANAGEMENT
OVERALL
The Company's principal business activities engender significant market and
credit risks. In addition, the Company is subject to operational, legal, funding
and other risks. Effective identification, assessment and management of these
risks are critical to the success and stability of the Company. As a result,
comprehensive risk management procedures have been established to identify,
monitor and control each of these major risks. The Company's diverse securities
industry activities help to reduce the impact that volatility in any particular
market may have on its net revenues. Funding risk is discussed in Management's
Discussion and Analysis of Financial Condition and Results of Operations in the
"Liquidity and Capital Resources" section.
Managing risk at the Company begins with the expertise and experience of trading
department management. Senior managing directors in each department have
extensive knowledge of the specialized products, markets and activities in which
they do business. Their experience and insight are supplemented by risk
management procedures that monitor and evaluate the Company's risk profile.
The cornerstone of these procedures is constant communication between trading
department management and senior management concerning inventory positions and
market risk profile. This process culminates each week with the trading
departments making formal reports of positions, profits and losses and certain
trading strategies to Bear Stearns' Risk Committee. The Risk Committee, which
comprises senior managing directors from each trading department as well as the
Risk Management Department, oversees trading departments and their trading
strategies.
The risk management process encompasses many units independent of the trading
desks, including the Risk Management, Global Credit, Correspondent Clearing,
Controllers, Operations, Compliance and Financial Analytics & Structured
Transactions Departments, and is intended to support and enforce the Company's
policies and procedures with a focus on market and credit risk. Those procedures
begin with the Company marking its financial instruments owned to fair value on
a daily basis and producing daily profit and loss statements for senior
management covering all trading departments.
The Company believes that a clear understanding of how its positions generate
profit or loss on a daily basis is crucial to managing risk. Many of the
independent units are actively involved in ensuring the integrity and clarity of
the daily profit and loss statements. Activities include daily and monthly price
verification procedures, position reconciliation, reviewing pricing models and
reviewing booking of complex transactions. Furthermore, the Company uses
market-based credit pricing to estimate the appropriate credit reserves
associated with certain counterparty credit exposures.
In addition, trading desk management, senior management and independent units
also review the age and composition of proprietary accounts and review risk
reports appropriate to the risk profile of each trading activity. Risk limits
are established and monitored, market conditions are evaluated, certain
transactions are reviewed in detail, and quantitative methods such as
value-at-risk and stress testing are employed (see the "Value-at-Risk" section).
These activities better ensure that trading strategies are followed within
acceptable risk parameters.
The Risk Management Department is independent of all trading areas and reports
directly to the Executive Committee. The goals of the department are to
understand the market risk profile of each trading area, to consolidate risk
firmwide, to articulate large trading or position risks to senior management, to
provide traders with perspectives on their positions and to better ensure
accurate mark-to-market pricing. The department supplements the communication
between trading managers and senior management by providing its independent
perspective on the Company's market risk profile via a daily risk highlights
report that is distributed to a number of senior managers in the Company.
The Global Credit Department, in conjunction with the Credit Policy Committee
and its subcommittee, the Global Credit Committee, establishes and reviews
appropriate credit limits for customers and dealer counterparties. The Credit
Policy Committee is composed of senior risk, legal and business managers. The
Credit Policy Committee establishes policies and guidelines and reviews large
exposures and other items brought to its attention. The Global Credit Committee
meets weekly or more often as necessary to set credit limits and to monitor the
exposure of customers that enter into repurchase and resale agreement
facilities, stock borrowing or loan facilities, derivative financial instruments
and other products that may give rise to secured and unsecured credit.
THE BEAR STEARNS COMPANIES INC.
page 45
RISK MANAGEMENT
continued
The following discussion of the Company's risk management procedures for its
principal risks and the estimated amounts of the Company's market risk exposure
generated by the Company's statistical analyses contains forward-looking
statements. The analyses used to assess such risks are not predictions of future
events, and actual results may vary significantly from such analyses due to
events in the markets in which the Company operates and certain other factors as
described herein.
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, equity and futures prices,
changes in the implied volatility of interest rates, foreign exchange rates,
equity and futures prices, and price deterioration or changes in value due to
changes in market perception or actual credit quality of either the issuer or
its country of origin. Market risk can be exacerbated in times of illiquidity
where market participants refrain from transacting in normal quantities and/or
at normal bid-offer spreads. Market risk is inherent to both cash and 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 trading transactions and to its proprietary
trading, investment 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, emerging markets debt obligations, mortgages and mortgage-backed
securities, other collateralized securities and municipal bonds. The Company is
also an active market maker and conducts block trading activities in both listed
and over-the-counter equity markets. In connection with these activities, the
Company may be required to maintain significant inventories to ensure
availability and to facilitate customer order flow. The Company is also engaged
as a dealer in both listed and over-the-counter derivatives and, accordingly,
enters into transactions such as interest rate and cross-currency swaps,
over-the-counter swaps and options on interest rates and foreign currencies,
various credit default swaps and equity swaps and options, all as part of its
customer and proprietary trading activities. In connection with these
activities, the Company attempts to mitigate its exposure to market risk by
entering into hedging transactions, which may include listed and
over-the-counter derivative contracts or the purchase or sale of securities,
financial futures and options on futures or forward contracts. Additionally, the
Company has a significant investment in a limited liability company that is
involved in specialist activities. Stock exchange rules require that specialists
maintain an orderly market, including purchasing shares in a declining market,
which may result in trading losses.
The Company's arbitrage activities are designed to take advantage of market
price discrepancies in securities trading in different markets, between related
products or derivative instruments. 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 market
risk in these activities by entering into hedging transactions.
Following is a discussion of the Company's primary market risk exposures as of
November 30, 2002 and November 30, 2001, including a discussion of how those
exposures are currently managed.
INTEREST RATE RISK
Interest rate risk is a consequence of maintaining market-making and proprietary
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 level and shape
of the yield curve. The Company's fixed income activities also expose it to the
risk of loss related to changes in credit spreads on debt instruments. Credit
spread risk arises from the potential that changes in an issuer's credit rating
or credit perception could affect the value of financial instruments. Credit
risk resulting from default on counterparty obligations is discussed in
THE BEAR STEARNS COMPANIES INC.
page 46
RISK MANAGEMENT
continued
the Credit Risk section. The Company attempts to hedge its exposure to interest
rate risk primarily through the use of interest rate swaps, options, Eurodollar
and US government securities, and futures and forward contracts designed to
reduce the Company's risk profile. Credit spread risk is hedged through the use
of credit derivatives such as credit default swaps, as well as offsetting long
or short positions in various related securities.
FOREIGN EXCHANGE RATE RISK
Foreign exchange rate risk arises from the possibility that changes in foreign
exchange rates will affect 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 the 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 Company attempts to hedge the risk
arising from its foreign exchange activities primarily through the use of
currency borrowing, swaps, options, forwards and futures.
EQUITY PRICE RISK
The Company is exposed to equity price risk through making markets in equity
securities and equity derivatives as well as specialist activities. 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 of equity
securities by entering into hedging transactions, including equity options and
futures, designed to mitigate the Company's market risk profile.
VALUE-AT-RISK
An estimation of potential losses that could arise from changes in market
conditions is typically accomplished through the use of a statistical model,
known as value-at-risk ("VaR"), that seeks to predict risk of loss based on
historical and/or market-implied price and volatility patterns. VaR estimates
the probability of the value of a financial instrument rising above or falling
below a specified amount. The calculation uses 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.
The Company has performed an entity-wide VaR analysis of the Company's financial
assets and liabilities, including financial instruments owned and sold,
repurchase and resale agreements, and funding assets and liabilities. The
Company regularly evaluates and enhances such VaR models in an effort to more
accurately measure risk of loss. Certain equity-method investments, leveraged
lending activities and non-publicly traded investments are not reflected in the
VaR results. The VaR related to non-trading financial instruments has been
included in this analysis and is not reported separately because the amounts are
not material. The calculation is based on a methodology that 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,
where appropriate. These were generated from principal component analysis. In
addition, volatility and spread risk factors as well as intercountry
correlations were used, where appropriate.
Equity price risk was measured using a combination of historical and Monte Carlo
approaches. Equity and equity derivatives risk were treated as correlated with
various domestic and international indices, of which the Company used
approximately 50 at November 30, 2002 and November 30, 2001. Parameter
estimates, such as volatilities and correlations, were based on daily tests
through November 30, 2002.
VaR has inherent limitations, including reliance on historical data, which may
not accurately predict future market risk, and the quantitative risk information
generated is limited by the parameters established in creating the models. There
can be no assurance that actual losses occurring on any one day arising from
changes in market conditions will not exceed the VaR amounts shown below or that
such losses will not occur more than once in 20 days. However, the Company
believes VaR models are an appropriate methodology for comparison of risk
profiles across companies in the financial services industry.
THE BEAR STEARNS COMPANIES INC.
page 47
RISK MANAGEMENT
continued
The aggregate VaR 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 VaR for each component of market risk as of November 30, 2002
and 2001. Commodity risk has been excluded due to immateriality at November 30,
2002 and 2001.
-------
2002 2001
- --------------------------------------------------------------------------------
(in millions)
- --------------------------------------------------------------------------------
MARKET RISK
Interest rate $ 17.8 $ 12.6
Currency 0.6 1.1
Equity 3.4 5.3
Diversification benefit (3.7) (5.3)
- --------------------------------------------------------------------------------
Aggregate VaR $ 18.1 $ 13.7
================================================================================
The table below illustrates the high, low and average (calculated on a monthly
basis) VaR for each component of market risk and aggregate market risk during
fiscal 2002:
High Low Average
- --------------------------------------------------------------------------------
(in millions)
- --------------------------------------------------------------------------------
MARKET RISK
Interest rate $22.7 $ 9.7 $16.0
Currency 1.5 0.4 0.9
Equity 5.3 2.8 4.0
Aggregate VaR 22.9 10.7 16.5
================================================================================
As previously discussed, the Company utilizes a wide variety of market risk
management methods, including trading limits; marking all positions to market on
a daily basis; daily profit and loss statements; position reports; daily risk
highlight reports; aged inventory position reports; and independent verification
of inventory pricing. Additionally, management of each trading department
reports positions, profits and losses and notable trading strategies to the Risk
Committee on a weekly basis. The Company believes that these procedures, which
stress timely communication between traders, trading department management and
senior management, are the most important elements of the risk management
process.
Stress testing (also referred to as scenario analysis) measures the risk of loss
over a variety of extreme market conditions that are defined in advance. Stress
testing is a key methodology used in the management of market risk as well as
counterparty credit risk (see "Credit Risk" below). Stress tests are calculated
at the firmwide level, for particular trading books, for particular customer
accounts and for particular individual positions. Stress tests are performed on
a regular basis as well as on an ad hoc basis, as deemed appropriate. The
ongoing evaluation process of trading risks as well as the consideration of new
trading positions commonly incorporates an ad hoc discussion of "what-if"
stressed market conditions and their impact on profitability. This analysis
varies in its degree of formality based on the judgment of trading department
management, risk management and senior managers. While the Company recognizes
that no methodology can perfectly predict future market conditions, it believes
that these tools are an important supplement to the Company's risk management
process. The Company expects to continue to develop and refine its formal stress
testing methodologies.
The following charts represent a summary of the daily principal transactions
revenues and reflect a combination of trading revenues, net interest revenues
for certain trading areas and other revenues for the fiscal year ended November
30, 2002 and the fiscal year ended November 30, 2001, respectively. These charts
represent a historical summary of the results generated by the Company's trading
activities as opposed to the probability approach used by the VaR model. The
average daily trading profit was $10.1 million and $9.1 million for the fiscal
years ended November 30, 2002 and November 30, 2001, respectively. Daily trading
losses exceeded the reported average VaR amounts less than 1% of the total
trading days during the fiscal years ended November 30, 2002 and 2001. The
frequency distribution of the Company's daily net trading revenues reflects the
Company's historical ability to manage its exposure to market risk and the
diversified nature of its trading activities. No guarantee can be given
regarding future net trading revenues or future earnings volatility. The Company
believes that these results are indicative of its commitment to the management
of market trading risk.
THE BEAR STEARNS COMPANIES INC.
page 48
RISK MANAGEMENT
continued
DISTRIBUTION OF DAILY NET TRADING REVENUES
[Vertical bar graphs of Number of Trading days (y-axis) versus Daily
Net Trading Revenues (x-axis) representing the following information appear here
in paper format]
FISCAL YEAR ENDED NOVEMBER 30, 2002
DAILY NET TRADING
REVENUES NUMBER OF
($ IN MILLIONS) TRADING DAYS
(10)+ 3
(10)-(5) 2
(5)-0 17
0-5 45
5-10 62
10-15 55
15-20 40
20-25 15
25-30 6
30+ 6
FISCAL YEAR ENDED NOVEMBER 30, 2001
DAILY NET TRADING
REVENUES NUMBER OF
($ IN MILLIONS) TRADING DAYS
(10)+ 2
(10)-(5) 4
(5)-0 6
0-5 56
5-10 101
10-15 44
15-20 21
20-25 9
25-30 4
30+ 3
THE BEAR STEARNS COMPANIES INC.
page 49
RISK MANAGEMENT
continued
CREDIT RISK
Credit risk arises from potential non-performance by counterparties, customers,
borrowers, or debt security issuers. The Company is exposed to credit risk as
trading counterparty to dealers and customers, as direct lender, as holder of
securities and as member of exchanges and clearing organizations. The Company
has established policies and procedures to manage credit risk.
The Credit Policy Committee delegates credit approval authority to the Global
Credit Committee, approves exposure measurement standards, reviews
concentrations of credit risk, sets documentation and credit support standards
and considers new or unusual credit-related transactions. The Global Credit
Committee, which includes several members of the Credit Policy Committee,
implements policy through its review and approval of counterparty credit limits.
The Company's Principal Activities Committee, consisting of senior investment
banking, capital markets, credit and risk management professionals, reviews and
approves loan underwriting proposals. Certain leveraged loan commitments, as
well as large or unusual credit extensions, are referred for approval to the
Company's Executive Committee. Dedicated professionals in several departments
contribute to the administration of the Company's credit policies and
procedures. The responsible groups include Global Credit, Operations and
Administration (Margin), Correspondent Clearing (Prime Brokerage), Risk
Management and Investment Banking.
The Global Credit Department monitors and controls extensions of credit to
counterparties of the Company. The department's professionals assess the
creditworthiness of the Company's counterparties and assign or recommend credit
limits and requirements. In addition, credit and quantitative analysts assess
the quality and acceptability of collateral, measure potential credit exposure
associated with certain transactions, monitor compliance with credit limits,
obtain appropriate legal documentation and provide comprehensive credit risk
reporting for senior management.
Credit analysts and managers are based in Company offices in New York, San
Francisco, London, Dublin and Hong Kong and specialize by industry within the US
and otherwise by country or region. Each analyst provides rating and limit
recommendations to senior credit officers who either take action or refer
recommendations to the Global Credit Committee or the Credit Policy Committee.
All counterparties are assigned internal credit ratings reflecting the Global
Credit Department's quantitative and qualitative assessment of the
counterparty's relative probability of default. The internal rating process may
include review of audited financial statements, review of opinions of major
statistical rating agencies, assessment of industry or sovereign factors, review
of market developments, meetings with management and analysis of the risk of
transactions with the counterparty.
The Company measures its actual credit exposure (the replacement cost of
counterparty contracts) on a daily basis. Master netting agreements, collateral
and credit insurance are used to mitigate 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 November 30, 2002 and November 30, 2001 approximated $4.2
billion and $2.9 billion, respectively. These amounts are net of counterparty
credit reserves, which are estimated by applying counterparty-specific
market-based credit spreads to the expected exposure of derivatives and foreign
exchange transactions, after giving effect to collateral. Exchange-traded
financial instruments, which typically are guaranteed by a highly rated clearing
organization, have margin requirements that substantially mitigate risk of
credit loss.
The Company establishes potential exposure limits across a variety of financing
and trading products for all counterparties on a group and individual entity
basis. Potential exposure is the statistically estimated net credit exposure
associated with adverse market moves over the life of transactions at a 97.7%
confidence interval. For over-the-counter derivative and foreign exchange
contracts, the potential exposure is estimated daily using sophisticated,
internally developed risk models that employ Monte Carlo simulations. Potential
exposure estimates consider the size and maturity of contracts; the volatility
of, and correlations among, the underlying assets, indices and currencies;
settlement mechanisms; rights to demand additional collateral; and other legally
enforceable credit mitigants such as third-party guarantees or insurance. For
other credit-sensitive fixed income products, potential exposure limits are
converted to notional amounts using appropriate risk factors.
The Company establishes country concentration limits and monitors actual and
potential exposures, including both position and counterparty
THE BEAR STEARNS COMPANIES INC.
page 50
RISK MANAGEMENT
continued
exposures, in emerging markets. The Sovereign Risk Unit evaluates international
macroeconomic conditions and recommends country concentration limits. The
Company limits and monitors its exposure to sovereign default, devaluation and
inconvertibility of local currencies.
The Margin Department is responsible for evaluating the risk of extending loans
to the Company's customers secured by certain marketable securities. The
department evaluates the creditworthiness of the borrower as well as the
acceptability of collateral and actively monitors to ensure that collateral
received meets regulatory and internal requirements. Internal (or "house")
margin requirements generally exceed minimum regulatory requirements and may be
adjusted for specific securities based on volatility or liquidity. The Special
Credit Services unit of the Global Credit Department evaluates and sets terms
for loans secured by restricted or control stock, emerging markets securities
and concentrated or less liquid securities.
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 to quantify and
limit the risk to the Company of issuer default or changes in credit spreads. In
a similar manner, the department also evaluates the credit quality of reference
issuer obligations associated with derivatives contracts whose values are linked
to the credit quality or credit spread trading level of reference issuers. The
department monitors issuer credit exposures across the various cash and
derivative trading desks that trade in securities or derivatives of the same or
related issuers to monitor aggregate exposures. This process also aggregates
counterparty credit exposures with issuer exposures to produce a more
comprehensive perspective on the Company's exposure to credit risks.
The Risk Department of Global Clearing Services 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 and portfolio
basis.
The Company is subject to concentration risk by holding large positions or
committing to hold large positions in certain types of securities, securities of
a single issuer, including sovereign governments, issuers located in a
particular country or geographic area or engaged in a particular industry.
Positions taken and commitments made by the Company, including underwriting,
often involve substantial amounts and significant exposure to individual issuers
and businesses, including non-investment-grade issuers. The Company seeks to
limit concentration risk through the use of the systems and procedures described
in the preceding discussions of market and credit risk.
The Company, through BSSC and BSIL, transacts with professional clients,
including floor traders and specialists, arbitrageurs, broker-dealers, hedge
funds and fund of funds groups. These clients employ a wide variety of trading
styles including option hedging, market-neutral statistical arbitrage, risk
arbitrage and hedged convertible strategies to multiple fixed income strategies.
Trading strategies are employed in both domestic and international markets. The
extension of credit, via margin debt for a given customer, is determined by the
systematic analysis of the securities held and trading strategy that such
customer employs. The Company has established a risk-based, margin-lending
policy under which the minimum capital requirement may be greater than the
applicable regulatory capital requirement. In other words, customers can only
achieve maximum regulatory leverage if their portfolios satisfy the internal
risk parameters.
Client portfolios are analyzed and evaluated daily through extensive simulation
analysis designed to estimate market-related risk. Using its internally
developed risk management system known as RACS (Risk Analytic Control System),
the Risk Department is able to analyze every professional client's portfolio
prior to each market open as well as on an intra-day basis. RACS uses scenario
analysis to estimate market risk through extensive stress testing. Client
positions are simulated across more than 200 different scenarios resulting in a
wide variety of potential profit and loss possibilities. Some basic assumptions
used in the analysis are minimum portfolio moves of 20% as well as minimum moves
in individual securities of 25% or more. Other scenarios include price movement
tests of 1 and 2 standard deviations, fixed percentage moves, beta-weighted and
market-capitalization-driven extreme price moves. Scenarios are constructed in
such a way as to assess position and portfolio sensitivities to changes in
underlying prices, volatilities, interest rates, credit spreads, cross-currency
rates and forward time horizons. Experienced managers review the results of the
stress testing to determine whether additional margin is necessary. In addition
to client-level security and portfolio analysis, the system produces over 40
various reports that provide multi-dimensional views, which include industry
exposures, country/region exposures and security concentration and liquidity
risk.
THE BEAR STEARNS COMPANIES INC.
page 51
RISK MANAGEMENT
continued
OPERATIONAL RISK
Operational risk is the potential for loss arising from limitations in the
Company's financial systems and controls, deficiencies in legal documentation,
non-compliance with the execution of legal and fiduciary responsibilities,
deficiencies in technology and the risk of loss attributable to operational
problems. In particular, the Company is an active participant in
over-the-counter markets, including derivative, commercial and residential
mortgage loans, leveraged loans and Chapter 13 and other credit card
receivables. The nature of many of these financial instruments is such that they
are valued through the use of models. The complexities and reduced transparency
inherent in financial instruments valued using models, as compared with
exchange-traded prices or other quoted market valuations, introduce a particular
element of operational risk into the Company's business. These risks are less
direct than credit and market risk, but managing them is critical, particularly
in a rapidly changing environment with increasing regulation and transaction
volumes. In an effort to reduce or mitigate these risks, the Company has
established and maintains an internal control environment which incorporates
various control mechanisms at different levels throughout the organization and
within such departments as Controllers, Operations, Legal, Compliance and
Internal Audit. These control mechanisms are designed to better 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 in
the books and records of the Company. 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 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, the Company's
investment in technology allows the Company to communicate information
efficiently and securely to customers and to groups within the Company.
The Management and Compensation Committee, together with the Operations
Committee, has oversight responsibilities for operational and other matters that
affect the Company's day-to-day activities. These committees also review new
products and businesses to ensure that procedures, policies and safeguards are
in place before activities commence.
LEGAL RISK
Legal risk includes the risk of non-compliance with applicable legal and
regulatory requirements and the risk that a counterparty will not perform on its
obligations due to non-credit-related conditions, including counterparty legal
authority and capacity. The Company is generally subject to extensive regulation
in the various jurisdictions in which it conducts its business. The Company has
established procedures based on legal and regulatory requirements on a worldwide
basis that are designed to ensure compliance with applicable statutory and
regulatory requirements. The Company has established policies and procedures in
an effort to mitigate the risk that counterparty performance obligations will be
unenforceable.
OTHER RISKS
Other risks encountered by the Company include political, terrorist, regulatory
and tax risks. These risks reflect the potential impact that changes in local
and international laws, regulatory requirements or tax statutes have on the
economics and viability of current or future transactions. In an effort to
mitigate these risks, the Company seeks to continuously review new and pending
regulations and legislation and participates in various special interest groups.
THE BEAR STEARNS COMPANIES INC.
page 52
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF INCOME
------------
Fiscal Years Ended November 30, 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands, except share and per share data)
- ------------------------------------------------------------------------------------------------------------------------------------
REVENUES
Commissions $ 1,110,974 $ 1,116,731 $ 1,207,122
Principal transactions 2,537,799 2,282,797 2,225,018
Investment banking 833,480 772,125 1,021,969
Interest and dividends 2,232,159 4,339,298 5,642,361
Other income 176,404 190,082 151,494
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues 6,890,816 8,701,033 10,247,964
Interest expense 1,762,580 3,793,998 4,772,286
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 5,128,236 4,907,035 5,475,678
- ------------------------------------------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSES
Employee compensation and benefits 2,508,197 2,528,852 2,788,638
Floor brokerage, exchange and clearance fees 197,266 161,363 158,940
Communications and technology 382,857 453,261 449,691
Occupancy 152,523 146,620 134,596
Advertising and market development 102,984 126,669 125,153
Professional fees 132,927 175,249 190,871
Other expenses 340,519 380,577 456,266
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 3,817,273 3,972,591 4,304,155
- ------------------------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes and
cumulative effect of change in accounting principle 1,310,963 934,444 1,171,523
Provision for income taxes 432,618 309,479 398,340
- ------------------------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of change in accounting principle 878,345 624,965 773,183
Cumulative effect of change in accounting principle, net of tax -- (6,273) --
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 878,345 $ 618,692 $ 773,183
====================================================================================================================================
Net income applicable to common shares $ 842,739 $ 579,579 $ 734,070
====================================================================================================================================
Basic earnings per share $ 7.00 $ 4.49 $ 5.37
Diluted earnings per share $ 6.47 $ 4.27 $ 5.35
====================================================================================================================================
Weighted average common shares outstanding:
Basic 132,798,359 142,643,018 151,437,116
Diluted 146,346,111 152,216,936 152,034,249
====================================================================================================================================
See Notes to Consolidated Financial Statements.
THE BEAR STEARNS COMPANIES INC.
page 53
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
-------------
As of November 30, 2002 2001
- -----------------------------------------------------------------------------------------------
(in thousands, except share data)
- -----------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 5,520,285 $ 7,332,747
Cash and securities deposited with clearing
organizations or segregated in compliance
with federal regulations 7,100,138 9,287,673
Securities purchased under agreements to resell 36,505,447 41,742,485
Securities received as collateral 5,669,811 3,037,956
Securities borrowed 53,116,267 51,911,092
Receivables:
Customers 18,105,196 17,558,956
Brokers, dealers and others 1,358,377 2,828,081
Interest and dividends 297,980 277,246
Financial instruments owned, at fair value
Pledged as collateral 30,752,090 23,562,448
Not pledged as collateral 22,692,578 24,348,803
Property, equipment and leasehold
improvements, net of accumulated depreciation and
amortization of $722,690 and $952,014 in 2002
and 2001, respectively 483,827 519,089
Other assets 3,252,427 3,123,652
- -----------------------------------------------------------------------------------------------
Total Assets $ 184,854,423 $ 185,530,228
===============================================================================================
LIABILITIES & STOCKHOLDERS' EQUITY
Short-term borrowings $ 14,409,826 $ 13,658,510
Securities sold under agreements to repurchase 44,469,414 50,135,295
Obligation to return securities received as collateral 5,669,811 3,037,956
Payables:
Customers 53,814,105 53,590,217
Brokers, dealers and others 8,550,450 7,879,469
Interest and dividends 515,228 575,645
Financial instruments sold, but not yet purchased,
at fair value 24,421,273 24,749,040
Accrued employee compensation and benefits 1,158,699 1,284,391
Other liabilities and accrued expenses 1,219,635 799,624
- -----------------------------------------------------------------------------------------------
154,228,441 155,710,147
- -----------------------------------------------------------------------------------------------
Commitments and contingencies (Note 15)
Long-term borrowings 23,681,399 23,429,054
- -----------------------------------------------------------------------------------------------
Guaranteed Preferred Beneficial Interests in
Company Subordinated Debt Securities 562,500 762,500
- -----------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Preferred stock 692,832 800,000
Common stock, $1.00 par value; 500,000,000
shares authorized as of November 30, 2002 and
November 30, 2001; 184,805,848 shares issued as
of November 30, 2002 and November 30, 2001 184,806 184,806
Paid-in capital 2,866,290 2,728,981
Retained earnings 3,909,272 3,118,635
Employee stock compensation plans 2,213,979 2,015,375
Unearned compensation (208,588) (230,071)
Treasury stock, at cost -
Adjustable Rate Cumulative Preferred Stock Series A:
2,520,750 shares as of November 30, 2002 and
November 30, 2001 (103,421) (103,421)
Common stock: 84,781,479 and 84,763,780 shares as of
November 30, 2002 and November 30, 2001, respectively (3,173,087) (2,885,778)
- -----------------------------------------------------------------------------------------------
Total Stockholders' Equity 6,382,083 5,628,527
- -----------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 184,854,423 $ 185,530,228
===============================================================================================
See Notes to Consolidated Financial Statements.
THE BEAR STEARNS COMPANIES INC.
page 54
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------
Fiscal Years Ended November 30, 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------
(in thousands)
- ---------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 878,345 $ 618,692 $ 773,183
Adjustments to reconcile net income to cash (used in)
provided by operating activities:
Noncash items included in net income:
Depreciation and amortization 161,879 208,822 153,616
Deferred income taxes (24,374) (232,916) (263,693)
Employee stock compensation plans 533,240 355,612 676,920
Other 16,043 16,423 17,559
Changes in operating assets and liabilities:
Cash and securities deposited with clearing organizations
or segregated in compliance with federal regulations 2,187,535 (5,514,441) (2,584,444)
Securities purchased under agreements to resell 5,237,038 (6,243,253) 500,766
Securities borrowed (1,205,175) 9,848,739 (1,330,534)
Receivables from customers (546,240) (243,724) (476,192)
Receivables from brokers, dealers and others 1,469,704 (2,038,030) (248,013)
Financial instruments owned (5,130,001) (4,424,247) (3,888,357)
Other assets (217,640) 584,722 (1,472,789)
Securities sold under agreements to repurchase (5,665,881) (1,552,833) (1,634,981)
Payables to customers 223,888 6,804,906 3,941,554
Payables to brokers, dealers and others 673,646 3,431,849 (1,142,985)
Financial instruments sold, but not yet purchased (327,767) 5,743,264 (699,145)
Accrued employee compensation and benefits (120,267) (191,910) 746,176
Other liabilities and accrued expenses 487,722 (105,665) 671,659
- ---------------------------------------------------------------------------------------------------------------
Cash (used in) provided by operating activities (1,368,305) 7,066,010 (6,259,700)
- ---------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from (payments for) short-term borrowings 751,316 (2,973,254) 3,923,988
Net proceeds from issuances of long-term borrowings 5,006,611 6,574,299 8,500,596
Redemption of preferred stock issued by a subsidiary (200,000) -- --
Issuance of common stock 26,436 288 --
Net proceeds from issuance of subsidiary securities -- 254,231 --
Redemption of preferred stock (91,336) -- --
Proceeds from put option premium -- -- 1,065
Payments for retirement of long-term borrowings (5,239,816) (4,250,313) (4,359,932)
Treasury stock purchases-common stock (629,664) (1,048,015) (726,836)
Cash dividends paid (97,544) (100,206) (99,329)
- ---------------------------------------------------------------------------------------------------------------
Cash (used in) provided by financing activities (473,997) (1,542,970) 7,239,552
- ---------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold improvements (126,617) (185,298) (192,189)
Business acquisition -- (242,983) --
Purchases of investment securities and other assets (107,502) (101,891) (178,014)
Proceeds from sales of investment securities and other assets 263,959 19,905 139,842
- ---------------------------------------------------------------------------------------------------------------
Cash provided by (used in) investing activities 29,840 (510,267) (230,361)
- ---------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (1,812,462) 5,012,773 749,491
Cash and cash equivalents, beginning of year 7,332,747 2,319,974 1,570,483
- ---------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 5,520,285 $ 7,332,747 $ 2,319,974
===============================================================================================================
See Notes to Consolidated Financial Statements.
Note: Certain reclassifications have been made to prior period amounts to
conform to the current year's presentation.
SFAS No. 140 and SFAS No. 125, as applicable, require balance sheet recognition
for collateral related to certain secured transactions which are non-cash
activities and did not have an impact on the Consolidated Statements of Cash
Flows.
THE BEAR STEARNS COMPANIES INC.
page 55
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Preferred Common Stock Paid-In Retained
Stock $1 Par Value Capital Earnings
- ----------------------------------------------------------------------------------------------------
(in thousands, except share
and per share data)
- ----------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 26, 1999 $ 800,000 $ 184,806 $ 2,509,801 $ 1,916,516
Net income 773,183
Cash dividends declared -
Common ($0.55 per share) (60,215)
Preferred (29,335)
Treasury stock -
Common stock purchased
(16,939,591 shares)
Common stock issued out of treasury
(7,491,085 shares) 1,099
Income tax benefit related to distributions
from employee stock compensation plans 72,973
Put option premium 1,065
Unearned employee stock compensation
Employee stock compensation awards
Amortization of preferred stock issue costs (1,300)
- ----------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2000 800,000 184,806 2,583,638 2,600,149
Net income 618,692
Cash dividends declared -
Common ($0.60 per share) (61,093)
Preferred (39,113)
Treasury stock -
Common stock purchased
(19,723,837 shares)
Common stock issued out of treasury
(10,734,551 shares) 3,256
Income tax benefit related to distributions
from employee stock compensation plans 143,387
Unearned employee stock compensation, net
Employee stock compensation awards, net
Amortization of preferred stock issue costs (1,300)
- ----------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2001 $ 800,000 $ 184,806 $ 2,728,981 $ 3,118,635
====================================================================================================
Treasury Stock
--------------------------
Adjustable Rate
Cumulative
Preferred Stock,
Employee Stock Series A-$50
Compensation Unearned Liquidation Common
Plans Compensation Preference Stock
- --------------------------------------------------------------------------------------------------------
(in thousands, except share
and per share data)
- --------------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 26, 1999 $ 1,179,101 $ 0 $ (103,421) $(1,544,856)
Net income
Cash dividends declared -
Common ($0.55 per share)
Preferred
Treasury stock -
Common stock purchased
(16,939,591 shares) (723,530)
Common stock issued out of treasury
(7,491,085 shares) (158,104) 159,585
Income tax benefit related to distributions
from employee stock compensation plans
Put option premium
Unearned employee stock compensation (218,791)
Employee stock compensation awards 895,711
Amortization of preferred stock issue costs
- --------------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2000 1,916,708 (218,791) (103,421) (2,108,801)
Net income
Cash dividends declared -
Common ($0.60 per share)
Preferred
Treasury stock -
Common stock purchased
(19,723,837 shares) (1,045,350)
Common stock issued out of treasury
(10,734,551 shares) (268,224) 268,373
Income tax benefit related to distributions
from employee stock compensation plans
Unearned employee stock compensation, net (11,280)
Employee stock compensation awards, net 366,891
Amortization of preferred stock issue costs
- --------------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2001 $ 2,015,375 $ (230,071) $ (103,421) $(2,885,778)
========================================================================================================
THE BEAR STEARNS COMPANIES INC.
page 56
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
continued
Preferred Common Stock Paid-In Retained
Stock $1 Par Value Capital Earnings
- ----------------------------------------------------------------------------------------------------
(in thousands, except share
and per share data)
- ----------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2001 $ 800,000 $ 184,806 $ 2,728,981 $ 3,118,635
Net income 878,345
Cash dividends declared -
Common ($0.62 per share) (61,144)
Preferred (36,400)
Dividend equivalents (5,996)
Treasury stock -
Common stock purchased
(10,490,940 shares)
Common stock issued out of treasury
(10,473,241 shares) 11,320
Redemption of preferred stock (107,168) 15,832
Income tax benefit related to distributions
from employee stock compensation plans 128,128
Unearned employee stock compensation, net
Employee stock compensation awards, net
Amortization of preferred stock issue costs (2,139)
- ----------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2002 $ 692,832 $ 184,806 $ 2,866,290 $ 3,909,272
====================================================================================================
Treasury Stock
----------------------------
Adjustable Rate
Cumulative
Preferred Stock,
Employee Stock Series A-$50
Compensation Unearned Liquidation Common
Plans Compensation Preference Stock
- --------------------------------------------------------------------------------------------------------
(in thousands, except share
and per share data)
- --------------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2001 $ 2,015,375 $ (230,071) $ (103,421) $(2,885,778)
Net income
Cash dividends declared -
Common ($0.62 per share)
Preferred
Dividend equivalents
Treasury stock -
Common stock purchased
(10,490,940 shares) (626,999)
Common stock issued out of treasury
(10,473,241 shares) (319,148) 339,690
Redemption of preferred stock
Income tax benefit related to distributions
from employee stock compensation plans
Unearned employee stock compensation, net 21,483
Employee stock compensation awards, net 517,752
Amortization of preferred stock issue costs
- --------------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2002 $ 2,213,979 $ (208,588) $ (103,421) $(3,173,087)
========================================================================================================
See Notes to Consolidated Financial Statements.
THE BEAR STEARNS COMPANIES INC.
page 57
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 ("Company"). All material intercompany
transactions and balances have been eliminated in consolidation. Certain prior
year amounts have been reclassified to conform to the current year's
presentation.
The consolidated financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America. These principles
require management to make certain estimates and assumptions, including those
regarding inventory valuations, stock compensation, certain accrued liabilities
and the potential outcome of litigation, which may affect the amounts reported
in the consolidated financial statements and accompanying notes. Actual results
could differ materially from these estimates.
The Company, through its principal operating subsidiaries, Bear, Stearns & Co.
Inc. ("Bear Stearns"), Bear, Stearns Securities Corp. ("BSSC"), Bear, Stearns
International Limited ("BSIL") and Bear Stearns Bank plc ("BSB"), is primarily
engaged in business as a securities broker-dealer and operates in three
principal segments: Capital Markets, Global Clearing Services and Wealth
Management. Capital Markets is composed of the institutional equities, fixed
income and investment banking areas. Global Clearing Services is composed of
clearance and commission-related areas which concentrate on the execution of
trades for customers. Wealth Management is composed of the Private Client
Services ("PCS") and asset management areas. See Note 16, "Segment and
Geographic Area Data," in the Notes to Consolidated Financial Statements.
FINANCIAL INSTRUMENTS
Proprietary securities, futures and other derivatives transactions are recorded
on a trade date basis. Financial instruments owned and financial instruments
sold, but not yet purchased, including contractual commitments for 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 principal transactions.
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 affect 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, yield curve and volatility factors, prepayment speeds,
default rates, loss severity, current market and contractual prices for the
underlying financial instruments, as well as other economic measurements.
Equity securities acquired as a result of leveraged acquisition transactions are
reflected in the consolidated financial statements at their initial costs until
significant transactions or developments indicate that a change in the carrying
value of the securities is appropriate. Generally, the carrying values of these
securities will be increased only in those instances where market values are
readily ascertainable by reference to substantial transactions occurring in the
marketplace or quoted market prices. Reductions to the carrying value of these
securities are made when the Company's estimate of net realizable value has
declined below the carrying value.
CUSTOMER TRANSACTIONS
Customer securities 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. Receivables from and
payables to customers include amounts related to both cash and margin
transactions. Securities owned by customers, including those that collateralize
margin or other similar transactions, are generally not reflected in the
Consolidated Statements of Financial Condition.
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. Resulting interest income and expense is generally
included in "Principal Transactions" revenues in the Consolidated Statements of
Income. Reverse repurchase agreements and repurchase agreements are presented on
a net-by-counterparty basis, where appropriate. It is the Company's general
policy to take possession of securities with a market value in excess of the
principal amount loaned plus the accrued interest thereon, to collateralize
reverse repurchase agreements. Similarly, the Company is generally required to
provide securities to counterparties to collateralize
THE BEAR STEARNS COMPANIES INC.
page 58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
repurchase agreements. The Company's agreements with counterparties generally
contain contractual provisions allowing for additional collateral to be
obtained, or excess collateral returned. 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.
Securities borrowed and securities loaned are recorded based on 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 retrieved, when deemed
appropriate.
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 daily
average rates of exchange for the fiscal 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") No. 109, "Accounting for
Income Taxes." Under SFAS No. 109, deferred income taxes are based on 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 by the enacted tax rates and laws expected to be in effect when the
related temporary differences are expected to be reversed.
EARNINGS PER SHARE
Earnings per share ("EPS") is computed in accordance with SFAS No. 128,
"Earnings Per Share." Basic EPS is computed by dividing net income applicable to
common shares, adjusted for costs related to vested shares under the Capital
Accumulation Plan for Senior Managing Directors, as amended (the "CAP Plan"), as
well as the effect of the redemption of preferred stock, by the weighted average
number of common shares outstanding. Common shares outstanding includes vested
units issued under certain employee stock compensation plans, which will be
distributed as shares of common stock. Diluted EPS includes the determinants of
basic EPS and, in addition, gives effect to dilutive potential common shares
related to employee stock compensation plans.
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 fiscal years ended
November 30, 2002, 2001 and 2000. Income taxes paid totaled $221.5 million,
$55.0 million and $985.0 million for the fiscal years ended November 30, 2002,
2001 and 2000, respectively.
STOCK-BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does
not require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has elected to account for its
stock-based compensation plans using the intrinsic value method prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25"), as permitted by SFAS No. 123. Under the provisions of
APB No. 25, compensation cost for stock options is measured as the excess, if
any, of the quoted market price of the Company's common stock at the date of
grant over the amount an employee must pay to acquire the stock. Accordingly, no
compensation expense has been recognized for stock option awards because the
exercise price was at the fair market value of the Company's common stock on the
grant dates. Commencing with stock options granted after November 30, 2002, the
Company will begin to expense the fair value of stock options issued to
employees over the related vesting period. Compensation expense related to
restricted stock units is recognized over the applicable service period.
THE BEAR STEARNS COMPANIES INC.
page 59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
INVESTMENT BANKING AND ADVISORY SERVICES
Underwriting revenues and fees for mergers and acquisitions advisory services
are accrued when services for the transactions are substantially completed.
Transaction expenses are deferred until the related revenue is recognized.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and
Certain Hedging Activities," establishes accounting and reporting standards for
stand-alone derivative instruments, derivatives embedded within other contracts
or securities, and hedging activities. It requires that all derivatives, whether
stand-alone or embedded within other contracts or securities (except in narrowly
defined circumstances), be carried on the Company's Consolidated Statement of
Financial Condition at their then fair value, with such changes in fair value
recorded in current earnings. It also requires hedged items not carried at fair
value to be marked (to the extent of the profit or loss on the derivative) for
the risk being hedged, with such changes in the fair value recorded in current
earnings.
TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES
The Company follows SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities -- a Replacement of FASB
Statement No. 125," to account for securitizations and other transfers of
financial assets and collateral. SFAS No. 140 establishes accounting and
reporting standards with a financial-components approach that focuses on
control. Under this approach, financial assets or liabilities are recognized
when control is established and derecognized when control has been surrendered
or the liability has been extinguished. In addition, specific implementation
guidelines have been established to further distinguish transfers of financial
assets that are sales from transfers that are secured borrowings.
NEW ACCOUNTING PRONOUNCEMENTS
In October 2002, the Emerging Issues Task Force ("EITF") issued guidance on
Issue No. 02-3, "Issues Involved in Accounting for Derivative Contracts Held for
Trading Purposes and Contracts Involved in Energy Trading and Risk Management
Activities." This guidance would generally eliminate the practice of recognizing
profit at the inception of a derivative contract unless the fair value of the
derivative is obtained from a quoted market price in an active market or is
otherwise evidenced by comparison to other observable current market
transactions or based on a valuation technique that incorporates observable
market data. The guidance was effective for contracts entered into subsequent to
November 22, 2002 and did not materially affect the consolidated financial
statements. The effect in future financial statements will depend on the nature
of derivative transactions entered into in the future.
In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation ("FIN") No. 45, "Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." FIN No. 45 requires a guarantor to recognize, at the inception of the
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. It also provides additional guidance on the disclosure of
guarantees. The recognition and measurement provisions are effective for
guarantees made or modified after December 31, 2002. The disclosure provisions
are effective for fiscal periods ending after December 15, 2002. The Company
will adopt FIN No. 45 as required in fiscal 2003 and does not expect a material
impact on the consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation -- Transition and Disclosure," which amends SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS No. 148 provides three
alternative methods of transition for a voluntary change to fair value
accounting for stock-based compensation as permitted under SFAS No. 123. It also
requires prominent disclosures about the method of accounting for stock-based
compensation and its effect on reported results.The three alternatives are: 1)
the prospective method in which fair value expense would be recognized for all
awards granted in the year of adoption, but not previous awards, 2) the modified
prospective method in which fair value expense would be recognized for the
unvested portion of all prior stock options granted and those granted in the
year of adoption, and 3) the retroactive restatement method which is similar to
the modified prospective method, except that all prior periods are restated. The
Company will adopt fair value accounting for stock-based compensation in fiscal
2003 using the prospective method provided by SFAS No. 148. As a result, the
Company will begin to expense the fair value of stock options issued to
employees over the related vesting period, starting with stock options granted
after November 30, 2002.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities -- an Interpretation of ARB No. 51." FIN No. 46 provides
THE BEAR STEARNS COMPANIES INC.
page 60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
guidance on the consolidation of certain entities in which equity investors do
not have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support. Such entities are referred to as
variable interest entities ("VIEs"). FIN No. 46 requires the primary beneficiary
of a VIE to consolidate the entity. For existing entities, FIN No. 46 is
effective for fiscal periods beginning after June 15, 2003. For new entities,
FIN No. 46 was effective after January 31, 2003. The Company will adopt FIN No.
46 as required in fiscal 2003 and is currently evaluating its effect on the
consolidated financial statements.
The transition provisions of FIN No. 46 require certain disclosures in the
financial statements issued after January 31, 2003. Although the Company is
still evaluating the effect of FIN No. 46, it is reasonably possible that FIN
No. 46 will require consolidation of, or additional disclosures related to, the
entities described below.
The Company acts as portfolio manager in several collateralized debt obligation
transactions. In these transactions, the Company establishes a trust that
purchases a portfolio of assets and issues trust certificates that represent
interests in the portfolio of assets. In addition to receiving variable
compensation for managing the portfolio, the Company also may retain certain
trust certificates. The assets in these trusts at November 30, 2002 approximated
$1.3 billion. The Company's maximum exposure to loss as a result of its
relationship with these trusts is approximately $11.9 million, which represents
the fair value of its interests.
The Company owns subordinated interests in several entities related to
collateralized debt obligation transactions in which it does not act as
portfolio manager. It may own these interests as a result of its underwriting
activities or by direct proprietary investment. These entities may qualify as
VIEs. At November 30, 2002, the total assets of those entities in which the
Company owned significant variable interests were $1.6 billion. As owners of
significant variable interests, the Company may be required to make additional
disclosures related to these entities, but will not be required to consolidate
them. The Company's maximum exposure to loss related to these entities is
approximately $14.5 million, which represents the fair value of its interests at
November 30, 2002.
The Company has entered into a lease arrangement for its world headquarters at
383 Madison Avenue with an entity that may be a VIE. The Company makes periodic
LIBOR-based payments to this entity and guarantees a portion of the value of the
building to the creditors of the entity. As a result of its involvement with
this entity, the Company's maximum exposure to loss is $570 million, which
represents the guarantee to the entity's creditors. The entity's sole asset is
the building, which was completed in 2002 at a cost of approximately $670
million.
In 1997, the Company established a program whereby it has created a series of
municipal securities trusts in which it has retained interests. These trusts
purchase fixed-rate, long-term, highly rated, insured or escrowed municipal
bonds financed by the issuance of trust certificates. Certain of the trust
certificates entitle the holder to receive future payments of principal and
variable interest and to tender such certificates at the option of the holder on
a periodic basis. The Company acts as placement agent for the trust certificates
and as liquidity provider to the trust. The purpose of the program is to allow
the Company's clients to purchase synthetic short-term, floating-rate municipal
debt that does not otherwise exist in the marketplace. In the Company's capacity
as liquidity provider to the trusts, the maximum exposure to loss at November
30, 2002 was approximately $2.7 billion, which represents the outstanding amount
of all trust certificates. This exposure to loss is mitigated by the underlying
municipal bonds. The underlying municipal bonds in the trusts are either AAA- or
AA-rated, insured or escrowed to maturity. Such bonds had a market value
approximating $2.7 billion at November 30, 2002.
At November 30, 2002, the Company had an approximate 40% equity interest in
Liquid Funding, Ltd. ("LFL"), a AAA-rated special purpose vehicle established to
participate in the repurchase agreement and total return swap markets. A
subsidiary of the Company acts as investment manager. The Company accounts for
such investment under the equity method of accounting. At November 30, 2002, the
total assets of this entity approximated $900 million. The Company's maximum
exposure to loss as a result of its investment in this entity is approximately
$5.0 million.
The Company regularly creates or transacts with entities that may be VIEs. These
entities are an essential part of its securitization, asset management and
structured finance businesses. In addition, the Company may purchase and sell
instruments that may be variable interests. Given the short period of time from
the issuance of FIN No. 46 and its effective date, at this time the Company
cannot definitively quantify the effect of FIN No. 46.
THE BEAR STEARNS COMPANIES INC.
page 61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
2 FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the Company's assets and liabilities are carried at fair
value or contracted amounts that approximate fair value.
Assets that are recorded at contracted amounts approximating fair value consist
largely of short-term secured receivables, including reverse repurchase
agreements, securities borrowed, customer receivables and certain other
receivables. Similarly, the Company's short-term liabilities such as bank loans,
commercial paper, medium-term notes, repurchase agreements, securities loaned,
customer payables 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, therefore their fair
values are not materially affected by changes in interest rates.
The estimated fair value of the Company's long-term borrowings, based on market
rates of interest and current foreign exchange rates available to the Company at
November 30, 2002 for debt obligations of similar maturity, approximate carrying
value. The Company hedges the economic risks associated with its long- and
short-term debt. The Company generally enters into interest rate swaps and other
transactions designed to either convert its fixed-rate debt into floating-rate
debt or otherwise hedge its exposure to interest rate movements.
3 FINANCIAL INSTRUMENTS
Financial instruments owned and financial instruments sold, but not yet
purchased, consisting of the Company's proprietary trading inventories, at fair
value, as of November 30, were as follows:
-----------
2002 2001
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
FINANCIAL INSTRUMENTS OWNED:
US government and agency $ 5,754,144 $ 7,182,008
Other sovereign governments 1,064,850 1,337,042
Corporate equity and convertible debt 7,746,419 6,977,353
Corporate debt and other 7,337,940 9,087,306
Mortgages, mortgage- and asset-backed 20,019,289 16,051,753
Derivative financial instruments 11,522,026 7,275,789
- --------------------------------------------------------------------------------
$53,444,668 $47,911,251
================================================================================
FINANCIAL INSTRUMENTS SOLD,
BUT NOT YET PURCHASED:
US government and agency $ 8,206,597 $12,596,768
Other sovereign governments 1,209,421 1,327,125
Corporate equity 4,935,396 3,279,875
Corporate debt and other 2,213,984 2,532,224
Derivative financial instruments 7,855,875 5,013,048
- --------------------------------------------------------------------------------
$24,421,273 $24,749,040
================================================================================
As of November 30, 2002 and 2001, all financial instruments owned that were
pledged to counterparties where the counterparty has the right, by contract or
custom, to rehypothecate these securities are classified as "Financial
Instruments Owned, Pledged as Collateral" in the Consolidated Statements of
Financial Condition.
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 purchase the financial instrument in the
market at prevailing prices. These transactions result in off-balance-sheet risk
as the Company's ultimate obligation to purchase such securities may exceed the
amount recognized in the Consolidated Statements of Financial Condition.
THE BEAR STEARNS COMPANIES INC.
page 62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Continued
4 SHORT-TERM BORROWINGS
The Company obtains short-term borrowings, the majority of which are unsecured,
through the issuance of commercial paper, medium-term notes ("MTNs") and bank
loans. The interest rates on such short-term borrowings reflect market rates of
interest at the time of the transactions.
Borrowings made under the Company's commercial paper programs were $7.3 billion
and $5.5 billion at November 30, 2002 and 2001, respectively. During the fiscal
years ended November 30, 2002, 2001 and 2000, the weighted average interest
rates on such borrowings were 1.89%, 4.55% and 6.34%, respectively. The weighted
average rates on commercial paper outstanding at November 30, 2002 and November
30, 2001 were 1.52% and 2.28%, respectively.
At November 30, 2002 and November 30, 2001, the Company had outstanding $1.9
billion and $3.2 billion, respectively, in the principal amount of short-term
MTNs. MTNs generally bear interest at variable rates based on LIBOR. During the
fiscal years ended November 30, 2002, 2001 and 2000, the weighted average
interest rates on MTNs were 2.05%, 4.85% and 6.63%, respectively. The weighted
average rates on MTNs outstanding at November 30, 2002 and November 30, 2001
were 1.60% and 2.57%, respectively.
Short-term borrowings at November 30, 2002 and November 30, 2001 included $5.2
billion and $5.0 billion, respectively, in bank loans and other borrowings.
During the fiscal years ended November 30, 2002, 2001 and 2000, the weighted
average interest rates on such short-term borrowings were 2.41%, 3.60% and
5.86%, respectively. The weighted average rates on such short-term borrowings
outstanding at November 30, 2002 and November 30, 2001 were 1.96% and 2.54%,
respectively.
5 LONG-TERM BORROWINGS
Long-term borrowings (which have original maturities of at least 12 months) at
November 30 consisted of the following:
-----------
2002 2001
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
Fixed-rate notes due 2003 to 2014:(1)
US-dollar-denominated $ 8,997,716 $ 8,151,168
Floating-rate notes due 2003 to 2007:
US-dollar-denominated 2,807,525 3,368,678
Non-US-dollar-denominated 49,750 44,800
Medium-term notes and other borrowings:(2)
US-dollar-denominated 7,756,837 8,519,451
Non-US-dollar-denominated 4,069,571 3,344,957
- --------------------------------------------------------------------------------
Total long-term borrowings $23,681,399 $23,429,054
================================================================================
(1) At November 30, 2002, US-dollar-denominated fixed-rate notes are at
interest rates ranging from 5.70% to 8.75%.
(2) Included are various equity-linked or indexed instruments.
The Company has entered into interest rate swaps and other transactions to
convert its fixed-rate notes into floating rates based on LIBOR. The weighted
average effective interest rates on the Company's fixed-rate notes, after giving
effect to the swaps, during the fiscal years ended November 30, 2002, 2001 and
2000, were 2.69%, 5.29% and 6.94%, respectively. The weighted average effective
interest rates on the Company's fixed-rate notes outstanding at November 30,
2002 and November 30, 2001 were 2.24% and 3.05%, respectively.
The floating-rate notes bear interest at rates primarily related to LIBOR. For
floating-rate notes that are not based on LIBOR, the Company has entered into
interest rate swaps and other transactions to convert them into floating rates
based on LIBOR. During the fiscal years ended November 30, 2002, 2001 and 2000,
the weighted average effective interest rates on the floating-rate notes were
2.45%, 5.24% and 6.90%, respectively. The weighted average effective interest
rates on the floating-rate notes outstanding at November 30, 2002 and November
30, 2001 were 2.18% and 2.99%, respectively.
At November 30, 2002, the Company's MTNs have initial maturities ranging from 12
months to 30 years from the date of issue and bear interest at either a fixed
rate or a variable rate primarily based on LIBOR. The Company has entered into
interest rate swaps and certain other transactions to convert substantially all
of its fixed-rate MTNs into floating rates based on LIBOR. During the fiscal
years ended November 30, 2002, 2001 and 2000, the weighted average interest
rates on the MTNs, after giving effect to the swaps, were 2.53%, 4.91% and
6.63%, respectively. The weighted average interest rates on the Company's MTNs
at November 30, 2002 and November 30, 2001 were 2.08% and 2.79%, respectively.
THE BEAR STEARNS COMPANIES INC.
page 63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
Long-term borrowings at November 30, 2002 mature as follows:
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
FISCAL YEAR AMOUNT
2003 $ 4,889,068
2004 4,552,115
2005 3,825,958
2006 2,492,817
2007 3,270,677
Thereafter 4,650,764
- --------------------------------------------------------------------------------
Total $23,681,399
================================================================================
Amounts include fair value adjustments in accordance with SFAS No. 133.
Instruments governing certain indebtedness of the Company contain various
financial covenants, including maintenance of minimum levels of stockholders'
equity of the Company. At November 30, 2002, the Company was in compliance with
all financial covenants contained in these debt agreements.
6 INCOME TAXES
The provision for income taxes for the fiscal years ended November 30 consisted
of the following:
---------
2002 2001 2000
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
CURRENT:
Federal $ 342,982 $ 400,343 $ 402,410
State and local 85,954 108,191 137,841
Foreign 28,056 33,861 121,782
- --------------------------------------------------------------------------------
Total current 456,992 542,395 662,033
- --------------------------------------------------------------------------------
DEFERRED:
Federal (16,364) (166,718) (185,477)
State and local (6,452) (67,752) (78,216)
Foreign (1,558) 1,554 --
- --------------------------------------------------------------------------------
Total deferred (24,374) (232,916) (263,693)
- --------------------------------------------------------------------------------
Total provision for income taxes $ 432,618 $ 309,479 $ 398,340
================================================================================
As of November 30, 2002, the Company had approximately $454 million in
accumulated earnings permanently reinvested overseas. If such income were
repatriated, additional federal income tax (net of available tax credits) at
current tax rates would be approximately $47 million.
Significant components of the Company's deferred tax assets (liabilities) as of
November 30 were as follows:
-----------
2002 2001
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
DEFERRED TAX ASSETS:
Deferred compensation $ 955,619 $ 852,637
Liability reserves 181,895 177,733
Valuation reserves 7,392 9,125
Depreciation/amortization 331 30,873
Unrealized loss 15,769 42,309
Partnerships 61,253 94,519
Other 34,863 12,596
- --------------------------------------------------------------------------------
Total deferred tax assets 1,257,122 1,219,792
- --------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
Unrealized appreciation (56,845) (48,488)
Other (9,118) (4,519)
- --------------------------------------------------------------------------------
Total deferred tax liabilities (65,963) (53,007)
- --------------------------------------------------------------------------------
Net deferred tax assets $ 1,191,159 $ 1,166,785
================================================================================
No valuation allowance has been established against deferred tax assets since it
is more likely than not that the deferred tax assets will be realized.
THE BEAR STEARNS COMPANIES INC.
page 64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
A reconciliation of the statutory federal income tax rates to the Company's
effective tax rates for the fiscal years ended November 30 was as follows:
----------
2002 2001 2000
- --------------------------------------------------------------------------------
Statutory rate 35.0% 35.0% 35.0%
State and local income taxes,
net of federal benefit 3.9 2.8 3.3
Tax-exempt interest income and
dividend exclusion (3.0) (2.4) (1.3)
Domestic tax credits (2.5) (3.2) (2.6)
Other, net (0.4) 0.8 (0.4)
- --------------------------------------------------------------------------------
Effective tax rate 33.0% 33.0% 34.0%
================================================================================
Not included in the reconciliation table is the effect of approximately $128.1
million, $143.4 million and $73.0 million in income tax benefits attributable to
the distribution of common stock under the CAP Plan and other deferred
compensation plans, credited directly to paid-in capital, for fiscal 2002, 2001
and 2000, respectively.
7 REGULATORY REQUIREMENTS
Bear Stearns and BSSC are registered broker-dealers and, accordingly, are
subject to Rule 15c3-1 under the Securities Exchange Act of 1934 ("Net Capital
Rule") and the capital rules of the New York Stock Exchange, Inc. ("NYSE"), the
Commodity Futures Trading Commission ("CFTC") and other principal exchanges of
which Bear Stearns and BSSC are members. Included in the computation of net
capital, as defined, of Bear Stearns is $435.9 million, which is net capital of
BSSC in excess of 5.5% of aggregate debit items arising from customer
transactions. At November 30, 2002, Bear Stearns' net capital of $1.46 billion
exceeded the minimum requirement by $1.41 billion.
BSIL and Bear Stearns International Trading Limited ("BSIT"), London-based
broker-dealer subsidiaries, are subject to the regulatory capital requirements
of the Financial Services Authority.
BSB, an Ireland-based bank principally involved in the trading and sales of
fixed income products, is registered in Ireland and is subject to the regulatory
capital requirements of the Central Bank of Ireland.
At November 30, 2002, Bear Stearns, BSSC, BSIL, BSIT and BSB were in compliance
with their respective regulatory capital requirements.
These regulatory rules, 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 November 30, 2002, approximately $2.2 billion in equity capital of
Bear Stearns, BSSC, BSIL, BSIT and BSB 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 ("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 10-year Constant Maturity Rate and the 30-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 5.50% during the fiscal year ended November 30, 2002.
The Company did not repurchase any shares during the fiscal year ended November
30, 2002. At November 30, 2002, the Company held 2,520,750 shares of Preferred
Stock in treasury.
The Company has outstanding 3,817,850 depositary shares representing 954,463
shares of Cumulative Preferred Stock, Series E ("Series E Preferred Stock"),
having an aggregate liquidation preference of $190.9 million as of November 30,
2002. Each depositary share represents a one-fourth interest in a share of
Series E Preferred Stock. Dividends on the Series E Preferred Stock are payable
at an annual rate
THE BEAR STEARNS COMPANIES INC.
page 65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
of 6.15%. Series E Preferred Stock is redeemable at the option of the Company at
any time on or after January 15, 2008, in whole or in part, at a redemption
price of $200 per share (equivalent to $50 per depositary share), plus accrued
but unpaid dividends to the redemption date. During the fiscal year ended
November 30, 2002, the Company redeemed and retired 1,182,150 depositary shares.
The Company has outstanding 3,293,800 depositary shares representing 823,450
shares of Cumulative Preferred Stock, Series F ("Series F Preferred Stock"),
having an aggregate liquidation preference of $164.7 million as of November 30,
2002. Each depositary share represents a one-fourth interest in a share of
Series F Preferred Stock. Dividends on the Series F Preferred Stock are payable
at an annual rate of 5.72%. Series F Preferred Stock is redeemable at the option
of the Company at any time on or after April 15, 2008, in whole or in part, at a
redemption price of $200 per share (equivalent to $50 per depositary share),
plus accrued but unpaid dividends to the redemption date. During the fiscal year
ended November 30, 2002, the Company redeemed and retired 706,200 depositary
shares.
The Company has outstanding 3,745,000 depositary shares representing 936,250
shares of Cumulative Preferred Stock, Series G ("Series G Preferred Stock"),
having an aggregate liquidation preference of $187.3 million as of November 30,
2002. Each depositary share represents a one-fourth interest in a share of
Series G Preferred Stock. Dividends on the Series G Preferred Stock are payable
at an annual rate of 5.49%. Series G Preferred Stock is redeemable at the option
of the Company at any time on or after July 15, 2008, in whole or in part, at a
redemption price of $200 per share (equivalent to $50 per depositary share),
plus accrued but unpaid dividends to the redemption date. During the fiscal year
ended November 30, 2002, the Company redeemed and retired 255,000 depositary
shares.
PREFERRED STOCK ISSUED BY SUBSIDIARIES
Bear Stearns Capital Trust I ("Trust"), a wholly owned subsidiary of the
Company, had outstanding $200.0 million of Guaranteed Preferred Beneficial
Interests in Company Subordinated Debt Securities ("Capital Securities"). The
Capital Securities are fixed- or adjustable-rate capital securities, which have
a liquidation value of $1,000 per capital security. Holders of the Capital
Securities were entitled to receive semiannual preferential cumulative cash
distributions at an annual rate of 7.0% through January 2002. Thereafter, the
distributions were made at a variable rate based on the three-month LIBOR plus a
margin of 1.75%. The proceeds of the issuance of the Capital Securities were
used to purchase fixed- or adjustable-rate junior subordinated deferrable
interest debentures ("Subordinated Debentures") issued by the Company. The
Subordinated Debentures are the sole assets of the Trust. The Subordinated
Debentures had a maturity date of January 15, 2027. 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. On January 15, 2002, the
Company prepaid all of the outstanding Subordinated Debentures, resulting in the
corresponding redemption of $200.0 million aggregate principal amount of Capital
Securities plus accrued distributions.
Bear Stearns Capital Trust II ("Capital Trust II"), a wholly owned subsidiary of
the Company, has outstanding $300.0 million of Guaranteed Preferred Beneficial
Interests in Company Subordinated Debt Securities ("Preferred Securities"). The
Preferred Securities are fixed-rate securities, which have a liquidation value
of $25 per security. Holders of the Preferred Securities are entitled to receive
quarterly preferential cash distributions at an annual rate of 7.5% through
December 15, 2028. The proceeds of the issuance of the Preferred Securities were
used to purchase junior subordinated deferrable interest debentures
("Debentures") issued by the Company. The Debentures have terms that correspond
to the terms of the Preferred Securities and are the sole assets of Capital
Trust II. The Preferred Securities will mature on December 15, 2028. The
Company, at its option, may redeem the Preferred Securities at their principal
amount plus accrued distributions beginning December 15, 2003. The Company's
guarantee of the Preferred Securities, considered together with other
obligations of the Company with respect to the Preferred Securities, constitute
a full and unconditional guarantee by the Company of Capital Trust II's
obligation under the Preferred Securities issued by Capital Trust II.
On May 3, 2001, Bear Stearns Capital Trust III ("Capital Trust III"), a wholly
owned subsidiary of the Company, issued $262.5 million (10,500,000 shares) of
Guaranteed Preferred Beneficial Interests in Company Subordinated Debt
Securities ("Preferred Securities"). The Preferred Securities are fixed-rate
securities, which have a liquidation value of $25 per security. Holders of the
Preferred Securities are
THE BEAR STEARNS COMPANIES INC.
page 66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
entitled to receive quarterly preferential cash distributions at an annual rate
of 7.8% through May 15, 2031. The proceeds of the issuance of the Preferred
Securities were used to acquire junior subordinated deferrable interest
debentures ("Debentures") issued by the Company. The Debentures have terms that
correspond to the terms of the Preferred Securities and are the sole assets of
Capital Trust III. The Preferred Securities will mature on May 15, 2031. The
Company, at its option, may redeem the Preferred Securities at their principal
amount plus accrued distributions beginning May 15, 2006. The Company's
guarantee of the Preferred Securities, considered together with other
obligations of the Company with respect to the Preferred Securities, constitute
a full and unconditional guarantee by the Company of Capital Trust III's
obligation under the Preferred Securities issued by Capital Trust III.
9 EARNINGS PER SHARE
EPS is computed in accordance with SFAS No. 128, "Earnings Per Share." Basic EPS
is computed by dividing net income applicable to common shares, adjusted for
costs related to vested shares under the CAP Plan, as well as the effect of the
redemption of preferred stock, by the weighted average number of common shares
outstanding. Common shares outstanding includes vested units issued under
certain employee stock compensation plans that will be distributed as shares of
common stock. Diluted EPS includes the determinants of Basic EPS and, in
addition, gives effect to dilutive potential common shares related to employee
stock compensation plans.
The computations of Basic and Diluted EPS for the fiscal years ended November 30
are set forth below:
---------
2002 2001 2000
- --------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
- --------------------------------------------------------------------------------------------------
Net income $ 878,345 $ 618,692 $ 773,183
Preferred stock dividends (35,606) (39,113) (39,113)
Redemption of preferred stock 15,832 -- --
Income adjustment (net of tax) applicable to
deferred compensation arrangements-vested shares 70,428 60,197 79,484
- --------------------------------------------------------------------------------------------------
Net earnings used for basic EPS 928,999 639,776 813,554
Income adjustment (net of tax) applicable to deferred
compensation arrangements-non-vested shares 17,536 9,797 --
- --------------------------------------------------------------------------------------------------
Net earnings used for diluted EPS $ 946,535 $ 649,573 $ 813,554
==================================================================================================
Total basic weighted average common shares outstanding(1) 132,798 142,643 151,437
- --------------------------------------------------------------------------------------------------
Effect of dilutive securities:
Employee stock options 1,593 917 372
CAP and restricted units 11,955 8,657 225
- --------------------------------------------------------------------------------------------------
Dilutive potential common shares 13,548 9,574 597
- --------------------------------------------------------------------------------------------------
Weighted average number of common shares outstanding
and dilutive potential common shares 146,346 152,217 152,034
==================================================================================================
Basic EPS $ 7.00 $ 4.49(2) $ 5.37
Diluted EPS $ 6.47 $ 4.27(2) $ 5.35
==================================================================================================
(1) Includes 34,083,394, 41,612,857 and 35,201,719 vested units for the fiscal
years ended November 30, 2002, 2001 and 2000, respectively, issued under
certain employee stock compensation plans, which will be distributed as
shares of common stock.
(2) Net of a $.04 per share loss due to the cumulative effect of a change in
accounting principle.
10 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 fiscal years ended November 30, 2002, 2001 and 2000 was $26.2
million, $13.5 million and $18.9 million, respectively.
The Company maintains a non-qualified defined contribution retirement plan
covering substantially all account executives. The plan
THE BEAR STEARNS COMPANIES INC.
page 67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
provides for retirement benefits to be paid based on a percentage of each
participant's compensation and the performance of certain participant-selected
investment options for benefits accrued. No firm contributions were made for the
fiscal years ended November 30, 2002 and 2001 as such plan benefits have been
replaced by the Restricted Stock Unit Plan discussed in Note 11, "Stock
Compensation Plans," in the Notes to Consolidated Financial Statements. The
Company's expense related to the defined contribution retirement plan for the
fiscal year ended November 30, 2000 was $11.9 million.
11 STOCK COMPENSATION PLANS
The Company has various stock compensation plans designed to increase the
emphasis on stock-based incentive compensation and align the compensation of our
key employees with the long-term interests of stockholders. These plans are
summarized below.
CAPITAL ACCUMULATION PLAN
Pursuant to the CAP Plan, certain key executives receive a portion of their
total annual compensation in the form of CAP units. Beginning with fiscal 2001,
the number of CAP units credited is a function of the dollar amount awarded to
each participant and the closing fair market value of the Company's common stock
on the date of the award. Such CAP units generally must be deferred for a
minimum of five years from the date of the award. The CAP units awarded under
the CAP Plan subsequent to June 30, 1999 are generally subject to vesting. The
total number of CAP units that may be issued under the CAP Plan during any
fiscal year may not exceed 15% of the sum of issued and outstanding shares of
common stock and CAP units outstanding determined as of the last day of the
current fiscal year.
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 certain 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 ("earnings
adjustment"). The earnings adjustment will be credited to each participant's
deferred compensation account in the form of additional CAP units, subject to
certain limitations, based on the number of CAP units in such account at the end
of each fiscal year. The number of CAP units credited depends on the amount
awarded to each participant and the average per share cost of common stock
acquired by the Company. On 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 fiscal years ended November 30, 2002, 2001 and 2000, the Company
expensed $245.1 million, $167.8 million and $307.8 million, respectively,
attributable to CAP units granted to participants in each of these years. In
addition, during the fiscal years ended November 30, 2002, 2001 and 2000, the
Company recognized expense of $154.0 million, $123.0 million and $140.0 million,
respectively, attributable to CAP units with respect to the earnings adjustment.
Compensation deferred pursuant to the CAP Plan is credited to participants'
deferred compensation accounts in the form of CAP units and included in
stockholders' equity.
RESTRICTED STOCK UNIT PLAN
The Restricted Stock Unit Plan ("RSU Plan") provides for the deferral of a
portion of certain key employees' compensation, with allocations made to
participants' deferred compensation accounts in the form of restricted stock
units ("RSUs"). Under the RSU Plan, RSUs granted to employees have various
vesting provisions and generally convert to common stock within four years. Such
units are restricted from sale, transfer or assignment until the end of the
restricted period. Holders of restricted stock units generally may forfeit
ownership of a portion of their award if employment is terminated before the end
of the vesting period. Holders of RSUs are entitled to receive a dividend in the
form of additional RSUs, based on dividends declared on the Company's common
stock. The total number of RSUs that may be granted under the RSU Plan may not
exceed 10,000,000. As of November 30, 2002, the total number of RSUs outstanding
were 5,299,657 and 214,187 RSUs have been converted to common stock.
The Company measures compensation cost for RSUs based on the fair market value
of its common stock at the award date. A portion related to current service is
expensed in the year of the award and that portion relating to future service is
amortized over the vesting period. Amounts awarded and deferred pursuant to the
RSU Plan and the unamortized portion of these amounts are shown as separate
components of stockholders' equity. During the fiscal years ended November 30,
2002, 2001 and 2000, the Company recognized compensation expense of $108.4
million, $84.7 million and $92.3 million, respectively, related to these awards.
THE BEAR STEARNS COMPANIES INC.
page 68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
STOCK AWARD PLAN
Pursuant to the Stock Award Plan, certain key employees may be offered the
opportunity to acquire common stock through the grant of options. Stock options
generally vest three years after the date of grant and have a 10-year
expiration. The total number of stock options that may be issued under the Stock
Award Plan may not exceed 35,000,000. As of November 30, 2002, the total number
of stock options outstanding was 20,454,067, and 556,166 stock options have been
converted to common stock.
NON-EMPLOYEE DIRECTORS' STOCK OPTION AND STOCK UNIT PLAN
Pursuant to the Non-Employee Directors' Stock Option and Stock Unit Plan
("Directors' Plan"), members of the Board of Directors of the Company who are
not employees of the Company or any of its subsidiaries ("Non-Employee
Directors") may be offered the opportunity to acquire common stock through the
grant of options and will receive common stock on the vesting of RSUs.
Non-Employee Directors may elect to exchange a portion of their annual cash
retainer paid by the Company for services rendered as a director, for stock
options or RSUs. Stock options and RSUs issued under the plan generally vest six
months after the date of issuance and stock options have a 10-year expiration.
The total number of stock options and RSUs combined that may be issued under the
Directors' Plan may not exceed 300,000. The total number of stock options and
RSUs outstanding combined was 64,176, and 686 RSUs have been converted to common
stock as of November 30, 2002.
The following is a summary of CAP units and RSUs outstanding:
Cap Units RSUs(2)
- --------------------------------------------------------------------------------
Balance, November 26, 1999 42,261,696 --
Granted(1) 14,287,046 6,402,562
Forfeited -- --
Distributed (7,491,085) --
- --------------------------------------------------------------------------------
Balance, November 30, 2000 49,057,657 6,402,562
Granted(1) 5,280,746 2,684,220
Forfeited (999,238) (952,404)
Distributed (10,663,459) (65,283)
- --------------------------------------------------------------------------------
Balance, November 30, 2001 42,675,706 8,069,095
Granted(1) 6,615,127 2,540,522
Forfeited (175,259) (522,861)
Distributed (9,644,990) (209,914)
- --------------------------------------------------------------------------------
Balance, November 30, 2002 39,470,584 9,876,842
================================================================================
(1) Average market price for shares granted was $60.32, $55.27 and $43.86 for
fiscal years ended November 30, 2002, 2001 and 2000, respectively.
(2) Includes 4,573,030, 4,473,301 and 4,333,811 RSUs outstanding as of
November 30, 2002, 2001 and 2000, respectively, which were granted under
one-time awards.
Activity with respect to stock options for the fiscal years ended November 30 is
presented below:
-------------------------
2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------
WEIGHTED Weighted Weighted
AVERAGE Average Average
NUMBER OF EXERCISE Number of Exercise Number of Exercise
SHARES PRICE Shares Price Shares Price
- ---------------------------------------------------------------------------------------------------------------------
Beginning balance 17,474,422 $50.23 12,800,450 $46.76 3,886,334 $38.75
Granted 4,315,153 $63.78 6,038,092 $56.81 9,211,831 $49.88
Exercised (550,357) $48.03 (5,809) $49.63 -- --
Forfeited (785,151) $51.10 (1,358,311) $46.73 (297,715) $38.75
- ---------------------------------------------------------------------------------------------------------------------
Ending balance 20,454,067(1) $53.12 17,474,422(1) $50.23 12,800,450 $46.76
=====================================================================================================================
(1) 267,559 and 308,613 stock options were exercisable with a weighted average
exercise price of $52.76 and $47.53 at November 30, 2002 and 2001,
respectively. There were no stock options exercisable at November 30,
2000.
Information for the Company's stock options as of November 30, 2002 is presented
in the following table:
Options Outstanding Options Exercisable
- -------------------------------------------------------------------------------------------------------
Average Weighted
Weighted Remaining Average
Range of Number Average Contractual Number Exercise
Exercise Prices Outstanding Exercise Price Life (Years) Exercisable Price
- -------------------------------------------------------------------------------------------------------
$38.75-$45.99 3,074,188 $38.82 7.2 7,245 $38.82
$46.00-$54.99 7,144,423 $49.65 8.0 139,760 $50.02
$55.00-$64.99 10,235,456 $59.83 9.4 120,554 $56.77
- -------------------------------------------------------------------------------------------------------
Total 20,454,067 $53.12 8.6 267,559 $52.76
=======================================================================================================
PRO FORMA EFFECT OF SFAS NO. 123
The Company accounts for its stock compensation plans using the intrinsic value
method prescribed by APB No. 25, as permitted by SFAS No. 123. Under the
provisions of APB No. 25, compensation cost for stock options is measured as the
excess, if any, of the quoted market price of the Company's common stock at the
date of grant over the amount an employee must pay to acquire the stock.
Accordingly, no compensation expense has been recognized for stock option awards
because the exercise price was at the fair market value of the Company's common
stock on the grant date.
SFAS No. 123 requires companies that have elected to continue to account for
stock compensation plans using the intrinsic value method to provide pro forma
disclosures of net income and earnings per share in the Notes to Consolidated
Financial Statements as if the fair value of
THE BEAR STEARNS COMPANIES INC.
page 69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
stock-based compensation had been recorded. Fair value was estimated at grant
date based on a modified Black-Scholes option-pricing model. The weighted
average fair value of options granted related to the fiscal years ended November
30, 2002, 2001 and 2000 was $21.19, $19.29 and $14.18 per option, respectively.
These amounts reflect adjustments for vesting requirements and potential
maturity shortening.
The following table highlights the assumptions used for the fiscal years ended
November 30:
--------
2002 2001 2000
- --------------------------------------------------------------------------------
Risk-free interest rate 4.21% 5.20% 6.40%
Option life 10 years 10 years 10 years
Stock price volatility 33% 33% 37%
Dividend yield 1.06% 1.00% 1.45%
================================================================================
If the Company had elected to account for its stock compensation plans using the
fair value method prescribed by SFAS No. 123, pro forma net income and earnings
per share would have been as presented in the following table for the fiscal
years ended November 30:
--------
2002 2001 2000
- --------------------------------------------------------------------------------
(in millions, except per share amounts)
- --------------------------------------------------------------------------------
Net income, as reported $ 878.3 $ 618.7 $ 773.2
Add: Stock-based employee
compensation plans
expense included in
reported net income,
net of related tax effects 216.7 153.7 224.4
Deduct: Total stock-based
employee compensation
plans expense determined
under the fair value
based method, net of
related tax effects (263.0) (181.4) (230.3)
- --------------------------------------------------------------------------------
Pro forma net income $ 832.0 $ 591.0 $ 767.3
================================================================================
Earnings per share:
Basic - as reported $ 7.00 $ 4.49 $ 5.37
Basic - pro forma $ 6.65 $ 4.29 $ 5.33
Diluted - as reported $ 6.47 $ 4.27 $ 5.35
Diluted - pro forma $ 6.15 $ 4.09 $ 5.31
================================================================================
12 DERIVATIVES AND HEDGING ACTIVITIES
In its capacity as a dealer in over-the-counter derivative financial instruments
and its proprietary market-making and trading activities, the Company enters
into transactions in a variety of cash and derivative financial instruments to
manage its exposure to market and credit risk. These risks include interest
rate, exchange rate, equity price and commodity price risk. A derivative is
defined as a financial contract whose value is based on underlying reference
interest rates, currencies, commodities, market indices or securities. This
includes futures, forward, swap or option contracts, as well as caps, floors and
collars. Generally, these financial instruments represent future commitments or
rights to exchange interest payment streams or currencies or to purchase or sell
other securities 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 specified price on or before an established date or
dates. These financial instruments may result in market and/or credit risk in
excess of amounts recorded in the Consolidated Statements of Financial
Condition.
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 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 and between financial
instruments with off-balance-sheet risk, the Company's proprietary securities,
futures and derivatives 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 through the use of hedging strategies and various statistical
monitoring techniques.
CREDIT RISK
Derivative financial instruments represent contractual commitments between
counterparties that derive their value from changes in an 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
THE BEAR STEARNS COMPANIES INC.
page 70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
indexed referenced warrants, can be traded on an exchange. Other derivatives,
such as interest rate and currency swaps, caps, floors, collars, swaptions,
equity swaps and options, credit derivatives, structured notes and forward
contracts, are negotiated in the over-the-counter markets. Derivatives generate
both on- and off-balance-sheet risks 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 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. 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 as well
as futures contracts and US treasury positions to hedge its debt issuances as
part of its asset and liability management.
Credit risk arises from the potential inability of counterparties to perform in
accordance with the terms of the contract. At any point in time, the Company's
exposure to credit risk associated with counterparty non-performance is
generally limited to the net replacement cost of over-the-counter contracts net
of the value of collateral held. Such financial instruments are reported at fair
value on a net-by-counterparty basis pursuant to enforceable netting agreements.
Exchange-traded financial instruments, such as futures and options, generally do
not give rise to significant unsecured counterparty exposure due to the
Company's margin requirements, which may be greater than those prescribed by 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 assessing the
future creditworthiness of counterparties and limiting transactions with
specific 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 counterparty credit quality of the Company's
exposure with respect to over-the-counter derivatives (including foreign
exchange and forward-settling mortgage transactions) as of November 30, 2002:
OVER-THE-COUNTER DERIVATIVE CREDIT EXPOSURE(1)
Percentage
Exposure, of Exposure,
Net of Net of
Rating(2) Exposure Collateral(3) Collateral(4) Collateral
- --------------------------------------------------------------------------------
(in millions)
- --------------------------------------------------------------------------------
AAA $2,420 $1,012 $1,509 36%
AA 2,256 717 1,565 37%
A 1,287 660 842 20%
BBB 185 298 96 2%
BB and lower 540 1,013 191 5%
Non-rated 1 0 1 0%
- --------------------------------------------------------------------------------
(1) Excluded are covered transactions structured to ensure that the market
values of collateral will at all times equal or exceed the related
exposures. The net exposure for these transactions will, under all
circumstances, be zero.
(2) Internal counterparty credit ratings, as assigned by the Company's Credit
Department, converted to rating agency equivalents.
(3) For lower-rated counterparties, the Company generally receives collateral
in excess of the current market value of derivatives contracts.
(4) In calculating exposure net of collateral, collateral amounts are limited
to the amount of current exposure for each counterparty. Excess collateral
is not applied to reduce exposure because such excess in one counterparty
portfolio cannot be applied to deficient collateral in a different
counterparty portfolio.
CONCENTRATION RISK
The Company is subject to concentration risk by holding or committing to hold
large positions in certain types of securities, securities of a single issuer
(including governments), issuers located in a particular country or geographic
area, or issuers engaged in a particular industry. Positions taken and
commitments made by the Company, including underwritings, often involve
substantial amounts and significant exposure to individual issuers and
businesses, including non-investment-grade issuers. In addition, substantially
all of the collateral held by the Company for reverse repurchase agreements
consists of securities issued by the US government and agencies. The Company
seeks to limit concentration risk through the use of the systems and procedures
described in the preceding discussions of market and credit risk.
NON-TRADING DERIVATIVES ACTIVITY
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 US-dollar- and foreign currency-denominated debt with both variable- and
fixed-rate interest payment obligations. The Company has entered into interest
rate swaps, primarily
THE BEAR STEARNS COMPANIES INC.
page 71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
based on LIBOR, to convert fixed-rate interest payments on its debt obligations
into variable-rate payments. In addition, for foreign currency debt obligations
that are not used to fund assets in the same currency, the Company has entered
into currency swap agreements that effectively convert the debt into US dollar
obligations. Such transactions are accounted for as fair value hedges. 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.
These financial instruments are subject to the same market and credit risks as
those that 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.
Interest rate swap agreements reduced net interest expense on the Company's
long- and short-term debt obligations by $630.4 million and $164.4 million
during the fiscal years ended November 30, 2002 and 2001, respectively, and
increased net interest expense by $29.5 million for the fiscal year ended
November 30, 2000.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and
Certain Hedging Activities,"establishes accounting and reporting standards for
stand-alone derivative instruments, derivatives embedded within other contracts
or securities and for hedging activities. It requires that all derivatives,
whether stand-alone or embedded within other contracts or securities (except in
very defined circumstances) be carried on the Company's Statement of Financial
Condition at their then fair value. The Company adopted SFAS No. 133 on December
1, 2000. As a result of adopting the statement, the Company recognized a
cumulative after-tax loss of $6.3 million. This loss is reported separately in
the Consolidated Statement of Income for fiscal 2001 as a "cumulative effect of
change in accounting principle."
SFAS No. 133 requires that all derivatives be carried at fair value, including
those used as hedges. SFAS No. 133 also requires items designated as being
hedged, previously carried at accrued values now be marked to market for the
risk being hedged, provided that the intent to hedge is fully documented. Any
resultant net change in value for both the hedging derivative and the hedged
item is recognized in earnings immediately, such net effect being deemed the
"ineffective" portion of the hedge. The gains and losses associated with the
ineffective portion of the fair value hedges are included in "Principal
Transactions" revenues in the Consolidated Statements of Income. In fiscal 2002
and 2001, the Company recognized a net gain of $5.6 million and $9.7 million,
respectively, for the ineffective portion of all fair value hedges.
13 CUSTOMER ACTIVITIES
CUSTOMER ACTIVITIES
The Company's clearance activities for both clearing clients and customers
involve the execution, settlement and financing of customers' securities and
futures transactions. Customers' securities activities are transacted on either
a cash or margin basis, while customer futures transactions are generally
transacted on a margin basis, subject to 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 loss
if customers are unable to fulfill their contractual obligations and customers'
margin deposits are insufficient to fully cover their losses. If customers fail
to satisfy their obligations, the Company may be required to purchase or sell
financial instruments at prevailing market prices to fulfill the customers'
obligations.
The Company seeks to control the risks associated with its customers' activities
by requiring them 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 reduce positions when deemed necessary. The
Company also establishes credit limits for customers engaged in futures
activities and monitors credit compliance daily. Additionally, with respect to
the Company's correspondent clearing activities, introducing correspondent firms
guarantee the contractual obligations of their customers. Further, the Company
seeks to reduce credit risk by entering into netting agreements with customers,
which permits receivables and payables with such customers to be offset in the
event of a customer's default.
In connection with the Company's customer financing and securities settlement
activities, the Company may pledge certain customers'
THE BEAR STEARNS COMPANIES INC.
page 72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
securities collateral to satisfy exchange margin deposit requirements or to
support various secured financing sources such as bank loans, securities loaned
and repurchase agreements. If 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 to satisfy its obligations to customers. 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 exposure. Moreover, the Company establishes credit limits for such
activities and monitors credit compliance daily.
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 and partnerships, 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, mutual funds, hedge 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 futures transactions, can be directly affected 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 requiring, when deemed necessary,
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 significant levels of credit extension such as
leveraged purchases, 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 these risks by monitoring collateral
levels on a daily basis for compliance with both regulatory and internal
guidelines. Additional collateral is obtained when necessary. To further control
this risk, the Company has developed computerized risk control systems that
analyze customers' sensitivity to major market movements. The Company will
require customers to deposit additional margin collateral or reduce positions if
it is determined that their activities may be subject to above-normal market
risks.
14 TRANSFERS OF FINANCIAL ASSETS AND LIABILITIES
SECURITIZATIONS
The Company regularly securitizes commercial and residential mortgages, consumer
receivables and other financial assets. Interests in these securitized assets
may be retained in the form of senior or subordinated securities or as residual
interests. These retained interests are included in "Financial Instruments
Owned" in the Consolidated Statements of Financial Condition and are carried at
fair value. Securitization transactions are generally treated as sales, with
resulting gain or loss included in "Principal Transactions" revenue in the
Consolidated Statements of Income. Consistent with the valuation of similar
inventory, fair value is determined by broker-dealer price quotations and
internal valuation pricing models that utilize variables such as yield curves,
prepayment speeds, default rates, loss severity, interest rate volatilities and
spreads. The assumptions used for pricing variables are primarily based on
observable transactions in similar securities and are often further verified by
external pricing sources, when available. During fiscal 2002 and fiscal 2001,
the Company executed securitization transactions of approximately $112.7 billion
and $109.0 billion, including securitizations of its own assets of approximately
$78.6 billion and $62.9 billion. Securitizations of its own assets include $55.0
billion and $39.4 billion, respectively, in agency mortgage-backed securities;
$19.6 billion and $17.3 billion, respectively, in non-agency mortgage-backed
securities; and $4.0 billion and $6.2 billion, respectively, in other
asset-backed securities. The Company is an active market maker in these
securities and therefore may retain interests in assets it securitizes,
predominantly highly rated or government agency-backed securities. Retained
interests in assets the Company securitized, including senior and subordinated
securities, approximated $2.3 billion and $3.8 billion at November 30, 2002 and
November 30, 2001, respectively. As of November 30, 2002 and November 30, 2001,
retained interests include $1.7 billion and $2.2 billion in agency
THE BEAR STEARNS COMPANIES INC.
page 73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
mortgage-backed securities, respectively; $0.4 billion and $1.5 billion in
non-agency mortgage-backed securities, respectively, and $0.2 billion and $0.1
billion in other asset-backed securities, respectively.
The models employed in the valuation of retained interests use discount rates
that are based on the swap curve. Key points on the swap curve at November 30,
2002 were 2.45% for two-year swaps and 4.72% for 10-year swaps. These models
also consider prepayment speeds, as well as credit losses. Credit losses are
considered through option-adjusted spreads that also utilize additional factors
such as liquidity and optionality.
Key valuation assumptions used in measuring the current fair value of retained
interests in assets the Company securitized at November 30, 2002 were as
follows:
Agency Other
Mortgage-Backed Mortgage-Backed Other
- --------------------------------------------------------------------------------
Weighted average life (years) 3.26 7.90 2.68
Average prepayment
speeds (annual rate) 12%-61% 0%-76% n/a
Credit losses 0.09% 10.85% 0.65%
================================================================================
The following hypothetical sensitivity analysis as of November 30, 2002
illustrates the potential change in fair value of these retained interests due
to a specified change in the key valuation assumptions. The interest rate
changes represent a parallel shift in the swap curve. This shift considers the
effect on other variables, including prepayments. The remaining valuation
assumptions are changed independently.
Agency Other
Mortgage-Backed Mortgage-Backed Other
- --------------------------------------------------------------------------------
(in millions)
- --------------------------------------------------------------------------------
Interest rates
50 basis point increase $(27.8) $(2.5) $(0.5)
100 basis point increase (58.9) (5.8) (1.0)
50 basis point decrease 21.9 2.9 0.5
100 basis point decrease 40.0 7.1 1.0
- --------------------------------------------------------------------------------
Prepayment speeds
10% adverse change
(increase in prepayments) (0.7) (0.7) n/a
20% adverse change (1.3) (1.3) n/a
10% favorable change 0.7 0.8 n/a
20% favorable change 1.7 1.7 n/a
- --------------------------------------------------------------------------------
Credit losses
10% adverse change (2.9) (8.6) (1.2)
20% adverse change (5.8) (16.3) (2.3)
10% favorable change 2.9 9.8 1.2
20% favorable change 5.9 21.1 2.6
================================================================================
The previous table should be viewed with caution since the changes in a single
variable generally cannot occur without changes in other variables or conditions
that may counteract or amplify the effect of the changes outlined in the table.
In addition, the table does not consider the change in fair value of hedging
positions which would generally offset the changes detailed in the table, nor
does it consider any corrective action that the Company may take in response to
changes in these conditions. The effect of hedges is not presented because
hedging positions are established on a macro level and allocating the effect
would not be practicable.
The following table summarizes cash flows from securitization trusts related to
securitization transactions during the fiscal year ended November 30, 2002:
Agency Other
Mortgage-Backed Mortgage-Backed Other
- --------------------------------------------------------------------------------
(in millions)
- --------------------------------------------------------------------------------
Cash flows received from
retained interests $ 74.1 $ 73.3 $ 5.4
Cash flows from servicing n/a $ 6.0 n/a
================================================================================
COLLATERALIZED FINANCING ARRANGEMENTS
The Company enters into secured borrowing or lending agreements to obtain
collateral necessary to effect settlements, finance inventory positions, meet
customer needs or re-lend as part of its dealer operations.
The Company receives collateral under reverse repurchase agreements, securities
borrowing transactions, derivative transactions, customer margin loans and other
secured money-lending activities. In many instances, the Company is permitted to
rehypothecate such securities. The Company also pledges financial instruments
owned to collateralize certain financing arrangements. These securities are
recorded as "Financial Instruments Owned, Pledged As Collateral" in the
Consolidated Statements of Financial Condition.
At November 30, 2002 and November 30, 2001, the Company had received securities
pledged as collateral that can be repledged, delivered or otherwise used with a
fair value of approximately $184 billion and $192 billion, respectively. This
collateral was generally obtained under reverse repurchase, securities borrowing
or margin lending agreements. Of these securities received as collateral, those
with a fair value of approximately $116 billion and $134 billion were delivered
or repledged, generally as collateral under repurchase or securities lending
agreements or to cover short sales at November 30, 2002 and November 30, 2001,
respectively.
THE BEAR STEARNS COMPANIES INC.
page 74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
15 COMMITMENTS AND CONTINGENCIES
LEASES
The Company occupies office space under leases that expire at various dates
through 2018.
At November 30, 2002, future minimum aggregate annual rentals payable under
non-cancelable leases (net of subleases), including 383 Madison Avenue in New
York City, for fiscal years 2003 through 2007 and the aggregate amount
thereafter, are as follows:
(in thousands)
- --------------------------------------------------------------------------------
FISCAL YEAR
2003 $ 55,113
2004 52,794
2005 44,345
2006 42,611
2007 35,872
Thereafter 106,478
================================================================================
The various leases contain provisions for periodic escalations resulting from
increased operating and other costs. Rental expense, including escalations and
net of sublease rental income, under these leases was $113.2 million, $100.5
million and $96.6 million for the fiscal years ended November 30, 2002, 2001 and
2000, respectively.
383 MADISON AVENUE
The Company has entered into a lease arrangement for its new worldwide
headquarters at 383 Madison Avenue. Under the terms of the arrangement, the
Company is obligated to make monthly payments based on the lessor's underlying
interest costs. The arrangement expires on May 20, 2007, after which the Company
may request a renewal. If the lease renewal cannot be negotiated, the Company
has the right to purchase the building for the amount of the then outstanding
indebtedness of the lessor or to arrange for the sale of the property with the
proceeds of the sale to be used to satisfy the lessor's debt obligation. If the
sale of the property does not generate enough proceeds to satisfy the lessor's
debt obligation, the Company is required to fund the shortfall up to a maximum
residual value guarantee. As of November 30, 2002, there was no expected
shortfall and the residual value guarantee approximated $570 million.
In the ordinary course of business, the Company has commitments in connection
with various activities, the most significant of which are as follows:
COMMERCIAL LENDING
In connection with certain of the Company's business activities, the Company
provides financing or financing commitments to investment-grade and
non-investment-grade companies in the form of senior and subordinated debt,
including bridge financing. Commitments have varying maturity dates and are
generally contingent on the accuracy and validity of certain representations,
warranties and contractual conditions applicable to the borrower. Commercial
lending commitments to investment-grade borrowers aggregated approximately $1.2
billion at November 30, 2002 (gross commitments of $1.9 billion less $0.7
billion of associated hedges). Commercial lending commitments to
non-investment-grade borrowers totaled $867.9 million at November 30, 2002.
PRIVATE EQUITY-RELATED INVESTMENTS AND PARTNERSHIPS
In connection with the Company's merchant banking activities, the Company has
commitments to invest in merchant banking or private equity-related investment
funds as well as commitments to invest directly in private equity-related
investments. At November 30, 2002, such commitments aggregated $668.5 million.
These commitments will be funded, if called, through the end of the respective
investment periods, primarily ending in 2011.
UNDERWRITING
In connection with the Company's mortgage-backed securitizations, the Company
has commitments to purchase and sell new issues of securities aggregating $1.3
billion at November 30, 2002.
LETTERS OF CREDIT
At November 30, 2002, the Company was contingently liable for unsecured letters
of credit of approximately $1.9 billion and letters of credit of $986.7 million
secured by financial instruments, primarily used to provide collateral for
securities borrowed and to satisfy margin requirements at option and commodity
exchanges.
BORROW VERSUS PLEDGE
At November 30, 2002, the Company had pledged securities, primarily US
government and agency securities with a market value of approximately
THE BEAR STEARNS COMPANIES INC.
page 75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
$1.4 billion as collateral for securities borrowed, with an approximate market
value of $1.4 billion.
MUNICIPAL SECURITIES
As part of the Company's municipal securities business, the Company acts as
placement agent for municipal securities trust certificates ("Trust
Certificates"). Certain of the Trust Certificates entitle the holder to receive
future payments of principal and variable interest and to tender such
certificates at the option of the holder on a periodic basis. As placement agent
for the Trust Certificates, the Company has an obligation to remarket the
certificates. The Company also serves as liquidity provider to the trusts.
Consequently, if the Trust Certificates were unable to be remarketed, the
Company would be required to acquire such certificates, which approximated $2.7
billion at November 30, 2002. The underlying securities in the trusts are either
AAA- or AA-rated, insured or escrowed to maturity municipal bonds. The market
value of the underlying securities was in excess of $2.7 billion at November 30,
2002.
OTHER
The Company participates in the acquisition, securitization, servicing,
financing and disposition of commercial and residential loans. At November 30,
2002, the Company had entered into commitments to purchase and finance mortgage
loans of $466.4 million.
The Company had commitments to purchase Chapter 13 and other credit card
receivables of $127.8 million at November 30, 2002.
The Company has entered into agreements with providers of hardware, software,
data processing and systems consulting services. At November 30, 2002, minimum
fee commitments over the remaining life of these agreements aggregated $53.0
million.
With respect to certain of the commitments outlined above, the Company utilizes
various hedging strategies to actively manage its market, credit and liquidity
exposures. Additionally, since these commitments may expire unused, the total
commitment amount does not necessarily reflect the actual future cash funding
requirements.
LITIGATION
In the normal course of business, the Company has been named as a defendant in
various lawsuits that involve claims for substantial amounts.
Included among these is an action that was originally filed in the United States
District Court for the Southern District of New York by Henryk de Kwiatkowski, a
former customer of Bear Stearns. During the year, the United States Court of
Appeals for the Second Circuit overturned a district court decision that upheld
a jury verdict awarding Henryk de Kwiatkowski approximately $163.8 million in
damages and interest in May 2000 and ordered that the complaint be dismissed. On
December 5, 2002, the Second Circuit denied the plaintiff's motions for
reargument and rehearing of this decision.
Also, the Company is involved from time to time in investigations and
proceedings by governmental agencies and self-regulatory organizations. Included
among these is an industry-wide investigation by the Securities and Exchange
Commission ("SEC"), the National Association of Securities Dealers, the New York
Stock Exchange and several state attorney generals' offices of certain research
and initial public offering practices of major brokerage firms, including Bear
Stearns. Bear Stearns is cooperating fully with the investigation. On December
20, 2002, these regulatory agencies announced an agreement in principle, subject
to approval of the governing bodies of these regulatory and/or governmental
authorities, including the SEC, with 10 brokerage firms, including Bear Stearns
(and shortly thereafter an additional two brokerage firms) to resolve the
investigation concerning research practices. The agreement requires, among other
things, that Bear Stearns pay $80 million in penalties, restitution and money
for investor education.
Although the ultimate outcome of the various matters cannot be ascertained at
this time, it is the opinion of management, after consultation with counsel,
that the resolution of the foregoing matters will not have a material adverse
effect on the financial condition of the Company, taken as a whole; such
resolution may, however, have a material effect on the operating results in any
future period, depending on the level of income for such period. Litigation
charges are reflected in "Other Expenses" in the Consolidated Statements of
Income.
THE BEAR STEARNS COMPANIES INC.
page 76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
16 SEGMENT AND GEOGRAPHIC AREA DATA
The Company operates in three principal segments -- Capital Markets, Global
Clearing Services and Wealth Management. These segments offer different products
and services and are managed separately as different levels and types of
expertise are required to effectively manage the segments' transactions.
The Capital Markets segment comprises the institutional equities, fixed income
and investment banking areas. It operates as a single integrated unit to provide
sales, trading and origination for various fixed income, equity and advisory
products and services to corporate and institutional clients.
Institutional 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- and asset-backed securities, corporate and government bonds,
municipal and high yield securities and foreign exchange and fixed income
derivatives. Investment banking provides capabilities in capital raising,
strategic advisory, mergers and acquisitions and merchant banking. Capital
raising encompasses the Company's underwriting of equity, investment-grade and
high yield debt products.
The Global Clearing Services segment provides execution, clearing, margin
lending and securities borrowing to facilitate customer short sales to clearing
clients worldwide. Prime brokerage clients include hedge funds and clients of
money managers, short sellers, arbitrageurs and other professional investors.
Fully disclosed clients engage in either the retail or institutional brokerage
business.
The Wealth Management segment is composed of the PCS and asset management areas.
PCS provides high-net-worth individuals with an institutional level of
investment service. Asset management serves the diverse investment needs of
corporations, municipal governments, multi-employer plans, foundations,
endowments, family groups and high-net-worth individuals for which it earns
management and performance fees on the institutional and high-net-worth products
it offers.
The three business segments comprise many business areas with interactions among
each. Revenues and expenses include those that are directly related to each
segment. Revenues from intersegment transactions are based on specific criteria
or agreed-upon rates with such amounts eliminated in consolidation. Individual
segments also include revenues and expenses relating to various items, including
corporate overhead and interest, which are internally allocated by the Company
primarily based on balance-sheet usage or expense levels. The Company generally
evaluates performance of the segments based on net revenues and profit or loss
before provision for income taxes.
THE BEAR STEARNS COMPANIES INC.
page 77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
Fiscal Years Ended November 30
- --------------------------------------------------------------------------------
-------------
2002 2001 2000
- --------------------------------------------------------------------------------
(In thousands)
- --------------------------------------------------------------------------------
NET REVENUES
Capital Markets
Institutional equities $ 1,117,762 $ 1,131,124 $ 1,417,592
Fixed income 1,938,045 1,602,034 1,092,568
Investment banking 883,717 752,473 1,000,079
- --------------------------------------------------------------------------------
Total Capital Markets 3,939,524 3,485,631 3,510,239
- --------------------------------------------------------------------------------
Global Clearing Services 778,087 810,601 1,074,498
Wealth Management 498,411 543,495 683,791
Other(1) (87,786) 67,308 207,150
- --------------------------------------------------------------------------------
Total net revenues $ 5,128,236 $ 4,907,035 $ 5,475,678
================================================================================
PRE-TAX INCOME
Capital Markets $ 1,343,912 $ 867,166 $ 899,101
Global Clearing Services 265,327 249,754 466,217
Wealth Management 11,616 40,314 127,856
Other(1) (309,892) (222,790) (321,651)
- --------------------------------------------------------------------------------
Total pre-tax income $ 1,310,963 $ 934,444 $ 1,171,523
================================================================================
As of November 30
- --------------------------------------------------------------------------------
-------------
2002 2001 2000(2)
- --------------------------------------------------------------------------------
SEGMENT ASSETS
Capital Markets $ 123,332,776 $ 137,845,003 $ 111,304,589
Global Clearing Services 60,754,131 52,137,242 54,802,650
Wealth Management 3,555,762 3,860,954 3,250,866
Other(1) (2,788,246) (8,312,971) (726,503)
- --------------------------------------------------------------------------------
Total segment assets $ 184,854,423 $ 185,530,228 $ 168,631,602
================================================================================
(1) Includes consolidation and elimination entries, unallocated revenues
(predominantly interest) and certain corporate administrative functions,
including certain legal costs and costs related to the CAP Plan, which
approximated $154.0 million, $123.0 million and $140.0 million for the
fiscal years ended November 30, 2002, 2001 and 2000, respectively.
(2) Restated in accordance with SFAS No. 140.
THE BEAR STEARNS COMPANIES INC.
page 78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
The operations of the Company are conducted primarily in the United States of
America. The Company also maintains offices in Europe, Asia and Latin America.
The following are net revenues, income before provision for income taxes and
assets by geographic region for the fiscal years ended November 30:
-------------
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------
(in thousands)
- ------------------------------------------------------------------------------------------------------------
US net revenues $ 4,663,264 $ 4,355,784 $ 4,698,562
Non-US net revenues 464,972 551,251 777,116
- ------------------------------------------------------------------------------------------------------------
Consolidated net revenues $ 5,128,236 $ 4,907,035 $ 5,475,678
============================================================================================================
US income before provision for income taxes
and cumulative effect of change in accounting principle $ 1,296,656 $ 912,443 $ 791,349
Non-US income before provision for income taxes
and cumulative effect of change
in accounting principle 14,307 22,001 380,174
- ------------------------------------------------------------------------------------------------------------
Consolidated income before provision for income taxes
and cumulative effect of change
in accounting principle $ 1,310,963 $ 934,444 $ 1,171,523
============================================================================================================
US assets $ 222,453,066 $ 199,597,987 $ 188,095,521
Non-US assets 39,965,312 33,858,496 34,251,804
Eliminations (77,563,955) (47,926,255) (53,715,723)
- ------------------------------------------------------------------------------------------------------------
Consolidated assets $ 184,854,423 $ 185,530,228 $ 168,631,602
============================================================================================================
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 on management judgments
and internal allocations. The decrease in non-US income before provision for
income taxes and cumulative effect of change in accounting principle in fiscal
2002 and 2001 as compared with fiscal 2000 was primarily due to decreased
trading profits and increased compensation and other expenses for certain non-US
entities. The fiscal 2002 and 2001 expense base was significantly higher
compared with fiscal 2000 due to an expansion of the London investment banking
platform. During fiscal 2000, a favorable trading environment benefited
international equity sales and trading, derivatives and investment banking
revenues for certain non-US entities.
THE BEAR STEARNS COMPANIES INC.
page 79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
17 BUSINESS ACQUISITION
At the close of business on April 20, 2001, the Company, through a joint
venture, completed an acquisition of the assets (including specialist rights)
and the assumption of certain liabilities of Wagner Stott Mercator. The Company
participates, together with its joint venture partner, in specialist activities
on the NYSE, AMEX and International Securities Exchange, through a limited
liability company in which the Company has just less than a 50% profit and loss
interest. For fiscal 2002 and 2001, net revenues from these specialist
activities are reflected in "Principal Transactions" revenues in the
Consolidated Statements of Income. The combination was accounted for under the
purchase method of accounting for business combinations. The purchase price
resulted in recordation of tangible and identifiable intangible assets acquired
and liabilities assumed based on their estimated fair values as of the effective
date of the combination. The portion of goodwill/identifiable intangible assets
allocable to the Company at acquisition was approximately $238 million and the
carrying value of such assets at November 30, 2002 was approximately $217
million.
THE BEAR STEARNS COMPANIES INC.
page 80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
18 QUARTERLY INFORMATION (UNAUDITED)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
- ------------------------------------------------------------------------------------------------------------------------------------
FISCAL YEAR ENDED NOVEMBER 30, 2002
Revenues $ 1,718,144 $2,070,404 $1,581,397 $1,520,871 $ 6,890,816
Interest expense 478,966 462,738 427,013 393,863 1,762,580
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 1,239,178 1,607,666 1,154,384 1,127,008 5,128,236
- ------------------------------------------------------------------------------------------------------------------------------------
Non-interest expenses
Employee compensation and benefits 633,642 713,569 595,616 565,370 2,508,197
Other 332,009 374,645 313,564 288,858 1,309,076
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 965,651 1,088,214 909,180 854,228 3,817,273
- ------------------------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 273,527 519,452 245,204 272,780 1,310,963
Provision for income taxes 93,001 176,600 80,786 82,231 432,618
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 180,526 $ 342,852 $ 164,418 $ 190,549 $ 878,345
====================================================================================================================================
Basic earnings per share(1) $ 1.39 $ 2.80 $ 1.32 $ 1.48 $ 7.00
Diluted earnings per share $ 1.29 $ 2.59 $ 1.23 $ 1.36 $ 6.47
====================================================================================================================================
Cash dividends declared per common share $ 0.15 $ 0.15 $ 0.15 $ 0.17 $ 0.62
====================================================================================================================================
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
- ------------------------------------------------------------------------------------------------------------------------------------
FISCAL YEAR ENDED NOVEMBER 30, 2001
Revenues $ 2,136,176 $2,449,382 $2,301,805 $1,813,670 $ 8,701,033
Interest expense 922,389 1,080,724 1,097,047 693,838 3,793,998
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 1,213,787 1,368,658 1,204,758 1,119,832 4,907,035
- ------------------------------------------------------------------------------------------------------------------------------------
Non-interest expenses
Employee compensation and benefits 635,125 735,641 635,034 523,052 2,528,852
Other 325,698 366,188 365,038 386,815 1,443,739
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 960,823 1,101,829 1,000,072 909,867 3,972,591
- ------------------------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes and
cumulative effect of change in accounting principle 252,964 266,829 204,686 209,965 934,444
Provision for income taxes 87,010 97,336 70,114 55,019 309,479
- ------------------------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of change in
accounting principle 165,954 169,493 134,572 154,946 624,965
Cumulative effect of change in accounting principle,
net of tax (6,273) -- -- -- (6,273)
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 159,681 $ 169,493 $ 134,572 $ 154,946 $ 618,692
====================================================================================================================================
Basic earnings per share(1) $ 1.11(2) $ 1.23 $ 1.00 $ 1.14 $ 4.49(2)
Diluted earnings per share $ 1.06(2) $ 1.18 $ 0.95 $ 1.08 $ 4.27(2)
====================================================================================================================================
Cash dividends declared per common share $ 0.15 $ 0.15 $ 0.15 $ 0.15 $ 0.60
====================================================================================================================================
(1) Due to rounding, the sum of the quarters' earnings per share amounts does
not equal the full fiscal year amount.
(2) Net of a $.04 per share loss due to the cumulative effect of a change in
accounting principle.
THE BEAR STEARNS COMPANIES INC.
page 81
THE BEAR STEARNS COMPANIES INC.
INDEPENDENT AUDITORS' REPORT
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF THE BEAR STEARNS COMPANIES INC.
Deloitte
& Touche
We have audited the accompanying consolidated statements of financial condition
of The Bear Stearns Companies Inc. and subsidiaries (the "Company") as of
November 30, 2002 and November 30, 2001, and the related consolidated statements
of income, cash flows and changes in stockholders' equity for the fiscal years
ended November 30, 2002, 2001 and 2000. 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 auditing standards generally accepted
in the United States of America. 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 November 30, 2002 and November 30, 2001, and the results of
their operations and their cash flows for the fiscal years ended November 30,
2002, 2001 and 2000 in conformity with accounting principles generally accepted
in the United States of America.
/s/ Deloitte & Touche LLP
New York, New York
January 15, 2003
THE BEAR STEARNS COMPANIES INC.
page 84
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 closing high and low
prices for the common stock and the cash dividends declared on the common stock.
As of February 10, 2003, there were 2,012 holders of record of the Company's
common stock. On February 10, 2003, the last reported sales price of the
Company's common stock was $59.97.
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 E; Cumulative Preferred Stock,
Series F; and Cumulative Preferred Stock, Series G (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" and Management's Discussion and Analysis of Financial
Condition and Results of Operations under the caption "Regulated Subsidiaries"
for a further description of the restrictions on dividends.
Cash Dividends
Declared Per
Common
High Low Share
- --------------------------------------------------------------------------------
---------------------------
FISCAL YEAR ENDED NOVEMBER 30, 2002
First Quarter (through February 28, 2002) $62.10 $53.87 $ 0.15
Second Quarter (through May 31, 2002) 66.53 56.16 0.15
Third Quarter (through August 31, 2002) 67.39 52.70 0.15
Fourth Quarter (through November 30, 2002) 66.05 51.92 0.17
---------------------------
FISCAL YEAR ENDED NOVEMBER 30, 2001
First Quarter (through February 23, 2001) $64.04 $45.25 $ 0.15
Second Quarter (through May 25, 2001) 57.90 42.06 0.15
Third Quarter (through August 31, 2001) 60.60 51.65 0.15
Fourth Quarter (through November 30, 2001) 61.75 43.50 0.15
================================================================================
The Bear Stearns Companies Inc.
383 Madison Avenue
New York, NY 10179
www.bearstearns.com
INVESTOR RELATIONS
Elizabeth Ventura
(212) 272-9251
Kerri Kelly
(212) 272-2529
ir@bear.com
A copy of the Company's Annual Report on Form 10-K for fiscal 2002 is available
on request by writing:
Investor Relations Department
The Bear Stearns Companies Inc.
383 Madison Avenue
New York, NY 10179
or by calling our automated service for financial information requests:
(866) 299-9331
MEDIA RELATIONS
Elizabeth Ventura
(212) 272-9251
Russell Sherman
(212) 292-5219
media@bear.com
INFORMATION CENTER
(212) 272-3939
TRANSFER AGENT AND REGISTRAR
Mellon Investor Services L.L.C.
Overpeck Centre
Ridgefield Park, NJ 07660
(800) 279-1229
LEGAL COUNSEL
Cadwalader, Wickersham & Taft
100 Maiden Lane
New York, NY 10038
(212) 504-6000
AUDITORS
Deloitte & Touche LLP
2 World Financial Center
New York, NY 10281
(212) 436-2000
THE BEAR STEARNS COMPANIES INC.