Exhibit 13
FINANCIAL HIGHLIGHTS
The following table presents, for the periods and as of the dates indicated,
selected statement of income data and balance sheet data of The Bear Stearns
Companies Inc. on a consolidated basis. The selected historical consolidated
financial data for each of the four fiscal years ended November 30, 2003, 2002,
2001, 2000, the five months ended November 26, 1999 and the fiscal year ended
June 30, 1999 presented below has been derived from the company's audited
consolidated financial statements. Such data should be read in conjunction with
both the consolidated financial statements and related notes and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included in this annual report.
Fiscal year Fiscal year Fiscal year Fiscal year Five months Fiscal year
ended ended ended ended ended ended
November 30, November 30, November 30, November 30, November 26, June 30,
2003 2002 2001 2000 1999* 1999
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(in thousands, except common share and other data)
- -----------------------------------------------------------------------------------------------------------------------------------
Results
Revenues, net of interest expense $ 5,994,491 $ 5,128,236 $ 4,907,035 $ 5,475,678 $ 1,938,503 $ 4,502,124
Employee compensation and benefits 2,880,695 2,508,197 2,528,852 2,788,638 964,529 2,265,830
Non-compensation expenses 1,341,527 1,309,076 1,443,739 1,515,517 520,382 1,172,186
Total expenses 4,222,222 3,817,273 3,972,591 4,304,155 1,484,911 3,438,016
Net income $ 1,156,406 $ 878,345 $ 618,692 $ 773,183 $ 285,814 $ 673,048
Net income applicable to
common shares $ 1,125,031 $ 842,739 $ 579,579 $ 734,070 $ 269,517 $ 633,618
- -----------------------------------------------------------------------------------------------------------------------------------
Financial Position
Total assets $212,168,110 $184,854,423 $185,530,228 $168,631,602 $162,037,962 $153,894,340
Long-term borrowings $ 29,430,465 $ 23,681,399 $ 23,429,054 $ 20,095,888 $ 15,911,392 $ 14,647,092
Guaranteed Preferred Beneficial
Interests in Company
Subordinated Debt Securities(1) $ 562,500 $ 562,500 $ 762,500 $ 500,000 $ 500,000 $ 500,000
Stockholders' equity $ 7,470,088 $ 6,382,083 $ 5,628,527 $ 5,654,288 $ 4,941,947 $ 4,955,509
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Common Share Data
Basic earnings per share(2) $ 9.44 $ 7.00 $ 4.49 $ 5.37 $ 1.78 $ 4.26
Diluted earnings per share(2) $ 8.52 $ 6.47 $ 4.27 $ 5.35 $ 1.78 $ 4.26
Cash dividends declared per
common share(2) $ 0.74 $ 0.62 $ 0.60 $ 0.55 $ 0.29 $ 0.56
Book value per common share(2) $ 48.69 $ 39.94 $ 33.84 $ 31.51 $ 26.93 $ 25.60
Common shares outstanding(2)(3) 142,369,836 145,591,496 146,465,210 158,039,960 165,956,810 167,265,996
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Financial Ratios
Return on average common equity 20.2% 18.1% 13.7% 19.1% 16.6% 18.8%
Profit margin(4) 29.6% 25.6% 19.0% 21.4% 23.4% 23.6%
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Other Data (in billions, except
employees)
Assets under management $ 27.1 $ 24.0 $ 24.2 $ 19.5 $ 13.0 $ 12.2
Employees 10,532 10,574 10,452 11,201 10,081 9,808
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* 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, 2003, and 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.
(2) Reflects all stock dividends prior to November 30, 2003.
(3) Common shares outstanding includes 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.
[The following tables were depicted as bar charts in the printed material.]
Earnings Per Share (Diluted)
For the twelve-month periods ended 11/30
'99 '00 '01 '02 '03
- ---------------------------------------------------------------
$5.33 $5.35 $4.27 $6.47 $8.52
Pre-tax Profit Margin
for the twelve-month periods ended 11/30
'99 '00 '01 '02 '03
- ---------------------------------------------------------------
26.0% 21.4% 19.0% 25.6% 29.6%
Book Value Per Common Share
As of 11/30
'99 '00 '01 '02 '03
- ---------------------------------------------------------------
$26.93 $31.51 $33.84 $39.94 $48.69
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THE BEAR STEARNS COMPANIES INC. 3
FINANCIAL REPORT
TABLE OF CONTENTS
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Forward-Looking Statements 24
Certain Factors Affecting Results of Operations 24
Business Environment 24
Results of Operations 25
Business Segments 29
Capital Markets 29
Global Clearing Services 31
Wealth Management 32
Liquidity and Capital Resources 33
Financial Leverage 33
Funding Strategy & Liquidity
Risk Management 34
Capital Resources 36
Stock Repurchase Program 36
Cash Flows 37
Regulated Subsidiaries 37
Merchant Banking Investments 38
High Yield Positions 38
Contractual Obligations 39
Commitments 39
Derivative Financial Instruments 40
Critical Accounting Policies 41
Off-Balance-Sheet Arrangements 43
New Accounting Pronouncements 44
Specialist Activities 45
Effects of Inflation 45
Risk Management
Overall 46
Market Risk 47
Interest Rate Risk 47
Foreign Exchange Rate Risk 48
Equity Price Risk 48
Value-At-Risk 48
Distribution of Daily Net Trading Revenues 50
Credit Risk 51
Operational Risk 52
Legal Risk 53
Other Risks 53
Independent Auditors' Report 54
Consolidated Financial Statements
Consolidated Statements of Income 55
Consolidated Statements of Financial Condition 56
Consolidated Statements of Cash Flows 57
Consolidated Statements of Changes in
Stockholders' Equity 58
Notes to Consolidated Financial Statements
Note 1 Summary of Significant
Accounting Policies 60
Note 2 Fair Value of Financial Instruments 63
Note 3 Financial Instruments 64
Note 4 Short-Term Borrowings 64
Note 5 Long-Term Borrowings 65
Note 6 Income Taxes 65
Note 7 Regulatory Requirements 66
Note 8 Preferred Stock 67
Note 9 Earnings Per Share 68
Note 10 Employee Benefit Plan 69
Note 11 Stock Compensation Plans 69
Note 12 Derivatives and Hedging Activities 72
Note 13 Customer Activities 74
Note 14 Transfers of Financial Assets
and Liabilities 75
Note 15 Consolidation of Variable
Interest Entities 76
Note 16 Commitments and Contingencies 77
Note 17 Guarantees 79
Note 18 Segment and Geographic Area Data 81
Note 19 Business Acquisition 83
Note 20 Quarterly Information (Unaudited) 84
Corporate Information
Price Range of Common Stock and Dividends 85
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 23
================================================================================
THE BEAR STEARNS COMPANIES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
FORWARD-LOOKING STATEMENTS
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 following
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.
CERTAIN FACTORS AFFECTING 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 and legislative developments, monetary and fiscal policy, investor
sentiment, availability and cost of capital, technological changes and events,
outcome of legal proceedings, changes in currency values, inflation, credit
ratings and the size, volume and timing of transactions.
BUSINESS ENVIRONMENT
The weak global and US economic conditions that existed in fiscal 2002 continued
into the first half of fiscal 2003 as heightened geopolitical risks and reduced
investor confidence created a difficult operating environment for equities. The
conflict with Iraq, lack of capital spending, weakness in the labor markets and
high energy prices were causes for concern. These factors contributed to
double-digit declines in the Dow Jones Industrial Average ("DJIA") and Standard
and Poor's 500 Index ("S&P 500") through mid-March. However, the major US equity
market indices recovered from their mid-March lows as geopolitical tensions
subsided and positive economic data indicated that the US economy was
strengthening and that capital spending was firming. The shift in sentiment,
along with upbeat forecasts for economic growth, precipitated a sell-off in US
Treasuries during the second half of fiscal 2003. Long-term interest rates, as
measured by the 10-year Treasury bond, were extremely volatile. On an intra-day
basis, the 10-Year Treasury bond yield climbed from 3.07% on June 16, 2003 to
4.67% on August 14, 2003. The Federal Reserve Board ("Fed") eased the sell-off
in the Treasuries market by suggesting that low interest rates could be
maintained for a considerable period. The Fed met eight times during fiscal 2003
and cut the federal funds rate by a total of 25 basis points to 1.00% from
1.25%. Better than expected corporate profits, economic reports evidencing
strong consumer spending and accelerated capital spending in the second half of
2003 served to push the major US equity market indices higher in fiscal 2003
after three years of declines. For the fiscal year ended November 30, 2003, the
DJIA increased 10.0%, while the S&P 500 and the Nasdaq Composite Index
("NASDAQ") increased 13.0% and 32.6%, respectively.
While the major US equity market indices showed improvement based on positive
economic data during fiscal 2003, equity market conditions were generally weak.
Average daily trading volume on the New York Stock Exchange, Inc. ("NYSE") and
Nasdaq decreased 5.0% and 6.1%, respectively, from the fiscal year ended
November 30, 2002. During fiscal 2003, underwriting activities remained at low
levels compared to fiscal 2002. Global- and US-announced mergers and
acquisitions ("M&A") activity improved modestly compared with fiscal 2002 while
global- and US-completed M&A declined compared with fiscal 2002. However, a
review of quarterly activity indicated a gradually improving environment for
deal activity and equity underwriting. Business conditions were favorable in the
fixed income markets throughout fiscal 2003. A combination of low interest
rates, a steep yield curve and continued tightening of corporate credit spreads
resulted in strong demand for domestic debt issuances and strong secondary
market activity. Mortgage-backed securities underwriting continued to benefit
from high levels of residential mortgage refinancings throughout the first half
of fiscal 2003. However, the increase in long-term interest rates during the
third quarter of fiscal 2003 led to a decline in residential refinancing volumes
and agency collateralized mortgage obligation ("CMO")
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24 THE BEAR STEARNS COMPANIES INC.
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
new-issue activity over the last half of fiscal 2003. Despite the slowdown in
agency CMO new issue activity, mortgage activities continued to be brisk,
reflecting a continued strong housing market and significant customer activity.
These factors, along with increased operating leverage from cost cutting
initiatives, led to the industry's improved overall performance in fiscal 2003.
The business environment during fiscal 2002 was characterized by economic
uncertainty and challenging market conditions. During the first half of fiscal
2002, several negative factors affected the business environment. These factors
included 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 negative 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,
ongoing concerns pertaining to corporate accountability, and high unemployment,
along with the emergence of the WorldCom, Inc. difficulties and geopolitical
risks, combined to result in a steady decline in consumer confidence and
significant volatility in the equity markets during the second half of fiscal
2002. The DJIA and 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
sell-off 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 contained, the Fed cut the federal funds rate twice in fiscal
2002, for a total of 75 basis points to 1.25% from 2.00%, 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 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 declined 17.8% and 23.4%, respectively. Equity capital markets activities
were adversely affected by the impact of difficult global economic conditions,
reflecting continued lack of investor demand. Global- and US-announced M&A
volumes remained at low levels. Domestic-completed M&A activity dropped 53.8%,
reflecting unstable market conditions. 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.
RESULTS OF OPERATIONS
In the discussion to follow, results for the fiscal year ended November 30, 2003
("fiscal 2003") will be compared with the results for the fiscal year ended
November 30, 2002 ("fiscal 2002"), and the results for fiscal 2002 will be
compared with the results for the fiscal year ended November 30, 2001 ("fiscal
2001").
The following table sets forth an overview of the Company's financial results
for the fiscal years ended November 30:
2003 2002 2001
- --------------------------------------------------------------------------------
(in thousands, except per share amounts,
pre-tax profit margin and return on
average common equity)
- --------------------------------------------------------------------------------
Revenues,
net of interest expense $5,994,491 $5,128,236 $4,907,035
Income before provision
for income tax $1,772,269 $1,310,963 $ 934,444
Net income $1,156,406 $ 878,345 $ 618,692
Diluted earnings per share $ 8.52 $ 6.47 $ 4.27
Pre-tax profit margin 29.6% 25.6% 19.0%
Return on average
common equity 20.2% 18.1% 13.7%
- --------------------------------------------------------------------------------
The Company reported net income of $1.16 billion, or $8.52 per share (diluted),
for fiscal 2003, which represented an increase of 31.7% from $878.3 million, or
$6.47 per share (diluted), for fiscal 2002. The Company reported net income of
$618.7 million for fiscal 2001, or $4.27 per share (diluted).
Fiscal 2003 versus Fiscal 2002 Revenues, net of interest expense ("net
revenues") increased 16.9% to $5.99 billion in fiscal 2003 from $5.13 billion in
fiscal 2002 due to an increase in principal transactions revenues, net interest
revenues and investment banking revenues, partially offset by a decrease in
commission revenues.
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THE BEAR STEARNS COMPANIES INC. 25
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
The Company's commission revenues for the fiscal years ended November 30 were as
follows:
2003 2002 2001
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
Institutional $ 537,505 $ 542,344 $ 476,075
Clearance 312,550 340,117 384,466
Retail & other 227,871 228,513 256,190
- --------------------------------------------------------------------------------
Total commissions $1,077,926 $1,110,974 $1,116,731
- --------------------------------------------------------------------------------
Commission revenues in fiscal 2003 decreased 3.0% to $1.08 billion from $1.11
billion in fiscal 2002. Institutional commissions decreased 0.9% to $537.5
million from $542.3 million, reflecting reduced average daily trading volumes
for both listed and over-the-counter securities partially offset by the
migration to commission equivalents in the Company's over-the-counter business.
Clearance commissions decreased 8.1% to $312.6 million from $340.1 million
primarily due to reduced prime brokerage customer activity. Retail and other
commissions were $227.9 million in fiscal 2003, down 0.3% compared to $228.5
million in fiscal 2002.
The Company's principal transactions revenues by reporting categories for the
fiscal years ended November 30 were as follows:
2003 2002 2001
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(in thousands)
- --------------------------------------------------------------------------------
Fixed income $2,466,484 $1,662,952 $1,325,588
Equities 248,399 382,057 524,144
Derivative financial
instruments 578,005 492,790 433,065
- --------------------------------------------------------------------------------
Total principal
transactions $3,292,888 $2,537,799 $2,282,797
- --------------------------------------------------------------------------------
Note: Certain prior year items have been reclassified from equities to
derivative financial instruments to conform to the current year's
presentation.
Revenues from principal transactions in fiscal 2003 increased 29.8% to $3.29
billion from $2.54 billion in fiscal 2002, primarily due to strong results from
the Company's fixed income activities, reflecting the low level of short-term
interest rates and a steep yield curve. Fixed income revenues increased 48.3% to
$2.47 billion from $1.66 billion in fiscal 2002, reflecting strong performances
across all fixed income products. The Company's mortgage- and asset-backed
securities business continued to perform strongly reflecting favorable market
conditions and growth in the breadth of the Company's franchise. Corporate
credit products also achieved record revenues during fiscal 2003 as corporate
credit spreads tightened, which resulted in increased primary and secondary
activity and increased customer order flow. In particular, the investment-grade,
high-yield and distressed debt areas all performed strongly, reflecting
favorable market conditions and increased market share. Revenues derived from
equities activities declined 35.0% to $248.4 million during fiscal 2003 from
$382.1 million in fiscal 2002. Equities-related businesses, particularly the
over-the-counter stock, equity arbitrage and specialist areas, decreased due to
a decline in average daily trading volumes and lower market volatility. These
decreases were partially offset by increased revenues in international equities
driven by increased European customer activity. Revenues from derivative
financial instruments increased 17.3% to $578.0 million in fiscal 2003 from
$492.8 million in fiscal 2002, primarily due to increases in the foreign
exchange and fixed income derivatives areas as a result of the favorable
environment and expansion of the Company's market share. Such increases were
partially offset by a decline in the equity derivatives area, due to declines in
the Company's electronic listed options market-making business. Equity
derivatives revenues excluding the listed options market-making business
increased on more active customer business. The listed options market-making
business was exited in the second quarter of fiscal 2003.
The Company's investment banking revenues by reporting categories for the fiscal
years ended November 30 were as follows:
2003 2002 2001
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
Underwriting $ 456,161 $ 405,050 $ 377,639
Advisory services 267,252 190,141 317,115
Merchant banking 181,199 238,289 77,371
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Total investment
banking $ 904,612 $ 833,480 $ 772,125
- --------------------------------------------------------------------------------
Investment banking revenues increased 8.5% to $904.6 million in fiscal 2003 from
$833.5 million in fiscal 2002. Investment banking revenues include fees earned
for underwriting public and private offerings of fixed income and equity
securities and advising clients on M&A and other services, and merchant banking
revenues. Underwriting revenues increased 12.6% to $456.2 million in fiscal 2003
from $405.1 million in fiscal 2002, reflecting an increase in fixed income new
issue activity, particularly in the high yield and high grade areas. The Company
also experienced increases in market share in these areas over fiscal 2002.
These increases were partially offset by reduced equity underwriting revenues
reflecting the impact of lower equity underwriting levels
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26 THE BEAR STEARNS COMPANIES INC.
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
industry-wide. Equity underwriting revenues improved significantly in the second
half of fiscal 2003 as global economic conditions improved and equity market
indices rose. Advisory services revenues in fiscal 2003 increased 40.6% to
$267.3 million from $190.1 million in fiscal 2002 due to higher levels of US
completed M&A activity. While industry-wide US completed M&A volumes declined in
fiscal 2003, the Company increased market share and was retained on the largest
completed merger and acquisition transaction in fiscal 2003, Pfizer Inc.'s $60.7
billion acquisition of Pharmacia Corp. Merchant banking revenues were $181.2
million in fiscal 2003, compared to $238.3 million in fiscal 2002. Included in
net revenues are gains of $172.6 million and $226.9 million in fiscal 2003 and
fiscal 2002, respectively, relating to an investment in, and subsequent
offerings and open market sales of, Aeropostale, Inc. During fiscal 2003, the
Company sold its remaining position in this investment.
Net interest revenues, interest and dividend revenue less interest expense, was
$554.4 million in fiscal 2003, an 18.1% increase from $469.6 million for fiscal
2002. Interest and dividends revenue and interest expense are a function of the
level and mix of total assets and liabilities, including financial instruments
owned, financial instruments sold, but not yet purchased, customer related
balances and the prevailing level of interest rates. The increase in net
interest revenues was primarily attributable to higher levels of customer
interest-bearing balances attributable to prime brokerage clients reflecting
improved US equity market conditions. Average customer margin debt balances
increased 16.7% to $39.8 billion in fiscal 2003 from $34.1 billion in fiscal
2002. Average customer short balances were $63.6 billion during fiscal 2003
compared to $54.6 billion during fiscal 2002.
Fiscal 2002 versus Fiscal 2001 Net revenues increased 4.5% to $5.13 billion in
fiscal 2002 from $4.91 billion in fiscal 2001.
Commission revenues in fiscal 2002 were virtually unchanged from fiscal 2001 at
$1.11 billion. Weak economic conditions led to a reduction in clearance and
retail and other commission revenues, which declined 11.2% to $568.6 million in
fiscal 2002 from $640.7 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.
Revenues from principal transactions in fiscal 2002 increased 11.2% to $2.54
billion from $2.28 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
equities activities, particularly in the over-the-counter, convertible arbitrage
and risk arbitrage areas. Derivative financial instruments increased 13.8% to
$492.8 million in fiscal 2002 from $433.1 million in fiscal 2001, reflecting
increased equity and interest rate derivatives revenues due to increased
customer activity.
Investment banking revenues increased 7.9% to $833.5 million in fiscal 2002 from
$772.1 million in fiscal 2001. 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 M&A 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
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THE BEAR STEARNS COMPANIES INC. 27
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
conditions experienced throughout fiscal 2002 continued to cause professional
investors to employ generally lower levels of leverage. Average margin debt
balances fell 13.2% to $34.1 billion in fiscal 2002 from $39.3 billion in fiscal
2001.
Non-Interest Expenses
The Company's non-interest expenses for the fiscal years ended November 30 were
as follows:
2003 2002 2001
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
Employee compensation
and benefits $2,880,695 $2,508,197 $2,528,852
Floor brokerage, exchange
and clearance fees 180,548 197,266 161,363
Communications and
technology 365,317 382,857 453,261
Occupancy 137,778 152,523 146,620
Advertising and market
development 106,506 102,984 126,669
Professional fees 133,304 132,927 175,249
Other expenses 418,074 340,519 380,577
- --------------------------------------------------------------------------------
Total non-interest expenses $4,222,222 $3,817,273 $3,972,591
- --------------------------------------------------------------------------------
Fiscal 2003 versus Fiscal 2002 Employee compensation and benefits includes the
cost of salaries and benefits and incentive compensation, including restricted
stock and option awards. Employee compensation and benefits for fiscal 2003 was
$2.88 billion, up 14.9% from $2.51 billion for fiscal 2002, primarily due to
higher discretionary compensation associated with the increase in net revenues.
Employee compensation and benefits as a percentage of net revenues was 48.1% for
fiscal 2003 compared to 48.9% for fiscal 2002. Excluding the impact of the
merchant banking gains related to the Company's investment in Aeropostale, Inc.,
employee compensation and benefits as a percentage of net revenues was 49.2% for
fiscal 2003 compared to 50.9% for fiscal 2002. During fiscal 2003, the Company
adopted an accounting policy of expensing employee stock options under the
prospective method provided by Statement of Financial Accounting Standards
("SFAS") No. 148. Approximately $92.7 million of employee stock options were
expensed in fiscal 2003 reflecting awards granted in and related to 2003. No
stock option compensation expense was recognized by the Company in fiscal 2002.
Full-time employees decreased to 10,532 at November 30, 2003 from 10,574 at
November 30, 2002.
Non-compensation expenses were $1.34 billion for fiscal 2003, an increase of
2.5% from $1.31 billion in fiscal 2002. Non- compensation expenses as a
percentage of net revenues decreased to 22.4% in fiscal 2003, compared with
25.5% in fiscal 2002, reflecting the Company's continued disciplined approach to
expense management and the increase in net revenues. Floor brokerage, exchange
and clearance fees decreased 8.5% to $180.5 million in fiscal 2003 compared with
$197.3 million in fiscal 2002, reflecting lower trading volumes for futures and
options associated with the reduction of the Company's electronic options
market-making business. The decline in communications and technology costs
during fiscal 2003 was primarily attributable to non-recurring costs associated
with the completion of the Company's relocation of its corporate headquarters to
383 Madison Avenue during fiscal 2002 along with reduced technology equipment
depreciation and lower communication costs. Occupancy costs also decreased
during fiscal 2003 due to the Company's relocation. These decreases were offset
by an increase in other expenses. Excluding expenses related to the Capital
Accumulation Plan for Senior Managing Directors, as amended ("CAP Plan"), other
expenses were up 20.7% to $225.1 million for fiscal 2003 from $186.5 million for
fiscal 2002, primarily due to increased legal and litigation costs and a $20.5
million charge in fiscal 2003 for the impairment of goodwill associated with the
2001 acquisition of an electronic options market maker. These increases were
partially offset by a decrease in certain other costs including employee
severance. Included in other expenses are CAP Plan-related expenses which were
$193.0 million for fiscal 2003, an increase of 25.3% from $154.0 million in
fiscal 2002, reflecting the higher level of earnings in fiscal 2003 as compared
with fiscal 2002. The Company achieved a pre-tax profit margin of 29.6% in
fiscal 2003 versus 25.6% for fiscal 2002. Excluding the impact of Aeropostale,
Inc., pre-tax profit margin was 27.9% and 22.9% for fiscal 2003 and 2002,
respectively.
The Company's effective tax rate increased to 34.75% for fiscal 2003 compared to
33.0% for fiscal 2002 principally as a result of decreased tax preference items
relative to the level of income.
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
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28 THE BEAR STEARNS COMPANIES INC.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
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 were
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
beginning in 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 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.
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 to conform to the current year's presentation,
including the reclassification of certain revenues within the Wealth Management
segment from asset management to private client services.
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
2003 2002 2001
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
Net revenues
Institutional
equities $ 932,567 $1,117,762 $1,131,124
Fixed income 2,925,483 1,938,045 1,602,034
Investment banking 961,267 883,717 752,473
- --------------------------------------------------------------------------------
Total net revenues $4,819,317 $3,939,524 $3,485,631
Pre-tax income $1,924,071 $1,343,912 $ 867,166
- --------------------------------------------------------------------------------
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.
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THE BEAR STEARNS COMPANIES INC. 29
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MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
Institutional equities consists of research, sales and trading in areas such as
domestic and international equities, block trading, convertible bonds,
over-the-counter equities, equity derivatives, risk and convertible arbitrage
and through a joint venture, the NYSE, American Stock Exchange, Inc. ("AMEX")
and International Securities Exchange specialist activities. Fixed income
includes sales, trading and research provided to institutional clients across a
variety of products such as mortgage- and asset-backed securities, corporate and
government bonds, municipal bonds, high yield products, foreign exchange and
interest rate and credit 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, municipal and high yield debt products.
Fiscal 2003 versus Fiscal 2002 Net revenues for Capital Markets were $4.82
billion in fiscal 2003, an increase of 22.3% from $3.94 billion in fiscal 2002.
Pre-tax income for Capital Markets was $1.92 billion in fiscal 2003, an increase
of 43.2% from $1.34 billion in fiscal 2002. Pre-tax profit margin was 39.9% in
fiscal 2003 compared to 34.1% for fiscal 2002.
Institutional equities net revenues for fiscal 2003 decreased 16.6% to $932.6
million from $1.12 billion in fiscal 2002. While the major equity market indices
showed improvement during fiscal 2003 on positive economic data, average daily
trading volumes declined on both the NYSE and Nasdaq when compared to fiscal
2002. As a result, institutional equities commissions in the Company's US listed
and over-the-counter businesses declined. The decline in average daily trading
volume and lower market volatility also resulted in a decline in net revenues
from the Company's specialist activities. Equity derivatives revenues also
declined reflecting a significant drop in net revenues from the Company's listed
options market-making business. During the second quarter of fiscal 2003 the
Company announced its intention to exit the listed options market-making
business, with the sale of the business being completed during the fourth
quarter of fiscal 2003. Excluding the listed options market-making business,
equity derivatives net revenues increased reflecting increased customer
activity. In addition, the decline in market volatility served to adversely
impact net revenues attributable to convertible arbitrage activities. These
decreases were partially offset by increased revenues in international equities
driven by increased market share and European customer activity.
Fixed income net revenues increased to $2.93 billion in fiscal 2003, an increase
of 51.0% from $1.94 billion in fiscal 2002, primarily reflecting strong results
from the Company's mortgage, credit and interest rate product areas. In
particular, the mortgage-backed, high yield and distressed, corporate bonds,
foreign exchange, interest rate derivatives and government bonds areas. These
businesses benefited from the low level of interest rates, a steep yield curve
and narrowing of corporate credit spreads. Mortgage-backed securities revenues
increased significantly as residential mortgage refinancing activity reached
record levels during the year driving record new issue activity, and demand for
high-quality fixed income investments continued. As a result, customer activity
increased and secondary trading volumes achieved record levels. High yield and
distressed debt revenues increased, reflecting increased leveraged finance
origination and improved secondary trading activities. Revenues from the
Company's interest rate product businesses also increased, reflecting improved
results in the Company's interest rate derivatives, foreign exchange and
government bond areas.
Investment banking revenues increased 8.8% to $961.3 million in fiscal 2003 from
$883.7 million in fiscal 2002. Investment banking revenues include fees earned
for underwriting public and private offerings of fixed income and equity
securities and advising clients on merger and acquisition and other services,
and merchant banking revenues. Underwriting revenues increased 12.1% to $547.7
million in fiscal 2003 from $488.6 million in fiscal 2002, reflecting an
increase in fixed income new issue activity particularly in the high yield and
high grade areas. The Company also experienced increases in market share in
these areas over fiscal 2002. These increases were partially offset by reduced
equity underwriting revenues reflecting the impact of lower equity underwriting
levels industry-wide. Equity underwriting revenues improved significantly in the
second half of fiscal 2003 as global economic conditions improved and equity
market indices rose. Advisory services revenues increased 48.2% to $232.4
million from $156.8 million in fiscal 2002 due to higher levels of US completed
M&A activity. While industry-wide US completed M&A volumes declined in fiscal
2003, the Company increased market share and was retained on the largest
completed merger and acquisition transaction in fiscal 2003, Pfizer Inc.'s $60.7
billion acquisition of Pharmacia Corp. Merchant banking revenues were $181.2
million in fiscal 2003, as compared to $238.3 million in fiscal 2002. Merchant
banking revenues for both fiscal years
- --------------------------------------------------------------------------------
30 THE BEAR STEARNS COMPANIES INC.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
were largely related to gains in an investment in, and subsequent offerings and
open market sales of, Aeropostale, Inc.
Fiscal 2002 versus Fiscal 2001 Net revenues for Capital Markets were $3.94
billion in fiscal 2002, an increase of 13.0% from $3.49 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 $1.34 billion in fiscal 2002, an increase of
55.0% from $867.2 million in fiscal 2001. Excluding the gain on the Aeropostale,
Inc. merchant banking transaction, net revenues for Capital Markets were $3.71
billion, an increase of 6.5% from fiscal 2001. Similarly, pre-tax income for
Capital Markets was $1.15 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 $1.94 billion in fiscal 2002, an increase
of 21.0% from $1.60 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 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. 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.
Global Clearing Services
2003 2002 2001
- ------------------------------------------------------------------------------
(in thousands)
- ------------------------------------------------------------------------------
Net revenues $784,072 $778,087 $810,601
Pre-tax income $245,531 $265,327 $249,754
- ------------------------------------------------------------------------------
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, 2003 and November 30, 2002, the Company held
approximately $203.6 billion and $162.1 billion, respectively, in equity in
Global Clearing Services client accounts.
Fiscal 2003 versus Fiscal 2002 Net revenues for Global Clearing Services
increased 0.8% to $784.1 million in fiscal 2003 from $778.1 million in fiscal
2002. Commission revenues were $312.6 million in fiscal 2003, a decrease of 8.1%
from $340.1 million in fiscal 2002 reflecting reduced prime brokerage customer
activity. Net interest revenues were $458.5 million, a 9.9% increase from $417.2
million in fiscal 2002, primarily reflecting increased margin balances from
prime brokerage and fully disclosed clearance clients due to improving US equity
market conditions. Pre-tax income was $245.5 million, a 7.5% decrease from
$265.3 million in fiscal 2002. The decline in pre-tax income reflects certain
legal settlements that were previously provided for but allocated to the segment
in fiscal 2003 and increased compensation costs.
Average customer margin balances were $39.8 billion in fiscal 2003 compared to
$34.1 billion in fiscal 2002. Customer margin balances totaled $43.6 billion at
November 30, 2003, an
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 31
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
increase from $36.7 billion at November 30, 2002. Average customer short
balances were $63.6 billion during fiscal 2003 compared to $54.6 billion during
fiscal 2002 and totaled $71.6 billion at November 30, 2003, an increase from
$58.8 billion at November 30, 2002. Average free credit balances were $20.1
billion during fiscal 2003 compared to $19.3 billion during fiscal 2002 and
totaled $22.3 billion at November 30, 2003, an increase from $17.1 billion at
November 30, 2002.
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.
Wealth Management
2003 2002 2001
- ------------------------------------------------------------------------------
(in thousands)
- ------------------------------------------------------------------------------
Net revenues $511,307 $498,411 $543,495
Pre-tax income $ 19,217 $ 11,616 $ 40,314
- ------------------------------------------------------------------------------
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. At November 30, 2003, PCS has 513 account
executives in its principal office, six regional offices and two international
offices. Asset management manages equity, fixed income and alternative assets
for 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 2003 versus Fiscal 2002 Net revenues for Wealth Management were $511.3
million in fiscal 2003, an increase of 2.6%, from $498.4 million for fiscal
2002. PCS revenues increased 5.6% to $378.8 million in fiscal 2003 from $358.8
million in fiscal 2002. Increased retail customer activity and the continued
expansion of the Company's PCS sales force contributed positively to PCS
revenues during fiscal 2003. Broker headcount at November 30, 2003 was 513, up
6.2% from 483 at November 30, 2002. Asset management revenues decreased 5.1% to
$132.5 million in fiscal 2003, from $139.6 million in fiscal 2002, reflecting
reduced management fees associated with mutual funds and reduced management and
performance fees on proprietary hedge fund products. Pre-tax income for Wealth
Management approximated $19.2 million in fiscal 2003 period compared to pre-tax
income of $11.6 million for fiscal 2002.
Assets under management were $27.1 billion at November 30, 2003, reflecting a
12.9% increase from $24.0 billion in assets under management at November 30,
2002. The increase in assets under management reflects net cash inflows as well
as increased market value for separate accounts and wrap accounts. Assets from
separate accounts and wrap accounts rose 26.2% to $16.4 billion at November 30,
2003, from $13.0 billion at November 30, 2002. Assets from alternative
investment products under management were $6.0 billion at November 30, 2003 and
2002.
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 7.2% to $358.8 million in fiscal 2002, from $386.7
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 10.9% to $139.6 million in fiscal 2002, from
$156.8 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.
- --------------------------------------------------------------------------------
32 THE BEAR STEARNS COMPANIES INC.
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
FINANCIAL LEVERAGE
Asset Composition
The Company's actual level of capital, capital requirements and thereby the
level of financial leverage, are a function of numerous variables, including
asset composition, rating agency/creditor perception, business prospects,
regulatory requirements, balance sheet liquidity, cost/availability of capital
and risk of loss. The Company consistently 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 and do fluctuate, depending largely on economic and
market conditions, volume of activity and customer demand.
The Company's total assets at November 30, 2003 increased to $212.17 billion
from $184.85 billion at November 30, 2002. The increase was primarily
attributable to increases in securities borrowed, financial instruments owned,
cash and securities deposited with clearing organizations or segregated in
compliance with federal regulations and receivables from customers, partially
offset by a decrease in securities purchased under agreements to resell. The
Company's total capital base, which consists of long-term debt, preferred equity
issued by subsidiaries and total stockholders' equity, increased to $37.46
billion at November 30, 2003 from $30.63 billion at November 30, 2002. This
change was primarily due to an increase in equity associated with net income,
partially reduced by treasury stock purchases and a net increase in long-term
debt.
The amount of long-term debt, as well as total capital, that the Company
maintains is driven by a number of factors with particular focus on 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 fluctuate and are closely related to 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 especially decisive 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, 2003 and November 30,
2002, total assets of $212.17 billion and $184.85 billion were approximately
10.1% and 13.3%, respectively, 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 predominantly
in highly liquid, readily marketable 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 BEAR STEARNS COMPANIES INC. 33
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
Leverage Ratios
The following table presents total assets, adjusted assets and net adjusted
assets with the resultant leverage ratios at November 30, 2003 and November 30,
2002. 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 Company maintains a financial statement date guideline for
net adjusted leverage ratio of no greater than 15.0, which the Company continued
to meet at the end of fiscal 2003.
2003 2002
- ------------------------------------------------------------------------------
(in billions, except ratios)
- ------------------------------------------------------------------------------
Total assets $212.17 $184.85
Adjusted assets(1) $172.85 $142.68
Net adjusted assets(2) $ 99.53 $ 89.56
Leverage ratio(3) 26.4 26.6
Adjusted leverage ratio(4) 21.5 20.5
Net adjusted leverage ratio(5) 12.4 12.9
- ------------------------------------------------------------------------------
(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 & LIQUIDITY RISK MANAGEMENT
General 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 under
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, firm and customer short sales, sell/buy
arrangements, securities lending arrangements and customer free credit balances.
Short-term unsecured funding sources expose the Company to rollover risk, as
providers of credit are not obligated to refinance the instruments at maturity.
Within this context, the Company seeks to prudently manage its reliance on
short-term unsecured borrowings by maintaining an adequate total capital base
and through the extensive use of secured funding. Beyond this, the Company's
emphasis on diversification by product, geography, maturity and instrument seeks
to further ensure 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 secured
borrowing, the Company views this as inherently less credit sensitive and
therefore a more stable source of 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.
Alternative Funding Strategy
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
twelve months) and funding sources to enable the Company to refinance
short-term, unsecured borrowings with fully secured borrowings. As such, the
Company is not reliant upon or contemplating forced balance sheet reduction to
endure a period of constrained funding availability. This underlying approach is
supported by maintenance of a formal contingency funding plan, which includes a
detailed delegation of authority and precise action steps for managing an
event-driven liquidity crisis. The plan identifies the crisis management team,
details an effective internal and external communication strategy, and
facilitates the greater information flow required to effect a rapid and
efficient transition to a secured funding environment.
As it relates to the alternative funding strategy discussed above, 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. In light of these assumptions, 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. Also within this strategy, the Company endeavors to maintain
cash
- --------------------------------------------------------------------------------
34 THE BEAR STEARNS COMPANIES INC.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
capital in excess of that portion of its assets that cannot be funded on a
secured basis (i.e. positive net cash capital). These two measures, liquidity
ratio and net cash capital, are complementary and constitute the core elements
of the Company's alternative funding strategy and, consequently, its approach to
funding and liquidity risk management.
As of the end of the fiscal year, the market value of unencumbered,
unhypothecated securities owned by the Company was approximately $23.0 billion
with a borrowing value of $19.6 billion. The assets are comprised primarily of
US Government and Agency securities, mortgage-backed and asset-backed
securities, investment-grade corporate debt and US equities. The average advance
rate on these different asset types ranges from 70% to 98% and is based
predominantly on committed, secured facilities that the Company and its
subsidiaries maintain in different regions globally. The liquidity ratio
(explained above) has averaged 177% over the previous twelve months including
unused committed unsecured bank credit and 167% excluding the unsecured portion
of the Company's $3.08 billion committed revolving credit facility. The firm's
net cash capital position has averaged just over $2.0 billion over the same
twelve-month period.
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 general guideline of approximately no more
than 20% of its long-term debt portfolio maturing in any one year. As of
November 30, 2003 the weighted average maturity of the firm's long-term debt was
4.14 years.
Committed Credit Facilities
At November 30, 2003, the Company had a committed revolving credit facility
("Facility") totaling $3.08 billion, which permitted borrowing on a secured
basis by Bear, Stearns & Co. Inc. ("Bear Stearns"), Bear, Stearns Securities
Corp. ("BSSC") and certain other subsidiaries. The Facility also provides that
The Bear Stearns Companies Inc. ("Parent Company") may borrow up to $1.54
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, the most significant of which require maintenance of specified levels
of stockholders' equity of the Company and net capital of BSSC. In February
2004, the Company renewed the facility at a $3.4 billion committed level with
substantially the same terms, except it also permits borrowing on a secured
basis by Bear, Stearns International Limited ("BSIL") while sharing the same
unsecured borrowing terms as the Parent Company. There were no borrowings
outstanding under the Facility at November 30, 2003.
The Company has a $1.50 billion committed revolving securities repo facility
("Repo Facility"), which permits borrowings secured by a broad range of
collateral, under a repurchase arrangement, by 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 2004, with all repos outstanding at that date payable no
later than August 2005. There were no borrowings outstanding under the Repo
Facility at November 30, 2003.
At November 30, 2003, the Company had a $300 million committed revolving credit
facility ("Credit Facility"), which permits borrowing on a secured basis
collateralized by Japanese securities at pre-specified advance rates. 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 2003, the Company renewed the Credit Facility at a
$350 million committed level with substantially the same terms, while permitting
borrowing collateralized by other foreign securities in addition to Japanese
securities. The Credit Facility, as renewed, terminates in December 2004 with
all loans outstanding at that date payable no later than December 2005. There
were no borrowings outstanding under the Credit Facility at November 30, 2003.
The Company also maintains a series of committed credit facilities to support
liquidity needs for the financing of non-investment-grade loans, auto loans,
residential mortgages, commercial
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 35
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
mortgages and listed options. The facilities are expected to be drawn from time
to time and expire at various dates during fiscal 2004. All of these facilities
contain a term out option of one year or more for borrowings outstanding at
expiration. The banks providing these facilities are committed to provide up to
an aggregate of approximately $1.95 billion.
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. Within this funding
framework, the Company attempts to fund equity investments in subsidiaries with
equity from the Parent Company (i.e., utilize no equity double leverage). At
November 30, 2003, the Parent Company's equity double leverage ratio was
approximately 0.91 based on common equity and 0.84 including preferred equity.
At November 30, 2002, these measures compare to 1.06 based on common equity and
0.96 including preferred equity. Additionally, all subordinated debt advances to
regulated subsidiaries for use as regulatory capital are funded with long-term
debt issued by the Company that have maturities equal to or greater than the
maturity of the subordinated debt advance. 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 $24.6 billion and $18.8 billion had remaining maturities
beyond one year at November 30, 2003 and November 30, 2002, 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 long- and short-term debt ratings, which are
influenced by a number of factors. These include, but are not limited to:
material changes in operating margins; earnings trends and volatility; the
prudence of funding and liquidity management practices; financial leverage on an
absolute basis or relative to peers; the composition of the balance sheet and/or
capital structure; geographic and business diversification; and the Company's
market share and competitive position in the business segments in which it
operates. Material deterioration in any one or a combination of these factors
could result in a downgrade of the Company's credit ratings, thus increasing the
cost of and/or limiting the availability of unsecured financing. Additionally, a
reduction in the Company's credit ratings could also trigger incremental
collateral requirements, predominantly in the over-the-counter derivatives
market. As of the end of fiscal 2003, a downgrade by either Moody's Investors
Service or Standard & Poor's to the Company's long-term ratings to the level of
A3 or A- would have required the Company to post approximately $900 million in
additional collateral for outstanding over-the-counter derivatives contracts.
At November 30, 2003, the Company's long-term/short-term debt ratings were as
follows:
Rating
- ------------------------------------------------------------------------------
Dominion Bond Rating Service Limited(1) A(high)/R-1 (middle)
Fitch(2) A+/F1+
Moody's Investors Service(3) A1/P-1
Rating & Investment Information, Inc. A+/nr
Standard & Poor's(4) A/A-1
- ------------------------------------------------------------------------------
nr - does not assign a short-term rating
(1) On August 26, 2003, Dominion Bond Rating Service Limited upgraded the
Company's long-term debt ratings from "A" to "A (high)" with a "stable"
trend, while simultaneously affirming the Company's short-term credit
ratings.
(2) On March 28, 2003, Fitch revised the outlook for the Company's long-term
debt ratings from "negative" to "stable," while simultaneously affirming
the Company's credit ratings.
(3) On October 22, 2003, Moody's Investors Service raised the Company's
long-term debt ratings from A2 to A1 placing a "stable" outlook at the
higher rating level, while simultaneously affirming the Company's
short-term credit ratings.
(4) On April 9, 2003, Standard & Poor's revised the outlook for the Company's
long-term debt ratings from "negative" to "stable," 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, 2003, 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 $1.0 billion of common
stock in fiscal 2003 or beyond. During the fiscal year ended November 30, 2003,
the Company purchased under the current and prior authorizations a total of
11,003,455 shares at a cost of approximately $776.4 million.
- --------------------------------------------------------------------------------
36 THE BEAR STEARNS COMPANIES INC.
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
Approximately $263.2 million was available to be purchased under the current
authorization as of November 30, 2003. On January 7, 2004, the Board of
Directors of the Company approved an amendment to the Repurchase Program to
replenish the previous authorizations to allow the Company to purchase up to
$1.0 billion of common stock in fiscal 2004 and beyond.
During the fiscal year ended November 30, 2003, the Company purchased a total of
3,034,532 shares of its common stock at a total cost of approximately $210
million pursuant to a $210 million CAP Plan Earnings Purchase Authorization by
the Compensation Committee of the Company. On November 24, 2003, the
Compensation Committee of the Company approved an amendment to the CAP Plan
Earnings Purchase Authorization to replenish the previous authorization to allow
the Company to purchase up to $200 million of common stock in fiscal 2004.
CASH FLOWS
Fiscal 2003 Cash and cash equivalents decreased $1.68 billion to $3.84 billion
at November 30, 2003 from $5.52 billion at November 30, 2002. Cash used in
operating activities was $5.39 billion, primarily attributable to an increase in
securities borrowed, financial instruments owned, receivables from brokers,
dealers, and others and receivables from customers, partially offset by an
increase in payables to customers, securities sold under agreements to
repurchase and financial instruments sold, but not yet purchased, which occurred
in the normal course of business as a result of changes in customer needs,
market conditions and trading strategies. Cash provided by financing activities
of $3.57 billion reflected net proceeds of $11.20 billion from issuances of
long-term borrowings used primarily to fund normal operating activities and to
repay $6.07 billion in long-term borrowings, and net payments relating to
short-term borrowings. Treasury stock purchases of $986.2 million were made to
provide for the annual grant of CAP Plan units, restricted stock units and stock
options. Cash provided by investing activities of $138.8 million reflected
proceeds from net sales of investment securities and other assets in connection
with the Company's merchant banking activities, partially offset by purchases of
property, equipment and leasehold improvements.
Fiscal 2002 Cash and cash equivalents decreased $1.81 billion to $5.52 billion
at November 30, 2002 from $7.33 billion at November 30, 2001. Cash used in
operating activities was $1.37 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, which occurred in the normal course of business as
a result of changes in customer needs, market conditions and trading strategies.
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 in
connection with the Company's merchant banking activities, partially offset by
purchases of property, equipment and leasehold improvements.
Fiscal 2001 Cash and cash equivalents increased $5.01 billion to $7.33 billion
at November 30, 2001 from $2.32 billion at November 30, 2000. Cash provided by
operating activities was $7.07 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, which occurred in the normal course of business as
a result of changes in customer needs, market conditions and trading strategies.
Cash used in financing activities of $1.54 billion primarily reflected payments
for the retirement of long-term borrowings, net payments of short-term
borrowings and payments for treasury stock purchases, 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 19,
"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 in connection with the
Company's merchant banking activities.
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
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 37
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
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 Irish Financial Services
Regulatory Authority. At November 30, 2003, Bear Stearns, BSSC, BSIL, BSIT and
BSB were in compliance with their respective regulatory capital requirements.
The Company's broker-dealer subsidiaries and other regulated subsidiaries are
subject to minimum capital requirements and may also be 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, 2003, the Company held investments in eight leveraged
transactions with an aggregate recorded value of approximately $19.6 million,
reflected in the Consolidated Statements of Financial Condition in "Other
Assets." Five transactions were private principal investments aggregating $11.0
million at November 30, 2003. Three transactions were principal investments in
public entities, aggregating $8.6 million at November 30, 2003. At November 30,
2002, the Company held investments in eleven leveraged transactions with an
aggregate recorded value of approximately $163.2 million. Seven transactions
were private principal investments aggregating $35.2 million and four
transactions were principal investments in public entities, aggregating $128.0
million. Included in these public principal investments is the Company's
ownership interest of approximately 10.3 million shares in Aeropostale, Inc. at
November 30, 2002. During fiscal 2003, the Company sold such shares in
Aeropostale, Inc.
In connection with the Company's merchant banking activities, the Company also
has investments in private equity-related investment funds aggregating $333.7
million and $172.7 million at November 30, 2003 and November 30, 2002,
respectively. In addition to the various direct and indirect principal
investments, the Company has made commitments to invest in private
equity--related investments and partnerships (see the summary table under
"Commitments" in Management's Discussion and Analysis).
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, 2003 and November 30,
2002, the Company held high yield positions approximating $5.0 billion and $3.6
billion, respectively, substantially all of which are in "Financial Instruments
Owned" in the Consolidated Statements of Financial Condition, and $847.6 million
and $561.4 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 $1.5 billion and $1.2 billion at November 30, 2003 and November 30,
2002, respectively.
Also included in the high yield positions above are extensions of credit to
highly leveraged companies. At November 30, 2003 and November 30, 2002, the
amount outstanding to highly leveraged borrowers totaled $902.8 million (gross
position of $922.8 million less $20.0 million of associated hedges) and $574.6
million (gross $591.6 million less $17.0 million of associated hedges),
respectively. The largest industry concentration was to the telecommunications
industry, which approximated 18.8% and 18.0% of these high yield positions at
November 30, 2003 and November 30, 2002, respectively. Additionally, the Company
has lending commitments with these non-investment-grade borrowers (see the
summary table under "Commitments" in Management's Discussion and Analysis). The
Company also has exposure to non-investment-grade counterparties through its
trading-related derivative activities. These amounts, net of collateral, were
approximately $214.0 million and $192.0 million at November 30, 2003 and
November 30, 2002, respectively.
- --------------------------------------------------------------------------------
38 THE BEAR STEARNS COMPANIES INC.
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
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.
CONTRACTUAL OBLIGATIONS
The Company's contractual obligations, excluding derivative financial
instruments, as of November 30, 2003 were as follows:
Payments Due by Period
- --------------------------------------------------------------------------------
Fiscal Fiscal Fiscal
2004 2005-2006 2007-2008 Thereafter Total
- --------------------------------------------------------------------------------
(in millions)
- --------------------------------------------------------------------------------
Long-term borrowings(1) $4,867 $10,775 $6,784 $7,004 $29,430
Future minimum operating
lease payments(2)(3) 49 93 88 187 417
- --------------------------------------------------------------------------------
(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 16, "Commitments and Contingencies," in the Notes to Consolidated
Financial Statements.
COMMITMENTS
The Company's commitments(1) as of November 30, 2003 were as follows:
Amount of Commitment Expiration Per Period
- --------------------------------------------------------------------------------
Fiscal Fiscal Fiscal
2004 2005-2006 2007-2008 Thereafter Total
- --------------------------------------------------------------------------------
(in millions)
- --------------------------------------------------------------------------------
Commercial loan
commitments:(2)
Investment-grade $1,270 $ 388 $ 306 $ -- $1,964
Non-investment-grade 365 218 377 176 1,136
Commitments to invest in
private equity-related
investments and
partnerships(3) 601
Underwriting commitments 411 -- -- -- 411
Letters of credit 2,802 64 40 35 2,941
Other commercial
commitments(4) 982 116 2 -- 1,135
- --------------------------------------------------------------------------------
(1) See Note 16, "Commitments and Contingencies," in the Notes to Consolidated
Financial Statements.
(2) Commitments are shown gross of associated hedges of $644 million for
investment-grade borrowers.
(3) At November 30, 2003, commitments to invest in private equity-related
investments and partnerships aggregated $601 million. These commitments
will be funded, if called, through the end of the respective investment
periods, the longest of such periods ending in 2010.
(4) Includes $35 million in commitments with no stated maturity.
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 39
================================================================================
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 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 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, the failure of BSFP to maintain
its credit rating and the occurrence of a bankruptcy event with respect to 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
their 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, 2003, the potential cash
settlement payable by BSTRM on the occurrence of a trigger event was $93.7
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, 2003 and November 30, 2002, the Company had notional/contract
amounts of approximately $2.15 trillion and $1.55 trillion, respectively, of
derivative financial instruments, of which $413.1 billion and $421.1 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, debt, or are part of its derivative dealer activities, are marked to
fair value.
The Company's derivatives have a notional weighted average maturity of
approximately 4.2 years and 3.9 years at November 30, 2003 and November 30,
2002, respectively.
- --------------------------------------------------------------------------------
40 THE BEAR STEARNS COMPANIES INC.
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
The maturities of notional/contract amounts outstanding for derivative financial
instruments as of November 30, 2003 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 $269.9 $472.0 $401.7 $508.9 $1,652.5
Futures contracts 107.5 65.7 11.7 -- 184.9
Forward contracts 65.5 -- -- -- 65.5
Options held 129.8 24.7 0.9 0.2 155.6
Options written 74.1 14.8 0.8 0.1 89.8
- --------------------------------------------------------------------------------------------
Total $646.8 $577.2 $415.1 $509.2 $2,148.3
============================================================================================
Percent of total 30.1% 26.9% 19.3% 23.7% 100.0%
============================================================================================
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 whose fair value is 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 using 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
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 41
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
models that consider various 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 preceding "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, 2003 and November 30, 2002,
such positions (primarily fixed income cash positions) aggregated approximately
$3.4 billion and $3.1 billion, respectively, in "Financial Instruments Owned"
and $740 million and $328 million, respectively, 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 or 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.
Controls Over Valuation of Financial 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 management 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. See "Risk Management" for
additional details.
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
- --------------------------------------------------------------------------------
42 THE BEAR STEARNS COMPANIES INC.
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
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 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"
in Management's Discussion and Analysis for additional details.
OFF-BALANCE-SHEET ARRANGEMENTS
In the normal course of business, the Company enters into arrangements with
special-purpose entities ("SPEs"), also known as variable interest entities
("VIEs"). SPEs are corporations, trusts or partnerships which are established
for a limited purpose. SPEs, by their nature, generally are not controlled by
their equity owners, as the establishing documents govern all material
decisions. The Company's primary involvement with SPEs relates to securitization
transactions in which transferred assets, including commercial and residential
mortgages, consumer receivables, securities and other financial assets are sold
to an SPE and repackaged into securities or similar beneficial interests. SPEs
may also be used to create securities with a unique risk profile desired by
investors and as a means of intermediating financial risk. The Company, in the
normal course of business may establish SPEs, sell assets to SPEs, underwrite,
distribute, and make a market in securities or other beneficial interests issued
by SPEs, transact derivatives with SPEs, own securities or other beneficial
interests, including residuals, in SPEs and provide liquidity or other
guarantees for SPEs.
The Company follows Statement of Financial Accounting Standards ("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. In
accordance with SFAS No. 140, the Company accounts for transfers of financial
assets as sales provided that control has been relinquished. Control is deemed
to be relinquished only when all of the following conditions have been met: (1)
the assets have been isolated from the transferor, even in bankruptcy or other
receivership; (2) the transferee is a Qualifying Special Purpose Entity ("QSPE")
or has the right to pledge or exchange the assets received and (3) the
transferor has not maintained effective control over the transferred assets.
Therefore, the Company derecognizes financial assets transferred in
securitizations provided that such transfer meets all of these criteria. See
Note 14, "Transfers of Financial Assets and Liabilities," in the Notes to
Consolidated Financial Statements for a complete discussion of the Company's
securitization activities.
The Company currently determines whether to consolidate SPEs based upon the
accounting guidance provided in SFAS No. 140 and Emerging Issues Task Force
("EITF") Topic D-14, "Transactions Involving Special Purpose Entities," for
entities in which it acquired interests prior to January 31, 2003 and FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities--an
Interpretation of ARB No. 51," ("FIN No. 46") for entities in which it acquired
interests after January 31, 2003. In fiscal 2004, theCompany plans to adopt FIN
No. 46 as revised, and will use this guidance to determine whether an SPE should
be consolidated. See Note 15, "Consolidation of Variable Interest Entities," in
the Notes to Consolidated Financial Statements for a complete discussion of the
consolidation of VIEs.
The majority of the SPEs that the Company sponsors or transacts with are QSPEs,
which the Company does not consolidate in accordance with this guidance. QSPEs
are entities that have no discretionary activities and may only passively hold
assets and distribute cash generated by the assets they hold. The Company
reflects the fair value of its interests in QSPEs on its balance sheet but does
not recognize the assets or liabilities of QSPEs. QSPEs are employed extensively
in the Company's mortgage and asset securitization business.
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 43
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MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
Certain other SPEs do not meet the requirements of a QSPE, because their
activities are not sufficiently limited or they have entered into certain
non-qualifying transactions. The Company generally consolidates these entities
under EITF D-14 unless a third-party investor owns a substantive equity
investment that represents a controlling interest and is subject to first dollar
risk of loss, or under FIN No. 46 if it owns a majority of the variable
interests. These SPEs are commonly employed in collateralized debt obligation
transactions where portfolio managers require the ability to buy and sell assets
or in synthetic credit transactions. These transactions typically involve no
recourse to the Company.
In addition to the above, in the ordinary course of business the Company issues
various guarantees to counterparties in connection with certain derivative,
leasing, securitization and other transactions. See Note 17, "Guarantees," for a
complete discussion on guarantees.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." FIN No. 45 requires a guarantor to recognize, at inception, 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 were effective for guarantees made or
modified after December 31, 2002. The disclosure provisions were effective for
fiscal periods ending after December 15, 2002. The Company adopted FIN No. 45 as
required in fiscal 2003 with no 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 amended SFAS No. 123 "Accounting
for Stock-Based Compensation." SFAS No. 148 provides three alternative methods
for a voluntary change to fair value accounting for stock-based compensation as
permitted under SFAS No. 123. The Company elected to adopt fair value accounting
for stock-based compensation in fiscal 2003 using the prospective method
provided by SFAS No. 148. See Note 11, "Stock Compensation Plans," in the Notes
to Consolidated Financial Statements for a discussion of the impact of this
election.
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. On December 24, 2003, the FASB published a revision
to FASB Interpretation No. 46, "Consolidation of Variable Interest Entities--an
Interpretation of ARB No. 51," ("FIN No. 46 (R)"), a replacement of FIN No. 46.
FIN No. 46 (R) provides technical corrections and addresses implementation
issues.
In fiscal 2003, the Company adopted FIN No. 46 for VIEs in which it acquired an
interest after January 31, 2003. In fiscal 2004, the Company plans to adopt FIN
No. 46 (R) for VIEs in which it acquired variable interests before February 1,
2003 as well as for those VIEs for which the Company has previously applied FIN
No. 46. Such adoption is not currently expected to have a material impact on the
consolidated financial statements. See Note 15, "Consolidation of Variable
Interest Entities," in the Notes to Consolidated Financial Statements for a
further discussion.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." In addition, the statement clarifies when a derivative
contains a financing element that warrants special reporting in the statement of
cash flows. SFAS No. 149 was effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June 30,
2003. The Company adopted SFAS No. 149 as required in fiscal 2003 with no
material impact on the consolidated financial statements.
- --------------------------------------------------------------------------------
44 THE BEAR STEARNS COMPANIES INC.
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
continued
- --------------------------------------------------------------------------------
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The Company adopted SFAS No. 150 as required in
fiscal 2003 with no material impact on the consolidated financial statements.
SPECIALIST ACTIVITIES
The Company participates, through a majority-owned joint venture, in specialist
activities on the NYSE, AMEX and International Securities Exchange. For fiscal
2003, 2002 and 2001, the Company included revenues from specialist activities in
"Principal Transactions" revenues in the Consolidated Statements of Income. Due
to the occurrence of a Control Event triggered in December 2003, as defined by
the joint venture Operating Agreement, the Company is now entitled to designate
a majority of the voting members of the Management Committee, which would result
in a controlling interest. As a result, commencing in fiscal 2004, the Company
will begin consolidating this entity. Such consolidation is not currently
expected to have a material impact on the consolidated financial statements.
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. 45
================================================================================
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, provides a high level of oversight to trading
departments and their trading strategies.
The risk management process encompasses many units independent of the trading
desks, including the Risk Management, Global Credit, Global Clearing Services,
Controllers, Operations, Compliance, Legal 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, review of pricing models and
review of 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 "Value-at-Risk"). 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 monitors and controls extensions of credit to
customers and dealer counterparties and, in conjunction with the Credit Policy
Committee and its subcommittee, the Global Credit Committee, establishes and
reviews appropriate credit limits and collateral requirements for customers and
dealer counterparties. The Credit Policy Committee is composed of senior risk,
legal and business managers. 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. Credit limits are set to cap potential exposure arising from
repurchase and resale
- --------------------------------------------------------------------------------
46 THE BEAR STEARNS COMPANIES INC.
================================================================================
RISK MANAGEMENT
continued
- --------------------------------------------------------------------------------
agreements, stock borrowing or loan facilities, derivative financial instruments
and other products which may give rise to secured and unsecured credit.
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), Global Clearing Services (Prime Brokerage), Risk
Management and Investment Banking.
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 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, 2003 and November 30, 2002, 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
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 47
================================================================================
RISK MANAGEMENT
continued
- --------------------------------------------------------------------------------
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 Credit Risk section below. 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 statistical models,
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 simulated changes in value 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 and
non-publicly traded investments are not reflected in the VaR results. The VaR
related to certain 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 risk for most desks use a historical simulation
approach for VaR. Foreign exchange rate risk and for a limited number of desks
the interest rate risk, use a "Monte Carlo" value-at-risk approach. Historical
simulation involves the generation of price movements in a portfolio using price
sensitivities, and historical movements of the underlying risk factors to which
the securities are sensitive. 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, 2003 and November 30, 2002. Parameter
estimates, such as volatilities and correlations, were based on daily tests
through November 30, 2003.
VaR has inherent limitations, including reliance on historical data, which may
not accurately predict future market risk, and the
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48 THE BEAR STEARNS COMPANIES INC.
================================================================================
RISK MANAGEMENT
continued
- --------------------------------------------------------------------------------
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 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, 2003
and 2002. Commodity risk has been excluded due to immateriality at November 30,
2003 and 2002.
2003 2002
- --------------------------------------------
(in millions)
- --------------------------------------------
MARKET RISK
Interest rate $14.9 $17.8
Currency 0.9 0.6
Equity 3.7 3.4
Diversification benefit (4.2) (3.7)
- --------------------------------------------
Aggregate VaR $15.3 $18.1
- --------------------------------------------
Aggregate VaR decreased in 2003 due primarily to decreases in interest rate and
credit spread VaR.
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 2003:
High Low Average
- -------------------------------------------
(in millions)
- -------------------------------------------
MARKET RISK
Interest rate $17.9 $12.6 $15.2
Currency 1.3 0.6 0.8
Equity 5.4 3.0 4.2
Aggregate VaR 18.5 13.4 15.8
- -------------------------------------------
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 years ended November
30, 2003 and November 30, 2002, 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 $13.1 million and $10.1 million for the fiscal years ended
November 30, 2003 and November 30, 2002, respectively. There were no daily
trading losses for the fiscal year ended November 30, 2003. Daily trading losses
exceeded the reported average VaR amounts less than 1% of the total trading days
during the fiscal year ended November 30, 2002. The frequency distribution of
the Company's daily net trading revenues reflects the Company's historical
ability to manage its exposure to market risk and the diversified nature of its
trading activities. No guarantee can be given regarding future net trading
revenues or future earnings volatility. The Company believes that these results
are indicative of its commitment to the management of market trading
risk.
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THE BEAR STEARNS COMPANIES INC. 49
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RISK MANAGEMENT
continued
- --------------------------------------------------------------------------------
DISTRIBUTION OF DAILY NET TRADING REVENUES
Fiscal Year Ended November 30, 2003
- ---------------------------------------------------------------
Daily Net Trading Revenues ($ in millions) # of Trading Days
- ---------------------------------------------------------------
(10)+ 0
(10)-(5) 0
(5)-0 0
0-5 34
5-10 65
10-15 77
15-20 28
20-25 31
25-30 4
30+ 12
- ---------------------------------------------------------------
Fiscal Year Ended November 30, 2002
- ---------------------------------------------------------------
Daily Net Trading Revenues ($ in millions) # of 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
- ---------------------------------------------------------------
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50 THE BEAR STEARNS COMPANIES INC.
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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 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, assign a credit rating to each
counterparty 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, Hong Kong and Tokyo 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
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, 2003 and November 30, 2002 approximated $4.11
billion and $4.20 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 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 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 BEAR STEARNS COMPANIES INC. 51
================================================================================
RISK MANAGEMENT
continued
- --------------------------------------------------------------------------------
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 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.
Global Clearing Services carries the accounts of 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,
hedged convertible strategies and multiple fixed income strategies. Trading
strategies are employed in both domestic and international markets. The
extension of credit, via secured margin debt for a given customer, is determined
by the Risk Department of Global Clearing Services using a systematic analysis
of the securities held and trading strategy that such customer employs. Global
Clearing Services has established a risk-based, margin lending policy under
which the minimum capital requirement for a portfolio may be greater than the
applicable regulatory capital requirement for the sum of the underlying
constituents of that portfolio.
Client portfolios are analyzed and evaluated daily through extensive stress
testing simulations designed to estimate market-related risk under different
scenarios. 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 opening as well as to track
that portfolio on an intra-day basis. 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.
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, regulatory 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.
- --------------------------------------------------------------------------------
52 THE BEAR STEARNS COMPANIES INC.
================================================================================
RISK MANAGEMENT
continued
- --------------------------------------------------------------------------------
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 authorization. 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, along with the
newly-formed New Products and Special Structured Transactions Committee, ensure
that identified new businesses and products are reviewed in advance for legal,
credit, operational, accounting, risk and related concerns.These committees also
better 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, 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 industry interest
groups.
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 53
================================================================================
THE BEAR STEARNS COMPANIES INC.
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
[LOGO] Deloitte.
To the Board of Directors and Stockholders of the Bear Stearns Companies Inc.
We have audited the accompanying consolidated statements of financial condition
of The Bear Stearns Companies Inc. and subsidiaries ("Company") as of November
30, 2003 and November 30, 2002, and the related consolidated statements of
income, cash flows and changes in stockholders' equity for each of the three
years in the period ended November 30, 2003. 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, 2003 and November 30, 2002, and the results of
their operations and their cash flows for the fiscal years ended November 30,
2003, 2002 and 2001 in conformity with accounting principles generally accepted
in the United States of America.
As discussed in Note 1, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," as
amended by SFAS No. 148, "Accounting for Stock-Based Compensation--Transition
and Disclosure, an amendment of FASB Statement No. 123," in the fiscal year
ended November 30, 2003.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
New York, New York
February 13, 2004
- --------------------------------------------------------------------------------
54 THE BEAR STEARNS COMPANIES INC.
================================================================================
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
Fiscal Years Ended November 30, 2003 2002 2001
- --------------------------------------------------------------------------------------------
(in thousands, except share and per share data)
- --------------------------------------------------------------------------------------------
REVENUES
Commissions $1,077,926 $1,110,974 $1,116,731
Principal transactions 3,292,888 2,537,799 2,282,797
Investment banking 904,612 833,480 772,125
Interest and dividends 1,955,373 2,232,159 4,339,298
Other income 164,645 176,404 190,082
- --------------------------------------------------------------------------------------------
Total revenues 7,395,444 6,890,816 8,701,033
Interest expense 1,400,953 1,762,580 3,793,998
- --------------------------------------------------------------------------------------------
Revenues, net of interest expense 5,994,491 5,128,236 4,907,035
- --------------------------------------------------------------------------------------------
NON-INTEREST EXPENSES
Employee compensation and benefits 2,880,695 2,508,197 2,528,852
Floor brokerage, exchange and clearance fees 180,548 197,266 161,363
Communications and technology 365,317 382,857 453,261
Occupancy 137,778 152,523 146,620
Advertising and market development 106,506 102,984 126,669
Professional fees 133,304 132,927 175,249
Other expenses 418,074 340,519 380,577
- --------------------------------------------------------------------------------------------
Total non-interest expenses 4,222,222 3,817,273 3,972,591
- --------------------------------------------------------------------------------------------
Income before provision for income taxes and
cumulative effect of change in
accounting principle 1,772,269 1,310,963 934,444
Provision for income taxes 615,863 432,618 309,479
- --------------------------------------------------------------------------------------------
Income before cumulative effect of change in
accounting principle 1,156,406 878,345 624,965
Cumulative effect of change in accounting
principle, net of tax -- -- (6,273)
- --------------------------------------------------------------------------------------------
Net income $1,156,406 $ 878,345 $ 618,692
- --------------------------------------------------------------------------------------------
Net income applicable to common shares $1,125,031 $ 842,739 $ 579,579
- --------------------------------------------------------------------------------------------
Basic earnings per share $ 9.44 $ 7.00 $ 4.49
Diluted earnings per share $ 8.52 $ 6.47 $ 4.27
- --------------------------------------------------------------------------------------------
Weighted average common shares outstanding:
Basic 127,819,514 132,798,359 142,643,018
Diluted 45,027,266 146,346,111 152,216,936
- --------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 55
================================================================================
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
- --------------------------------------------------------------------------------
As of November 30, 2003 2002
- -------------------------------------------------------------------------------------------------------
(in thousands, except share data)
- -------------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 3,837,570 $ 5,520,285
Cash and securities deposited with clearing organizations or
segregated in compliance with federal regulations 8,657,065 7,100,138
Securities purchased under agreements to resell 33,822,695 36,505,447
Securities received as collateral 5,496,832 5,669,811
Securities borrowed 73,317,962 53,116,267
Receivables:
Customers 19,646,879 18,105,196
Brokers, dealers and others 3,730,306 1,358,377
Interest and dividends 268,054 297,980
Financial instruments owned, at fair value
Pledged as collateral 32,349,781 30,752,090
Not pledged as collateral 26,882,877 22,692,578
Property, equipment and leasehold improvements,
net of accumulated depreciation and
amortization of $816,646 and $722,690 in 2003
and 2002, respectively 381,262 483,827
Other assets 3,776,827 3,252,427
- -------------------------------------------------------------------------------------------------------
Total Assets $ 212,168,110 $ 184,854,423
- -------------------------------------------------------------------------------------------------------
LIABILITIES & STOCKHOLDERS' EQUITY
Short-term borrowings $ 13,387,662 $ 14,409,826
Securities sold under agreements to repurchase 47,464,156 44,469,414
Obligation to return securities received as collateral 5,496,832 5,669,811
Securities loaned 6,648,165 5,638,771
Payables:
Customers 68,666,893 53,814,105
Brokers, dealers and others 2,676,351 2,911,679
Interest and dividends 567,575 515,228
Financial instruments sold, but not yet purchased,
at fair value 27,109,147 24,421,273
Accrued employee compensation and benefits 1,376,215 1,158,699
Other liabilities and accrued expenses 1,312,061 1,219,635
- -------------------------------------------------------------------------------------------------------
174,705,057 154,228,441
- -------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 16)
Long-term borrowings 29,430,465 23,681,399
- -------------------------------------------------------------------------------------------------------
Guaranteed Preferred Beneficial Interests in Company Subordinated Debt
Securities 562,500 562,500
- -------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Preferred stock 538,415 692,832
Common stock, $1.00 par value; 500,000,000 shares authorized
as of November 30, 2003 and November 30, 2002; 184,805,848
shares issued as of November 30, 2003 and November 30, 2002 184,806 184,806
Paid-in capital 3,245,380 2,866,290
Retained earnings 4,954,508 3,909,272
Employee stock compensation plans 2,299,170 2,213,979
Unearned compensation (188,952) (208,588)
Treasury stock, at cost--
Adjustable-Rate Cumulative Preferred Stock, Series A:
2,520,750 shares as of November 30, 2002 -- (103,421)
Common stock: 82,233,811 and 84,781,479 shares
as of November 30, 2003 and
November 30, 2002, respectively (3,563,239) (3,173,087)
- -------------------------------------------------------------------------------------------------------
Total Stockholders' Equity 7,470,088 6,382,083
- -------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 212,168,110 $ 184,854,423
- -------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
Note: Certain reclassifications have been made to prior period amounts to
conform to the current year's presentation.
- --------------------------------------------------------------------------------
56 THE BEAR STEARNS COMPANIES INC.
================================================================================
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
Fiscal Years Ended November 30, 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,156,406 $ 878,345 $ 618,692
Adjustments to reconcile net income to cash (used in)
provided by operating activities:
Noncash items included in net income:
Depreciation and amortization 139,276 161,879 208,822
Deferred income taxes (184,830) (24,374) (232,916)
Employee stock compensation plans 729,406 533,240 355,612
Other 10,467 16,043 16,423
Changes in operating assets and liabilities:
Cash and securities deposited with clearing organizations or
segregated in compliance with federal regulations (1,556,927) 2,187,535 (5,514,441)
Securities purchased under agreements to resell 2,682,752 5,237,038 (6,243,253)
Securities borrowed (20,201,695) (1,205,175) 9,848,739
Receivables from customers (1,541,683) (546,240) (243,724)
Receivables from brokers, dealers and others (2,371,929) 1,469,704 (2,038,030)
Financial instruments owned (5,307,641) (5,130,001) (4,424,247)
Other assets (361,083) (217,640) 584,722
Securities sold under agreements to repurchase 2,994,742 (5,665,881) (1,552,833)
Securities loaned 1,009,394 1,465,158 1,589,887
Payables to customers 14,852,788 223,888 6,804,906
Payables to brokers, dealers and others (737,237) (791,512) 1,841,962
Financial instruments sold, but not yet purchased 2,687,874 (327,767) 5,743,264
Accrued employee compensation and benefits 214,691 (120,267) (191,910)
Other liabilities and accrued expenses 392,248 487,722 (105,665)
- --------------------------------------------------------------------------------------------------------------------------
Cash (used in) provided by operating activities (5,392,981) (1,368,305) 7,066,010
- --------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net (payments for) proceeds from short-term borrowings (1,022,164) 751,316 (2,973,254)
Net proceeds from issuances of long-term borrowings 11,198,660 5,006,611 6,574,299
Proceeds from issuances of derivatives with a financing element, net 501,907 -- --
Redemption of preferred stock issued by a subsidiary -- (200,000) --
Issuance of common stock 78,004 26,436 288
Net proceeds from issuance of subsidiary securities -- -- 254,231
Redemption of preferred stock (27,659) (91,336) --
Payments for retirement of long-term borrowings (6,066,144) (5,239,816) (4,250,313)
Treasury stock purchases--common stock (986,193) (629,664) (1,048,015)
Cash dividends paid (104,964) (97,544) (100,206)
- --------------------------------------------------------------------------------------------------------------------------
Cash provided by (used in) financing activities 3,571,447 (473,997) (1,542,970)
- --------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold improvements (36,711) (126,617) (185,298)
Business acquisition -- -- (242,983)
Purchases of investment securities and other assets (189,216) (107,502) (101,891)
Proceeds from sales of investment securities and other assets 364,746 263,959 19,905
- --------------------------------------------------------------------------------------------------------------------------
Cash provided by (used in) investing activities 138,819 29,840 (510,267)
- --------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (1,682,715) (1,812,462) 5,012,773
Cash and cash equivalents, beginning of year 5,520,285 7,332,747 2,319,974
- --------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 3,837,570 $ 5,520,285 $ 7,332,747
- --------------------------------------------------------------------------------------------------------------------------
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 requires 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. 57
================================================================================
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITy
- --------------------------------------------------------------------------------
Treasury Stock
----------------------------
Adjustable-
Rate
Cumulative
Preferred
Employee Stock,
Common Stock Series A-$50
Preferred Stock $1 Paid-in Retained Compensation Unearned Liquidation
Stock Par Value Capital Earnings Plans Compensation Preference Common Stock
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands, except share and per share data)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2000 $800,000 $184,806 $2,583,638 $2,600,149 $1,916,708 $(218,791) $(103,421) $(2,108,801)
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) (1,045,350)
Common stock issued out of
treasury (10,734,551 shares) 3,256 (268,224) 268,373
Income tax benefit related to
distributions from employee
stock compensation plans 143,387
Unearned employee stock
compensation, net (11,280)
Employee stock compensation
awards, net 366,891
Amortization of preferred
stock issue costs (1,300)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2001 $800,000 $184,806 $2,728,981 $3,118,635 $2,015,375 $(230,071) $(103,421) $(2,885,778)
Net income 878,345
Cash dividends declared--
Common ($0.62 per share) (61,144)
Preferred (36,400)
Dividend equivalents (5,996) 6,369
Treasury stock--
Common stock purchased
(10,490,940 shares) (626,999)
Common stock issued out
of treasury (10,473,241
shares) 11,320 (319,148) 339,690
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 21,483
Employee stock compensation
awards, net 511,383
Amortization of preferred stock
issue costs (2,139)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2002 $692,832 $184,806 $2,866,290 $3,909,272 $2,213,979 $(208,588) $(103,421) $(3,173,087)
- ------------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
58 THE BEAR STEARNS COMPANIES INC.
================================================================================
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
Treasury Stock
----------------------------
Adjustable-
Rate
Cumulative
Preferred
Employee Stock,
Common Stock Series A-$50
Preferred Stock $1 Paid-in Retained Compensation Unearned Liquidation
Stock Par Value Capital Earnings Plans Compensation Preference Common Stock
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands, except share and per share data)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2002 $ 692,832 $184,806 $2,866,290 $3,909,272 $2,213,979 $(208,588) $(103,421) $(3,173,087)
Net income 1,156,406
Cash dividends declared--
Common ($0.74 per share) (73,392)
Preferred (31,572)
Dividend equivalents (6,926) 7,333
Treasury stock--
Common stock purchased (986,193)
(14,037,987 shares)
Common stock issued out
of treasury 17,934 (534,723) 596,041
(16,585,635 shares)
Redemption of preferred stock (154,417) 22,617 720 103,421
Income tax benefit related to
distributions from employee
stock compensation plans 247,475
Unearned employee stock
compensation, net 19,636
Employee stock compensation
awards, net 92,709 612,581
Amortization of preferred stock
issue costs (1,645)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 2003 $ 538,415 $184,806 $3,245,380 $4,954,508 $2,299,170 $(188,952) $ 0 $(3,563,239)
- ------------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 59
================================================================================
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
period 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 the
clearance business for prime broker and fully disclosed clients. Wealth
Management is composed of the Private Client Services ("PCS") and asset
management areas. See Note 18, "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 arising pursuant
to futures, forward and option contracts, interest rate swaps and other
derivative contracts, are recorded at fair value with the resulting net
unrealized gains and losses reflected in "Principal Transactions" revenues in
the Consolidated Statements of Income.
Fair value is generally based on quoted market prices. If quoted market prices
are not available, or if liquidating the Company's position is reasonably
expected to 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 permitted by generally accepted accounting
principles. 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, in order to collateralize
- --------------------------------------------------------------------------------
60 THE BEAR STEARNS COMPANIES INC.
================================================================================
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
reverse repurchase agreements. Similarly, the Company is generally required to
provide securities to counterparties to collateralize repurchase agreements. The
Company's agreements with counterparties generally contain contractual
provisions allowing for additional collateral to be obtained, or excess
collateral returned. It is the Company's policy to value collateral and to
obtain additional collateral, or to retrieve excess collateral from
counterparties, when deemed appropriate.
Securities borrowed and securities loaned are recorded based upon the amount of
cash collateral advanced or received. Securities borrowed transactions
facilitate the settlement process and require the Company to deposit cash,
letters of credit or other collateral with the lender. With respect to
securities loaned, the Company receives collateral in the form of cash or other
collateral. The amount of collateral required to be deposited for securities
borrowed, or received for securities loaned, is an amount generally in excess of
the market value of the applicable securities borrowed or loaned. The Company
monitors the market value of securities borrowed and loaned, 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
fiscal 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 ("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, 2003, 2002 and 2001. Income taxes paid totaled $503.3 million,
$221.5 million and $55.0 million for the fiscal years ended November 30, 2003,
2002 and 2001, respectively.
STOCK-BASED COMPENSATION
In December 2002, the Financial Accounting Standards Board ("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 for a voluntary change to fair value
accounting for stock-based compensation as permitted under SFAS No. 123.
Effective December 1, 2002, the Company elected to adopt fair value accounting
for stock-based compensation consistent with SFAS No. 123 using the prospective
method with guidance provided by SFAS No. 148. As a result, commencing with
options granted after November 30, 2002, the Company expenses the fair value of
stock options issued to employees over the related vesting period. Prior to
December 1, 2002, the Company elected to account for its
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 61
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
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 had been recognized for stock option awards granted prior
to December 1, 2002 because the exercise price was at the fair market value of
the Company's common stock on the grant date.
The cost related to stock-based compensation included in the determination of
net income for the fiscal years ended November 30, 2003, 2002 and 2001 is less
than that which would have been recognized if the fair value based method had
been applied to stock option awards since the original effective date of SFAS
No. 123.
The following table illustrates the effect on net income and earnings per share
if the fair value based method had been applied to all outstanding awards in
each fiscal year.
2003 2002 2001
- ---------------------------------------------------------------------------
(in millions, except per share amounts)
- ---------------------------------------------------------------------------
Net income, as reported $1,156.4 $ 878.3 $ 618.7
Add: Stock-based employee
compensation plans
expense included in
reported net income,
net of related tax effects 306.4 216.7 153.7
Deduct: Total stock-based
employee compensation
plans expense determined
under the fair value
based method, net of
related tax effects (359.5) (263.0) (181.4)
- ---------------------------------------------------------------------------
Pro forma net income $1,103.3 $ 832.0 $ 591.0
- ---------------------------------------------------------------------------
Earnings per share:
Basic--as reported $ 9.44 $ 7.00 $ 4.49
Basic--pro forma $ 9.03 $ 6.65 $ 4.29
Diluted--as reported $ 8.52 $ 6.47 $ 4.27
Diluted--pro forma $ 8.16 $ 6.15 $ 4.09
- ---------------------------------------------------------------------------
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," and SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and 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 in the
Company's Consolidated Statement of Financial Condition at their then fair
value, with changes in fair value recorded in current earnings. It also requires
designated 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 November 2002, the FASB issued FASB Interpretation ("FIN") No. 45
"Guarantor's Accounting and Disclosure Requirements
- --------------------------------------------------------------------------------
62 THE BEAR STEARNS COMPANIES INC.
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN
No. 45 requires a guarantor to recognize, at inception, 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 were effective for guarantees made or modified after
December 31, 2002. The disclosure provisions were effective for fiscal periods
ending after December 15, 2002. The Company adopted FIN No. 45 as required in
fiscal 2003 with no material impact on the consolidated financial statements.
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. On December 24, 2003, the FASB published a revision
to FASB Interpretation No. 46, "Consolidation of Variable Interest Entities-- an
Interpretation of ARB No. 51," ("FIN No. 46 (R)"), a replacement of FIN No. 46.
FIN No. 46 (R) provides technical corrections and addresses certain
implementation issues.
In fiscal 2003, the Company adopted FIN No. 46 for VIEs in which it acquired an
interest after January 31, 2003. In fiscal 2004, the Company plans to adopt FIN
No. 46 (R) for VIEs in which it acquired variable interests before February 1,
2003 as well as for those VIEs for which the Company has previously applied FIN
No. 46. Such adoption is not currently expected to have a material impact on the
consolidated financial statements. See Note 15, "Consolidation of Variable
Interest Entities," in the Notes to Consolidated Financial Statements for a
further discussion.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." In addition, the statement clarifies when a derivative
contains a financing element that warrants special reporting in the statement of
cash flows. SFAS No. 149 was effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June 30,
2003. The Company adopted SFAS No. 149 as required in fiscal 2003 with no
material impact on the consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The Company adopted SFAS No. 150 as required in
fiscal 2003 with no material impact on the consolidated financial statements.
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 which 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, 2003 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.
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 63
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
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:
2003 2002
- ------------------------------------------------------------------------
(in thousands)
- ------------------------------------------------------------------------
Financial Instruments Owned:
US government and agency $ 4,963,125 $ 5,754,144
Other sovereign governments 1,019,394 1,064,850
Corporate equity and convertible debt 12,531,849 7,746,419
Corporate debt and other 9,554,939 7,158,347
Mortgages, mortgage- and asset-backed 21,377,386 20,198,882
Derivative financial instruments 9,785,965 11,522,026
- ------------------------------------------------------------------------
$59,232,658 $53,444,668
- ------------------------------------------------------------------------
Financial Instruments Sold,
But Not Yet Purchased:
US government and agency $ 9,991,764 $ 8,206,597
Other sovereign governments 740,052 1,209,421
Corporate equity and
convertible debt 6,301,051 4,935,396
Corporate debt and other 1,477,448 2,034,391
Mortgages, mortgage- and
asset-backed 278,294 179,593
Derivative financial instruments 8,320,538 7,855,875
- ------------------------------------------------------------------------
$27,109,147 $24,421,273
- ------------------------------------------------------------------------
As of November 30, 2003 and 2002, all financial instruments owned that were
pledged to counterparties where the counterparty has the right, by contract or
custom, to rehypothecate those 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. Accordingly, these transactions result in
off-balance-sheet risk as the Company's ultimate obligation to repurchase such
securities may exceed the amount recognized in the Consolidated Statements of
Financial Condition.
4 SHORT-TERM BORROWINGS
The Company obtains short-term borrowings, the majority of which are unsecured,
through the issuance of commercial paper, short-term 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.
The Company's short-term borrowings at November 30 consisted of the following:
2003 2002
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
Commercial paper $ 3,696,758 $ 7,316,853
Medium-term notes 1,950,088 1,856,599
Bank loans & other borrowings 7,740,816 5,236,374
- --------------------------------------------------------------------------------
Total short-term borrowings $13,387,662 $14,409,826
- --------------------------------------------------------------------------------
During the fiscal years ended November 30, 2003, 2002 and 2001, the weighted
average interest rates on commercial paper borrowings were 1.28%, 1.89% and
4.55%, respectively. The weighted average rates on commercial paper outstanding
at November 30, 2003 and November 30, 2002 were 1.07% and 1.52%, respectively.
MTNs generally bear interest at variable rates based on LIBOR. During the fiscal
years ended November 30, 2003, 2002 and 2001, the weighted average interest
rates on MTNs were 1.35%, 2.05% and 4.85%, respectively. The weighted average
rates on MTNs outstanding at November 30, 2003 and 2002 were 1.18% and 1.60%,
respectively.
During the fiscal years ended November 30, 2003, 2002 and 2001, the weighted
average interest rates on bank loans and other borrowings were 1.61%, 2.41% and
3.60%, respectively. The weighted average rates on such borrowings outstanding
at November 30, 2003 and November 30, 2002 were 1.44% and 1.96%, respectively.
- --------------------------------------------------------------------------------
64 BEAR STEARNS COMPANIES INC.
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
5 LONG-TERM BORROWINGS
The Company's long-term borrowings (which have original
maturities of at least 12 months) at November 30 consisted of the following:
2003 2002
- ------------------------------------------------------------------------
(in thousands)
- ------------------------------------------------------------------------
Fixed-rate notes due 2004 to 2018:(1)
US-dollar-denominated $13,356,389 $ 8,997,716
Floating-rate notes due 2004 to 2007:
US-dollar-denominated 1,643,902 2,807,525
Non-US-dollar-denominated 59,734 49,750
Medium-term notes and
other borrowings:(2)
US-dollar-denominated 8,925,476 7,756,837
Non-US-dollar-denominated 5,444,964 4,069,571
- ------------------------------------------------------------------------
Total long-term borrowings $29,430,465 $23,681,399
- ------------------------------------------------------------------------
Amounts include fair value adjustments in accordance with SFAS No. 133.
(1) At November 30, 2003, US-dollar-denominated fixed-rate notes are at interest
rates ranging from 2.88% 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, 2003, 2002 and
2001, were 1.99%, 2.69% and 5.29%, respectively. The weighted average effective
interest rates on the Company's fixed-rate notes outstanding, after giving
effect to the swaps, at November 30, 2003 and November 30, 2002 were 1.73% and
2.24%, 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, 2003, 2002 and 2001,
the weighted average effective interest rates on the floating-rate notes, after
giving effect to the swaps, were 1.77%, 2.45% and 5.24%, respectively. The
weighted average effective interest rates on the floating-rate notes
outstanding, after giving effect to the swaps, at November 30, 2003 and November
30, 2002 were 1.65% and 2.18%, respectively.
At November 30, 2003, the Company's long-term MTNs have initial maturities
ranging from 12 months to 25 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, 2003, 2002 and 2001, the weighted
average interest rates on the MTNs, after giving effect to the swaps, were
1.95%, 2.53% and 4.91%, respectively. The weighted average interest rates on the
Company's MTNs, after giving effect to the swaps, at November 30, 2003 and
November 30, 2002 were 1.65% and 2.08%, respectively.
The Company's long-term borrowings at November 30, 2003 mature as follows:
- -------------------------------------------
(in thousands)
- -------------------------------------------
FISCAL YEAR AMOUNT
2004 $ 4,867,086
2005 5,989,382
2006 4,785,396
2007 3,385,735
2008 3,398,650
Thereafter 7,004,216
- -------------------------------------------
Total $29,430,465
- -------------------------------------------
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, 2003, 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:
2003 2002 2001
- -------------------------------------------------------------------------------
(in thousands)
- -------------------------------------------------------------------------------
Current:
Federal $ 594,442 $ 342,982 $ 400,343
State and local 156,451 85,954 108,191
Foreign 49,800 28,056 33,861
- -------------------------------------------------------------------------------
Total current 800,693 456,992 542,395
- -------------------------------------------------------------------------------
Deferred:
Federal (133,688) (16,364) (166,718)
State and local (52,700) (6,452) (67,752)
Foreign 1,558 (1,558) 1,554
- -------------------------------------------------------------------------------
Total deferred (184,830) (24,374) (232,916)
- -------------------------------------------------------------------------------
Total provision for
income taxes $ 615,863 $432,618 $ 309,479
- -------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 65
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
As of November 30, 2003, the Company had approximately $582 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 $77 million.
Significant components of the Company's deferred tax assets (liabilities) as of
November 30 were as follows:
2003 2002
- ------------------------------------------------------------------------
(in thousands)
- ------------------------------------------------------------------------
Deferred tax assets:
Deferred compensation $1,114,456 $ 955,619
Liability reserves 163,153 181,895
Valuation reserves 16,890 7,392
Depreciation/amortization -- 331
Unrealized loss 29,084 15,769
Partnerships 72,039 61,253
Other 44,265 34,863
- ------------------------------------------------------------------------
Total deferred tax assets 1,439,887 1,257,122
- ------------------------------------------------------------------------
Deferred tax liabilities:
Unrealized appreciation (40,771) (56,845)
Depreciation/amortization (11,669) --
Other (11,458) (9,118)
- ------------------------------------------------------------------------
Total deferred tax liabilities (63,898) (65,963)
- ------------------------------------------------------------------------
Net deferred tax assets $1,375,989 $1,191,159
- ------------------------------------------------------------------------
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.
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:
2003 2002 2001
- ------------------------------------------------------------------------
Statutory rate 35.0% 35.0% 35.0%
State and local income taxes,
net of federal benefit 3.8 3.9 2.8
Tax-exempt interest income
and dividend exclusion (2.8) (3.0) (2.4)
Domestic tax credits (0.3) (2.5) (3.2)
Other, net (0.9) (0.4) 0.8
- ------------------------------------------------------------------------
Effective tax rate 34.8% 33.0% 33.0%
- ------------------------------------------------------------------------
Not included in the effective tax rate is the effect of approximately $247.5
million, $128.1 million and $143.4 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 2003, 2002
and 2001, 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 $785.6 million, which is net capital of
BSSC in excess of 5.5% of aggregate debit items arising from customer
transactions. At November 30, 2003, Bear Stearns' net capital of $2.04 billion
exceeded the minimum requirement by $2.00 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 Irish Financial Services Regulatory Authority.
At November 30, 2003, Bear Stearns, BSSC, BSIL, BSIT and BSB were in compliance
with their respective regulatory capital requirements.
Regulatory rules, as well as 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. Also, the Company's broker-dealer subsidiaries and other regulated
subsidiaries are subject to minimum capital requirements which 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, 2003,
approximately $2.34 billion in equity capital of Bear Stearns,
- --------------------------------------------------------------------------------
66 THE BEAR STEARNS COMPANIES INC.
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
BSSC, BSIL, BSIT and BSB was 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 previously issued 3.0 million shares of Adjustable-rate Cumulative
Preferred Stock, Series A ("Preferred Stock"). The Preferred Stock had a
liquidation preference of $50 per share and was 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
could not be less than 5.50% per annum, nor greater than 11.00% per annum. The
weighted average dividend rate on the Preferred Stock was 5.50% during the
fiscal year ended November 30, 2003. The Company did not repurchase any shares
during the fiscal year ended November 30, 2003. On November 26, 2003, the
Company retired 2,520,750 shares of Preferred Stock held in treasury stock. On
January 15, 2004, the Company redeemed and retired all of the outstanding
Preferred Stock, approximating $24.0 million in aggregate principal amount plus
accrued dividends.
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,
2003. 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 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. The Company did not
repurchase any depositary shares during the fiscal year ended November 30, 2003.
The Company has outstanding 3,092,800 depositary shares representing 773,200
shares of Cumulative Preferred Stock, Series F ("Series F Preferred Stock"),
having an aggregate liquidation preference of $154.6 million as of November 30,
2003. 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, 2003, the Company redeemed and retired 201,000 depositary
shares.
The Company has outstanding 3,378,400 depositary shares representing 844,600
shares of Cumulative Preferred Stock, Series G ("Series G Preferred Stock"),
having an aggregate liquidation preference of $168.9 million as of November 30,
2003. 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, 2003, the Company redeemed and retired 366,600 depositary
shares.
PREFERRED STOCK ISSUED BY SUBSIDIARIES
Bear Stearns Capital Trust II ("Capital Trust II"), a wholly owned subsidiary of
the Company, had outstanding $300.0 million of Guaranteed Preferred Beneficial
Interests in Company Subordinated Debt Securities ("Preferred Securities"). The
Preferred Securities were fixed-rate securities, which had a liquidation value
of $25 per security. Holders of the Preferred Securities were 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 had terms that
correspond to the terms of the Preferred Securities and were the sole assets of
Capital Trust II. The Preferred Securities had a maturity date of December 15,
2028. On December 15, 2003, the Company exercised its option and prepaid all of
the outstanding Debentures, resulting in the corresponding redemption of $300.0
million aggregate principal amount of Capital Securities plus accrued
distributions.
Bear Stearns Capital Trust III ("Capital Trust III"), a wholly owned subsidiary
of the Company, has issued $262.5 million (10,500,000
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 67
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
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 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.
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:
2003 2002 2001
- -------------------------------------------------------------------------------------
(in thousands, except per share amounts)
- -------------------------------------------------------------------------------------
Net income $1,156,406 $878,345 $618,692
Preferred stock dividends (31,375) (35,606) (39,113)
Redemption of preferred stock 720 15,832 --
Income adjustment (net of tax) applicable to
deferred compensation arrangements--vested
shares 81,177 70,428 60,197
- -------------------------------------------------------------------------------------
Net earnings used for Basic EPS 1,206,928 928,999 639,776
Income adjustment (net of tax) applicable
to deferred compensation arrangements--
non-vested shares 29,063 17,536 9,797
- -------------------------------------------------------------------------------------
Net earnings used for Diluted EPS $1,235,991 $946,535 $649,573
- -------------------------------------------------------------------------------------
Total basic weighted average common shares
outstanding(1) 127,820 132,798 142,643
- -------------------------------------------------------------------------------------
Effect of dilutive securities:
Employee stock options 2,415 1,593 917
CAP and restricted units 14,792 11,955 8,657
- -------------------------------------------------------------------------------------
Dilutive potential common shares 17,207 13,548 9,574
- -------------------------------------------------------------------------------------
Weighted average number of common shares
outstanding and dilutive potential common shares 145,027 146,346 152,217
- -------------------------------------------------------------------------------------
Basic EPS $ 9.44 $ 7.00 $ 4.49(2)
Diluted EPS $ 8.52 $ 6.47 $ 4.27(2)
- -------------------------------------------------------------------------------------
(1) Includes 29,610,739, 34,083,394 and 41,612,857 vested units for the fiscal
years ended November 30, 2003, 2002 and 2001, 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.
- --------------------------------------------------------------------------------
68 THE BEAR STEARNS COMPANIES INC.
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
10 EMPLOYEE BENEFIT PLAN
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, 2003, 2002 and 2001 was $32.4
million, $26.2 million and $13.5 million, respectively.
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. 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 five year 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, 2003, 2002 and 2001, the Company
expensed $294.8 million, $245.1 million and $167.8 million, respectively,
attributable to CAP units granted to participants in each of those years. In
addition, during the fiscal years ended November 30, 2003, 2002 and 2001, the
Company recognized expense of $193.0 million, $154.0 million and $123.0 million,
respectively, attributable to CAP units with respect to the earnings adjustment.
Compensation allocated 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 a portion of certain
key employees' compensation to be granted, 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
restriction 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, 2003, the total number of RSUs outstanding
were 8,091,651. Through November 30, 2003, 694,838 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,
2003, 2002 and 2001, the Company recognized compensation expense of $111.9
million, $108.4 million and $84.7 million, respectively, related to these
awards.
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 69
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
STOCK AWARD PLAN
Pursuant to the Stock Award Plan, certain key employees are given the
opportunity to acquire common stock through the grant of options. Stock options
generally 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, 2003, the total number of stock options outstanding was 23,733,199. Through
November 30, 2003, 2,423,672 stock options have been converted to common stock.
Effective December 1, 2002, the Company has adopted fair value accounting for
stock-based compensation consistent with SFAS No. 123 using the prospective
method with guidance provided by SFAS No. 148. As a result, commencing with
options granted after November 30, 2002, the Company expenses the fair value of
stock options issued to employees over the related vesting period. Prior to
December 1, 2002, the Company elected to account for its stock-based
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 had been
recognized for stock option awards prior to December 1, 2002 because the
exercise price was at the fair market value of the Company's common stock on the
grant date.
On December 15, 2003, the Company awarded approximately $110 million of employee
stock options of which $89.5 million were immediately vested and expensed in
fiscal 2003, with the balance of the unvested awards to be expensed over the
future vesting periods. In fiscal 2003, the Company recognized total
compensation expense related to stock options of $92.7 million. No stock option
compensation expense was recognized by the Company in fiscal 2002. The effects
of applying SFAS No. 123 may be less in fiscal 2003 than the effects on net
income and earnings per share in future periods because this is the initial year
of adoption. Future years may reflect compensation expense from options granted
in that year, as well as continuing recognition of expense associated with
options issued in prior years as they vest.
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, 2003, 2002, and 2001 was $19.36, $21.19
and $19.29 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:
2003 2002 2001
- ------------------------------------------------------------------------
Risk-free interest rate 3.17% 4.21% 5.20%
Expected option life 5 years 5 years 5 years
Expected stock price volatility 27% 33% 33%
Dividend yield 1.11% 1.06% 1.00%
- ------------------------------------------------------------------------
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. As of November 30, 2003, the total
number of stock options and RSUs outstanding was 77,650 and 9,534, respectively.
Through November 30, 2003, 2,000 stock options and 686 RSUs have been converted
to common stock.
- --------------------------------------------------------------------------------
70 THE BEAR STEARNS COMPANIES INC.
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
The following is a summary of CAP units and RSUs outstanding:
Cap Units RSUs(2)
- -------------------------------------------------------------------------------
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
Granted(1) 6,785,704 2,386,795
Forfeited (230,740) (458,073)
Distributed (13,230,305) (1,436,785)
- -------------------------------------------------------------------------------
Balance, November 30, 2003 32,795,243 10,368,779
- -------------------------------------------------------------------------------
(1) Average market price for units granted was $72.01, $60.32 and $55.27 for
fiscal years ended November 30, 2003, 2002 and 2001, respectively.
(2) Includes 2,267,594, 3,381,903, 3,546,676 and 4,218,402 RSUs outstanding as
of November 30, 2003, 2002, 2001 and 2000, respectively, which were
granted under a one-time award.
Activity with respect to stock options for the fiscal years ended November 30 is
presented below:
2003 2002 2001
- --------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price
- --------------------------------------------------------------------------------------------
Beginning balance 20,454,067 $53.12 17,474,422 $50.23 12,800,450 $46.76
Granted 5,727,498 $73.70 4,315,153 $63.78 6,038,092 $56.81
Exercised (1,869,506) $41.72 (550,357) $48.03 (5,809) $49.63
Forfeited (501,210) $55.73 (785,151) $51.10 (1,358,311) $46.73
- -------------------------------------------------------------------------------------------
Ending balance 23,810,849(1) $58.91 20,454,067(1) $53.12 17,474,422(1) $50.23
- -------------------------------------------------------------------------------------------
(1) 6,808,154, 267,559 and 308,613 stock options were exercisable with a
weighted average exercise price of $63.98, $52.76 and $47.53 at November 30,
2003, 2002 and 2001, respectively.
Information for the Company's stock options as of November 30, 2003 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 1,588,186 $38.89 6.1 1,586,231 $38.88
$46.00-$54.99 6,733,374 $49.64 7.0 66,273 $50.29
$55.00-$64.99 9,779,559 $59.88 8.4 579,576 $57.33
$65.00-$81.99 5,709,730 $73.74 10.0 4,576,074 $73.73
- --------------------------------------------------------------------------------------------
Total 23,810,849 $58.91 8.2 6,808,154 $63.98
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 71
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
12 DERIVATIVES AND HEDGING ACTIVITIES
The Company, in its capacity as a dealer in over-the-counter derivative
financial instruments and its proprietary market-making and trading activities,
enters into transactions in a variety of cash and derivative financial
instruments for proprietary trading and 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 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 generally provide the holder with the
right, but not the obligation, to purchase or sell a financial instrument at a
specific price on or before an established date 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 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.
- --------------------------------------------------------------------------------
72 THE BEAR STEARNS COMPANIES INC.
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
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, 2003:
Over-the-Counter Derivatives Credit Exposure(1)
Percentage
Exposure, of Exposure,
Net of Net of
Rating(2) Exposure Collateral(3) Collateral(4) Collateral
- --------------------------------------------------------------------
(in millions)
- --------------------------------------------------------------------
AAA $2,063 $ 825 $1,293 32%
AA 2,209 826 1,427 35%
A 1,559 793 951 23%
BBB 436 769 222 5%
BB and lower 679 1,181 212 5%
Non-rated 2 -- 2 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 large positions 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 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 similar 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 $635.3 million, $630.4 million and
$164.4 million during the fiscal years ended November 30, 2003, 2002 and 2001,
respectively.
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," and SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and 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. 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 BEAR STEARNS COMPANIES INC. 73
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
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 2003, 2002 and 2001, the Company
recognized a net gain of $1.8 million, $5.6 million and $9.7 million,
respectively, for the ineffective portion of all fair value hedges.
13 CUSTOMER ACTIVITIES
CUSTOMER CREDIT RISKS
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 the customer clearance activities, the Company executes and
clears customers' transactions involving the sale of borrowed securities ("short
sales"), entering into futures transactions 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. In the event 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
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' securities collateral to
satisfy exchange margin deposit requirements or to support various secured
financing sources such as bank loans, securities loaned and repurchase
agreements. In the event 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 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, individuals 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 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, broker-dealers, market makers 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. In addition, the
Company may be subject to concentration risk through providing margin to these
customers holding 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 issuers engaged in a particular
industry, where the Company receives such large
- --------------------------------------------------------------------------------
74 THE BEAR STEARNS COMPANIES INC.
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
positions as collateral. The Company seeks to control these risks by monitoring
collateral levels for compliance with both regulatory and internal guidelines.
Additional collateral is obtained when necessary. To further control these
risks, 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 customers' 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" revenues 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 based on observable
transactions in similar securities and are further verified by external pricing
sources, when available.
The Company's securitization activity is detailed below:
Agency Other Other
Mortgage- Mortgage- Asset-
Backed Backed Backed
- ------------------------------------------------------------------------------
(in billions)
- ------------------------------------------------------------------------------
Total securitizations
Fiscal 2003 $ 59.0 $ 51.3 $ 5.4
Fiscal 2002 $ 55.0 $ 19.6 $ 4.0
Retained interests
As of November 30, 2003 $ 1.8 $ 1.4 $ 0.2
As of November 30, 2002 $ 1.7 $ 0.4 $ 0.2
- ------------------------------------------------------------------------------
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. The models employed in the valuation of
retained interests use discount rates that are based on the swap curve plus a
spread. Key points on the swap curve at November 30, 2003 were 2.36% for 2-year
swaps and 4.71% for 10-year swaps and ranged from 1.17% to 5.44%. 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, 2003 were as
follows:
Agency Other Other
Mortgage- Mortgage- Asset-
Backed Backed Backed
- -----------------------------------------------------------------
Weighted average
life (years) 5.11 5.88 3.89
Average prepayment
speeds (annual rate) 8%-35% 0%-49% N/A
Credit losses 0.93% 7.27% 2.66%
- -----------------------------------------------------------------
The following hypothetical sensitivity analysis as of November 30, 2003
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 of other variables, including prepayments. The remaining valuation
assumptions are changed independently.
Agency Other Other
Mortgage- Mortgage- Asset-
Backed Backed Backed
- -------------------------------------------------------------------
(in millions)
- -------------------------------------------------------------------
Interest rates
50 basis point increase $ (30.4) $ (28.7) $ (0.8)
100 basis point increase (68.5) (59.2) (2.3)
50 basis point decrease 16.4 23.5 1.1
100 basis point decrease 16.5 36.6 2.3
- -------------------------------------------------------------------
Prepayment speeds
10% increase 0.1 (1.2) N/A
20% increase (2.3) (2.5) N/A
10% decrease 3.6 1.5 N/A
20% decrease 7.6 2.9 N/A
- -------------------------------------------------------------------
Credit losses
10% increase (5.5) (15.3) (5.5)
20% increase (10.9) (29.6) (11.3)
10% decrease 5.6 16.7 5.9
20% decrease 11.4 35.1 11.3
- -------------------------------------------------------------------
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 75
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
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 impact of hedges is not presented because
hedging positions are established on a portfolio level and allocating the impact
would not be practicable.
The following table summarizes cash flows from securitization trusts related to
securitization transactions during the fiscal year ended November 30, 2003:
Agency Other Other
Mortgage- Mortgage- Asset-
Backed Backed Backed
- ------------------------------------------------------------------------------
(in millions)
- ------------------------------------------------------------------------------
Cash flows received
from retained interests $411.2 $165.6 $20.8
Cash flows
from servicing N/A $ 8.8 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, 2003 and November 30, 2002, the Company had received securities
pledged as collateral that can be repledged, delivered or otherwise used with a
fair value of approximately $223.09 billion and $183.89 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 $140.69 billion and $115.70
billion were delivered or repledged, generally as collateral under repurchase or
securities lending agreements or to cover short sales at November 30, 2003 and
November 30, 2002, respectively.
15 CONSOLIDATION OF VARIABLE INTEREST ENTITIES
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.
The Company adopted the provisions of FIN No. 46 for VIEs created after January
31, 2003 and for VIEs in which the Company acquired an interest after January
31, 2003 with no material impact on the consolidated financial statements. The
Company currently expects to early adopt the provisions of FIN No. 46 (R) on
February 29, 2004. Although the Company is still evaluating the impact of FIN
No. 46 (R) relating to interests in VIEs that existed prior to January 31, 2003,
it is reasonably possible that FIN No. 46 (R) will require consolidation of, or
additional disclosures related to, the entities described below. Such adoption
is not currently expected to have a material impact on the consolidated
financial statements.
The Company acts as transferor, seller, investor, structurer or underwriter in
securitization transactions. These transactions typically involve entities that
are qualifying special purpose entities as defined in SFAS No. 140. However,
occasionally such entities are VIEs. The VIEs in these transactions own the
securitized assets and issue beneficial interests in such assets. The holders of
the beneficial interest have no recourse to the Company, only to the assets held
by the related VIE. In certain of these VIEs, the Company is the primary
beneficiary through its ownership of certain beneficial interests, which it may
sell in the normal course of business.
- --------------------------------------------------------------------------------
76 THE BEAR STEARNS COMPANIES INC.
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
The Company also acts as portfolio manager and/or underwriter 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 may also
retain certain trust certificates. In certain of these transactions these
interests result in the Company becoming the primary beneficiary of these
entities. The holders of the trust certificates have recourse only to the
underlying assets of the trusts and not to other assets of the Company.
Assets held by VIEs, which are not currently consolidated, in which the Company
is the primary beneficiary, as discussed in the preceding two paragraphs,
approximated $1.18 billion at November 30, 2003. The Company's maximum exposure
to a loss as a result of its relationship with these VIEs is approximately $7.4
million, which represents the fair value of its interests and is reflected in
the consolidated financial statements.
The Company also owns significant variable interests in several VIEs related to
collateralized debt obligations or asset securitizations for which the Company
is not the primary beneficiary and therefore does not consolidate these
entities. In aggregate, these VIEs have assets approximating $2.28 billion. At
November 30, 2003 the Company's maximum exposure to loss from these entities
approximates $10.4 million, which represents the fair value of its interests and
is reflected in the consolidated financial statements.
The Company purchases and sells interests in entities that may be deemed to be
VIEs in its market-making capacity in the ordinary course of business. As a
result of these activities, it is reasonably possible that such entities may be
consolidated and deconsolidated at various points in time. Therefore, the
Company's variable interests included above may not be held by the Company in
future periods.
16 COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company has commitments in connection
with various activities, the most significant of which are as follows:
LEASES
The Company occupies office space under leases that expire at various dates
through 2018. At November 30, 2003, future minimum aggregate annual rentals
payable under non-cancelable leases (net of subleases), including 383 Madison
Avenue in New York City, for fiscal years 2004 through 2008 and the aggregate
amount thereafter, are as follows:
- ------------------------------------------
(in thousands)
- ------------------------------------------
FISCAL YEAR
2004 $ 48,677
2005 47,648
2006 45,813
2007 45,429
2008 42,627
Thereafter 186,832
- ------------------------------------------
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 $108.1 million, $113.2
million and $100.5 million for the fiscal years ended November 30, 2003, 2002
and 2001, respectively.
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 $1.32
billion at November 30, 2003 (gross commitments of approximately $1.96 billion
less $644.0 million of associated hedges). Commercial lending commitments to
non-investment-grade borrowers approximated $1.14 billion at November 30, 2003.
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 77
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
PRIVATE EQUITY-RELATED INVESTMENTS AND PARTNERSHIPS
In connection with the Company's merchant banking activities, the Company has
commitments to invest in merchant banking and private equity-related investment
funds as well as commitments to invest directly in private equity-related
investments. At November 30, 2003, such commitments aggregated $601.0 million.
These commitments will be funded, if called, through the end of the respective
investment periods, the longest of such periods ending in 2010.
UNDERWRITING
In connection with the Company's mortgage-backed securitizations and equity
underwriting, the Company had commitments to purchase and sell new issues of
securities aggregating $411.1 million at November 30, 2003.
LETTERS OF CREDIT
At November 30, 2003, the Company was contingently liable for unsecured letters
of credit of approximately $2.16 billion and letters of credit of $776.4 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, 2003, the Company had pledged securities, primarily US
government and agency securities with a market value of approximately $2.61
billion as collateral for securities borrowed with an approximate market value
of $2.54 billion.
OTHER
The Company participates in the acquisition, securitization, servicing,
financing and disposition of commercial and residential loans. At November 30,
2003, the Company had entered into commitments to purchase or finance mortgage
loans of $863.1 million.
The Company had commitments to purchase Chapter 13 and other credit card
receivables of $183.1 million at November 30, 2003.
The Company has entered into agreements with providers of hardware, software,
data processing and systems consulting services. At November 30, 2003,
commitments over the remaining life of these agreements aggregated $53.6
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. Also, the Company
is involved from time to time in investigations and proceedings by governmental
agencies and self-regulatory organizations. Although the ultimate outcome of
these matters cannot be ascertained at this time, it is the opinion of
management, after consultation with counsel, that the resolution of 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.
- --------------------------------------------------------------------------------
78 THE BEAR STEARNS COMPANIES INC.
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
17 GUARANTEES
In the ordinary course of business, the Company issues various guarantees to
counterparties in connection with certain derivative, leasing, securitization
and other transactions. On February 28, 2003, the Company adopted the new
disclosure requirements for guarantees in accordance with FIN No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." On January 1, 2003, the Company
adopted the recognition requirements of FIN No. 45, requiring the Company to
recognize a liability at the inception of certain guarantees for obligations it
has undertaken in issuing the guarantees. The adoption of FIN No. 45 did not
have a material effect on the consolidated financial statements.
The guarantees covered by FIN No. 45 include contracts that contingently require
the guarantor to make payments to the guaranteed party based on changes related
to an asset, a liability or an equity security of the guaranteed party,
contracts that contingently require the guarantor to make payments to the
guaranteed party based on another entity's failure to perform under an agreement
and indirect guarantees of the indebtedness of others, even though the payment
to the guaranteed party may not be based on changes to an asset, liability or
equity security of the guaranteed party. In addition, FIN No. 45 covers certain
indemnification agreements that contingently require the guarantor to make
payments to the indemnified party, such as an adverse judgment in a lawsuit or
the imposition of additional taxes due to either a change in the tax law or an
adverse interpretation of the tax law.
The following table sets forth the maximum payout/notional amounts associated
with the Company's guarantees as of November 30, 2003:
Amount of Guarantee Expiration Per Period
- ------------------------------------------------------------------------------------------------------
Greater
Less Than One to Three Three to Than Five
(in millions) One Year Years Five Years Years Total
- ------------------------------------------------------------------------------------------------------
Derivative contracts (notional)(1) $163,738 $160,798 $110,275 $63,996 $498,807
Municipal securities 1,708 727 -- -- 2,435
Residual value guarantee -- -- 570 -- 570
- ------------------------------------------------------------------------------------------------------
(1) The carrying value of these derivatives approximated $7.06 billion.
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 79
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
DERIVATIVE CONTRACTS
The Company's dealer activities cause it to make markets and trade a variety of
derivative instruments. Certain derivative contracts that the Company has
entered into meet the accounting definition of a guarantee under FIN No. 45.
Derivatives that meet the FIN No. 45 definition of guarantees include credit
default swaps (whereby a default or significant change in the credit quality of
the underlying financial instrument may obligate the Company to make a payment),
certain written call and put options, swaptions, as well as floors, caps and
collars. Since the Company does not track the counterparties' purpose for
entering into a derivative contract, it has disclosed derivative contracts that
are likely to be used to protect against a change in an underlying financial
instrument, regardless of their actual use.
On certain of these contracts, such as written interest rate caps and floors and
foreign currency options, the maximum payout cannot be quantified since the
increase in interest rates and foreign exchange rates is not contractually
limited by the terms of the contracts. As such, the Company has disclosed
notional amounts as a measure of the extent of its involvement in these classes
of derivatives rather than maximum payout. Notional amounts do not represent the
maximum payout and generally overstate the Company's exposure to these
contracts. These derivative contracts are recorded at fair value which
approximated $7.06 billion at November 30, 2003.
In connection with these activities, the Company attempts to mitigate its
exposure to market risk by entering into a variety of offsetting derivative
contracts and security positions. For a discussion of derivatives, see Risk
Management and Management's Discussion and Analysis of Financial Condition and
Results of Operations.
MUNICIPAL SECURITIES
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 and as liquidity provider.
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, 2003 was approximately
$2.44 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, net of related
hedges, approximating $2.45 billion at November 30, 2003.
RESIDUAL VALUE GUARANTEE
The Company has entered into a new operating lease arrangement for its worldwide
headquarters at 383 Madison Avenue (the "Synthetic Lease"). Under the terms of
the Synthetic Lease, the Company is obligated to make monthly payments based on
the lessor's underlying interest costs. The Synthetic Lease expires on August
15, 2008, 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
sufficient 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, 2003, there was no expected shortfall and the residual value
guarantee approximated $570 million.
INDEMNIFICATIONS
The Company provides representations and warranties to counterparties in
connection with a variety of commercial transactions, including certain asset
sales and securitizations and occasionally indemnifies them against potential
losses caused by the breach of those representations and warranties. To mitigate
these risks with respect to assets being securitized that have been originated
by third parties, the Company seeks to obtain appropriate representations and
warranties from such third-party originators upon acquisition of such assets.
The Company generally performs due-diligence on assets purchased and maintains
underwriting standards for assets originated. The Company
- --------------------------------------------------------------------------------
80 THE BEAR STEARNS COMPANIES INC.
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
may also provide indemnifications to some counterparties to protect them in the
event additional taxes are owed or payments are withheld, due either to a change
in or adverse application of certain tax laws. These indemnifications generally
are standard contractual terms and are entered into in the normal course of
business. Generally, there are no stated or notional amounts included in these
indemnifications, and the contingencies triggering the obligation to indemnify
are not expected to occur.
Maximum payout information under these indemnifications is not readily available
because of the number, size, and lives of these transactions. In implementing
this accounting interpretation, the Company reviewed its experience with the
indemnifications on these structures. Based on such experience, it is unlikely
that the Company will have to make significant payments under these
arrangements.
OTHER GUARANTEES
The Company is a member of numerous exchanges and clearinghouses. Under the
membership agreements, members are generally required to guarantee the
performance of other members. Additionally, if a member becomes unable to
satisfy its obligations to the clearinghouse, other members would be required to
meet shortfalls. To mitigate these performance risks, the exchanges and
clearinghouses often require members to post collateral. The Company's maximum
potential liability under these arrangements cannot be quantified. However, the
potential for the Company to be required to make payments under these
arrangements is unlikely. Accordingly, no contingent liability is recorded in
the consolidated financial statements for these arrangements.
18 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. 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 research, sales and trading in areas such as
domestic and international equities, block trading, convertible bonds,
over-the-counter equities, equity derivatives, risk and convertible arbitrage
and through a joint venture, the NYSE, American Stock Exchange, Inc. ("AMEX")
and International Securities Exchange specialist activities. Fixed income
includes sales, trading and research provided to institutional clients across a
variety of products such as mortgage- and asset-backed securities, corporate and
government bonds, municipal bonds, high yield products, foreign exchange and
interest rate and credit 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, municipal 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 BEAR STEARNS COMPANIES INC. 81
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
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, including access to the Company's resources and
professionals. 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.
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.
Fiscal Years Ended November 30, 2003 2002 2001
- ------------------------------------------------------------------------------------
(in thousands)
- ------------------------------------------------------------------------------------
NET REVENUES
Capital Markets
Institutional equities $ 932,567 $ 1,117,762 $ 1,131,124
Fixed income 2,925,483 1,938,045 1,602,034
Investment banking 961,267 883,717 752,473
- ------------------------------------------------------------------------------------
Total Capital Markets 4,819,317 3,939,524 3,485,631
- ------------------------------------------------------------------------------------
Global Clearing Services 784,072 778,087 810,601
Wealth Management 511,307 498,411 543,495
Other(1) (120,205) (87,786) 67,308
- ------------------------------------------------------------------------------------
Total net revenues $ 5,994,491 $ 5,128,236 $ 4,907,035
- ------------------------------------------------------------------------------------
PRE-TAX INCOME
Capital Markets $ 1,924,071 $ 1,343,912 $ 867,166
Global Clearing Services 245,531 265,327 249,754
Wealth Management 19,217 11,616 40,314
Other(1) (416,550) (309,892) (222,790)
- ------------------------------------------------------------------------------------
Total pre-tax income $ 1,772,269 $ 1,310,963 $ 934,444
- ------------------------------------------------------------------------------------
As of November 30, 2003 2002 2001
- ------------------------------------------------------------------------------------
SEGMENT ASSETS
Capital Markets $143,866,138 $123,332,776 $137,845,003
Global Clearing Services 69,974,025 60,754,131 52,137,242
Wealth Management 3,705,922 3,555,762 3,860,954
Other(1) (5,377,975) (2,788,246) (8,312,971)
- ------------------------------------------------------------------------------------
Total segment assets $212,168,110 $184,854,423 $185,530,228
====================================================================================
(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 $193.0 million, $154.0 million and $123.0 million for the
fiscal years ended November 30, 2003, 2002 and 2001, respectively.
- --------------------------------------------------------------------------------
82 THE BEAR STEARNS COMPANIES INC.
================================================================================
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:
2003 2002 2001
- ------------------------------------------------------------------------------------
(in thousands)
- ------------------------------------------------------------------------------------
US net revenues $ 5,493,407 $ 4,663,264 $ 4,355,784
Non-US net revenues 501,084 464,972 551,251
- ------------------------------------------------------------------------------------
Consolidated net revenues $ 5,994,491 $ 5,128,236 $ 4,907,035
====================================================================================
US income before provision for income taxes
and cumulative effect of change in
accounting principle $ 1,704,898 $ 1,296,656 $ 912,443
Non-US income before provision for income
taxes and cumulative effect of change in
accounting principle 67,371 14,307 22,001
====================================================================================
Consolidated income before provision for
income taxes and cumulative effect of
change in accounting principle $ 1,772,269 $ 1,310,963 $ 934,444
====================================================================================
US assets $279,673,476 $222,453,066 $199,597,987
Non-US assets 43,432,595 39,965,312 33,858,496
Eliminations (110,937,961) (77,563,955) (47,926,255)
- ------------------------------------------------------------------------------------
Consolidated assets $212,168,110 $184,854,423 $185,530,228
====================================================================================
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. Favorable business conditions during fiscal 2003,
including low interest rates and a steep yield curve, helped to benefit fixed
income revenues for certain non-US entities. Additionally, increased revenues in
international equities driven by increased European customer activity has also
helped to increase non-US net revenues during fiscal 2003 compared to fiscal
2002. Employee compensation and benefits as a percentage of net revenues for
certain non-US entities decreased in fiscal 2003 compared to fiscal 2002
resulting in increased non-US income.
19 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, through a majority-owned joint venture, in specialist activities
on the NYSE, AMEX and International Securities Exchange. For fiscal 2003, 2002,
and 2001, the Company included revenues from specialist activities in "Principal
Transactions" revenues in the Consolidated Statements of Income. Due to the
occurrence of a Control Event triggered in December 2003, as defined by the
joint venture Operating Agreement, the Company is now entitled to designate a
majority of the voting members of the Management Committee, which would result
in a controlling interest. As a result, commencing in fiscal 2004, the Company
will begin consolidating this entity. Such consolidation is not currently
expected to have a material impact on the consolidated financial statements.
- --------------------------------------------------------------------------------
THE BEAR STEARNS COMPANIES INC. 83
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
20 QUARTERLY INFORMATION (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter Total
- ------------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
- ------------------------------------------------------------------------------------------------------------------------------
FISCAL YEAR ENDED NOVEMBER 30, 2003
Revenues $1,837,915 $1,850,212 $1,842,271 $1,865,046 $7,395,444
Interest expense 322,481 387,492 357,211 333,769 1,400,953
- ------------------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 1,515,434 1,462,720 1,485,060 1,531,277 5,994,491
- ------------------------------------------------------------------------------------------------------------------------------
Non-interest expenses
Employee compensation and benefits 757,889 692,181 681,745 748,880 2,880,695
Other 332,346 342,409 321,138 345,634 1,341,527
- ------------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 1,090,235 1,034,590 1,002,883 1,094,514 4,222,222
- ------------------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 425,199 428,130 482,177 436,763 1,772,269
Provision for income taxes 150,946 147,719 168,762 148,436 615,863
- ------------------------------------------------------------------------------------------------------------------------------
Net income $ 274,253 $ 280,411 $ 313,415 $ 288,327 $1,156,406
Basic earnings per share(1) $ 2.21 $ 2.27 $ 2.54 $ 2.43 $ 9.44
Diluted earnings per share(1) $ 2.00 $ 2.05 $ 2.30 $ 2.19 $ 8.52
- ------------------------------------------------------------------------------------------------------------------------------
Cash dividends declared per common share $ 0.17 $ 0.17 $ 0.20 $ 0.20 $ 0.74
==============================================================================================================================
First Quarter Second Quarter Third Quarter Fourth 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
==============================================================================================================================
(1) Due to rounding and/or the effect of averaging the number of shares of
common stock and common stock equivalents throughout the year, the sum of
the quarters' earnings per share amounts does not equal the full fiscal
year amount.
- --------------------------------------------------------------------------------
84 THE BEAR STEARNS COMPANIES INC.
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
- --------------------------------------------------------------------------------
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 12, 2004, there were 1,859 holders of record of the Company's
common stock. On February 12, 2004, the last reported sales price of the
Company's common stock was $85.84.
Dividends are payable on January 15, April 15, July 15 and October 15 in each
year on the Company's outstanding 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
dividends 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
High Low Common Share
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FISCAL YEAR ENDED NOVEMBER 30, 2003
First Quarter (through February 28, 2003) $65.18 $58.65 $0.17
Second Quarter (through May 31, 2003) 77.27 59.05 0.17
Third Quarter (through August 31, 2003) 82.55 65.11 0.20
Fourth Quarter (through November 30, 2003) 78.31 69.29 0.20
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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
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REQUESTS FOR FINANCIAL INFORMATION
A copy of The Bear Stearns TRANSFER AGENT AUDITORS INVESTOR RELATIONS
Companies Inc. Annual Report, AND REGISTRAR Deloitte & Touche LLP Elizabeth Ventura
Forms 10-K, 10-Q and 8-K along Mellon Investor 2 World Financial Center (212) 272-9251
with other Securities and Services L.L.C. New York, NY 10281 ir@bear.com
Exchange Commission Overpeck Centre (212) 436-2000
filings are available through Ridgefield Park, NJ 07660 MEDIA RELATIONS
www.bearstearns.com, or by (800) 279-1229 Elizabeth Ventura
writing: (212) 272-9251
LEGAL COUNSEL Russell Sherman
Investor Relations Department Cadwalader, Wickersham (212) 292-5219
The Bear Stearns Companies Inc. & Taft LLP media@bear.com
383 Madison Avenue 100 Maiden Lane
New York, NY 10179 New York, NY 10038 INFORMATION CENTER
(212) 504-6000 (212) 272-3939>
or by calling our automated
service for financial
information requests:
(800) 417-2327
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THE BEAR STEARNS COMPANIES INC. 85