THE BANK OF NEW YORK COMPANY, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended September 30, 2005
The Quarterly Report on Form 10-Q and cross reference index is on page 67.
THE BANK OF NEW YORK COMPANY, INC.
FINANCIAL REVIEW
TABLE OF CONTENTS
Consolidated Financial Highlights 1
Management's Discussion and Analysis of Financial
Condition and Results of Operations
- Introduction 3
- Overview 3
- Third Quarter 2005 Highlights 4
- Consolidated Income Statement Review 5
- Business Segment Review 9
- Critical Accounting Policies 23
- Consolidated Balance Sheet Review 27
- Liquidity 34
- Capital Resources 36
- Trading Activities 38
- Asset/Liability Management 40
- Statistical Information 41
- Other Developments 43
- Forward-Looking Statements and
Factors That Could Affect Future Results 47
- Website Information 50
Consolidated Financial Statements
- Consolidated Balance Sheets
September 30, 2005 and December 31, 2004 51
- Consolidated Statements of Income
for the Three Months and Nine Months Ended
September 30, 2005 and 2004 52
- Consolidated Statement of Changes In
Shareholders' Equity for the Nine
Months Ended September 30, 2005 53
- Consolidated Statements of Cash Flows
for the Nine Months Ended
September 30, 2005 and 2004 54
- Notes to Consolidated Financial Statements 55 - 66
Form 10-Q
- Cover 67
- Controls and Procedures 68
- Legal Proceedings 68
- Changes in Securities, Use of Proceeds, and
Issuer Purchases of Equity Securities 69
- Exhibits 69
- Signature 70
1
THE BANK OF NEW YORK COMPANY, INC.
Financial Highlights
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, June 30, September 30,
2005 2005 2004
------------ ------------- ------------
Quarter
-------
Revenue (tax equivalent basis) $ 2,126 $ 2,077 $ 1,747
Net Income 389 398 354
Basic EPS 0.51 0.52 0.46
Diluted EPS 0.51 0.52 0.46
Cash Dividends Per Share 0.21 0.20 0.20
Return on Average Common
Shareholders' Equity 16.15% 17.12% 15.90%
Return on Average Assets 1.53 1.59 1.45
Efficiency Ratio 65.5 65.7 65.2
Year-to-date
------------
Revenue (tax equivalent basis) $ 6,103 $ 3,995 $ 5,197
Net Income 1,166 777 1,089
Basic EPS 1.52 1.01 1.41
Diluted EPS 1.51 1.00 1.40
Cash Dividends Per Share 0.61 0.40 0.59
Return on Average Common
Shareholders' Equity 16.59% 16.82% 16.73%
Return on Average Assets 1.56 1.57 1.47
Efficiency Ratio 65.8 65.9 66.0
Assets $ 101,766 $ 103,063 $ 93,175
Loans 42,143 40,681 37,119
Securities 26,230 25,779 23,246
Deposits - Domestic 34,807 37,921 34,786
- Foreign 26,270 26,076 23,654
Long-Term Debt 7,529 7,586 6,137
Common Shareholders' Equity 9,608 9,471 9,054
Common Shareholders'
Equity Per Share $ 12.48 $ 12.29 $ 11.66
Market Value Per Share
of Common Stock 29.41 28.78 29.17
Allowance for Loan Losses as
a Percent of Total Loans 1.33% 1.38% 1.61%
Allowance for Loan Losses as
a Percent of Non-Margin Loans 1.57 1.62 1.92
Total Allowance for Credit Losses as
a Percent of Total Loans 1.68 1.75 2.04
Total Allowance for Credit Losses as
a Percent of Non-Margin Loans 1.97 2.05 2.42
Tier 1 Capital Ratio 7.93 8.07 8.09
Total Capital Ratio 12.20 12.49 12.09
Leverage Ratio 6.59 6.55 6.38
Tangible Common Equity Ratio 5.32 5.26 5.49
Employees 23,081 22,993 23,034
2
THE BANK OF NEW YORK COMPANY, INC.
Financial Highlights
(Dollars in millions, except per share amounts)
(Estimated)
September 30, June 30, September 30,
2005 2005 2004
------------- ------------ -------------
Assets Under Custody (In trillions)
-----------------------------------
Assets Under Custody $ 10.3 $ 10.3 $ 8.9
Equity Securities 31% 35% 33%
Fixed Income Securities 69 65 67
Cross-Border Assets $ 3.1 $ 2.9 $ 2.5
Assets Under Management (In billions)
-------------------------------------
Total Assets Under Management $ 107 $ 105 $ 97
Equity Securities 34% 34% 35%
Fixed Income Securities 21 21 21
Alternative Investments 14 14 15
Liquid Assets 31 31 29
3
Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
INTRODUCTION
The Bank of New York Company, Inc.'s (the "Company") actual results of
future operations may differ from those estimated or anticipated in certain
forward-looking statements contained herein for reasons that are discussed
below and under the heading "Forward-Looking Statements and Factors That Could
Affect Future Results". When used in this report, the words "estimate,"
"forecast," "project," "anticipate," "expect," "intend," "believe," "plan,"
"goal," "should," "may," "strategy," "target," and words of similar meaning
are intended to identify forward-looking statements in addition to statements
specifically identified as forward-looking statements.
OVERVIEW
The Bank of New York Company, Inc. (NYSE: BK) is a global leader in
providing a comprehensive array of services that enable institutions and
individuals to move and manage their financial assets in more than 100 markets
worldwide. The Company has a long tradition of collaborating with clients to
deliver innovative solutions through its core competencies: securities
servicing, treasury management, investment management, and individual and
regional banking services. The Company's extensive global client base
includes a broad range of leading financial institutions, corporations,
government entities, endowments and foundations. Its principal subsidiary,
The Bank of New York, founded in 1784, is the oldest bank in the United States
and has consistently played a prominent role in the evolution of financial
markets worldwide.
The Company has executed a consistent strategy over the past decade by
focusing on highly scalable, fee-based securities servicing and fiduciary
businesses, with top-three market share in most of its major product lines.
The Company distinguishes itself competitively by offering the broadest array
of products and services around the investment lifecycle. These include:
advisory and asset management services to support the investment decision;
extensive trade execution, clearance and settlement capabilities; custody,
securities lending, accounting and administrative services for investment
portfolios; and sophisticated risk and performance measurement tools for
analyzing portfolios. The Company also provides services for issuers of both
equity and debt securities. By providing integrated solutions for clients'
needs, the Company strives to be the preferred partner in helping its clients
succeed in the world's rapidly evolving financial markets.
The Company has grown both through internal reinvestment as well as
execution of strategic acquisitions to expand product offerings and increase
market share in its scale businesses. Internal reinvestment occurs through
increased technology spending, staffing levels, marketing/branding
initiatives, quality programs, and product development. The Company
consistently invests in technology to improve the breadth and quality of its
product offerings, and to increase economies of scale. With respect to
acquisitions, the Company has acquired 96 businesses since 1995, almost
exclusively in its securities servicing and fiduciary segment. The
acquisition of Pershing in 2003 for $2 billion was the largest of these
acquisitions.
As part of the transformation to a leading securities servicing provider,
the Company has also de-emphasized or exited its slower-growth traditional
banking businesses over the past decade. The Company's more significant
actions include selling its credit card business in 1997 and its factoring
business in 1999, and most recently, significantly reducing non-financial
corporate credit exposures by 47% from December 31, 2000 to December 31, 2004.
4
Capital generated by these actions has been reallocated to the Company's
higher-growth businesses.
The Company's business model is well positioned to benefit from a number
of long-term secular trends. These include the growth of worldwide financial
assets, globalization of investment activity, structural market changes, and
increased outsourcing. These trends benefit the Company by driving higher
levels of financial asset trading volume and other transactional activity, as
well as higher asset price levels and growth in client assets, all factors by
which the Company is compensated for its services. In addition, international
markets offer strong growth opportunities.
THIRD QUARTER 2005 HIGHLIGHTS
The Company reported third quarter net income of $389 million and diluted
earnings per share of 51 cents, compared with net income of $354 million and
diluted earnings per share of 46 cents in the third quarter of 2004 and net
income of $398 million and diluted earnings per share of 52 cents in the
second quarter of 2005. Year-to-date net income was $1,166 million, or $1.51
of diluted earnings per share, compared to $1,089 million, or $1.40 of diluted
earnings per share in 2004.
Additional highlights for the quarter include:
* Positive operating leverage over the third quarter of 2004.
* Securities servicing fees up 18% versus the year-ago quarter.
* Net interest income up 15% over the year-ago quarter.
* Foreign exchange and other trading revenues up 39% from the year-ago
quarter.
* Agreed on October 16, 2005 to acquire Alcentra Group Ltd., an
international asset management group.
* New marketing alliances with leading clients in key growth markets.
The Company's third quarter earnings reflect significant progress toward
its key objectives of achieving positive operating leverage on an annual basis
and sustaining top-line growth by expanding client relationships and winning
new ones. The Company's credit performance remains excellent and its cost re-
engineering efforts continue to be effective.
5
CONSOLIDATED INCOME STATEMENT REVIEW
Noninterest Income
------------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q05 vs. 3Q05 vs. -------------- Inc/
(Dollars in millions) 3Q05 2Q05 3Q04 2Q05 3Q04 2005 2004 (Dec)
------ ------ ------ -------- -------- ------ ------ -------
Servicing Fees
Securities $ 806 $ 776 $ 684 4% 18% $2,333 $2,116 10%
Global Payment Services 75 76 85 (1) (12) 226 247 (9)
------ ------ ------ ------ ------
881 852 769 3 15 2,559 2,363 8
Private Client Services
and Asset Management Fees 120 122 113 (2) 6 363 333 9
Service Charges and Fees 93 103 98 (10) (5) 288 286 1
Foreign Exchange and
Other Trading Activities 93 103 67 (10) 39 292 273 7
Securities Gains 15 23 14 (35) 7 50 59 (15)
Other* 46 53 38 (13) 21 130 160 (19)
------ ------ ------ ------ ------
Total Noninterest Income $1,248 $1,256 $1,099 (1) 14 $3,682 $3,474 6
====== ====== ====== ====== ======
* See "Other Developments."
The increase in noninterest income versus the third quarter and year-to-
date periods of 2004 reflects broadly stronger performance in securities
servicing, foreign exchange and other trading, and private client services and
asset management. The sequential quarter decrease primarily reflects declines
in foreign exchange and other trading, service charges and fees, and
securities gains.
Securities servicing fees in the third quarter of 2005 were up from the
third quarter of 2004 reflecting solid growth across all business segments.
On a year-to-date basis, 2005 securities servicing fees were up from 2004 due
to strength in investor services and broker-dealer services. See "Business
Segment Review" for additional details.
Global payment services fees were lower than the third quarter and year-
to-date periods of 2004 and on a sequential quarter basis. The decline
reflects customers choosing to pay with higher compensating balances, which
benefits net interest income. On an invoiced services basis, total revenue
was up 6% over the third quarter of 2004 and 3% sequentially.
Private client services and asset management fees for the third quarter
were up from the third quarter of 2004 reflecting higher fees at Ivy Asset
Management. The sequential quarter decrease reflects higher asset management
fees which were more than offset by seasonally lower private client fees. For
the nine months ended September 30, 2005, private client services and asset
management fees increased by 9% from a year ago, reflecting continued growth
at Ivy Asset Management. Total assets under management were $107 billion, up
from $97 billion a year ago and $105 billion at June 30, 2005.
Service charges and fees were down from the third quarter of 2004 and
from the second quarter of 2005. For the nine months of 2005, service charges
and fees increased slightly from 2004. The year-over-year quarterly decrease
reflects lower advisory and commitment fees offset by higher capital markets
and syndication fees. The sequential quarter decrease reflects lower capital
markets fees due to seasonally lower market activity.
Foreign exchange and other trading revenues were up significantly from
the third quarter of 2004 and down on a sequential-quarter basis. In
comparison to the third quarter of 2004, the improved results reflect
significantly higher client activity in foreign exchange as well as more
favorable markets in interest rate derivatives. Sequential quarter results
were impacted by a decline in fixed income trading, lower retail flows at
6
Pershing, and a seasonal slowdown in foreign exchange activity. For the nine
months ending September 30, 2005, foreign exchange and other trading revenues
were up from 2004.
Securities gains in the third quarter were up compared with the third
quarter of 2004 and down compared with the second quarter of 2005. The
sequential-quarter decrease reflects lower gains in the Company's sponsor fund
portfolio. Securities gains declined in the first nine months of 2005 versus
a year ago reflecting $19 million of realized gains on four sponsor fund
investments recorded in the first quarter of 2004.
Other noninterest income increased versus the third quarter of 2004 and
decreased from the second quarter of 2005. The third quarter of 2005 included
gains on the sale of certain Community Reinvestment Act ("CRA") investments of
$12 million ($5 million after related tax considerations) and four New York
Stock Exchange seats of $6 million ($4 million after-tax). On a year-to-date
basis, other noninterest income included a $17 million gain on the second
quarter of 2005 sale of the Company's interest in Financial Models Company,
Inc. For the nine months ended September 30, 2005, other noninterest income
was down from the nine months ended September 30, 2004, primarily reflecting a
2004 pre-tax gain of $48 million on the sale of a portion of the Company's
investment in Wing Hang Bank Limited. See "Other Developments".
Net Interest Income
-------------------
Percent Percent
Inc/(Dec) Year-to-date Inc/(Dec)
------------ ---------------------- ---------------
(Dollars in millions) 3Q05 3Q05
vs. vs. 2004 2004
3Q05 2Q05 3Q04 2Q05 3Q04 2005 Reported Core** Reported Core**
------ ------ ------ ----- ----- ----- -------- ------ -------- -------
Net Interest Income $ 492 $ 470 $ 428 5% 15% $1,417 $1,118 $1,263 27% 12%
Tax Equivalent
Adjustment* 8 7 8 21 20 20
------ ------ ------ ----- ------ -----
Net Interest
Income on a Tax
Equivalent Basis $ 500 $ 477 $ 436 5 15 $1,438 $1,138 $1,283 26 12
====== ====== ====== ====== ====== ======
Net Interest Rate
Spread 1.84% 1.84% 1.88% 1.87% 1.62% 1.86%
Net Yield
on Interest
Earning Assets 2.42 2.34 2.18 2.37 1.88 2.11
* A number of amounts related to net interest income are presented on a
"tax equivalent" basis. The Company believes that this presentation
provides comparability of net interest income arising from both taxable and
tax-exempt sources and is consistent with industry standards.
** Excludes SFAS 13 adjustments. See "Other Developments."
The increases in net interest income over 2004 reflect the higher value
of interest-free deposits as short-term rates increased, as well as growth in
earning assets. The third quarter of 2005 also includes $4 million ($3 million
after-tax) related to the recognition of interest on nonaccrual loans that
were sold. The increase from the prior quarter also reflects asset-sensitive
interest rate positioning, continued expansion of deposit spreads, and
increased liquidity generated by servicing activities. As a result of less of
an ability to lag deposit repricing, the Company expects a moderation of the
growth rate of net interest income in the fourth quarter of 2005.
The net interest income rate spread was 1.84% in the third quarter of
2005, compared with 1.88% in the third quarter of 2004 and 1.84% in the second
quarter of 2005. The net yield on interest earning assets was 2.42% in the
third quarter of 2005, compared with 2.18% in the third quarter of 2004 and
2.34% in the second quarter of 2005. The decline in spread from the third
7
quarter of 2004 reflects deposits repricing faster than the Company's
investment securities portfolio.
The year-to-date net interest income spread was 1.87% in 2005 compared
with 1.62% in 2004, while the net yield on interest earning assets was 2.37%
in 2005 and 1.88% in 2004. Excluding the impact of the SFAS 13 leasing
adjustments on the leveraged lease portfolio in 2004, the year-to-date 2004
net interest rate spread was 1.86% while net yield on interest earning assets
was 2.11%. The rise in the net yield from 2004 reflects the increasing value
of interest-free deposits in a rising rate environment.
Noninterest Expense and Income Taxes
------------------------------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q05 vs. 3Q05 vs. -------------- Inc/
(Dollars in million) 3Q05 2Q05 3Q04 2Q05 3Q04 2005 2004* (Dec)
------ ------ ------ -------- -------- ------ ------ -------
Salaries and
Employee Benefits $ 644 $ 640 $ 564 1% 14% $1,902 $1,708 11%
Net Occupancy 79 82 77 (4) 3 239 230 4
Furniture and Equipment 52 51 51 2 2 155 153 1
Clearing 49 42 39 17 26 137 131 5
Sub-custodian Expenses 25 24 21 4 19 72 65 11
Software 54 55 52 (2) 4 162 151 7
Communications 24 22 22 9 9 69 69 -
Amortization
of Intangibles 10 10 9 - 11 28 26 8
Other 198 197 164 1 21 571 492 16
------ ------ ------ ------ ------
Total Noninterest
Expense $1,135 $1,123 $ 999 1 14 $3,335 $3,025 10
====== ====== ====== ====== ======
* See "Other Developments."
Noninterest expense for the third quarter of 2005 was up compared with
the third quarter of 2004 and the second quarter of 2005. The increase versus
the year-ago quarter principally reflects increased staffing and clearing
costs associated with new business and acquisitions, as well as higher pension
and option expenses, expanded occupancy costs associated with business
continuity, and higher legal and consulting costs. Other expenses in the third
quarter included $14 million (both pre- and after-tax) of expenses associated
with an anticipated settlement of the previously disclosed Russian funds
transfer matter. The sequential increase reflects higher salaries and employee
benefits and clearing expenses tied to the LJR acquisition. The year 2005 is
the third and final year the adoption of expensing stock options will impact
year-over-year expense comparisons.
Relative to the third quarter of 2004, salaries and employee benefits
expense increased, reflecting higher pension and stock option expense as well
as higher staffing levels associated with growth in investor services and
expansion of certain staff functions. Salaries and employee benefits expense
for the third quarter increased slightly on a sequential quarter basis,
reflecting the Lynch, Jones, & Ryan, Inc.("LJR") acquisition. For the first
nine months of 2005, salaries and employee benefit expense also was higher,
reflecting many of these same factors affecting the year-over-year quarterly
comparison.
During the quarter, headcount increased by 88 people reflecting additions
related to LJR and in the correspondent clearing business. The Company
migrated approximately 200 positions to lower-cost locations during the
quarter, keeping it on target to meet its full-year objective of 500
positions.
Occupancy expenses were down sequentially as a result of a write-off in
the second quarter. On a year-to-date basis, occupancy expenses were up from
2004, primarily reflecting business continuity initiatives and higher energy
8
costs. Occupancy expense in 2004 included lease termination expenses of $8
million recorded in the first quarter of 2004.
Clearing and sub-custodian expenses, which are tied to transaction
volumes, were up $8 million, or 12%, sequentially on a combined basis to $74
million. On a year-to-date basis, clearing and sub-custodian expenses were
$209 million on a combined basis, increased $13 million, or 7%, from a year
ago. The increases reflect a higher level of business activity.
The increase in software expense versus a year ago reflects spending and
development to support business growth.
Other expenses increased versus the prior-year quarter and year-to-date
periods due to higher legal, advertising, and consulting costs as well as
various other expenses tied to organic growth and business acquisitions.
The effective tax rate for the third quarter of 2005 was 34.7%, compared
to 32.8% in the third quarter of 2004 and 33.4% in the second quarter of 2005.
The effective tax rate for the nine-month period ended September 30, 2005 was
33.7%, compared with 29.5% for the nine-month period ended September 30, 2004.
The increase in the year-to-date period reflects the benefit associated with
the SFAS 13 leasing adjustment related to the Company's leasing portfolio in
the first quarter of 2004.
The sequential quarter increase principally reflects the non-
deductibility of the amount associated with the anticipated settlement
referenced above and the tax impact on the sale of the CRA investments. For
the fourth quarter and full year 2005, the Company expects the effective tax
rate to be approximately 33.7%.
The effective tax rates in all periods reflect a reclassification related
to Section 42 tax credits. See "Other Developments".
Credit Loss Provision and Net Charge-Offs
-----------------------------------------
3rd 2nd 3nd
Quarter Quarter Quarter Year-to-Date
(In millions) 2005 2005 2004 2005 2004
------- ------- ------- ------- -------
Provision $ 10 $ 5 $ - $ 5 $ 22
======= ======= ======= ======= =======
Net Charge-offs:
Commercial $ (2) $ (2) $ (4) $ (7) $ (21)
Foreign (2) (4) (9) (6) (26)
Regional Commercial (3) 2 (1) (3) (1)
Consumer (6) (7) (5) (18) (22)
------- ------- ------- ------- -------
Total $ (13) $ (11) $ (19) $ (34) $ (70)
======= ======= ======= ======= =======
The provision was $10 million in the third quarter of 2005, compared to
the third quarter of 2004 when none was taken and $5 million in the second
quarter of 2005. For the first nine months of 2005, the provision was $5
million compared with $22 million in 2004. On a year-to-date basis, the lower
provision in 2005 reflects the Company's improved asset quality and a
continued strong credit environment.
The total allowance for credit losses was $707 million at September 30,
2005, $756 million at September 30, 2004, and $710 million at June 30, 2005.
The total allowance for credit losses as a percent of non-margin loans was
1.97% at September 30, 2005, compared with 2.42% at September 30, 2004, and
2.05% at June 30, 2005.
Net charge-offs were $13 million in the third quarter of 2005 versus $19
million in the third quarter of 2004 and $11 million in the second quarter of
2005. These represent 0.12% of total loans in the most recent quarter,
9
compared with 0.21% in the quarter ended September 30, 2004 and 0.11% in the
quarter ended June 30, 2005. For the nine months ended September 30, 2005,
net charge-offs were $34 million compared to $70 million for the same period
in 2004.
BUSINESS SEGMENT REVIEW
The Company has an internal information system that produces performance
data for its four business segments along product and service lines.
Business Segment Accounting Principles
---------------------------------------
The Company's segment data has been determined on an internal management
basis of accounting, rather than the generally accepted accounting principles
used for consolidated financial reporting. These measurement principles are
designed so that reported results of the segments will track their economic
performance. Segment results are subject to restatement whenever improvements
are made in the measurement principles or organizational changes are made. In
2004, the Company made several methodology changes. These include a
modification to the method for allocating its pension expense to the segments;
changes to the method used to allocate earnings on capital, which caused a
slight reallocation from reconciling items to the individual segments; and
greater allocations of corporate expenses previously included in reconciling
items to the individual segments. See "Reconciling Items." Prior periods
have been restated.
The measure of revenues and profit or loss by operating segment has been
adjusted to present segment data on a taxable equivalent basis. The provision
for credit losses allocated to each reportable segment is based on
management's judgment as to average credit losses that will be incurred in the
operations of the segment over a credit cycle of a period of years.
Management's judgment includes the following two factors among others:
historical charge-off experience and the volume, composition, and size of the
credit portfolio. This method is different from that required under generally
accepted accounting principles as it anticipates future losses which are not
yet probable and therefore not recognizable under generally accepted
accounting principles. Balance sheet assets and liabilities and their related
income or expense are specifically assigned to each segment. Funds transfer-
pricing methods are used to allocate a cost of funds used or credit for funds
provided to all segment assets or liabilities using a matched funding concept.
Support and other indirect expenses are allocated to segments based on general
internal guidelines.
Description of Business Segments
--------------------------------
The results of individual business segments exclude unusual items such as
the SFAS 13 lease adjustments and the RW Matter in 2004, which are included
within reconciling amounts.
The Company reports data for the four business segments: Servicing and
Fiduciary, Corporate Banking, Retail Banking, and Financial Markets.
The Servicing and Fiduciary businesses segment comprises the Company's
core services, including securities servicing, global payment services, and
private client services and asset management. These businesses all share
certain favorable attributes: they are well-diversified and fee-based; the
Company serves the role of an intermediary rather than principal, thereby
limiting risk and generating more stable earnings streams; and the businesses
are scalable, which result in higher margins as revenues grow. Long-term
trends that should favor these businesses include the growth of financial
assets worldwide, the globalization of investment activity, heightened demand
for financial servicing outsourcing, and continuing structural changes in
financial markets.
Securities servicing provides financial institutions, corporations and
financial intermediaries with a broad array of products and customized
services for every step of the investment lifecycle. The Company facilitates
the movement, settlement, recordkeeping and accounting of financial assets
10
around the world by delivering timely and accurate information to issuers,
investors and broker-dealers. The Company groups its securities servicing
businesses into four categories, each comprised of separate but related
businesses. Issuer services include corporate trust, depositary receipts and
stock transfer. Investor services include global fund services, global
custody, securities lending, global liquidity services and outsourcing.
Broker-dealer services include government securities clearance and collateral
management. Execution and clearing services include in the execution area
institutional agency brokerage, electronic trading, transition management
services, and independent research. Through Pershing, the clearing part of
the business provides clearing, execution, financing, and custody for
introducing brokers-dealers. The Servicing and Fiduciary Businesses segment
also includes customer-related foreign exchange trading.
In issuer services, the Company sponsors more than 1,200 American and
global depositary receipt programs, a 65% market share, acting in partnership
with leading companies from 60 countries. As a trustee, the Company provides
diverse services for corporate, municipal, and structured issuers globally.
Over 90,000 issues for more than 30,000 worldwide clients have resulted in the
Company being trustee for more than $3 trillion in outstanding debt. The
Company is the third largest stock transfer agent, servicing more than 16
million shareowners. Employee investment plan services has more than 118
clients with 625,000 employees in over 54 countries.
In investor services, the Company is one of the leading custodians with
$10.3 trillion of assets under custody at September 30, 2005. The Company is
one of the largest mutual fund custodians for U.S. funds and one of the
largest providers of fund services in the world with over $1.6 trillion in
total assets. The Company services 18% of the total industry assets for
exchange-traded funds. The Company is a leading U.K. custodian. In
securities lending, the Company is the largest lender of U.S. Treasury
securities and depositary receipts with a lending pool of approximately $1.4
trillion in 27 markets around the world.
The Company's broker-dealer services business clears approximately 50% of
U.S. Government securities. The Company is the leader in global clearance,
clearing equity and fixed income transactions in 101 markets. With over $1
trillion in tri-party balances worldwide, the Company is the world's largest
collateral management agent.
The Company's execution and clearing services business is the largest
global institutional agency brokerage organization. In addition, it is one of
the world's leading institutional electronic brokers for non-U.S. dollar
equity execution. The Company provides execution, clearing and financial
services outsourcing solutions in over 80 global markets, executing trades for
more than 600 million shares and clearing more than 925,000 trades daily. The
Company has 17 seats on the New York Stock Exchange. Pershing services more
than 1,100 institutional and retail financial organizations and independent
investment advisors who collectively represent nearly 6 million individual
investors.
Global payment services facilitates the flow of funds between the
Company's customers and their clients through such business lines as funds
transfer, cash management and trade services. The Company is one of the
largest funds transfer banks in the U.S., transferring $1.11 trillion daily
via more than 130,000 wire transfers.
Private client services and asset management includes traditional banking
and trust services to affluent clients and investment management services for
institutional and high-net-worth clients. The Company offers a full array of
wealth management services including financial and tax planning, trust and
fiduciary services, fiduciary real estate management, estate planning, private
banking, brokerage and investment solutions through BNY Asset Management.
The Company's strategy is to be a market leader in these servicing and
fiduciary businesses and continue to build on its product and service
capabilities and add new clients. The Company has completed 96 acquisitions
since 1995 primarily in this segment, has made significant investments in
technology to maintain its industry-leading position, and has continued the
development of new products and services to meet its clients' needs.
11
The Corporate Banking segment provides lending and credit-related
services to large public and private financial institutions and corporations
nationwide, as well as to public and private mid-size businesses in the New
York metropolitan area. Special industry groups focus on industry segments
such as banks, broker-dealers, insurance, media and telecommunications,
energy, real estate, retailing, and government banking institutions. Through
BNY Capital Markets, Inc., the Company provides a broad range of capital
markets and investment banking services including syndicated loans, bond
underwriting, private placements of corporate debt and equity securities, and
merger, acquisition and advisory services. The Company is a leading arranger
of syndicated financings with 113 transactions totaling approximately $48
billion for clients in the nine months ended September 30, 2005.
Corporate Banking coordinates delivery of all of the Company's services
to customers through its global relationship managers. The two main client
bases served are financial institution clients and corporate clients. The
Company's strategy is to focus on those clients and industries that are major
users of securities servicing and global payment services.
The Company believes that credit is an important product for many of its
customers to execute their business strategies. However, the Company has
continued to reduce its credit exposures in recent years by culling its loan
portfolio of non-strategic exposures, focusing on increasing total
relationship returns through cross-selling and limiting the size of its
individual credit exposures and industry concentrations to reduce earnings
volatility.
The Retail Banking segment includes branch banking and consumer and
residential mortgage lending. The Company's retail franchise includes more
than 620,800 customer relationships and 76,900 business relationships. The
Company operates 341 branches in 23 counties in the New York tri-state region.
The Company has 241 branches in New York, 92 in New Jersey and 8 in
Connecticut. The New York branches are primarily suburban-based with 118 in
upstate New York, 85 on Long Island and 38 in New York City. The retail
network is a source of low-cost funding and provides a platform to cross-sell
core services from the Servicing and Fiduciary businesses to both individuals
and small businesses in the New York metropolitan area. The branches are a
meaningful source of private client referrals. Small business and investment
centers are set up in the largest 100 branches.
The Financial Markets segment includes non-client related trading of
foreign exchange, trading of interest rate risk management products, investing
and leasing activities, and treasury services to other business segments. The
segment offers a comprehensive array of multi-currency hedging and yield
enhancement strategies, and complements the other business segments. The
Financial Markets segment centralizes interest rate risk management for the
Company.
There were no major customers from whom revenues were individually
material to the Company's performance.
12
Servicing and Fiduciary Businesses
----------------------------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q05 vs. 3Q05 vs. ---------------- Inc/
(Dollars in millions) 3Q05 2Q05 3Q04 2Q05 3Q04 2005 2004 (Dec)
------- ------- ------- -------- -------- ------- ------- -------
Net Interest Income $ 189 $ 178 $ 135 6% 40% $ 535 $ 403 33%
Provision for
Credit Losses 1 1 1 - - 3 2 50
Noninterest Income 1,095 1,058 953 3 15 3,178 2,937 8
Noninterest Expense 884 872 770 1 15 2,605 2,340 11
Income Before Taxes 399 363 317 10 26 1,105 998 11
Average Assets $22,799 $23,114 $20,937 (1) 9 $22,966 $22,195 3
Average Deposits 37,418 36,624 35,897 2 4 36,710 36,330 1
Nonperforming Assets - 1 3 - 3
(Dollars in billions)
Assets Under Custody $10,343 $10,298 $ 8,906 - 16 $10,343 $ 8,906 16
Equity Securities 31% 35% 33% 31% 33%
Fixed Income
Securities 69 65 67 69 67
Cross-border Assets $ 3,117 $ 2,883 $ 2,494 8 25 $ 3,117 $ 2,494 25
Assets Under
Management 107 105 97 2 10 107 97 10
Equity Securities 34% 34% 35% 34% 35%
Fixed Income
Securities 21 21 21 21 21
Alternative
Investments 14 14 15 14 15
Liquid Assets 31 31 29 31 29
S&P (registered
trademark) 500
Index (Period End) 1,229 1,191 1,115 3 10 1,229 1,115 10
NASDAQ (registered
trademark) Index
(Period End) 2,152 2,057 1,897 5 13 2,152 1,897 13
Lehman Brothers
Aggregate Bond
(service mark)
Index 210.0 212.4 200.4 (1) 5 210.0 200.4 5
MSCI (registered
trademark) EAFE
Index 1,618.8 1,473.7 1,318.0 10 23 1,618.8 1,318.0 23
NYSE (registered
trademark) Volume
(In billions) 98.1 100.4 84.9 (2) 16 297.9 271.1 10
NASDAQ (registered
trademark) Volume
(In billions) 104.9 112.5 99.6 (7) 5 338.6 334.2 1
The S&P 500 (registered trademark) Index was up 10% for the third
quarter of 2005, with average daily price levels up 11% from the third
quarter of 2004. The NASDAQ (registered trademark) Index was up 13% for
the third quarter of 2005, with average daily prices up 15% compared
with the third quarter of 2004. Globally, the MSCI(registered trademark)
EAFE index was up 23%. The Lehman Brothers Aggregate Bond (service mark)
index was up 5% for the third quarter of 2005. On a sequential quarter
basis, combined NYSE and NASDAQ (registered trademark) non-program
trading volumes were down approximately 3% during the third quarter of 2005.
As the Company's business model is more volume- than price-sensitive, this
created a drag on the Company's equity-linked businesses compared with the
second quarter of 2005.
Third quarter 2005 results showed continued strength in comparison to the
third quarter of 2004, reflecting solid growth across all business segments.
In the third quarter of 2005, pre-tax income was $399 million, up 26% from $317
million a year ago and up 10% from $363 million in the second quarter of 2005.
On a year-to-date basis, pre-tax income was $1,105 million, up 11% from $998
million in 2004.
Noninterest income for the third quarter of 2005 increased $142 million,
or 15%, to $1,095 million from a year ago and $37 million, or 3%, on a
sequential quarter basis. On a year-to-date basis, noninterest income was
$3,178 million, up 8% compared with $2,937 million a year ago.
13
Securities Servicing Fees
-------------------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q05 vs. 3Q05 vs. -------------- Inc/
(In millions) 3Q05 2Q05 3Q04 2Q05 3Q04 2005 2004 (Dec)
------ ------ ------ -------- -------- ------ ------ -------
Execution and
Clearing Services $ 314 $ 294 $ 262 7% 20% $ 901 $ 844 7%
Investor Services 265 265 228 - 16 793 683 16
Issuer Services 170 159 141 7 21 468 433 8
Broker-Dealer Services 57 58 53 (2) 8 171 156 10
------ ------ ------ ------ ------
Securities
Servicing Fees $ 806 $ 776 $ 684 4 18 $2,333 $2,116 10
====== ====== ====== ====== ======
Securities servicing fees were $806 million in the third quarter, an
increase of $122 million, or 18%, from the third quarter of 2004 and $30
million, or 4%, from the second quarter of 2005. The year-over-year increase
reflects solid growth across all business segments. The sequential increase
reflects strong growth in issuer services as well as the early success of the
LJR acquisition within execution and clearing. For the nine months of 2005,
securities servicing fees were $2,333 million, an increase of $217 million from
the nine months of 2004, reflecting strong growth in investor services and
broker-dealer services.
Execution and clearing includes institutional agency brokerage, electronic
trading, transition management services, independent research and through
Pershing, correspondent clearing services such as clearing, execution,
financing, and custody for introducing broker-dealers. The third quarter of
2005 was up from 2004 reflecting the benefits of the LJR acquisition and solid
organic growth at Pershing. Fees for execution and clearing increased
significantly from the second quarter of 2005, reflecting higher transition
management activity. Transition activity can vary significantly from quarter to
quarter and has no correlation to market volumes.
Pershing's fees were up from the third quarter of 2004 and essentially
flat compared with the second quarter of 2005. The year-over-year increase
reflects Pershing's continuing strategic shift to more value-added, fee-based
non-transactional services as well as higher transaction-based revenue. The
majority of Pershing's revenues is generated from non-transactional activities,
such as asset gathering and technology services to broker-dealers, with
revenues tied to both assets under administration and services provided. On a
year-over-year basis, stable assets under administration and net new business
drove modest increase in fees. Pershing's assets under administration were $752
billion at quarter-end, compared with $730 billion at June 30, 2005. As of
September 30, 2005, margin loans increased slightly compared with the second
quarter of 2005.
Investor services, which includes global fund services, global custody,
securities lending, global liquidity services and outsourcing, was up
significantly from the third quarter of 2004 and essentially unchanged from the
second quarter of 2005. Year-over-year results reflect strong performance
across all business lines. The sequential quarter was flat as a seasonal
slowdown in securities lending was offset by solid results across most
businesses. Global fund services was favorably impacted by new business from
Europe and higher international transaction volumes. Securities lending
increased significantly year-over-year and decreased sequentially. The
year-over-year positive variance in securities lending reflects continued
growth in new business and robust demand for Treasury collateral.
14
At September 30, 2005, assets under custody was $10.3 trillion, up from
$8.9 trillion at September 30, 2004 and essentially unchanged from $10.3
trillion at June 30, 2005. A substantial portion of the increase in assets
under custody since 2004 was due to new business and business line growth.
Issuer services, which includes corporate trust, depositary receipts and
stock transfer, showed strong growth versus the third quarter of 2004 and
increased sequentially. The increase versus the year-ago quarter primarily
reflects increase in trading volumes and corporate actions in depositary
receipt ("DR"). In the DR business, higher revenue reflects increased corporate
actions activity, such as dividends, capital raisings, and mergers &
acquisitions. DR issuance also showed solid performance, reflecting the growing
interest among U.S. investors in global equities. Corporate trust fees showed
continued strength in international issuance and structured products In
corporate trust, international issuance was seasonally slower, which was offset
by strength in structured, municipal, and corporate products. The new business
wins in corporate trust are driven by the Company's introduction of new
products, analytic tools, and expanded capacity.
Broker-dealer services, which includes government securities clearance and
collateral management, improved versus the year-ago period as a result of
increased collateral management activity and higher volumes in government
securities clearance. Sequential performance was marginally lower, as higher
fees from collateral management were offset by lower volumes in government
securities clearance. In collateral management services, the Company continues
to attract new business in both the U.S. and European markets. In addition,
the Company's growth has been paced by broader adoption and greater utilization
of collateral management products.
Global payment services fees were lower than the third quarter and year-
to-date periods of 2004 and on a sequential quarter basis. The decline reflects
customers choosing to pay with higher compensating balances, which benefits net
interest income. On an invoiced services basis, total revenue was up 6% over
the third quarter of 2004 and 3% sequentially.
Private client services and asset management revenues continue to
demonstrate solid performance with fees up 6% compared with the third quarter
of 2004. The increase from the third quarter of 2004 primarily reflects higher
fees at Ivy Asset Management. On a sequential quarter basis, private client
services and asset management revenues were down slightly, reflecting
seasonally lower private client fees partially offset by higher asset
management fees.
Assets under management ("AUM") were $107 billion at September 30, 2005,
up from $97 billion at September 30, 2004 and $105 billion at June 30, 2005.
The sequential increase in AUM was driven by growth in money market and fixed
income classes. Institutional clients represent 70% of AUM while individual
clients equal 30%. AUM at September 30, 2005, are 34% invested in equities, 21%
in fixed income, 14% in alternative investments and the remainder in liquid
assets. Ivy's AUM was $15.3 billion at September 30, 2005, compared with $14.6
billion at September 30, 2004 and $15.3 billion at June 30, 2005. The year-
over-year increase in Ivy's AUM reflects primarily net new business and
stronger market performance of the assets.
In the third quarter of 2005, noninterest income attributable to foreign
exchange and other trading activities was $51 million, up from $44 million in
the third quarter of 2004 and down from $55 million in the second quarter of
2005. The year-over-year increase reflects higher volatility in foreign
exchange and fixed income trading. The sequential quarter decrease reflects a
seasonal slow down in foreign exchange activity. On a year-to-date basis,
noninterest income attributable to foreign exchange and other trading
activities was $156 million, down from $163 million in 2004, reflecting lower
foreign exchange volatility and lower other trading activities.
Net interest income in the Servicing and Fiduciary businesses segment was
$189 million for the third quarter of 2005, up 40% compared with $135 million
15
in the third quarter of 2004 and $178 million in the second quarter of 2005.
The significant increase from the third quarter of 2004 is primarily due to
higher value of interest-free deposits related to the rise in short-term rates
and customers' increased use of compensating balances to pay for services. The
increase in net interest income from the second quarter of 2005 is primarily
due to the expansion of deposit spreads and increased liquidity generated by
servicing activities. Average assets for the quarter ended September 30, 2005
were $22.8 billion, compared with $20.9 billion in the third quarter of 2004
and $23.1 billion in the second quarter of 2005. The year-over-year increase
in average assets reflects a higher level of servicing activity in 2005
compared with 2004. Average assets for the nine months ended September 30, 2005
were $23.0 billion compared with $22.2 billion in the first nine months of
2004. The third quarter of 2005 average deposits were $37.4 billion, compared
with $35.9 billion in the third quarter of 2004 and $36.6 billion in the second
quarter of 2005. The increases in average deposits reflects customers'
increased use of compensating balances in a rising interest rate environment.
Average deposits for the nine months of 2005 were $36.7 billion compared with
$36.3 billion in 2004.
Net charge-offs in the Servicing and Fiduciary Businesses segment were $2
million in the third quarter of 2005, compared with $10 million in the third
quarter of 2004 and $5 million in the second quarter of 2005. On a year-to-
date basis, net charge-offs were $7 million compared with $15 million in 2004.
Nonperforming assets were zero at September 30, 2005, compared with $3 million
at September 30, 2004 and $1 million at June 30, 2005.
Noninterest expense for the third quarter of 2005 was $884 million,
compared with $770 million in the third quarter of 2004 and $872 million in the
second quarter of 2005. The increase in noninterest expense from the third
quarter of 2004 reflects higher staffing levels associated with growth in
investor services and expansion of certain staff functions as well as increased
pension and stock option expense. The sequential quarter increase reflects
higher staffing and incentives tied to improved revenues and higher clearing
expense tied to the LJR acquisition. Noninterest expense for the nine months of
2005 was $2,605 million compared with $2,340 million for the same period in
2004 and is attributable to the same factors affecting the year-over-year
quarterly increase.
Corporate Banking
-----------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q05 vs. 3Q05 vs. --------------- Inc/
(In millions) 3Q05 2Q05 3Q04 2Q05 3Q04 2005 2004 (Dec)
-------- -------- -------- -------- -------- ------- ------- -------
Net Interest Income $ 92 $ 87 $ 88 6% 5% $ 266 $ 262 2%
Provision for
Credit Losses 16 18 15 (11) 7 52 50 4
Noninterest Income 84 91 71 (8) 18 256 217 18
Noninterest Expense 59 59 57 - 4 175 172 2
Income Before Taxes 101 101 87 - 16 295 257 15
Average Assets $ 17,022 $ 17,271 $ 17,485 (1) (3) $17,274 $17,384 (1)
Average Deposits 5,702 5,653 5,422 1 5 5,628 5,921 (5)
Nonperforming Assets 94 126 269 (25) (65) 94 269 (65)
Net Charge-offs 4 - 3 - 33 9 24 (63)
The Corporate Banking segment coordinates all banking and credit-related
services to customers through its global relationship managers. The two main
client bases served are financial institution clients and corporate clients.
The Company's strategy is to focus on those clients and industries that are
major users of securities servicing and global payment services.
Over the past several years, the Company has been seeking to improve its
overall risk profile by reducing its credit exposures through elimination of
non-strategic exposures, cutting back large individual exposures and avoiding
outsized industry concentrations. In 2002, the Company set a goal of reducing
corporate credit exposure to $24 billion by December 31, 2004. This goal was
accomplished in early 2004 and exposures have since declined to $22.6 billion.
16
In the third quarter of 2005, pre-tax income was $101 million, up 16%,
compared with $87 million in the third quarter of 2004 and flat in comparison
to the $101 million in the second quarter of 2005. The improvement in year-
over-year results primarily reflects higher net interest income. On a year-to-
date basis, pre-tax income was $295 million, up 15% compared with $257 million
in 2004 reflecting both higher noninterest income and net interest income.
The Corporate Banking segment's net interest income was $92 million in the
third quarter of 2005, compared with $88 million in the third quarter of 2004
and $87 million in the second quarter of 2005. On a year-to-date basis, net
interest income was $266 million, compared with $262 million for the nine
months of 2004. Average assets for the quarter were $17.0 billion, compared
with $17.5 billion in the third quarter of last year and $17.3 billion in the
second quarter of 2005. Average assets for the nine months of 2005 were $17.3
billion compared with $17.4 billion in 2004. The sequential and year-over-year
declines reflect a reduction in corporate borrowing. Average deposits in the
Corporate Banking segment were $5.7 billion versus $5.4 billion in the third
quarter of 2004 and $5.7 billion in the second quarter of 2005. On a year-to-
date basis, average deposits were $5.6 billion compared with $5.9 billion in
2004.
The third quarter of 2005 provision for credit losses was $16 million,
compared with $15 million in the third quarter of last year and $18 million in
the second quarter of 2005. On a year-to-date basis, provision for credit
losses was $52 million compared with $50 million in 2004. After a significant
period of reduction, exposures in Corporate Banking have leveled out. Net
charge-offs in the Corporate Banking segment were $4 million in the third
quarter of 2005, $3 million in the third quarter of 2004, and zero in the
second quarter of 2005. Net charge-offs for the nine months of 2005 were $9
million compared with $24 million in 2004. Nonperforming assets were $94
million at September 30, 2005, down from $269 million at September 30, 2004 and
$126 million at June 30, 2005. The decrease in nonperforming assets from the
third quarter of 2004 primarily reflects loan sales, paydowns, and charge-offs
of commercial loans.
Noninterest income was $84 million in the current quarter, compared with
$71 million in the third quarter of 2004 and $91 million in the second quarter
of 2005. On a year-to-date basis, noninterest income was $256 million compared
with $217 million in 2004. The increases reflect higher gains on asset
dispositions, higher capital markets fees and higher income from Wing Hang
Bank. The sequential quarter decline reflects lower syndication and other
capital markets fees.
Noninterest expense in the third quarter was $59 million, compared with
$57 million in the third quarter of 2004 and $59 million in the second quarter
of 2005. On a year-to-date basis, noninterest expense was $175 million compared
with $172 million in 2004. The year-over-year increase primarily reflects
higher pension and stock options expenses.
17
Retail Banking
--------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q05 vs. 3Q05 vs. --------------- Inc/
(In millions) 3Q05 2Q05 3Q04 2Q05 3Q04 2005 2004 (Dec)
-------- -------- -------- -------- -------- ------- ------- -------
Net Interest Income $ 136 $ 131 $ 125 4% 9% $ 395 $ 366 8%
Provision for Credit
Losses 5 5 6 - (17) 15 16 (6)
Noninterest Income 27 27 28 - (4) 80 85 (6)
Noninterest Expense 101 99 99 2 2 298 286 4
Income Before Taxes 57 54 48 6 19 162 149 9
Average Assets $ 6,180 $ 6,071 $ 5,639 2 10 $ 6,119 $ 5,445 12
Average Noninterest
Bearing Deposits 5,377 5,510 5,398 (2) - 5,462 5,212 5
Average Deposits 14,862 15,125 15,311 (2) (3) 15,000 15,094 (1)
Nonperforming Assets 12 13 15 (8) (20) 12 15 (20)
Net Charge-offs 7 6 6 17 17 18 17 6
Number of Branches 341 341 341 - - 341 341 -
Number of ATMs 378 376 379 1 - 378 379 -
The Retail Banking segment provides the Company with a stable source of
core deposits. The segment represents an attractive distribution channel, and
the Company has continued to expand the products offered through the retail
branch system. The branch system is focused on the suburban Tri-State New York
metropolitan area.
The Retail Banking segment continues to demonstrate good results in spite
of increased competition in the New York metropolitan area. Net interest income
has been strong, reflecting the benefit of a rising rate environment on the
value of the segment's deposits. In the third quarter of 2005, pre-tax income
was $57 million, up 19% from $48 million in the third quarter of 2004 and 6%
from $54 million in the second quarter of 2005. On a year-to-date basis, pre-
tax income was $162 million, up 9% from $149 million in 2004.
The Company continues to enhance the services offered through the branch
system. This includes leveraging its retail client base to distribute BNY
Asset Management and third-party investment products. Currently, investment
products are cross-sold to over 10% of the client base. The Company is also
seeking selective expansion opportunities within its current branch footprint.
Net interest income in the third quarter of 2005 was $136 million,
compared with $125 million in the third quarter of 2004 and $131 million in the
second quarter of 2005. Net interest income has increased over the third
quarter of 2004 and on a sequential quarter basis as rates have risen,
benefiting spreads. The increase in average assets since the third quarter of
2004 has also contributed to the increase in net interest income. On a year-to-
date basis, net interest income was $395 million compared with $366 million in
2004 reflecting the same factor discussed above.
Noninterest income was $27 million for the quarter, compared with $28
million in the third quarter of last year and $27 million in the second quarter
of 2005. On a year-to-date basis, noninterest income was $80 million compared
with $85 million in 2004. The decrease in noninterest income compared to 2004
reflects lower monthly service fees partially offset by higher debit card fees.
Noninterest expense in the third quarter of 2005 was $101 million,
compared with $99 million last year and $99 million in the second quarter of
2005. The increases from the third quarter of 2004 and second quarter of 2005
reflect slightly higher compensation and occupancy expense. For the nine months
of 2005, noninterest expense was $298 million compared with $286 million in
2004 reflecting higher employee benefits, advertising, occupancy, and
consulting costs.
Net charge-offs were $7 million in the third quarter of 2005, compared
with $6 million in the third quarter of 2004 and $6 million in the second
quarter of 2005. For the nine months of 2005, net charge-offs were $18 million
18
compared with $17 million from a year ago. Nonperforming assets were $12
million at September 30, 2005, compared with $15 million at September 30, 2004
and $13 million at June 30, 2005.
Average deposits generated by the Retail Banking segment were $14.9
billion in the third quarter of 2005, compared with $15.3 billion in the third
quarter of 2004 and $15.1 billion in the second quarter of 2005. For the nine
months of 2005, average deposits were $15.0 billion compared with $15.1 billion
in 2004. The decrease reflects customers seeking higher yields in a rising rate
environment. Average assets in the Retail Banking sector were $6.2 billion,
compared with $5.6 billion in the third quarter of 2004 and $6.1 billion in the
second quarter of 2005. On a year-to-date basis, average assets were $6.1
billion, compared with $5.4 billion in 2004. The increase from 2004 in average
assets is due to higher consumer loans.
Financial Markets
-----------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q05 vs. 3Q05 vs. --------------- Inc/
(In millions) 3Q05 2Q05 3Q04 2Q05 3Q04 2005 2004 (Dec)
------- ------- ------- -------- -------- ------- ------- -------
Net Interest Income $ 71 $ 70 $ 79 1% (10)%$ 209 $ 237 (12)%
Provision for
Credit Losses 4 6 5 (33) (20) 15 15 -
Noninterest Income 42 49 35 (14) 20 137 126 9
Noninterest Expense 33 34 29 (3) 14 100 83 20
Income Before Taxes 76 79 80 (4) (5) 231 265 (13)
Average Assets $50,507 $49,741 $49,148 2 3 $49,547 $49,973 (1)
Average Deposits 3,850 4,137 3,517 (7) 9 3,983 3,724 7
Average Investment
Securities 25,642 24,719 22,374 4 15 24,642 22,783 8
Net Charge-offs - - - - - - 14 (100)
In the third quarter of 2005, pre-tax income was $76 million, compared
with $80 million a year ago and $79 million in the second quarter of 2005. On a
year-to-date basis, pre-tax income was $231 million, down from $265 million in
2004. The decreases over the third quarter and year-to-date 2004 are primarily
due to a decline in net interest income, resulting from higher funding costs
for the segment's securities portfolio.
Net interest income for the third quarter was $71 million compared with
$79 million a year ago and $70 million for the second quarter of 2005. The
decrease from the third quarter of 2004 reflects the rising rate environment,
which increased funding costs. On a year-to-date basis, net interest income
was $209 million, down 12% from $237 million in 2004. The year-over-year
decreases primarily reflect the rising rate environment and on a year-to-date
basis, a decline in average assets. Average third quarter 2005 assets in the
Financial Markets segment, composed primarily of short-term liquid assets and
investment securities, were $50.5 billion, compared with $49.1 billion in the
third quarter last year and $49.7 billion on a sequential quarter basis. The
increases reflect higher levels of investment securities. Average investment
securities increased as the Company continues to invest in adjustable or short
life classes of structured mortgage-backed securities, both of which have short
durations. Average assets for the first nine months of 2005 were $49.5
billion, compared to $50.0 billion for the first nine months of 2004.
Noninterest income was $42 million in the third quarter of 2005, compared
with $35 million in the third quarter of 2004 and $49 million in the second
quarter of 2005. On a year-to-date basis, noninterest income was $137 million
in 2005 compared with $126 million in 2004. The positive variances reflect
stronger interest rate derivatives and other trading activities.
Net charge-offs were zero in the third quarter and second quarter of 2005
and in the third quarter of 2004, respectively. For the nine months of 2005,
net charge-offs were zero compared with $14 million for the same period in
2004. Charge-offs in 2004 primarily related to the Company's airline exposure.
Noninterest expense was $33 million in the third quarter of 2005, compared with
19
$29 million in last year's third quarter and $34 million in the second quarter
of 2005. On a year-to-date basis, noninterest expense was $100 million for
2005 compared with $83 million for 2004. The increases over the third quarter
and year-to-date 2004 are attributable to higher employee incentive
compensation and technology expenses.
The consolidating schedule below shows the contribution of the Company's
segments to its overall profitability.
(Dollars in millions) Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
September 30, 2005 Businesses Banking Banking Markets Items Total
-------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 189 $ 92 $ 136 $ 71 $ 4 $ 492
Provision for Credit Losses 1 16 5 4 (16) 10
Noninterest Income 1,095 84 27 42 - 1,248
Noninterest Expense 884 59 101 33 58 1,135
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 399 $ 101 $ 57 $ 76 $ (38) $ 595
========== ========= ========= ========= =========== ============
Contribution Percentage 63% 16% 9% 12%
Average Assets $ 22,799 $ 17,022 $ 6,180 $ 50,507 $ 4,402 $ 100,910
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2005 Businesses Banking Banking Markets Items Total
-------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 178 $ 87 $ 131 $ 70 $ 4 $ 470
Provision for Credit Losses 1 18 5 6 (25) 5
Noninterest Income 1,058 91 27 49 31 1,256
Noninterest Expense 872 59 99 34 59 1,123
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 363 $ 101 $ 54 $ 79 $ 1 $ 598
========== ========= ========= ========= =========== ============
Contribution Percentage 61% 17% 9% 13%
Average Assets $ 23,114 $ 17,271 $ 6,071 $ 49,741 $ 4,264 $ 100,461
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
September 30, 2004 Businesses Banking Banking Markets Items Total
-------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 135 $ 88 $ 125 $ 79 $ 1 $ 428
Provision for Credit Losses 1 15 6 5 (27) -
Noninterest Income 953 71 28 35 12 1,099
Noninterest Expense 770 57 99 29 44 999
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 317 $ 87 $ 48 $ 80 $ (4) $ 528
========== ========= ========= ========= =========== ============
Contribution Percentage 60% 16% 9% 15%
Average Assets $ 20,937 $ 17,485 $ 5,639 $ 49,148 $ 4,146 $ 97,355
20
(Dollars in millions)
Servicing
and
For the Nine Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
September 30, 2005 Businesses Banking Banking Markets Items Total
------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 535 $ 266 $ 395 $ 209 $ 12 $ 1,417
Provision for
Credit Losses 3 52 15 15 (80) 5
Noninterest Income 3,178 256 80 137 31 3,682
Noninterest Expense 2,605 175 298 100 157 3,335
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 1,105 $ 295 $ 162 $ 231 $ (34) $ 1,759
========== ========= ========= ========= =========== ============
Contribution Percentage 62% 16% 9% 13%
Average Assets $ 22,966 $ 17,274 $ 6,119 $ 49,547 $ 4,305 $ 100,211
Servicing
and
For the Nine Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
September 30, 2004 Businesses Banking Banking Markets Items Total
------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 403 $ 262 $ 366 $ 237 $ (150) $ 1,118
Provision for
Credit Losses 2 50 16 15 (61) 22
Noninterest Income 2,937 217 85 126 109 3,474
Noninterest Expense 2,340 172 286 83 144 3,025
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 998 $ 257 $ 149 $ 265 $ (124) $ 1,545
========== ========= ========= ========= =========== ============
Contribution Percentage 60% 15% 9% 16%
Average Assets $ 22,195 $ 17,384 $ 5,445 $ 49,973 $ 4,132 $ 99,129
21
Reconciling Items
-----------------
Description-Reconciling items for net interest income primarily relate to
the recording of interest income on a taxable equivalent basis, reallocation of
capital, and the funding of goodwill and intangibles. The adjustment to the
provision for credit losses reflects the difference between the aggregate of
the credit provision over a credit cycle for the reportable segments and the
Company's recorded provision. The Company's approach to acquisitions is highly
centralized and controlled by senior management. Accordingly, the resulting
goodwill and other intangible assets are reconciling items for average assets.
The related amortization is a reconciling item for noninterest expense. Other
reconciling items for noninterest expense primarily reflect corporate overhead
and severance.
To assess as accurately as possible the performance of its segments in
2004, the Company analyzed reconciling items related to corporate overhead. As
a result of this analysis, the Company reclassified from reconciling items to
the individual segments certain items related to insurance, compliance, and
incentive compensation expenses. In addition, a minor modification was made to
the method used to allocate earnings on capital. The impact of these changes
was a decline in pre-tax income of the segments and a reduction in the amount
of reconciling items as shown below:
3rd 2nd 1st
Segment Quarter Quarter Quarter Year-to-date
--------- --------- --------- ------------
(In millions) 2004 2004 2004 2004
----------------------- --------- --------- --------- ------------
Servicing and Fiduciary $ (30) $ (35) $ (30) $ (95)
Corporate Banking (5) (5) (5) (15)
Retail Banking (5) (1) (6) (12)
Financial Markets (7) (5) 1 (11)
---------- ---------- --------- -----------
Subtotal (47) (46) (40) (133)
Reconciling 47 46 40 133
---------- ---------- --------- ----------
Total $ - $ - $ - $ -
========== ========== ========= ==========
22
The detail of reconciling items for 2005 and 2004 are presented in the
following table.
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-date
-------- -------- -------- -----------------
(In millions) 2005 2005 2004 2005 2004
-------- -------- -------- -------- --------
Segments' Revenue $ 1,736 $ 1,691 $ 1,514 $ 5,056 $ 4,633
Adjustments:
Earnings Associated with
Assignment of Capital (8) (8) (13) (25) (48)
Securities Gains - 10 - 10 19
SFAS 13 Cumulative
Lease Adjustment - - - - (145)
Taxable Equivalent Basis and
Other Tax-Related Items 12 12 14 37 41
Other - 21 12 21 92
-------- -------- -------- -------- --------
Subtotal- Revenue Adjustments 4 35 13 43 (41)
-------- -------- -------- -------- --------
Consolidated Revenue $ 1,740 $ 1,726 $ 1,527 $ 5,099 $ 4,592
======== ======== ======== ======== ========
Segments' Income Before Tax $ 633 $ 597 $ 532 $ 1,793 $ 1,669
Adjustments:
Revenue Adjustments (Above) 4 35 13 43 (41)
Provision for Credit Losses
Different than GAAP 16 25 27 80 61
Severance (2) (4) - (7) (12)
Goodwill and
Intangible Amortization (10) (10) (9) (28) (25)
Lease Termination - - - - (8)
Corporate Overhead and Other (46) (45) (35) (122) (99)
-------- -------- -------- -------- --------
Consolidated Income
Before Tax $ 595 $ 598 $ 528 $ 1,759 $ 1,545
======== ======== ======== ======== ========
Segments' Total
Average Assets $ 96,508 $ 96,197 $ 93,209 $ 95,906 $ 94,997
Adjustments:
Goodwill and Intangibles 4,402 4,264 4,146 4,305 4,132
-------- -------- -------- -------- --------
Consolidated Average Assets $100,910 $100,461 $ 97,355 $100,211 $ 99,129
======== ======== ======== ======== ========
In addition to the recurring items discussed above, other significant
items may be included as reconciling items. In the third quarter of 2005, the
$14 million of expenses associated with an anticipated settlement of the
previously disclosed Russian funds transfer matter was a reconciling item. In
the second quarter of 2005, the $17 million gain on the sale of Financial
Models Company, Inc. ("FMC"), $10 million of above trend securities gains, and
the $10 million legal accrual for certain regulatory matters were reconciling
items. In the first quarter of 2004, SFAS 13 cumulative adjustments to the
leasing portfolio, securities gains on four large sponsor funds, gains on sale
on Wing Hang Bank, and severance and lease termination expenses were
reconciling items.
Allocation to Segments - Earnings associated with the assignment of capital
relate to preferred trust securities, which are assigned as capital to
segments. Since the Company considers these issues to be capital, it does not
allocate the interest expense associated with these securities to individual
segments. If this interest expense were allocated to segments, it could be
assigned based on segment capital, assets, risks, or some other basis.
The reconciling item for securities gains relates to the Financial
Markets business. The taxable equivalent adjustment is not allocated to
segments because all segments contribute to the Company's taxable income and
the Company believes it is arbitrary to assign the tax savings to any
particular segment. Most of the assets that are attributable to the tax
23
equivalent adjustment are recorded in the Financial Markets segment. In the
second quarter of 2005, the gain on sale of FMC would be allocated to the
Servicing and Fiduciary segment as would the $10 million regulatory charge.
Most of the securities gains result from securities attributable to the
Financial Markets segment. In the first quarter of 2004, the $145 million
reconciling item related to SFAS 13 cumulative lease adjustment and the $19
million gain on sponsor fund investments would be attributable to the
Financial Markets segment. In addition, the $48 million gain on the sale of
Wing Hang recorded in Other would be attributable to the Corporate Banking
segment.
The reconciling item for the provision for loan losses primarily relates
to Corporate Banking. Severance and lease termination costs primarily relate
to the Servicing and Fiduciary segment, the Corporate Banking segment, and to
staff areas. Goodwill and intangible amortization primarily relates to the
Securities Servicing and Fiduciary segment. Corporate overhead is difficult
to identify specifically with any particular segment. Approaches to
allocating corporate overhead to segments could be based on revenues,
expenses, number of employees, or a variety of other measures.
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are described in the "Notes
to Consolidated Financial Statements" under "Summary of Significant Accounting
and Reporting Policies" in the Company's 2004 Annual Report on Form 10-K. Four
of the Company's more critical accounting policies are those related to the
allowance for credit losses, the valuation of derivatives and securities where
quoted market prices are not available, goodwill and other intangibles, and
pension accounting.
Allowance for Credit Losses
---------------------------
The allowance for credit losses represents management's estimate of
probable losses inherent in the Company's loan portfolio. This evaluation
process is subject to numerous estimates and judgments. Probabilities of
default ratings are assigned after analyzing the credit quality of each
borrower/counterparty and the Company's internal ratings are generally
consistent with external rating agencies' default databases. Loss given
default ratings are driven by the collateral, structure, and seniority of each
individual asset and are consistent with external loss given default/recovery
databases. The portion of the allowance related to impaired credits is based
on the present value of future cash flows. Changes in the estimates of
probability of default, risk ratings, loss given default/recovery rates, and
cash flows could have a direct impact on the allocated allowance for loan
losses.
To the extent actual results differ from forecasts or management's
judgment, the allowance for credit losses may be greater or less than future
charge-offs.
The Company considers it difficult to quantify the impact of changes in
forecast on its allowance for credit losses. Nevertheless, the Company believes
the following discussion may enable investors to better understand the
variables that drive the allowance for credit losses.
Another key variable in determining the allowance is management's judgment
in determining the size of the unallocated allowance. At September 30, 2005,
the unallocated allowance was 14% of the total allowance. If the unallocated
allowance were five percent higher or lower, the allowance would have increased
or decreased by $35 million, respectively.
The credit rating assigned to each pass credit is another significant
variable in determining the allowance. If each pass credit were rated one
grade better, the allowance would have decreased by $54 million, while if each
pass credit were rated one grade worse, the allowance would have increased by
$100 million.
24
For higher risk rated credits, if the loss given default were 10% worse,
the allowance would have increased by $6 million, while if the loss given
default were 10% better, the allowance would have decreased by $51 million.
For impaired credits, if the fair value of the loans were 10% higher or
lower, the allowance would have increased or decreased by $5 million,
respectively.
Valuation of Derivatives and Securities Where Quoted Market Prices Are Not
--------------------------------------------------------------------------
Available
---------
When quoted market prices are not available for derivatives and
securities values, such values are determined at fair value, which is defined
as the value at which positions could be closed out or sold in a transaction
with a willing counterparty over a period of time consistent with the
Company's trading or investment strategy. Fair value for these instruments is
determined based on discounted cash flow analysis, comparison to similar
instruments, and the use of financial models. Financial models use as their
basis independently sourced market parameters including, for example, interest
rate yield curves, option volatilities, and currency rates. Discounted cash
flow analysis is dependent upon estimated future cash flows and the level of
interest rates. Model-based pricing uses inputs of observable prices for
interest rates, foreign exchange rates, option volatilities and other factors.
Models are benchmarked and validated by independent parties. The Company's
valuation process takes into consideration factors such as counterparty credit
quality, liquidity and concentration concerns. The Company applies judgment
in the application of these factors. In addition, the Company must apply
judgment when no external parameters exist. Finally, other factors can affect
the Company's estimate of fair value including market dislocations, incorrect
model assumptions, and unexpected correlations.
These valuation methods could expose the Company to materially different
results should the models used or underlying assumptions be inaccurate. See
"Use of Estimates" in "Summary of Significant Accounting and Reporting
Policies" of the Notes to Consolidated Financial Statement in the Company's
2004 Annual Report on Form 10-K.
To assist in assessing the impact of a change in valuation, at September
30, 2005, approximately $2.6 billion of the Company's portfolio of securities
and derivatives is not priced based on quoted market prices because no such
quoted market prices are available. A change of 2.5% in the valuation of
these securities and derivatives would result in a change in pre-tax income of
$64 million.
Goodwill and Other Intangibles
------------------------------
The Company records all assets and liabilities acquired in purchase
acquisitions, including goodwill, indefinite-lived intangibles, and other
intangibles, at fair value as required by SFAS 141. Goodwill ($3,613 million
at September 30, 2005) and indefinite-lived intangible assets ($370 million at
September 30, 2005) are not amortized but are subject to annual tests for
impairment or more often if events or circumstances indicate they may be
impaired. Other intangible assets are amortized over their estimated useful
lives and are subject to impairment if events or circumstances indicate a
possible inability to realize the carrying amount. The initial recording of
goodwill and other intangibles requires subjective judgments concerning
estimates of the fair value of acquired assets. The goodwill impairment test
is performed in two phases. The first step of the goodwill impairment test
compares the fair value of the reporting unit with its carrying amount,
including goodwill. If the fair value of the reporting unit exceeds its
carrying amount, goodwill of the reporting unit is considered not impaired;
however, if the carrying amount of the reporting unit exceeds its fair value,
an additional procedure must be performed. That additional procedure compares
the implied fair value of the reporting unit's goodwill with the carrying
amount of that goodwill. An impairment loss is recorded to the extent that
the carrying amount of goodwill exceeds its implied fair value. Indefinite-
25
lived intangible assets are evaluated for impairment at least annually by
comparing their fair value to their carrying value.
Other identifiable intangible assets ($443 million at September 30, 2005)
are evaluated for impairment if events and circumstances indicate a possible
impairment. Such evaluation of other intangible assets is based on
undiscounted cash flow projections. Fair value may be determined using:
market prices, comparison to similar assets, market multiples, discounted cash
flow analysis and other determinates. Estimated cash flows may extend far
into the future and, by their nature, are difficult to determine over an
extended timeframe. Factors that may significantly affect the estimates
include, among others, competitive forces, customer behaviors and attrition,
changes in revenue growth trends, cost structures and technology, and changes
in discount rates and specific industry or market sector conditions. Other
key judgments in accounting for intangibles include useful life and
classification between goodwill and indefinite-lived intangibles or other
intangibles that require amortization. See Note "Goodwill and Intangibles" of
the Notes to Consolidated Financial Statements for additional information
regarding intangible assets.
The following discussion may assist investors in assessing the impact of
a goodwill or intangible asset impairment charge. The Company has $4.4
billion of goodwill and intangible assets at September 30, 2005. The impact
of a 5% impairment charge would result in a change of pre-tax income of
approximately $221 million.
Pension Accounting
------------------
The Company has defined benefit pension plans covering approximately
14,700 U.S. employees and approximately 2,400 non-U.S. employees at September
30, 2004.
The Company has three defined benefit pension plans in the U.S. and six
overseas. At December 31, 2004, the U.S. plans account for 86% of the
projected benefit obligation. Pension credits were $24 million, $39 million,
and $95 million in 2004, 2003 and 2002. In addition to its pension plans, the
Company also has an Employee Stock Ownership Plan ("ESOP") that may provide
additional benefits to certain employees. Upon retirement, covered employees
are entitled to the higher of their benefit under the ESOP or the defined
benefit plan. If the benefit is higher under the defined benefit plan, the
employees' ESOP account is contributed to the pension plan.
A number of key assumption and measurement date values determine pension
expense. The key elements include the long-term rate of return on plan
assets, the discount rate, the market-related value of plan assets, and for
the primary U.S. plan, the price used to value stock in the ESOP. Since 2002,
these key elements have varied as follows:
2005 2004 2003 2002
Domestic Plans: -------- -------- -------- --------
Long-Term Rate of Return
on Plan Assets 8.25% 8.75% 9.00% 10.50%
Discount Rate 6.00 6.25 6.50 7.25
Market-Related Value of
Plan Assets(1) (in millions) $ 1,502 $ 1,523 $ 1,483 $ 1,449
ESOP Stock Price(1) 30.67 27.88 33.30 42.58
(In millions)
Net U.S Pension Credit/(Expense) $ 31 $ 46 $ 100
All other Pension Credit/(Expense) (7) (7) (5)
-------- -------- --------
Total Pension Credit $ 24 $ 39 $ 95
======== ======== ========
------------
(1) Actuarially smoothed data. See "Critical Accounting Policies" in the MD&A
section of the Company's 2004 Annual Report on Form 10-K.
26
The discount rate for U.S. pension and postretirement plans is based on,
among other factors, a spread over the Lehman AA Long-Term Corporate Bond
Index Yield. At September 30, 2004 and 2003, the Lehman AA Long-Term
Corporate Bond Index Yields were 5.36% and 5.35%, and the discount rates were
6.00% and 6.25%, respectively. The discount rates for foreign pension plans
are based on high quality corporate bonds rates in countries that have an
active corporate bond market. In those countries with no active corporate
bond market, discount rates are based on local government bond rates plus a
credit spread.
The Company's expected long-term rate of return on plan assets is based
on anticipated returns for each asset class. For 2005 and 2004, the
assumptions for the long-term rates of return on plan assets were 8.25% and
8.75%, respectively. Anticipated returns are weighted for the target
allocation for each asset class. Anticipated returns are based on forecasts
for prospective returns in the equity and fixed income markets, which should
track the long-term historical returns for these markets. The Company also
considers the growth outlook for U.S. and global economies, as well as current
and prospective interest rates.
The market-related value of plan assets also influences the level of
pension expense. Differences between expected and actual returns are
recognized over five years to compute an actuarially derived market-related
value of plan assets.
Unrecognized actuarial gains and losses are amortized over the future
service period (11 years) of active employees if they exceed a threshold
amount. The Company currently has unrecognized losses which are being
amortized.
For the first nine months of 2005, pension expense increased by $36
million, in line with an anticipated $48 million increase for the year 2005.
This increase reflects changes in assumptions, the amortization of
unrecognized pension losses and a decline in the market-related value of plan
assets. These same factors are expected to further increase pension expense
in 2006. To reduce the impact of these factors, the Company changed certain
of its domestic defined benefit pension plans during the third quarter of
2005. The primary change was to switch the computation of benefits from final
average pay to career average pay effective January 1, 2006.
The annual impact on the primary U.S. plan of hypothetical changes in the
key elements on the pension credit are shown in the table below.
(Dollars in millions) Increase in Decrease in
Pension Expense 2005 Base Pension Expense
--------------- ------------- ---------------
Long-Term Rate of Return
on Plan Assets 7.25% 7.75% 8.25% 8.75% 9.25%
Change in Pension Expense $ 14.6 $ 7.3 $ - $ 7.3 $ 14.6
Discount Rate 5.50% 5.75% 6.00% 6.25% 6.50%
Change in Pension Expense $ 7.4 $ 3.7 $ - $ 3.6 $ 7.2
Market-Related Value of
Plan Assets -20.00% -10.00% $1,502 +10.00% +20.00%
Change in Pension Expense $ 58.2 $ 29.1 - $ 27.2 $ 39.6
ESOP Stock Price $20.67 $25.67 $30.67 $35.67 $40.67
Change in Pension Expense $ 14.6 $ 7.0 $ - $ 6.5 $ 12.6
27
CONSOLIDATED BALANCE SHEET REVIEW
Total assets were $101.8 billion at September 30, 2005, compared with
$94.5 billion at December 31, 2004 and $103.1 billion at June 30, 2005. The
September 30, 2005 balance sheet was slightly elevated due to some sizable
overdrafts from securities servicing customers. The increase in assets from
December 31, 2004 reflects increased loans to securities industry customers.
Total shareholders' equity was $9.6 billion at September 30, 2005, compared
with $9.3 billion at December 31, 2004 and $9.5 billion at June 30, 2005. In
comparison to December 31, 2004, shareholders' equity reflects the retention
of earnings and an increase in the securities valuation allowance.
Return on average common equity for the third quarter of 2005 was 16.15%,
compared with 15.90% in the third quarter of 2004 and 17.12% in the second
quarter of 2005. For the nine months of 2005, return on average common equity
was 16.59% compared with 16.73% in 2004.
Return on average assets for the third quarter of 2005 was 1.53%,
compared with 1.45% in the third quarter of 2004 and 1.59% in the second
quarter of 2005. For the nine months of 2005, return on average assets was
1.56% compared with 1.47% in 2004.
Investment Securities
---------------------
The table below shows the distribution of the Company's securities
portfolio:
Investment Securities (at Fair Value)
(In millions) 09/30/05 12/31/04
---------- ----------
Fixed Income:
Mortgage-Backed Securities $ 21,967 $ 19,393
Asset-Backed Securities 29 -
Corporate Debt 1,160 1,259
Short-Term Money Market Instruments 964 982
U.S. Treasury Securities 225 403
U.S. Government Agencies 620 505
State and Political Subdivisions 228 197
Emerging Market Debt (Collateralized
By U.S. Treasury Zero Coupon Obligations) 117 107
Other Foreign Debt 471 545
---------- ----------
Subtotal Fixed Income 25,781 23,391
Equity Securities:
Money Market Funds 394 388
Other 32 10
---------- ----------
Subtotal Equity Securities 426 398
---------- ----------
Total Securities $ 26,207 $ 23,789
========== ==========
Total investment securities were $26.2 billion at September 30, 2005,
compared with $25.8 billion at June 30, 2005. Average investment securities
were $25.6 billion in the third quarter of 2005, compared with $22.4 billion
in the third quarter of last year and $24.7 billion in the second quarter of
2005. The increases were primarily due to growth in the Company's portfolio
of highly rated mortgage-backed securities, which are 89% rated AAA, 7% AA,
and 4% A. The Company has been adding either adjustable or short life classes
of structured mortgage-backed securities, both of which have short durations.
The effective duration of the Company's mortgage portfolio at September 30,
2005 was approximately 1.7 years.
Net unrealized loss for securities available-for-sale was $59 million at
September 30, 2005, compared with net unrealized gains of $150 million at
28
September 30, 2004 and net unrealized gains of $60 million at June 30, 2005.
The change in the value of available-for-sale securities at September 30, 2005
from June 30, 2005 reflects the increase in long-term interest rates over the
quarter. The asymmetrical accounting treatment of the impact of a change in
interest rates on the Company's balance sheet may create a situation in which
an increase in interest rates can adversely affect reported equity and
regulatory capital, even though economically there may be no impact on the
economic capital position of the Company. For example, an increase in rates
will result in a decline in the value of the fixed rate portion of the
Company's fixed income investment portfolio, which will be reflected through a
reduction in other comprehensive income in the Company's shareholders' equity,
thereby affecting the tangible common equity ("TCE") ratio. Under current
accounting rules, there is no corresponding change in value of the Company's
fixed rate liabilities, even though economically these liabilities are more
valuable as rates rise.
Loans
-----
(Dollars in billions) Quarterly Year-to-date
Period End Average Average
-------------------------- -------------------------- -------------------------
Total Non-Margin Margin Total Non-Margin Margin Total Non-Margin Margin
----- ---------- ------- ----- ---------- ------ ----- ---------- ------
September 30, 2005 $42.1 $ 35.8 $ 6.3 $39.9 $ 33.5 $ 6.4 $39.3 $ 32.9 $ 6.4
December 31, 2004 35.8 29.7 6.1 39.4 33.0 6.4 37.8 31.5 6.3
September 30, 2004 37.1 31.2 5.9 37.6 31.3 6.3 37.2 30.9 6.3
Total loans were $42.1 billion at September 30, 2005 compared with $35.8
billion at December 31, 2004. The increase in total loans from December 31,
2004 primarily reflects an increase in overdrafts and securities industry
loans. The Company continues to focus on its strategy of reducing non-
strategic and outsized corporate loan exposures to improve its credit risk
profile. Average total loans were $39.9 billion in the third quarter of 2005,
compared with $37.6 billion in the third quarter of 2004 while for the nine
months ended September 30, 2005, average loans were $39.3 billion compared
with $37.2 billion for September 30, 2004. The increase in average loans from
September 30, 2004 results from increased lending to financial institutions.
The following tables provide additional details on the Company's credit
exposures and outstandings at September 30, 2005 in comparison to December 31,
2004.
Overall Loan Portfolio
----------------------
Unfunded Total Unfunded Total
(In billions) Loans Commitments Exposure Loans Commitments Exposure
---------------------------- ----------------------------
09/30/05 09/30/05 09/30/05 12/31/04 12/31/04 12/31/04
-------- -------- -------- -------- -------- --------
Financial Institutions $ 14.7 $ 22.7 $ 37.4 $ 9.5 $ 21.6 $ 31.1
Corporate 3.6 19.0 22.6 3.6 19.4 23.0
-------- -------- -------- -------- -------- --------
18.3 41.7 60.0 13.1 41.0 54.1
-------- -------- -------- -------- -------- --------
Consumer & Middle Market 9.8 4.6 14.4 8.9 4.5 13.4
Leasing Financings 5.7 0.1 5.8 5.6 - 5.6
Commercial Real Estate 2.0 1.3 3.3 2.1 1.2 3.3
Margin loans 6.3 - 6.3 6.1 - 6.1
-------- -------- -------- -------- -------- --------
Total $ 42.1 $ 47.7 $ 89.8 $ 35.8 $ 46.7 $ 82.5
======== ======== ======== ======== ======== ========
29
Financial Institutions
----------------------
The financial institutions portfolio exposure was $37.4 billion at
September 30, 2005 compared to $31.1 billion at December 31, 2004. The
increase in exposure from year-end 2004 reflects greater activity in the
capital markets at September 30, 2005, which drove higher levels of customer
borrowing, compared with December 31, 2004. These exposures are of high
quality with 81% meeting the investment grade criteria of the Company's rating
system. These exposures are generally short-term, with 77% expiring within
one year and are frequently secured. For example, mortgage banking,
securities industry, and investment managers often borrow against marketable
securities held in custody at the Company. The diversity of the portfolio is
shown in the accompanying table.
(In billions)
September 30, 2005 December 31, 2004
--------------------------- ----- ----- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Banks $ 5.7 $ 4.0 $ 9.7 66% 91% $ 4.2 $ 3.5 $ 7.7
Securities Industry 3.7 3.5 7.2 80 96 1.5 3.0 4.5
Insurance 0.5 5.1 5.6 93 43 0.5 4.8 5.3
Government 0.1 4.5 4.6 98 58 - 5.0 5.0
Asset Managers 4.4 3.9 8.3 82 84 3.0 3.8 6.8
Mortgage Banks 0.2 0.6 0.8 69 54 0.2 0.7 0.9
Endowments 0.1 1.1 1.2 99 48 0.1 0.8 0.9
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $14.7 $ 22.7 $ 37.4 81% 77% $ 9.5 $ 21.6 $ 31.1
===== =========== ========= ===== ===== ===== =========== =========
Corporate
---------
The corporate portfolio exposure declined to $22.6 billion at September
30, 2005 from $23.0 billion at year-end 2004. Approximately 74% of the
portfolio is investment grade while 18% of the portfolio matures within one
year.
(In billions)
September 30, 2005 December 31, 2004
--------------------------- ----- ----- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Media $ 1.1 $ 2.1 $ 3.2 61% 12% $ 0.9 $ 2.2 $ 3.1
Cable 0.4 0.3 0.7 29 20 0.6 0.4 1.0
Telecom 0.1 0.4 0.5 79 3 0.1 0.5 0.6
----- ----------- --------- ----- ----- ----- ----------- ---------
Subtotal 1.6 2.8 4.4 57% 12% 1.6 3.1 4.7
Energy 0.4 4.6 5.0 85 8 0.4 4.4 4.8
Retailing 0.1 2.1 2.2 75 28 0.1 2.1 2.2
Automotive* 0.1 1.2 1.3 57 40 0.1 1.7 1.8
Healthcare 0.2 1.7 1.9 84 17 0.3 1.5 1.8
Other** 1.2 6.6 7.8 78 22 1.1 6.6 7.7
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $ 3.6 $ 19.0 $ 22.6 74% 18% $ 3.6 $ 19.4 $ 23.0
===== =========== ========= ===== ===== ===== =========== =========
* During the third quarter of 2005, the Company eliminated the Automotive division and
transferred the customers to the other geographic lending divisions. The amounts in the
table were reconstructed for comparison to year-end.
** Diversified portfolio of industries and geographies
The Company's exposure to the airline industry consists of a $473 million
leasing portfolio (including a $16 million real estate lease exposure). The
airline-leasing portfolio consists of $250 million to major U.S. carriers,
$134 million to foreign airlines and $89 million to U.S. regionals.
During the third quarter of 2005, the airline industry continued to face
liquidity issues driven by persistently high fuel prices and the inability to
implement meaningful fare increases. The industry's considerable excess
30
capacity and higher oil prices continue to negatively impact the valuations of
aircraft, especially the less fuel-efficient models, in the secondary market.
Because of these factors, the Company continues to maintain a sizable
allowance for loan losses against these exposures and to closely monitor the
portfolio. At September 30, 2005, two of the Company's airline customers with
aggregate exposure of $150 million had filed for bankruptcy. These exposures
are 94% reserved. The Company expects these airlines to make decisions during
the fourth quarter to affirm or disaffirm these leases. These decisions will
drive the Company's level of charge-offs in the fourth quarter.
Counterparty Risk Ratings Profile
---------------------------------
The table below summarizes the risk ratings of the Company's foreign
exchange and interest rate derivative counterparty credit exposure for the
past year.
For the Quarter Ended
--------------------------------------------------
Rating(1) 9/30/05 6/30/05 3/31/05 12/31/04 9/30/04
--------------------- --------------------------------------------------
AAA to AA- 71% 68% 74% 68% 68%
A+ to A- 13 15 13 19 21
BBB+ to BBB- 13 14 10 10 8
Noninvestment Grade 3 3 3 3 3
-------- --------- ---------- --------- ----------
Total 100% 100% 100% 100% 100%
======== ========= ========== ========= ==========
(1) Represents credit rating agency equivalent of internal credit ratings.
Nonperforming Assets
--------------------
Change Percent
9/30/05 vs. Inc/
(Dollars in millions) 9/30/05 6/30/05 6/30/05 (Dec)
--------- --------- ----------- --------
Loans:
Commercial $ 35 $ 78 $ (43) (55)%
Foreign 15 15 (-) -
Other 57 47 10 21
--------- --------- -----------
Total Nonperforming Loans 107 140 (33) (24)
Other Real Estate - - - -
--------- --------- -----------
Total Nonperforming Assets $ 107 $ 140 $ (33) (24)
========= ========= ===========
Nonperforming Assets Ratio 0.3% 0.4%
Allowance for Loan
Losses/Nonperforming Loans 524.9 400.5
Allowance for Loan
Losses/Nonperforming Assets 524.9 400.5
Total Allowance for Credit
Losses/Nonperforming Loans 661.2 506.1
Total Allowance for Credit
Losses/Nonperforming Assets 661.2 506.1
Nonperforming assets declined by $33 million, or 24%, during the third
quarter of 2005 to $107 million and are down 63% from a year ago. The
sequential quarter decrease in nonperforming loans primarily reflects the
Company's partial sale of exposure to a cable operator that is categorized
as nonperforming. The decrease from the third quarter of 2004 primarily
reflects loan sales, paydowns, and charge-offs of commercial loans. The
ratio of the total allowance for credit losses to nonperforming assets
increased to 661.2% at September 30, 2005, compared with 263.3% at
September 30, 2004 and 506.1% at June 30, 2005.
31
Activity in Nonperforming Assets
(In millions) Quarter End Year-to-date
September 30, 2005 September 30, 2005
------------------ ------------------
Balance at Beginning of Period $ 140 $ 214
Additions 18 24
Charge-offs (6) (18)
Paydowns/Sales (45) (113)
------------------ ------------------
Balance at End of Period $ 107 $ 107
================== ==================
Interest income would have been increased by $1 million for each of the
third quarters of 2005 and 2004 if loans on nonaccrual status at September 30,
2005 and 2004 had been performing for the entire period. On a year-to-date
basis, interest income would have increased by $3 million and $8 million for
2005 and 2004 had loans on nonaccrual status at September 30, 2005 and 2004
been performing for the entire period.
Impaired Loans
--------------
The table below sets forth information about the Company's impaired
loans. The Company uses the discounted cash flow, collateral value, or market
price methods for valuing its impaired loans:
September 30, June 30, September 30,
(In millions) 2005 2005 2004
------------ -------- -------------
Impaired Loans with an Allowance $ 48 $ 55 $ 160
Impaired Loans without an Allowance(1) 22 64 108
------------ -------- -------------
Total Impaired Loans $ 70 $ 119 $ 268
============ ======== =============
Allowance for Impaired Loans(2) $ 20 $ 30 $ 57
Average Balance of Impaired Loans
during the Quarter $ 120 $ 145 $ 293
Interest Income Recognized on
Impaired Loans during the Quarter $ 1.2 $ 1.6 $ 2.4
(1) When the discounted cash flows, collateral value or market price equals
or exceeds the carrying value of the loan, then the loan does not require
an allowance under the accounting standard related to impaired loans.
(2) The allowance for impaired loans is included in the Company's allowance
for credit losses.
32
Allowance
---------
September 30, June 30, September 30,
(Dollars in millions) 2005 2005 2004
------------ --------- ------------
Margin Loans $ 6,320 $ 6,055 $ 5,911
Non-Margin Loans 35,823 34,626 31,208
------------ --------- ----------
Total Loans $ 42,143 $ 40,681 $ 37,119
============ ========= ==========
Allowance for Loan Losses $ 561 $ 562 $ 598
Allowance for Lending-Related
Commitments 146 148 158
------------ --------- ----------
Total Allowance for Credit Losses $ 707 $ 710 $ 756
============ ========= ==========
Allowance for Loan Losses As a
Percent of Total Loans 1.33% 1.38% 1.61%
Allowance for Loan Losses As a
Percent of Non-Margin Loans 1.57 1.62 1.92
Total Allowance for Credit Losses
As a Percent of Total Loans 1.68 1.75 2.04
Total Allowance for Credit Losses
As a Percent of Non-Margin Loans 1.97 2.05 2.42
The total allowance for credit losses was $707 million, or 1.68% of total
loans at September 30, 2005, compared with $756 million, or 2.04% of total
loans at September 30, 2004 and $710 million, or 1.75% of total loans at June
30, 2005.
The Company has $6.3 billion of secured margin loans on its balance sheet
at September 30, 2005. The Company has rarely suffered a loss on these types
of loans and doesn't allocate any of its allowance for credit losses to these
loans. As a result, the Company believes the ratio of total allowance for
credit losses to non-margin loans is a more appropriate metric to measure the
adequacy of the reserve.
The ratio of the total allowance for credit losses to non-margin loans
decreased to 1.97% at September 30, 2005, compared with 2.42% at September 30,
2004, and 2.05% at June 30, 2005, reflecting continued improvement in the
credit quality in the third quarter of 2005.
The ratio of the allowance for loan losses to nonperforming assets was
524.9% at September 30, 2005, up from 208.1% at September 30, 2004, and 400.5%
at June 30, 2005.
The allowance for loan losses and the allowance for lending related
commitments consists of four elements: (1) an allowance for impaired credits
(nonaccrual commercial credits over $1 million), (2) an allowance for higher
risk rated credits, (3) an allowance for pass rated credits, and (4) an
unallocated allowance based on general economic conditions and risk factors in
the Company's individual markets.
The first element, impaired credits, is based on individual analysis of
all nonperforming commercial credits over $1 million. The allowance is
measured by the difference between the recorded value of impaired loans and
their fair value. Fair value is either the present value of the expected
future cash flows from borrower, the market value of the loan, or the fair
value of the collateral.
The second element, higher risk rated credits, is based on the assignment
of loss factors for each specific risk category of higher risk credits. The
Company rates each credit in its portfolio that exceeds $1 million and assigns
the credits to specific risk pools. A potential loss factor is assigned to
each pool, and an amount is included in the allowance equal to the product of
the amount of the loan in the pool and the risk factor. Reviews of higher
33
risk rated loans are conducted quarterly and the loan's rating is updated as
necessary. The Company prepares a loss migration analysis and compares its
actual loss experience to the loss factors on an annual basis to attempt to
ensure the accuracy of the loss factors assigned to each pool. Pools of past
due consumer loans are included in specific risk categories based on their
length of time past due.
The third element, pass rated credits, is based on the Company's expected
loss model. Borrowers are assigned to pools based on their credit ratings.
The expected loss for each loan in a pool incorporates the borrower's credit
rating, loss given default rating and maturity. The credit rating is
dependent upon the borrower's probability of default. The loss given default
incorporates a recovery expectation. Borrower and loss given default ratings
are reviewed semi-annually at a minimum and are periodically mapped to third
party, including rating agency, default and recovery data bases to ensure
ongoing consistency and validity. Commercial loans over $1 million are
individually analyzed before being assigned a credit rating. The Company also
applies this technique to its leasing and consumer portfolios. All current
consumer loans are included in the pass rated consumer pools.
The fourth element, the unallocated allowance, is based on management's
judgment regarding the following factors:
* Economic conditions including duration of the current cycle;
* Past experience including recent loss experience;
* Credit quality trends;
* Collateral values;
* Volume, composition, and growth of the loan portfolio;
* Specific credits and industry conditions;
* Results of bank regulatory and internal credit exams;
* Actions by the Federal Reserve Board;
* Delay in receipt of information to evaluate loans or confirm existing
credit deterioration; and
* Geopolitical issues and their impact on the economy.
Based on an evaluation of these four elements, including individual
credits, historical credit losses, and global economic factors, the Company
has allocated its allowance for credit losses as follows:
September 30, December 31,
2005 2004
------------ -----------
Domestic
Real Estate 2% 2%
Commercial 75 75
Consumer 7 3
Foreign 2 4
Unallocated 14 16
------------ -----------
100% 100%
============ ===========
Such an allocation is inherently judgmental, and the entire allowance for
credit losses is available to absorb credit losses regardless of the nature of
the loss.
34
Deposits
--------
Total deposits were $61.1 billion at September 30, 2005, compared with
$58.4 billion at September 30, 2004 and $64.0 billion at June 30, 2005. The
decrease on a sequential quarter basis was primarily due to lower market
activity levels, which resulted in a reduced level of customer deposits at
quarter end. Noninterest-bearing deposits were $16.3 billion at September 30,
2005, compared with $17.4 billion at December 31, 2004. Interest-bearing
deposits were $44.8 billion at September 30, 2005, compared with $41.3 billion
at December 31, 2004.
LIQUIDITY
The Company maintains its liquidity through the management of its assets
and liabilities, utilizing worldwide financial markets. The diversification of
liabilities reflects the Company's efforts to maintain flexibility of funding
sources under changing market conditions. Stable core deposits, including
demand, retail time, and trust deposits from processing businesses, are
generated through the Company's diversified network and managed with the use
of trend studies and deposit pricing. The use of derivative products such as
interest rate swaps and financial futures enhances liquidity by enabling the
Company to issue long-term liabilities with limited exposure to interest rate
risk. Liquidity also results from the maintenance of a portfolio of assets
which can be easily sold and the monitoring of unfunded loan commitments,
thereby reducing unanticipated funding requirements. Liquidity is managed on
both a consolidated basis and at The Bank of New York Company, Inc. parent
company ("Parent").
On a consolidated basis, non-core sources of funds such as money market
rate accounts, certificates of deposits greater than $100,000, federal funds
purchased, and other borrowings were $13.1 billion and $14.5 billion on an
average basis for the nine months of 2005 and 2004. Average foreign deposits,
primarily from the Company's European based securities servicing business,
were $25.9 billion at both September 30, 2005 and 2004. Domestic savings and
other time deposits were $9.9 billion on a year-to-date average basis at
September 30, 2005 compared to $10.2 billion at September 30, 2004. Average
payables to customers and broker-dealers decreased to $6.0 billion from $6.5
billion. On a year-to-date basis, long-term debt averaged $7.2 billion and
$6.1 billion at September 30, 2005 and 2004. A significant reduction in the
Company's securities servicing businesses would reduce its access to foreign
deposits.
The Parent has four major sources of liquidity: dividends from its
subsidiaries, the commercial paper market, a revolving credit agreement with
third party financial institutions, and access to the capital markets.
At September 30 2005, the Bank can pay dividends of approximately $744
million to the Parent without the need for regulatory waiver. This dividend
capacity would increase in the remainder of 2005 to the extent of the Bank's
net income less dividends. Nonbank subsidiaries of the Parent have liquid
assets of approximately $264 million. These assets could be liquidated and
the proceeds delivered by dividend or loan to the Parent.
For the quarter ended September 30, 2005, the Parent's quarterly average
commercial paper borrowings were $231 million compared with $67 million in
2004. At September 30, 2005, the Parent had cash of $409 million compared
with cash of $777 million at September 30, 2004 and $858 million at June 30,
2005. Net of commercial paper outstanding, the Parent's cash position at
September 30, 2005 was down $475 million compared with September 30, 2004
reflecting the Parent's purchase of Pershing from the Bank in the first
quarter of 2005.
The Parent has a back-up line of credit of $275 million with 14 financial
institutions. This line of credit matures in October 2006. There were no
borrowings under the line of credit at September 30, 2005 and September 30,
2004.
35
The Parent also has the ability to access the capital markets. At
September 30, 2005, the Parent had a shelf registration statement with a
capacity of $1.7 billion of debt, preferred stock, preferred trust securities,
or common stock. Access to the capital markets is partially dependent on the
Company's credit ratings, which as of September 30, 2005 were as follows:
The Bank of
Parent Parent Parent Senior New York
Commercial Subordinated Long-Term Long-Term
Paper Long-Term Debt Debt Deposits Outlook
---------- -------------- ------------- ----------- -------
Standard &
Poor's A-1 A A+ AA- Stable
Moody's P-1 A1 Aa3 Aa2 Stable
Fitch F1+ A+ AA- AA Stable
The Parent's major uses of funds are payment of principal and interest on
its borrowings, acquisitions, and additional investment in its subsidiaries.
The Parent has $100 million of long-term debt that becomes due in 2005
subsequent to September 30, 2005 and $225 million of long-term debt that is
due in 2006. In addition, at September 30, 2005, the Parent has the option to
call $230 million of subordinated debt in 2006, which it will call and
refinance if market conditions are favorable. The Parent expects to refinance
any debt it repays by issuing a combination of senior and subordinated debt.
The Company has $200 million of preferred trust securities that are
callable in 2005. These securities qualify as Tier 1 Capital. The Company has
not yet decided if it will call these securities. The decision to call will be
based on interest rates, the availability of cash and capital, and regulatory
conditions. If the Company calls the preferred trust securities, it expects
to replace them with new preferred trust securities or senior or subordinated
debt.
Double leverage is the ratio of investment in subsidiaries divided by the
Company's consolidated equity plus trust preferred securities. The Company's
double leverage ratio at September 30, 2005 and 2004 was 103.82% and 98.44%,
respectively. The Company's target double leverage ratio is a maximum of 120%.
The double leverage ratio is monitored by regulators and rating agencies and
is an important constraint on the Company's ability to invest in its
subsidiaries to expand its businesses.
Pershing LLC, an indirect subsidiary of the Company, has committed and
uncommitted lines of credit in place for liquidity purposes. The committed
line of credit of $500 million with five financial institutions matures in
March 2006. There were no borrowings against this line of credit during the
third quarter of 2005. Pershing LLC has three separate uncommitted lines of
credit amounting to $1 billion in aggregate. Average daily borrowing under
these lines was $14 million, in aggregate, during the third quarter of 2005.
Pershing Limited, an indirect subsidiary of the Company, has committed
and uncommitted lines in place for liquidity purposes. The committed lines of
credit of $275 million with four financial institutions matures in April 2006.
There were no borrowings against this line of credit during the third quarter
of 2005. Pershing Limited has three separate uncommitted lines of credit
amounting to $300 million in aggregate. Average daily borrowing under these
lines was $217 million, in aggregate, during the third quarter of 2005.
The following comments relate to the information disclosed in the
Consolidated Statements of Cash Flows.
Cash used for other operating activities was $0.2 billion for the nine
months of 2005, compared with $3.4 billion provided by operating activities
through September 30, 2004. The use of funds from operations in 2005 was
principally the result of changes in trading activities. The sources of cash
36
flows from operations in 2004 were principally the result of changes in
trading and net income.
In the nine months of 2005, cash used for investing activities was $7.0
billion as compared to cash used for investing activities in the nine months
of 2004 of $3.5 billion. In the nine months of 2005, purchases of securities
available-for-sale and principal disbursed on loans to customers were a
significant use of funds. Purchases of securities available-for-sale and
change in interest-bearing deposits were the primary use of funds in 2004.
Through September 30, 2005, cash provided by financing activities was
$6.5 billion, compared to cash used of $0.5 billion in the nine months of
2004. Sources of funds in 2005 include deposits and the issuance of long-term
debt. Deposits, other borrowed funds and the issuance of long-term debt and
common stock were the primary source of funds in 2004.
CAPITAL RESOURCES
Regulators establish certain levels of capital for bank holding companies
and banks, including the Company and the Bank, in accordance with established
quantitative measurements. In order for the Parent to maintain its status as a
financial holding company, the Bank must qualify as well capitalized. In
addition, major bank holding companies such as the Parent are expected by the
regulators to be well capitalized. As of September 30, 2005 and 2004, the
Company and the Bank were considered well capitalized on the basis of the
ratios (defined by regulation) of Total and Tier 1 capital to risk-weighted
assets and leverage (Tier 1 capital to average assets), which are shown as
follows:
September 30, 2005 September 30, 2004 Well Adequately
------------------ ------------------ Company Capitalized Capitalized
Company Bank Company Bank Targets Guidelines Guidelines
--------- ------- --------- ------- ---------- ----------- -----------
Tier 1* 7.93% 8.37% 8.09% 7.59% 7.75% 6% 4%
Total Capital** 12.20 11.52 12.09 11.69 11.75 10 8
Leverage 6.59 7.01 6.38 5.98 5 3-5
Tangible Common
Equity ("TCE") 5.32 6.29 5.49 5.79 5.25+ N.A. N.A.
* Tier 1 capital consists, generally, of common equity, preferred trust securities, and
certain qualifying preferred stock, less goodwill and most other intangibles.
**Total Capital consists of Tier 1 capital plus Tier 2 capital. Tier 2 capital consists,
generally, of certain qualifying preferred stock and subordinated debt and a portion of the
loan loss allowance.
During the third quarter of 2005 the Company retained $228 million of
earnings. Also in the quarter, the Company issued $55 million subordinated
debt qualifying as Tier II capital. During the third quarter of 2005, the
Company bought back 2.2 million shares.
The Company's regulatory Tier 1 capital and Total capital ratios were
7.93% and 12.20% at September 30, 2005, compared with 8.09% and 12.09% at
September 30, 2004, and 8.07% and 12.49% at June 30, 2005. The regulatory
leverage ratio was 6.59% at September 30, 2005, compared with 6.38% at
September 30, 2004 and 6.55% at June 30, 2005. The Company's tangible common
equity as a percentage of total assets was 5.32% at September 30, 2005,
compared with 5.49% at September 30, 2004 and 5.26% at June 30, 2005. The
tangible common equity ratio varies depending on the size of the balance sheet
at quarter-end and the impact of interest rates on unrealized gains and losses
among other things. The balance sheet size fluctuates from quarter to quarter
based on levels of market activity. In general, when servicing clients are
more actively trading securities, deposit balances, and the balance sheet as a
whole, are higher to finance these activities.
37
A billion dollar change in assets changes the TCE ratio by 5 basis points
while a $100 million change in common equity changes the TCE ratio by 10 basis
points.
On March 1, 2005, the Board of Governors of the Federal Reserve System
(the "FRB") adopted a final rule that allows the continued limited inclusion
of trust preferred securities in the Tier 1 capital of bank holding companies
(BHCs). See "Accounting Changes and New Accounting Pronouncements" in the
Notes to the Consolidated Financial Statements.
The following table presents the components of the Company's risk-based
capital at September 30, 2005 and 2004:
(In millions) 2005 2004
------- -------
Common Stock $ 9,631 $ 9,054
Preferred Stock - -
Preferred Trust Securities 1,150 1,150
Adjustments: Intangibles (4,421) (4,165)
Securities Valuation Allowance - (93)
Merchant Banking Investments (8) (6)
------- -------
Tier 1 Capital 6,352 5,940
------- -------
Qualifying Unrealized Equity Security Gains - -
Qualifying Subordinated Debt 2,709 2,193
Qualifying Allowance for Loan Losses 706 749
------- -------
Tier 2 Capital 3,415 2,942
------- -------
Total Risk-Based Capital $ 9,767 $ 8,882
======= =======
Risk-Adjusted Assets $80,065 $73,447
======= =======
38
TRADING ACTIVITIES
The fair value and notional amounts of the Company's financial
instruments held for trading purposes at September 30, 2005 and 2004 are as
follows:
September 30, 2005 2005 Average
--------------------------- ------------------
(In millions) Notional Fair Value Fair Value
------------------ ------------------
Trading Account Amount Assets Liabilities Assets Liabilities
--------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 29,868 $ - $ - $ - $ 9
Swaps 252,347 1,690 1,059 1,577 870
Written Options 203,688 - 1,201 - 1,222
Purchased Options 158,130 211 - 160 -
Foreign Exchange Contracts:
Swaps 3,087 - - - -
Written Options 5,316 - - - 2
Purchased Options 7,096 28 - 44 -
Commitments to Purchase
and Sell Foreign Exchange 79,491 522 471 422 398
Debt Securities - 3,642 124 3,359 104
Credit Derivatives 1,807 1 5 1 7
Equities 2,999 198 140 159 115
------ ----------- ------ -----------
Total Trading Account $6,292 $ 3,000 $5,722 $ 2,727
====== =========== ====== ===========
September 30, 2004 2004 Average
--------------------------- ------------------
Notional Fair Value Fair Value
------------------ ------------------
Trading Account Amount Assets Liabilities Assets Liabilities
--------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 38,572 $ 26 $ - $ 35 $ -
Swaps 222,255 1,717 725 1,655 744
Written Options 160,255 - 1,324 - 1,244
Purchased Options 112,129 186 - 210 -
Foreign Exchange Contracts:
Swaps 2,937 - - - -
Written Options 6,333 - - - 9
Purchased Options 9,356 39 - 50 -
Commitments to Purchase
and Sell Foreign Exchange 69,985 502 503 374 396
Debt Securities - 1,332 102 1,581 106
Credit Derivatives 1,497 2 5 2 7
Equities 1,958 217 196 119 83
------ ----------- ------ -----------
Total Trading Account $4,021 $ 2,855 $4,026 $ 2,589
====== =========== ====== ===========
The Company's trading activities are focused on acting as a market maker
for the Company's customers. The risk from these market making activities and
from the Company's own positions is managed by the Company's traders and
limited in total exposure as described below.
The Company manages trading risk through a system of position limits, a
value at risk (VAR) methodology-based on a Monte Carlo simulation, stop loss
advisory triggers, and other market sensitivity measures. Risk is monitored
and reported to senior management by an independent unit on a daily basis.
Based on certain assumptions, the VAR methodology is designed to capture the
potential overnight pre-tax dollar loss from adverse changes in fair values of
all trading positions. The calculation assumes a one-day holding period for
most instruments, utilizes a 99% confidence level, and incorporates the non-
linear characteristics of options. The VAR model is used to calculate
economic capital, which is allocated to the business units for computing risk-
adjusted performance.
39
As VAR methodology does not evaluate risk attributable to extraordinary
financial, economic or other occurrences, the risk assessment process includes
a number of stress scenarios based upon the risk factors in the portfolio and
management's assessment of market conditions. Additional stress scenarios
based upon historic market events are also tested. Stress tests by their
design incorporate the impact of reduced liquidity and the breakdown of
observed correlations. The results of these stress tests are reviewed weekly
with senior management.
The following table indicates the calculated VAR amounts for the trading
portfolio for the periods indicated.
(Dollars in millions) 3rd Quarter 2005 Year-to-date 2005
--------------------------- -------------------------------------
Average Minimum Maximum Average Minimum Maximum 9/30/05
------- ------- ------- ------- ------- ------- -------
Interest Rate $ 2.7 $ 1.8 $ 4.4 $ 2.8 $ 1.8 $ 4.6 $ 3.7
Foreign Exchange 1.1 0.4 2.9 1.6 0.4 4.1 0.8
Equity 0.5 0.3 0.8 0.6 0.3 1.1 0.7
Credit Derivatives 1.2 0.9 1.8 1.6 0.9 2.1 1.0
Diversification (1.0) NM NM (1.3) NM NM (1.2)
Overall Portfolio 4.5 3.2 7.0 5.3 3.2 9.1 5.0
3rd Quarter 2004 Year-to-date 2004
--------------------------- -------------------------------------
Average Minimum Maximum Average Minimum Maximum 9/30/04
------- ------- ------- ------- ------- ------- -------
Interest Rate $ 2.8 $ 2.1 $ 4.2 $ 4.1 $ 2.1 $ 7.8 $ 2.9
Foreign Exchange 0.9 0.5 1.6 1.0 0.4 3.1 1.4
Equity 0.8 0.6 1.6 1.2 0.6 2.4 1.3
Credit Derivatives 1.5 1.3 1.6 1.8 1.3 2.1 1.5
Diversification (1.4) NM NM (1.4) NM NM (2.2)
Overall Portfolio 4.6 3.6 6.2 6.7 3.6 12.8 4.9
NM - Because the minimum and maximum may occur on different days for different
risk components, it is not meaningful to compute a portfolio
diversification effect.
During the nine months of 2005, interest rate risk generated
approximately 42% of average VAR, credit derivatives generated 24% of average
VAR, foreign exchange accounted for 25% of average VAR, and equity generated
9% of average VAR. During the third quarter and nine months of 2005, the
Company's daily trading loss did not exceed the Company's calculated VAR
amounts on any given day.
The following table of total daily revenue or loss captures trading
volatility and shows the number of days on which the Company's trading
revenues fell within particular ranges during the past year.
Distribution of Revenues
------------------------
For the Quarter Ended
--------------------------------------------------
Revenue Range 9/30/05 6/30/05 3/31/05 12/31/04 9/30/04
--------------------------------------------------
(Dollars in millions) Number of Occurrences
---------------------- --------- --------- --------- ---------- ---------
Less than $(2.5) 0 0 0 0 0
$(2.5)~ $ 0 3 6 1 6 11
$ 0 ~ $ 2.5 51 40 50 49 48
$ 2.5 ~ $ 5.0 8 16 11 8 5
More than $5.0 2 2 0 0 0
40
ASSET/LIABILITY MANAGEMENT
The Company's asset/liability management activities include lending,
investing in securities, accepting deposits, raising money as needed to fund
assets, and processing securities and other transactions. The market risks
that arise from these activities are interest rate risk, and to a lesser
degree, foreign exchange risk. The Company's primary market risk is exposure
to movements in U.S. dollar interest rates. Exposure to movements in foreign
currency interest rates also exists, but to a significantly lower degree. The
Company actively manages interest rate sensitivity. In addition to gap
analysis, the Company uses earnings simulation and discounted cash flow models
to identify interest rate exposures.
An earnings simulation model is the primary tool used to assess changes
in pre-tax net interest income. The model incorporates management's
assumptions regarding interest rates, balance changes on core deposits, and
changes in the prepayment behavior of loans and securities and the impact of
derivative financial instruments used for interest rate risk management.
These assumptions have been developed through a combination of historical
analysis and future expected pricing behavior. These assumptions are
inherently uncertain, and, as a result, the earnings simulation model may not
precisely estimate net interest income or the impact of higher or lower
interest rates on net interest income. Actual results may differ from
projected results due to timing, magnitude and frequency of interest rate
changes and changes in market conditions and management's strategies, among
other factors.
The Company evaluates the effect on earnings by running various interest
rate ramp scenarios up and down from a baseline scenario, which assumes no
changes in interest rates. These scenarios are reviewed to examine the impact
of large interest rate movements. Interest rate sensitivity is quantified by
calculating the change in pre-tax net interest income between the scenarios
over a 12-month measurement period. The measurement of interest rate
sensitivity is the percentage change in net interest income as shown in the
following table:
(Dollars in millions) September 30, 2005 June 30, 2005
$ % $ %
--------- -------- ---------- ------
+200 bp Ramp vs. Stable Rate $ (26) (1.25)% $ (15) (0.74)%
+100 bp Ramp vs. Stable Rate (6) (0.27) 4 0.20
-100 bp Ramp vs. Stable Rate (3) (0.16) (17) (0.84)
The base case scenario Fed Funds rate in the September 30, 2005 analysis
was 3.75% versus 3.25% for the June 30, 2005 analysis. The 100+ basis point
ramp scenario assumes short-term rates rise 25 basis points in each of the
next four quarters, while the 200+ ramp scenario assumes a 50 basis point per
quarter increase. The 100+ basis point September 30, 2005 scenario assumes a
steepening of the yield curve with 10-year rates rising 106 basis points.
The 200+ basis point September 30, 2005 scenario assumes a slight steepening
of the yield curve with 10-year rates rising 205 basis points. These
scenarios do not reflect strategies that management could employ to limit the
impact as interest rate expectations change.
The above table relies on certain critical assumptions including
depositors' behavior related to interest rate fluctuations and the prepayment
and extension risk in certain of the Company's assets. To the extent that
actual behavior is different from that assumed in the models, there could be a
change in interest rate sensitivity.
41
STATISTICAL INFORMATION
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the three months For the three months
ended September 30, 2005 ended September 30, 2004
---------------------------- ----------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
-------- -------- ------- -------- -------- -------
ASSETS
------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 8,629 $ 68 3.13% $ 11,416 $ 77 2.69%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 4,465 38 3.37 6,443 20 1.22
Margin Loans 6,392 71 4.40 6,315 40 2.50
Loans
Domestic Offices 22,955 271 4.69 21,333 218 4.06
Foreign Offices 10,561 121 4.53 9,939 72 2.89
--------- -------- --------- --------
Non-Margin Loans 33,516 392 4.64 31,272 290 3.69
--------- -------- --------- --------
Securities
U.S. Government Obligations 228 2 3.55 450 3 2.64
U.S. Government Agency Obligations 3,956 41 4.19 3,560 30 3.37
Obligations of States and
Political Subdivisions 231 4 6.59 227 4 8.29
Other Securities 21,227 224 4.23 18,137 162 3.57
Trading Securities 3,361 38 4.49 1,587 11 2.81
--------- -------- --------- --------
Total Securities 29,003 309 4.27 23,961 210 3.52
--------- -------- --------- --------
Total Interest-Earning Assets 82,005 878 4.25% 79,407 637 3.19%
-------- --------- --------
Allowance for Credit Losses (562) (592)
Cash and Due from Banks 2,974 3,027
Other Assets 16,493 15,513
--------- ---------
TOTAL ASSETS $ 100,910 $ 97,355
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 6,827 $ 30 1.74% $ 6,474 $ 13 0.83%
Savings 8,637 27 1.23 9,296 16 0.70
Certificates of Deposit
$100,000 & Over 3,137 28 3.56 3,640 14 1.56
Other Time Deposits 1,529 11 2.84 934 4 1.61
Foreign Offices 25,887 152 2.33 25,227 92 1.44
--------- -------- --------- --------
Total Interest-Bearing Deposits 46,017 248 2.14 45,571 139 1.22
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,245 9 2.96 1,572 4 1.12
Other Borrowed Funds 1,716 13 3.10 2,416 9 1.51
Payables to Customers and Broker-Dealers 5,714 35 2.41 5,785 14 0.95
Long-Term Debt 7,568 73 3.81 6,083 35 2.26
--------- -------- --------- --------
Total Interest-Bearing Liabilities 62,260 378 2.41% 61,427 201 1.31%
-------- --------- --------
Noninterest-Bearing Deposits 15,815 14,576
Other Liabilities 13,271 12,489
Common Shareholders' Equity 9,564 8,863
--------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 100,910 $ 97,355
========= =========
Net Interest Earnings
and Interest Rate Spread $ 500 1.84% $ 436 1.88%
======== ======= ======== =======
Net Yield on Interest-Earning Assets 2.42% 2.18%
======= =======
42
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the nine months For the nine months
ended September 30, 2005 ended September 30, 2004
-------------------------- --------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- -------
ASSETS
------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 9,207 $ 206 2.99% $11,960 $ 224 2.50%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 4,813 102 2.82 6,964 53 1.02
Margin Loans 6,380 188 3.94 6,330 108 2.29
Loans
Domestic Offices 22,606 760 4.50 21,547 483 2.99
Foreign Offices 10,336 322 4.17 9,364 197 2.81
-------- -------- ------- --------
Non-Margin Loans 32,942 1,082 4.39 30,911 680 2.94
-------- -------- ------- --------
Securities
U.S. Government Obligations 289 7 3.23 456 8 2.47
U.S. Government Agency Obligations 3,690 110 3.97 3,955 98 3.29
Obligations of States and
Political Subdivisions 214 11 7.03 236 13 7.23
Other Securities 20,449 617 4.02 18,136 474 3.48
Trading Securities 3,084 98 4.30 2,139 34 2.17
-------- -------- ------- --------
Total Securities 27,726 843 4.06 24,922 627 3.36
-------- -------- ------- --------
Total Interest-Earning Assets 81,068 2,421 3.99% 81,087 1,692 2.79%
-------- ------- --------
Allowance for Credit Losses (578) (633)
Cash and Due from Banks 3,342 2,947
Other Assets 16,379 15,728
-------- --------
TOTAL ASSETS $100,211 $ 99,129
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 6,939 $ 77 1.49% $ 6,648 $ 36 0.73%
Savings 8,824 72 1.09 9,267 47 0.68
Certificates of Deposit
$100,000 & Over 3,028 70 3.09 3,847 39 1.33
Other Time Deposits 1,101 20 2.37 967 11 1.55
Foreign Offices 25,896 413 2.13 25,874 251 1.30
-------- -------- ------- --------
Total Interest-Bearing Deposits 45,788 652 1.90 46,603 384 1.10
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,262 23 2.44 1,599 10 0.82
Other Borrowed Funds 1,831 33 2.43 2,400 27 1.50
Payables to Customers and Broker-Dealers 6,025 88 1.95 6,521 38 0.78
Long-Term Debt 7,223 187 3.42 6,143 95 2.04
-------- -------- ------- --------
Total Interest-Bearing Liabilities 62,129 983 2.12% 63,266 554 1.17%
-------- ------- --------
Noninterest-Bearing Deposits 15,533 14,465
Other Liabilities 13,152 12,701
Common Shareholders' Equity 9,397 8,697
-------- -------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $100,211 $99,129
======== =======
Net Interest Earnings
and Interest Rate Spread $ 1,438 1.87% $ 1,138 1.62%
======== ======= ======== =======
Net Yield on Interest-Earning Assets 2.37% 1.88%
======= =======
43
OTHER DEVELOPMENTS
In July 2005, the Company acquired the bond administration business of
Marshall & Ilsley Trust Company N.A., and M&I Marshall & Ilsley Bank
(together, "M&I"), where they act as bond trustee, paying/fiscal agent,
master trustee, transfer agent and/or registrar. The transaction involves
the acquisition of approximately 560 bond trusteeships and agency
appointments, representing $4.8 billion of principal debt outstanding for an
estimated 225 clients.
In August 2005, the Company and Nordea, the leading financial services
provider in the Nordic region, have entered into a strategic agreement to
provide global custody and selected related services to Nordea's
institutional clients in the Nordic and Baltic Sea regions. The scope of the
agreement involves approximately EUR 240 billion of assets, which represent
about half of Nordea's EUR 500 billion assets under custody.
In August 2005, the Company announced a strategic arrangement with
IL&FS Trust Company Limited ("ITCL"), a leading provider of trust and
fiduciary services in India. The arrangement between the two organizations
will provide Indian issuers with access to the Company's global network, a
comprehensive array of services to the international capital markets, and
leading-edge technology capabilities. Under the arrangement, ITCL will
perform corporate trust services in India, and the Company will provide
offshore services.
In October 2005, the Company announced a marketing alliance with
National Australia Bank ("National"). The arrangement will enable the
Company to offer commission recapture services to National's custody clients
in Australia and New Zealand. The alliance continues the strategic
international build-out of the Company's transition management and
commission recapture capabilities, which has included the opening of its
Sydney office and acquisition of LJR.
On October 18, 2005, the Company announced its definitive agreement to
acquire Alcentra Group Limited, an international asset management group
focused on funds which invest in sub-investment grade debt. Alcentra's
management team will retain a 20 percent shareholder interest. Alcentra has
operations in London and Los Angeles and currently manages 15 different
investment funds with over $6.2 billion of assets. The transaction is
expected to close by year-end, pending regulatory approval and other
customary conditions of closing.
Construction of the new data center in the mid-south region of the U.S.
has been completed and the Company has obtained a certificate of occupancy.
The data center is expected to be operating at two-thirds capacity in early
November and fully operational next year. The new data center will improve
the geographic diversification and resilience of the Company's operations
and will support the processing needs of the Company's institutional and
retail customers.
The Company participates in unconsolidated investments that own real
estate qualifying for low income housing tax credits based on Section 42 of
the Internal Revenue Code. The Company's share of operating losses generated
by these investments is recorded as other income. The Company has historically
netted the tax credits generated by these investments against the related
operating losses. The Company has reviewed this accounting method and has
decided to record these tax credits as a reduction of income tax expense. To
provide comparable historical information, the tables below show the restated
prior period results. The resulting adjustments did not have an impact on net
income.
44
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income
(Dollars in millions, except per share amounts)
(Unaudited)
For the three months ended
--------------------------------------------
March 31, June 30, September 30, December 31, Year
2004 2004 2004 2004 2004
--------- -------- ------------- ----------- ------
Interest Income
---------------
Loans $ 118 $ 272 $ 290 $ 401 $1,080
Margin Loans 34 35 40 48 156
Securities
Taxable 181 180 181 197 741
Exempt from Federal Taxes 10 10 10 11 40
--------- -------- ------------- ----------- ------
191 190 191 208 781
Deposits in Banks 68 78 77 81 305
Federal Funds Sold and Securities Purchased
Under Resale Agreements 16 17 20 27 80
Trading Assets 14 9 11 17 51
--------- -------- ------------- ----------- ------
Total Interest Income 441 601 629 782 2,453
--------- -------- ------------- ----------- ------
Interest Expense
----------------
Deposits 118 126 139 164 548
Federal Funds Purchased and Securities Sold
Under Repurchase Agreements 3 3 4 6 15
Other Borrowed Funds 9 9 9 25 52
Customer Payables 13 12 14 19 57
Long-Term Debt 30 30 35 41 136
--------- -------- ------------- ----------- ------
Total Interest Expense 173 180 201 255 808
--------- -------- ------------- ----------- ------
Net Interest Income 268 421 428 527 1,645
-------------------
Provision for Credit Losses 12 10 - (7) 15
--------- -------- ------------- ----------- ------
Net Interest Income After Provision
for Credit Losses 256 411 428 534 1,630
--------- -------- ------------- ----------- ------
Noninterest Income
------------------
Servicing Fees
Securities 716 716 685 742 2,858
Global Payment Services 79 83 84 71 317
--------- -------- ------------- ----------- ------
795 799 769 813 3,175
Private Client Services and
Asset Management Fees 108 113 113 115 448
Service Charges and Fees 96 93 98 98 385
Foreign Exchange and Other Trading Activities 106 100 67 90 364
Securities Gains 33 12 14 18 78
Other 82 39 38 42 200
--------- -------- ------------- ----------- ------
Total Noninterest Income 1,220 1,156 1,099 1,176 4,650
--------- -------- ------------- ----------- ------
Noninterest Expense
-------------------
Salaries and Employee Benefits 574 570 564 617 2,324
Net Occupancy 81 72 77 75 305
Furniture and Equipment 51 51 51 51 204
Clearing 48 44 39 45 176
Sub-custodian Expenses 22 22 21 22 87
Software 49 50 52 43 193
Communications 24 23 22 23 93
Amortization of Intangibles 8 8 9 9 34
Other 156 172 164 212 706
--------- -------- ------------- ----------- ------
Total Noninterest Expense 1,013 1,012 999 1,097 4,122
--------- -------- ------------- ----------- ------
Income Before Income Taxes 463 555 528 613 2,158
Income Taxes 99 184 174 262 718
--------- -------- ------------- ----------- ------
Net Income $ 364 $ 371 $ 354 $ 351 $1,440
---------- ========= ======== ============= =========== ======
Per Common Share Data:
----------------------
Basic Earnings $ 0.47 $ 0.48 $ 0.46 $ 0.45 $ 1.87
Diluted Earnings 0.47 0.48 0.46 0.45 1.85
Cash Dividends Paid 0.19 0.20 0.20 0.20 0.79
Diluted Shares Outstanding 778 779 778 780 778
------------------------------------------------------------------------------------------------
45
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income
(Dollars in millions, except per share amounts)
(Unaudited)
For the year ended December 31,
-------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- --------- --------- ---------
Interest Income
---------------
Loans $ 1,080 $ 1,187 $ 1,452 $ 2,239 $ 2,889
Margin Loans 156 86 12 32 21
Securities
Taxable 741 651 639 463 323
Exempt from Federal Income Taxes 40 48 61 74 63
--------- --------- --------- --------- ---------
781 699 700 537 386
Deposits in Banks 305 150 133 252 273
Federal Funds Sold and Securities Purchased
Under Resale Agreements 80 79 51 159 277
Trading Assets 51 129 259 401 531
--------- --------- --------- --------- ---------
Total Interest Income 2,453 2,330 2,607 3,620 4,377
--------- --------- --------- --------- ---------
Interest Expense
----------------
Deposits 548 507 644 1,392 2,011
Federal Funds Purchased and Securities Sold
Under Repurchase Agreements 15 13 29 103 153
Other Borrowed Funds 52 21 65 163 139
Customer Payables 57 30 2 4 -
Long-Term Debt 136 150 202 277 317
--------- --------- --------- --------- ---------
Total Interest Expense 808 721 942 1,939 2,620
--------- --------- --------- --------- ---------
Net Interest Income 1,645 1,609 1,665 1,681 1,757
-------------------
Provision for Credit Losses 15 155 685 375 105
--------- --------- --------- --------- ---------
Net Interest Income After Provision
for Credit Losses 1,630 1,454 980 1,306 1,652
--------- --------- --------- --------- ---------
Noninterest Income
------------------
Servicing Fees
Securities 2,858 2,412 1,896 1,775 1,650
Global Payment Services 317 314 296 291 265
--------- --------- --------- --------- ---------
3,175 2,726 2,192 2,066 1,915
Private Client Services and
Asset Management Fees 448 384 344 314 296
Service Charges and Fees 385 375 357 352 360
Foreign Exchange and Other Trading Activities 364 327 234 338 261
Securities Gains 78 35 (118) 154 150
Other 200 149 124 337 120
--------- --------- --------- --------- ---------
Total Noninterest Income 4,650 3,996 3,133 3,561 3,102
--------- --------- --------- --------- ---------
Noninterest Expense
-------------------
Salaries and Employee Benefits 2,324 2,002 1,581 1,593 1,493
Net Occupancy 305 261 230 233 184
Furniture and Equipment 204 185 138 178 108
Clearing 176 154 124 61 36
Sub-custodian Expenses 87 74 70 62 68
Software 193 170 115 90 66
Communications 93 92 65 86 56
Amortization of Goodwill and Intangibles 34 25 8 112 115
Merger and Integration Costs - 96 - - -
Other 706 639 420 404 384
--------- --------- --------- --------- ---------
Total Noninterest Expense 4,122 3,698 2,751 2,819 2,510
--------- --------- --------- --------- ---------
Income Before Income Taxes 2,158 1,752 1,362 2,048 2,244
Income Taxes 718 595 460 705 815
--------- --------- --------- --------- ---------
Net Income $ 1,440 $ 1,157 $ 902 $ 1,343 $ 1,429
---------- ========= ========= ========= ========= =========
Per Common Share Data:
----------------------
Basic Earnings $ 1.87 $ 1.54 $ 1.25 $ 1.84 $ 1.95
Diluted Earnings 1.85 1.52 1.24 1.81 1.92
Cash Dividends Paid 0.79 0.76 0.76 0.72 0.66
Diluted Shares Outstanding 778 759 728 741 745
------------------------------------------------------------------------------------------------
46
Other 2004 Developments
Other First Quarter Developments in 2004 are summarized in the following
table:
(In millions)
Income Statement Pre-Tax After-Tax
Item Caption Income Tax Income
---------------------------- ---------------- ------- ----- ---------
Net Interest Income
---------------------
SFAS 13 cumulative
lease adjustment - Net Interest
(leasing portfolio) Income $ (145) $ 113 $ (32)
Noninterest Income
--------------------
Gain on sale of Wing Hang Other Income 48 (21) 27
Gain on sponsor fund
investments Securities
Gains 19 (7) 12
Subtotal-Noninterest ------- ----- --------
Income 67 (28) 39
Noninterest Expense
---------------------
Severance tied to Salaries and
relocations Employee Benefits (10) 4 (6)
Lease terminations Net Occupancy (8) 3 (5)
Subtotal-Noninterest ------- ----- --------
Expense (18) 7 (11)
------- ----- --------
Total $ (96) $ 92 $ (4)
======= ===== ========
Net interest income in the first quarter of 2004 included an after-tax
charge of $32 million resulting from a cumulative adjustment to the leasing
portfolio, which was triggered under Statement of Financial Accounting
Standards No. 13 "Accounting for Leases" ("SFAS 13") by the combination of a
reduction in state and local taxes and a restructuring of the lease portfolio
completed in the first quarter. The SFAS 13 adjustment impacts the timing of
lease income reported by the Company, and resulted in a reduction in net
interest income of $145 million, offset by tax benefits of $113 million.
Noninterest income in the first quarter of 2004 included a $27 million
after-tax gain on the sale of a portion of the Company's interest in Wing Hang
Bank Limited ("Wing Hang"), a Hong Kong based bank, which was recorded in
other income, and $19 million ($12 million after-tax) of higher than
anticipated securities gains in the first quarter resulting from realized
gains on sponsor fund investments in Kinkos, Inc., Bristol West Holdings,
Inc., Willis Group Holdings, Ltd., and True Temper Sports, Inc.
The Company took several actions in the first quarter of 2004 associated
with its long-term cost reduction initiatives impacting noninterest expense.
These actions included an after-tax severance charge of $6 million related to
staff reductions tied to job relocations and a $5 million after-tax charge for
terminating high cost leases associated with the staff redeployments.
47
FORWARD-LOOKING STATEMENTS AND FACTORS THAT COULD AFFECT FUTURE RESULTS
The information presented with respect to, among other things, earnings
and revenue outlook, projected business growth, the outcome of legal,
regulatory and investigatory proceedings, future loan losses, and the
Company's plans, objectives and strategies is forward-looking information.
Forward-looking statements are the Company's current estimates or
expectations of future events or future results.
The Company, or its executive officers and directors on behalf of the
Company, may from time to time make forward-looking statements. When used in
this report, any press release or oral statements, the words "estimate, "
"forecast," "project," "anticipate," "target," "expect," "intend," "think,"
"continue," "seek," "believe," "plan," "goal," "could," "should," "may,"
"will," "strategy," and words of similar meaning are intended to identify
forward-looking statements in addition to statements specifically identified
as forward-looking statements.
Forward-looking statements, including the Company's discussions and
projections of future results of operations and discussions of future plans
contained in Management's Discussion and Analysis and elsewhere in this Form
10-Q, are based on management's current expectations and assumptions and are
subject to risks and uncertainties, some of which are discussed herein, that
could cause actual results to differ materially from projected results.
Forward-looking statements could be affected by a number of factors, some of
which by their nature are dynamic and subject to rapid and possibly abrupt
changes which the Company is necessarily unable to predict with accuracy,
including:
General Business and Economic Conditions and Internal Operations - Disruptions
in general economic activity in the United States or abroad to the Company's
operational functions or to financial market settlement functions. The
economic and other effects of the continuing threat of terrorist activity
following the WTC disaster and subsequent U.S. military actions. Changes in
customer credit quality, future changes in interest rates, actual and assumed
rates of return on pension assets, inflation, rising employee benefit
expenses, the effectiveness of management's efforts to control expenses,
general credit quality, the levels of economic, capital market, and merger and
acquisition activity, consumer behavior, government monetary policy,
competition, credit, market and operating risk, and loan demand. The
performance of the domestic economy, international economic markets,
technological, regulatory and structural changes in the Company's industry,
market demand for the Company's products and services, continuation of the
trend to investment management outsourcing, the savings rate of individuals,
growth of worldwide financial assets, continued globalization of investment
activity, and future global political, economic, business and market
conditions. Variations in management projections, methodologies used by
management to set adequate reserve levels for expected and contingent
liabilities, evaluate risk or market forecasts and the actions that management
could take in response to these changes.
Continuation of favorable global trends - The Company's businesses benefit
from certain global trends, such as the growth of financial assets, creation
of new securities, financial services industry consolidation, rapid
technological change, globalization of investment activities, structural
changes to financial markets, shortened settlement cycles, straight-through
processing requirements, and increased demand for outsourcing. These long-
term trends all increase the demand for the Company's products and services
around the world. However, in the near term, uncertainty surrounding recently
adopted regulations and potential legislative and regulatory changes in the
securities industry, as well as investigations by various federal and state
regulatory agencies, the Department of Justice and state attorney generals,
could have an adverse effect on investment activity and the Company.
Acquisitions - Lower than expected performance or higher than expected costs
in connection with acquisitions and integration of acquired businesses,
48
acquisitions of businesses with expensive technology components, changes in
relationships with customers, entering new and unfamiliar markets, incurring
undiscovered liabilities, incorrectly valuing acquisition candidates, the
ability to satisfy customer requirements, retain customers and realize the
growth opportunities of acquired businesses and management's ability to
achieve efficiency goals.
Competition - The Company is subject to increased competition from other
domestic and international banks and financial service companies such as
trading firms, broker-dealers and asset managers as well as from unregulated
financial services organizations. It is also subject to rapid technological
changes requiring significant and ongoing investments in technology to develop
competitive new products and services or adopt new technologies. Technological
advances which result in lower transaction costs may adversely impact the
Company's revenues.
Interest rates - The levels of market interest rates, the shape of the yield
curve and the direction of interest rate changes all affect net interest
income that the Company earns in many different businesses.
Volatility of currency markets - The degree of volatility in foreign exchange
rates can affect the amount of foreign exchange trading revenue. While most
of the Company's foreign exchange revenue is derived from its securities
servicing client base, activity levels are generally higher when there is more
volatility. Therefore, the Company benefits from currency volatility.
Dependence on fee-based business - Revenues reflect changes in the volume of
financial transactions in the United States and abroad, the level of capital
market activity affects processing revenues, changes in asset values affect
fees which are based on the value of assets under custody and management, the
level of cross-border investing, investor sentiment, the pace of worldwide
pension reform and the concomitant creation of new pools of pension assets,
the level of debt issuance and currency exchange rate volatility all impact
the Company's revenues.
Access to liquidity - Limitations on the Company's access to the funds
markets, arising from a loss of confidence of debt purchasers or
counterparties in the funds markets in general or the Company in particular,
it would adversely affect the Company.
Operational risk and business continuity - The Company continually assesses
and monitors operational risk in its businesses. Operational risk is
mitigated by formal risk management oversight within the Company as well as by
automation, standardized operating procedures, segregation of duties and
controls, timely confirmation and reconciliation procedures and insurance. In
addition, the Company provides for disaster and business recovery planning for
events that could damage the Company's physical facilities, cause delay or
disruptions to operational functions, including telecommunications networks,
or impair the Company's clients, vendors and counterparties. Events beyond
those contemplated in the plans could negatively affect the Company.
Reputational and legal risk - Adverse publicity and damage to the Company's
reputation arising from its failure or perceived failure to comply with legal
and regulatory requirements, financial reporting irregularities involving
other large and well known companies and regulatory investigations of the
mutual fund industry could affect the Company's ability to attract and retain
customers, maintain access to the capital markets or result in suits,
enforcement actions, fines and penalties.
Legislative and regulatory environment - Heightened regulatory scrutiny and
increased sanctions, changes or potential changes in domestic and
international legislation and regulation as well as domestic or international
regulatory investigations impose compliance, legal, review and response costs
and may allow additional competition, facilitate consolidation of competitors,
or attract new competitors into the Company's businesses. The cost of
geographically diversifying the Company's facilities to comply with regulatory
49
mandates. The nature of any new capital accords to be adopted by the Basel
Committee on Banking Supervision and implemented by the Federal Reserve.
Taxes - The U.S. Treasury and Internal Revenue Service have taken increasingly
aggressive positions against certain corporate investment programs that either
reduce or defer taxes. The Company believes that its historic investments
have been carefully structured to comply with then current tax law, and
received external legal and tax advice confirming the Company's treatment of
the investments. Going forward, there may be fewer opportunities to
participate in lease investing, tax credit programs and similar transactions
that have benefited the Company in the past. This may adversely impact the
Company's net interest income and effective tax rate.
The Company has entered into investments that produce synthetic fuel from
coal byproducts. Section 29 of the Internal Revenue code provides a tax
credit for these types of transactions. The amount of the credit is dependent
on the amount of synthetic fuel produced by these investments. Synthetic fuel
production can be impacted by mine, workforce, transportation, and weather
conditions among other factors. The tax credits available under Section 29 of
the Internal Revenue Code for the production and sale of synthetic fuel
produced in any given year are phased out if the Reference Price of a barrel
of oil for that year falls within a specified, inflation-adjusted price range.
The Company estimates that the 2005 phase-out would begin if the entire
calendar year 2005 reference prices average above $52 (which corresponds to
popularly published spot prices of $56) and the credit would be fully phased
out at $65 (which corresponds to popularly published spot prices of $69).
Based on information available through October 31, 2005, the Company does
not expect that further changes in the price of oil in the fourth quarter of
2005 should adversely impact its effective tax rate for 2005. If the reference
price of a barrel of oil in future years exceeds the applicable phase-out
threshold for those years, the tax credits generated by the synthetic fuel
facilities in those years could be reduced or eliminated.
Acts of terrorism - Acts of terrorism could have a significant impact on the
Company's business and operations. While the Company has in place business
continuity and disaster recovery plans, acts of terrorism could still damage
the Company's facilities and disrupt or delay normal operations, and have a
similar impact on the Company's clients, suppliers, and counterparties. Acts
of terrorism could also negatively impact the purchase of the Company's
products and services to the extent they resulted in reduced capital markets
activity or lower asset price levels.
Accounting Principles - Changes in generally accepted accounting principles in
the United States that are applicable to the Company could have an impact on
the Company's reported results of operations even though they do not have an
economic impact on the Company's business.
* * *
This is not an exhaustive list and as a result of variations in any of
these factors, actual results may differ materially from any forward-looking
statements.
Forward-looking statements speak only as of the date they are made. The
Company will not update forward-looking statements to reflect facts,
assumptions, circumstances or events which have changed after a forward-
looking statement was made.
50
Government Monetary Policies
----------------------------
The Federal Reserve Board has the primary responsibility for United
States monetary policy. Its actions have an important influence on the demand
for credit and investments and the level of interest rates, and thus on the
earnings of the Company.
Competition
-----------
The businesses in which the Company operates are very competitive.
Competition is provided by both unregulated and regulated financial services
organizations, whose products and services span the local, national, and
global markets in which the Company conducts operations.
A wide variety of domestic and foreign companies compete for processing
services. For securities servicing and global payment services, international,
national, and regional commercial banks, trust banks, investment banks,
specialized processing companies, outsourcing companies, data processing
companies, stock exchanges, and other business firms offer active competition.
In the private client services and asset management markets, international,
national, and regional commercial banks, standalone asset management
companies, mutual funds, securities brokerage firms, insurance companies,
investment counseling firms, and other business firms and individuals actively
compete for business. Commercial banks, savings banks, savings and loan
associations, and credit unions actively compete for deposits, and money
market funds and brokerage houses offer deposit-like services. These
institutions, as well as consumer and commercial finance companies, national
retail chains, factors, insurance companies and pension trusts, are important
competitors for various types of loans. Issuers of commercial paper compete
actively for funds and reduce demand for bank loans.
WEBSITE INFORMATION
The Company makes available on its website, www.bankofny.com:
* All of its SEC filings, including annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and
all amendments to these reports, SEC Forms 3, 4 and 5 and its
proxy statement as soon as reasonably practicable after such
material is electronically filed with or furnished to the SEC,
* Its earnings releases and management conference calls and
presentations, and
* Its corporate governance guidelines and the charters of the
audit and examining, compensation and organization, and
nominating and governance committees of its Board of Directors.
The corporate governance guidelines and committee charters are available
in print to any shareholder who requests it. Requests should be sent to The
Bank of New York Company, Inc., Corporate Communications, One Wall Street, NY,
NY 10286.
51
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Balance Sheets
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, 2005 December 31, 2004
------------------ -----------------
Assets
------
Cash and Due from Banks $ 3,493 $ 3,886
Interest-Bearing Deposits in Banks 7,058 8,192
Securities
Held-to-Maturity (fair value of $2,048 in 2005
and $1,873 in 2004) 2,071 1,886
Available-for-Sale 24,159 21,916
------------------ -----------------
Total Securities 26,230 23,802
Trading Assets at Fair Value 6,292 4,627
Federal Funds Sold and Securities Purchased
Under Resale Agreements 3,572 5,708
Loans (less allowance for loan losses of $561 in 2005
and $591 in 2004) 41,582 35,190
Premises and Equipment 1,040 1,097
Due from Customers on Acceptances 175 137
Accrued Interest Receivable 357 285
Goodwill 3,613 3,477
Intangible Assets 813 793
Other Assets 7,541 7,335
------------------ -----------------
Total Assets $ 101,766 $ 94,529
================== =================
Liabilities and Shareholders' Equity
------------------------------------
Deposits
Noninterest-Bearing (principally domestic offices) $ 16,289 $ 17,442
Interest-Bearing
Domestic Offices 18,966 18,692
Foreign Offices 25,822 22,587
------------------ -----------------
Total Deposits 61,077 58,721
Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 3,349 1,205
Trading Liabilities 3,000 2,873
Payables to Customers and Broker-Dealers 8,103 8,664
Other Borrowed Funds 1,270 533
Acceptances Outstanding 176 139
Accrued Taxes and Other Expenses 4,552 4,452
Accrued Interest Payable 132 113
Other Liabilities (including allowance for
lending-related commitments of
$146 in 2005 and $145 in 2004) 2,970 2,418
Long-Term Debt 7,529 6,121
------------------ -----------------
Total Liabilities 92,158 85,239
------------------ -----------------
Shareholders' Equity
Common Stock-par value $7.50 per share,
authorized 2,400,000,000 shares, issued
1,048,772,989 shares in 2005 and
1,044,841,603 shares in 2004 7,866 7,836
Additional Capital 1,865 1,790
Retained Earnings 6,846 6,162
Accumulated Other Comprehensive Income (107) (6)
------------------ -----------------
16,470 15,782
Less: Treasury Stock (278,556,517 shares in 2005
and 266,720,629 shares in 2004), at cost 6,852 6,492
Loan to ESOP (305,261 shares in 2005), at cost 10 -
------------------ -----------------
Total Shareholders' Equity 9,608 9,290
------------------ -----------------
Total Liabilities and Shareholders' Equity $ 101,766 $ 94,529
================== =================
------------------------------------------------------------------------------------------------
Note: The balance sheet at December 31, 2004 has been derived from the audited financial
statements at that date.
See accompanying Notes to Consolidated Financial Statements.
52
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income
(Dollars in millions, except per share amounts)
(Unaudited)
For the three For the nine
months ended months ended
September 30, September 30,
2005 2004 2005 2004
---- ---- ---- ----
Interest Income
---------------
Loans $ 392 $ 290 $1,082 $ 680
Margin Loans 71 40 188 108
Securities
Taxable 253 181 694 543
Exempt from Federal Income Taxes 10 10 30 30
------ ------ ------ ------
263 191 724 573
Deposits in Banks 68 77 206 224
Federal Funds Sold and Securities Purchased
Under Resale Agreements 38 20 102 53
Trading Assets 38 11 98 34
------ ------ ------ ------
Total Interest Income 870 629 2,400 1,672
------ ------ ------ ------
Interest Expense
----------------
Deposits 248 139 652 384
Federal Funds Purchased and Securities Sold
Under Repurchase Agreements 9 4 23 10
Other Borrowed Funds 13 9 33 27
Customer Payables 35 14 88 38
Long-Term Debt 73 35 187 95
------ ------ ------ ------
Total Interest Expense 378 201 983 554
------ ------ ------ ------
Net Interest Income 492 428 1,417 1,118
-------------------
Provision for Credit Losses 10 - 5 22
------ ------ ------ ------
Net Interest Income After Provision for Credit Losses 482 428 1,412 1,096
------ ------ ------ ------
Noninterest Income
------------------
Servicing Fees
Securities 806 684 2,333 2,116
Global Payment Services 75 85 226 247
------ ------ ------ ------
881 769 2,559 2,363
Private Client Services and Asset Management Fees 120 113 363 333
Service Charges and Fees 93 98 288 286
Foreign Exchange and Other Trading Activities 93 67 292 273
Securities Gains 15 14 50 59
Other 46 38 130 160
------ ------ ------ ------
Total Noninterest Income 1,248 1,099 3,682 3,474
------ ------ ------ ------
Noninterest Expense
-------------------
Salaries and Employee Benefits 644 564 1,902 1,708
Net Occupancy 79 77 239 230
Furniture and Equipment 52 51 155 153
Clearing 49 39 137 131
Sub-custodian Expenses 25 21 72 65
Software 54 52 162 151
Communications 24 22 69 69
Amortization of Intangibles 10 9 28 26
Other 198 164 571 492
------ ------ ------ ------
Total Noninterest Expense 1,135 999 3,335 3,025
------ ------ ------ ------
Income Before Income Taxes 595 528 1,759 1,545
Income Taxes 206 174 593 456
------ ------ ------ ------
Net Income $ 389 $ 354 $1,166 $1,089
---------- ====== ====== ====== ======
Per Common Share Data:
Basic Earnings $ 0.51 $ 0.46 $ 1.52 $ 1.41
Diluted Earnings 0.51 0.46 1.51 1.40
Cash Dividends Paid 0.21 0.20 0.61 0.59
Diluted Shares Outstanding 769 778 773 778
---------------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
53
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statement of Changes in Shareholders' Equity
For the nine months ended September 30, 2005
(Dollars in millions)
(Unaudited)
Common Stock
Balance, January 1 $ 7,836
Issuances in Connection with Employee Benefit Plans 30
-------------
Balance, September 30 7,866
-------------
Additional Capital
Balance, January 1 1,790
Issuances in Connection with Employee Benefit Plans 114
Stock Rights Redemption (39)
-------------
Balance, September 30 1,865
-------------
Retained Earnings
Balance, January 1 6,162
Net Income $ 1,166 1,166
Cash Dividends on Common Stock (482)
-------------
Balance, September 30 6,846
-------------
Accumulated Other Comprehensive Income
Balance, January 1 (6)
Change in Fair Value of Securities Available-for-Sale,
Net of Taxes of $(51) (81) (81)
Reclassification Adjustment, Net of Taxes of $5 7 7
Foreign Currency Translation Adjustment,
Net of Taxes of $(8) (24) (24)
Net Unrealized Derivative loss on Cash Flow Hedges,
Net of Taxes of $(2) (1) (1)
Minimum Pension Liability Adjustment,
Net of Taxes of $(1) (2) (2)
----------- -------------
Balance, September 30 (107)
Total Comprehensive Income $ 1,065
===========
Less Treasury Stock
Balance, January 1 6,492
Issued (36)
Acquired 396
-------------
Balance, September 30 6,852
-------------
Less Loan to ESOP
Balance, January 1 -
Loan to ESOP 10
-------------
Balance, September 30 10
-------------
Total Shareholders' Equity, September 30, 2005 $ 9,608
=============
-------------------------------------------------------------------------------------------
Comprehensive Income for the three months ended September 30, 2005 and 2004 was $306 and $435.
Comprehensive Income for the nine months ended September 30, 2005 and 2004 was $1,065 and $1,045.
See accompanying Notes to Consolidated Financial Statements.
54
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Cash Flows
(Dollars in millions)
(Unaudited)
For the nine months
ended September 30,
2005 2004
-------- --------
Operating Activities
Net Income $ 1,166 $ 1,089
Adjustments to Determine Net Cash Attributable to
Operating Activities:
Provision for Credit Losses
and Losses on Other Real Estate 5 22
Depreciation and Amortization 403 367
Deferred Income Taxes 236 208
Securities Gains (50) (59)
Change in Trading Activities (1,815) 1,753
Change in Accruals and Other, Net (152) 35
-------- --------
Net Cash (Used for) Provided by Operating Activities (207) 3,415
-------- --------
Investing Activities
Change in Interest-Bearing Deposits in Banks 713 (1,337)
Change in Margin Loans (262) (199)
Purchases of Securities Held-to-Maturity (508) (1,224)
Paydowns of Securities Held-to-Maturity 277 154
Maturities of Securities Held-to-Maturity 38 6
Purchases of Securities Available-for-Sale (13,018) (10,532)
Sales of Securities Available-for-Sale 3,578 3,278
Paydowns of Securities Available-for-Sale 5,103 6,177
Maturities of Securities Available-for-Sale 1,787 1,708
Net Principal Received (Disbursed) on Loans to Customers (6,687) (1,055)
Sales of Loans and Other Real Estate 141 28
Change in Federal Funds Sold and Securities
Purchased Under Resale Agreements 2,136 (249)
Purchases of Premises and Equipment (71) (222)
Acquisitions, Net of Cash Acquired (257) (100)
Proceeds from the Sale of Premises and Equipment - 8
Other, Net 51 23
-------- --------
Net Cash Used for Investing Activities (6,979) (3,536)
-------- --------
Financing Activities
Change in Deposits 3,459 2,098
Change in Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 2,144 135
Change in Payables to Customers and Broker-Dealers (560) (2,460)
Change in Other Borrowed Funds 694 137
Proceeds from the Issuance of Long-Term Debt 1,589 148
Repayments of Long-Term Debt (102) (126)
Issuance of Common Stock 140 155
Treasury Stock Acquired (406) (119)
Cash Dividends Paid (482) (455)
-------- --------
Net Cash Provided by (Used for) Financing Activities 6,476 (487)
-------- --------
Effect of Exchange Rate Changes on Cash 317 (178)
-------- --------
Change in Cash and Due From Banks (393) (786)
Cash and Due from Banks at Beginning of Period 3,886 3,843
-------- --------
Cash and Due from Banks at End of Period $ 3,493 $ 3,057
======== ========
-------------------------------------------------------------------------------
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Period for:
Interest $ 965 $ 462
Income Taxes 273 313
Noncash Investing Activity
(Primarily Foreclosure of Real Estate) - 1
-------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
55
THE BANK OF NEW YORK COMPANY, INC.
Notes to Consolidated Financial Statements
1. General
-------
The accounting and reporting policies of The Bank of New York Company,
Inc., a financial holding company, and its consolidated subsidiaries (the
"Company") conform with generally accepted accounting principles and general
practice within the banking industry. Such policies are consistent with those
applied in the preparation of the Company's annual financial statements.
The accompanying consolidated financial statements are unaudited. In the
opinion of management, all adjustments necessary for a fair presentation of
financial position, results of operations and cash flows for the interim
periods have been made.
2. Accounting Changes and New Accounting Pronouncements
----------------------------------------------------
The Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," in 1995. At that time, as permitted by the standard, the
Company elected to continue to apply the provisions of Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
accounted for the options granted to employees using the intrinsic value
method, under which no expense is recognized for stock options because they
were granted at the stock price on the grant date and therefore have no
intrinsic value.
On January 1, 2003, the Company adopted the fair value method of
accounting for its options under SFAS 123 as amended by SFAS 148 "Accounting
for Stock-Based Compensation-Transition and Disclosure". SFAS 148 permits
three different methods of adopting fair value: (1) the prospective method,
(2) the modified prospective method, and (3) the retroactive restatement
method. Under the prospective method, options issued after January 1, 2003
are expensed while all options granted prior to January 1, 2003 are accounted
for under APB 25 using the intrinsic value method. Consistent with industry
practice, the Company elected the prospective method of adopting fair value
accounting.
During the nine months ended September 30, 2005, approximately 6 million
options were granted. In the third quarter and nine months of 2005, the
Company recorded $14 million and $37 million of stock option expense.
The retroactive restatement method requires the Company's financial
statements to be restated as if fair value accounting had been adopted in
1995. The following table discloses the pro forma effects on the Company's
net income and earnings per share as if the retroactive restatement method had
been adopted.
(Dollars in millions, Third Quarter Year-to-date
except per share amounts) 2005 2004 2005 2004
------ ------ ------ ------
Reported net income $ 389 $ 354 $1,166 $1,089
Stock based employee compensation costs,
using prospective method, net of tax 8 6 22 17
Stock based employee compensation costs,
using retroactive restatement method,
net of tax (8) (14) (29) (44)
------ ------ ------ ------
Pro forma net income $ 389 $ 346 $1,159 $1,062
====== ====== ====== ======
Reported diluted earnings per share $ 0.51 $ 0.46 $ 1.51 $ 1.40
Impact on diluted earnings per share - (0.01) (0.01) (0.03)
------ ------ ------ ------
Pro forma diluted earnings per share $ 0.51 $ 0.45 $ 1.50 $ 1.37
====== ====== ====== ======
56
The fair value of options granted in 2005 and 2004 were estimated at the
grant date using the following weighted average assumptions:
Third Quarter Year-to-date
2005 2004 2005 2004
----- ----- ---- ----
Dividend Yield * 3.00% 2.77% 2.50%
Expected Volatility * 25.06 25.21 25.00
Risk Free Interest Rates * 3.35 4.18 2.61
Expected Options Lives * 5 5 5
* There were no stock options granted in the third quarter of 2005.
In December 2004, the FASB issued FASB Statement No. 123 (revised 2004)
("SFAS 123(R)"), "Share-Based Payment", which is a revision of FASB Statement
No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation." SFAS 123(R)
eliminates the ability to account for share-based compensation transactions
using Accounting Principles Board Opinion No. 25 and requires that such
transactions be accounted for using a fair value-based method. SFAS 123(R)
covers a wide range of share-based compensation arrangements including share
options, restricted share plans, performance-based awards, share appreciation
rights, and employee share purchase plans. In April 2005, the Securities and
Exchange Commission ("SEC") issued a release that amends the compliance dates
for SFAS 123(R). Under the SEC's new rule, the Company will be required to
apply SFAS 123(R) as of January 1, 2006.
SFAS 123(R) may be adopted using one of two methods: (1) A "modified
prospective" method in which compensation cost is recognized beginning with
the effective date (a) based on the requirements of SFAS 123(R) for all share-
based payments granted after the effective date and (b) based on the
requirements of SFAS 123 for all awards granted to employees prior to the
effective date of SFAS 123(R) that remain unvested on the effective date. (2)
A "modified retrospective" method which includes the requirements of the
modified prospective method described above, but also permits entities to
restate based on the amounts previously recognized under SFAS 123 for purposes
of pro forma disclosures either (a) all prior periods presented or (b) prior
interim periods of the year of adoption. The Company expects to adopt SFAS
123(R) using the "modified prospective" method.
The Company adopted the fair value method of accounting for stock-based
compensation prospectively as of January 1, 2003. By January 1, 2006, the
Company will be amortizing all of its unvested stock option grants. Certain
of the Company's stock compensation grants vest when the employee retires.
SFAS 123(R) will require the completion of expensing of new grants with this
feature by the first date the employee is eligible to retire. Currently, the
Company generally expenses these grants over their stated vesting period.
The Company is currently evaluating the impact of adopting SFAS 123(R).
On February 1, 2003, the Company adopted FASB Interpretation No. 46 ("FIN
46"), "Consolidation of Variable Interest Entities". This interpretation
requires a company that holds a variable interest in an entity to consolidate
the entity if the company's interest in the variable interest entity ("VIE")
is such that the company will absorb a majority of the VIE's expected losses
and/or receives a majority of the entity's expected residual returns. FIN 46
also requires additional disclosures by primary beneficiaries and other
significant variable interest holders. The consolidation requirements of FIN
46 applied immediately to VIEs created after January 31, 2003. Various
amendments to FIN 46, including FIN 46(R), delayed the effective date for
certain previously established entities until the first quarter of 2004. The
adoption of FIN 46 and FIN 46(R) did not have a significant impact on the
Company's results of operations or financial condition.
As of December 31, 2004, the Company had variable interests in 5
securitization trusts. These trusts are qualifying special-purpose entities,
57
which are exempt from the consolidation requirements of FIN 46. See Footnote
"Securitizations" in the 2004 Annual Report.
The most significant impact of FIN 46 and FIN 46(R) was to require that
the trusts used to issue trust preferred securities be deconsolidated. As a
result, the trust preferred securities no longer represent a minority
interest. Under regulatory capital rules, minority interests count as Tier 1
Capital. The Company has $1,150 million of trust preferred securities
outstanding.
On March 1, 2005, the Board of Governors of the Federal Reserve System
(the "FRB") adopted a final rule that allows the continued limited inclusion
of trust preferred securities in the Tier 1 capital of bank holding companies
(BHCs). Under the final rule, the Company will be subject to a 15 percent
limit in the amount of trust preferred securities that can be included in Tier
1 capital, net of goodwill, less any related deferred tax liability. Amounts
in excess of these limits will continue to be included in Tier 2 capital. The
final rule provides a five-year transition period, ending March 31, 2009, for
application of quantitative limits. Under the transition rules, the Company
expects all its trust preferred securities to continue to qualify as Tier 1
capital. Both the Company and the Bank are expected to remain "well
capitalized" under the final rule. At the end of the transition period, the
Company expects all its current trust preferred securities will continue to
qualify as Tier 1 capital.
In May 2004, FASB issued FASB Staff Position No. 106-2, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003" ("FSP FAS 106-2"), which supersedes FSP FAS
106-1, in response to the December 2003 enactment of the Medicare Prescription
Drug, Improvement and Modernization Act of 2003 ("the Act"). FSP FAS 106-2
provides guidance on the accounting for the effects of the Act for employers
that sponsor postretirement health care plans that provide prescription drug
benefits. The Company believes that its plans are eligible for the subsidy
provided by the Act and adopted FSP FAS 106-2 in the third quarter of 2004
retroactive to January 1, 2004. The adoption of FSP FAS 106-2 did not have a
significant impact on the Company's results of operations or financial
position.
In September 2004, the FASB issued FASB Staff Position (FSP) EITF 03-1-1,
which delaying the recognition and measurement provisions of EITF 03-1 pending
the issuance of further implementation guidance. Such guidance was also
issued in September 2004 in the form of proposed FSP EITF Issue No. 03-1-a,
"Implementation Guidance for the Application of Paragraph 16 of EITF Issue No.
03-1" (FSP EITF 03-1-a). At its June 2005 meeting, the FASB decided that they
will issue proposed FSP EITF 03-1-a as final. The final FSP, to be re-titled
FSP FAS 115-1, "The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments", requires that a) for each individual
impaired security, a company assert its ability and intent to hold to recovery
and to designate an expected recovery period in order to avoid recognizing an
impairment charge through earnings, b) a company need not make such an
assertion for minor impairments caused by changes in interest rate and sector
spreads, c) the company must recognize an impairment charge on securities
impaired as a result of interest rate and/or sector spreads immediately upon
changing their assertion to an intent to sell such security, and d) defines
when a change in a company's assertion for one security would not call into
question assertions made for other impaired securities. The final FSP is
expected to be issued in the fourth quarter of 2005 and would be effective for
reporting periods beginning after December 15, 2005. The Company does not
expect the adoption of the final standard will have a significant impact on
its financial condition or results of operations.
The FASB has issued an exposure draft revising the accounting guidance
under SFAS 13 surrounding leveraged leases. The exposure draft modifies
existing interpretations of SFAS 13 and associated industry practice. As a
result, a settlement of the tax matters associated with the Company's
structured leasing investments (see "Commitments and Contingencies" footnote)
58
could result in a material one-time charge to earnings related to a change in
the timing of the lease cash flows. However, an amount approximating this
one-time charge would be recognized into income over the remaining term of the
affected leases. The FASB has indicated it plans to issue a final
pronouncement by the end of 2005 that would be effective for 2005.
In June 2005, the FASB ratified the consensus in EITF Issue No. 04-5,
"Determining Whether a General Partner, or the General Partners as a Group,
Controls a Limited Partnership or Similar Entity When the Limited Partners
Have Certain Rights" ("EITF 04-5"), which provides guidance in determining
whether a general partner controls a limited partnership. EITF 04-5 is
effective for general partners of all new limited partnerships formed and for
existing limited partnerships for which the partnership agreements are
modified. The guidance in EITF 04-5 is effective after June 29, 2005. For
general partners in all other limited partnerships, the guidance in this Issue
is effective no later than the beginning of the first reporting period in
fiscal years beginning after December 15, 2005. The Company is currently
evaluating the impact of adopting EITF 04-5.
In July 2005, the FASB issued an Exposure Draft of a proposed
Interpretation, "Accounting for Uncertain Tax Positions". The proposed
Interpretation clarifies the accounting for uncertain tax positions in
accordance with FASB Statement No. 109, "Accounting for Income Taxes". The
proposed Interpretation requires that a tax position meet a "probable
recognition threshold" for the benefit of the uncertain tax position to be
recognized in the financial statements. A tax position that fails to meet the
probable recognition threshold will result in either reduction of current or
deferred tax asset or receivable, or recording a current or deferred tax
liability. The proposed Interpretation also provides guidance on measurement,
derecognition of tax benefits, classification, interim period accounting
disclosure, and transition requirements in accounting for uncertain tax
positions. The proposed Interpretation has a 60-day comment period and shall
be effective for all companies as of the first fiscal year ending after
December 15, 2005. The Company is assessing the impact of adopting the new
pronouncement and is currently unable to estimate its impact on the Company's
consolidated financial statements.
The Company participates in unconsolidated investments that own real
estate qualifying for low income housing tax credits based on Section 42 of
the Internal Revenue Code. The Company's share of operating losses generated
by these investments is recorded as other income. The Company has historically
netted the tax credits generated by these investments against the related
operating losses. In the first quarter of 2005, the Company reviewed this
accounting method and determined it was more appropriate to record these tax
credits as a reduction of income tax expense. Prior period results for other
income and income tax expense have been reclassified and did not have an
impact on net income. See "Other Developments."
Certain other prior year information has been reclassified to conform its
presentation with the 2005 financial statements.
59
3. Acquisitions and Dispositions
-----------------------------
The Company continues to be an active acquirer of securities servicing
and asset management businesses.
The Company has announced 5 acquisitions in 2005. The total acquisition
cost in the third quarter and nine months of 2005 was $177 million and $188
million, paid in cash. The Company frequently structures its acquisitions with
both an initial payment and a later contingent payment tied to post-closing
revenue or income growth. The Company records the fair value of contingent
payments as an additional cost of the entity acquired in the period that the
payment becomes probable.
Goodwill and the tax-deductible portion of goodwill related to
acquisitions in the third quarter and nine months of 2005 was $124 million, in
both periods. At September 30, 2005, the Company was liable for potential
contingent payments related to acquisitions in the amount of $204 million.
During the third quarter and the nine months of 2005, the Company paid or
accrued $9 million and $43 million for contingent payments related to
acquisitions made in prior years. The pro forma effect of the 2005
acquisitions is not material to year-to-date 2005 net income.
2005
----
In January 2005, the Company acquired certain of the assets and
liabilities of Standard & Poor's Securities, Inc. ("SPSI"), the institutional
brokerage subsidiary of Standard & Poor's. The Company will assume SPSI's
client relationships and Standard & Poor's research clients will have access
to BNY Securities Group's diverse set of execution management platforms and
commission management services. The acquisition demonstrates the Company's
strategy to work with leading independent providers of research and other
financial services.
In March 2005, the Company acquired the execution and commission
management services of Boston Institutional Services ("BIS"). Under the terms
of the agreement, the Company will assume BIS's client relationships for its
execution and commission management business.
In July 2005, the Company acquired Lynch, Jones & Ryan, Inc. ("LJR"), a
subsidiary of Instinet Group. LJR is the pioneer and premier provider of
commission recapture programs, with over 30 years experience in providing
value-added trading services to institutional investors who comprise 1,400
plan sponsor funds, with more than $2.2 trillion in assets. The Company's
headquarters are in New York, with regional offices in Chicago, Dallas, and
San Francisco and a presence in London, Tokyo and Sydney. The acquisition of
LJR bolsters the Company's position as a leading provider of agency brokerage
and commission management services, and reinforces its long-standing
commitment to the plan sponsor and institutional fund community around the
world.
In June 2005, the Company and Trust Company of Australia Ltd. ("Trust")
formed a joint venture that will provide securitization trustee and other
agency-related services to Australian-based issuers of debt. The new company
will combine Trust's strong local infrastructure and market presence with the
Company's global experience and expertise to provide a wide range of trustee
and agency services. The joint venture, based in Sydney, began operating in
early June 2005. The joint venture presents the Company with a significant
opportunity to expand its footprint in Australia and to capitalize on the
sizeable growth potential in the securitization market across a variety of
asset classes.
In July 2005, The Bank of New York and BHF-BANK established BHF BNY
Securities Services GmbH as a jointly held subsidiary. Based in Frankfurt am
60
Main, the new company will market Global Custody (Depotbank) services for
German investment companies, and securities custody and settlement services
for the national and international direct investments of institutional
investors.
In July 2005, the Company acquired the bond administration business of
Marshall & Ilsley Trust Company N.A., and M&I Marshall & Ilsley Bank
(together, "M&I"), where they act as bond trustee, paying/fiscal agent, master
trustee, transfer agent and/or registrar. The transaction involved the
acquisition of approximately 560 bond trusteeships and agency appointments,
representing $4.8 billion of principal debt outstanding for an estimated 225
clients.
In August 2005, the Company and Nordea, the leading financial services
provider in the Nordic region, have entered into a strategic agreement to
provide global custody and selected related services to Nordea's
institutional clients in the Nordic and Baltic Sea regions. The scope of the
agreement involves approximately EUR 240 billion of assets which represent
about half of Nordea's EUR 500 billion assets under custody.
In August 2005, the Company announced a strategic arrangement with
IL&FS Trust Company Limited ("ITCL"), a leading provider of trust and
fiduciary services in India. The arrangement between the two organizations
will provide Indian issuers with access to the Company's global network, a
comprehensive array of services to the international capital markets, and
leading-edge technology capabilities. Under the arrangement, ITCL will
perform corporate trust services in India, and the Company will provide
offshore services.
In October 2005, the Company announced a marketing alliance with
National Australia Bank ("National"). The arrangement will enable the
Company to offer commission recapture services to National's custody clients
in Australia and New Zealand. The alliance continues the strategic
international build-out of the Company's transition management and
commission recapture capabilities, which has included the opening of its
Sydney office and acquisition of LJR.
In October 2005, the Company announced a definitive agreement to acquire
Alcentra Group Limited, an international asset management group focused on
funds that invest in sub-investment grade debt. Alcentra's management team
will retain a 20 percent interest. Alcentra has operations in London and Los
Angeles and currently manages 15 different investment funds with over $6.2
billion of assets. The transaction is expected to close by year-end, subject
to regulatory approval and other customary conditions of closing.
4. Goodwill and Intangibles
------------------------
Goodwill by business segment is as follows:
(In millions)
September 30, 2005 December 31, 2004
------------------ -----------------
Servicing and
Fiduciary Businesses $ 3,473 $ 3,337
Corporate Banking 31 31
Retail Banking 109 109
Financial Markets - -
------------------ -----------------
Consolidated Total $ 3,613 $ 3,477
================== =================
The Company's business segments are tested annually for goodwill
impairment.
61
Intangible Assets
-----------------
September 30, 2005 December 31, 2004
---------------------------------------------- ------------------------------
Weighted
Gross Net Average Gross Net
Carrying Accumulated Carrying Amortization Carrying Accumulated Carrying
(Dollars in millions) Amount Amortization Amount Period in Years Amount Amortization Amount
-------- ------------ -------- --------------- -------- ------------ --------
Trade Names $ 370 $ - $ 370 Indefinite Life $ 370 $ - $ 370
Customer Relationships 521 (89) 432 16 474 (65) 409
Other Intangible
Assets 28 (17) 11 6 41 (27) 14
The aggregate amortization expense of intangibles was $10 million and $9
million for the quarters ended September 30, 2005 and 2004, respectively. The
aggregate amortization expense of intangibles was $28 million and $26 million
for the nine months ended September 30, 2005 and 2004, respectively. Estimated
amortization expense for the next five years is as follows:
For the Year Ended Amortization
(In millions) December 31, Expense
------------------ ------------
2005 $40
2006 43
2007 39
2008 38
2009 37
5. Allowance for Credit Losses
---------------------------
The allowance for credit losses is maintained at a level that, in
management's judgment, is adequate to absorb probable losses associated with
specifically identified loans, as well as estimated probable credit losses
inherent in the remainder of the loan portfolio at the balance sheet date.
Management's judgment includes the following factors, among others: risks of
individual credits; past experience; the volume, composition, and growth of
the loan portfolio; and economic conditions.
The Company conducts a quarterly portfolio review to determine the
adequacy of its allowance for credit losses. All commercial loans over $1
million are assigned to specific risk categories. Smaller commercial and
consumer loans are evaluated on a pooled basis and assigned to specific risk
categories. Following this review, senior management of the Company analyzes
the results and determines the allowance for credit losses. The Risk
Committee of the Company's Board of Directors reviews the allowance at the end
of each quarter.
The portion of the allowance for credit losses allocated to impaired
loans (nonaccrual commercial loans over $1 million) is measured by the
difference between their recorded value and fair value. Fair value is the
present value of the expected future cash flows from borrowers, the market
value of the loan, or the fair value of the collateral.
Commercial loans are placed on nonaccrual status when collateral is
insufficient and principal or interest is past due 90 days or more, or when
there is reasonable doubt that interest or principal will be collected.
Accrued interest is usually reversed when a loan is placed on nonaccrual
status. Interest payments received on nonaccrual loans may be recognized as
income or applied to principal depending upon management's judgment.
Nonaccrual loans are restored to accrual status when principal and interest
are current or they become fully collateralized. Consumer loans are not
classified as nonperforming assets, but are charged off and interest accrued
is suspended based upon an established delinquency schedule determined by
product. Real estate acquired in satisfaction of loans is carried in other
assets at the lower of the recorded investment in the property or fair value
minus estimated costs to sell.
62
Transactions in the allowance for credit losses are summarized as
follows:
(In millions) Three Months Ended September 30, 2005
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 562 $ 148 $ 710
Charge-Offs (14) - (14)
Recoveries 1 - 1
-------------- --------------- -------------
Net Charge-Offs (13) - (13)
Provision 12 (2) 10
-------------- --------------- -------------
Balance, End of Period $ 561 $ 146 $ 707
============== =============== =============
Three Months Ended September 30, 2004
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 598 $ 177 $ 775
Charge-Offs (21) - (21)
Recoveries 2 - 2
-------------- --------------- -------------
Net Charge-Offs (19) - (19)
Provision 19 (19) -
-------------- --------------- -------------
Balance, End of Period $ 598 $ 158 $ 756
============== =============== =============
Nine Months Ended September 30, 2005
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 591 $ 145 $ 736
Charge-Offs (40) - (40)
Recoveries 6 - 6
-------------- --------------- -------------
Net Charge-Offs (34) - (34)
Provision 4 1 5
-------------- --------------- -------------
Balance, End of Period $ 561 $ 146 $ 707
============== =============== =============
Nine Months Ended September 30, 2004
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 668 $ 136 $ 804
Charge-Offs (76) - (76)
Recoveries 6 - 6
-------------- --------------- -------------
Net Charge-Offs (70) - (70)
Provision - 22 22
-------------- --------------- -------------
Balance, End of Period $ 598 $ 158 $ 756
============== =============== =============
63
6. Capital Transactions
--------------------
The Company has 5 million authorized shares of Class A preferred stock
having a par value of $2.00 per share. At September 30, 2005 and December 31,
2004, 3,000 shares were outstanding.
During the quarter ended September 30, 2005, the Company issued $55
million subordinated debt qualifying as Tier II capital.
At September 30, 2005, the Company had registration statements with a
remaining capacity of approximately $1.7 billion of debt, preferred stock,
preferred trust securities, or common stock.
7. Earnings Per Share
------------------
The following table illustrates the computations of basic and diluted
earnings per share:
(Dollars in millions, Three Months Ended Nine Months Ended
except per share amounts) September 30, September 30,
------------------ ------------------
2005 2004 2005 2004
-------- -------- -------- --------
Net Income (1) $ 389 $ 354 $ 1,166 $ 1,089
======== ======== ======== ========
Basic Weighted Average
Shares Outstanding 761 772 766 772
Shares Issuable Due to
Employee Stock Compensation 8 6 7 6
-------- -------- -------- --------
Diluted Weighted Average
Shares Outstanding 769 778 773 778
======== ======== ======== ========
Basic Earnings Per Share: $ 0.51 $ 0.46 $ 1.52 $ 1.41
Diluted Earnings Per Share: 0.51 0.46 1.51 1.40
(1) Net Income, net income available to common shareholders and diluted net
income are the same for all periods presented.
64
8. Employee Benefit Plans
----------------------
The components of net periodic benefit cost are as follows:
Pension Benefits Healthcare Benefits
-------------------------------------- ------------------------------------
Three Months Ended Nine Months Ended Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
------------------- ------------------- ------------------ ----------------
Domestic Foreign Domestic Foreign
--------- --------- --------- ---------
(In millions) 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004
--------------------- ---- ---- ---- ---- ---- ---- ---- ---- -------- -------- -------- ------
Net Periodic Cost (Income)
Service Cost $ 16 $ 12 $ 2 $ 2 $ 48 $ 35 $ 6 $ 7 $ - $ - $ 1 $ 1
Interest Cost 14 13 2 2 42 38 7 6 2 2 6 6
Expected Return on Assets (30) (33) (2) (2) (90) (99) (8) (8) (2) (1) (5) (5)
Other 4 1 - - 13 3 1 - 2 2 5 5
---- ---- ---- ---- ---- ---- ---- ---- ------- -------- ------- ------
Net Periodic Cost (Income) $ 4 $ (7)$ 2 $ 2 $ 13 $(23)$ 6 $ 5 $ 2 $ 3 $ 7 $ 7
==== ==== ==== ==== ==== ==== ==== ==== ======= ======== ======= ======
9. Income Taxes
------------
The statutory federal income tax rate is reconciled to the Company's
effective income tax rate below:
Nine Months Ended
September 30,
----------------
2005 2004
---- ----
Federal Rate 35.0% 35.0%
State and Local Income Taxes,
Net of Federal Income Tax Benefit 3.7 (0.9)
Nondeductible Expenses 0.5 0.1
Credit for Synthetic Fuel Investments (1.8) (1.2)
Credit for Low-Income Housing Investments (1.6) (2.0)
Tax-Exempt Income From Municipal Securities (0.1) (0.2)
Other Tax-Exempt Income (1.1) (1.3)
Foreign Operations (0.2) 0.5
Leveraged Lease Portfolio (0.3) (0.7)
Tax Reserve - LILO Exposure 0.5 0.5
Other - Net (0.9) (0.3)
----- -----
Effective Rate 33.7% 29.5%
====== ======
65
10. Commitments and Contingent Liabilities
--------------------------------------
In the normal course of business, various commitments and contingent
liabilities are outstanding which are not reflected in the accompanying
consolidated balance sheets. Management does not expect any material losses
to result from these matters.
A summary of the notional amount of the Company's off-balance-sheet
credit transactions, net of participations, at September 30, 2005 and December
31, 2004 follows:
Off-Balance-Sheet Credit Risks
------------------------------
September 30, December 31,
(In millions) 2005 2004
----------------------------------- ------------ -----------
Lending Commitments $ 34,225 $ 34,834
Standby Letters of Credit, Net 10,205 9,507
Commercial Letters of Credit 1,464 1,264
Securities Lending Indemnifications 297,237 232,025
The total potential loss on undrawn commitments, standby and commercial
letters of credit, and securities lending indemnifications is equal to the
total notional amount if drawn upon, which does not consider the value of any
collateral. Since many of the commitments are expected to expire without
being drawn upon, the total amount does not necessarily represent future cash
requirements.
In securities lending transactions, the Company generally requires the
borrower to provide 102% cash collateral which is monitored on a daily basis,
thus reducing credit risk. Securities lending transactions are generally
entered into only with highly-rated counterparties. At September 30, 2005 and
December 31, 2004, securities lending indemnifications were secured by
collateral of $303.5 billion and $233.0 billion, respectively.
The notional amounts for other off-balance-sheet risks express the dollar
volume of the transactions; however, credit risk is much smaller. The Company
performs credit reviews and enters into netting agreements to minimize the
credit risk of foreign currency and interest rate risk management products.
The Company enters into offsetting positions to reduce exposure to foreign
exchange and interest rate risk.
Standby letters of credit principally support corporate obligations and
include $0.9 billion and $0.5 billion that were collateralized with cash and
securities on September 30, 2005 and December 31, 2004. At September 30,
2005, approximately $6.8 billion of the standbys will expire within one year,
and the balance between one to five years.
Other
-----
In the ordinary course of business, the Company makes certain investments
that have tax consequences. From time to time, the IRS may question or
challenge the tax position taken by the Company. The Company engaged in
certain types of structured leasing investments, referred to as "LILOs", prior
to 1999 that the IRS has challenged. In 2004, the IRS proposed adjustments to
the Company's tax treatment of these transactions. The Company believes that
its tax position related to these transactions was proper based upon
applicable statutes, regulations and case law in effect at the time the
transactions were entered into. However, a court or other judicial or
administrative authority, if presented with the transactions, could disagree.
Beginning in the fourth quarter of 2004, the Company had several
appellate conferences with the IRS related to the Company's LILO transactions.
Negotiations have continued with the IRS and based on these negotiations, the
Company believes it is likely it will settle the proposed IRS tax adjustments
relating to transactions closed in 1996 and 1997. However, negotiations are
not final and it remains possible that the matter will be litigated. The
66
Company's 1998 leveraged lease transactions are in a later audit cycle and
thus are unlikely to be part of any settlement of the 1996 and 1997 leases.
However, the Company believes that a comparable settlement for 1998 will
ultimately be possible given the similarity between these leases and the
earlier leases.
There were no significant new developments on the LILO matter during the
third quarter of 2005.
On February 11, 2005, the IRS released Notice 2005-13, which identified
certain lease investments known as "SILOs" as potentially subject to IRS
challenge. The Company believes that certain of its lease investments entered
into between 1999 and 2004 may be consistent with transactions described in
the notice. In response, the Company is reviewing its lease portfolio and
evaluating the technical merits of the IRS' position. Although it is likely
the IRS will challenge the tax benefits associated with these leases, the
Company remains confident that its leases complied with statutory,
administrative and judicial authority existing at that time.
The Company currently believes it has adequate tax reserves to cover its
LILO exposure for all years and any other potential tax exposures the IRS
could raise, based on a probability assessment of various potential outcomes.
Probabilities and outcomes are reviewed as events unfold, and adjustments to
the reserves are made when appropriate.
In the ordinary course of business, the Company and its subsidiaries are
routinely defendants in or parties to a number of pending and potential legal
actions, including actions brought on behalf of various classes of claimants,
and regulatory matters. Claims for significant monetary damages are asserted
in certain of these actions and proceedings. Due to the inherent difficulty
of predicting the outcome of such matters, the Company cannot ascertain what
the eventual outcome of these matters will be; however, based on current
knowledge and after consultation with legal counsel, the Company does not
believe that judgments or settlements, if any, arising from pending or
potential legal actions or regulatory matters, either individually or in the
aggregate, will have a material adverse effect on the consolidated financial
position or liquidity of the Company although they could have a material
effect on net income for a given period. The Company intends to defend itself
vigorously against all of the claims asserted in these matters.
See discussion of contingent legal matters in the "Legal Proceedings"
section.
67
QUARTERLY REPORT ON FORM 10-Q
THE BANK OF NEW YORK COMPANY, INC.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30, 2005
Commission file number 001-06152
THE BANK OF NEW YORK COMPANY, INC.
Incorporated in the State of New York
I.R.S. Employer Identification No. 13-2614959
Address: One Wall Street
New York, New York 10286
Telephone: (212) 495-1784
As of September 30, 2005, The Bank of New York Company, Inc. had
769,911,211 shares of common stock ($7.50 par value) outstanding.
The Bank of New York Company, Inc. (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months(or such shorter period that the
registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.
The registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
The following sections of the Financial Review set forth in the cross-
reference index are incorporated in the Quarterly Report on Form 10-Q.
Cross-reference Page(s)
-----------------------------------------------------------------------------
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets as of
September 30, 2005 and December 31, 2004 51
Consolidated Statements of Income for
the Three Months and Nine Months Ended
September 30, 2005 and 2004 52
Consolidated Statement of Changes in
Shareholders' Equity for the Nine Months
Ended September 30, 2005 53
Consolidated Statement of Cash Flows
for the Nine Months Ended
September 30, 2005 and 2004 54
Notes to Consolidated Financial Statements 55 - 66
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 3 - 50
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 38 - 40
68
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company's Disclosure Committee, whose members include the Chief
Executive Officer and Chief Financial Officer, has responsibility for ensuring
that there is an adequate and effective process for establishing, maintaining,
and evaluating disclosure controls and procedures which are designed to ensure
that information required to be disclosed by the Company in its SEC reports
is timely recorded, processed, summarized and reported. In addition, the
Company has established a Code of Conduct designed to provide a statement of
the values and ethical standards to which the Company requires its employees
and directors to adhere. The Code of Conduct provides the framework for
maintaining the highest possible standards of professional conduct. The
Company also maintains an ethics hotline for employees.
As of the end of the period covered by this report, an evaluation was
carried out under the supervision and with the participation of the Company's
management, including the Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the Company's disclosure controls and procedures as
defined in Exchange Act Rule 13a-15(e) and 15d-15(e). Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
In the ordinary course of business, the Company may routinely modify,
upgrade and enhance its internal controls and procedures for financial
reporting. However, there have not been any changes in the Company's internal
controls over financial reporting as defined in Exchange Act Rule 13a-15(f)
and 15d-15(f) during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
--------------------------
In the ordinary course of business, the Company and its subsidiaries
are routinely defendants in or parties to a number of pending and
potential legal actions, including actions brought on behalf of various
classes of claimants, and regulatory matters. Claims for significant
monetary damages are asserted in certain of these actions and proceedings.
In regulatory enforcement matters, claims for disgorgement and the
imposition of penalties and/or other remedial sanctions are possible. Due
to the inherent difficulty of predicting the outcome of such matters, the
Company cannot ascertain what the eventual outcome of these matters will
be; however, based on current knowledge and after consultation with legal
counsel, the Company does not believe that judgments or settlements, if
any, arising from pending or potential legal actions or regulatory
matters, either individually or in the aggregate, will have a material
adverse effect on the consolidated financial position or liquidity of the
Company although they could have a material effect on net income for a
given period. The Company intends to defend itself vigorously against all
of the claims asserted in these legal actions.
As discussed in a report filed on Form 8-K on November 8, 2005, the
Bank entered into a non-prosecution agreement with the U.S. Attorney's
Offices for the Southern and Eastern Districts of New York ("SDNY" and
"EDNY"). The agreement resolves the previously disclosed SDNY
investigation involving funds transfer activities to and from Russia from
1996-1999 and the EDNY investigation of a fraudulent scheme conducted by a
former customer of one of the Bank's Long Island branch offices.
69
There have been no material changes in the proceedings previously
disclosed in the 10-Q for the second quarter of 2005 relating to the
Company's mutual fund and issuer services businesses.
Item 2. Changes in Securities, Use of Proceeds, and
----------------------------------------------------
Issuer Purchases of Equity Securities
-------------------------------------
Shares of the Company's common stock were issued in the following
transactions exempt from registration under the Securities Act of 1933
pursuant to Section 4(2) thereof:
(a) On October 10, 2005, 2,400 shares of common stock were issued to
Richard C. Vaughan as part of his annual retainer as a non-employee director.
(c) Under its stock repurchase program, the Company buys back shares from
time to time. The following table discloses the Company's repurchases of the
Company's common stock made during the third quarter of 2005.
Issuer Purchases of Equity Securities
-------------------------------------
Total Number Maximum
Total Average of Shares Number of Shares
Number Price Purchased as That May be
Period of Shares Paid Part of Repurchased
Purchased Per Share Publicly Under the Plans
Announced Plans or Programs
or Programs
-------------- ---------- ---------- --------------- ------------------
July 1-31 2,160,639 $ 31.08(1) 2,160,639 19,333,333
August 1-31 20,450 29.17 20,450 19,312,883
September 1-30 6,301 30.85 6,301 19,306,582
---------- ---------------
Total 2,187,390 2,187,390
========== ===============
(1) Based on initial price.
All shares were repurchased through the Company's stock repurchase
programs announced on November 12, 2002, and July 12, 2005, which permits the
repurchase of 16 million shares and 20 million shares, respectively. The
shares repurchased in August and September primarily resulted from open market
purchases, while 2.0 million shares were repurchased in July at an initial
price of $31.25 from a broker-dealer counterparty who borrowed the shares, as
part of an accelerated share repurchase program. The initial price is subject
to a purchase price adjustment based on the price the counterparty actually
pays for the shares.
Item 6. Exhibits
-----------------
Exhibit 12 - Ratio of Earnings to Fixed Charges for the Three Months and
Nine Months Ended September 30, 2005 and 2004;
Exhibit 31 - Certification of Chairman and Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002;
Exhibit 31.1 - Certification of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002;
Exhibit 32 - Certification of Chairman and Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002; and
Exhibit 32.1 - Certification of Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
70
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
THE BANK OF NEW YORK COMPANY, INC.
----------------------------------
(Registrant)
Date: November 08, 2005 By: /s/ Thomas J. Mastro
---------------------------------
Name: Thomas J. Mastro
Title: Comptroller
71
EXHIBIT INDEX
-------------
Exhibit Description
------- -----------
12 Ratio of Earnings to Fixed Charges for the Three Months and
Nine Months Ended September 30, 2005 and 2004.
31 Certification of Chairman and Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
31.1 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Chairman and Chief Executive Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.