THE BANK OF NEW YORK COMPANY, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended June 30, 2005
The Quarterly Report on Form 10-Q and cross reference index is on page 66.
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 2
- Overview 2
- Second Quarter 2005 Highlights 3
- Consolidated Income Statement Review 5
- Business Segment Review 9
- Critical Accounting Policies 23
- Consolidated Balance Sheet Review 27
- Liquidity 33
- 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
June 30, 2005 and December 31, 2004 51
- Consolidated Statements of Income
for the Three Months and Six Months Ended
June 30, 2005 and 2004 52
- Consolidated Statement of Changes In
Shareholders' Equity for the Six
Months Ended June 30, 2005 53
- Consolidated Statements of Cash Flows
for the Six Months Ended June 30, 2005 and 2004 54
- Notes to Consolidated Financial Statements 55 - 65
Form 10-Q
- Cover 66
- Controls and Procedures 67
- Legal Proceedings 67
- Changes in Securities, Use of Proceeds, and
Issuer Purchases of Equity Securities 69
- Submission of Matters to Vote of Security Holders 70
- Exhibits 71
- Signature 72
1
THE BANK OF NEW YORK COMPANY, INC.
Financial Highlights
(Dollars in millions, except per share amounts)
(Unaudited)
June 30, March 31, June 30,
2005 2005 2004
------------ ------------- ------------
Quarter
-------
Revenue (tax equivalent basis) $ 2,077 $ 1,917 $ 1,775
Net Income 398 379 371
Basic EPS 0.52 0.49 0.48
Diluted EPS 0.52 0.49 0.48
Cash Dividends Per Share 0.20 0.20 0.20
Return on Average Common
Shareholders' Equity 17.12% 16.52% 17.14%
Return on Average Assets 1.59 1.55 1.49
Efficiency Ratio 65.7 66.2 63.9
Year-to-date
------------
Revenue (tax equivalent basis) $ 3,995 $ 1,917 $ 3,450
Net Income 777 379 735
Basic EPS 1.01 0.49 0.95
Diluted EPS 1.00 0.49 0.94
Cash Dividends Per Share 0.40 0.20 0.39
Return on Average Common
Shareholders' Equity 16.82% 16.52% 17.15%
Return on Average Assets 1.57 1.55 1.48
Efficiency Ratio 65.9 66.2 66.3
Assets $ 103,063 $ 96,537 $ 97,536
Loans 40,681 38,764 38,205
Securities 25,779 23,907 22,986
Deposits - Domestic 37,921 33,634 36,279
- Foreign 26,076 25,328 24,781
Long-Term Debt 7,586 7,389 6,025
Common Shareholders' Equity 9,471 9,335 8,785
Common Shareholders'
Equity Per Share $ 12.29 $ 12.02 $ 11.29
Market Value Per Share
of Common Stock 28.78 29.05 29.48
Allowance for Loan Losses as
a Percent of Total Loans 1.38% 1.50% 1.57%
Allowance for Loan Losses as
a Percent of Non-Margin Loans 1.62 1.78 1.86
Total Allowance for Credit Losses as
a Percent of Total Loans 1.75 1.85 2.03
Total Allowance for Credit Losses as
a Percent of Non-Margin Loans 2.05 2.19 2.42
Tier 1 Capital Ratio 8.07 8.13 7.70
Total Capital Ratio 12.49 12.54 11.63
Leverage Ratio 6.55 6.56 6.00
Tangible Common Equity Ratio 5.26 5.48 4.95
Employees 22,993 23,160 23,001
Assets Under Custody (In trillions)
Total Assets Under Custody $ 10.3 $ 9.9 $ 8.7
Equity Securities 35% 34% 34%
Fixed Income Securities 65 66 66
Assets Under Administration (In billions) $ 33 $ 33 $ 32
Assets Under Management (In billions)
Total Assets Under Management 106 104 93
Equity Securities 34% 34% 36%
Fixed Income Securities 21 21 22
Alternative Investments 15 15 14
Liquid Assets 30 30 28
2
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 &
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 94 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.
Capital generated by these actions has been reallocated to the Company's
higher-growth businesses.
3
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.
SECOND QUARTER 2005 HIGHLIGHTS
The Company reported second quarter net income of $398 million and
diluted earnings per share of 52 cents, compared with net income of $371
million and diluted earnings per share of 48 cents in the second quarter of
2004 and net income of $379 million and diluted earnings per share of 49 cents
in the first quarter of 2005. Year-to-date net income was $777 million, or
$1.00 of diluted earnings per share, compared to $735 million, or 94 cents of
diluted earnings per share in 2004. 2004 year-to-date results included several
gains and charges recorded in the first quarter of 2004 that in the aggregate
did not influence reported earnings per share. See "Other Developments".
Additional highlights for the quarter include:
* Securities servicing fees increased by 8% compared to the second
quarter of 2004 and 3% sequentially to $776 million, driven by
strong growth in investor services on a year-over-year basis
while issuer services was strong sequentially.
* Net interest income grew by 12% versus the second quarter of last
year and 3% on a sequential quarter basis reflecting the Company's
sound interest rate positioning and strong liquidity generated by its
core servicing businesses.
* Positive operating leverage, reflecting top-line growth and tight
operating expense control.
* Foreign exchange and other trading revenues grew by 3% compared to
the second quarter 2004 and 7% on a sequential quarter basis
reflecting continued strong customer flows and a trending market in
foreign exchange.
* Private client services and asset management revenue increased by 8%
versus the second quarter of 2004 reflecting growth in assets at Ivy
Asset Management. On a sequential quarter basis revenues were up 1%.
* Continued excellent credit performance.
* Acquired on July 1, 2005 Lynch, Jones & Ryan, Inc. ("LJR"), a leader
in providing commission recapture services to institutional clients.
* Active capital management as the Company repurchased 7.6 million
shares during the quarter.
The Company's results for the quarter reflect a strong, balanced
performance - broad-based revenue growth coupled with focused expense control.
This produced solid positive operating leverage, which has been a primary
objective.
The Company expects continued growth in net interest income in the second
half of the year as well as continued favorable credit costs and progress on
managing its expense base. With respect to noninterest income, there tends to
be seasonality to the Company's business. The third quarter is generally lower
sequentially, as market volumes lighten considerably between mid-July and
Labor Day. The fourth quarter tends to be stronger. In the third quarter, the
Company will have the full-quarter benefit of the LJR acquisition, which
should contribute roughly $15 million to third quarter revenue and a modest
earnings contribution as the Company works through the integration process.
During the second quarter of 2005, the Company continued to invest in
enhancing its service offerings, critical to sustaining and growing revenue
through all types of markets, while maintaining its commitment to expense
4
discipline. Service offerings enhancements were the result of both internal
development and acquisitions.
The Company continues to win significant new business in a very competitive
environment. Evidence of this can be seen in Investor Services, which added
$365 billion in assets from new and existing clients. The Company continues to
make inroads in Asia, with several notable business wins this quarter.
In Korea, for example, an evolving market for pension and asset management
services where the Company has had a presence for some time, it won
a mandate to provide securities lending to the Korea Securities Depository.
The Company is also making progress in penetrating the large and
growing China marketplace. The latest mandate there comes from Industrial and
Commercial Bank of China, the largest commercial bank in China, which awarded
the Company custody and securities lending business. The Company's
longstanding client relationships in China, especially among banks and
government agencies, give the Company credibility for cross-selling efforts as
capital and asset management sectors emerge.
Another important mandate in the second quarter was the 13 UK Building
Societies that selected the Company as global custodian and issuing and paying
agent. This win reflects the Company's principal role in supporting the
infrastructure of the UK financial markets, where the Company continues to be
a leader.
As a result of the Company's increased investment in service quality, it
has won industry awards in a number of areas, including custody, tri-party
services, transition management and global trade. This type of recognition
helps to support the Company's sales efforts.
The Company has also taken a number of steps to lay the groundwork for
future growth by partnering with local providers in select markets. Joint
ventures can be an effective way to extend the Company's market leadership
into markets that are smaller but potentially lucrative. An example of this
is in Australia, where the Company entered into a corporate trust joint
venture with Trust Company of Australia.
Joint ventures can also be effective in helping the Company entering a
large market such as Germany, which demands a local perspective. In Germany,
the Company partnered with BHF to provide global custody and "depotbank"
services.
Another new business partnership is in Japan where the Company extended
its longstanding commercial relationship with Mizuho Trust to target corporate
pension funds, leverage Ivy's products, and distribute the Company's
proprietary mutual funds.
The Company continues to make acquisitions that enhance its strategic
positioning. On July 1, the Company acquired Lynch, Jones & Ryan, the market
leader in commission recapture. In addition, LJR gives the Company 1,400
pension fund clients, which offers natural cross-selling opportunities for its
transition management services.
All in all, the Company achieved a strong, well-balanced performance this
quarter with some notable business wins and the continued development of
strategic partnerships, providing a foundation for future revenue growth.
5
CONSOLIDATED INCOME STATEMENT REVIEW
Noninterest Income
------------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
2Q05 vs. 2Q05 vs. -------------- Inc/
(Dollars in millions) 2Q05 1Q05 2Q04 1Q05 2Q04 2005 2004 (Dec)
------ ------ ------ -------- -------- ------ ------ -------
Servicing Fees
Securities $ 776 $ 751 $ 716 3% 8% $1,527 $1,432 7%
Global Payment Services 76 75 83 1 (8) 151 162 (7)
------ ------ ------ ------ ------
852 826 799 3 7 1,678 1,594 5
Private Client Services
and Asset Management Fees 122 121 113 1 8 243 221 10
Service Charges and Fees 103 92 93 12 11 195 189 3
Foreign Exchange and
Other Trading Activities 103 96 100 7 3 199 206 (3)
Securities Gains 23 12 12 92 92 35 45 (22)
Other* 53 31 39 71 36 84 121 (31)
------ ------ ------ ------ ------
Total Noninterest Income $1,256 $1,178 $1,156 7 9 $2,434 $2,376 2
====== ====== ====== ====== ======
See "Other Developments."
The second quarter of 2005 increase in noninterest income versus both the
year ago quarter and the sequential quarter reflects broadly stronger
performance in securities servicing, service charges and fees, securities
gains, and other income.
Securities servicing fees in the second quarter of 2005 were up from the
second quarter of 2004 and from the first quarter of 2005, reflecting strong
growth in investor services and broker-dealer services versus the prior year
and in issuer services sequentially. 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 second quarter and year-
to-date periods of 2004 and essentially unchanged on a sequential quarter
basis. The decline reflects customers choosing to pay with higher
compensating balances, which benefits net interest income, partially offset by
new business. On an invoiced services basis, total revenue was up 5% over the
second quarter of 2004 and 4% sequentially as new business wins were driven by
new capabilities in processing cross-border transactions as well as remote
check deposit. Global payment services fees were down 7% on a year-to-date
basis, reflecting lower fees due to customers choosing to pay with higher
compensating balances.
Private client services and asset management fees for the second quarter
were up significantly from the second quarter of 2004 reflecting growth in
fees at Ivy Asset Management. The small sequential quarter increase reflects
seasonally higher private client fees partially offset by a slight decline in
fees at Ivy Asset Management. For the six months ended June 30, 2005, private
client services and asset management fees increased by 10% from a year ago,
reflecting continued growth at Ivy Asset Management. Total assets under
management were $106 billion, up from $93 billion a year ago and $104 billion
at March 31, 2005.
Service charges and fees were up from the second quarter of 2004 and from
the first quarter of 2005. For the second quarter and first six months of
2005, service charges and fees were up from 2004, reflecting higher capital
markets fees. The sequential quarter increase reflects higher capital markets
fees due to increased loan syndication and advisory fees.
Foreign exchange and other trading revenues were up slightly from the
second quarter of 2004 and increased more significantly on a sequential
6
quarter basis. In comparison to the second quarter of 2004 the improved
results reflect new business wins as well as improved results in interest rate
derivatives. Sequential quarter results were paced by new business wins in
foreign exchange, seasonal activity tied to dividends and a trending currency
market. For the six months ending June 30, 2005, foreign exchange and other
trading revenues were down from the very strong comparable 2004 period.
Securities gains in the second quarter were up compared with the second
quarter of 2004 and the first quarter of 2005. The increase reflects higher
gains in the Company's sponsor fund portfolio. Securities gains declined in
the first six 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 second quarter of 2004 and
the sequential quarter. The second quarter and year-to-date periods of 2005
include a $17 million gain on the sale of the Company's interest in Financial
Models Company, Inc. In the six months ended June 30, 2005, other noninterest
income was down from the six months ended June 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) 2Q05 2Q05
vs. vs. 2004 2004
2Q05 1Q05 2Q04 1Q05 2Q04 2005 Reported Core** Reported Core**
------ ------ ------ ----- ----- ----- -------- ------ -------- -------
Net Interest Income $ 470 $ 455 $ 421 3% 12% $ 925 $ 689 $ 834 34% 11%
Tax Equivalent
Adjustment* 7 7 8 14 14 14
------ ------ ------ ----- ------ -----
Net Interest
Income on a Tax
Equivalent Basis $ 477 $ 462 $ 429 3 11 $ 939 $ 703 $ 848 34 11
====== ====== ====== ===== ====== =====
Net Interest Rate
Spread 1.84% 1.93% 1.84% 1.89% 1.49% 1.84%
Net Yield
on Interest
Earning Assets 2.34 2.36 2.09 2.35 1.73 2.08
* A number of amounts related to net interest income are presented on a
"taxable 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 Company's
positioning to benefit from the rise in short-term rates, as well as
customers' increasing use of compensating balances to pay for services. The
increase from the first quarter of 2005 is due to sound interest rate
positioning, driven in part by the expansion of deposit spreads and increased
liquidity generated by servicing activities including custody, clearing and
corporate trust. The increase in liquidity reflects a solid level of activity
through these businesses.
The net interest income rate spread was 1.84% in the second quarter of
2005, compared with 1.84% in the second quarter of 2004, and 1.93% in the
first quarter of 2005. The net yield on interest earning assets was 2.34% in
the second quarter of 2005, compared with 2.09% in the second quarter of 2004,
and 2.36% in the first quarter of 2005. The decline in spread from the first
quarter of 2005 is attributable to increased liquidity as higher deposits from
the servicing business were invested in short-duration, lower-yielding assets.
7
The year-to-date net interest income spread was 1.89% in 2005 compared
with 1.49% in 2004, while the net yield on interest earning assets was 2.35%
in 2005 and 1.73% 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 1.84% while net yield on interest earning assets
was 2.08%. 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
2Q05 vs. 2Q05 vs. -------------- Inc/
(Dollars in million) 2Q05 1Q05 2Q04 1Q05 2Q04 2005 2004 (Dec)
------ ------ ------ -------- -------- ------ ------ -------
Salaries and
Employee Benefits $ 640 $ 618 $ 570 4% 12% $1,258 $1,144 10%
Net Occupancy 82 78 72 5 14 160 153 5
Furniture and Equipment 51 52 51 (2) - 103 102 1
Clearing 42 46 44 (9) (5) 88 92 (4)
Sub-custodian Expenses 24 23 22 4 9 47 44 7
Software 55 53 50 4 10 108 99 9
Communications 22 23 23 (4) (4) 45 47 (4)
Amortization
of Intangibles 10 8 8 25 25 18 16 13
Other 197 176 172 12 15 373 328 14
------ ------ ------ ------ ------
Total Noninterest
Expense $1,123 $1,077 $1,012 4 11 $2,200 $2,025 9
====== ====== ====== ====== ======
Noninterest expense for the second quarter of 2005 was up compared with
the second quarter of 2004 and the first quarter of 2005. The increase versus
the year ago quarter reflects staffing costs associated with new business, as
well as higher pension and option expenses, expanded occupancy costs
associated with business continuity, and higher consulting expenses in other
expense. The sequential increase reflects higher salaries and employee
benefits tied to new business and revenue growth, higher severance of $5
million, and incremental option expense of $4 million. The year 2005 is the
third and final year the adoption of expensing stock options will impact year-
over-year expense comparisons. Other expenses were impacted by legal costs
which increased by $12 million, including the accrual of $10 million for the
potential settlement of certain regulatory matters previously disclosed, and
higher seasonal travel expenses.
Relative to the second 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 second quarter increased on a sequential quarter basis, reflecting
higher incentives tied to improved revenues and a $5 million increase in
severance as the Company accelerated the migration of staff to lower-cost
locations, as well as an additional $4 million of stock option expense related
to grants awarded in March 2005. For the first six months of 2005, salaries
and employee benefit expense also was higher, reflecting many of these same
factors.
During the quarter, the Company further reduced headcount through its
successful reengineering initiatives. Staff decreased by 167 people, or 1%
over the quarter, even with strong new business momentum and the expansion of
staff in key sales areas and support functions. The Company also began the
migration of 220 positions to lower-cost locations during the quarter, keeping
it on target to meet its full-year objective of 500 positions.
Occupancy expenses were up sequentially, partly reflecting a write-off
associated with Ivy's move to a new location. On a year-to-date basis,
occupancy expenses were up from 2004, primarily reflecting higher energy costs
and business continuity initiatives. Occupancy expense in 2004 included lease
termination expenses of $8 million recorded in the first quarter of 2004.
8
Clearing and sub-custodian expenses, which are tied to transaction
volumes, were down $3 million, or 4%, sequentially on a combined basis to $66
million. The decrease reflects a lower level of business activity. On a year-
to-date basis, clearing and sub-custodian expenses were $135 million on a
combined basis, essentially unchanged from a year ago.
The increase in software expense versus a year ago reflects spending and
development to support business growth, with the sequential quarter comparison
largely reflecting a $3 million software write-off.
The effective tax rate for the second quarter of 2005 was 33.4%, compared
to 33.1% in the second quarter of 2004 and 33.1% in the first quarter of 2005.
The effective tax rate for the six months period ended June 30, 2005 was
33.3%, compared with 27.8% for the six months period ended June 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 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
-----------------------------------------
2nd 1st 2nd
Quarter Quarter Quarter Year-to-Date
(In millions) 2005 2005 2004 2005 2004
------- ------- ------- ------- -------
Provision $ 5 $ (10) $ 10 $ (5) $ 22
======= ======= ======= ======= =======
Net Charge-offs:
Commercial $ (2) $ (3) $ (11) $ (5) $ (16)
Foreign (4) - (8) (4) (18)
Regional Commercial 2 (2) - - -
Consumer (7) (5) (6) (12) (17)
------- ------- ------- ------- -------
Total $ (11) $ (10) $ (25) $ (21) $ (51)
======= ======= ======= ======= =======
The provision was $5 million in the second quarter of 2005, compared to
$10 million in the second quarter of 2004 and a $10 million credit to the
provision in the first quarter of 2005. For the first six months of 2005, the
provision was a $5 million credit to the provision compared with $22 million
in 2004. 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 $710 million at June 30, 2005,
$775 million at June 30, 2004, and $716 million at March 31, 2005. The total
allowance for credit losses as a percent of non-margin loans was 2.05% at June
30, 2005, compared with 2.42% at June 30, 2004 and 2.19% at March 31, 2005.
Net charge-offs were $11 million in the second quarter of 2005 versus $25
million in the second quarter of 2004 and $10 million in the first quarter of
2005. These represent 0.11% of total loans in the most recent quarter,
compared with 0.26% in the quarter ended June 30, 2004 and 0.10% in the
quarter ended March 31, 2005. For the first six months ended June 30, 2005,
net charge-offs were $21 million compared to $51 million for the same period
in 2004.
9
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
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
10
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.
In issuer services, the Company's American and global depositary receipt
business has over 1,190 programs representing over 60 countries. As a
trustee, the Company provides diverse services for corporate, municipal,
structured and international debt issuances. Over 90,000 appointments for
more than 30,000 worldwide clients have resulted in the Company being trustee
for more than $3 trillion in outstanding debt securities. 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 the largest custodian with $10.3
trillion of assets under custody and administration at June 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 more than 17% of the total industry assets
for exchange-traded funds. The Company is the largest 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 the
world's largest institutional electronic broker 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 630 million shares and clearing more than 600,000 trades daily. The
Company has 21 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 trillion daily via
more than 135,000 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 94 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.
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
11
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 77 transactions totaling to approximately $35
billion for clients in the six months ended June 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 611,600 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 growing 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
2Q05 vs. 2Q05 vs. ---------------- Inc/
(Dollars in million) 2Q05 1Q05 2Q04 1Q05 2Q04 2005 2004 (Dec)
------- ------- ------- -------- -------- ------- ------- -------
Net Interest Income $ 178 $ 168 $ 136 6% 31% $ 346 $ 268 29%
Provision for
Credit Losses 1 1 1 - - 2 1 100
Noninterest Income 1,058 1,025 994 3 6 2,084 1,984 5
Noninterest Expense 872 849 791 3 10 1,721 1,570 10
Income Before Taxes 363 343 338 6 7 707 681 4
Average Assets $23,114 $22,987 $22,891 1 1 $23,051 $22,831 1
Average Deposits 37,830 36,072 35,520 5 7 36,956 35,329 5
Nonperforming Assets 1 1 3 - (67) 1 3 (67)
(Dollars in billions)
Assets Under Custody $10,298 $ 9,859 $ 8,662 4 19 $10,298 $ 8,662 19
Equity Securities 35% 34% 34% 35% 34%
Fixed Income
Securities 65 66 66 65 66
Assets Under
Administration $ 33 $ 33 $ 32 - 3 $ 33 $ 32 3
Assets Under
Management 106 104 93 2 14 106 93 14
Equity Securities 34% 34% 36% 34% 36%
Fixed Income
Securities 21 21 22 21 22
Alternative
Investments 15 15 14 15 14
Liquid Assets 30 30 28 30 28
S&P(registered
trademark) 500 Index
(Period End) 1,191 1,181 1,141 1 4 1,191 1,141 4
NASDAQ(registered
trademark) Index
(Period End) 2,057 1,999 2,048 3 - 2,057 2,048 -
Lehman Brothers
Aggregate Bond
(servicemark)
Index 212.4 214.0 190.6 (1) 11 212.4 190.6 11
MSCI(registered
trademark) EAFE Index 1,473.7 1,503.9 1,327.9 (2) 11 1,473.7 1,327.9 11
NYSE(registered
trademark) Volume
(In billions) 100.4 99.4 90.8 1 11 199.8 186.2 7
NASDAQ(registered
trademark) Volume
(In billions) 112.5 121.2 108.3 (7) 4 233.7 234.6 -
The S&P 500(registered trademark) Index was up 4% for the
second quarter of 2005, with average daily price levels up 5% from the
second quarter of 2004. The NASDAQ (registered trademark) Index was flat
for the second quarter of 2005, with average daily prices up 1% compared
with the second quarter of 2004. Globally, the MSCI (registered trademark)
EAFE index was up 11%. The Lehman Brothers Aggregate Bond (servicemark)
index was up 11% for the second quarter of 2005. On a sequential quarter
basis, combined NYSE and NASDAQ (registered trademark) non-program trading
volumes were down approximately 5% during the second 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.
Second quarter results showed continued strength in comparison to the
second quarter of 2004 in several of the Company's primary businesses,
including issuer services, broker-dealer services, asset management, and
foreign exchange and other trading. In the second quarter of 2005, pre-tax
income was $363 million, compared with $338 million a year ago and $343 million
in the first quarter of 2005. On a year-to-date basis, pre-tax income was $707
million, up 4% from $681 million in 2004.
Noninterest income for the second quarter of 2005 increased $64 million to
$1,058 million from a year ago and $33 million on a sequential quarter basis.
On a year-to-date basis, noninterest income was $2,084 million, compared with
$1,984 million a year ago.
13
Securities Servicing Fees
-------------------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
2Q05 vs. 2Q05 vs. -------------- Inc/
(In millions) 2Q05 1Q05 2Q04 1Q05 2Q04 2005 2004 (Dec)
------ ------ ------ -------- -------- ------ ------ -------
Execution and
Clearing Services $ 294 $ 293 $ 279 -% 5% $ 587 $ 582 1%
Investor Services 265 263 229 1 16 528 455 16
Issuer Services 159 139 155 14 3 298 292 2
Broker-Dealer Services 58 56 53 4 9 114 103 11
------ ------ ------ ------ ------
Securities
Servicing Fees $ 776 $ 751 $ 716 3 8 $1,527 $1,432 7
====== ====== ====== ====== ======
Securities servicing fees were $776 million in the second quarter, an
increase of $60 million, or 8%, from the second quarter of 2004 and $25
million, or 3%, from the first quarter of 2005. The year-over-year increase is
due to increases in investor services and broker-dealer services. The
sequential increase reflects strong growth in issuer services. For the first
six months of 2005, securities servicing fees were $1,527 million, an increase
of $95 million from the first six 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 second quarter of
2005 was up from 2004 as modest growth at Pershing was offset by weakness in
the execution business. Fees for execution and clearing were essentially
unchanged from the first quarter of 2005. In execution services, higher
transition management revenue and additional trading days helped to offset the
decline in daily trading volumes. Transition activity can vary significantly
from quarter to quarter and has no correlation to market volumes. Execution
services was also favorably impacted by additional trading days.
Pershing's fees were up from the second quarter of 2004 and essentially
flat compared with the first quarter of 2005. The year-over-year increase
reflects Pershing's continuing strategic shift to more value-added, fee-based
non-transactional services offset by lower 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.
Billable trades for Pershing were up 1% sequentially despite a 13% decline in
total retail market activity. Increased trading days provided 5% positive
impact and the balance reflects growing market share and less volatile client
base. Stable assets under administration and net new business drove modest
increase in fees sequentially. Pershing's assets under administration were $730
billion at quarter-end, compared with $708 billion at March 31, 2005. As of
June 30, 2005, margin loans remained flat compared with the first quarter of
2005, reflecting the current lack of direction in the equity markets.
Investor services, which includes global fund services, global custody,
securities lending, global liquidity services and outsourcing, was up
significantly from the second quarter of 2004 and up slightly from the first
quarter of 2005. Year-over-year results reflect strong performance across all
business lines. Global fund services was favorably impacted by new business
and higher international transaction volumes. Securities lending improved
year-over-year and sequentially due to continued growth in new business and
robust demand for Treasury collateral. Sequential performance in securities
lending also reflects a robust dividend arbitrage season. Offsetting the strong
14
performance in securities lending was the negative impact on global custody of
lower transaction volumes in Europe. During the quarter, the Company added
approximately $365 billion in assets from new and existing clients, reflecting
its success in developing an enhanced service offering.
At June 30, 2005, assets under custody rose to $10.3 trillion, from $8.7
trillion at June 30, 2004 and $9.9 trillion at March 31, 2005. A substantial
portion of the increase in assets under custody since year-end 2004 was due to
new business and business line growth.
Issuer services, which includes corporate trust, depositary receipts and
stock transfer, increased versus the second quarter of 2004 and showed strong
growth sequentially. The increase versus the second quarter of 2004 primarily
reflects higher depositary receipt fees particularly for corporate actions
related to dividends. Corporate trust fees showed continued strength in
international issuance and structured products. The sequential quarter increase
reflects higher depositary receipts fees due to seasonally higher dividend
activity and an increase in corporate trust fees due to new business wins in
municipal and structured 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, increased over both the second quarter and year-to-date
periods of 2004 and the first quarter of 2005, as a result of increased
collateral management activity and higher volumes in securities clearance. Both
the U.S. and European markets contributed to the strong growth in collateral
management. The Company continues to attract new business to its collateral
management services. In addition, the Company has grown by helping accelerate
the trend toward utilizing non-traditional securities such as equities,
corporate bonds and municipal securities.
Global payment services fees were lower than the second quarter and year-
to-date periods of 2004 and essentially unchanged on a sequential quarter
basis. The decline reflects customers choosing to pay with higher compensating
balances, which benefits net interest income, partially offset by new business.
On an invoiced services basis, total revenue was up 5% over the second quarter
of 2004 and 4% sequentially as new business wins were driven by new products
such as remote check deposit and global mass payments.
Private client services and asset management revenues continue to
demonstrate solid performance with fees up 8% compared with the second quarter
of 2004 and 1% sequentially. The increase from the second quarter of 2004
primarily reflects growth in fees at Ivy Asset Management. The small sequential
quarter increase reflects seasonally higher private client fees partially
offset by a slight decline in fees at Ivy Asset Management.
Assets under management ("AUM") were $106 billion at June 30, 2005, up
from $93 billion at June 30, 2004 and $104 billion at March 31, 2005. The
sequential increase in AUM was driven by growth in money market, fixed income
and equity classes. Institutional clients represent 69% of AUM while individual
clients equal 31%. AUM at June 30, 2005, are 34% invested in equities, 21% in
fixed income, 15% in alternative investments and the remainder in liquid
assets. Ivy's AUM were $15.3 billion at June 30, 2005, compared with $13.2
billion at June 30, 2004 and $15.6 billion at March 31, 2005. The sequential
quarter decrease in Ivy's AUM reflects net outflows of high-net-worth clients
overseas. Overall performance remains favorable relative to the industry, and
the pipeline remains strong, particularly with the Company's core institutional
investors. To better leverage the growth opportunities in Europe and Asia, Ivy
opened a new office in Tokyo in January and is expanding its presence in
London.
In the second quarter of 2005, noninterest income attributable to foreign
exchange and other trading activities was $51 million, down from $54 million in
the second quarter of 2004 and but up from $47 million in the first quarter of
2005. The year-over-year decline reflects lower volatility in foreign exchange
and lower fixed income trading. On a year-to-date basis, noninterest income
attributable to foreign exchange and other trading activities was $98 million
15
compared with $114 million in 2004 again reflecting lower foreign exchange
volatility and lower fixed-income trading.
Net interest income in the Servicing and Fiduciary businesses segment was
$178 million for the second quarter of 2005, compared with $136 million in the
second quarter of 2004 and $168 million in the first quarter of 2005. The
increase from the second quarter of 2004 is primarily due to increasing spreads
on 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 first quarter of 2005 is primarily due to the expansion of
deposit spreads and increased liquidity generated by custody, clearing and
corporate trust. Average assets for the quarter ended June 30, 2005 were $23.1
billion, compared with $22.9 billion in the second quarter of 2004 and $23.0
billion in the first quarter of 2005. Average assets for the six months ended
June 30, 2005 were $23.1 billion compared with $22.8 billion in the first six
months of 2004. The second quarter of 2005 average deposits were $37.8
billion, compared with $35.5 billion in the second quarter of 2004 and $36.1
billion in the first quarter of 2005. The sequential quarter increase in
deposits reflects customers leaving higher compensating balances as well as
increased activity in securities servicing. Average deposits for the six
months of 2005 were $37.0 billion compared with $35.3 billion in 2004.
Net charge-offs in the Servicing and Fiduciary Businesses segment were $5
million in the second quarter of 2005, compared with zero in the second quarter
of 2004 and zero in the first quarter of 2005. On a year-to-date basis, net
charge-offs were $5 million compared with $5 million in 2004. Nonperforming
assets were $1 million at June 30, 2005, compared with $3 million at June 30,
2004 and $1 million at March 31, 2005.
Noninterest expense for the second quarter of 2005 was $872 million,
compared with $791 million in the second quarter of 2004 and $849 million in
the first quarter of 2005. The increases in noninterest expense from second
quarter of 2004 reflects staffing costs associated with new business, the
Company's continued investment in technology and business continuity, and
increased pension and stock option expense. The sequential quarter increase
reflects higher staffing and incentives tied to improved revenues as well
as higher stock option expense. Noninterest expense for the first six months
of 2005 was $1,721 million compared with $1,570 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
2Q05 vs. 2Q05 vs. --------------- Inc/
(In millions) 2Q05 1Q05 2Q04 1Q05 2Q04 2005 2004 (Dec)
-------- -------- -------- -------- -------- ------- ------- -------
Net Interest Income $ 87 $ 87 $ 86 -% 1% $ 174 $ 174 -%
Provision for
Credit Losses 18 18 15 - 20 36 35 3
Noninterest Income 91 81 75 12 21 172 146 18
Noninterest Expense 59 57 58 4 2 116 115 1
Income Before Taxes 101 93 88 9 15 194 170 14
Average Assets $ 17,271 $ 17,534 $ 17,000 (1) 2 $17,402 $17,333 -
Average Deposits 5,653 5,528 6,345 2 (11) 5,591 6,573 (15)
Nonperforming Assets 126 177 293 (29) (57) 126 293 (57)
Net Charge-offs - 5 9 (100) (100) 5 20 (75)
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
16
corporate credit exposure to $24 billion by December 31, 2004. This goal was
accomplished in early 2004 and exposures have since declined to $22.7 billion.
In the second quarter of 2005, pre-tax income was $101 million, compared
with $88 million in the second quarter of 2004 and $93 million in the first
quarter of 2005. The improvement in results primarily reflects higher
noninterest income. On a year-to-date basis, pre-tax income was $194 million
compared with $170 million in 2004 again reflecting higher noninterest income.
The Corporate Banking segment's net interest income was $87 million in the
second quarter of 2005, compared with $86 million in the second quarter of 2004
and $87 million in the first quarter of 2005. On a year-to-date basis, net
interest income was $174 million, unchanged from the first six months of 2004.
Average assets for the quarter were $17.3 billion, compared with $17.0 billion
in the second quarter of last year and $17.5 billion in the first quarter of
2005. Average assets for the six months of 2005 were $17.4 billion compared
with $17.3 billion in 2004. Average deposits in the Corporate Banking segment
were $5.7 billion versus $6.3 billion in second quarter of 2004 and $5.5
billion in the first quarter of 2005. On a year-to-date basis, average deposits
were $5.6 billion compared with $6.6 billion.
The second quarter of 2005 provision for credit losses was $18 million,
compared with $15 million in the second quarter of last year and $18 million in
the first quarter of 2005. On a year-to-date basis, provision for credit losses
was $36 million compared with $35 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 zero in the second quarter of 2005, $9
million in the second quarter of 2004, and $5 million in the first quarter of
2005. Net charge-offs for the six months of 2005 were $5 million compared with
$20 million in 2004. Nonperforming assets were $126 million at June 30, 2005,
down from $293 million at June 30, 2004 and $177 million at March 31, 2005.
The decrease in nonperforming assets from the second quarter of 2004 primarily
reflects paydowns and charge-offs of commercial loans.
Noninterest income was $91 million in the current quarter, compared with
$75 million in the second quarter of 2004 and $81 million in the first quarter
of 2005. On a year-to-date basis, noninterest income was $172 million compared
with $146 million in 2004. The increases reflect higher gains on asset
dispositions, higher capital markets fees and higher income from Wing Hang
Bank.
Noninterest expense in the second quarter was $59 million, compared with
$58 million in the second quarter of 2004 and $57 million in the first quarter
of 2005. On a year-to-date basis, noninterest expense was $116 million compared
with $115 million in 2004. The increases reflect higher compensation costs.
17
Retail Banking
--------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
2Q05 vs. 2Q05 vs. --------------- Inc/
(In millions) 2Q05 1Q05 2Q04 1Q05 2Q04 2005 2004 (Dec)
-------- -------- -------- -------- -------- ------- ------- -------
Net Interest Income $ 131 $ 128 $ 124 2% 6% $ 259 $ 241 7%
Provision for Credit
Losses 5 5 5 - - 10 10 -
Noninterest Income 27 26 28 4 (4) 53 57 (7)
Noninterest Expense 99 98 94 1 5 197 187 5
Income Before Taxes 54 51 53 6 2 105 101 4
Average Assets $ 6,071 $ 6,105 $ 5,317 (1) 14 $ 6,088 $ 5,347 14
Average Noninterest
Bearing Deposits 5,510 5,499 5,209 - 6 5,505 5,118 8
Average Deposits 15,125 15,015 15,162 1 - 15,070 14,985 1
Nonperforming Assets 13 14 15 (7) (13) 13 15 (13)
Net Charge-offs 6 5 5 20 20 11 11 -
Number of Branches 341 341 341 - - 341 341 -
Number of ATMs 376 375 379 - (1) 376 379 (1)
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 stable results in
spite of increased competition in the New York metropolitan area. In the
second quarter of 2005, pre-tax income was $54 million, compared with $53
million in the second quarter of 2004 and $51 million in the first quarter of
2005. On a year-to-date basis, pre-tax income was $105 million compared with
$101 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 second quarter of 2005 was $131 million,
compared with $124 million in the second quarter of 2004 and $128 million in
the first quarter of 2005. Net interest income has increased over the second
quarter of 2004 and on a sequential quarter basis as rates have risen,
benefiting spreads. The increase in average assets and noninterest-bearing
deposits since the second quarter of 2004 has also contributed to the increase
in net interest income. On a year-to-date basis, net interest income was $259
million compared with $241 million in 2004 reflecting the same factor discussed
above.
Noninterest income was $27 million for the quarter, compared with $28
million in the second quarter of last year and $26 million in the first quarter
of 2005. On a year-to-date basis, noninterest income was $53 million compared
with $57 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 second quarter of 2005 was $99 million,
compared with $94 million last year and $98 million in the first quarter of
2005. The increase from the second quarter of 2004 reflects higher
compensation and technology costs. For the six months of 2005, noninterest
expense was $197 million compared with $187 million in 2004.
Net charge-offs were $6 million in the second quarter of 2005, compared
with $5 million in the second quarter of 2004 and $5 million in the first
quarter of 2005. For the six months of 2005, net charge-offs were $11 million,
unchanged from a year ago. Nonperforming assets were $13 million at June 30,
2005, compared with $15 million at June 30, 2004 and $14 million at March 31,
2005.
18
Average deposits generated by the Retail Banking segment were $15.1
billion in the second quarter of 2005, compared with $15.2 billion in the
second quarter of 2004 and $15.0 billion in the first quarter of 2005. For the
six months of 2005, average deposits were $15.1 billion compared with $15.0
billion in 2004. Average assets in the Retail Banking sector were $6.1 billion,
compared with $5.3 billion in the second quarter of 2004 and $6.1 billion in
the first quarter of 2005. On a year-to-date basis, average assets were $6.1
billion compared with $5.3 billion in 2004. The year-over-year increase in
average assets is due to higher mortgage lending.
Financial Markets
-----------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
2Q05 vs. 2Q05 vs. --------------- Inc/
(In millions) 2Q05 1Q05 2Q04 1Q05 2Q04 2005 2004 (Dec)
------- ------- ------- -------- -------- ------- ------- -------
Net Interest Income $ 70 $ 68 $ 77 3% (9)%$ 138 $ 158 (13)%
Provision for
Credit Losses 6 5 5 20 20 11 10 10
Noninterest Income 49 46 42 7 17 95 91 4
Noninterest Expense 34 33 27 3 26 67 54 24
Income Before Taxes 79 76 87 4 (9) 155 185 (16)
Average Assets $49,741 $48,370 $51,036 3 (3) $49,059 $50,390 (3)
Average Deposits 4,137 3,964 5,460 4 (24) 4,051 4,662 (13)
Average Investment
Securities 24,719 23,540 22,885 5 8 24,133 22,893 5
Net Charge-offs - - 10 - (100) - 14 (100)
In the second quarter of 2005, pre-tax income was $79 million, compared
with $87 million a year ago and $76 million in the first quarter of 2005. On a
year-to-date basis, pre-tax income was $155 million, down 16% from $185 million
in 2004. The decreases over the second quarter and year-to-date 2004 are
primarily due to a decline in net interest income.
Net interest income for the second quarter was $70 million compared with
$77 million a year ago and $68 million for the first quarter of 2005. The
decrease from the second quarter of 2004 reflects the rising rate environment,
which increased funding costs. The increase from the first quarter of 2005
primarily reflects an additional day in the quarter. On a year-to-date basis,
net interest income was $138 million, down 13% from $158 million in 2004. The
decrease primarily reflects the rising rate environment and a decline in
average assets. Average second quarter 2005 assets in the Financial Markets
segment, composed primarily of short-term liquid assets and investment
securities, were $49.7 billion, compared with $51.0 billion in the second
quarter last year and $48.4 billion on a sequential quarter basis. Average
assets for the first six months of 2005 was $49.1 billion, compared to $50.4
billion for the first six months of 2004. The decrease in average assets on a
year-over-year basis reflects a decline in liquid assets, which were reduced to
fund asset growth in other segments. 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.
Noninterest income was $49 million in the second quarter of 2005, compared
with $42 million in the second quarter of 2004 and $46 million in the first
quarter of 2005. On a year-to-date basis, noninterest income was $95 million
in 2005 compared with $91 million in 2004. The positive variances reflect
stronger fixed income trading results.
Net charge-offs were zero in the second quarter of 2005, compared with $10
million a year ago and zero in the first quarter of 2005. For the first half
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 $34 million in the second quarter of 2005,
compared with $27 million in last year's second quarter and $33 million in the
first quarter of 2005. On a year-to-date basis, noninterest expense was $67
million for 2005 compared with $54 million for 2004. The increases over the
second quarter and year-to-date 2004 are attributable to higher employee
incentive compensation and technology expenses.
19
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
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
March 31, 2005 Businesses Banking Banking Markets Items Total
-------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 168 $ 87 $ 128 $ 68 $ 4 $ 455
Provision for Credit Losses 1 18 5 5 (39) (10)
Noninterest Income 1,025 81 26 46 - 1,178
Noninterest Expense 849 57 98 33 40 1,077
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 343 $ 93 $ 51 $ 76 $ 3 $ 566
========== ========= ========= ========= =========== ============
Contribution Percentage 61% 16% 9% 14%
Average Assets $ 22,987 $ 17,534 $ 6,105 $ 48,370 $ 4,246 $ 99,242
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2004 Businesses Banking Banking Markets Items Total
-------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 136 $ 86 $ 124 $ 77 $ (2) $ 421
Provision for Credit Losses 1 15 5 5 (16) 10
Noninterest Income 994 75 28 42 17 1,156
Noninterest Expense 791 58 94 27 42 1,012
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 338 $ 88 $ 53 $ 87 $ (11) $ 555
========== ========= ========= ========= =========== ============
Contribution Percentage 60% 16% 9% 15%
Average Assets $ 22,891 $ 17,000 $ 5,317 $ 51,036 $ 4,129 $ 100,373
20
(Dollars in millions)
Servicing
and
For the Six Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2005 Businesses Banking Banking Markets Items Total
------------------------ ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 346 $ 174 $ 259 $ 138 $ 8 $ 925
Provision for
Credit Losses 2 36 10 11 (64) (5)
Noninterest Income 2,084 172 53 95 30 2,434
Noninterest Expense 1,721 116 197 67 99 2,200
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 707 $ 194 $ 105 $ 155 $ 3 $ 1,164
========== ========= ========= ========= =========== ============
Contribution Percentage 61% 17% 9% 13%
Average Assets $ 23,051 $ 17,402 $ 6,088 $ 49,059 $ 4,255 $ 99,855
Servicing
and
For the Six Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2004 Businesses Banking Banking Markets Items Total
------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 268 $ 174 $ 241 $ 158 $ (152) $ 689
Provision for
Credit Losses 1 35 10 10 (34) 22
Noninterest Income 1,984 146 57 91 98 2,376
Noninterest Expense 1,570 115 187 54 99 2,025
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 681 $ 170 $ 101 $ 185 $ (119) $ 1,018
========== ========= ========= ========= =========== ============
Contribution Percentage 60% 15% 9% 16%
Average Assets $ 22,831 $ 17,333 $ 5,347 $ 50,390 $ 4,125 $ 100,026
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:
2nd 1st
Segment Quarter Quarter Year-to-date
--------- --------- ------------
(In millions) 2004 2004 2004
----------------------- --------- --------- ------------
Servicing and Fiduciary $ (35) $ (30) $ (65)
Corporate Banking (5) (5) (10)
Retail Banking (1) (6) (7)
Financial Markets (5) 1 (4)
---------- --------- -----------
Subtotal (46) (40) (86)
Reconciling 46 40 86
---------- --------- -----------
Total $ - $ - $ -
========== ========= ===========
22
The detail of reconciling items for 2005 and 2004 are presented in the
following table.
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
-------- -------- -------- -----------------
(In millions) 2005 2005 2004 2005 2004
-------- -------- -------- -------- --------
Segments' Revenue $ 1,691 $ 1,629 $ 1,562 $ 3,320 $ 3,119
Adjustments:
Earnings Associated with
Assignment of Capital (8) (9) (15) (17) (35)
Securities Gains 10 - - 10 19
SFAS 13 Cumulative
Lease Adjustment - - - - (145)
Taxable Equivalent Basis and
Other Tax-Related Items 12 13 12 25 27
Other 21 - 18 21 80
-------- -------- -------- -------- --------
Subtotal-Revenue Adjustments 35 4 15 39 (54)
-------- -------- -------- -------- --------
Consolidated Revenue $ 1,726 $ 1,633 $ 1,577 $ 3,359 $ 3,065
======== ======== ======== ======== ========
Segments' Income Before Tax $ 597 $ 563 $ 566 $ 1,160 $ 1,137
Adjustments:
Revenue Adjustments (Above) 35 4 15 39 (54)
Provision for Credit Losses
Different than GAAP 25 39 16 64 34
Severance (4) (1) (1) (5) (12)
Goodwill and
Intangible Amortization (10) (8) (8) (18) (16)
Lease Termination - - - - (8)
Corporate Overhead and Other (45) (31) (33) (76) (63)
-------- -------- -------- -------- --------
Consolidated Income
Before Tax $ 598 $ 566 $ 555 $ 1,164 $ 1,018
======== ======== ======== ======== ========
Segments' Total
Average Assets $ 96,197 $ 94,996 $ 96,244 $ 95,600 $ 95,901
Adjustments:
Goodwill and Intangibles 4,264 4,246 4,129 4,255 4,125
-------- -------- -------- -------- --------
Consolidated Average Assets $100,461 $ 99,242 $100,373 $ 99,855 $100,026
======== ======== ======== ======== ========
In addition to the recurring items discussed above, other significant
items may be included as reconciling items. 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
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
23
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 June 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 $36 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 $60 million, while if each
pass credit were rated one grade worse, the allowance would have increased by
$93 million.
For higher risk rated credits, if the loss given default were 10% worse,
the allowance would have increased by $2 million, while if the loss given
default were 10% better, the allowance would have decreased by $30 million.
For impaired credits, if the fair value of the loans were 10% higher or
lower, the allowance would have increased or decreased by $9 million,
respectively.
24
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 footnote one "Summary of Significant Accounting and
Reporting Policies" in the Company's 2004 Annual Report on Form 10-K.
To assist in assessing the impact of a change in valuation, at June 30,
2005, approximately $2.7 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 $67
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 ($3,492 million
at June 30, 2005) and indefinite-lived intangible assets ($370 million at June
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-lived intangible assets are
evaluated for impairment at least annually by comparing their fair value to
their carrying value.
Other identifiable intangible assets ($415 million at June 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:
25
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 four 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 $4.3
billion of goodwill and intangible assets at June 30, 2005. The impact of a
5% impairment charge would result in a change of pre-tax income of
approximately $214 million.
Pension Accounting
------------------
The Company has defined benefit 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") which 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.
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
26
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. In 2005, the Company expects the market-related value
of plan assets to decline as the extraordinary actual return in 2000 is
replaced with a more modest return.
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.
In 2005, based on the Company's review of changes in prospective
assumptions, the amortization of unrecognized pension losses and the
anticipated decline in the market-related value of plan assets, the pre-tax
U.S. pension credit is expected to decline by approximately $48 million.
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 $103.1 billion at June 30, 2005, compared with $97.5
billion at June 30, 2004 and $96.5 billion at March 31, 2005. The increase in
assets from March 31, 2005 reflects increased loans to securities industry
customers. Total shareholders' equity was $9.5 billion at June 30, 2005,
compared with $8.8 billion at June 30, 2004 and $9.3 billion at March 31,
2005. In comparison to the first quarter of 2005, shareholders' equity
reflects the retention of earnings and an increase in the securities valuation
allowance partially offset by the repurchase of common stock. The major reason
for the increase in shareholders' equity from a year ago is the retention of
earnings.
Return on average common equity for the second quarter of 2005 was
17.12%, compared with 17.14% in the second quarter of 2004 and 16.52% in the
first quarter of 2005. For the first six months of 2005, return on average
common equity was 16.82% compared with 17.15% in 2004.
Return on average assets for the second quarter of 2005 was 1.59%,
compared with and 1.49% in the second quarter of 2004 and 1.55% in the first
quarter of 2005. For the first six months of 2005, return on average assets
was 1.57% compared with 1.48% in 2004.
Investment Securities
---------------------
The table below shows the distribution of the Company's securities
portfolio:
Investment Securities (at Fair Value)
(In millions) 06/30/05 12/31/04
---------- ----------
Fixed Income:
Mortgage-Backed Securities $ 20,928 $ 19,393
Asset-Backed Securities 29 -
Corporate Debt 1,181 1,259
Short-Term Money Market Instruments 1,000 982
U.S. Treasury Securities 227 403
U.S. Government Agencies 623 505
State and Political Subdivisions 231 197
Emerging Market Debt (Collateralized
By U.S. Treasury Zero Coupon Obligations) 116 107
Other Foreign Debt 497 545
---------- ----------
Subtotal Fixed Income 24,832 23,391
Equity Securities:
Money Market Funds 931 388
Other 12 10
---------- ----------
Subtotal Equity Securities 943 398
---------- ----------
Total Securities $ 25,775 $ 23,789
========== ==========
Total investment securities were $25.8 billion at June 30, 2005, compared
with $23.9 billion at March 31, 2005. Average investment securities were
$24.7 billion in the second quarter of 2005, compared with $22.9 billion in
the second quarter of last year and $23.5 billion in the first 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 June 30, 2005
was approximately 1.4 years.
Net unrealized gains for securities available-for-sale were $60 million
at June 30, 2005, compared with net unrealized gains of $14 million at June
28
30, 2004 and net unrealized losses of $51 million at March 31, 2005. The
change in unrealized gains at June 30, 2005 from March 31, 2005 reflects the
decline 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
----- ---------- ------ ----- ---------- ------ ----- ---------- ------
June 30, 2005 $40.7 $ 34.6 $ 6.1 $39.2 $ 32.9 $ 6.3 $39.0 $ 32.6 $ 6.4
December 31, 2004 35.8 29.7 6.1 39.4 33.0 6.4 37.8 31.5 6.3
June 30, 2004 38.2 32.1 6.1 37.7 31.2 6.5 37.0 30.7 6.3
Total loans were $40.7 billion at June 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 $39.2 billion in the second quarter of
2005, compared with $37.7 billion in the second quarter of 2004 while for the
six months ended June 30, 2005, average loans were $39.0 billion compared with
$37.0 billion for June 30, 2004. The increase in average loans from June 30,
2004 results from increased lending to financial institutions.
The following tables provide additional details on the Company's credit
exposures and outstandings at June 30, 2005 in comparison to December 31,
2004.
Overall Loan Portfolio
----------------------
Unfunded Total Unfunded Total
(In billions) Loans Commitments Exposure Loans Commitments Exposure
---------------------------- ----------------------------
06/30/05 06/30/05 06/30/05 12/31/04 12/31/04 12/31/04
-------- -------- -------- -------- -------- --------
Financial Institutions $ 13.8 $ 22.1 $ 35.9 $ 9.5 $ 21.6 $ 31.1
Corporate 3.6 19.1 22.7 3.6 19.4 23.0
-------- -------- -------- -------- -------- --------
17.4 41.2 58.6 13.1 41.0 54.1
-------- -------- -------- -------- -------- --------
Consumer & Middle Market 9.5 4.6 14.1 8.9 4.5 13.4
Leasing Financings 5.7 0.1 5.8 5.6 - 5.6
Commercial Real Estate 2.0 1.4 3.4 2.1 1.2 3.3
Margin loans 6.1 - 6.1 6.1 - 6.1
-------- -------- -------- -------- -------- --------
Total $ 40.7 $ 47.3 $ 88.0 $ 35.8 $ 46.7 $ 82.5
======== ======== ======== ======== ======== ========
29
Financial Institutions
----------------------
The financial institutions portfolio exposure was $35.9 billion at June
30, 2005 compared to $31.1 billion at December 31, 2004. These exposures are
of high quality with 83% meeting the investment grade criteria of the
Company's rating system. These exposures are generally short-term, with 78%
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)
June 30, 2005 December 31, 2004
--------------------------- ----- ----- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Banks $ 5.1 $ 3.9 $ 9.0 68% 90% $ 4.2 $ 3.5 $ 7.7
Securities Industry 3.6 3.3 6.9 80 94 1.5 3.0 4.5
Insurance 0.5 4.8 5.3 94 44 0.5 4.8 5.3
Government 0.1 4.7 4.8 98 71 - 5.0 5.0
Asset Managers 4.2 3.6 7.8 83 82 3.0 3.8 6.8
Mortgage Banks 0.3 0.7 1.0 80 64 0.2 0.7 0.9
Endowments 0.1 1.0 1.1 99 47 0.1 0.8 0.9
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $13.9 $ 22.0 $ 35.9 83% 78% $ 9.5 $ 21.6 $ 31.1
===== =========== ========= ===== ===== ===== =========== =========
Corporate
---------
The corporate portfolio exposure declined to $22.7 billion at June 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)
June 30, 2005 December 31, 2004
--------------------------- ----- ----- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Media $ 1.2 $ 2.1 $ 3.3 61% 10% $ 0.9 $ 2.2 $ 3.1
Cable 0.5 0.4 0.9 36 - 0.6 0.4 1.0
Telecom 0.1 0.5 0.6 83 13 0.1 0.5 0.6
----- ----------- --------- ----- ----- ----- ----------- ---------
Subtotal 1.8 3.0 4.8 59% 8% 1.6 3.1 4.7
Energy 0.4 4.6 5.0 86 10 0.4 4.4 4.8
Retailing 0.1 2.3 2.4 77 27 0.1 2.1 2.2
Automotive 0.1 1.0 1.1 46 33 0.1 1.7 1.8
Healthcare 0.2 1.5 1.7 84 17 0.3 1.5 1.8
Other* 1.1 6.6 7.7 78 23 1.1 6.6 7.7
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $ 3.7 $ 19.0 $ 22.7 74% 18% $ 3.6 $ 19.4 $ 23.0
===== =========== ========= ===== ===== ===== =========== =========
* Diversified portfolio of industries and geographies
The Company had previously targeted the telecom exposure for reduction to
a total of $750 million by December 31, 2004. This goal was accomplished in
the first quarter of 2004 and exposures have since declined to $590 million.
The percentage of investment grade borrowers in the telecom portfolio was 83%
compared with 77% at year-end 2004.
The Company's exposure to the airline industry consists of a $471 million
leasing portfolio (including a $15 million real estate lease exposure). The
airline leasing portfolio consists of $250 million to major U.S. carriers,
$132 million to foreign airlines and $89 million to U.S. regionals.
During the second 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
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
30
allowance for loan losses against these exposures and to closely monitor the
portfolio.
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) 6/30/05 03/31/05 12/31/04 9/30/04 6/30/04
--------------------- --------------------------------------------------
AAA to AA- 68% 74% 68% 68% 70%
A+ to A- 15 13 19 21 16
BBB+ to BBB- 14 10 10 8 11
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
6/30/05 vs. Inc/
(Dollars in millions) 6/30/05 3/31/05 3/31/05 (Dec)
--------- --------- ----------- --------
Loans:
Commercial $ 78 $ 124 $ (46) (37)%
Foreign 15 19 (4) (21)
Other 47 49 (2) (4)
--------- --------- -----------
Total Nonperforming Loans 140 192 (52) (27)
Other Real Estate - - - -
--------- --------- -----------
Total Nonperforming Assets $ 140 $ 192 $ (52) (27)
========= ========= ===========
Nonperforming Assets Ratio 0.4% 0.6%
Allowance for Loan
Losses/Nonperforming Loans 400.5 304.0
Allowance for Loan
Losses/Nonperforming Assets 400.5 304.0
Total Allowance for Credit
Losses/Nonperforming Loans 506.1 373.4
Total Allowance for Credit
Losses/Nonperforming Assets 506.1 373.4
Nonperforming assets declined by $52 million, or 27%, during the second
quarter of 2005 to $140 million and are down 55% from a year ago. The
sequential quarter decrease primarily reflects the disposition of a $36
million loan to a retailer as well as charge-offs. The ratio of the total
allowance for credit losses to nonperforming assets increased to 506.1% at
June 30, 2005, compared with 249.1% at June 30, 2004 and 373.4% at March 31,
2005.
31
Activity in Nonperforming Assets
(In millions) Quarter End Year-to-date
June 30, 2005 June 30, 2005
------------------ ------------------
Balance at Beginning of Period $ 192 $ 214
Additions 3 6
Charge-offs (6) (12)
Paydowns/Sales (49) (68)
------------------ ------------------
Balance at End of Period $ 140 $ 140
================== ==================
Interest income would have been increased by $1 million and $3 million
for the second quarters of 2005 and 2004 if loans on nonaccrual status at June
30, 2005 and 2004 had been performing for the entire period. On a year-to-
date basis, interest income would have increased by $2 million and $7 million
for 2005 and 2004 had loans on nonaccrual status at June 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:
June 30, March 31, June 30,
(In millions) 2005 2005 2004
------------ ----------- ----------
Impaired Loans with an Allowance $ 55 $ 68 $ 168
Impaired Loans without an Allowance(1) 64 103 121
------------ ----------- ----------
Total Impaired Loans $ 119 $ 171 $ 289
============ =========== ==========
Allowance for Impaired Loans(2) $ 30 $ 34 $ 69
Average Balance of Impaired Loans
during the Quarter $ 145 $ 182 $ 305
Interest Income Recognized on
Impaired Loans during the Quarter $ 1.6 $ 2.2 $ 0.6
(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.
Allowance
---------
June 30, March 31, June 30,
(Dollars in millions) 2005 2005 2004
------------ ----------- ----------
Margin Loans $ 6,055 $ 6,038 $ 6,114
Non-Margin Loans 34,626 32,726 32,091
------------ ----------- ----------
Total Loans $ 40,681 $ 38,764 $ 38,205
============ =========== ==========
Allowance for Loan Losses $ 562 $ 583 $ 598
Allowance for Lending-Related
Commitments 148 133 177
------------ ----------- ----------
Total Allowance for Credit Losses $ 710 $ 716 $ 775
============ =========== ==========
Allowance for Loan Losses As a
Percent of Total Loans 1.38% 1.50% 1.57%
Allowance for Loan Losses As a
Percent of Non-Margin Loans 1.62 1.78 1.86
Total Allowance for Credit Losses
As a Percent of Total Loans 1.75 1.85 2.03
Total Allowance for Credit Losses
As a Percent of Non-Margin Loans 2.05 2.19 2.42
32
The total allowance for credit losses was $710 million, or 1.75% of total
loans at June 30, 2005, compared with $775 million, or 2.03% of total loans at
June 30, 2004 and $716 million, or 1.85% of total loans at March 31, 2005.
The Company has $6.1 billion of secured margin loans on its balance sheet
at June 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 2.05% at June 30, 2005, compared with 2.42% at June 30, 2004, and
2.19% at March 31, 2005, reflecting continued improvement in the credit
quality in the second quarter of 2005.
Nonperforming assets declined another 27% this quarter, and have declined
by 55% from a year ago. The Company's criticized and classified exposures
continued to show improvement on a risk weighted basis versus the first
quarter of 2005 and a year ago.
The ratio of the allowance for loan losses to nonperforming assets was
400.5% at June 30, 2005, up from 192.2% at June 30, 2004, and 304.0% at March
31, 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
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.
33
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:
June 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.
Deposits
--------
Total deposits were $64.0 billion at June 30, 2005, compared with $61.1
billion at June 30, 2004 and $59.0 billion at March 31, 2005. The increase on
a sequential quarter basis was primarily due to higher market activity levels,
which resulted in a higher level of customer deposits at quarter end.
Noninterest-bearing deposits were $18.5 billion at June 30, 2005, compared
with $17.4 billion at December 31, 2004. Interest-bearing deposits were $45.5
billion at June 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,
34
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 $14.7 billion on an
average basis for the first six months of 2005 and 2004. Average foreign
deposits, primarily from the Company's European based securities servicing
business, were $25.9 billion and $26.2 billion at June 30, 2005 and 2004.
Domestic savings and other time deposits were $9.8 billion on a year-to-date
average basis at June 30, 2005 compared to $10.2 billion at June 30, 2004.
Average payables to customers and broker-dealers decreased to $6.2 billion
from $6.9 billion. Long-term debt averaged $7.0 billion and $6.2 billion at
June 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 June 30 2005, the Bank can pay dividends of approximately $485 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 $268 million. These assets could be liquidated and the proceeds
delivered by dividend or loan to the Parent.
For the quarter ended June 30, 2005, the Parent's quarterly average
commercial paper borrowings were $222 million compared with $75 million in
2004. At June 30, 2005, the Parent had cash of $858 million compared with
cash of $631 million at June 30, 2004 and $739 million at March 31, 2005. Net
of commercial paper outstanding, the Parent's cash position at June 30, 2005
was down $121 million compared with June 30, 2004.
The Parent has a back-up line of credit of $275 million with 15 financial
institutions. This line of credit matures in October 2006. There were no
borrowings under the line of credit at June 30, 2005 and June 30, 2004.
The Parent also has the ability to access the capital markets. At June
30, 2005, the Parent had a shelf registration statement with a capacity of
$1.8 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 June 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 June 30, 2005 and $225 million of long-term debt that is due in
2006. In addition, at June 30, 2005, the Parent has the option to call $231
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
35
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 June 30, 2005 and 2004 was 102.3% and 98.63%. 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
second 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 $31 million, in aggregate, during the second 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 second 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 $144 million, in aggregate, during the second 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 $0.7 billion for the first
six months of 2005, compared with $3.4 billion provided by operating
activities through June 30, 2004. The use of funds from operations in 2005
was principally the result of changes in trading activities. The sources of
cash flows from operations in 2004 were principally the result of changes in
trading and net income.
In the first six months of 2005, cash used for investing activities was
$8.3 billion as compared to cash used for investing activities in the first
six months of 2004 of $8.4 billion. In the first six 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 federal funds purchased and securities sold under resale
agreements were the primary use of funds in 2004.
Through June 30, 2005, cash provided by financing activities was $7.8
billion, compared to $4.4 billion in the first six months of 2004. Sources of
funds in 2005 include deposits, other borrowed funds, and the issuance of
long-term debt. Deposits and other borrowed funds were the primary source of
funds in 2004.
36
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 June 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:
June 30, 2005 June 30, 2004 Well Adequately
------------------ ------------------ Company Capitalized Capitalized
Company Bank Company Bank Targets Guidelines Guidelines
--------- ------- --------- ------- ---------- ----------- -----------
Tier 1* 8.07% 8.48% 7.70% 7.32% 7.75% 6% 4%
Total Capital** 12.49 11.74 11.63 11.36 11.75 10 8
Leverage 6.55 6.92 6.00 5.70 5 3-5
Tangible Common
Equity ("TCE") 5.26 6.19 4.95 5.31 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 second quarter of 2005 the Company retained $244 million of
earnings. Also in the quarter the Company issued $83 million subordinated debt
qualifying as Tier II capital. In July 2005, the Company raised its quarterly
common stock dividend by 5% to 21 cents per share. During the second quarter,
the Company bought back 7.6 million shares and in July 2005 announced a new
buyback program of 20 million shares. Buyback activity during the remainder of
2005 will depend on a variety of factors including acquisitions and other
balance sheet demands. The Company bought back 2 million shares in July 2005.
The Company's regulatory Tier 1 capital and Total capital ratios were
8.07% and 12.49% at June 30, 2005, compared with 7.70% and 11.63% at June 30,
2004, and 8.13% and 12.54% at March 31, 2005. The regulatory leverage ratio
was 6.55% at June 30, 2005, compared with 6.00% at June 30, 2004 and 6.56% at
March 31, 2005. The Company's tangible common equity as a percentage of total
assets was 5.26% at June 30, 2005, compared with 4.95% at June 30, 2004 and
5.48% at March 31, 2005. The increase in the tangible common equity ratio
compared with June 30, 2004 reflects the retention of earnings to restore the
capital ratio to its target level following the Pershing acquisition. The
decline in the tangible common equity ratio from March 31, 2005 reflects an
elevated balance sheet at June 30, which reduced the ratio by about 25 basis
points. This 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 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
Footnotes to the Consolidated Financial Statements.
The following table presents the components of the Company's risk-based
capital at June 30, 2005 and 2004:
(In millions) 2005 2004
------- -------
Common Stock $ 9,422 $ 8,777
Preferred Stock - -
Preferred Trust Securities 1,150 1,150
Adjustments: Intangibles (4,273) (4,159)
Securities Valuation Allowance - -
Merchant Banking Investments (6) (5)
------- -------
Tier 1 Capital 6,293 5,763
------- -------
Qualifying Unrealized Equity Security Gains - -
Qualifying Subordinated Debt 2,743 2,174
Qualifying Allowance for Loan Losses 709 763
------- -------
Tier 2 Capital 3,452 2,937
------- -------
Total Risk-based Capital $9,745 $ 8,700
======= =======
Risk-Adjusted Assets $78,003 $74,809
======= =======
38
TRADING ACTIVITIES
The fair value and notional amounts of the Company's financial
instruments held for trading purposes at June 30, 2005 and 2004 are as
follows:
June 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 $ 32,949 $ - $ - $ - $ 5
Swaps 249,997 1,809 923 1,677 831
Written Options 182,793 - 1,425 - 1,337
Purchased Options 143,793 274 - 229 -
Foreign Exchange Contracts:
Swaps 3,520 - - - -
Written Options 5,732 - 18 - 24
Purchased Options 7,214 32 - 70 -
Commitments to Purchase
and Sell Foreign Exchange 75,276 582 545 515 546
Debt Securities - 3,824 83 3,372 245
Credit Derivatives 1,708 1 4 2 7
Equities 2,023 110 90 126 116
------ ----------- ------ -----------
Total Trading Account $6,632 $ 3,088 $5,991 $ 3,111
====== =========== ====== ===========
June 30, 2004 2004 Average
--------------------------- ------------------
Notional Fair Value Fair Value
------------------ ------------------
Trading Account Amount Assets Liabilities Assets Liabilities
--------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 58,295 $ - $ 15 $ - $ 39
Swaps 208,624 1,816 853 1,282 201
Written Options 169,638 - 1,178 - 1,183
Purchased Options 100,969 206 - 99 -
Foreign Exchange Contracts:
Swaps 2,806 - - - -
Written Options 8,732 - 15 - 21
Purchased Options 10,783 50 - 51 -
Commitments to Purchase
and Sell Foreign Exchange 67,333 286 316 206 242
Debt Securities - 952 74 2,064 83
Credit Derivatives 1,562 2 3 2 7
Equities 1,602 150 122 158 112
------ ----------- ------ -----------
Total Trading Account $3,462 $ 2,576 $3,862 $ 1,888
====== =========== ====== ===========
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) 2nd Quarter 2005 Year-to-date 2005
--------------------------- --------------------------- --------
Average Minimum Maximum Average Minimum Maximum 6/30/05
------- ------- ------- ------- ------- ------- --------
Interest rate $ 2.7 $ 1.9 $ 4.6 $ 2.8 $ 1.9 $ 4.6 $ 2.3
Foreign Exchange 2.8 1.6 4.1 1.9 0.4 4.1 2.3
Equity 0.6 0.3 1.0 0.7 0.3 1.1 0.4
Credit Derivatives 1.8 1.5 2.1 1.7 1.5 2.1 1.8
Diversification (1.4) NM NM (1.4) NM NM (1.0)
Overall Portfolio 6.5 3.8 9.1 5.7 3.7 9.1 5.8
2nd Quarter 2004 Year-to-date 2004
--------------------------- --------------------------- --------
Average Minimum Maximum Average Minimum Maximum 6/30/04
------- ------- ------- ------- ------- ------- --------
Interest rate $ 5.2 $ 3.0 $ 7.8 $ 4.8 $ 2.2 $ 7.8 $ 3.0
Foreign Exchange 1.0 0.4 3.1 1.0 0.4 3.1 2.3
Equity 1.6 1.4 2.4 1.4 0.6 2.4 1.6
Credit Derivatives 1.7 1.6 2.1 1.9 1.6 2.1 1.7
Diversification (1.9) NM NM (1.3) NM NM (3.0)
Overall Portfolio 7.6 5.6 12.8 7.8 4.9 12.8 5.6
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 first half of 2005, interest rate risk generated approximately
39% of average VAR, credit derivatives generated 24% of average VAR, foreign
exchange accounted for 27% of average VAR, and equity generated 10% of average
VAR. During the second quarter and first six 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 6/30/05 3/31/05 12/31/04 9/30/04 6/30/04
--------------------------------------------------
(Dollars in millions) Number of Occurrences
---------------------- --------- --------- --------- ---------- ---------
Less than $(2.5) 0 0 0 0 1
$(2.5)~ $ 0 6 1 6 11 11
$ 0 ~ $ 2.5 40 50 49 48 32
$ 2.5 ~ $ 5.0 16 11 8 5 17
More than $5.0 2 0 0 0 3
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) June 30, 2005 March 31, 2005
$ % $ %
--------- -------- ---------- ------
+200 bp Ramp vs. Stable Rate $ (15) (0.74)% $ 5 0.26%
+100 bp Ramp vs. Stable Rate 4 0.20 10 0.50
-100 bp Ramp vs. Stable Rate (17) (0.84) (25) (1.30)
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 scenario assumes
a steepening of the yield curve with 10-year rates rising 113 basis points.
The 200+ basis point scenario assumes a flattening of the yield curve with 10-
year rates rising only 159 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 June 30, 2005 ended June 30, 2004
---------------------------- ----------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
-------- -------- ------- -------- -------- -------
ASSETS
------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 9,182 $ 67 2.91% $ 12,779 $ 78 2.47%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 5,160 36 2.81 7,340 17 0.92
Margin Loans 6,341 62 3.93 6,495 35 2.18
Loans
Domestic Offices 22,719 261 4.62 22,236 209 3.79
Foreign Offices 10,141 106 4.19 8,947 62 2.80
--------- -------- --------- --------
Non-Margin Loans 32,860 367 4.49 31,183 271 3.50
--------- -------- --------- --------
Securities
U.S. Government Obligations 282 2 3.21 479 3 2.46
U.S. Government Agency Obligations 3,804 38 3.95 4,008 33 3.27
Obligations of States and
Political Subdivisions 211 4 7.24 235 5 7.96
Other Securities 20,422 206 4.04 18,163 158 3.45
Trading Securities 3,416 39 4.62 2,082 9 1.69
--------- -------- --------- --------
Total Securities 28,135 289 4.12 24,967 208 3.30
--------- -------- --------- --------
Total Interest-Earning Assets 81,678 821 4.04% 82,764 609 2.95%
-------- --------
Allowance for Credit Losses (584) (629)
Cash and Due from Banks 2,898 2,842
Other Assets 16,469 15,396
--------- ---------
TOTAL ASSETS $ 100,461 $ 100,373
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 7,075 $ 26 1.48% $ 6,864 $ 12 0.68%
Savings 8,939 24 1.10 9,357 15 0.66
Certificates of Deposit
$100,000 & Over 3,065 24 3.10 3,917 12 1.21
Other Time Deposits 868 5 2.18 953 4 1.60
Foreign Offices 26,332 141 2.14 26,568 83 1.26
--------- -------- --------- --------
Total Interest-Bearing Deposits 46,279 220 1.91 47,659 126 1.06
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,152 7 2.58 1,612 3 0.68
Payables to Customers and Broker-Dealers 5,984 28 1.90 6,813 12 0.69
Other Borrowed Funds 1,954 25 5.11 2,387 9 1.51
Long-Term Debt 7,485 64 3.41 6,139 30 1.92
--------- -------- --------- --------
Total Interest-Bearing Liabilities 62,854 344 2.20% 64,610 180 1.11%
-------- --------
Noninterest-Bearing Deposits 15,260 14,803
Other Liabilities 13,022 12,256
Common Shareholders' Equity 9,325 8,704
--------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 100,461 $ 100,373
========= =========
Net Interest Earnings
and Interest Rate Spread $ 477 1.84% $ 429 1.84%
======== ======= ======== =======
Net Yield on Interest-Earning Assets 2.34% 2.09%
======= =======
42
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the six months For the six months
ended June 30, 2005 ended June 30, 2004
-------------------------- --------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- -------
ASSETS
------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 9,502 $ 138 2.93% $12,235 $ 147 2.41%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 4,989 64 2.57 7,228 33 0.93
Margin Loans 6,374 117 3.70 6,337 69 2.18
Loans
Domestic Offices 22,429 507 4.56 21,655 264 2.46
Foreign Offices 10,221 201 3.97 9,074 125 2.77
-------- -------- -------- --------
Non-Margin Loans 32,650 708 4.37 30,729 389 2.55
-------- -------- -------- --------
Securities
U.S. Government Obligations 320 5 3.12 459 5 2.39
U.S. Government Agency Obligations 3,554 69 3.85 4,154 68 3.25
Obligations of States and
Political Subdivisions 205 7 7.29 241 8 6.73
Other Securities 20,054 392 3.91 18,039 311 3.46
Trading Securities 2,943 61 4.20 2,417 24 1.95
-------- -------- -------- --------
Total Securities 27,076 534 3.95 25,310 416 3.29
-------- -------- -------- --------
Total Interest-Earning Assets 80,591 1,561 3.91% 81,839 1,054 2.59%
-------- --------
Allowance for Credit Losses (586) (654)
Cash and Due from Banks 3,528 2,907
Other Assets 16,322 15,934
-------- --------
TOTAL ASSETS $ 99,855 $100,026
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 6,996 $ 47 1.37% $ 6,736 $ 23 0.68%
Savings 8,920 45 1.02 9,253 31 0.66
Certificates of Deposit
$100,000 & Over 2,973 42 2.85 3,952 24 1.23
Other Time Deposits 883 9 1.97 984 7 1.53
Foreign Offices 25,900 261 2.03 26,201 159 1.22
-------- -------- -------- --------
Total Interest-Bearing Deposits 45,672 404 1.78 47,126 244 1.04
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,270 14 2.18 1,612 5 0.67
Other Borrowed Funds 1,890 38 4.03 2,393 18 1.50
Payables to Customers and Broker-Dealers 6,184 53 1.73 6,893 24 0.71
Long-Term Debt 7,047 113 3.21 6,174 60 1.94
-------- -------- -------- --------
Total Interest-Bearing Liabilities 62,063 622 2.02% 64,198 351 1.10%
-------- --------
Noninterest-Bearing Deposits 15,389 14,410
Other Liabilities 13,090 12,805
Common Shareholders' Equity 9,313 8,613
-------- --------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 99,855 $100,026
======== ========
Net Interest Earnings
and Interest Rate Spread $ 939 1.89% $ 703 1.49%
======== ======= ======== =======
Net Yield on Interest-Earning Assets 2.35% 1.73%
======= =======
In 2004, excluding SFAS 13 Leveraged Lease adjustment, the rates on Domestic Office Loan and Non-Margin
Loans would have been 3.80% and 3.50%, respectively. The Net Interest Rate Spread and Net Yield on
Interest-Earning Assets would have been 1.84% and 2.08%, respectively for the six months of 2004.
43
OTHER DEVELOPMENTS
On July 1, 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. LJR'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 the 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, begin 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
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 the second quarter of 2005, the Company sold its 28% equity investment
in BNY Inter Maritime Bank, a Swiss private bank. The Company did not record a
gain or loss on the sale.
In July 2005, the Company signed a definitive agreement to acquire 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. The transaction is expected to close
in the third quarter of 2005.
In July 2005, the Company raised its quarterly dividend by 5% to 21 cents
per share payable August 4, 2005 to shareholders of record on July 26, 2005.
In July 2005, the Company announced that its board of directors has
approved a new share buyback program, which authorizes the Company to purchase
20 million shares on the open market.
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 Income 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, 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,
acquisitions of businesses with expensive technology components, changes in
48
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 - 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. Rapid technological changes requiring significant and ongoing
investments in technology to develop competitive new products and services or
adopt new technologies.
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 - If the Company should experience limitations on its
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's results
of operations.
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
mandates. The nature of any new capital accords to be adopted by the Basel
Committee on Banking Supervision and implemented by the Federal Reserve.
49
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 coal produced by these investments. Coal 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).
If the Reference Price of a barrel of oil in 2005 or 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:
* Its annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and all amendments to these reports
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)
June 30, 2005 December 31, 2004
------------------ -----------------
Assets
------
Cash and Due from Banks $ 2,957 $ 3,886
Interest-Bearing Deposits in Banks 7,061 8,192
Securities
Held-to-Maturity (fair value of $2,179 in 2005
and $1,873 in 2004) 2,183 1,886
Available-for-Sale 23,596 21,916
------------------ -----------------
Total Securities 25,779 23,802
Trading Assets at Fair Value 6,632 4,627
Federal Funds Sold and Securities Purchased
Under Resale Agreements 7,194 5,708
Loans (less allowance for loan losses of $562 in 2005
and $591 in 2004) 40,119 35,190
Premises and Equipment 1,050 1,097
Due from Customers on Acceptances 120 137
Accrued Interest Receivable 331 285
Goodwill 3,492 3,477
Intangible Assets 785 793
Other Assets 7,543 7,335
------------------ -----------------
Total Assets $ 103,063 $ 94,529
================== =================
Liabilities and Shareholders' Equity
------------------------------------
Deposits
Noninterest-Bearing (principally domestic offices) $ 18,485 $ 17,442
Interest-Bearing
Domestic Offices 19,898 18,692
Foreign Offices 25,614 22,587
------------------ -----------------
Total Deposits 63,997 58,721
Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 1,415 1,205
Trading Liabilities 3,088 2,873
Payables to Customers and Broker-Dealers 8,647 8,664
Other Borrowed Funds 1,058 533
Acceptances Outstanding 121 139
Accrued Taxes and Other Expenses 4,442 4,452
Accrued Interest Payable 123 113
Other Liabilities (including allowance for
lending-related commitments of
$148 in 2005 and $145 in 2004) 3,115 2,418
Long-Term Debt 7,586 6,121
------------------ -----------------
Total Liabilities 93,592 85,239
------------------ -----------------
Shareholders' Equity
Common Stock-par value $7.50 per share,
authorized 2,400,000,000 shares, issued
1,047,761,908 shares in 2005 and
1,044,841,603 shares in 2004 7,858 7,836
Additional Capital 1,820 1,790
Retained Earnings 6,618 6,162
Accumulated Other Comprehensive Income (24) (6)
------------------ -----------------
16,272 15,782
Less: Treasury Stock (276,660,662 shares in 2005
and 266,720,629 shares in 2004), at cost 6,791 6,492
Loan to ESOP (305,261 shares in 2005), at cost 10 -
------------------ -----------------
Total Shareholders' Equity 9,471 9,290
------------------ -----------------
Total Liabilities and Shareholders' Equity $ 103,063 $ 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 six
months ended months ended
June 30, June 30,
2005 2004 2005 2004
------ ------ ------ ------
Interest Income
---------------
Loans $ 367 $ 272 $ 708 $ 389
Margin loans 62 35 117 69
Securities
Taxable 233 180 440 360
Exempt from Federal Income Taxes 10 10 19 19
------ ------ ------ ------
243 190 459 379
Deposits in Banks 67 78 138 147
Federal Funds Sold and Securities Purchased
Under Resale Agreements 36 17 64 33
Trading Assets 39 9 61 23
------ ------ ------ ------
Total Interest Income 814 601 1,547 1,040
------ ------ ------ ------
Interest Expense
----------------
Deposits 220 126 404 244
Federal Funds Purchased and Securities Sold
Under Repurchase Agreements 7 3 14 5
Other Borrowed Funds 25 9 38 18
Customer Payables 28 12 53 24
Long-Term Debt 64 30 113 60
------ ------ ------ ------
Total Interest Expense 344 180 622 351
------ ------ ------ ------
Net Interest Income 470 421 925 689
-------------------
Provision for Credit Losses 5 10 (5) 22
------ ------ ------ ------
Net Interest Income After Provision for Credit Losses 465 411 930 667
------ ------ ------ ------
Noninterest Income
------------------
Servicing Fees
Securities 776 716 1,527 1,432
Global Payment Services 76 83 151 162
------ ------ ------ ------
852 799 1,678 1,594
Private Client Services and Asset Management Fees 122 113 243 221
Service Charges and Fees 103 93 195 189
Foreign Exchange and Other Trading Activities 103 100 199 206
Securities Gains 23 12 35 45
Other 53 39 84 121
------ ------ ------ ------
Total Noninterest Income 1,256 1,156 2,434 2,376
------ ------ ------ ------
Noninterest Expense
-------------------
Salaries and Employee Benefits 640 570 1,258 1,144
Net Occupancy 82 72 160 153
Furniture and Equipment 51 51 103 102
Clearing 42 44 88 92
Sub-custodian Expenses 24 22 47 44
Software 55 50 108 99
Communications 22 23 45 47
Amortization of Intangibles 10 8 18 16
Other 197 172 373 328
------ ------ ------ ------
Total Noninterest Expense 1,123 1,012 2,200 2,025
------ ------ ------ ------
Income Before Income Taxes 598 555 1,164 1,018
Income Taxes 200 184 387 283
------ ------ ------ ------
Net Income $ 398 $ 371 $ 777 $ 735
---------- ====== ====== ====== ======
Per Common Share Data:
----------------------
Basic Earnings $ 0.52 $ 0.48 $ 1.01 $ 0.95
Diluted Earnings 0.52 0.48 1.00 0.94
Cash Dividends Paid 0.20 0.20 0.40 0.39
Diluted Shares Outstanding 772 779 775 778
-----------------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
53
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statement of Changes in Shareholders' Equity
For the six months ended June 30, 2005
(Dollars in millions)
(Unaudited)
Common Stock
Balance, January 1 $ 7,836
Issuances in Connection with Employee Benefit Plans 22
-------------
Balance, June 30 7,858
-------------
Additional Capital
Balance, January 1 1,790
Issuances in Connection with Employee Benefit Plans 69
Stock Rights Redemption (39)
-------------
Balance, June 30 1,820
-------------
Retained Earnings
Balance, January 1 6,162
Net Income $ 777 777
Cash Dividends on Common Stock (321)
-------------
Balance, June 30 6,618
-------------
Accumulated Other Comprehensive Income
Balance, January 1 (6)
Change in Fair Value of Securities Available-for-Sale,
Net of Taxes of $(7) million (11) (11)
Reclassification Adjustment, Net of Taxes of $2 million 3 3
Foreign Currency Translation Adjustment,
Net of Taxes of $(1) million (14) (14)
Net Unrealized Derivative Gains on Cash Flow Hedges,
Net of Taxes of $2 million 5 5
Minimum Pension Liability Adjustment,
Net of Taxes of $(1) million (1) (1)
----------- -------------
Balance, June 30 (24)
Total Comprehensive Income $ 759
===========
Less Treasury Stock
Balance, January 1 6,492
Issued (29)
Acquired 328
-------------
Balance, June 30 6,791
-------------
Less Loan to ESOP
Balance, January 1 -
Loan to ESOP 10
-------------
Balance, June 30 10
-------------
Total Shareholders' Equity, June 30, 2005 $ 9,471
=============
-------------------------------------------------------------------------------------------
Comprehensive Income for the three months ended June 30, 2005 and 2004 was $461 million
and $160 million.
Comprehensive Income for the six months ended June 30, 2005 and 2004 was $759 million
and $610 million.
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 six months
ended June 30,
2005 2004
-------- --------
Operating Activities
Net Income $ 777 $ 735
Adjustments to Determine Net Cash Attributable to
Operating Activities:
Provision for Credit Losses
and Losses on Other Real Estate (5) 22
Depreciation and Amortization 281 234
Deferred Income Taxes 131 21
Securities Gains (35) (45)
Change in Trading Activities (1,977) 2,034
Change in Accruals and Other, Net 110 431
-------- --------
Net Cash (Used for) Provided by Operating Activities (718) 3,432
-------- --------
Investing Activities
Change in Interest-Bearing Deposits in Banks 623 (2,377)
Change in Margin Loans 4 (402)
Purchases of Securities Held-to-Maturity (480) (946)
Paydowns of Securities Held-to-Maturity 155 105
Maturities of Securities Held-to-Maturity 23 -
Purchases of Securities Available-for-Sale (8,402) (7,377)
Sales of Securities Available-for-Sale 2,083 2,318
Paydowns of Securities Available-for-Sale 3,160 4,446
Maturities of Securities Available-for-Sale 1,315 1,162
Net Principal Received (Disbursed) on Loans to Customers (5,376) (1,949)
Sales of Loans and Other Real Estate 126 51
Change in Federal Funds Sold and Securities
Purchased Under Resale Agreements (1,486) (3,262)
Purchases of Premises and Equipment (42) (130)
Acquisitions, Net of Cash Acquired (70) (87)
Proceeds from the Sale of Premises and Equipment - 6
Other, Net 19 8
-------- --------
Net Cash Used for Investing Activities (8,348) (8,434)
-------- --------
Financing Activities
Change in Deposits 6,243 4,770
Change in Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 210 276
Change in Payables to Customers and Broker-Dealers (17) (753)
Change in Other Borrowed Funds 536 380
Proceeds from the Issuance of Long-Term Debt 1,538 107
Repayments of Long-Term Debt (102) (101)
Issuance of Common Stock 81 95
Treasury Stock Acquired (338) (47)
Cash Dividends Paid (321) (301)
-------- --------
Net Cash Provided by Financing Activities 7,830 4,426
-------- --------
Effect of Exchange Rate Changes on Cash 307 (165)
-------- --------
Change in Cash and Due From Banks (929) (741)
Cash and Due from Banks at Beginning of Period 3,886 3,843
-------- --------
Cash and Due from Banks at End of Period $ 2,957 $ 3,102
======== ========
-------------------------------------------------------------------------------
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Period for:
Interest $ 612 $ 298
Income Taxes 140 246
Noncash Investing Activity
(Primarily Foreclosure of Real Estate) - -
-------------------------------------------------------------------------------
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 first six months ended June 30, 2005, approximately 6 million
options were granted. In the second quarter and first six months of 2005, the
Company recorded $13 million and $23 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, Second Quarter Year-to-date
except per share amounts) 2005 2004 2005 2004
------ ------- ------ ------
Reported net income $ 398 $ 371 $ 777 $ 735
Stock based employee compensation costs,
using prospective method, net of tax 8 6 14 11
Stock based employee compensation costs,
using retroactive restatement method,
net of tax (11) (14) (21) (30)
------ ------- ------ ------
Pro forma net income $ 395 $ 363 $ 770 $ 716
====== ====== ====== ======
Reported diluted earnings per share $ 0.52 $ 0.48 $ 1.00 $ 0.94
Impact on diluted earnings per share - (0.01) (0.01) (0.02)
------ ------- ------ ------
Pro forma diluted earnings per share $ 0.52 $ 0.47 $ 0.99 $ 0.92
====== ====== ====== ======
56
The fair value of options granted in 2005 and 2004 were estimated at the
grant date using the following weighted average assumptions:
Second Quarter Year-to-date
2005 2004 2005 2004
------ ------- ------ ------
Dividend yield 2.95% 2.50% 2.77% 2.50%
Expected volatility 25.00 25.10 25.21 25.00
Risk free interest rates 3.94 3.73 4.18 2.60
Expected options lives 5 5 5 5
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,
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
57
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 July 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 August 2005 and become effective for other-than-
temporary impairment analysis conducted in periods beginning after September
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)
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 would like to issue a final
pronouncement by end 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, "Accounting for Stock-Based Compensation." FASB 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. Statement 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 Statement 123(R) for all
share-based payments granted after the effective date and (b) based on the
requirements of Statement 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 Statement 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 expense these grants over their stated vesting period.
The Company is currently evaluating the impact of adopting SFAS 123(R).
58
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.
3. Acquisitions and Dispositions
-----------------------------
The Company continues to be an active acquirer of securities servicing
and asset management businesses.
The Company has announced 4 acquisitions in 2005. The total acquisition
cost in the second quarter and first six months of 2005 was $3 million and $11
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 second quarter and first six months of 2005 was zero. At
June 30, 2005, the Company was liable for potential contingent payments
related to acquisitions in the amount of $191 million. During the second
quarter and the first six months of 2005, the Company paid or accrued $25
million and $34 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
59
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, begin 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
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 signed a definitive agreement to acquire 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. The transaction is expected to close
in the third quarter of 2005.
4. Goodwill and Intangibles
------------------------
Goodwill by business segment is as follows:
(In millions)
June 30, 2005 December 31, 2004
------------------ -----------------
Servicing and
Fiduciary Businesses $ 3,352 $ 3,337
Corporate Banking 31 31
Retail Banking 109 109
Financial Markets - -
------------------ -----------------
Consolidated Total $ 3,492 $ 3,477
================== =================
The Company's business segments are tested annually for goodwill
impairment.
60
Intangible Assets
-----------------
June 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 483 (80) 403 17 474 (65) 409
Other Intangible
Assets 28 (16) 12 6 41 (27) 14
The aggregate amortization expense of intangibles was $10 million and $8
million for the quarters ended June 30, 2005 and 2004, respectively. The
aggregate amortization expense of intangibles was $18 million and $16 million
for the six months ended June 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 $39
2006 39
2007 37
2008 36
2009 32
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.
61
Transactions in the allowance for credit losses are summarized as
follows:
(In millions) Three Months Ended June 30, 2005
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 583 $ 133 $ 716
Charge-Offs (15) - (15)
Recoveries 4 - 4
-------------- --------------- -------------
Net Charge-Offs (11) - (11)
Provision (10) 15 5
-------------- --------------- -------------
Balance, End of Period $ 562 $ 148 $ 710
============== =============== =============
(In millions) Three Months Ended June 30, 2004
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 632 $ 158 $ 790
Charge-Offs (27) - (27)
Recoveries 2 - 2
-------------- --------------- -------------
Net Charge-Offs (25) - (25)
Provision (9) 19 10
-------------- --------------- -------------
Balance, End of Period $ 598 $ 177 $ 775
============== =============== =============
(In millions) Six Months Ended June 30, 2005
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 591 $ 145 $ 736
Charge-Offs (26) - (26)
Recoveries 5 - 5
-------------- --------------- -------------
Net Charge-Offs (21) - (21)
Provision (8) 3 (5)
-------------- --------------- -------------
Balance, End of Period $ 562 $ 148 $ 710
============== =============== =============
(In millions) Six Months Ended June 30, 2004
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 668 $ 136 $ 804
Charge-Offs (56) - (56)
Recoveries 5 - 5
-------------- --------------- -------------
Net Charge-Offs (51) - (51)
Provision (19) 41 22
-------------- --------------- -------------
Balance, End of Period $ 598 $ 177 $ 775
============== =============== =============
62
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 June 30, 2005 and December 31,
2004, 3,000 shares were outstanding.
During the quarter ended June 30, 2005, the Company issued $83 million
subordinated debt qualifying as Tier II capital.
At June 30, 2005, the Company had registration statements with a
remaining capacity of approximately $1.8 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 Six Months Ended
except per share amounts) June 30, June 30,
---------------------------------------
2005 2004 2005 2004
-------- -------- -------- --------
Net Income (1) $ 398 $ 371 $ 777 $ 735
======== ======== ======== ========
Basic Weighted Average
Shares Outstanding 765 772 768 771
Shares Issuable Due to
Employee Stock Compensation 7 7 7 7
-------- -------- -------- --------
Diluted Weighted Average
Shares Outstanding 772 779 775 778
======== ======== ======== ========
Basic Earnings Per Share: $ 0.52 $ 0.48 $ 1.01 $ 0.95
Diluted Earnings Per Share: 0.52 0.48 1.00 0.94
(1) Net Income, net income available to common shareholders and diluted net
income are the same for all periods presented.
63
8. Employee Benefit Plans
----------------------
The components of net periodic benefit cost are as follows:
Pension Benefits Healthcare Benefits
-------------------------------------- ------------------------------------
Three Months Ended Six Months Ended Three Months Ended Six Months Ended
June 30, June 30, June 30, June 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 $ 32 $ 24 $ 4 $ 4 $ - $ - $ - $ -
Interest Cost 14 13 2 2 28 26 5 4 2 3 4 6
Expected Return on Assets (30) (33) (3) (2) (60) (66) (6) (4) (2) (2) (4) (4)
Other 4 1 1 1 9 2 1 2 2 2 4 4
---- ---- ---- ---- ---- ---- ---- ---- ------- -------- ------- ------
Net Periodic Cost (Income) $ 4 $ (7)$ 2 $ 3 $ 9 $(14)$ 4 $ 6 $ 2 $ 3 $ 4 $ 6
==== ==== ==== ==== ==== ==== ==== ==== ======= ======== ======= ======
9. Income Taxes
The statutory federal income tax rate is reconciled to the Company's
effective income tax rate below:
Six months ended
June 30,
----------------
2005 2004
------ -----
Federal Rate 35.0% 35.0%
State and Local Income Taxes,
Net of Federal Income Tax Benefit 3.7 (2.6)
Nondeductible Expenses 0.2 0.2
Credit for Synthetic Fuel Investments (1.7) (1.2)
Credit for Low-Income Housing Investments (2.0) (2.0)
Tax-Exempt Income From Municipal Securities (0.2) (0.2)
Other Tax-Exempt Income (1.1) (1.2)
Foreign Operations 0.1 0.8
Leveraged Lease Portfolio (0.2) (0.7)
Tax Reserve - LILO Exposure 0.2 0.5
Other - Net (0.7) (0.8)
------ ------
Effective Rate 33.3% 27.8%
====== ======
64
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 June 30, 2005 and December 31,
2004 follows:
Off-Balance-Sheet Credit Risks
------------------------------
June 30, December 31,
(In millions) 2005 2004
----------------------------------- ------------ -----------
Lending Commitments $ 34,662 $ 34,834
Standby Letters of Credit, net 9,757 9,507
Commercial Letters of Credit 1,448 1,264
Securities Lending Indemnifications 281,668 232,025
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 June 30, 2005 and
December 31, 2004, securities lending indemnifications were secured by
collateral of $288.2 billion and $233.0 billion.
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 June 30, 2005 and December 31, 2004. At June 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 mid-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 cross-border
leveraged lease transactions. Negotiations have continued during the first
half of 2005. 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 Company's 1998 leveraged
lease transactions are in a later audit cycle and thus are unlikely to be part
65
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.
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,
administration 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 necessary.
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.
66
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 June 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 June 30, 2005, The Bank of New York Company, Inc. had
770,795,985 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
June 30, 2005 and December 31, 2004 51
Consolidated Statements of Income for
the three months and six months ended
June 30, 2005 and 2004 52
Consolidated Statement of Changes in
Shareholders' Equity for the six months
ended June 30, 2005 53
Consolidated Statement of Cash Flows
for the six months ended June 30, 2005 and 2004 54
Notes to Consolidated Financial Statements 55 - 65
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 2 - 50
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 38 - 40
67
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.
The Company continues to cooperate with the previously disclosed
investigation by law enforcement authorities, principally by The United States
Attorney's Office for the Southern District of New York (the "SDNY"), into
funds transfer activities in certain accounts at the Bank, primarily involving
wire transfers from Russian and other sources in Eastern Europe, as well as
certain other matters involving the Bank and its affiliates. The SDNY has
proposed to resolve its investigation through an agreement between the Bank
and the SDNY. The Bank is reviewing the SDNY's proposal. There can be no
assurance that an agreement will be reached.
As previously disclosed, the U.S. Attorney's office for the Eastern
District of New York (the "EDNY") is conducting an investigation of an alleged
68
fraudulent scheme by RW Professional Leasing Services Corp. ("RW"), a former
customer of a Long Island branch of the Bank. The Bank continues to cooperate
fully with the investigation. The EDNY has proposed to resolve its
investigation through an agreement between the Bank and the EDNY. While the
Company expects to reach an agreement with the EDNY, there can be no assurance
that such an agreement will be reached.
The Company is broadly involved in the mutual fund industry, and various
governmental and self-regulatory agencies have sought documents and other
information from it in connection with investigations relating to that
industry. The Company is cooperating with these investigations. One of these
investigations, by the U.S. Securities and Exchange Commission ("SEC"),
concerns the relationship between: (1) the BNY Hamilton Funds, Inc., a family
of mutual funds; (2) the Company, which acts as the investment adviser to the
Hamilton Funds and provides certain other services; and (3) a third-party
service provider that acts as administrator and principal underwriter of the
Hamilton Funds. This investigation principally concerns the appropriateness
of certain expenditures made in connection with marketing and distribution of
the Hamilton Funds. Another SEC investigation has focused on possible market-
timing transactions cleared by Pershing LLC ("Pershing"), a wholly owned
subsidiary of the Company, for Mutuals.com and other introducing brokers.
Pershing, which was acquired from Credit Suisse First Boston (USA), Inc.
("CSFB") in May 2003, is defending three putative class action lawsuits filed
against CSFB seeking unspecified damages relating to mutual fund market-timing
transactions that were cleared through Pershing's facilities. Because the
conduct at issue is alleged to have occurred largely during the period that
Pershing was owned by CSFB, the Company had made a claim for indemnification
against CSFB relating to these lawsuits under the agreement relating to the
acquisition of Pershing. CSFB is disputing this claim for indemnification.
As previously disclosed, the SEC has sought documents and other
information from the Company in connection with investigations relating to its
issuer services business. The Company continues to cooperate with these
investigations. Those investigations have focused primarily on (i) the
Company's role as transfer agent on behalf of equity issuers in the United
States and the process used by the Company's stock transfer division to search
for lost security holders of its issuer clients; and (ii) the Company's role
as auction agent in connection with auction rate securities issued by various
issuers. The Company has entered into settlement negotiations with the SEC
staff concerning the transfer agent investigation and believes that these
discussions will result in a resolution of this investigation. There can be no
assurance that a settlement will be reached.
69
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 June 15, 2005, 9,600 shares of common stock were issued to serving
non-employee directors as part of their annual retainer.
(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 second 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
-------------- ---------- ---------- --------------- ------------------
April 1-30 3,737,220 $ 28.90 3,737,220 5,394,555
May 1-31 799,187 28.78 799,187 4,595,368
June 1-30 3,101,396 29.18 3,101,396 1,493,972
---------- ---------------
Total 7,637,803 7,637,803
========== ===============
All shares were repurchased through the Company's stock repurchase
program, which was announced on November 12, 2002 and permits the repurchase
of 16 million shares. The shares repurchased in May and June primarily
resulted from open market purchases, while 3.7 million shares were repurchased
in April in a single transaction. 0n July 12, 2005, the Company announced that
its board of directors has approved a new share buyback program, which
authorizes the Company to purchase 20 million shares on the open market.
70
Item 4. Submission of Matters to Vote of Security Holders
----------------------------------------------------------
The Company held its annual meeting on April 12, 2005 at The Bank of New
York at 101 Barclay St. in New York, New York. The shareholders:
(1) elected thirteen persons to serve as directors of the Company;
(2) ratified the appointment of Ernst & Young LLP as the Company's
independent public accountants for 2005;
(3) defeated a shareholder proposal with respect to cumulative voting;
(4) defeated a shareholder proposal with respect to executive
compensation.
The number of votes cast for, against or withheld, and the number of
abstentions with respect to each such matter is set forth below, as are the
number of broker non-votes, where applicable. Pursuant to New York law,
abstentions and broker non-votes are not counted toward the election of
directors.
AGAINST/ BROKER
FOR WITHHELD ABSTAINED NON-VOTES
(1) Election of Directors:
Frank J. Biondi, Jr. 645,480,947 21,776,540
Nicholas M. Donofrio 645,996,963 21,260,524
Gerald L. Hassell 645,703,930 21,553,557
Richard J. Kogan 645,501,117 21,756,370
Michael J. Kowalski 643,302,133 23,955,354
John A. Luke, Jr. 645,527,267 21,730,220
John C. Malone 593,209,930 74,047,557
Paul Myners 643,333,399 23,924,088
Catherine A. Rein 640,985,846 26,271,641
Thomas A. Renyi 642,924,505 24,332,982
William C. Richardson 645,699,199 21,558,288
Brian L. Roberts 639,459,781 27,797,706
Samuel C. Scott III 645,981,402 21,276,085
(2) Ratification of Auditors 649,129,534 12,752,077 5,375,876
(3) Approval of Shareholder
Proposal With Respect to
Cumulative Voting 276,353,290 279,367,355 9,637,939 101,898,903
(4) Approval of Shareholder
Proposal With Respect to
Executive Compensation 36,809,908 519,043,452 9,505,224 101,898,903
71
Item 6. Exhibits
-----------------
Exhibit 10(i)* - Employee Severance Agreement dated July 1, 2005;
Exhibit 12 - Ratio of Earnings to Fixed Charges for
the Three Months and Six Months Ended June 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.
* Constitutes a Management Contract or Compensatory Plan or Arrangement
72
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: August 3, 2005 By: /s/ Thomas J. Mastro
---------------------------------
Name: Thomas J. Mastro
Title: Comptroller
73
EXHIBIT INDEX
-------------
Exhibit Description
------- -----------
10 (i) Employee Severance Agreement dated July 1, 2005.
12 Ratio of Earnings to Fixed Charges for the Three Months and
Six Months Ended June 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.