THE BANK OF NEW YORK COMPANY, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended March 31, 2006
The Quarterly Report on Form 10-Q and cross reference index is on page 61.
THE BANK OF NEW YORK COMPANY, INC.
FINANCIAL REVIEW
TABLE OF CONTENTS
Consolidated Financial Highlights 1
Management's Discussion and Analysis of Financial
Condition and Results of Operations
- Introduction 3
- Overview 3
- First Quarter 2006 Highlights 4
- Consolidated Income Statement Review 5
- Business Segment Review 10
- Critical Accounting Policies 24
- Consolidated Balance Sheet Review 28
- Liquidity 34
- Capital Resources 37
- Trading Activities 39
- Asset/Liability Management 41
- Statistical Information 42
- Other Developments 43
- Forward-Looking Statements and
Risk Factors That Could Affect Future Results 45
- Website Information 47
Consolidated Financial Statements
- Consolidated Balance Sheets
March 31, 2006 and December 31, 2005 48
- Consolidated Statements of Income
for the Three Months Ended
March 31, 2006 and 2005 49
- Consolidated Statement of Changes In
Shareholders' Equity for the Three
Months Ended March 31, 2006 50
- Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 2006 and 2005 51
- Notes to Consolidated Financial Statements 52 - 60
Form 10-Q
- Cover 61
- Controls and Procedures 62
- Legal and Regulatory Proceedings 62
- Risk Factors 63
- Unregistered Sales of Equity Securities
and Use of Proceeds 64
- Exhibits 65
- Signature 66
1
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Financial Highlights
(Dollars in millions, except per share amounts)
(Unaudited)
March 31, December 31, March 31,
2006 2005 2005
------------ -------------- -------------
Quarter
-------
Net Interest Income $ 488 $ 492 $ 455
Noninterest Income 1,332 1,273 1,178
------------ ------------- ------------
1,820 1,765 1,633
Tax Equivalent Adjustment 7 7 7
------------ ------------- ------------
Revenue (tax equivalent basis) $ 1,827 $ 1,772 $ 1,640
============ ============= ============
Net Income $ 422 $ 405 $ 379
Basic EPS 0.55 0.53 0.49
Diluted EPS 0.55 0.53 0.49
Cash Dividends Per Share 0.21 0.21 0.20
Return on Average Common
Shareholders' Equity 17.31% 16.57% 16.52%
Return on Average Assets 1.61 1.53 1.55
Efficiency Ratio 65.1 65.5 66.2
Assets $ 103,611 $ 102,074 $ 96,537
Loans 40,054 40,726 38,764
Securities 27,288 27,326 23,907
Deposits - Domestic 35,175 37,374 33,634
- Foreign 30,049 27,050 25,328
Long-Term Debt 8,309 7,817 7,389
Common Shareholders' Equity 10,101 9,876 9,335
Common Shareholders'
Equity Per Share $ 13.09 $ 12.79 $ 12.02
Market Value Per Share
of Common Stock 36.04 31.85 29.05
Allowance for Loan Losses as
a Percent of Total Loans 1.05% 1.01% 1.50%
Allowance for Loan Losses as
a Percent of Non-Margin Loans 1.21 1.19 1.78
Total Allowance for Credit Losses as
a Percent of Total Loans 1.41 1.39 1.85
Total Allowance for Credit Losses as
a Percent of Non-Margin Loans 1.63 1.63 2.19
Tier 1 Capital Ratio 8.28 8.38 8.13
Total Capital Ratio 12.44 12.48 12.54
Leverage Ratio 6.51 6.60 6.56
Tangible Common Equity Ratio 5.42 5.58 5.48
Employees 23,500 23,451 23,160
2
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Financial Highlights
(Dollars in millions, except per share amounts)
(Estimated)
March 31, December 31, March 31,
2006 2005 2005
------------- ------------- -------------
Assets Under Custody (In trillions)
-----------------------------------
Assets Under Custody $ 11.3 $ 10.9 $ 9.9
Equity Securities 33% 32% 34%
Fixed Income Securities 67 68 66
Cross-Border Assets Under Custody $ 3.7 $ 3.4 $ 2.8
Assets Under Management (In billions)
-------------------------------------
Asset Management Sector $ 113 $ 105 $ 105
Equity Securities 37 37 37
Fixed Income Securities 21 21 21
Alternative Investments 26 15 16
Liquid Assets 29 32 31
Foreign Exchange Overlay 11 10 9
Securities Lending Short-term
Investment Funds 49 40 36
------------ ------------- ------------
Total Assets Under Management $ 173 $ 155 $ 150
============ ============= ============
3
Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations ("MD&A")
------------------------------
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 Risk 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. In addition, certain
business terms used in this document are defined in the Company's 2005 Annual
Report on Form 10-K.
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: institutional
services, private banking, and asset management. 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's strategy over the past decade has been to focus on highly
scalable, fee-based securities servicing and fiduciary businesses, and it has
achieved top three market share in most of its major product lines. The
Company distinguishes itself competitively by offering one of the industry's
broadest arrays 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;
* sophisticated risk and performance measurement tools for analyzing
portfolios; and
* 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's key objectives include:
* achieving positive operating leverage on an annual basis; and
* sustaining top-line growth by expanding client relationships and winning
new ones.
To achieve its key objectives, 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. The Company has
4
acquired over 90 businesses over the past ten years, almost exclusively in its
securities servicing and asset management areas. The acquisition of Pershing
LLC ("Pershing") in 2003 for $2 billion was the largest of these acquisitions
completed to date. The acquisition of the corporate trust business of JPMorgan
Chase & Co. ("JPMorgan Chase"), announced in April 2006, will also contribute
to the Company's ability to achieve its key objectives. See "Other
Developments."
As part of the transformation to a leading securities servicing provider,
the Company has also de-emphasized or exited several of 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, significantly reducing non-financial corporate
credit exposures by 41% from December 31, 2001 to December 31, 2005, and,
most recently, announcing an agreement to sell retail and regional middle
market businesses to JPMorgan Chase. To the extent these actions generated
capital, the capital has been reallocated to the Company's higher-growth
businesses.
The Company's business model is well positioned to benefit from a number
of long-term secular trends. These include:
* 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
prices its services. In addition, international markets offer excellent growth
opportunities.
FIRST QUARTER 2006 HIGHLIGHTS
The Company reported first quarter net income of $422 million, compared
with $379 million in the year-ago quarter and diluted earnings per share of 55
cents, up 12% over the 49 cents earned in the first quarter of 2005. In the
fourth quarter of 2005, earnings were $405 million and 53 cents.
Additional highlights for the quarter include:
* Positive operating leverage over year-ago and sequential periods.
* Securities servicing fees up 11% versus the year-ago quarter. The growth
was led by strong performance in issuer services, broker-dealer services,
and execution and clearing services.
* Net interest income was up 7% over last year, reflecting growth in
liquidity from the Company's core servicing businesses.
* Foreign exchange and other trading revenues were up 20% from the year-ago
quarter.
* Private banking and asset management revenues were up 16% from the year-
ago quarter reflecting both organic growth and the acquisition of
Alcentra Group Limited and Urdang Capital Management.
On April 8, 2006, the Company announced a definitive agreement with
JPMorgan Chase to acquire its corporate trust business, with JPMorgan Chase
acquiring the Company's retail and regional middle market banking businesses.
The transaction will strengthen the Company's leadership position in corporate
trust both in the U.S. and internationally, serving a combined client base with
$8 trillion in total debt outstanding in 20 countries.
5
CONSOLIDATED INCOME STATEMENT REVIEW
Noninterest Income
------------------
Percent Inc/(Dec)
-----------------
1Q06 vs. 1Q06 vs.
(Dollars in millions) 1Q06 4Q05 1Q05 4Q05 1Q05
------ ------ ------ -------- --------
Servicing Fees
Securities $ 831 $ 814 $ 750 2% 11%
Global Payment Services 70 68 75 3 (7)
------ ------ ------
901 882 825 2 9
Private Banking
and Asset Management Fees 141 128 122 10 16
Service Charges and Fees 89 94 92 (5) (3)
Foreign Exchange and
Other Trading Activities 115 98 96 17 20
Securities Gains 17 18 12 (6) 42
Other 69 53 31 30 123
------ ------ ------
Total Noninterest Income $1,332 $1,273 $1,178 5 13
====== ====== ======
The increase in noninterest income versus the first quarter of 2005
reflects positive revenue trends in securities servicing, foreign exchange and
other trading, private banking and asset management, and other income. On a
sequential-quarter basis, noninterest income primarily reflects increases in
foreign exchange and other trading, private banking and asset management, and
other income.
The following table provides the breakdown of securities servicing fees.
Percent Inc/(Dec)
-----------------
1Q06 vs. 1Q06 vs.
(Dollars in millions) 1Q06 4Q05 1Q05 4Q05 1Q05
------ ------ ------ -------- --------
Execution and Clearing Services $ 339 $ 321 $ 293 6% 16%
Issuer Services 154 171 139 (10) 11
Investor Services 277 264 263 5 5
Broker-Dealer Services 61 58 55 5 11
------ ------ ------
Securities Servicing Fees $ 831 $ 814 $ 750 2 11
====== ====== ======
Double-digit securities servicing fee growth over the first quarter of
2005 reflects strong performance within issuer services, broker-dealer
services, and execution and clearing services. On a sequential-quarter basis,
fees were moderately higher, reflecting strong growth in execution and clearing
services, broker-dealer services and investor services, partially offset by
seasonally slower activity in issuer services. See "Institutional Services
Segment" in "Business Segment Review" for additional details.
Global payment services fees decreased from the first quarter of 2005 but
increased moderately on a sequential-quarter basis. The year-over-year decline
reflects customers choosing to pay with higher compensating balances, which
benefits net interest income. The sequential increase reflects growth from U.S.
financial institutions. On an invoiced services basis, total revenue was up 6%
over the first quarter of 2005 and 1% sequentially.
Private banking and asset management fees increased significantly from the
first quarter of 2005 and on a sequential-quarter basis primarily due to the
6
acquisition of Alcentra Group Limited ("Alcentra") on January 3, 2006 and the
acquisition of Urdang Capital Management ("Urdang") on March 2, 2006, as well
as higher fees in private banking. Total assets under management were $113
billion, up from $105 billion at March 31, 2005 and December 31, 2005.
Service charges and fees were down from the first quarter of 2005 and the
fourth quarter of 2005. The year-over-year decline reflects lower underwriting
fees. The sequential quarter decrease is due to lower syndication fees.
Foreign exchange and other trading revenues were up significantly from the
first quarter of 2005 and on a sequential-quarter basis. Foreign exchange was
up from the first quarter of 2005 and sequentially due to higher volumes fueled
by cross-border investment, particularly in emerging markets. On a year-over-
year basis, other trading decreased slightly reflecting a decline in interest
rate derivative activity and lower trading revenues at Pershing. On a
sequential-quarter basis, other trading increased primarily as a result of
improved performance in fixed income trading.
Securities gains in the first quarter increased $5 million from the year-
ago quarter and decreased slightly on a sequential-quarter basis. The gains in
the quarter were primarily attributable to the Company's sponsor fund
portfolio.
Other noninterest income is attributable to asset-related gains, equity
investments, and other transactions. Asset-related gains include gains on
lease residuals, as well as loan and real estate dispositions. Equity
investment income primarily reflects the Company's proportionate share of the
income from its investment in Wing Hang Bank Limited, AIB/BNY Securities
Services (Ireland) Limited, and RBSI Securities Services (Holdings) Limited.
Other income primarily includes income or loss from insurance contracts, low
income housing and other investments as well as various miscellaneous
revenues. The breakdown among these three categories is shown below:
Other Noninterest Income
(In millions) 1Q06 4Q05 1Q05
------------------------------- ---------- ---------- ----------
Asset-Related Gains $ 47 $ 27 $ 14
Equity Investment Income 11 9 12
Other 11 17 5
---------- ---------- ----------
Total Other Noninterest Income $ 69 $ 53 $ 31
========== ========== ==========
Other noninterest income increased versus the first quarter of 2005 and
the fourth quarter of 2005. In the first quarter of 2006, asset-related gains
included a pre-tax gain of $31 million related to the conversion of the
Company's New York Stock Exchange seats into cash and shares of NYSE. Asset-
related gains in the fourth quarter of 2005 included the sale of a building for
a $10 million pre-tax gain and four New York Stock Exchange seats for a $6
million pre-tax gain.
During the first quarter of 2006, the higher than anticipated gain on the
NYSE seats was partially offset by several items, affecting both revenues and
expenses of the Company including: the impact of the loss of a major Pershing
customer ($6 million) for which the Company is pursuing a termination fee; a
final adjustment to the Company's reserve position with the Federal Reserve
Bank ($6 million); and severance tied to relocation initiatives ($6 million).
7
Net Interest Income
-------------------
Percent
Inc/(Dec)
------------
(Dollars in millions) 1Q06 1Q06
vs. vs.
1Q06 4Q05 1Q05 4Q05 1Q05
------ ------ ------ ----- -----
Net Interest Income $ 488 $ 492 $ 455 (1)% 7%
Tax Equivalent
Adjustment* 7 7 7
------ ------ ------
Net Interest
Income on a Tax
Equivalent Basis $ 495 $ 499 $ 462 (1) 7
====== ====== ======
Net Interest Rate
Spread 1.73% 1.71% 1.94%
Net Yield
on Interest
Earning Assets 2.35 2.35 2.36
* A number of amounts related to net interest income are presented on a
"tax equivalent basis" for better comparability. To calculate the
tax equivalent revenues and profit or loss, the Company adjusts
tax-exempt revenues and the income or loss from such tax-
exempt revenues to show these items as if they were taxable,
applying an assumed tax rate of 35 percent. 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.
Net interest income increased on a year-over-year quarterly basis
reflecting higher earning assets and the higher value of interest-free balances
in a rising rate environment. Average earning assets increased to $84.5
billion in the first quarter of 2006 from $79.5 billion in last year's first
quarter. Net interest income decreased on a sequential-quarter basis reflecting
a decline in interest earning assets, the loss of a major Pershing customer,
the funding of Alcentra and Urdang acquisitions, and fewer days in the
quarter. The first quarter of 2006 included a $6 million impact of a
cumulative adjustment in the Company's reserve position with the Federal
Reserve Bank, which concludes this matter, while the fourth quarter of 2005
reflected $8 million related to this item.
The net interest income rate spread was 1.73% in the first quarter of
2006, compared with 1.94% in the first quarter of 2005 and 1.71% in the fourth
quarter of 2005. The net yield on interest earning assets was 2.35% in the
first quarter of 2006, compared with 2.36% in the first quarter of 2005 and
2.35% in the fourth quarter of 2005.
8
Noninterest Expense and Income Taxes
------------------------------------
Percent Inc/(Dec)
-----------------
1Q06 vs. 1Q06 vs.
(Dollars in million) 1Q06 4Q05 1Q05 4Q05 1Q05
------ ------ ------ -------- --------
Salaries and
Employee Benefits $ 668 $ 647 $ 618 3% 8%
Net Occupancy 88 84 78 5 13
Furniture and Equipment 53 53 52 - 2
Clearing 50 50 46 - 9
Sub-custodian Expenses 34 24 23 42 48
Software 56 53 53 6 6
Communications 27 26 23 4 17
Amortization
of Intangibles 13 12 8 8 63
Other 189 199 176 (5) 7
------ ------ ------
Total Noninterest
Expense $1,178 $1,148 $1,077 3 9
====== ====== ======
Noninterest expense increased compared with the first quarter of 2005 and
the fourth quarter of 2005. The increase versus the year-ago quarter reflects
increased staffing costs associated with new business and acquisitions, as well
as higher pension expenses. Occupancy increased reflecting acquisitions and
higher business continuity expenses.
Relative to the year-ago quarter, salaries rose 6% as tight headcount
control and reengineering and relocation projects offset the impact of growth
related to business wins, and acquisitions, as well as the impact of severance
and additional legal and compliance personnel. Severance expense, which was
largely related to relocation initiatives, was $6 million in the first quarter
of 2006. Benefit expense increased due to higher pension and medical costs, as
well as higher incentives tied to growth in revenues. Salaries and employee
benefits expense for the first quarter increased on a sequential-quarter basis,
reflecting higher seasonal social security expense, higher pension expenses
reflecting the new 2006 assumptions, and increased expenses associated with
acquisitions. During the quarter, headcount increased by 49 people reflecting
additions related to Alcentra and Urdang.
Occupancy expenses were up on a year-over-year quarter basis reflecting
the costs associated with the Company's new out-of-region data center in the
mid-south region of the U.S. and the growth center in Manchester, England. On
a sequential-quarter basis, occupancy expenses were up 5%, primarily
reflecting acquisitions.
Clearing and sub-custodian expenses, which are tied to transaction
volumes, were up $10 million, or 14%, sequentially on a combined basis to $84
million. Sub-custodian expenses increased on a year-over-year basis and on a
sequential-quarter basis reflecting higher level of business activity.
The increase in software expense versus a year ago reflects spending and
development to support business growth.
Other noninterest expense is attributable to vendor services, business
development, legal expenses, settlements and claims, and other. Vendor services
include professional fees, computer services, market data, courier, and other
services. Business development includes advertising, charitable contributions,
travel, and entertainment expenses. The breakdown among these four categories
is shown below:
9
Other Noninterest Expense
(In millions) 1Q06 4Q05 1Q05
------------------------------- ---------- ---------- ----------
Vendor Services $ 81 $ 88 $ 80
Business Development 32 37 26
Legal Fees, Settlements and Claims 23 23 20
Other 53 51 50
---------- ---------- ----------
Total Other Noninterest Expense $ 189 $ 199 $ 176
========== ========== ==========
Other expenses were higher compared with the first quarter of 2005
reflecting higher costs for advertising and travel and entertainment in
business development, as well as other expenses associated with business
growth. On a sequential-quarter basis, the decline in vendor services was due
to lower Depository Trust Company and consulting expenses. The sequential
decrease in business development primarily reflects seasonally lower travel
and entertainment expenses.
The effective tax rate for the first quarter of 2006 was 33.7%, compared
to 33.1% in the first quarter of 2005 and 33.3% in the fourth quarter of 2005.
The increases primarily reflect lower expected Section 29 tax credits.
Credit Loss Provision and Net Charge-Offs
-----------------------------------------
(In millions) 1Q06 4Q05 1Q05
------- ------- -------
Provision $ 5 $ 10 $ (10)
======= ======= =======
Net Charge-offs:
Commercial $ 1 $ (139) $ (3)
Foreign 2 (1) -
Regional Commercial 1 (3) (2)
Consumer (8) (8) (5)
------- ------- -------
Total $ (4) $ (151) $ (10)
======= ======= =======
The provision was $5 million in the first quarter of 2006, compared to a
credit to the provision of $10 million in the first quarter of 2005 and a
provision of $10 million in the fourth quarter of 2005. The sequential decline
in the provision reflects a decline in charge-offs and a decline in
nonperforming loans.
The total allowance for credit losses was $566 million at March 31, 2006,
$716 million at March 31, 2005 and $565 million at December 31, 2005. The
total allowance for credit losses as a percent of non-margin loans was 1.63% at
March 31, 2006, compared with 2.19% at March 31, 2005 and 1.63% at December 31,
2005.
Net charge-offs were $4 million in the first quarter of 2006 versus $10
million in the first quarter of 2005 and $151 million in the fourth quarter of
2005. These represent 0.04% of total loans in the most recent quarter,
compared with 0.10% in the quarter-ended March 31, 2005 and 1.48% in the
quarter-ended December 31, 2005. During the fourth quarter of 2005, the
Company charged-off $140 million of leases with two domestic bankrupt airline
customers.
10
BUSINESS SEGMENT REVIEW
Segment Data
The Company has an internal information system that produces performance
data for its four business segments along product and service lines.
Business Segments 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 when organizational changes are
made.
In 2005, the Company determined that it is appropriate to modify its
segment presentation in order to provide more transparency into its results of
operations and to better reflect modifications in the management structure that
the Company implemented during the fourth quarter of 2005. As such, the
Company identified four major business segments for assessing its overall
performance, with the Institutional Services Segment being further subdivided
into four business groupings. These segments are shown below:
* Institutional Services Segment
o Investor & Broker-Dealer Services Business
o Execution & Clearing Services Business
o Issuer Services Business
o Treasury Services Business
* Private Bank & BNY Asset Management Segment
* Retail & Middle Market Banking Segment
* Corporate and Other Segment
All prior periods have been restated to reflect this realignment. Other
specific accounting principles employed include:
* The measure of revenues and profit or loss by a segment has been adjusted
to present segment data on a tax equivalent basis.
* The provision for credit losses allocated to each 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 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.
* Net interest income is allocated to segments based on the yields on the
assets and liabilities generated by each segment. Assets and liabilities
generated by credit-related activities are allocated to businesses based
on borrower usage of those businesses' products or services. Credit-only
relationships and borrowers using both credit and payment services remain
in Treasury Services. Segments with a net liability position are
allocated assets primarily from the securities portfolio.
* Revenues and expenses associated with specific client bases are included
in those segments. For example, foreign exchange activity associated
with clients using custody products is allocated to Investor & Broker-
Dealer services business (which includes the Company's custody
operations.)
* Noninterest income associated with Treasury-related services (global
payment services for corporate customers, as well as lending and credit-
11
related services) is similarly allocated back to the other Institutional
Services businesses.
* Support and other indirect expenses are allocated to segments based on
internally-developed methodologies.
DESCRIPTION OF BUSINESS SEGMENTS
The activities within each business segment are described below.
Institutional Services Segment
------------------------------
Investor & Broker-Dealer Services Business
------------------------------------------
Investor & Broker-Dealer Services includes global custody, global fund
services, securities lending, global liquidity services, outsourcing,
government securities clearance, collateral management, credit-related
services, and other linked revenues, principally foreign exchange and execution
and clearing revenues.
In Investor Services, the Company is one of the leading custodians with
$11.3 trillion of assets under custody at March 31, 2006. 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 $1.7 trillion in total
assets. The Company also services more than 15% of the total industry assets
for exchange-traded funds, and is a leading U.K. custodian. In securities
lending, the Company is the largest lender of U.S. Treasury securities and
depositary receipts with a lending pool of approximately $1.5 trillion in 27
markets around the world.
The Company's Broker-Dealer Services business clears approximately 50% of
transactions in U.S. Government securities. The Company is a leader in global
clearance, clearing equity and fixed income transactions in 101 markets. With
over $1.2 trillion in tri-party balances worldwide, the Company is the world's
largest collateral management agent.
Execution & Clearing Services Business
--------------------------------------
The Company provides execution, clearing and financial services
outsourcing solutions in over 80 global markets, executing trades for 675
million shares and clearing one million trades daily. In Execution Services,
the Company provides broker-assisted and electronic trading services,
transition management, and independent research services. The Company's
Execution Services business is one of the largest global institutional agency
brokerage organizations. In addition, it is one of the leading institutional
electronic brokers for non-U.S. dollar equity execution.
The Company's Pershing subsidiary provides clearing, execution, financing,
and custody for introducing broker-dealers and registered investment advisors.
Pershing services more than 1,100 retail and institutional financial
organizations and independent investment advisors who collectively represent
nearly six million individual investors.
Issuer Services Business
------------------------
Issuer Services includes corporate trust, depositary receipts, employee
investment plan services, stock transfer, and credit-related services.
In Issuer Services, the Company is depositary for more than 1,230 American
and global depositary receipt programs, with a 64% market share, servicing
leading companies from 60 countries. As a trustee, the Company provides
diverse services for corporate, municipal, structured, and international debt
securities. 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 in the United States, servicing more than 16 million shareowners.
Employee Investment Plan Services has more than 124 clients with 650,000
employees in over 54 countries.
12
Treasury Services Business
--------------------------
Treasury Services includes global payment services for corporate customers
as well as lending and credit-related services.
Corporate global payment services offers leading-edge technology,
innovative products, and industry expertise to help its clients optimize cash
flow, manage liquidity, and make payments around the world in more than 90
different countries. The Company maintains a global network of branches,
representative offices and correspondent banks to provide comprehensive payment
services including funds transfer, cash management, trade services and
liquidity management. The Company is one of the largest funds transfer banks
in the U.S. transferring over $1.18 trillion daily via more than 150,000 wire
transfers.
The Company provides lending and credit-related services to large public
and private corporations nationwide. Special industry groups focus on industry
segments such as media, telecommunications, cable, energy, real estate,
retailing, and healthcare. Credit-related revenues are allocated to businesses
other than Treasury Services to the extent the borrower uses that businesses'
products or services. Credit-only relationships and borrowers using both
credit and payment services remain in Treasury Services. Through BNY Capital
Markets, Inc., the Company provides a broad range of capital markets and
investment banking services including syndicated loans, bond underwriting,
private placements of corporate debt and equity securities, and merger,
acquisition, and advisory services. The Company is an active arranger or agent
of syndicated financings for clients in the U.S., having completed during the
first quarter of 2006 21 transactions totaling in excess of $11.5 billion.
For its credit services business overall, the Company's corporate lending
strategy is to focus on those clients and industries that are major users of
securities servicing and global payment services.
Private Bank & BNY Asset Management Segment
The Private Bank & BNY Asset Management Segment includes traditional
banking and trust services for wealthy clients and investment management
services for institutional and high-net-worth clients. In private banking, the
Company offers a full array of wealth management services to help individuals
plan, invest, and arrange intergenerational wealth transition, which includes
financial and estate planning, trust and fiduciary services, customized banking
services, brokerage and investment solutions.
BNY Asset Management provides investment solutions for some of the
wealthiest individuals, largest corporations and most prestigious organizations
around the world applying a broad spectrum of investment strategies and wealth
management solutions. BNY Asset Management's alternative strategies have
expanded to include funds of hedge funds, private equity, alternative fixed
income, and real estate.
The Company's asset management subsidiaries include:
* Ivy Asset Management Corporation, one of the country's leading fund of
hedge funds firms, offers a comprehensive range of multi-manager hedge
fund products and customized portfolio solutions.
* Alcentra offers sophisticated alternative credit investments, including
leveraged loans and subordinated and distressed debt.
* Urdang, a real estate investment firm, offers the opportunity to invest
in real estate through separate accounts, a closed-end commingled fund
that invests directly in properties, and a separate account that invests
in publicly-traded REITs.
13
* Estabrook Capital Management LLC offers value-oriented investment
management strategies, including socially responsible investing.
* Gannett Welsh & Kotler specializes in tax-exempt securities management
and equity portfolio strategies.
The Company also provides investment management services directly to
institutions and manages the "Hamilton" family of mutual funds.
Retail & Middle Market Banking Segment
--------------------------------------
The Retail Bank includes branch banking, consumer, small business,
residential mortgage and asset management activities conducted through the
Company's investment centers. The Company's retail franchise includes more
than 600,000 consumer relationships and 100,000 business relationships. As of
March 31, 2006, the Company operates 342 branches in 23 counties in the New
York tri-state region. The Company has 241 branches in New York, 93 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 significant source of low-cost funding and provides a
platform to cross-sell core services to both individuals and small businesses
in the New York metropolitan area. The branches have been a source of private
client referrals. Small business and investment centers are set up in the
largest 100 branches.
Investment centers provide personalized professional investment counseling
to individuals. Products include mutual funds, annuities, and discount
brokerage services.
In middle market lending, the Company's regional commercial banking and
regional commercial real estate divisions provide financing for a variety of
businesses based in the New York metropolitan area. The types of financing
include lines of credit, term loans, global trade services, and commercial
mortgages.
The Company has entered into a definitive agreement to sell to JPMorgan
Chase substantially all of the assets of the Company's retail and regional
middle market banking businesses. At closing, the Company will retain four
branch offices as part of a network of offices in the tri-state area for
private banking clients. For further details, see "Other Developments."
The Company will report the businesses in this segment as discontinued
operations in the second quarter of 2006. Effective upon the close of the
transaction, the Company will cease to report this segment.
Corporate and Other Segment
---------------------------
The Corporate and Other Segment primarily includes the Company's leasing
operations and corporate overhead. Net interest income in this segment
primarily reflects the funding cost of goodwill and intangibles. The tax
equivalent adjustment on net interest income is eliminated in this segment.
Provision for credit losses reflects the difference between the aggregate of
the credit provision over a credit cycle for the other three 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 included in
this segment's assets. Noninterest expense includes the related amortization.
Noninterest income primarily reflects leasing, securities gains, and income
from the sale of other corporate assets. Noninterest expenses include direct
expenses supporting the leasing activities as well as certain corporate
overhead not directly attributable to the operations of the other segments.
14
Segment Analysis
Institutional Services Segment
------------------------------
Inc/(Dec)
-------------------
1Q06 vs. 1Q06 vs.
(In millions) 1Q06 4Q05 1Q05 4Q05 1Q05
------------------- -------- -------- -------- -------- --------
Net Interest Income $ 315 $ 314 $ 280 $ 1 $ 35
Noninterest Income 1,123 1,079 1,001 44 122
Total Revenue 1,438 1,393 1,281 45 157
Provision for Credit Losses 16 14 16 2 -
Noninterest Expense 906 881 833 25 73
Income Before Taxes 516 498 432 18 84
Average Assets 79,032 78,333 73,832 699 5,200
Average Deposits 48,840 48,284 42,574 556 6,266
The Company's Institutional Services business is conducted in four
business groupings: Investor & Broker-Dealer Services, Execution & Clearing
Services, Issuer Services, and Treasury Services. Income before taxes was up
19% to $516 million for the first quarter of 2006 from $432 million in the
first quarter of 2005, and up 4% from $498 million in the fourth quarter of
2005.
Equity volumes and pricing levels were up during the most recent quarter,
and cross-border activity levels were strong. As a result, the Company's
equity-linked businesses performed well. Execution and clearing and depositary
receipts businesses both showed good year-over-year growth. The fixed income
markets were stable, and as a result the Company's securities lending, broker-
dealer services and institutional trust businesses all improved on a year-over-
year basis. Other areas demonstrating strong growth include foreign exchange
and alternative investment servicing.
Market Data
-----------
Percent Inc/(Dec)
------------------
1Q06 vs. 1Q06 vs.
1Q06 4Q05 1Q05 4Q05 1Q05
-------- -------- -------- -------- --------
S&P 500
(registered trademark) Index 1,295 1,248 1,181 4% 10%
NASDAQ
(registered trademark) Index 2,340 2,205 1,999 6 17
Lehman Brothers
Aggregate Bond
(registered service mark)
Index 205.9 206.2 214.0 - (4)
MSCI (registered trademark)
EAFE 1,827.7 1,680.1 1,503.9 9 22
NYSE Volume (In billions) 108.4 105.9 99.4 2 9
NASDAQ
(registered trademark)
Volume (In billions) 129.4 110.6 121.2 17 7
The S&P 500 (registered terademark) Index was up 4% sequentially for the
quarter, with average daily price levels up 4% from the fourth quarter of
2005. Performance for the NASDAQ (registered trademark) Index was up 6%
sequentially for the first quarter of 2006, with average daily prices up by
5%. Globally, the MSCI (registered trademark) EAFE index was up 9%. On a
sequential-quarter basis, combined NYSE and NASDAQ (registered trademark)
non-program trading volumes were up an estimated 13%. Average fixed-income
trading volume was up 5% sequentially.
As of March 31, 2006, assets under custody rose to $11.3 trillion, from
$9.9 trillion at March 31, 2005 and $10.9 trillion at December 31, 2005. The
increase in assets under custody relative to both time periods primarily
reflects rising equity prices and new business wins. Equity securities
comprised 33% of the assets under custody at March 31, 2006 compared with 32%
at December 31, 2005, while fixed income securities were 67% compared with
68% at December 31, 2005. Assets under custody in the first quarter
consisted of assets related to the custody and mutual funds businesses of
$7.6 trillion, broker-dealer services assets of $2.3 trillion, and all
other assets of $1.4 trillion.
15
The results for the businesses in the Institutional Services Segment are
discussed below.
Investor & Broker-Dealer Services Business
------------------------------------------
Inc/(Dec)
------------------
1Q06 vs. 1Q06 vs.
(In millions) 1Q06 4Q05 1Q05 4Q05 1Q05
--------------------- -------- -------- -------- -------- --------
Net Interest Income $ 149 $ 148 $ 139 $ 1 $ 10
Noninterest Income 491 469 441 22 50
Total Revenue 640 617 580 23 60
Provision for Credit Losses 3 2 2 1 1
Noninterest Expense 438 425 393 13 45
Income Before Taxes 199 190 185 9 14
Average Assets 38,163 38,138 36,376 25 1,787
Average Deposits 31,357 30,799 27,498 558 3,859
Nonperforming Assets 6 5 25 1 (19)
Net Charge-offs 1 - - 1 1
In the first quarter of 2006, income before taxes in the Investor &
Broker-Dealer Services business increased to $199 million from $185 million in
the first quarter of 2005 and $190 million in the fourth quarter of 2005. The
year-over-year increase reflects improvements in net interest income and
noninterest income. The sequential quarter increase reflects higher noninterest
income.
Noninterest income was $491 million in the first quarter of 2006, compared
with $441 million in the first quarter of 2005 and $469 million in the fourth
quarter of 2005. The increase in noninterest income in the first quarter of
2006 relative to both time periods is attributable to an increase in both
investor and broker-dealer service fees as well as foreign exchange and other
trading revenue generated by clients in this segment.
Investor services fees increased compared with a year ago and the fourth
quarter of 2005. The year-over-year and sequential increases reflect strong
performance in securities lending and alternative asset servicing as well as
higher custody fees. Securities lending fees showed good growth in the first
quarter benefiting from higher loan volumes, driven by new business wins as
well as a favorable spread environment. Offsetting this strong performance
were revenue losses due to mutual fund clients that transferred to another
provider during late 2005.
Broker-dealer services fees increased compared with a year ago and the
fourth quarter of 2005. The increases reflect greater domestic and global
collateral management fees due to strong growth in cross-border activity
between the U.S. and Europe and higher values in global markets. The Company
now handles approximately $1.2 trillion of financing for the Company's broker-
dealer clients daily through tri-party collateralized financing agreements, up
approximately 20% from a year ago.
Net interest income in the Investor & Broker-Dealer Services business was
$149 million in the first quarter of 2006, compared with $139 million in the
first quarter of 2005 and $148 million in the fourth quarter of 2005. On a
year-over-year basis, net interest income growth in the first quarter reflects
increased deposit flows from customers in both businesses and higher rates.
Average deposits generated by the Investor & Broker-Dealer Services business
were $31.4 billion in the first quarter of 2006, compared with $27.5 billion in
the first quarter of 2005 and $30.8 billion in the fourth quarter of 2005.
Average assets in the business were $38.2 billion in the first quarter of 2006,
compared with $36.4 billion in the first quarter of 2005 and $38.1 billion in
the fourth quarter of 2005.
Noninterest expense was $438 million in the first quarter of 2006,
compared with $393 million in the first quarter of 2005 and $425 million in the
fourth quarter of 2005. The year-over-year increase in noninterest expense was
due to higher costs tied to increased activity levels, as well as the upfront
16
expenses associated with the implementation of cost reduction initiatives and
higher pension and occupancy expense. The sequential rise in noninterest
expense in the first quarter was attributable primarily to higher salaries,
benefits and sub-custody expenses, seasonal increases in social security
expenses, increased technology costs, and higher pension expenses.
Net charge-offs were $1 million in the first quarter of 2006, compared
with zero in the first quarter of 2005 and in the fourth quarter of 2005.
Nonperforming assets were $6 million at March 31, 2006, compared with $25
million at March 31, 2005, and $5 million at December 31, 2005.
Execution & Clearing Services Business
-------------------------------------- Inc/(Dec)
------------------
1Q06 vs. 1Q06 vs.
(In millions) 1Q06 4Q05 1Q05 4Q05 1Q05
--------------------- -------- -------- -------- -------- --------
Net Interest Income $ 61 $ 59 $ 45 $ 2 $ 16
Noninterest Income 390 351 317 39 73
Total Revenue 451 410 362 41 89
Provision for Credit Losses - 1 - (1) -
Noninterest Expense 297 293 280 4 17
Income Before Taxes 154 116 82 38 72
Average Assets 14,980 14,547 14,211 433 769
Average Payables to Customers
and Broker-Dealers 5,231 5,979 6,385 (748) (1,154)
Nonperforming Assets - - 2 - (2)
Net Charge-offs (2) 1 - (3) (2)
In the first quarter of 2006, income before taxes in the Execution &
Clearing Services Business increased to $154 million from $82 million a year
ago and $116 million in the fourth quarter of 2005. The increase over the first
quarter of 2005 reflects a $31 million gain on the New York Stock Exchange
seats, incremental revenues and earnings contribution from Lynch, Jones & Ryan,
Inc. ("LJR"), an execution-services business that the Company acquired in July
2005, strong growth in net interest income, and higher fees at Pershing for
value-added services. The sequential quarter increase reflects the same
factors as the year-over-year increase except for LJR and net interest income
growth was not as strong.
Noninterest income was $390 million in the first quarter of 2006, compared
with $317 million in the first quarter of 2005 and $351 million in the fourth
quarter of 2005.
Execution services fees were up reflecting the LJR acquisition, strong
market conditions, and higher cross-border trading volumes.
Pershing's first quarter 2006 servicing fees were also up, reflecting
organic growth from value-added services such as providing access to research,
market data and mutual fund investments, as well as strong market conditions,
partially offset by the loss of a significant customer. The loss of this
customer resulted in a decrease of over $6 million in Pershing's revenues,
mainly interest, commissions and trading revenues. Excluding the impact of the
loss of this client, Pershing's commissions were up 12% sequentially. The
Company expects the impact of the customer loss to be greater in the second
quarter. Pershing currently is in discussions seeking compensation for the
termination of the relationship.
Net interest income in the Execution & Clearing Services business was $61
million in the first quarter of 2006, compared with $45 million in the first
quarter of 2005 and $59 million in the fourth quarter of 2005. Net interest
income growth in the first quarter of 2006 versus the first quarter of 2005
reflects the benefit of rising interest rates on spreads at Pershing, partially
offset by the loss of the customer discussed above. The increase over the
fourth quarter of 2005 also reflects the benefit of rising rates. Average
assets in the business were $15.0 billion in the first quarter of 2006,
compared with $14.2 billion in the first quarter of 2005 and $14.5 billion in
the fourth quarter of 2005. Average payables to customers and broker-dealers
17
were $5.2 billion in the first quarter of 2006, compared with $6.4 billion in
the first quarter of 2005 and $6.0 billion in the fourth quarter of 2005. The
decrease in first quarter balances reflects the previously mentioned loss of a
significant customer.
Noninterest expense was $297 million in the first quarter of 2006,
compared with $280 million in the first quarter of 2005 and $293 million in the
fourth quarter of 2005. The increase in noninterest expense on a year-over-
year basis was due to stronger business activity, higher technology expenses
and the additional expenses of LJR. The rise in noninterest expense
sequentially was attributable to higher salaries, benefits and technology costs
tied to higher overall business activity.
Net charge-offs were a recovery of $2 million in the first quarter of
2006, zero in the first quarter of 2005 and $1 million in the fourth quarter of
2005, respectively. Nonperforming assets were zero at March 31, 2006, compared
with $2 million at March 31, 2005 and zero at December 31, 2005.
Issuer Services Business
------------------------
Inc/(Dec)
------------------
1Q06 vs. 1Q06 vs.
(In millions) 1Q06 4Q05 1Q05 4Q05 1Q05
--------------------- -------- -------- -------- -------- --------
Net Interest Income $ 67 $ 66 $ 53 $ 1 $ 14
Noninterest Income 179 199 167 (20) 12
Total Revenue 246 265 220 (19) 26
Provision for Credit Losses 4 2 3 2 1
Noninterest Expense 122 117 112 5 10
Income Before Taxes 120 146 105 (26) 15
Average Assets 14,588 14,394 13,302 194 1,286
Average Deposits 8,303 7,917 7,506 386 797
Nonperforming Assets 6 5 27 1 (21)
Net Charge-offs 1 - - 1 1
In the first quarter of 2006, income before taxes in the Issuer Services
Business increased to $120 million from $105 million in the first quarter of
2005 and decreased from $146 million in the fourth quarter of 2005. The year-
over-year increase in the first quarter reflects growth in net interest income
and higher corporate trust and depositary receipt fees. The sequential quarter
decline reflects seasonally lower depositary receipt fees as well as an
increase in sub-custodian expense.
Noninterest income was $179 million in the first quarter of 2006, compared
with $167 million in the first quarter of 2005 and $199 million in the fourth
quarter of 2005. Year-over-year, the double-digit growth in issuer services
fees reflects strong performance in structured and global trust products as
well as higher transactional activity in depositary receipts. The sequential
decrease is primarily due to seasonally lower dividend-related activity in
depositary receipts as well as the strong fourth quarter performance by
Corporate Trust in structured products.
Net interest income in the Issuer Services business was $67 million in the
first quarter of 2006, compared with $53 million in the first quarter of 2005
and $66 million in the fourth quarter of 2005. The increase in net interest
income year-over-year was driven primarily by the increase in interest rates
and higher average assets. Average deposits generated by the Issuer Services
business were $8.3 billion in the first quarter of 2006, compared with $7.5
billion in the first quarter of 2005 and $7.9 billion in the fourth quarter of
2005 reflecting increased liquidity from the Company's issuer services
customers. Average assets in the business were $14.6 billion in the first
quarter of 2006, compared with $13.3 billion in the first quarter of 2005 and
$14.4 billion in the fourth quarter of 2005.
Noninterest expense was $122 million in the first quarter of 2006,
compared with $112 million in the first quarter of 2005 and $117 million in the
fourth quarter of 2005. The rise in noninterest expense year-over-year and
18
sequentially was attributable to increased client activity as well as higher
sub-custodian and pension expenses.
Net charge-offs were $1 million in the first quarter of 2006, compared
with zero in the first quarter of 2005 and in the fourth quarter of 2005.
Nonperforming assets were $6 million at March 31, 2006, compared with $27
million at March 31, 2005 and $5 million at December 31, 2005.
Treasury Services Business
--------------------------
Inc/(Dec)
------------------
1Q06 vs. 1Q06 vs.
(In millions) 1Q06 4Q05 1Q05 4Q05 1Q05
--------------------- -------- -------- -------- -------- --------
Net Interest Income $ 38 $ 41 $ 43 $ (3) $ (5)
Noninterest Income 63 60 76 3 (13)
Total Revenue 101 101 119 - (18)
Provision for Credit Losses 9 9 11 - (2)
Noninterest Expense 49 46 48 3 1
Income Before Taxes 43 46 60 (3) (17)
Average Assets 11,301 11,254 9,943 47 1,358
Average Deposits 9,002 9,095 7,411 (93) 1,591
Nonperforming Assets 21 16 83 5 (62)
Net Charge-offs 1 2 - (1) 1
In the first quarter of 2006, income before taxes in the Treasury Services
Business was $43 million, compared with $60 million in the first quarter of
2005 and $46 million in the fourth quarter of 2005. The lower income versus a
year ago reflects both the Company's overall strategy to reduce corporate
credit risk, as well as higher asset-related gains in the year-ago quarter.
The decrease in noninterest income to $63 million in the current period
from $76 million in the first quarter of 2005 was due to a decline in asset-
related gains, lower underwriting fees from clients in this segment and lower
global payments fees as more clients used compensating balances to pay for
services. The sequential quarter increase in noninterest income reflects
higher foreign exchange related income partially offset by lower syndication
fees.
Net interest income was $38 million in the first quarter of 2006, compared
with $43 million in the first quarter of 2005 and $41 million in the fourth
quarter of 2005. On a year-over-year basis, the decrease reflects lower credit
spreads due to the higher asset quality of the portfolio. Average assets for
the first quarter of 2006 were $11.3 billion, compared with $9.9 billion in the
first quarter of 2005 and $11.3 billion in the fourth quarter of 2005. Average
deposits were $9.0 billion in the first quarter of 2006, compared with $7.4
billion in the first quarter of 2005 and $9.1 billion in the fourth quarter of
2005.
The provision for credit losses, which is assessed on a long-term credit
cycle basis (see "Business Segments Accounting Principles"), was $9 million in
the first quarter of 2006, compared with $11 million in the first quarter of
2005 and $9 million in the fourth quarter of 2005. The year-over-year decrease
reflects improved credit quality.
Net charge-offs in the Treasury Services business were $1 million, zero,
and $2 million in the first quarter of 2006, the first quarter of 2005, and the
fourth quarter of 2005, respectively. Nonperforming assets were $21 million at
March 31, 2006, compared with $83 million at March 31, 2005 and $16 million at
December 31, 2005.
Noninterest expense in the first quarter of 2006 was $49 million, compared
to $48 million in the first quarter of 2005 and $46 million in the fourth
quarter of 2005. The increase in noninterest expense year-over-year was due in
part to higher compensation and pension expenses.
19
Private Bank & BNY Asset Management Segment
-------------------------------------------
Inc/(Dec)
------------------
1Q06 vs. 1Q06 vs.
(In millions) 1Q06 4Q05 1Q05 4Q05 1Q05
--------------------- -------- -------- -------- -------- --------
Net Interest Income $ 17 $ 17 $ 17 $ - $ -
Noninterest Income 127 117 111 10 16
Total Revenue 144 134 128 10 16
Provision for Credit Losses - - 1 - (1)
Noninterest Expense 87 83 78 4 9
Income Before Taxes 57 51 49 6 8
Average Assets 2,543 2,459 2,106 84 437
Average Deposits 1,745 1,517 1,752 228 (7)
Nonperforming Assets 1 1 1 - -
Net Charge-offs - - - - -
In the first quarter of 2006, income before taxes in the Private Bank &
BNY Asset Management Segment was $57 million, compared with $49 million in the
first quarter of 2005 and $51 million in the fourth quarter of 2005. The
improvement over the prior periods is attributable to the acquisitions of
Alcentra and Urdang as well as higher fee levels in Private Banking.
Noninterest income was $127 million in the first quarter of 2006, compared
with $111 million in the first quarter of 2005 and $117 million in the fourth
quarter of 2005. Private Bank & BNY Asset Management revenues in the first
quarter of 2006 were up sequentially and year-over-year. The growth reflects
the acquisitions of Alcentra and Urdang as well as mid-single digit year-over-
year organic growth. The S&P 500 (registered trademark) Index was up 4% for
the quarter, with average daily price levels up 4% from December 31, 2005.
Performance for the NASDAQ (registered trademark) Index was up 6% for the
quarter, with average daily prices up by 5%. Sequential quarter performance
reflects the same factors that drove year-over-year performance.
Assets Under Management - Asset Management Sector
-------------------------------------------------
(In billions)- Estimated 1Q06 4Q05 1Q05
------ ------ ------
Equity Securities $ 37 $ 37 $ 37
Fixed Income Securities 21 21 21
Alternative Investments 26 15 16
Liquid Assets 29 32 31
---- ---- ----
Total Assets Under Management $113 $105 $105
==== ==== ====
Assets under management ("AUM") were $113 billion at March 31, 2006,
compared with $105 billion at March 31, 2005 and December 31, 2005. The year-
over-year and sequential quarter increases in AUM primarily reflect the
acquisitions of Alcentra and Urdang. Institutional clients represent 72% of
AUM while individual clients equal 28%. At March 31, 2006, such assets were
invested 33% in equities, 18% in fixed income, and 23% in alternative
investments, with the remaining amount invested in liquid assets.
Net interest income in the Private Bank & BNY Asset Management Segment was
$17 million in the first quarter of 2006, flat in comparison to the first
quarter of 2005 and the fourth quarter of 2005. Average deposits generated by
the Private Bank & BNY Asset Management Segment were $1.7 billion in first
quarter of 2006, compared with $1.8 billion in the first quarter of 2005 and
$1.5 billion in the fourth quarter of 2005. Average assets in the segment were
$2.5 billion in the first quarter of 2006, compared with $2.1 billion in the
first quarter of 2005 and $2.5 billion in the fourth quarter of 2005.
Noninterest expense was $87 million in the first quarter of 2006, compared
with $78 million in the first quarter of 2005 and $83 million in the fourth
quarter of 2005. Relative to a year ago, the increase reflects the
acquisitions of Alcentra and Urdang as well as higher compensation, technology,
20
and legal staffing costs. The increase in noninterest expense on a sequential
basis was primarily attributable to the acquisitions of Alcentra and Urdang.
Net charge-offs were zero in the first quarter of 2006, the first quarter
of 2005, and the fourth quarter of 2005, respectively. Nonperforming assets
were $1 million at March 31, 2006, March 31, 2005 and December 31, 2005.
Retail & Middle Market Banking Segment
--------------------------------------
Inc/(Dec)
------------------
1Q06 vs. 1Q06 vs.
(In millions) 1Q06 4Q05 1Q05 4Q05 1Q05
-------------- -------- -------- -------- -------- --------
Net Interest Income $ 163 $ 166 $ 159 $ (3) $ 4
Noninterest Income 69 69 58 - 11
Total Revenue 232 235 217 (3) 15
Provision for Credit Losses 6 7 7 (1) (1)
Noninterest Expense 135 130 125 5 10
Income Before Taxes 91 98 85 (7) 6
Average Assets 14,466 14,377 13,630 89 836
Average Noninterest-
Bearing Deposits 5,256 5,329 5,808 (73) (552)
Average Deposits 15,055 15,069 16,253 (14) (1,198)
Nonperforming Assets 28 34 48 (6) (20)
Net Charge-offs 7 8 10 (1) (3)
Number of Branches 342 342 341 - 1
Number of ATMs 411 401 375 10 36
In the first quarter of 2006, income before taxes was $91 million,
compared with $85 million in the first quarter of 2005 and $98 million in the
fourth quarter of 2005.
Net interest income in the Retail & Middle Market Banking Segment was $163
million in the first quarter of 2006, compared with $159 million in the first
quarter of 2005 and $166 million in the fourth quarter of 2005. Net interest
income growth on a year-over-year basis reflects the benefit of widening
interest-rate spreads, growth in loans, and small business customers'
increasing use of compensating balances to pay for services. The sequential
decline in net interest income reflects a narrowing of the spread on loans and
lower demand deposits.
Average deposits generated by the Retail & Middle Market Banking Segment
were $15.1 billion in the first quarter of 2006, compared with $16.3 billion in
the first quarter of 2005 and $15.1 billion in the fourth quarter of 2005.
Average noninterest-bearing deposits were $5.3 billion in the first quarter of
2006, compared with $5.8 billion in the first quarter of 2005 and $5.3 billion
in the fourth quarter of 2005. Average assets in the Retail & Middle Market
Banking Segment were $14.5 billion in the first quarter of 2006, compared with
$13.6 billion in the first quarter of 2005 and $14.4 billion in the fourth
quarter of 2005.
Noninterest income was $69 million in the first quarter of 2006, compared
with $58 million in the first quarter of 2005 and $69 million in the fourth
quarter of 2005. The growth on a year-over-year basis reflects higher asset-
related gains.
Noninterest expense was $135 million in the first quarter of 2006,
compared with $125 million in the first quarter of 2005 and $130 million in the
fourth quarter of 2005. The rise in noninterest expense year-over-year and
sequentially was primarily attributable to higher salary, pension, marketing,
and occupancy expenses.
Net charge-offs were $7 million in the first quarter of 2006, compared
with $10 million in the first quarter of 2005 and $8 million in the fourth
quarter of 2005. Nonperforming assets were $28 million at March 31, 2006,
compared with $48 million at March 31, 2005 and $34 million at
December 31, 2005.
21
Corporate and Other Segment
---------------------------
Inc/(Dec)
------------------
1Q06 vs. 1Q06 vs.
(In millions) 1Q06 4Q05 1Q05 4Q05 1Q05
--------------------- -------- -------- -------- -------- --------
Net Interest Income $ (7) $ (5) $ (1) $ (2) $ (6)
Noninterest Income 13 8 8 5 5
Total Revenue 6 3 7 3 (1)
Provision for Credit Losses (17) (11) (34) (6) 17
Noninterest Expense 50 54 41 (4) 9
Income Before Taxes (27) (40) - 13 (27)
Average Assets 10,092 9,898 9,674 194 418
Nonperforming Assets 4 18 6 (14) (2)
Net Charge-offs (4) 140 - (144) (4)
In the first quarter of 2006, income before taxes in the Corporate and
Other Segment was a loss of $27 million, compared with zero in the first
quarter of 2005 and a loss of $40 million in the fourth quarter of 2005.
Net interest income in the Corporate and Other Segment was a loss of $7
million in the first quarter of 2006, compared with a loss of $1 million in the
first quarter of 2005 and a loss of $5 million in the fourth quarter of 2005.
The decrease in net interest income over the first quarter of 2005 reflects the
impact of a $6 million cumulative adjustment in the Company's reserve position
with the Federal Reserve Bank.
Noninterest income was $13 million in the first quarter of 2006, compared
with $8 million in the first quarter of 2005 and $8 million in the fourth
quarter of 2005. The increase in noninterest income in the first quarter of
2006 over the first quarter of 2005 is attributable to higher securities gains.
Securities gains were $17 million in the first quarter of 2006, compared with
$12 million in the first quarter of 2005 and $18 million in the fourth quarter
of 2005. The increase in noninterest income of $5 million on a sequential
quarter basis reflects higher other investment income.
Provision for credit losses was a credit of $17 million in the first
quarter of 2006, compared with a $34 million credit in the first quarter of
2005 and a $11 million credit in the fourth quarter of 2005. The provision for
credit losses reflects the difference between the aggregate of the credit
provision over a credit cycle assigned to the other segments and the Company's
recorded provision. As such, the favorable credit environment has currently
resulted in the business segments absorbing more than the Company's aggregate
reported credit provision.
Noninterest expense, largely reflecting unallocated corporate overhead,
amortization of goodwill, and nonrecurring items, was $50 million in the first
quarter of 2006, compared with $41 million in the first quarter of 2005 and $54
million in the fourth quarter of 2005. The year-over-year growth includes
higher intangible amortization. The decrease in noninterest expense on a
sequential basis was due to lower corporate overhead.
Net charge-offs were a recovery of $4 million in the first quarter of
2006, compared with zero in the first quarter of 2005 and $140 million in the
fourth quarter of 2005. The charge-offs in the fourth quarter of 2005 were
attributable to the Company's airline leasing portfolio. Nonperforming assets
were $4 million at March 31, 2006, compared with $6 million at March 31, 2005,
and $18 million at December 31, 2005.
22
Significant other items related to the Corporate and Other Segment are
presented in the following table.
(In millions) 1Q06 4Q05 1Q05
------------------------------- ---------- ---------- ----------
Items impacting net interest income:
------------------------------------
Cost to Carry Goodwill
and Intangibles $ (49) $ (49) $ (50)
Tax Equivalent Basis (7) (7) (7)
Items impacting noninterest expense:
------------------------------------
Goodwill and
Intangibles Amortization $ 13 $ 12 $ 8
Other items - Acquisitions are the responsibility of corporate
management. Accordingly, goodwill and the funding cost of goodwill are
assigned to the Corporate and Other Segment. If the funding cost of goodwill
were allocated to the other three segments, it would be assigned on the basis
of the goodwill attributable to each segment.
The tax equivalent adjustment is eliminated in the Corporate and Other
Segment. Certain revenue and expense items have been driven by corporate
decisions and have been included in the Corporate and Other Segment. In the
first quarter of 2006 and fourth quarter of 2005, these included the impact of
the $6 million and $8 million cumulative adjustment in the Company's reserve
position with the Federal Reserve Bank. Alternatively, this item could be
allocated to the Institutional Services Segment.
23
The consolidating schedule below shows the contribution of the Company's
businesses to its overall profitability.
(Dollars in millions) Execution Private Retail
Investor & & Sub-total Bank & & Corporate
For the Quarter Ended Broker-Dealer Clearing Issuer Treasury Institutional BNY Asset Middle and
March 31, 2006 Services Services Services Services Services Management Market Other Total
------------------- -------- -------- -------- --------- ------------- ---------- ------- -------- -------
Net Interest Income $ 149 $ 61 $ 67 $ 38 $ 315 $ 17 $ 163 $ (7) $ 488
Noninterest Income 491 390 179 63 1,123 127 69 13 1,332
Total Revenue 640 451 246 101 1,438 144 232 6 1,820
Provision for
Credit Losses 3 - 4 9 16 - 6 (17) 5
Noninterest Expense 438 297 122 49 906 87 135 50 1,178
-------- -------- -------- -------- ------- --------- ------ -------- -------
Income Before Taxes $ 199 $ 154 $ 120 $ 43 $ 516 $ 57 $ 91 $ (27) $ 637
======== ======== ======== ======== ======= ========= ====== ======== =======
Contribution
Percentage* 30% 23% 18% 7% 78% 8% 14%
Average Assets $38,163 $14,980 $14,588 $11,301 $79,032 $2,543 $14,466 $10,092 $106,133
(Dollars in millions) Execution Private Retail
Investor & & Sub-total Bank & & Corporate
For the Quarter Ended Broker-Dealer Clearing Issuer Treasury Institutional BNY Asset Middle and
December 31, 2005 Services Services Services Services Services Management Market Other Total
------------------- --------- -------- -------- --------- ------------- ---------- ------- -------- -------
Net Interest Income $ 148 $ 59 $ 66 $ 41 $ 314 $ 17 $ 166 $ (5) $ 492
Noninterest Income 469 351 199 60 1,079 117 69 8 1,273
Total Revenue 617 410 265 101 1,393 134 235 3 1,765
Provision for
Credit Losses 2 1 2 9 14 - 7 (11) 10
Noninterest Expense 425 293 117 46 881 83 130 54 1,148
--------- -------- -------- -------- ------- --------- ------ -------- -------
Income Before Taxes $ 190 $ 116 $ 146 $ 46 $ 498 $ 51 $ 98 $ (40) $ 607
========= ======== ======== ======== ======= ========= ====== ======== =======
Contribution
Percentage* 29% 18% 23% 7% 77% 8% 15%
Average Assets $38,138 $14,547 $14,394 $11,254 $78,333 $2,459 $14,377 $9,898 $105,067
(Dollars in millions) Execution Private Retail
Investor & & Sub-total Bank & & Corporate
For the Quarter Ended Broker-Dealer Clearing Issuer Treasury Institutional BNY Asset Middle and
March 31, 2005 Services Services Services Services Services Management Market Other Total
------------------- -------- -------- -------- --------- ------------ ---------- ------- -------- -------
Net Interest Income $ 139 $ 45 $ 53 $ 43 $ 280 $ 17 $ 159 $ (1) $ 455
Noninterest Income 441 317 167 76 1,001 111 58 8 1,178
Total Revenue 580 362 220 119 1,281 128 217 7 1,633
Provision for
Credit Losses 2 - 3 11 16 1 7 (34) (10)
Noninterest Expense 393 280 112 48 833 78 125 41 1,077
-------- ------- -------- -------- ------- --------- ------ ------- -------
Income Before Taxes $ 185 $ 82 $ 105 $ 60 $ 432 $ 49 $ 85 $ - $ 566
======== ======= ======== ======== ======= ========= ====== ======= =======
Contribution
Percentage* 33% 14% 19% 10% 76% 9% 15%
Average Assets $36,376 $14,211 $13,302 $9,943 $73,832 $2,106 $13,630 $9,674 $99,242
*As a percent of total income before tax excluding Corporate and Other.
24
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 2005 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 and allowance for lending-related
commitments consist of four elements: (1) an allowance for impaired credits;
(2) an allowance for higher risk rated loans and exposures; (3) an allowance
for pass rated loans and exposures; and (4) an unallocated allowance based on
general economic conditions and certain risk factors in the Company's
individual portfolio and markets. Further discussion on the four elements can
be found under "Consolidated Balance Sheet Review" in the MD&A section.
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. Probability of default
ratings are assigned after analyzing the credit quality of each
borrower/counterparty and the Company's internal rating are generally
consistent with external ratings agency's 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.
A key variable in determining the allowance is management's judgment in
determining the size of the unallocated allowance. At March 31, 2006, the
unallocated allowance was 18% of the total allowance. If the unallocated
allowance were five percent higher or lower, the allowance would have increased
or decreased by $28 million, respectively.
The credit rating assigned to each credit is another significant variable
in determining the allowance. If each credit were rated one grade better, the
allowance would have decreased by $91 million, while if each credit were rated
one grade worse, the allowance would have increased by $147 million.
Similarly, if the loss given default were one rating worse, the allowance
would have increased by $61 million, while if the loss given default were one
rating better, the allowance would have decreased by $51 million.
For impaired credits, if the fair value of the loans were 10% higher or
lower, the allowance would have decreased or increased by $3 million,
respectively.
25
Valuation of Derivatives and Securities Where Quoted Market Prices Are Not
--------------------------------------------------------------------------
Available
---------
When quoted market prices are not available for derivatives and securities
values, such values are determined at fair value, which is defined as the value
at which positions could be closed out or sold in a transaction with a willing
counterparty over a period of time consistent with the Company's trading or
investment strategy. Fair value for these instruments is determined based on
discounted cash flow analysis, comparison to similar instruments, and the use
of financial models. Financial models use as their basis independently sourced
market parameters including, for example, interest rate yield curves, option
volatilities, and currency rates. Discounted cash flow analysis is dependent
upon estimated future cash flows and the level of interest rates. Model-based
pricing uses inputs of observable prices for interest rates, foreign exchange
rates, option volatilities and other factors. Models are benchmarked and
validated by independent parties. The Company's valuation process takes into
consideration factors such as counterparty credit quality, liquidity and
concentration concerns. The Company applies judgment in the application of
these factors. In addition, the Company must apply judgment when no external
parameters exist. Finally, other factors can affect the Company's estimate of
fair value including market dislocations, incorrect model assumptions, and
unexpected correlations.
These valuation methods could expose the Company to materially different
results should the models used or underlying assumptions be inaccurate. See
"Use of Estimates" in "Summary of Significant Accounting and Reporting
Policies" of the Notes to Consolidated Financial Statement in the Company's
2005 Annual Report on Form 10-K.
To assist in assessing the impact of a change in valuation, at March 31,
2006, approximately $2.3 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 $58
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 FASB Statement No. 141 ("SFAS 141"),
"Business Combination". Goodwill ($3,848 million at March 31, 2006) and
indefinite-lived intangible assets ($378 million at March 31, 2006) 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 ($518 million at March 31, 2006) are
evaluated for impairment if events and circumstances indicate a possible
impairment. Such evaluation of other intangible assets is based on
undiscounted cash flow projections. Fair value may be determined using: market
26
prices, comparison to similar assets, market multiples, discounted cash flow
analysis and other determinates. Estimated cash flows may extend far into the
future and, by their nature, are difficult to determine over an extended
timeframe. Factors that may significantly affect the estimates include, among
others, competitive forces, customer behaviors and attrition, changes in
revenue growth trends, cost structures and technology, and changes in discount
rates and specific industry or market sector conditions. Other key judgments
in accounting for intangibles include useful life and classification between
goodwill and indefinite-lived intangibles or other intangibles that require
amortization. See Note "Goodwill and Intangibles" in 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 $4.7 billion
of goodwill and intangible assets at March 31, 2006. The impact of a 5%
impairment charge would result in a change of pre-tax income of approximately
$237 million.
Pension Accounting
------------------
The Company has defined benefit plans covering approximately 13,900 U.S.
employees and approximately 3,175 non-US employees at September 30, 2005.
The Company has three defined benefit pension plans in the U.S. and six
overseas. The U.S. plans account for 82% of the projected benefit obligation.
Pension expense was $26 million in 2005 while there were pension credits in
2004 and 2003 of $24 million and $39 million. 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 2003, these key
elements have varied as follows:
2006 2005 2004 2003
-------- -------- -------- --------
(Dollars in millions,
except per share amounts)
Domestic Plans:
Long-Term Rate of Return
on Plan Assets 7.88% 8.25% 8.75% 9.00%
Discount Rate 5.88 6.00 6.25 6.50
Market-Related Value of
Plan Assets(1) $ 1,324 $ 1,502 $ 1,523 $ 1,483
ESOP Stock Price(1) 30.46 30.67 27.88 33.30
Net U.S Pension Credit/(Expense) $ (17) $ 31 $ 46
All other Pension Credit/(Expense) (9) (7) (7)
-------- -------- --------
Total Pension Credit/(Expense) $ (26) $ 24 $ 39
======== ======== ========
------------
(1) Actuarially smoothed data. See "Summary of Significant Accounting and
Reporting Policies" in Notes to the Consolidated Financial Statements
in the 2005 Annual Report on Form 10-K.
The discount rate for U.S. pension plans was determined after reviewing a
number of high quality long-term bond indices whose yields were adjusted to
match the duration of the Company's pension liability. The Company also
reviewed the results of several models that matched bonds to the Company's
pension cash flows. The various indices and models produced discount rates
ranging from 5.68% to 6.2%. After reviewing the various indices and models,
the Company selected a discount rate of 5.875%. The discount rates for foreign
27
pension plans are based on high quality corporate bonds rates in countries that
have an active corporate bond market. In those countries with no active
corporate bond market, discount rates are based on local government bond rates
plus a credit spread.
The Company's expected long-term rate of return on plan assets is based on
anticipated returns for each asset class. At September 30, 2005 and 2004, the
assumptions for the long-term rates of return on plan assets were 7.88% and
8.25%, 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 market-related value of plan assets declined as the
extraordinary actual return in 2000 was 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.
For 2005, U.S. pension expense increased by $48 million reflecting changes
in assumptions, the amortization of unrecognized pension losses and a decline
in the market-related value of plan assets. These same factors are expected to
further increase pension expense in 2006. To reduce the impact of these
factors, the Company changed certain of its domestic defined benefit pension
plans during the third quarter of 2005. The primary change was to switch the
computation of the benefits from final average pay to career average pay
effective January 1, 2006. As a result U.S. pension expense is expected to
increase by approximately $21 million.
The annual impacts on the primary U.S. plan of hypothetical changes in
the key elements on the pension expense are shown in the tables below.
(Dollars in millions) Increase in Decrease in
Pension Expense 2006 Base Pension Expense
--------------- ------------- ---------------
Long-Term Rate of Return
on Plan Assets 6.88% 7.38% 7.88% 8.38% 8.88%
Change in Pension Expense $ 16.0 $ 7.9 N/A $ 7.9 $ 15.7
Discount Rate 5.38% 5.63% 5.88% 6.13% 6.38%
Change in Pension Expense $ 14.9 $ 7.2 N/A $ 6.9 $ 13.4
Market-Related Value of
Plan Assets -20.00% -10.00% $1,324 +10.00% +20.00%
Change in Pension Expense $ 50.8 $ 25.4 N/A $ 25.4 $ 50.8
ESOP Stock Price $20.46 $25.46 $30.46 $35.46 $40.46
Change in Pension Expense $ 15.2 $ 7.3 N/A $ 6.7 $ 12.9
28
CONSOLIDATED BALANCE SHEET REVIEW
Total assets were $103.6 billion at March 31, 2006, compared with $96.5
billion at March 31, 2005 and $102.1 billion at December 31, 2005. The
increase in assets from December 31, 2005 reflects increase in short-term high
quality assets such as federal funds sold, securities purchased under resale
agreements, and trading assets. Total shareholders' equity was $10.1 billion
at March 31, 2006, compared with $9.3 billion at March 31, 2005 and $9.9
billion at December 31, 2005. The increase in shareholders' equity from
December 31, 2005, reflects the retention of earnings.
Return on average common equity for the first quarter of 2006 was 17.31%,
compared with 16.52% in the first quarter of 2005 and 16.57% in the fourth
quarter of 2005.
Return on average assets for the first quarter of 2006 was 1.61%, compared
with 1.55% in the first quarter of 2005 and 1.53% in the fourth quarter of
2005.
Investment Securities
---------------------
The table below shows the distribution of the Company's securities
portfolio:
Investment Securities (at Fair Value)
(In millions) 03/31/06 12/31/05
---------- ----------
Fixed Income:
Mortgage-Backed Securities $ 22,673 $ 22,483
Asset-Backed Securities 364 305
Corporate Debt 1,263 1,034
Short-Term Money Market Instruments 978 975
U.S. Treasury Securities 209 226
U.S. Government Agencies 643 620
State and Political Subdivisions 210 224
Emerging Market Debt (Collateralized
By U.S. Treasury Zero Coupon Obligations) 117 117
Other Foreign Debt 150 363
---------- ----------
Subtotal Fixed Income 26,607 26,347
Equity Securities:
Money Market Funds 571 922
Other 68 31
---------- ----------
Subtotal Equity Securities 639 953
---------- ----------
Total Securities $ 27,246 $ 27,300
========== ==========
Total investment securities were $27.2 billion at March 31, 2006, compared
with $27.3 billion at December 31, 2005. Average investment securities were
$27.1 billion in the first quarter of 2006, compared with $23.5 billion in the
first quarter of last year and $26.9 billion in the fourth 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, 8% AA, and 3% 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 March 31, 2006 was
approximately 2.0 years.
Net unrealized losses for securities available-for-sale was $195 million
at March 31, 2006, compared with net unrealized losses of $108 million at
December 31, 2005. The change in the value of available-for-sale securities at
March 31, 2006 from December 31, 2005 reflects the increase in long-term
interest rates over the quarter. The asymmetrical accounting treatment of the
impact of a change in interest rates on the Company's balance sheet may create
a situation in which an increase in interest rates can adversely affect
reported equity and regulatory capital, even though economically there may be
29
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
Period End Average
------------------------- -------------------------
Total Non-Margin Margin Total Non-Margin Margin
----- ---------- ------ ----- ---------- ------
March 31, 2006 $40.1 $ 34.8 $ 5.3 $39.6 $ 33.9 $ 5.7
December 31, 2005 40.7 34.6 6.1 40.8 34.3 6.5
March 31, 2005 38.8 32.8 6.0 38.8 32.4 6.4
Total loans were $40.1 billion at March 31, 2006 compared with $40.7
billion at December 31, 2005. The decrease in total loans from December 31,
2005 primarily reflects a decrease in margin loans reflecting the loss of a
significant customer at Pershing. Average total loans were $39.6 billion in
the first quarter of 2006, compared with $38.8 billion in the first quarter of
2005. The increase in average loans from March 31, 2005 results from increased
lending to financial institutions.
The following tables provide additional details on the Company's credit
exposures and outstandings at March 31, 2006 in comparison to December 31,
2005.
Overall Loan Portfolio
----------------------
Unfunded Total Unfunded Total
(In billions) Loans Commitments Exposure Loans Commitments Exposure
---------------------------- ----------------------------
03/31/06 03/31/06 03/31/06 12/31/05 12/31/05 12/31/05
-------- -------- -------- -------- -------- --------
Financial Institutions $ 12.7 $ 25.1 $ 37.8 $ 13.0 $ 22.5 $ 35.5
Corporate 4.0 19.2 23.2 3.7 19.6 23.3
-------- -------- -------- -------- -------- --------
16.7 44.3 61.0 16.7 42.1 58.8
-------- -------- -------- -------- -------- --------
Consumer & Middle Market 10.5 4.8 15.3 10.3 4.8 15.1
Leasing Financings 5.6 0.1 5.7 5.5 - 5.5
Commercial Real Estate 2.0 1.4 3.4 2.1 1.4 3.5
Margin loans 5.3 - 5.3 6.1 - 6.1
-------- -------- -------- -------- -------- --------
Total $ 40.1 $ 50.6 $ 90.7 $ 40.7 $ 48.3 $ 89.0
======== ======== ======== ======== ======== ========
30
Financial Institutions
----------------------
The financial institutions portfolio exposure was $37.8 billion at March
31, 2006 compared to $35.5 billion at December 31, 2005. The increase in
exposure from year-end 2005 reflects greater activity in the capital markets in
the first quarter of 2006, which drove increased demands for credit from
financial institutions. These exposures are of high quality with 85% meeting
the investment grade criteria of the Company's rating system. These exposures
are generally short-term, with 75% 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)
March 31, 2006 December 31, 2005
--------------------------- ----- ----- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Banks $ 4.6 $ 4.0 $ 8.6 65% 85% $ 5.1 $ 3.8 $ 8.9
Securities Industry 3.0 4.3 7.3 85 97 3.4 3.7 7.1
Insurance 0.4 5.3 5.7 97 43 0.4 4.9 5.3
Government 0.1 5.9 6.0 100 66 0.1 4.7 4.8
Asset Managers 4.3 3.6 7.9 87 80 3.8 3.6 7.4
Mortgage Banks 0.2 0.7 0.9 76 58 0.1 0.7 0.8
Endowments 0.1 1.3 1.4 99 51 0.1 1.1 1.2
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $12.7 $ 25.1 $ 37.8 85% 75% $13.0 $ 22.5 $ 35.5
===== =========== ========= ===== ===== ===== =========== =========
Corporate
---------
The corporate portfolio exposure declined slightly to $23.2 billion at
March 31, 2006 from $23.3 billion at year-end 2005. Approximately 74% of the
portfolio is investment grade while 15% of the portfolio matures within one
year.
(In billions)
March 31, 2006 December 31, 2005
--------------------------- ----- ----- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Media $ 1.1 $ 2.0 $ 3.1 64% 7% $ 1.1 $ 2.0 $ 3.1
Cable 0.3 0.4 0.7 48 - 0.4 0.5 0.9
Telecom 0.1 0.4 0.5 79 6 0.1 0.4 0.5
----- ----------- --------- ----- ----- ----- ----------- ---------
Subtotal 1.5 2.8 4.3 64% 6% 1.6 2.9 4.5
Energy 0.4 4.9 5.3 83 11 0.4 4.9 5.3
Retailing 0.1 2.1 2.2 79 24 0.1 2.1 2.2
Automotive* 0.1 1.2 1.3 57 38 0.1 1.2 1.3
Healthcare 0.4 1.5 1.9 81 8 0.3 1.7 2.0
Other** 1.5 6.7 8.2 74 19 1.2 6.8 8.0
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $ 4.0 $ 19.2 $ 23.2 74% 15% $ 3.7 $ 19.6 $ 23.3
===== =========== ========= ===== ===== ===== =========== =========
* During the third quarter of 2005, the Company eliminated the Automotive division and
transferred the customers to the other geographic lending divisions. The amounts in the
table were reconstructed for analytical purposes.
** Diversified portfolio of industries and geographies
Included in the Company's corporate exposures are automotive and airline
exposures. The Company continues to seek to selectively reduce automotive
exposures given ongoing weakness in the domestic automotive industry. Total
exposures reported in the Automotive Division were down $43 million at March
31, 2006 compared with December 31, 2005. At March 31, 2006, this broadly
defined industry portfolio consists of exposures of $184 million to Big Three
automotive manufacturing, $191 million to finance subsidiaries, $453 million
to highly rated asset-backed securitization vehicles, $289 million to
suppliers, and $141 million of other.
31
The Company's exposure to the airline industry consists of a $325 million
leasing portfolio (including a $16 million real estate lease exposure). The
airline-leasing portfolio consists of $129 million to major U.S. carriers, $134
million to foreign airlines and $62 million to U.S. regionals.
During the first quarter of 2006, 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 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) 3/31/06 12/31/05 9/30/05 6/30/05 3/31/05
--------------------- --------------------------------------------------
AAA to AA- 77% 74% 71% 68% 74%
A+ to A- 8 13 13 15 13
BBB+ to BBB- 9 9 13 14 10
Noninvestment Grade 6 4 3 3 3
-------- --------- ---------- --------- ----------
Total 100% 100% 100% 100% 100%
======== ========= ========== ========= ==========
(1) Represents credit rating agency equivalent of internal credit ratings.
Nonperforming Assets
--------------------
Change Percent
3/31/06 vs. Inc/
(Dollars in millions) 3/31/06 12/31/05 12/31/05 (Dec)
--------- --------- ----------- --------
Category of Loans:
Domestic:
Other Commercial $ 24 $ 17 $ 7 41%
Regional Commercial 29 35 (6) (17)
Foreign 13 14 (1) (7)
--------- --------- -----------
Total Nonperforming Loans 66 66 - -
Other Assets Owned - 13 (13) (100)
--------- --------- -----------
Total Nonperforming Assets $ 66 $ 79 $ (13) (16)
========= ========= ===========
Nonperforming Assets Ratio 0.2% 0.2%
Allowance for Loan
Losses/Nonperforming Loans 635.2 629.7
Allowance for Loan
Losses/Nonperforming Assets 635.2 524.0
Total Allowance for Credit
Losses/Nonperforming Loans 858.8 865.4
Total Allowance for Credit
Losses/Nonperforming Assets 858.8 720.2
Nonperforming assets declined by $13 million, or 16%, during the first
quarter of 2006 to $66 million and are down 66% from a year ago. The decrease
from the first quarter of 2005 reflects loan sales, paydowns, and charge-offs
of commercial loans. The decrease from the fourth quarter of 2005 primarily
reflects the sale of aircraft. The ratio of the total allowance for credit
losses to nonperforming assets was 858.8% at March 31, 2006, compared with
373.4% at March 31, 2005 and 720.2% at December 31, 2005.
32
Activity in Nonperforming Assets
(In millions) Quarter End Quarter End
March 31, 2006 December 31, 2005
------------------ ------------------
Balance at Beginning of Period $ 79 $ 107
Additions 10 21
Charge-offs (5) (7)
Paydowns/Sales (18) (42)
------------------ ------------------
Balance at End of Period $ 66 $ 79
================== ==================
Interest income would have been increased by $1 million for the first
quarters of 2006 and 2005 if loans on nonaccrual status at March 31, 2006 and
2005 had 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:
March 31, December 31, March 31,
(In millions) 2006 2005 2005
---------- ------------ ---------
Impaired Loans with an Allowance $ 45 $ 42 $ 68
Impaired Loans without an Allowance(1) - - 103
---------- ------------ ---------
Total Impaired Loans $ 45 $ 42 $ 171
========== ============ =========
Allowance for Impaired Loans(2) $ 15 $ 16 $ 34
Average Balance of Impaired Loans
during the Quarter 43 100 182
Interest Income Recognized on
Impaired Loans during the Quarter 0.4 0.3 2.2
(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
---------
March 31, December 31, March 31,
(Dollars in millions) 2006 2005 2005
------------ ------------ -----------
Margin Loans $ 5,312 $ 6,089 $ 6,038
Non-Margin Loans 34,742 34,637 32,726
------------ ------------ -----------
Total Loans $ 40,054 $ 40,726 $ 38,764
============ ============ ===========
Allowance for Loan Losses $ 419 $ 411 $ 583
Allowance for Lending-Related
Commitments 147 154 133
------------ ------------ -----------
Total Allowance for Credit Losses $ 566 $ 565 $ 716
============ ============ ===========
Allowance for Loan Losses As a
Percent of Total Loans 1.05% 1.01% 1.50%
Allowance for Loan Losses As a
Percent of Non-Margin Loans 1.21 1.19 1.78
Total Allowance for Credit Losses
As a Percent of Total Loans 1.41 1.39 1.85
Total Allowance for Credit Losses
As a Percent of Non-Margin Loans 1.63 1.63 2.19
33
The total allowance for credit losses was $566 million, or 1.41% of total
loans at March 31, 2006, compared with $716 million, or 1.85% of total loans at
March 31, 2005 and $565 million, or 1.39% of total loans at December 31, 2005.
The Company has $5.3 billion of secured margin loans on its balance sheet
at March 31, 2006. The Company has rarely suffered a loss on these types of
loans and does not 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 was
1.63% at March 31, 2006, compared with 2.19% at March 31, 2005 and 1.63% at
December 31, 2005, reflecting improvement in the credit quality since the first
quarter of 2005.
The ratio of the allowance for loan losses to nonperforming assets was
635.2% at March 31, 2006, compared with 304.0% at March 31, 2005 and 524.0% at
December 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.
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;
34
* 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:
March 31, December 31,
2006 2005
------------ -----------
Domestic
Real Estate 2% 2%
Commercial 67 69
Consumer 11 10
Foreign 2 2
Unallocated 18 17
------------ -----------
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 $65.2 billion at March 31, 2006, compared with $59.0
billion at March 31, 2005 and $64.4 billion at December 31, 2005. The increase
from March 31, 2005 was primarily due to increased market activity levels,
which resulted in higher levels of customer deposits at quarter end.
Noninterest-bearing deposits were $16.9 billion at March 31, 2006, compared
with $18.2 billion at December 31, 2005. Interest-bearing deposits were $48.3
billion at March 31, 2006, compared with $46.2 billion at December 31, 2005.
LIQUIDITY
The Company maintains its liquidity through the management of its assets
and liabilities, utilizing worldwide financial markets. The diversification of
liabilities reflects the Company's efforts to maintain flexibility of funding
sources under changing market conditions. Stable core deposits, including
demand, retail time, and trust deposits from processing businesses, are
generated through the Company's diversified network and managed with the use of
trend studies and deposit pricing. The use of derivative products such as
interest rate swaps and financial futures enhances liquidity by enabling the
Company to issue long-term liabilities with limited exposure to interest rate
risk. Liquidity also results from the maintenance of a portfolio of assets
which can be easily sold and the monitoring of unfunded loan commitments,
thereby reducing unanticipated funding requirements. Liquidity is managed on
both a consolidated basis and at The Bank of New York Company, Inc. parent
company ("Parent").
On a consolidated basis, non-core sources of funds such as money market
rate accounts, certificates of deposits greater than $100,000, federal funds
purchased, and other borrowings were $14.2 billion and $13.0 billion on an
average basis for the first three months of 2006 and 2005. Average foreign
35
deposits, primarily from the Company's European based securities servicing
business, were $30.2 billion and $25.5 billion in the first quarters of 2006
and 2005. The increase in foreign deposits reflects greater liquidity from the
Company's securities servicing customers. Domestic savings and other time
deposits were $9.7 billion on an average basis in the first quarter of 2006
compared to $9.8 billion in 2005. Average payables to customers and broker-
dealers decreased to $5.2 billion from $6.4 billion in the first quarter of
2005. The decline in payables to customers and broker-dealers reflects the
loss of a significant customer at Pershing. Long-term debt averaged $8.0
billion and $6.6 billion in the first quarters of 2006 and 2005. The increase
in long-term debt reflects the movement of Pershing from a subsidiary of the
Bank to a subsidiary of the Parent. A significant reduction in the Company's
securities servicing businesses would reduce its access to foreign deposits.
The Company's pending transaction with JPMorgan Chase will slightly alter
the composition of the balance sheet. Approximately $15 billion of U.S dollar
retail deposits will be replaced with approximately $13 billion of
institutional corporate trust deposits. On the asset side of the balance
sheet, approximately $8 billion of retail and middle market loans sold to
JPMorgan Chase will be replaced with liquid assets and securities. Goodwill and
intangibles are expected to increase approximately $2.1 billion. As a result
of the transaction, the Company expects its balance sheet footings to decline
slightly. See "Other Developments."
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 March 31, 2006, the Bank can pay dividends of approximately $510
million to the Parent without the need for regulatory waiver. This dividend
capacity would increase in the remainder of 2006 to the extent of the Bank's
net income less dividends. Nonbank subsidiaries of the Parent have liquid
assets of approximately $254 million. These assets could be liquidated and the
proceeds delivered by dividend or loan to the Parent.
For the quarter ended March 31, 2006, the Parent's quarterly average
commercial paper borrowings were $447 million compared with $234 million in
2005. At March 31, 2006, the Parent had cash of $685 million compared with
$739 million at March 31, 2005 and $791 million at December 31, 2005. Net of
commercial paper outstanding, the Parent's cash position at March 31, 2006 was
down $50 million compared with March 31, 2005.
The Parent has a back-up line of credit of $275 million with 14 financial
institutions. This line of credit matures in October 2006. There were no
borrowings under the line of credit at March 31, 2006 and March 31, 2005.
The Parent also has the ability to access the capital markets. At March
31, 2006, the Parent has two shelf registrations with a capacity of $1.2
billion of debt, preferred stock, trust preferred securities, or common stock.
Access to the capital markets is partially dependent on the Company's credit
ratings, which as of March 31, 2006 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
Dominion Bond
Rating Service R-1(middle) A(high) AA(low) AA Stable
The Parent's major uses of funds are payment of dividends, principal and
interest on its borrowings, acquisitions, and additional investment in its
subsidiaries.
36
The Parent has $225 million of long-term debt that becomes due in 2006
subsequent to March 31, 2006 and $700 million of long-term debt that is due in
2007. In addition, the Parent periodically has the option to call $228 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 $800 million of trust preferred securities that are
callable in 2006. These securities qualify as Tier 1 Capital. The Company has
not yet decided if it will call these securities. The decision to call will be
based on interest rates, the availability of cash and capital, and regulatory
conditions. If the Company calls the trust preferred securities, it expects to
replace them with new trust preferred 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 March 31, 2006 and 2005 was 109.85% and 101.15%,
respectively. The Company's target double leverage ratio is a maximum of 120%.
The double leverage ratio is monitored by regulators and rating agencies and is
an important constraint on the Company's ability to invest in its subsidiaries
to expand its businesses.
Pershing LLC, an indirect subsidiary of the Company, has committed and
uncommitted lines of credit in place for liquidity purposes. The committed
line of credit of $500 million with five financial institutions matures in
March 2007. There were no borrowings against this line of credit during the
first quarter of 2006. Pershing LLC has three separate uncommitted lines of
credit amounting to $1 billion in aggregate. Average daily borrowing under
these lines was $1 million, in aggregate, during the first quarter of 2006.
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 mature in March 2007.
Average daily borrowings under these lines were $75 million, in aggregate,
during the first quarter of 2006. Pershing Limited has three separate
uncommitted lines of credit amounting to $300 million in aggregate. Average
daily borrowing under these lines was $155 million, in aggregate, during the
first quarter of 2006.
The following comments relate to the information disclosed in the
Consolidated Statements of Cash Flows.
Cash provided by other operating activities was $0.5 billion for the three
months of 2006, compared with $0.4 billion used by operating activities through
March 31, 2005. The source of funds in 2006 was principally due to the changes
in accruals and other and net income. The use of funds from operations in 2005
was principally the result of changes in accruals and other as well as changes
in trading activities.
In the first three months of 2006, cash used for investing activities was
$1.0 billion as compared to cash used for investing activities in the first
three months of 2005 of $2.5 billion. In the first three months of 2006,
purchases of securities available-for-sale and changes in federal funds sold
and securities repurchased under resale agreements were a significant use of
funds. Purchases of securities available-for-sale and principal disbursed on
loans to customers were a significant use of funds in 2005.
Through March 31, 2006, cash provided by financing activities was $0.4
billion, compared to $1.7 billion in the first three months of 2005. Sources of
funds in 2006 and 2005 include deposits and proceeds from the issuance of long-
term debt.
37
CAPITAL RESOURCES
Shareholders' equity was $10,101 million at March 31, 2006, compared with
$9,335 million at March 31, 2005 and $9,876 million at December 31, 2005.
During the first quarter of 2006, the Company retained $258 million of
earnings. In April 2006, the Company declared a quarterly common stock
dividend of 21 cents per share. Accumulated other comprehensive income
declined $55 million from December 31, 2005 primarily reflecting higher
unrealized mark-to-market losses in the securities available-for-sale
portfolio.
In the first quarter of 2006, the Company issued $67 million of callable
medium-term subordinated notes bearing interest at rates from 5.55% to 6.00%.
The notes are due in 2021 and 2031 and are callable by the Company after three
to five years. The notes qualify as Tier 2 capital.
On February 27, 2006, the Company entered into a lease transaction
recorded as long-term debt of $527 million bearing interest at a fixed Euro
rate of 3.1% per annum and amortizing on a quarterly basis through 2031, unless
terminated earlier.
Regulators establish certain levels of capital for bank holding companies
and banks, including the Company and the Bank, in accordance with established
quantitative measurements. 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 March 31, 2006 and 2005, 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:
March 31, 2006 March 31, 2005 Well Adequately
------------------ ------------------ Company Capitalized Capitalized
Company Bank Company Bank Targets Guidelines Guidelines
--------- ------- --------- ------- ---------- ----------- -----------
Tier 1* 8.28% 9.14% 8.13% 8.46% 7.75% 6% 4%
Total Capital** 12.44 12.07 12.54 11.76 11.75 10 8
Leverage 6.51 7.26 6.56 6.98 5 3-5
Tangible Common
Equity ("TCE") 5.42 6.67 5.48 6.47 5.00-5.25 N.A. N.A.
* Tier 1 capital consists, generally, of common equity, trust preferred securities (subject to
limitations in 2009), 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.
The Company's regulatory Tier 1 capital and Total Capital ratios were
8.28% and 12.44% at March 31, 2006, compared with 8.13% and 12.54% at March 31,
2005 and 8.38% and 12.48% at December 31, 2005. The regulatory leverage ratio
was 6.51% at March 31, 2006, compared with 6.56% at March 31, 2005 and 6.60% at
December 31, 2005. The Company's tangible common equity as a percentage of
total assets was 5.42% at March 31, 2006, compared with 5.48% at March 31, 2005
and 5.58% at December 31, 2005. The Company's pending transaction with JPMorgan
Chase is expected to reduce its TCE ratio to approximately 4.67% primarily due
to the intangibles associated with the transaction. The tangible common equity
ratio varies depending on the size of the balance sheet at quarter-end and the
impact of interest rates on unrealized gains and losses among other things. The
balance sheet size fluctuates from quarter to quarter based on levels of market
activity. In general, when servicing clients are more actively trading
securities, deposit balances and the balance sheet as a whole, are higher to
finance these activities.
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.
38
On April 4, 2006, pursuant to a 10b5-1 plan, the Company repurchased 10
million shares of its common stock at an initial price of $35.85 from a broker-
dealer counterparty who borrowed the shares, as part of an accelerated share
repurchase program. The repurchase was triggered by the non-issuance of a
specified FSP for lease accounting for calendar year 2006 or prior periods.
See "Accounting Changes and New Accounting Pronouncements" in the Notes to the
Consolidated Financial Statements. The initial price is subject to a purchase
price adjustment based on the price the counterparty pays for the Company's
shares it purchases over time in the open market to cover the borrowed shares.
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.
The following table presents the components of the Company's risk-based
capital at March 31, 2006 and 2005:
(In millions) 2006 2005
------- -------
Shareholders' Equity $10,101 $ 9,335
Preferred Stock - -
Trust Preferred Securities 1,150 1,150
Adjustments: Intangibles (4,741) (4,275)
Securities Valuation Allowance 106 21
Merchant Banking Investments (18) (5)
------- -------
Tier 1 Capital 6,598 6,226
------- -------
Qualifying Unrealized Equity Security Gains 7 -
Qualifying Subordinated Debt 2,745 2,659
Qualifying Allowance for Loan Losses 566 716
------- -------
Tier 2 Capital 3,318 3,375
------- -------
Total Risk-Based Capital $ 9,916 $ 9,601
======= =======
Risk-Adjusted Assets $79,697 $76,567
======= =======
39
TRADING ACTIVITIES
The fair value and notional amounts of the Company's financial instruments
held for trading purposes at March 31, 2006 and 2005 are as follows:
March 31, 2006 2006 Average
--------------------------- ------------------
(In millions) Notional Fair Value Fair Value
------------------ ------------------
Trading Account Amount Assets Liabilities Assets Liabilities
--------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 98,606 $ 32 $ - $ 9 $ -
Swaps 261,730 1,416 826 1,886 1,174
Written Options 220,001 - 1,045 - 1,090
Purchased Options 182,731 190 - 174 -
Foreign Exchange Contracts:
Swaps 2,404 - - - -
Written Options 6,070 - 114 - 54
Purchased Options 7,913 125 - 100 -
Commitments to Purchase
and Sell Foreign Exchange 81,308 125 123 93 140
Debt Securities - 5,143 176 4,715 234
Credit Derivatives 1,491 1 6 1 7
Equities 5,383 97 68 135 118
------ ----------- ------ -----------
Total Trading Account $7,129 $ 2,358 $7,113 $ 2,817
====== =========== ====== ===========
March 31, 2005 2005 Average
--------------------------- ------------------
Notional Fair Value Fair Value
------------------ ------------------
Trading Account Amount Assets Liabilities Assets Liabilities
--------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 27,907 $ - $ - $ - $ -
Swaps 241,377 1,768 978 1,680 782
Written Options 181,754 - 1,260 - 1,266
Purchased Options 135,809 188 - 147 -
Foreign Exchange Contracts:
Swaps 3,650 - - - -
Written Options 5,485 - 13 - 16
Purchased Options 7,472 58 - 85 -
Commitments to Purchase
and Sell Foreign Exchange 72,715 323 378 279 277
Debt Securities - 2,687 183 2,405 152
Credit Derivatives 1,634 2 5 2 9
Equities 2,409 97 85 161 95
------ ----------- ------ -----------
Total Trading Account $5,123 $ 2,902 $4,759 $ 2,597
====== =========== ====== ===========
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 a separate 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.
40
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.
(In millions) 1st Quarter 2006
-------------------------------------
Average Minimum Maximum 3/31/06
------- ------- ------- -------
Interest Rate $ 2.8 $ 2.0 $ 4.4 $ 2.9
Foreign Exchange 1.0 0.6 1.7 0.8
Equity 0.8 0.5 1.2 0.9
Credit Derivatives 0.9 0.6 1.2 0.9
Diversification (1.4) NM NM (1.4)
Overall Portfolio 4.1 3.3 5.4 4.1
1st Quarter 2005
-------------------------------------
Average Minimum Maximum 3/31/05
------- ------- ------- -------
Interest Rate $ 2.8 $ 2.0 $ 4.3 $ 4.3
Foreign Exchange 1.0 0.4 3.3 2.2
Equity 0.8 0.5 1.1 0.9
Credit Derivatives 1.7 1.5 2.1 2.1
Diversification (1.4) NM NM (3.0)
Overall Portfolio 4.9 3.7 7.5 6.5
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 quarter of 2006, interest rate risk generated
approximately 47% of average VAR, credit derivatives generated 22% of average
VAR, foreign exchange accounted for 17% of average VAR, and equity generated
14% of average VAR. During the first quarter of 2006, 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 3/31/06 12/31/05 9/30/05 6/30/05 3/31/05
--------------------------------------------------
(Dollars in millions) Number of Occurrences
---------------------- --------- --------- --------- ---------- ---------
Less than $(2.5) 0 0 0 0 0
$(2.5)~ $ 0 4 3 3 6 1
$ 0 ~ $ 2.5 40 44 51 40 50
$ 2.5 ~ $ 5.0 18 14 8 16 11
More than $5.0 0 0 2 2 0
* Based on revenues before deducting share of joint venture partner,
Susquehanna Trading.
41
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 purposes. 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 cannot 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) Estimated Changes in
Net Interest Income
--------------------------------------
March 31, 2006 December 31, 2005
$ % $ %
--------- -------- ---------- ------
+200 Basis Point Ramp vs. Stable Rate $ (64) (3.1)% $ (65) (3.2)%
+100 Basis Point Ramp vs. Stable Rate (28) (1.3) (29) (1.4)
-100 Basis Point Ramp vs. Stable Rate (1) - (8) (0.4)
-200 Basis Point Ramp vs. Stable Rate (15) (0.7) (32) (1.6)
The base case scenario Fed Funds rate in the March 31, 2006 analysis was
4.75% versus 4.25% for the December 31, 2005 analysis. The +100 basis point
ramp scenario assumes short-term rates rise 25 basis points in each of the next
four quarters, while the +200 ramp scenario assumes a 50 basis point per
quarter increase. The +100 basis point March 31, 2006 scenario assumes a
steepening of the yield curve with 10-year rates rising 115 basis points. The
+200 basis point March 31, 2006 scenario assumes a slight steepening of the
yield curve with 10-year rates rising 214 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. The Company's pending transaction with
JPMorgan Chase will initially result in a more liability-sensitive balance
because corporate trust liabilities reprice more quickly than retail deposits.
The Company expects to use portfolio management to restore its interest rate
sensitivity to a position similar to pre-transaction levels.
42
STATISTICAL INFORMATION
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Tax Equivalent Basis
(Dollars in millions)
For the three months For the three months
ended March 31, 2006 ended March 31, 2005
---------------------------- ---------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
-------- -------- ------- --------- -------- -------
ASSETS
------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 9,624 $ 86 3.61% $ 9,824 $ 71 2.95%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 3,518 35 4.05 4,816 27 2.31
Margin Loans 5,655 77 5.54 6,407 55 3.46
Loans
Domestic Offices 22,984 298 5.23 22,135 239 4.38
Foreign Offices 10,965 143 5.30 10,302 96 3.76
--------- -------- --------- --------
Non-Margin Loans 33,949 441 5.26 32,437 335 4.19
--------- -------- --------- --------
Securities
U.S. Government Obligations 225 2 4.22 358 3 3.04
U.S. Government Agency Obligations 3,953 44 4.45 3,302 31 3.74
Obligations of States and
Political Subdivisions 227 4 6.66 199 4 7.34
Other Securities 22,678 265 4.66 19,681 185 3.77
Trading Securities 4,714 51 4.42 2,464 22 3.60
--------- -------- --------- -------
Total Securities 31,797 366 4.61 26,004 245 3.77
--------- -------- --------- -------
Total Interest-Earning Assets 84,543 1,005 4.79% 79,488 733 3.74%
-------- -------
Allowance for Credit Losses (415) (589)
Cash and Due from Banks 4,881 4,166
Other Assets 17,124 16,177
--------- ---------
TOTAL ASSETS $ 106,133 $ 99,242
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 6,025 $ 32 2.14% $ 6,915 $ 21 1.25%
Savings 8,123 31 1.56 8,901 21 0.94
Certificates of Deposit
$100,000 & Over 4,258 48 4.58 2,880 18 2.57
Other Time Deposits 1,623 15 3.65 899 4 1.76
Foreign Offices 30,220 208 2.80 25,464 120 1.92
--------- -------- --------- --------
Total Interest-Bearing Deposits 50,249 334 2.70 45,059 184 1.66
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,966 20 4.19 1,390 6 1.84
Other Borrowed Funds 1,980 20 4.02 1,825 7 1.54
Payables to Customers and Broker-Dealers 5,231 40 3.10 6,385 25 1.57
Long-Term Debt 8,011 96 4.81 6,605 49 2.98
--------- -------- --------- --------
Total Interest-Bearing Liabilities 67,437 510 3.06% 61,264 271 1.80%
-------- --------
Noninterest-Bearing Deposits 15,391 15,520
Other Liabilities 13,417 13,158
Common Shareholders' Equity 9,888 9,300
--------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 106,133 $ 99,242
========= =========
Net Interest Earnings
and Interest Rate Spread $ 495 1.73% $ 462 1.94%
======== ======= ======== =======
Net Yield on Interest-Earning Assets 2.35% 2.36%
======= =======
43
OTHER DEVELOPMENTS
On January 3, 2006, the Company acquired Alcentra, an international asset
management group focused on managing funds that invest in non-investment grade
debt. Alcentra's management team will retain a 20 percent interest. Alcentra
has operations in London and Los Angeles and currently manages 15 different
investment funds with over $6.2 billion of assets.
On March 2, 2006, the Company acquired Urdang, a real estate investment
management firm that manages approximately $3.0 billion in direct investments
and portfolios of REIT securities.
On April 8, 2006, the Company announced a definitive agreement to sell its
retail and regional middle market businesses to JPMorgan Chase for $3.1 billion
with a premium of $2.3 billion. JPMorgan Chase will sell its corporate trust
business to the Company for $2.8 billion with a premium of $2.15 billion. The
difference in premiums results in a net cash payment of $150 million to the
Company. There is also a contingent payment of up to $50 million to the Company
tied to customer retention.
The transaction further increases the Company's focus on the securities
services and wealth management businesses that have fueled the Company's growth
in recent years and that are at the core of its long-term business strategy.
The transaction has been approved by each company's board of directors and
is expected to be completed late in the third quarter or during the fourth
quarter of 2006, subject to regulatory approvals. The Company expects to
record an after-tax gain of $1.3 billion on the businesses to be sold. The
Company also expects to incur after-tax merger and integration charges of $90-
120 million, which will be recorded over several quarters. The transaction is
expected to be dilutive to GAAP earnings per share through 2009 (4.5 percent in
2007 to 1.5 percent in 2009), but to be accretive to cash earnings per share in
2009 when cost savings are fully phased in.
JPMorgan Chase's corporate trust business comprises issues representing $5
trillion in total debt outstanding. It has 2,400 employees in more than 40
locations globally. The Company's corporate trust business comprises issues
representing $3 trillion in total debt outstanding. It has 1,300 employees in
25 locations globally.
The Company's retail bank consists of 342 branches in the tri-state
region, serving approximately 700,000 consumer households and small businesses
with $14.5 billion in deposits and $15.4 billion in assets. The Company's
regional middle market businesses provide financing, banking and treasury
services for middle market clients, serving more than 2,000 clients in the tri-
state region. Together, the units have 4,000 employees located in New York,
New Jersey, Connecticut and Delaware.
During the first quarter of 2006, the Company repurchased 0.9 million
shares of its common stock in the open market and through the employee benefit
plans. The Company also repurchased 1.5 million shares of its common stock in
February at an initial price of $34.31 through an accelerated share repurchase
program.
44
Operating leverage is measured by comparing the rate of increase in revenue to
the rate of increase in expenses. The chart below shows the computation of
operating leverage.
Operating Leverage
------------------
(Dollars in millions)
1Q 2006 1Q 2005 % Change
------- ------- --------
Noninterest Income $1,332 $1,178 13.1%
Net Interest Income 488 455 7.3
Total Revenue 1,820 1,633 11.5
Total Expense 1,178 1,077 9.4
Operating Leverage 2.1%
=====
1Q 2006 4Q 2005 % Change
------- ------- --------
Noninterest Income $1,332 $1,273 4.6%
Net Interest Income 488 492 (0.8)
Total Revenue 1,820 1,765 3.1
Total Expense 1,178 1,148 2.6
Operating Leverage 0.5%
=====
45
FORWARD-LOOKING STATEMENTS AND RISK FACTORS THAT COULD AFFECT FUTURE RESULTS
Much of the information in this document is forward-looking. This
includes all statements about the Company's earnings and revenue outlook,
projected business growth, the expected outcome of legal, regulatory and
investigatory proceedings, predicted loan losses, and the Company's plans,
objectives and strategies. Forward-looking statements represent the Company's
current estimates or expectations of future events or results.
The Company, or its executive officers and directors on its behalf, may
make additional forward-looking statements from time to time. When used in
this report, any press release or any such oral statement, words such as
"estimate, ""forecast," "project," "anticipate," "confident," "target,"
"expect," "intend," "think," "continue," "seek," "believe," "plan," "goal,"
"could," "should," "may," "will," "strategy," and words of similar meaning,
signify forward-looking statements.
Forward-looking statements 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 that the Company is necessarily unable to predict
accurately, including the Risk Factors set forth in the Company's Annual
Report on Form 10-K for the year ended December 31, 2005 and the additional
risk factors set forth below.
This is not an exhaustive list of the risks the Company faces. For a
further discussion of other factors affecting the Company's businesses, see
"Forward-Looking Statements and Risk Factors That Could Affect Future Results"
in Part I, Item 1A of the Company's 2005 Annual Report on Form 10-K.
Forward-looking statements speak only as of the date they are made. The
Company will not update forward-looking statements to reflect new facts,
changes in assumptions or circumstances, or subsequent events.
In addition to the Risk Factors set forth in the Company's Annual Report
on Form 10-K for the year ended December 31, 2005, the following risk factors
should be considered before making an investment in the Company's securities:
The Company may not be able to complete its acquisition of the JPMorgan
Chase Corporate Trust Business and its divestiture of its retail banking and
middle market businesses in a timely manner or at all.
As discussed above, the Company recently announced its planned
acquisition of the JPMorgan Chase Corporate Trust Business (the "JPMorgan
Business") and divestiture of its retail and middle market banking businesses
to JPMorgan Chase. If obtaining the required regulatory approvals or
satisfying the other closing conditions for these transactions takes longer
than expected, the closing of the transactions may not occur in a timely
manner or at all. A delayed closing could adversely affect its efforts to
integrate the JPMorgan Business successfully. If the Company is unable to
close the transactions, the Company will have diverted resources away from
pursuits that could ultimately have proved to be more beneficial to its
business.
The Company may not realize the expected financial benefits from the
acquisition of the JPMorgan Business if the Company fails to integrate the
JPMorgan Chase Business successfully or if the JPMorgan Business does not
perform as well as the Company expects.
Achieving the expected benefits of this acquisition will require the
Company to retain a substantial portion of the JPMorgan Business's current
client base, to increase the revenue growth rate of the JPMorgan Business and
to retain key employees of the JPMorgan Business. The scale, scope and nature
46
of the integration and client retention efforts required as a result of the
acquisition present a significant challenge to the Company. The Company may
not be able to integrate the JPMorgan Business on the expected schedule,
realize the anticipated cost savings and economies of scale, or retain a
significant number of clients of the JPMorgan Business, any of which could
cause the Company not to realize expected benefits from the acquisition. The
Company will also seek to move the records of some existing corporate trust
clients to the JPMorgan Chase technology platform, which the Company is also
acquiring. The integration of the JPMorgan Business, including moving client
records, could take longer than planned and be subject to unanticipated
difficulties and expenses. It is possible that the transition of the JPMorgan
Business could adversely affect the Company's ability to maintain relationships
with clients and that some JPMorgan Business clients will elect other service
providers. The Company could experience client attrition or revenue loss in
the JPMorgan Business in excess of its expectations. The integration process
could also result in the loss of key JPMorgan Business employees.
If the Company is unable to integrate the JPMorgan Business successfully,
then the Company may fail to realize the anticipated synergies and growth
opportunities or achieve the cost savings and revenue growth the Company
expects from the acquisition. Furthermore, the integration of the JPMorgan
Business will require a significant commitment of time and resources by the
Company's management and other personnel, which could adversely affect its
ability to service and retain its existing corporate trust clients and could
divert the attention of management from its other businesses.
47
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 banking and asset management markets, international, national,
and regional commercial banks, standalone asset management companies, mutual
funds, securities brokerage firms, insurance companies, investment counseling
firms, and other business firms and individuals actively compete for business.
Commercial banks, savings banks, savings and loan associations, and credit
unions actively compete for deposits, and money market funds and brokerage
houses offer deposit-like services. These institutions, as well as consumer
and commercial finance companies, national retail chains, factors, insurance
companies and pension trusts, are important competitors for various types of
loans. Issuers of commercial paper compete actively for funds and reduce demand
for bank loans.
WEBSITE INFORMATION
The Company makes available on its website, www.bankofny.com:
* All of its SEC filings, including annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and
all amendments to these reports, SEC Forms 3, 4 and 5 and its
proxy statement as soon as reasonably practicable after such
material is electronically filed with or furnished to the SEC;
* Its earnings releases and management conference calls and
presentations; and
* Its corporate governance guidelines and the charters of the Audit
and Examining, Compensation and Organization, and Nominating and
Governance Committees of its Board of Directors.
The corporate governance guidelines and committee charters are available
in print to any shareholder who requests them. Requests should be sent to The
Bank of New York Company, Inc., Corporate Communications, One Wall Street, NY,
NY 10286.
48
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Balance Sheets
(Dollars in millions, except per share amounts)
(Unaudited)
March 31, 2006 December 31, 2005
------------------ -----------------
Assets
------
Cash and Due from Banks $ 3,408 $ 3,515
Interest-Bearing Deposits in Banks 7,635 8,644
Securities
Held-to-Maturity (fair value of $2,123 in 2006
and $1,951 in 2005) 2,165 1,977
Available-for-Sale 25,123 25,349
------------------ -----------------
Total Securities 27,288 27,326
Trading Assets at Fair Value 7,129 5,930
Federal Funds Sold and Securities Purchased
Under Resale Agreements 4,781 2,425
Loans (less allowance for loan losses of $419 in 2006
and $411 in 2005) 39,635 40,315
Premises and Equipment 1,059 1,060
Due from Customers on Acceptances 272 233
Accrued Interest Receivable 378 391
Goodwill 3,848 3,619
Intangible Assets 896 811
Other Assets 7,282 7,805
------------------ -----------------
Total Assets $ 103,611 $ 102,074
================== =================
Liabilities and Shareholders' Equity
------------------------------------
Deposits
Noninterest-Bearing (principally domestic offices) $ 16,889 $ 18,236
Interest-Bearing
Domestic Offices 18,863 19,522
Foreign Offices 29,472 26,666
------------------ -----------------
Total Deposits 65,224 64,424
Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 903 834
Trading Liabilities 2,358 2,401
Payables to Customers and Broker-Dealers 7,556 8,623
Other Borrowed Funds 1,158 860
Acceptances Outstanding 276 235
Accrued Taxes and Other Expenses 3,676 4,124
Accrued Interest Payable 171 172
Other Liabilities (including allowance for
lending-related commitments of
$147 in 2006 and $154 in 2005) 3,879 2,708
Long-Term Debt 8,309 7,817
------------------ -----------------
Total Liabilities 93,510 92,198
------------------ -----------------
Shareholders' Equity
Common Stock-par value $7.50 per share,
authorized 2,400,000,000 shares, issued
1,047,597,230 shares in 2006 and
1,044,994,517 shares in 2005 7,857 7,838
Additional Capital 1,904 1,826
Retained Earnings 7,347 7,089
Accumulated Other Comprehensive Income (189) (134)
------------------ -----------------
16,919 16,619
Less: Treasury Stock (275,833,078 shares in 2006
and 273,662,218 shares in 2005), at cost 6,811 6,736
Loan to ESOP (203,507 shares in 2006
and 203,507 shares in 2005), at cost 7 7
------------------ -----------------
Total Shareholders' Equity 10,101 9,876
------------------ -----------------
Total Liabilities and Shareholders' Equity $ 103,611 $ 102,074
================== =================
------------------------------------------------------------------------------------------------
Note: The balance sheet at December 31, 2005 has been derived from the audited financial statements at
that date.
49
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income
(Dollars in millions, except per share amounts)
(Unaudited)
For the three
months ended Percent
March 31, Inc/
2006 2005 (Dec)
------ ------ --------
Interest Income
---------------
Loans $ 441 $ 335 32%
Margin loans 77 55 40
Securities
Taxable 298 207 44
Exempt from Federal Income Taxes 10 9 11
------ ------
308 216 43
Deposits in Banks 86 71 21
Federal Funds Sold and Securities Purchased
Under Resale Agreements 35 27 30
Trading Assets 51 22 132
------ ------
Total Interest Income 998 726 37
------ ------
Interest Expense
----------------
Deposits 334 184 82
Federal Funds Purchased and Securities Sold
Under Repurchase Agreements 20 6 233
Other Borrowed Funds 20 7 186
Customer Payables 40 25 60
Long-Term Debt 96 49 96
------ ------
Total Interest Expense 510 271 88
------ ------
Net Interest Income 488 455 7
Provision for Credit Losses 5 (10)
------ ------
Net Interest Income After Provision for
Credit Losses 483 465 4
------ ------
Noninterest Income
------------------
Servicing Fees
Securities 831 750 11
Global Payment Services 70 75 (7)
------ ------
901 825 9
Private Banking and Asset Management Fees 141 122 16
Service Charges and Fees 89 92 (3)
Foreign Exchange and Other Trading Activities 115 96 20
Securities Gains 17 12 42
Other 69 31 123
------ ------
Total Noninterest Income 1,332 1,178 13
------ ------
Noninterest Expense
-------------------
Salaries and Employee Benefits 668 618 8
Net Occupancy 88 78 13
Furniture and Equipment 53 52 2
Clearing 50 46 9
Sub-custodian Expenses 34 23 48
Software 56 53 6
Communications 27 23 17
Amortization of Intangibles 13 8 63
Other 189 176 7
------ ------
Total Noninterest Expense 1,178 1,077 9
------ ------
Income Before Income Taxes 637 566 13
Income Taxes 215 187 15
------ ------
Net Income $ 422 $ 379 11
---------- ====== ======
Per Common Share Data:
---------------------
Basic Earnings $ 0.55 $ 0.49 12
Diluted Earnings 0.55 0.49 12
Cash Dividends Paid 0.21 0.20 5
Diluted Shares Outstanding 774 779 (1)
See accompanying Notes to Consolidated Financial Statements.
50
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statement of Changes in Shareholders' Equity
For the three months ended March 31, 2006
(Dollars in millions)
(Unaudited)
Common Stock
Balance, January 1 $ 7,838
Issuances in Connection with Employee Benefit Plans 19
-------------
Balance, March 31 7,857
-------------
Additional Capital
Balance, January 1 1,826
Issuances in Connection with Employee Benefit Plans 78
-------------
Balance, March 31 1,904
-------------
Retained Earnings
Balance, January 1 7,089
Net Income $ 422 422
Cash Dividends on Common Stock (164)
-------------
Balance, March 31 7,347
-------------
Accumulated Other Comprehensive Income
Balance, January 1 (134)
Change in Fair Value of Securities Available-for-Sale,
Net of Taxes of $(32) (45) (45)
Reclassification Adjustment, Net of Taxes of $(2) (2) (2)
Foreign Currency Translation Adjustment,
Net of Taxes of $2 2 2
Net Unrealized Derivative loss on Cash Flow Hedges,
Net of Taxes of $(3) (5) (5)
Minimum Pension Liability Adjustment,
Net of Taxes of $(3) (5) (5)
----------- -------------
Balance, March 31 (189)
Total Comprehensive Income $ 367
===========
Less Treasury Stock
Balance, January 1 6,736
Issued (7)
Acquired 82
-------------
Balance, March 31 6,811
-------------
Less Loan to ESOP
Balance, January 1 7
Loan to ESOP -
-------------
Balance, March 31 7
-------------
Total Shareholders' Equity, March 31, 2006 $ 10,101
=============
-------------------------------------------------------------------------------------------
Comprehensive Income for the three months ended March 31, 2006 and 2005 was $367 and $298.
See accompanying Notes to Consolidated Financial Statements.
51
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Cash Flows
(Dollars in millions)
(Unaudited)
For the three months
ended March 31,
2006 2005
-------- --------
Operating Activities
Net Income $ 422 $ 379
Adjustments to Determine Net Cash Attributable to
Operating Activities:
Provision for Credit Losses
and Losses on Other Real Estate 5 (10)
Depreciation and Amortization 117 146
Deferred Income Taxes (37) 89
Securities Gains (17) (12)
Change in Trading Activities (1,074) (358)
Change in Accruals and Other, Net 1,126 (664)
-------- --------
Net Cash Provided by (Used for) Operating Activities 542 (430)
-------- --------
Investing Activities
Change in Interest-Bearing Deposits in Banks 1,100 (793)
Change in Margin Loans 777 21
Purchases of Securities Held-to-Maturity (303) (26)
Paydowns of Securities Held-to-Maturity 65 73
Maturities of Securities Held-to-Maturity 40 6
Purchases of Securities Available-for-Sale (3,260) (3,835)
Sales of Securities Available-for-Sale 890 1,352
Paydowns of Securities Available-for-Sale 1,193 1,468
Maturities of Securities Available-for-Sale 1,436 680
Net Principal Received (Disbursed) on Loans to Customers (138) (3,135)
Sales of Loans and Other Real Estate 33 105
Change in Federal Funds Sold and Securities
Purchased Under Resale Agreements (2,356) 1,623
Purchases of Premises and Equipment (41) (16)
Acquisitions, Net of Cash Acquired (339) (31)
Other, Net (57) 23
-------- --------
Net Cash Used for Investing Activities (960) (2,485)
-------- --------
Financing Activities
Change in Deposits 637 560
Change in Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 69 (326)
Change in Payables to Customers and Broker-Dealers (1,067) 20
Change in Other Borrowed Funds 302 353
Proceeds from the Issuance of Long-Term Debt 600 1,453
Repayments of Long-Term Debt (12) (99)
Issuance of Common Stock 104 31
Treasury Stock Acquired (82) (117)
Cash Dividends Paid (164) (167)
-------- --------
Net Cash Provided by Financing Activities 387 1,708
-------- --------
Effect of Exchange Rate Changes on Cash (76) (82)
-------- --------
Change in Cash and Due From Banks (107) (1,289)
Cash and Due from Banks at Beginning of Period 3,515 3,886
-------- --------
Cash and Due from Banks at End of Period $ 3,408 $ 2,597
======== ========
-------------------------------------------------------------------------------
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Period for:
Interest $ 510 $ 277
Income Taxes 328 81
Noncash Investing Activity
(Primarily Foreclosure of Real Estate) - -
-------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
52
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 ("SFAS 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 No. 148 ("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 three months ended March 31, 2006, approximately 6 million
options were granted. In the first quarter of 2006, the Company recorded $10
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, 1st Quarter
except per share amounts) 2006 2005
------ ------
Reported net income $ 422 $ 379
Stock based employee compensation costs,
using prospective method, net of tax 6 6
Stock based employee compensation costs,
using retroactive restatement method,
net of tax (6) (13)
------ ------
Pro forma net income $ 422 $ 372
====== ======
Reported diluted earnings per share $ 0.55 $ 0.49
Impact on diluted earnings per share - (0.01)
------ ------
Pro forma diluted earnings per share $ 0.55 $ 0.48
====== ======
53
The fair value of options granted in 2006 and 2005 were estimated at the
grant date using the following weighted average assumptions:
1st Quarter
2006 2005
----- -----
Dividend Yield 2.44% 2.77%
Expected Volatility 21.94 25.05
Risk Free Interest Rates 4.66 4.15
Expected Options Lives 5 5
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. The Company adopted SFAS 123(R) on January
1, 2006 using the "modified prospective" method. Under this method,
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.
The Company adopted the fair value method of accounting for stock-based
compensation prospectively as of January 1, 2003. As of January 1, 2006, the
Company was 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. For
grants prior to January 1, 2006, the Company will continue to expense them over
their stated vesting period. The Company expects the adoption of FAS 123(R) to
increase pre-tax expense in 2006 by $3 million due to the vesting on retirement
feature.
In June 2005, the FASB ratified the consensus in EITF Issue No. 04-5("EITF
04-5"), "Determining Whether a General Partner, or the General Partners as a
Group, Controls a Limited Partnership or Similar Entity When the Limited
Partners Have Certain Rights", which provides guidance in determining whether a
general partner controls a limited partnership. The adoption of EITF 04-5 did
not have a significant impact on the Company's financial condition or results
of operation.
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. A final standard is expected to be issued in 2006. 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.
In July 2005, the FASB issued an exposure draft, FSP FAS 13-a, "Accounting
for a Change or Projected Change in the Timing of Cash Flows Relating to Income
Generated by a Leverage Lease Transaction," revising the accounting guidance
under SFAS No. 13 ("SFAS 13"), "Accounting for Leases," for leveraged leases.
54
The exposure draft modifies existing interpretations of SFAS 13 and
associated industry practice. As a result, when the revised FSP becomes
effective, the Company expects to recognize a material one-time after-tax
charge to earnings or capital of $340 to $385 million related to a change
in the timing of its lease cash flows due to the LILO settlement. See Note
"Commitments and Contingencies". However, an amount approximating this
one-time charge would be taken into income over the remaining term of the
affected leases.
In February 2006, the FASB issued FASB Statement No. 155 ("SFAS 155"),
"Accounting for Certain Hybrid Financial Instruments", an amendment of SFAS 140
and SFAS 133. SFAS 155 permits the Company to elect to measure any hybrid
financial instrument at fair value if the hybrid instrument contains an
embedded derivative that otherwise would require bifurcation and be accounted
for separately under SFAS 133. This statement clarifies which interest-only
strips and principal-only strips are not subject to the requirements of SFAS
133 and that concentrations of credit risk in the form of subordination are not
embedded derivatives. SFAS 155 is effective for all financial instruments
acquired, issued, or subject to a remeasurement event after December 31, 2006.
The Company does not expect the adoption of the standard will have a
significant impact on its financial conditions or results of operations.
Certain other prior year information has been reclassified to conform its
presentation with the 2006 financial statements.
3. Acquisitions and Dispositions
-----------------------------
The Company continues to be an active acquirer of securities servicing and
asset management businesses.
In the first quarter of 2006, two businesses were acquired for a total
cost of $323 million, primarily 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 related to acquisitions in the first quarter of 2006 was $212
million. The tax-deductible portion of goodwill related to acquisitions in the
first quarter of 2006 was $73 million. At March 31, 2006, the Company was
liable for potential contingent payments related to acquisitions in the amount
of $323 million. During the first quarter of 2006, the Company paid or accrued
$17 million for contingent payments related to acquisitions made in prior
years.
2006
----
On January 3, 2006, the Company acquired Alcentra, an international asset
management group focused on managing funds that invest in non-investment grade
debt. Alcentra's management team will retain a 20 percent interest. Alcentra
has operations in London and Los Angeles and currently manages 15 different
investment funds with over $6.2 billion of assets.
On March 2, 2006, the Company acquired Urdang, a real estate investment
management firm that manages approximately $3.0 billion in direct investments
and portfolios of REIT securities.
On April 8, 2006, the Company announced a definitive agreement to sell its
retail and regional middle market businesses to JPMorgan Chase for $3.1 billion
with a premium of $2.3 billion. JPMorgan Chase will sell its corporate trust
business to the Company for $2.8 billion with a premium of $2.15 billion. The
difference in premiums results in a net cash payment of $150 million to the
Company. There is also a contingent payment of up to $50 million to the Company
tied to customer retention. For further details, see "Other Developments."
55
4. Goodwill and Intangibles
------------------------
Goodwill by reportable segment is as follows:
(In millions)
March 31, 2006 December 31, 2005
------------------ -----------------
Institutional Services $ 3,138 $ 3,121
Private Bank &
BNY Asset Management 601 389
Retail & Middle Market Banking 109 109
Corporate & Other - -
------------------ -----------------
Consolidated Total $ 3,848 $ 3,619
================== =================
The Company's reporting units are tested annually for goodwill impairment.
Intangible Assets
-----------------
March 31, 2006 December 31, 2005
---------------------------------------------- ------------------------------
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 $ 378 $ - $ 378 Indefinite Life $ 370 $ - $ 370
Customer Relationships 624 (111) 513 15 531 (99) 432
Other Intangible
Assets 25 (20) 5 6 28 (19) 9
The aggregate amortization expense of intangibles was $13 million and $8
million for the quarters ended March 31, 2006 and 2005, respectively. Estimated
amortization expense for the next five years is as follows:
For the Year Ended Amortization
(In millions) December 31, Expense
------------------ ------------
2006 $56
2007 53
2008 52
2009 50
2010 48
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
56
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.
Transactions in the allowance for credit losses are summarized as follows:
(In millions) Three Months Ended March 31, 2006
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 411 $ 154 $ 565
Charge-Offs (14) - (14)
Recoveries 10 - 10
-------------- --------------- -------------
Net Charge-Offs (4) - (4)
Provision 12 (7) 5
-------------- --------------- -------------
Balance, End of Period $ 419 $ 147 $ 566
============== =============== =============
Three Months Ended March 31, 2005
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 591 $ 145 $ 736
Charge-Offs (11) - (11)
Recoveries 1 - 1
-------------- --------------- -------------
Net Charge-Offs (10) - (10)
Provision 2 (12) (10)
-------------- --------------- -------------
Balance, End of Period $ 583 $ 133 $ 716
============== =============== =============
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 March 31, 2006 and December 31,
2005, 3,000 shares were outstanding.
In addition to the Class A preferred stock, the Company has 5 million
authorized shares of preferred stock having no par value, with no shares
outstanding at March 31, 2006 and December 31, 2005, respectively.
57
7. Earnings Per Share
------------------
The following table illustrates the computations of basic and diluted
earnings per share:
(Dollars in millions, Three Months Ended
except per share amounts) March 31,
------------------
2006 2005
-------- --------
Net Income (1) $ 422 $ 379
======== ========
Basic Weighted Average
Shares Outstanding 764 771
Shares Issuable upon Conversion of
Employee Stock Options 10 8
-------- --------
Diluted Weighted Average
Shares Outstanding 774 779
======== ========
Basic Earnings Per Share: $ 0.55 $ 0.49
Diluted Earnings Per Share: 0.55 0.49
(1) Net Income, net income available to common shareholders and diluted net
income are the same for all periods presented.
8. Employee Benefit Plans
----------------------
The components of net periodic benefit cost are as follows:
Pension Benefits Healthcare Benefits
--------------------- -----------------------
Three Months Ended Three Months Ended
March 31, March 31,
--------------------- -----------------------
Domestic Foreign Domestic
--------- --------- ----------
(In millions) 2006 2005 2006 2005 2006 2005
--------------------- ---- ---- ---- ---- ---- -----
Net Periodic Cost (Income)
Service Cost $ 12 $ 16 $ 2 $ 2 $ - $ -
Interest Cost 13 14 3 2 2 2
Expected Return on Assets (25) (30) (3) (3) (1) (1)
Other 9 4 1 1 3 2
---- ---- ---- ---- ---- ----
Net Periodic Cost (Income) $ 9 $ 4 $ 3 $ 2 $ 4 $ 3
==== ==== ==== ==== ==== ====
58
9. Income Taxes
------------
The statutory federal income tax rate is reconciled to the Company's
effective income tax rate below:
Three Months Ended
March 31,
-----------------
2006 2005
------ ------
Federal Rate 35.0% 35.0%
State and Local Income Taxes,
Net of Federal Income Tax Benefit 2.8 3.7
Nondeductible Expenses 0.1 0.2
Credit for Synthetic Fuel Investments (0.9) (2.3)
Credit for Low-Income Housing Investments (1.6) (2.0)
Tax-Exempt Income From Municipal Securities (0.1) (0.2)
Other Tax-Exempt Income (1.0) (1.1)
Foreign Operations (0.8) (0.2)
Other - Net 0.2 -
------ ------
Effective Rate 33.7% 33.1%
====== ======
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.
The Company's significant trading and off-balance-sheet risks are
securities, foreign currency and interest rate risk management products,
commercial lending commitments, letters of credit, and securities lending
indemnifications. The Company assumes these risks to reduce interest rate and
foreign currency risks, to provide customers with the ability to meet credit
and liquidity needs, to hedge foreign currency and interest rate risks, and to
trade for its own account. These items involve, to varying degrees, credit,
foreign exchange, and interest rate risk not recognized in the balance sheet.
The Company's off-balance-sheet risks are managed and monitored in manners
similar to those used for on-balance-sheet risks. There are no significant
industry concentrations of such risks.
A summary of the notional amount of the Company's off-balance-sheet credit
transactions, net of participations, at March 31, 2006 and December 31, 2005
follows:
Off-Balance-Sheet Credit Risks
------------------------------
March 31, December 31,
(In millions) 2006 2005
----------------------------------- ------------ -----------
Lending Commitments $ 38,612 $ 36,954
Standby Letters of Credit 10,622 10,383
Commercial Letters of Credit 1,108 1,189
Securities Lending Indemnifications 352,380 310,970
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. The allowance for lending-related commitments at March 31, 2006
and December 31, 2005 was $147 million and $154 million.
A securities lending transaction is a fully collateralized transaction in
which the owner of a security agrees to lend the security through an agent (the
59
Company) to a borrower, usually a broker/dealer or bank, on an open, overnight
or term basis, under the terms of a prearranged contract, which generally
matures in less than 90 days. The Company generally lends securities with
indemnification against broker default. The Company generally requires the
borrower to provide 102% cash collateral which is monitored on a daily basis,
thus reducing credit risk. Security lending transactions are generally entered
into only with highly-rated counterparties. At March 31, 2006 and December 31,
2005, securities lending indemnifications were secured by collateral of $360.4
billion and $317.4 billion, respectively.
Standby letters of credit principally support corporate obligations and
include $0.9 billion that were collateralized with cash and securities on March
31, 2006 and December 31, 2005. At March 31, 2006, approximately $7.0 billion
of the standbys will expire within one year, and the balance between one to
five years.
The notional amounts for other off-balance-sheet risks (See "Trading
Activities" in the MD&A section) 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.
Other
-----
The Company has provided standard representations for underwriting
agreements, acquisition and divestiture agreements, sales of loans and
commitments, and other similar types of arrangements and customary
indemnification for claims and legal proceedings related to its provision of
financial services. Insurance has been purchased to mitigate certain of these
risks. The Company is a minority equity investor in, and member of, several
industry clearing or settlement exchanges through which foreign exchange,
securities or other transactions settle. Certain of these industry clearing or
settlement exchanges require their members to guarantee their obligations and
liabilities or to provide financial support in the event other partners do not
honor their obligations. It is not possible to estimate a maximum potential
amount of payments that could be required with such agreements.
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 cross-border leveraged 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. As previously disclosed, beginning in the fourth quarter of
2004, the Company had several appellate conferences with the IRS in an attempt
to settle the proposed adjustments related to these LILO transactions.
On February 28, 2006, the Company settled this matter with the IRS
relating to LILO transactions closed in 1996 and 1997. The settlement will not
affect first quarter 2006 net income, as the impact of the settlement was fully
reserved.
The Company's 1998 leveraged lease transactions are in a subsequent audit
cycle and were not part of the settlement. The Company believes that a
comparable settlement for 1998 will ultimately be possible, given the
similarity between these leases and the settled leases. However, negotiations
are not complete and the treatment of the 1998 leases may still be litigated.
Under current generally accepted accounting principles, if the 1998 leases are
settled on a basis comparable to the 1996 and 1997 leases, the Company would
not expect the settlement of the 1998 leases to have an impact on net income,
based on existing reserves.
In the fourth quarter of 2005 the Company deposited funds with the IRS in
anticipation of reaching a settlement on all of its LILO investments.
60
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 prior to 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 tax treatment of the leases complied with statutory,
administrative and judicial authority existing at the time they were entered
into.
The Company currently believes it has adequate tax reserves to cover its
LILO exposure and any other potential tax exposures, based on a probability
assessment of various potential outcomes. Probabilities and outcomes are
reviewed as events unfold, and adjustments to the reserves are made when
appropriate.
In the ordinary course of business, the Company and its subsidiaries are
routinely defendants in or parties to a number of pending and potential legal
actions, including actions brought on behalf of various classes of claimants,
and regulatory matters. Claims for significant monetary damages are asserted
in certain of these actions and proceedings. Due to the inherent difficulty of
predicting the outcome of such matters, the Company cannot ascertain what the
eventual outcome of these matters will be; however, based on current knowledge
and after consultation with legal counsel, the Company does not believe that
judgments or settlements, if any, arising from pending or potential legal
actions or regulatory matters, either individually or in the aggregate, after
giving effect to applicable reserves, 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.
See discussion of contingent legal matters in the "Legal and Regulatory
Proceedings" section.
61
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 March 31, 2006
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 April 28, 2006, The Bank of New York Company, Inc. had
761,953,149 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 a large accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
The registrant is not a shell company (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
March 31, 2006 and December 31, 2005 48
Consolidated Statements of Income for
the Three Months Ended March 31, 2006 and 2005 49
Consolidated Statement of Changes in
Shareholders' Equity for the Three Months
Ended March 31, 2006 50
Consolidated Statement of Cash Flows
for the Three Months Ended March 31, 2006 and 2005 51
Notes to Consolidated Financial Statements 52 - 60
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 3 - 47
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 39 - 41
62
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 that 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 and Regulatory 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, on the basis of 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, after
giving effect to applicable reserves, will have a material adverse effect on
the consolidated financial position or liquidity of the Company, although
they could have a material effect on net income for a given period.
The Company intends to defend itself vigorously against all of the claims
asserted in these legal actions.
As previously disclosed in the Company's 2005 Annual Report on Form 10-K,
the U.S. Securities and Exchange Commission ("SEC") is investigating 1) the
appropriateness of certain expenditures made in connection with marketing and
distribution of the Hamilton Funds; 2) possible market-timing transactions
cleared by Pershing LLC ("Pershing"); and 3) the trading activities of Pershing
Trading Company LP, a floor specialist, on two regional exchanges from 1999 to
2004.
Pershing, which the Company acquired from Credit Suisse First Boston
(USA), Inc. ("CSFB") in May 2003, is defending a putative class action lawsuit
63
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 in the putative class action and the Pershing
market timing and floor specialist investigations is alleged to have occurred
largely during the period when Pershing was owned by CSFB, the Company has made
claims for indemnification against CSFB relating to these matters under the
agreement relating to the acquisition of Pershing. CSFB is disputing these
claims for indemnification.
As previously disclosed, the SEC has been investigating two of the
Company's issuer services businesses. The Company continues to cooperate with
these investigations. One of the investigations has focused primarily on the
Company's role as transfer agent on behalf of equity issuers in the United
States and the process that the Company's stock transfer division used to
search for lost security holders of its issuer clients. On April 24, 2006, a
settlement with the SEC was announced resolving this matter. The settlement
includes, among other things: (i) a cease and desist order against the Bank for
violations of certain securities laws; (ii) the Bank's agreement to offer
payment to certain security holders for property escheated erroneously (while
reserving the right to pursue their claim for repayment with the state to which
the property was escheated) and a penalty of $250,000; and (iii) the Bank's
retention of an independent consultant to review and evaluate certain of the
Bank's policies and procedures. The Company believes the settlement will have
no adverse effect on its transfer agent business. The other SEC investigation
has focused on the Company's role as auction agent in connection with certain
auction rate securities. The Company has entered into settlement negotiations
with the SEC staff concerning the auction agent investigation. There can be no
assurance that a settlement will be reached.
As disclosed in a report filed on Form 8-K, the Company entered into a
written agreement with the Federal Reserve Bank of New York and the New York
State Banking Department on April 21, 2006. The agreement outlines a series of
steps to strengthen and enhance the Bank's compliance practices, systems,
controls, and procedures.
Item 1A. Risk Factors
----------------------
See "Forward-Looking Statements and Risk Factors That Could Affect Future
Results" in "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
64
Item 2. Unregistered Sales of Equity Securities
------------------------------------------------
and Use of Proceeds
-------------------
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) Shares of common stock were issued to former directors who had
deferred receipt of such common stock pursuant to the Deferred
Compensation Plan for Non-Employee Directors of The Bank of New
York Company, Inc. These issuances amounted to 4,963 shares on
February 6, 2006 and 2,521 shares on February 23, 2006.
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 first quarter of 2006.
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
-------------- ---------- ---------- --------------- ------------------
January 1-31 565,997 $ 31.61(1) 565,997 18,435,283
February 1-28 1,606,456 34.22 1,606,456 16,828,827
March 1-31 254,709 34.27 254,709 16,574,118
---------- ---------------
Total 2,427,162 2,427,162
========== ===============
(1) Based on initial price.
All shares were repurchased through the Company's stock repurchase
programs announced on July 12, 2005, which permits the repurchase of 20 million
shares. The shares repurchased in January primarily resulted from open market
purchases, while 1.5 million shares were repurchased in February at an initial
price of $34.31 from a broker-dealer counterparty who borrowed the shares, as
part of an accelerated share repurchase program. The initial price is subject
to a purchase price adjustment based on the price the counterparty actually
pays for the shares. The remaining shares repurchased were from employee
benefit plans.
64
Item 6. Exhibits
-----------------
3.1 - The By-Laws of The Bank of New York Company, Inc. as amended through
April 12, 2005, incorporated by reference to Exhibit 3(ii) to the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31,
2005.
3.2 - Restated Certificate of Incorporation of The Bank of New York
Company, Inc. dated May 8, 2001, incorporated by reference to Exhibit 4 to
the Company's Registration Statement on Form S-3 filed June 7, 2001 (File
No. 333-62516, 333-62516-01, 333-62516-02, 333-62516-03 and
333-62516-04).
4 - None of the outstanding instruments defining the rights of holders of
long-term debt of the Company represent long-term debt in excess of 10% of
the total assets of the Company. The Company hereby agrees to furnish to
the Commission, upon request, a copy of any such instrument.
10- Purchase and Assumption Agreement, dated as of April 7, 2006, by and
between The Bank of New York Company, Inc. and JPMorgan Chase & Co.,
incorporated by reference to Exhibit 99.1 to the Company's Current Report
on Form 8-K as filed with the Commission on April 13, 2006.
12- Ratio of Earnings to Fixed Charges for the Three Months Ended
March 31, 2006 and 2005.
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.
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: May 08, 2006 By: /s/ Thomas J. Mastro
---------------------------------
Name: Thomas J. Mastro
Title: Comptroller
67
EXHIBIT INDEX
-------------
Exhibit Description
------- -----------
3.1 The By-Laws of The Bank of New York Company, Inc. as amended
through April 12, 2005, incorporated by reference to Exhibit
3(ii) to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2005.
3.2 Restated Certificate of Incorporation of The Bank of New York
Company, Inc. dated May 8, 2001, incorporated by reference to
Exhibit 4 to the Company's Registration Statement on Form S-3
filed June 7, 2001 (File No. 333-62516, 333-62516-01,
333-62516-02, 333-62516-03 and 333-62516-04).
4 None of the outstanding instruments defining the rights of
holders of long-term debt of the Company represent long-term
debt in excess of 10% of the total assets of the Company. The
Company hereby agrees to furnish to the Commission, upon
request, a copy of any such instrument.
10 Purchase and Assumption Agreement, dated as of April 7, 2006, by
and between The Bank of New York Company, Inc. and JPMorgan
Chase & Co., incorporated by reference to Exhibit 99.1 to the
Company's Current Report on Form 8-K as filed with the
Commission on April 13, 2006.
12 Ratio of Earnings to Fixed Charges for the Three Months Ended
March 31, 2006 and 2005.
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.