THE BANK OF NEW YORK COMPANY, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended September 30, 2006
The Quarterly Report on Form 10-Q and cross reference index is on page 95.
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 6
- Overview 6
- Third Quarter 2006 Highlights 7
- Supplemental Financial Information 9
- Consolidated Income Statement Review 12
- Business Segment Review 20
- Critical Accounting Policies 36
- Consolidated Balance Sheet Review 40
- Liquidity 49
- Capital Resources 52
- Trading Activities 54
- Asset/Liability Management 56
- Statistical Information 58
- Supplemental Data 62
- Other Developments 71
- Forward-Looking Statements and
Risk Factors That Could Affect Future Results 72
- Government Monetary Policies and Competition 72
- Website Information 73
Consolidated Financial Statements
- Consolidated Balance Sheets
September 30, 2006 and December 31, 2005 74
- Consolidated Statements of Income
for the Three Months and Nine Months Ended
September 30, 2006 and 2005 75
- Consolidated Statement of Changes In
Shareholders' Equity for the Nine
Months Ended September 30, 2006 77
- Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2006 and 2005 78
- Notes to Consolidated Financial Statements 79
Form 10-Q
- Cover 95
- Controls and Procedures 96
- Legal and Regulatory Proceedings 96
- Risk Factors 97
- Unregistered Sales of Equity Securities
and Use of Proceeds 97
- Exhibits 98
- Signature 99
1
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Financial Highlights
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, June 30, September 30,
Continuing Operations (1) 2006 2006 2005
------------------------- ------------- -------------- -------------
Quarter
------
Net Interest Income $ 351 $ 358 $ 346
Noninterest Income 1,259 1,366 1,185
------------ ------------- ------------
1,610 1,724 1,531
Tax Equivalent Adjustment 7 7 7
------------ ------------- ------------
Revenue (tax equivalent basis) $ 1,617 $ 1,731 $ 1,538
============ ============= ============
Income from Continuing Operations
Before Income Taxes $ 422 $ 591 $ 490
Income Taxes 124 200 157
------------ ------------- ------------
Income from Continuing Operations 298 391 333
Income from Discontinued Operations,
Net of Taxes 54 57 56
------------ ------------- ------------
Net Income $ 352 $ 448 $ 389
============ ============= ============
Basic EPS:
Income from Continuing Operations $ 0.40 $ 0.52 $ 0.44
Income from Discontinued Operations, Net 0.07 0.07 0.07
Net Income 0.47 0.59 0.51
Diluted EPS:
Income from Continuing Operations 0.39 0.52 0.44
Income from Discontinued Operations, Net 0.07 0.07 0.07
Net Income 0.46 0.59 0.51
Cash Dividends Per Share 0.22 0.21 0.21
Return on Average Common
Shareholders' Equity 11.61% 15.85% 13.82%
Return on Average Assets 1.19 1.54 1.43
Efficiency Ratio 74.7 66.4 67.7
Efficiency Ratio Excluding Merger
and Integration Costs 69.1 66.4 67.7
(1) Continuing operations exclude the Company's retail and regional middle market banking businesses sold to
JPMorgan Chase & Co. on October 1, 2006, which are accounted for as discontinued operations.
2
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Financial Highlights
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, June 30, September 30,
Continuing Operations (1) 2006 2006 2005
------------------------- ------------- -------------- --------------
Year-to-date
------------
Net Interest Income $ 1,048 $ 697 $ 996
Noninterest Income 3,886 2,627 3,495
------------ ------------- ------------
4,934 3,324 4,491
Tax Equivalent Adjustment 21 14 22
------------ ------------- ------------
Revenue (tax equivalent basis) $ 4,955 $ 3,338 $ 4,513
============ ============= ============
Income from Continuing Operations
Before Income Taxes $ 1,548 $ 1,126 $ 1,478
Income Taxes 499 375 474
------------ ------------- ------------
Income from Continuing Operations 1,049 751 1,004
Income from Discontinued Operations,
Net of Taxes 173 119 162
------------ ------------- ------------
Net Income $ 1,222 $ 870 $ 1,166
============ ============= ============
Basic EPS:
Income from Continuing Operations $ 1.38 $ 0.99 $ 1.31
Income from Discontinued Operations, Net 0.23 0.15 0.21
Net Income 1.61 1.14 1.52
Diluted EPS:
Income from Continuing Operations 1.36 0.98 1.30
Income from Discontinued Operations, Net 0.23 0.15 0.21
Net Income 1.59 1.13 1.51
Cash Dividends Per Share 0.64 0.42 0.61
Return on Average Common
Shareholders' Equity 14.03% 15.30% 14.28%
Return on Average Assets 1.41 1.52 1.46
Efficiency Ratio 69.3 66.7 67.7
Efficiency Ratio Excluding Merger
and Integration Costs 67.5 66.7 67.7
Assets $ 97,808 $ 99,935 $ 93,081
Loans 33,958 35,650 34,358
Securities 22,015 27,355 26,127
Deposits - Domestic 20,837 25,602 19,775
- Foreign 34,116 31,139 26,270
Long-Term Debt 8,434 8,207 7,529
Common Shareholders' Equity 10,467 10,056 9,608
Employees 20,456 20,001 19,664
Allowance for Loan Losses as
a Percent of Total Loans 1.00% 0.95% 1.37%
Allowance for Loan Losses as
a Percent of Non-Margin Loans 1.16 1.10 1.68
Total Allowance for Credit Losses as
a Percent of Total Loans 1.40 1.35 1.77
Total Allowance for Credit Losses as
a Percent of Non-Margin Loans 1.63 1.57 2.16
(1) Continuing operations exclude the Company's retail and regional middle market banking businesses sold to
JPMorgan Chase & Co. on October 1, 2006, which are accounted for as discontinued operations.
3
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Financial Highlights - Supplemental Information
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, June 30, September 30,
Adjusted Results (1) 2006 2006 2005
-------------------- ------------- ------------- -------------
Quarter
-------
Net Interest Income $ 506 $ 512 $ 492
Noninterest Income 1,325 1,426 1,248
------------ ------------- ------------
1,831 1,938 1,740
Tax Equivalent Adjustment 8 9 8
------------ ------------- ------------
Revenue (tax equivalent basis) $ 1,839 $ 1,947 $ 1,748
============ ============= ============
Net Income Including
Merger and Integration Costs $ 352 $ 448 $ 389
Merger and Integration Costs 74 - -
Net Income Excluding
Merger and Integration Costs 426 448 389
Diluted EPS Including
Merger and Integration Costs 0.46 0.59 0.51
Merger and Integration Costs 0.10 - -
Diluted EPS Excluding
Merger and Integration Costs 0.56 0.59 0.51
Cash Dividends Per Share 0.22 0.21 0.21
Efficiency Ratio Excluding
Merger and Integration Costs 66.5% 64.9% 65.5%
Year-to-date
------------
Net Interest Income $ 1,506 $ 1,000 $ 1,417
Noninterest Income 4,083 2,758 3,682
------------ ------------- ------------
5,589 3,758 5,099
Tax Equivalent Adjustment 23 15 21
------------ ------------- ------------
Revenue (tax equivalent basis) $ 5,612 $ 3,773 $ 5,120
============ ============= ============
Net Income Including
Merger and Integration Costs $ 1,222 $ 870 $ 1,166
Merger and Integration Costs 74 - -
Net Income Excluding
Merger and Integration Costs 1,296 870 1,166
Diluted EPS Including
Merger and Integration Costs 1.59 1.13 1.51
Merger and Integration Costs 0.10 - -
Diluted EPS Excluding
Merger and Integration Costs 1.69 1.13 1.51
Cash Dividends Per Share 0.64 0.42 0.61
Efficiency Ratio Excluding
Merger and Integration Costs 65.5% 65.0% 65.8%
4
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Financial Highlights - Supplemental Information
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, June 30, September 30,
Adjusted Results (1) 2006 2006 2005
-------------------- ------------- ------------- -------------
Assets $ 106,636 $ 108,881 $ 101,766
Loans 41,726 43,622 42,143
Securities 22,135 27,459 26,230
Deposits - Domestic 33,818 39,280 34,807
- Foreign 34,116 31,139 26,270
Long-Term Debt 8,434 8,207 7,529
Common Shareholders' Equity 10,467 10,056 9,608
Allowance for Loan Losses as
a Percent of Total Loans 0.98% 0.96% 1.33%
Allowance for Loan Losses as
a Percent of Non-Margin Loans 1.11 1.08 1.57
Total Allowance for Credit Losses as
a Percent of Total Loans 1.33 1.30 1.68
Total Allowance for Credit Losses as
a Percent of Non-Margin Loans 1.49 1.47 1.97
Employees 23,808 23,575 23,081
(1) Adjusted results combine continuing and discontinued operations to provide
continuity with historical results. See "Supplemental Data."
5
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Financial Highlights
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, June 30, September 30,
2006 2006 2005
------------- ------------- --------------
Assets Under Custody
--------------------
(In trillions) - Estimated
Assets Under Custody $ 12.2 $ 12.0 $ 10.3
Equity Securities 31% 32% 31%
Fixed Income Securities 69 68 69
Cross-Border Assets Under Custody $ 4.2 $ 4.1 $ 3.1
Assets Under Management
-----------------------
(In billions) - Estimated
Asset Management Sector $ 120 $ 116 $ 106
Equity Securities 36 36 37
Fixed Income Securities 20 21 22
Alternative Investments 30 28 15
Liquid Assets 34 31 32
Foreign Exchange Overlay 11 11 10
Securities Lending Short-term
Investment Funds 48 43 41
------------ ------------- ------------
Total Assets Under Management $ 179 $ 170 $ 157
============ ============= ============
Capital Ratios
--------------
Tier 1 Capital Ratio 8.17% 7.96% 7.93%
Total Capital Ratio 12.32 12.06 12.20
Leverage Ratio 6.56 6.22 6.59
Tangible Common Equity Ratio 5.58 5.07 5.32
Performance Ratios
------------------
Quarter
-------
Return on Average Common
Shareholders' Equity 13.70% 18.17% 16.15%
Return on Average Common
Shareholders' Equity Excluding
Merger & Integration Costs 16.56 18.17 16.15
Return on Average Assets 1.29 1.63 1.53
Return on Average Assets Excluding
Merger & Integration Costs 1.55 1.63 1.53
Year-to-date
------------
Return on Average Common
Shareholders' Equity 16.35% 17.74% 16.59%
Return on Average Common
Shareholders' Equity Excluding
Merger & Integration Costs 17.33 17.74 16.59
Return on Average Assets 1.51 1.62 1.56
Return on Average Assets Excluding
Merger & Integration Costs 1.60 1.62 1.56
Other Data
----------
Common Shareholders'
Equity Per Share $ 13.70 $ 13.18 $ 12.48
Market Value Per Share
of Common Stock 35.26 32.20 29.41
6
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: securities
servicing, treasury management, 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 ("The Bank"),
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 asset management businesses, and
it has achieved top three market share in most of its major product lines. The
Company distinguishes itself competitively by offering to various parties 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 long-term 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 long-term 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,
7
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
acquired over 90 businesses over the past ten years, almost exclusively in its
securities servicing and asset management areas. The acquisition of the
corporate trust business of JPMorgan Chase & Co. ("JPMorgan Chase") and the
formation of BNY ConvergEx Group, both completed in early October, should also
contribute to the Company's ability to achieve its long-term objectives.
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, the sale of the retail and regional middle market banking businesses
in October 2006. To the extent these actions generated capital, the capital
has been reallocated to the Company's higher-growth businesses or used to
repurchase shares.
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.
THIRD QUARTER 2006 HIGHLIGHTS
The Company reported third quarter net income of $352 million and diluted
earnings per share of 46 cents, including after-tax charges of $74 million, or
10 cents per share, for merger and integration costs. On an operating basis,
excluding the merger and integration costs, third quarter net income was $426
million and diluted earnings per share was 56 cents, an increase of 10% from
net income of $389 million and diluted earnings per share of 51 cents in the
third quarter of 2005.
For the nine months ended September 30, 2006, net income was $1,222
million and diluted earnings per share was $1.59, including after-tax
charges of $74 million, or 10 cents per share, for merger and integration
costs. On an operating basis, excluding merger and integration costs,
year-to-date net income was $1,296 million compared with $1,166 million
last year and diluted earnings per share was $1.69, an increase of 12% over
$1.51 in the prior year period.
8
On October 1, 2006, the Company acquired JPMorgan Chase's corporate trust
business (the "Acquired Corporate Trust Business") and sold to JPMorgan Chase
the Company's retail and regional middle market banking businesses. In the
second quarter of 2006, the Company adopted discontinued operations accounting
for its retail and regional middle market banking businesses. Therefore, the
results from continuing operations through September 30, 2006 exclude the
results of the Company's retail and regional middle market banking businesses
but do not include the operations of the Acquired Corporate Trust Business,
since the transaction did not close until October 1, 2006. Adjusted financial
statements combining continuing and discontinued operations are presented in
"Supplemental Financial Information."
Performance highlights for the quarter include:
* Strong revenue growth in issuer services and broker-dealer services, both
up 14% over last year's third quarter.
* Private banking and asset management revenues up 23% from the year-ago
quarter, led by the Alcentra and Urdang acquisitions.
* Disciplined expense control.
* Continued excellent asset quality, with zero charge-offs on a continuing
operations basis.
* Closed the swap with JPMorgan Chase and the BNY ConvergEx transaction on
schedule in early October.
* Completion of balance sheet repositioning actions tied to the JPMorgan
Chase swap, taking advantage of favorable market conditions.
The following tables show the impact of the merger and integration costs
associated with the JPMorgan Chase transaction on diluted earnings per share
for the three months and nine months ended September 30, 2006:
Diluted Earnings Per Share
-----------------------------------------------------------------------------
Three Months Ended September 30, 2006 Nine Months Ended September 30, 2006
------------------------------------- --------------------------------------
Continuing Discontinued Continuing Discontinued
(In dollars) Operations Operations Adjusted(1) Operations Operations Adjusted(1)
---------- ------------ ----------- ---------- ------------ -----------
Including Merger &
Integration Costs $ 0.39 $ 0.07 $ 0.46 $ 1.36 $ 0.23 $ 1.59
Merger & Integration Costs 0.08 0.02 0.10 0.08 0.02 0.10
------- ------- ------- ------- ------- -------
Excluding Merger &
Integration Costs $ 0.47 $ 0.09 $ 0.56 $ 1.44 $ 0.25 $ 1.69
======= ======= ======= ======= ======= =======
(1) Adjusted results combine continuing and discontinued operations to provide continuity with historical
results.
Merger and integration costs include an investment portfolio restructuring
loss, employee-related costs, and other transaction-related expenses.
Third quarter 2006 income from continuing operations excluding merger and
integration costs was 47 cents of diluted earnings per share, up 7% from the 44
cents of diluted earnings per share in the third quarter of 2005. Net income
on a continuing operations basis, excluding merger and integration costs, was
$360 million in the third quarter of 2006, compared with $333 million last
year. Net income from continuing operations was $391 million or 52 cents of
diluted earnings per share in the second quarter of 2006. On a year-to-date
basis, excluding merger and integration costs, income from continuing
operations was $1,111 million, or $1.44 of diluted earnings per share,
compared to $1,004 million, or $1.30 of diluted earnings per share in 2005,
up 11%.
9
SUPPLEMENTAL FINANCIAL INFORMATION
On October 1, 2006, the Company purchased the Acquired Corporate Trust
Business and sold the Company's retail and regional middle market banking
businesses. The transaction further increases the Company's focus on the
securities services and asset management businesses that are at the core of
its long-term business strategy.
For the quarters and nine months ended September 30, 2006 and 2005, the
Company has prepared supplemental financial information as follows:
* Full income statements and balance sheets for continuing operations, which
exclude the results of substantially all of the Retail & Regional Middle
Market Banking Business
* Full income statements and balance sheets for the Retail & Regional Middle
Market Banking Business, which is reflected as discontinued operations
* Adjusted results, which combine continuing and discontinued operations to
provide continuity with historical results
* Continuing operations and adjusted results including and excluding merger
and integration costs
The Company believes that providing supplemental adjusted non-GAAP
financial information is useful to investors in understanding the underlying
operating performance of the Company and its businesses and performance trends,
particularly in view of the materiality and strategic significance of the
JPMorgan Chase transaction. Specifically, the Company believes that the
results of continuing operations are of limited value in projecting future
results because they do not include the net income associated with the Acquired
Corporate Trust Business, which closed on October 1, 2006. By combining the
results of continuing and discontinued operations and comparing the results
with prior periods, the Company believes investors can obtain greater insight
into the current performance of the Company in relation to historical results.
By excluding merger and integration costs, the Company believes investors can
gain greater insight into the operating performance of the Company. Although
the Company believes that the non-GAAP financial measures presented in this
report enhance investors' understanding of the Company's business and
performance, these non-GAAP measures should not be considered an alternative to
GAAP. A reconciliation of the Company's non-GAAP and GAAP financial results for
the quarters and nine-month periods ended September 30, 2006 and 2005 are
included in "Supplemental Data."
Income statements for both continuing operations and adjusted results are
provided on the following two pages. In addition, see "Consolidated Financial
Highlights - Supplemental Information" and "Supplemental Data."
10
THE BANK OF NEW YORK COMPANY, INC.
Income Statement - Supplemental Information
(In millions, except per share amounts)
(Unaudited)
Continuing Operations
--------------------------------------------------------------------
Quarter Ended Nine Months Ended
September 30, June 30, September 30, September 30,
2006 2006 2005 2006 2005
------------- --------- ------------- ------- ------
Net Interest Income $ 351 $ 358 $ 346 $1,048 $ 996
-------------------
Provision for Credit Losses (4) (1) 10 (5) (10)
----- ----- ------ ------ ------
Net Interest Income After
Provision for
Credit Losses 355 359 336 1,053 1,006
----- ----- ------ ------ ------
Noninterest Income
------------------
Servicing Fees
Securities 839 909 806 2,579 2,330
Global Payment Services 66 63 67 191 200
----- ----- ------ ------ ------
905 972 873 2,770 2,530
Private Banking and
Asset Management Fees 134 138 109 402 334
Service Charges and Fees 52 53 54 157 172
Foreign Exchange and Other
Trading Activities 84 130 90 327 283
Securities Gains 21 23 15 61 50
Other 63 50 44 169 126
----- ----- ------ ------ ------
Total Noninterest Income 1,259 1,366 1,185 3,886 3,495
----- ----- ------ ------ ------
Noninterest Expense
-------------------
Salaries and Employee Benefits 644 656 585 1,904 1,721
Net Occupancy 70 68 60 206 184
Furniture and Equipment 46 48 50 145 149
Clearing 47 53 49 150 137
Sub-custodian Expenses 31 36 25 101 72
Software 53 53 54 161 160
Communications 26 22 23 74 66
Amortization of Intangibles 14 15 10 42 28
Merger and Integration Costs 89 - - 89 -
Other 172 183 175 519 506
----- ----- ------ ------ ------
Total Noninterest Expense 1,192 1,134 1,031 3,391 3,023
----- ----- ------ ------ ------
Income Before Income Taxes, Including
Merger and Integration Costs 422 591 490 1,548 1,478
Income Taxes 124 200 157 499 474
----- ----- ------ ------ ------
Net Income Including Merger and
Integration Costs 298 391 333 1,049 1,004
Merger and Integration Costs, Net
of Taxes 62 - - 62 -
----- ----- ------ ------ ------
Net Income Excluding Merger and
Integration Costs $ 360 $ 391 $ 333 $1,111 $1,004
===== ===== ====== ====== ======
Diluted Earnings Per Share $0.39 $0.52 $0.44 $1.36 $1.30
Diluted Earnings Per Share Excluding
Merger and Integration Costs 0.47 0.52 0.44 1.44 1.30
Diluted earnings per share from continuing operations excluding merger and
integration costs for the third quarter of 2006 were 47 cents, up from 44 cents
a year ago. On the same basis for the year-to-date period, diluted earnings
per share grew 11% from a year ago to $1.44.
11
THE BANK OF NEW YORK COMPANY, INC.
Income Statement - Supplemental Information
(In millions, except per share amounts)
(Unaudited)
Adjusted Income Statement (1)
--------------------------------------------------------------------
Quarter Ended Nine Months Ended
September 30, June 30, September 30, September 30,
2006 2006 2005 2006 2005
------------- --------- ------------- ------- ------
Net Interest Income $ 506 $ 512 $ 492 $1,506 $1,417
-------------------
Provision for Credit Losses (5) - 10 - 5
----- ----- ------ ------ ------
Net Interest Income After
Provision for
Credit Losses 511 512 482 1,506 1,412
----- ----- ------ ------ ------
Noninterest Income
------------------
Servicing Fees
Securities 839 909 806 2,579 2,330
Global Payment Services 74 70 75 214 226
----- ----- ------ ------ ------
913 979 881 2,793 2,556
Private Banking and
Asset Management Fees 145 150 120 436 366
Service Charges and Fees 90 91 93 270 288
Foreign Exchange and Other
Trading Activities 86 132 93 333 292
Securities Gains 21 23 15 61 50
Other 70 51 46 190 130
----- ----- ------ ------ ------
Total Noninterest Income 1,325 1,426 1,248 4,083 3,682
----- ----- ------ ------ ------
Noninterest Expense
-------------------
Salaries and Employee Benefits 706 723 644 2,097 1,902
Net Occupancy 88 86 79 262 239
Furniture and Equipment 48 50 52 151 155
Clearing 47 53 49 150 137
Sub-custodian Expenses 31 36 25 101 72
Software 54 53 54 163 162
Communications 27 23 24 77 69
Amortization of Intangibles 14 15 10 42 28
Merger and Integration Costs 110 - - 110 -
Other 193 209 198 591 571
----- ----- ------ ------ ------
Total Noninterest Expense 1,318 1,248 1,135 3,744 3,335
----- ----- ------ ------ ------
Income Before Income Taxes, Including
Merger and Integration Costs 518 690 595 1,845 1,759
Income Taxes 166 242 206 623 593
----- ----- ------ ------ ------
Net Income Including Merger and
Integration Costs 352 448 389 1,222 1,166
Merger and Integration Costs, Net
of Taxes 74 - - 74 -
----- ----- ------ ------ ------
Net Income Excluding Merger and
Integration Costs $ 426 $ 448 $ 389 $1,296 $1,166
===== ===== ===== ====== ======
Diluted Earnings Per Share $0.46 $0.59 $0.51 $1.59 $1.51
Diluted Earnings Per Share, Excluding
Merger and Integration Costs 0.56 0.59 0.51 1.69 1.51
(1) Adjusted results combine continuing and discontinued operations to provide continuity with historical
results.
Diluted earnings per share from adjusted results excluding merger and
integration costs for the third quarter of 2006 were 56 cents, up from 51
cents a year ago. On the same basis for the year-to-date period, diluted
earnings per share grew 12% from a year ago to $1.69.
12
CONSOLIDATED INCOME STATEMENT REVIEW
Noninterest Income
------------------
Continuing Operations
---------------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q06 vs. 3Q06 vs. -------------- Inc/
(In millions) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------ ------ ------ -------- ------- ------ ------ -------
Servicing Fees
Securities $ 839 $ 909 $ 806 (8)% 4% $2,579 $2,330 11%
Global Payment
Services 66 63 67 5 (1) 191 200 (5)
------ ------ ------ ------ ------
905 972 873 (7) 4 2,770 2,530 9
Private Banking
and Asset
Management Fees 134 138 109 (3) 23 402 334 20
Service Charges and Fees 52 53 54 (2) (4) 157 172 (9)
Foreign Exchange and
Other Trading Activities 84 130 90 (35) (7) 327 283 16
Securities Gains 21 23 15 (9) 40 61 50 22
Other 63 50 44 26 43 169 126 34
------ ------ ------ ------ ------
Total Noninterest
Income $1,259 $1,366 $1,185 (8) 6 $3,886 $3,495 11
====== ====== ====== ====== ======
Adjusted(1)
----------
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q06 vs. 3Q06 vs. -------------- Inc/
(In millions) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------ ------ ------ -------- ------- ------ ------ -------
Servicing Fees
Securities $ 839 $ 909 $ 806 (8)% 4% $2,579 $2,330 11%
Global Payment
Services 74 70 75 6 (1) 214 226 (5)
------ ------ ------ ------ ------
913 979 881 (7) 4 2,793 2,556 9
Private Banking
and Asset
Management Fees 145 150 120 (3) 21 436 366 19
Service Charges
and Fees 90 91 93 (1) (3) 270 288 (6)
Foreign Exchange and
Other Trading Activities 86 132 93 (35) (8) 333 292 14
Securities Gains 21 23 15 (9) 40 61 50 22
Other 70 51 46 37 52 190 130 46
------ ------ ------ ------ ------
Total Noninterest
Income $1,325 $1,426 $1,248 (7) 6 $4,083 $3,682 11
====== ====== ====== ====== ======
(1) Adjusted results combine continuing and discontinued operations to provide
continuity with historical results.
Unless otherwise indicated, the discussion below refers to noninterest
income on both a continuing operations basis and on an adjusted basis.
The results of many of the Company's businesses are influenced by customer
activities that vary by quarter. For instances, consistent with an overall
decline in securities industry activity in the summer, the Company typically
experiences a seasonal decline in the third quarter. The Company also
experiences seasonal increases in securities lending and depositary receipts
reflecting the European dividend distribution season during the second quarter
of the year, and to a lesser extent, in the fourth quarter of the year.
13
The increase in noninterest income versus the year-ago quarter reflects
growth in securities servicing and private banking and asset management fees,
as well as a higher level of securities gains and other income, partially
offset by declines in service charges and fees and foreign exchange and other
trading activities. Most of these same trends explain the year-to-date increase
in noninterest income, with the exception of foreign exchange and other trading
activities, which were up significantly for the first nine months of the year.
The sequential decline in noninterest income reflects a pronounced seasonal
slowdown across several businesses.
The following table provides the breakdown of securities servicing fees.
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q06 vs. 3Q06 vs. -------------- Inc/
(In millions) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------ ------ ------ -------- -------- ------ ------ -------
Execution and
Clearing Services $ 298 $ 334 $ 314 (11)% (5)% $ 971 $ 901 8%
Issuer Services 194 207 170 (6) 14 555 468 19
Investor Services 282 302 265 (7) 6 861 792 9
Broker-Dealer Services 65 66 57 (2) 14 192 169 14
------ ------ ------ ------ ------
Securities
Servicing Fees $ 839 $ 909 $ 806 (8) 4 $2,579 $2,330 11
====== ====== ====== ====== ======
Securities servicing fee growth over the third quarter and year-to-date
periods of 2005 reflects double-digit growth in issuer and broker-dealer
services. Securities servicing fees were down sequentially reflecting the
pronounced seasonality that occurred during the third quarter. See
"Institutional Services Segment" in "Business Segment Review" for additional
details.
Global payment services fees increased sequentially, reflecting increased
funds transfer volume. Global payment service fees were down from the year-ago
quarter and on a year-to-date period. While the payments business continues to
grow, reflecting increases in funds transfer volume and net new business, the
level of fees has been impacted by customers paying with higher compensatory
balances in lieu of fees. On an invoiced services basis, total revenue was up
7% over the third quarter of 2005 and 4% on a sequential-quarter basis.
Private banking and asset management fees increased significantly from the
third quarter and year-to-date periods of 2005 primarily due to acquisitions
and higher fees in private banking. The sequential-quarter decline in fees is
attributable to a decline in activity-based fees in the private bank and lower
performance fees for certain asset management activities. Total assets under
management for private banking and asset management were $120 billion, up from
$106 billion at September 30, 2005 and $116 billion at June 30, 2006. The
year-over-year growth primarily reflects the acquisition of Alcentra and
Urdang. The sequential-quarter increase reflects growth in money market and
alternative investments.
Service charges and fees were down sequentially and from prior year periods
principally due to lower capital market fees.
Foreign exchange and other trading revenues were down sequentially and
from the third quarter of 2005, but up significantly from last year on a year-
to-date basis. Foreign exchange results were particularly weak in the third
quarter of 2006, compared with the year-over-year and sequential quarter, as
the typical seasonal slowdown was exacerbated by an eight-year historical low
in volatility. On a year-to-date basis, foreign exchange was up reflecting
higher customer volumes driven by cross-border investment flows, good new
business activity, and increased volatility in the first six months of 2006.
Other trading was down from the 2005 periods and sequentially primarily due to
weaker results in interest rate derivatives and fixed income trading.
14
Securities gains in the third quarter were up significantly from the
year-ago quarter and down on a sequential-quarter basis. The gains in the
quarter were primarily attributable to continued strong returns on investments
in the sponsor fund portfolio. Securities gains were up in the first nine
months of 2006 versus a year ago reflecting favorable market conditions and
liquidity in the private equity markets.
Other noninterest income is comprised of 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
Year-to-date
------------
(In millions) 3Q06 2Q06 3Q05 2006 2005
------------------------------- ------- ------- ------- ---- ----
Asset-Related Gains $ 40 $ 18 $ 21 $ 92 $ 70
Equity Investment Income 13 14 13 38 35
Other 10 18 10 39 21
Other Noninterest Income from ------- ------- ------- ----- -----
Continuing Operations 63 50 44 169 126
Other Noninterest Income from
Discontinued Operations 7 1 2 21 4
------- ------- ------- ----- -----
Adjusted Other Noninterest Income $ 70 $ 51 $ 46 $ 190 $ 130
======= ======= ======= ===== =====
Other noninterest income increased versus the third quarter of 2005 and
the second quarter of 2006. The current quarter results include a higher level
of asset-related gains compared to the third quarter of 2005 and the second
quarter of 2006. The year-to-date period of 2006 includes a pre-tax gain of
$35 million related to the conversion of the Company's New York Stock Exchange
seats into cash and shares of NYSE Group, Inc. common stock. The year-to-date
period of 2005 includes a $17 million gain on the sale of the Company's
interest in Financial Models Company, Inc.
15
Net Interest Income
-------------------
Continuing Operations
---------------------
Percent Inc/(Dec) Year-to-date
----------------- ------------ Percent
(Dollars in millions) 3Q06 vs. 3Q06 vs. 2006 2005 Inc/
3Q06 2Q06 3Q05 2Q06 3Q05 (Dec)
---- ---- ---- -------- -------- ------ ------ --------
Net Interest Income $ 351 $358 $346 (2)% 1% $1,048 $ 996 5%
Tax Equivalent
Adjustment(1) 7 7 7 21 22
---- ---- ---- ------ ------
Net Interest Income
on a Tax Equivalent
Basis $ 358 $365 $353 (2) 1 $1,069 $1,018 5
==== ==== ==== ====== ======
Interest Rate
Spread 1.14% 1.29% 1.52% 1.26% 1.56%
Net Interest Margin 1.89 1.95 2.09 1.93 2.04
Adjusted(2)
-----------
Percent Inc/(Dec) Year-to-date
----------------- ------------ Percent
(Dollars in millions) 3Q06 vs. 3Q06 vs. 2006 2005 Inc/
3Q06 2Q06 3Q05 2Q06 3Q05 (Dec)
---- ---- ---- -------- -------- ------ ------ --------
Net Interest Income $506 $512 $492 (1)% 3% $1,506 $1,417 6%
Tax Equivalent
Adjustment(1) 8 9 8 23 21
---- ---- ---- ------ ------
Net Interest Income
on a Tax Equivalent
Basis $514 $521 $500 (1) 3 $1,529 $1,438 6
==== ==== ==== ====== ======
Interest Rate
Spread 1.54% 1.65% 1.84% 1.64% 1.87%
Net Interest Margin 2.33 2.36 2.42 2.34 2.37
(1) 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.
(2) Adjusted results combine continuing and discontinued operations to provide continuity with
historical results.
Net interest income on a continuing operations basis and on an adjusted
basis increased from the year-ago quarter and year-to-date periods reflecting
higher interest-earning assets and the higher value of interest-free balances
in a rising rate environment. Average interest-earning assets increased to
$76.1 billion in the third quarter of 2006 from $67.9 billion in last year's
third quarter. Net interest income decreased on a sequential-quarter basis
reflecting a seasonal decline in interest-free balances.
On a continuing operations basis, the interest rate spread was 1.14% in
the third quarter of 2006, compared with 1.52% in the third quarter of 2005
and 1.29% in the second quarter of 2006. The net interest margin was 1.89% in
the third quarter of 2006, compared with 2.09% in the third quarter of 2005
and 1.95% in the second quarter of 2006. The decrease in the net interest
margin primarily reflects the decline in interest-free deposits related to
securities servicing businesses.
16
On a continuing operations basis, the year-to-date interest rate spread
was 1.26% in 2006 compared with 1.56% in 2005, while the net interest margin
was 1.93% in 2006 and 2.04% in 2005.
Noninterest Expense and Income Taxes
------------------------------------
Continuing Operations
---------------------
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q06 vs. 3Q06 vs. -------------- Inc/
(In million) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------ ------ ------ -------- -------- ------ ------ -------
Salaries and
Employee Benefits $ 644 $ 656 $ 585 (2)% 10% $1,904 $1,721 11%
Net Occupancy 70 68 60 3 17 206 184 12
Furniture and Equipment 46 48 50 (4) (8) 145 149 (3)
Clearing 47 53 49 (11) (4) 150 137 9
Sub-custodian Expenses 31 36 25 (14) 24 101 72 40
Software 53 53 54 - (2) 161 160 1
Communications 26 22 23 18 13 74 66 12
Amortization
of Intangibles 14 15 10 (7) 40 42 28 50
Merger and Integration Costs 89 - - 89 -
Other 172 183 175 (6) (2) 519 506 3
------ ------ ------ ------ ------
Total Noninterest
Expense Including
Merger and Integration
Costs 1,192 1,134 1,031 5 16 3,391 3,023 12
Merger and Integration Costs (89) - - (89) -
------ ------ ------ ------ ------
Total Noninterest
Expense Excluding
Merger and Integration
Costs $1,103 $1,134 $1,031 (3) 7 $3,302 $3,023 9
====== ====== ====== ====== ======
Adjusted (1)
------------
Percent Inc/(Dec) Year-to-date
----------------- ------------ Percent
3Q06 vs. 3Q06 vs. Inc/
(In million) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------ ------ ------ -------- -------- ------ ------ -------
Salaries and
Employee Benefits $ 706 $ 723 $ 644 (2)% 10% $2,097 $1,902 10%
Net Occupancy 88 86 79 2 11 262 239 10
Furniture and Equipment 48 50 52 (4) (8) 151 155 (3)
Clearing 47 53 49 (11) (4) 150 137 9
Sub-custodian Expenses 31 36 25 (14) 24 101 72 40
Software 54 53 54 2 - 163 162 1
Communications 27 23 24 17 13 77 69 12
Amortization
of Intangibles 14 15 10 (7) 40 42 28 50
Merger and Integration Costs 110 - - 110 -
Other 193 209 198 (8) (3) 591 571 4
------ ------ ------ ------ ------
Total Noninterest
Expense Including
Merger and Integration
Costs 1,318 1,248 1,135 6 16 3,744 3,335 12
Merger and Integration Costs (110) - - (110) -
------ ------ ------ ------ ------
Total Noninterest
Expense Excluding
Merger and Integration
Costs $1,208 $1,248 $1,135 (3) 6 $3,634 $3,335 9
====== ====== ====== ====== ======
(1) Adjusted results combine continuing and discontinued operations to provide continuity
with historical results. See "Supplemental Data."
17
Unless otherwise indicated, the discussion below refers to noninterest
expense on both a continuing operations basis and on an adjusted basis.
Excluding merger and integration costs, noninterest expense for the third
quarter and first nine months of 2006 was up over last year reflecting
increased costs associated with new business and acquisitions as well as higher
pension costs. On a sequential-quarter basis excluding merger and integration
costs, noninterest expense was down reflecting disciplined expense control,
lower incentive compensation and a decline in expenses related to lower
transaction volumes.
Relative to the year-ago periods, salaries and benefits increased
reflecting higher staff levels tied to new business and acquisitions. Pension
expense was also higher on a year-over-year basis. The sequential-quarter
decline in salaries and employee benefits reflected a lower level of incentive
compensation tied to revenues in the current quarter as well as an adjustment
in the second quarter of 2006 related to SFAS 123(R).
Clearing and sub-custodian expenses were higher on a year-to-date basis
reflecting increased asset values and transaction volumes. On a sequential-
quarter basis, clearing and sub-custodian expenses declined reflecting the
seasonal slowdown in activity.
Merger and integration costs primarily included a loss in connection with
the restructuring of the Company's investment portfolio and employee-related
costs such as severance. The swap of the Acquired Corporate Trust Business for
the retail and regional middle market banking businesses is expected to result
in a more liability-sensitive balance sheet because corporate trust liabilities
reprice more quickly than retail deposits. The Company sold $5.5 billion of
investment portfolio securities during the period to reduce interest rate
sensitivity going forward.
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:
Other Noninterest Expense
Year-to-date
------------
(In millions) 3Q06 2Q06 3Q05 2006 2005
------------------------------- ------- ------- ----- ---- ----
Vendor Services $ 85 $ 88 $ 72 $244 $218
Business Development 27 28 23 78 68
Legal Fees, Settlements and Claims 8 13 40 43 98
Other 52 54 40 154 122
Other Noninterest Expense from ------ ------- ----- ---- ----
Continuing Operations 172 183 175 519 506
Other Noninterest Expense from
Discontinued Operations 21 26 23 72 65
------- ------- ----- ---- ----
Adjusted Other Noninterest Expense $ 193 $ 209 $ 198 $591 $571
======= ======= ===== ==== ====
Other continuing expenses were higher on a year-to-date basis reflecting
higher vendor services, business development and other costs partially offset
by lower legal fees, settlement and claims. On a sequential-quarter basis,
other continuing operations expenses in the third quarter of 2006 decreased due
to lower claims and consulting costs. The decline in legal fees, settlements
and claims over the prior year periods reflects the settlement of certain
regulatory matters over the past year. The sequential decline reflects lower
claims.
18
The effective tax rate for the third quarter of 2006 on a continuing
operations basis was 29.4%, compared to 32.0% in the third quarter of 2005 and
33.8% in the second quarter of 2006. The effective tax rate for the nine-month
period ended September 30, 2006 was 32.2%, compared with 32.1% for the nine-
month period ended September 30, 2005. The effective tax rate for the third
quarter of 2006 on an adjusted basis was 32.0%, compared to 34.6% in the third
quarter of 2005 and 35.1% in the second quarter of 2006. The effective tax
rate for the nine-month period ended September 30, 2006 was 33.8% compared with
33.7% for the nine-month period ended September 30, 2005. The decreases on
both a sequential and year-over-year quarterly basis primarily reflect
increased tax credits related to synthetic fuels. The sequential-quarter
increase in synthetic fuel tax credits was driven by the decline in the price
of oil.
The Company's effective tax rate in the future is expected to be impacted
by the price of oil, which determines the amount of synthetic fuel tax credits
(Section 29 of the Internal Revenue Code) it will receive. These credits
relate to investments that produce alternative fuel from coal byproducts.
At September 30, 2006, the Company assumed a $65 average price per barrel
for the last three months of 2006 to estimate the 2006 benefit from synthetic
fuel credits. To the extent the average oil price differs from this
assumption, the table below shows the estimated effect on earnings per share
("EPS") for 2006.
Avg. Price
Per Barrel
September 30, 2006 - Phase- Net EPS
December 31, 2006 out % Benefit Effect
-------------------- -------- --------- --------
$ 56 23.56% $ 43.7 $ 0.01
59 29.06 40.6 0.01
62 34.56 37.4 -
**************************************************
*65 40.51 34.0 - * (1)
**************************************************
68 45.55 31.1 -
71 51.05 28.0 (0.01)
74 56.55 24.9 (0.01)
(1) September 30, 2006 assumption used to compute effective tax rate.
19
Credit Loss Provision and Net Charge-Offs
-----------------------------------------
(In millions) Year-to-date
-----------------
3Q06 2Q06 3Q05 2006 2005
------- ------- ------- ------- -------
Provision
Continuing Operations $ (4) $ (1) $ 10 $ (5) $ (10)
Discontinued Operations (1) 1 - 5 15
------- ------- ------- ------- -------
Adjusted Total Provision $ (5) $ - $ 10 $ - $ 5
======= ======= ======= ======= =======
Net (Charge-offs)/Recoveries:
Commercial $ - $ 2 $ (2) $ 2 $ (4)
Foreign - 4 (2) 7 (6)
Other - 1 - 1 -
------- ------- ------- ------- -------
Total Continuing
Operations - 7 (4) 10 (10)
------- ------- ------- ------- -------
Discontinued Operations (9) (6) (9) (22) (24)
------- ------- ------- ------- -------
Adjusted Total Net
(Charge-offs)/Recoveries $ (9) $ 1 $ (13) $ (12) $ (34)
======= ======= ======= ======= =======
The sequential increase in the credit to the provision for continuing
operations reflects a continued strong credit environment. During the third
quarter of 2006, nonperforming loans remained at low levels.
20
BUSINESS SEGMENT REVIEW
Segment Data
The Company has an internal information system that produces performance
data for its three 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 U.S. 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 was appropriate to modify its
segment presentation 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. All prior periods
have been restated to reflect this realignment.
On October 1, 2006, the Company sold substantially all of the assets of
the Company's retail and regional middle market banking businesses. The
business segment information is reported on a continuing operations basis for
all periods presented, but does not include the operations of the Acquired
Corporate Trust Business, which was also acquired on October 1, 2006. As a
result, information related to the Company's retail and regional middle market
banking businesses is no longer included in the segment data. See "Discontinued
Operations" in the Notes to the Consolidated Financial Statements for a
discussion of discontinued operations. The Company currently reports results
for three segments, 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
* Corporate and Other Segment
Other specific segment 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
U.S. generally accepted accounting principles as it anticipates future
losses which are not yet probable and therefore not recognizable under
U.S. 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 Business. 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
21
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-
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
$12.2 trillion of assets under custody at September 30, 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 $1.8 trillion in total
assets. The Company services more than 16% of the total industry assets for
U.S. exchange-traded funds and at 122 separate portfolios, 38% of the total
number of funds in the market. The Company is also 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 $1.8
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 $1.3 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 620 million shares
each day and clearing more than one million trades daily.
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.
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 joined forces with Eze Castle Software and GTCR Golder Rauner, LLC,
a private equity firm, to form a new company called BNY ConvergEx Group on
October 2, 2006. BNY ConvergEx Group brings together BNY Securities Group's
trade execution, commission management businesses, independent research and
transition management business with Eze Castle Software, a leading provider of
trade order management and related investment technologies. See "Other
Developments."
22
As a result of the BNY ConvergEx transaction, beginning in the fourth
quarter of 2006, the Company's Execution and Clearing Services business will
consist of its Pershing clearing business, its 35% equity interest in BNY
ConvergEx Group and the Company's B-Trade and G-Trade businesses which are
expected to become part of the BNY ConvergEx Group in 2008.
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 1,255 American
and global depositary receipt programs, with a 64% market share, servicing
leading companies from 61 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 17 million shareowners.
Employee Investment Plan Services has more than 120 clients with 650,000
employees in over 54 countries.
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 100
different currencies. 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 the fourth largest funds transfer bank in
the U.S. transferring over $1.1 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 those 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 82
transactions totaling in excess of $51 billion during the first nine months of
2006.
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.
23
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.
* 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.
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 two 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.
In addition, this segment includes the difference between amounts
previously reported in the Company's Retail and Middle Market Banking Segment
and the discontinued operations of the Company's retail and regional middle
market banking businesses.
24
Segment Analysis
Institutional Services Segment
------------------------------
Inc/(Dec)
----------------- Year-to-date
3Q06 vs. 3Q06 vs. ---------------- Inc/
(In millions) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------- ------- ------- -------- -------- ------- ------- -------
Net Interest Income $ 329 $ 337 $ 307 $ (8) $ 22 $ 981 $ 879 $ 102
Noninterest Income 1,095 1,196 1,056 (101) 39 3,414 3,102 312
Total Revenue 1,424 1,533 1,363 (109) 61 4,395 3,981 414
Provision for
Credit Losses 16 16 13 - 3 48 45 3
Noninterest Expense 915 947 873 (32) 42 2,768 2,563 205
Income Before Taxes 493 570 477 (77) 16 1,579 1,373 206
Average Assets 82,011 82,666 75,109 (655) 6,902 81,248 74,148 7,100
Average Deposits 52,513 51,680 45,087 833 7,426 51,279 44,228 7,051
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 3%
to $493 million for the third quarter of 2006 from $477 million in the third
quarter of 2005, and down 14% from $570 million in the second quarter of 2006.
For the first nine months of 2006, income before taxes was up 15% to $1,579
million compared with 2005.
As of September 30, 2006, assets under custody rose to $12.2 trillion,
from $10.3 trillion at September 30, 2005 and $12.0 trillion at June 30, 2006.
The increase in assets under custody relative to September 30, 2005 primarily
reflects rising asset prices and new business wins. Equity securities
comprised 31% of the assets under custody at September 30, 2006, compared with
32% at June 30, 2006, while fixed income securities were 69% compared with 68%
at June 30, 2006. Assets under custody at September 30, 2006 consisted of
assets related to the custody and mutual funds businesses of $7.6 trillion,
broker-dealer services assets of $2.5 trillion, and all other assets of $2.1
trillion.
The third quarter of 2006 was impacted by a pronounced seasonal decline
that impacted results in market-related businesses such as foreign exchange and
execution services. Non-program equity trading volumes were down 11%
sequentially and up only 2% year-over-year. Foreign exchange volatility was at
an eight-year low. In addition, average daily U.S. fixed income trading volume
was down 3% sequentially and 1% year-over-year. Total debt issuance declined
15% sequentially and 8% year-over-year. One of the positives in the quarter was
asset prices, which were strong sequentially, with the S&P 500 (registered
trademark) Index up 5% and the MSCI (registered trademark) EAFE Index up 3%.
In the first nine months of 2006, depositary receipts trading exceeded
$1.1 trillion, up over 50% from the comparable period in 2005. The sale of
global collateralized debt obligations is up 20% year-to-date versus 2005.
Despite these mixed conditions, the Company had a solid quarter because of
the diversity of its business mix. Strong growth in the depositary receipt
and collateral management businesses were offset by weaker results in the
Company's execution and clearing businesses.
25
Market Data
-----------
Percent Inc/(Dec)
----------------- Year-to-date Percent
3Q06 vs. 3Q06 vs. ---------------- Inc/
3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
----- ---- ---- ----------------- ---------------- ------
S&P 500 (registered
trademark) Index (1) 1,336 1,270 1,229 5% 9% 1,336 1,229 9%
NASDAQ (registered
trademark) Composite
Index (1) 2,258 2,172 2,152 4 5 2,258 2,152 5
Lehman Brothers
Aggregate Bond
(service mark)
Index (1) 220.0 213.2 210.0 3 5 220.0 210.0 5
MSCI (registered
trademark) EAFE
Index (1) 1,885.3 1,822.9 1,618.8 3 16 1,885.3 1,618.8 16
NYSE Volume
(In billions) 108.8 121.6 100.8 (11) 8 344.1 304.8 13
NASDAQ (registered
trademark) Volume
(In billions) 114.6 134.2 104.9 (15) 9 379.6 338.6 12
(1) Period End
The results for the businesses in the Institutional Services Segment are
discussed below.
Investor & Broker-Dealer Services Business
------------------------------------------
Inc/(Dec)
----------------- Year-to-date
3Q06 vs. 3Q06 vs. ---------------- Inc/
(In millions) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------- ------- ------- -------- -------- ------- ------- -------
Net Interest Income $ 150 $ 155 $ 144 $ (5) $ 6 $ 454 $ 421 $ 33
Noninterest Income 480 524 455 (44) 25 1,494 1,357 137
Total Revenue 630 679 599 (49) 31 1,948 1,778 170
Provision for
Credit Losses 2 3 1 (1) 1 8 5 3
Noninterest Expense 436 458 408 (22) 28 1,332 1,212 120
Income Before Taxes 192 218 190 (26) 2 608 561 47
Average Assets 39,729 39,839 36,282 (110) 3,447 39,250 35,969 3,281
Average Deposits 33,343 32,906 27,675 437 5,668 32,705 27,569 5,136
Nonperforming Assets 7 3 10 4 (3) 7 10 (3)
Net Charge-offs - - - - - 1 1 -
In the third quarter of 2006, income before taxes in the Investor & Broker-
Dealer Services business was $192 million essentially flat with the $190
million in the third quarter of 2005 and down from $218 million in the second
quarter of 2006. The decline on a sequential-quarter basis reflects seasonally
weaker transaction volumes in custody activities. For the first nine months of
2006, income before taxes was $608 million compared with $561 million in 2005.
The year-to-date increase reflects improvements in both net interest income and
noninterest income.
Noninterest income was $480 million in the third quarter of 2006, compared
with $455 million in the third quarter of 2005 and $524 million in the second
quarter of 2006. The year-over-year increase in noninterest income in the
third quarter of 2006 compared to 2005 is attributable to an increase in
broker-dealer service fees as well as foreign exchange and other trading
revenue generated by clients in this segment. On a year-to-date basis,
noninterest income increased to $1,494 million from $1,357 million, reflecting
the same factors impacting the quarterly results.
Investor services fees increased from the year-ago quarter reflecting
improved performance in global custody activities, consistent with higher
volumes of cross-border transactions, as well as continued strong performance
in securities lending. The decline in fees from the second quarter is
consistent with seasonally lower securities lending revenue and lower
transaction volumes in global custody and fund services. On a year-to-date
26
basis, investor services fees increased compared with 2005, reflecting the
same factors driving the year-over-year quarterly increase.
Broker-dealer services fees improved versus the year-ago period as a
result of continued strong performance in domestic and global collateral
management fees, an increase in transaction volumes and good net new business
flows. Broker-dealer services fees were down modestly from the second quarter
of 2006 consistent with the seasonal slowdown in fixed income trading. The
Company now handles approximately $1.3 trillion of financing for the Company's
broker-dealer clients daily through collateralized financing agreements, up
approximately 15% from a year ago.
Net interest income in the Investor & Broker-Dealer Services business was
$150 million in the third quarter of 2006, compared with $144 million in the
third quarter of 2005 and $155 million in the second quarter of 2006. On a
year-over-year basis, net interest income growth in the third quarter reflects
increased deposit flows from customers in both businesses and higher rates.
The sequential-quarter decline reflects lower interest-free balances. Average
deposits generated by the Investor & Broker-Dealer Services business were $33.3
billion in the third quarter of 2006, compared with $27.7 billion in the third
quarter of 2005 and $32.9 billion in the second quarter of 2006. Average assets
in the business were $39.7 billion in the third quarter of 2006, compared with
$36.3 billion in the third quarter of 2005 and $39.8 billion in the second
quarter of 2006. For the first nine months of 2006, average deposits were
$32.7 billion compared with $27.6 billion in 2005. On the same basis, average
assets in the business were $39.3 billion in 2006 compared with $36.0 billion
in 2005.
Noninterest expense was $436 million in the third quarter of 2006,
compared with $408 million in the third quarter of 2005 and $458 million in the
second quarter of 2006. The year-over-year increase in noninterest expense was
due to higher compensation costs as well as increases in pension, technology
and occupancy costs partially offset by lower claims from customers. The
sequential decline in noninterest expense in the third quarter was attributable
primarily to lower volume driven expenses. For the first nine months of 2006,
noninterest expense increased to $1,332 million compared with $1,212 million in
2005, reflecting activity-based costs associated with revenue growth and higher
technology and pension costs.
Net charge-offs were zero in the third quarter of 2006, third quarter of
2005 and second quarter of 2006. On a year-to-date basis, net charge-offs were
$1 million in both 2006 and 2005. Nonperforming assets were $7 million at
September 30, 2006, compared with $10 million at September 30, 2005 and $3
million at June 30, 2006.
Execution & Clearing Services Business
--------------------------------------
Inc/(Dec)
----------------- Year-to-date
3Q06 vs. 3Q06 vs. ---------------- Inc/
(In millions) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------- ------- ------- -------- -------- ------- ------- -------
Net Interest Income $ 69 $ 66 $ 55 $ 3 $ 14 $ 196 $ 152 $ 44
Noninterest Income 336 359 339 (23) (3) 1,085 975 110
Total Revenue 405 425 394 (20) 11 1,281 1,127 154
Provision for
Credit Losses 1 - - 1 1 1 - 1
Noninterest Expense 298 302 301 (4) (3) 897 858 39
Income Before Taxes 106 123 93 (17) 13 383 269 114
Average Assets 14,884 15,092 14,355 (208) 529 14,985 14,274 711
Average Deposits 264 205 222 59 42 216 191 25
Average Payables to
Customers and
Broker-Dealers 4,657 5,034 5,714 (377) (1,057) 4,972 6,025 (1,053)
Nonperforming Assets 1 - 1 1 - 1 1 -
Net Charge-offs/
(Recoveries) - (4) 2 4 (2) (6) 5 (11)
27
In the third quarter of 2006, income before taxes in the Execution &
Clearing Services Business increased to $106 million from $93 million a year
ago and decreased from $123 million in the second quarter of 2006. On a year-
to-date basis, income before taxes increased to $383 million from $269 million
in 2005. The increase in execution and clearing fees on a year-to-date basis
reflects growth in value-added fees at Pershing, an acquisition and increased
cross-border trading activity in execution services. The year-to-date period
also reflects the $35 million gain related to the conversion of the Company's
New York Stock Exchange seats into cash and shares of NYSE Group, Inc. common
stock.
Noninterest income was $336 million in the third quarter of 2006, compared
with $339 million in the third quarter of 2005 and $359 million in the second
quarter of 2006. For the first nine months of 2006, noninterest income
increased to $1,085 million from $975 million in 2005.
Execution and clearing fees decreased from the third quarter of 2005 and
second quarter of 2006. The decline in third quarter's execution and clearing
fees from the year-ago quarter reflects the previously disclosed loss of a
significant customer at Pershing, as well as a shift from traditional broker-
assisted execution to lower-commission electronic and program trading in
execution services. The sequential-quarter decline in execution and clearing
services reflects a seasonal reduction in trading volumes, as well as lower
transition management activity.
Net interest income in the Execution & Clearing Services business was $69
million in the third quarter of 2006, compared with $55 million in the third
quarter of 2005 and $66 million in the second quarter of 2006. On a year-to-
date basis, net interest income was $196 million, up from $152 million in 2005.
The increase in net interest income reflects the benefit of rising interest
rates on spreads at Pershing, partially offset by the loss of margin debits
associated with a significant customer.
Average assets in the business were $14.9 billion in the third quarter of
2006, compared with $14.4 billion in the third quarter of 2005 and $15.1
billion in the second quarter of 2006. For the first nine months of 2006,
average assets were $15.0 billion compared with $14.3 billion in 2005. Average
payables to customers and broker-dealers were $4.7 billion in the third quarter
of 2006, compared with $5.7 billion in the third quarter of 2005 and $5.0
billion in the second quarter of 2006. For the first nine months of 2006,
average payables to customers and broker-dealers were $5.0 billion compared
with $6.0 billion in 2005. The decrease in third quarter balances from last
year reflects the previously disclosed loss of a significant customer.
Noninterest expense was $298 million in the third quarter of 2006,
compared with $301 million in the third quarter of 2005 and $302 million in the
second quarter of 2006. The decrease in noninterest expense on a year-over-
year basis was due to lower clearing fees and claims by customers offset by
higher technology expenses. The decrease in noninterest expense sequentially
was attributable to lower clearing fees and incentive compensation partially
offset by higher severance. For the first nine months of 2006, noninterest
expense was $897 million compared with $858 million in 2005. The increase
reflects higher clearing fees, incentive compensation and an acquisition.
Net charge-offs were zero in the third quarter of 2006, $2 million in the
third quarter of 2005 and a recovery of $4 million in the second quarter of
2006, respectively. On a year-to-date basis, net charge-offs were a recovery of
$6 million compared with charge-offs of $5 million in 2005. Nonperforming
assets were $1 million at September 30, 2006, compared with $1 million at
September 30, 2005 and zero at June 30, 2006.
28
Issuer Services Business
------------------------
Inc/(Dec)
----------------- Year-to-date
3Q06 vs. 3Q06 vs. ---------------- Inc/
(In millions) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------- ------- ------- -------- -------- ------- ------- -------
Net Interest Income $ 68 $ 74 $ 63 $ (6) $ 5 $ 209 $ 173 $ 36
Noninterest Income 221 240 197 (19) 24 641 558 83
Total Revenue 289 314 260 (25) 29 850 731 119
Provision for
Credit Losses 4 4 3 - 1 12 9 3
Noninterest Expense 134 135 115 (1) 19 391 341 50
Income Before Taxes 151 175 142 (24) 9 447 381 66
Average Assets 15,409 15,549 13,800 (140) 1,609 15,185 13,465 1,720
Average Deposits 9,625 9,584 8,681 41 944 9,222 8,311 911
Nonperforming Assets 7 3 10 4 (3) 7 10 (3)
Net Charge-offs - - 1 - (1) - 1 (1)
In the third quarter of 2006, income before taxes in the Issuer Services
Business increased to $151 million from $142 million in the third quarter of
2005 and declined from $175 million in the second quarter of 2006. For the
first nine months of 2006, income before taxes increased to $447 million from
$381 million in 2005. The year-over-year increases in 2006 reflect growth in
net interest income and higher depositary receipt and corporate trust fees.
The sequential-quarter decline reflects seasonally lower depositary receipt
fees.
Noninterest income was $221 million in the third quarter of 2006, compared
with $197 million in the third quarter of 2005 and $240 million in the second
quarter of 2006. For the first nine months of 2006, noninterest income was
$641 million compared with $558 million in 2005. Issuer services fees
increased substantially versus the year-ago periods but were down on a
sequential-quarter basis. The depositary receipt business benefited from both
a higher level of net issuance, reflecting the continued growth in cross-border
investing activity, as well as increased corporate actions related to mergers,
acquisitions and spin-offs. Growth in corporate trust revenues over the year-
ago quarter was primarily attributable to continued strong results in global
trust products and structured finance, notably asset-backed and mortgage-backed
securities. On a sequential-quarter basis, corporate trust fees were flat
while there was a seasonal decline in depositary receipt fees.
Net interest income in the Issuer Services business was $68 million in the
third quarter of 2006, compared with $63 million in the third quarter of 2005
and $74 million in the second quarter of 2006. For the first nine months of
2006, net interest income was $209 million compared with $173 million in 2005.
The increases in net interest income year-over-year were driven primarily by
the increases in interest rates and higher average assets. On a sequential-
quarter basis interest-free balances declined.
Average deposits generated by the Issuer Services business were $9.6
billion in the third quarter of 2006, compared with $8.7 billion in the third
quarter of 2005 and $9.6 billion in the second quarter of 2006 reflecting
increased liquidity from the Company's issuer services customers compared with
2005. On a year-to-date basis, average deposits were $9.2 billion compared with
$8.3 billion in 2005. Average assets in the business were $15.4 billion in the
third quarter of 2006, compared with $13.8 billion in the third quarter of 2005
and $15.5 billion in the second quarter of 2006. On a year-to-date basis,
average assets were $15.2 billion compared with $13.5 billion in 2005.
Noninterest expense was $134 million in the third quarter of 2006,
compared with $115 million in the third quarter of 2005 and $135 million in the
second quarter of 2006. For the first nine months of 2006, noninterest expense
was $391 million compared with $341 million in 2005. The rise in noninterest
expense year-over-year was attributable to higher salaries and benefits and
sub-custodian expense reflecting increased activity.
29
Net charge-offs were zero in the third quarter of 2006, down from $1
million third quarter of 2005 and unchanged from the second quarter of 2006.
For the first nine months of 2006, net charge-offs were zero compared with $1
million in 2005. Nonperforming assets were $7 million at September 30, 2006,
compared with $10 million at September 30, 2005 and $3 million at June 30,
2006.
Treasury Services Business
--------------------------
Inc/(Dec)
----------------- Year-to-date
3Q06 vs. 3Q06 vs. ---------------- Inc/
(In millions) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------- ------- ------- -------- -------- ------- ------- -------
Net Interest Income $ 42 $ 42 $ 45 $ - $ (3) $ 122 $ 133 $ (11)
Noninterest Income 58 73 65 (15) (7) 194 212 (18)
Total Revenue 100 115 110 (15) (10) 316 345 (29)
Provision for
Credit Losses 9 9 9 - - 27 31 (4)
Noninterest Expense 47 52 49 (5) (2) 148 152 (4)
Income Before Taxes 44 54 52 (10) (8) 141 162 (21)
Average Assets 11,989 12,186 10,672 (197) 1,317 11,828 10,440 1,388
Average Deposits 9,281 8,984 8,509 297 772 9,136 8,157 979
Nonperforming Assets 23 11 32 12 (9) 23 32 (9)
Net Charge-offs/
(Recoveries) - (2) 1 2 (1) (1) 3 (4)
In the third quarter of 2006, income before taxes in the Treasury Services
Business was $44 million, compared with $52 million in the third quarter of
2005 and $54 million in the second quarter of 2006. On a year-to-date basis,
income before taxes was $141 million compared with $162 million in 2005. The
decrease reflects declines in both net interest income and noninterest income.
The decrease in noninterest income to $58 million in the current period
from $65 million in the third quarter of 2005 was due to lower global payments
fees as more clients used compensating balances to pay for services. The
sequential-quarter decrease in noninterest income reflects lower foreign
exchange related revenue. For the first nine months of 2006, noninterest
income decreased to $194 million from $212 million in 2005 due to lower global
payments fees.
Net interest income was $42 million in the third quarter of 2006, compared
with $45 million in the third quarter of 2005 and $42 million in the second
quarter of 2006. On a year-over-year basis, the decrease reflects lower credit
spreads due to the higher asset quality of the portfolio partially offset by
customers using compensating balances to pay for global payment services in
lieu of fees. For the first nine months of 2006, net interest income was $122
million compared with $133 million in 2005. Average assets for the third
quarter of 2006 were $12.0 billion, compared with $10.7 billion in the third
quarter of 2005 and $12.2 billion in the second quarter of 2006. For the first
nine months of 2006, average assets were $11.8 billion compared with $10.4
billion in 2005. Average deposits were $9.3 billion in the third quarter of
2006, compared with $8.5 billion in the third quarter of 2005 and $9.0 billion
in the second quarter of 2006. For the first nine months of 2006, average
deposits were $9.1 billion compared with $8.2 billion in 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 third quarter of 2006, the third quarter of 2005 and the second quarter of
2006. For the first nine months of 2006, provision for credit losses was $27
million compared with $31 million in 2005. The year-to-date decrease reflects
improved credit quality.
Net charge-offs in the Treasury Services business were zero in the third
quarter of 2006, compared with a charge-off of $1 million in the third quarter
of 2005 and a recovery of $2 million in the second quarter of 2006. For the
30
first nine months of 2006, net charge-offs were a recovery of $1 million
compared with a charge-off of $3 million in 2005. Nonperforming assets were
$23 million at September 30, 2006, compared with $32 million at September 30,
2005, and $11 million at June 30, 2006.
Noninterest expense in the third quarter of 2006 was $47 million, compared
to $49 million in the third quarter of 2005 and $52 million in the second
quarter of 2006. For the first nine months of 2006, noninterest expense was
$148 million compared with $152 million in 2005. The decrease in noninterest
expense year-over-year was due in part to lower consulting expenses.
Private Bank & BNY Asset Management Segment
-------------------------------------------
Inc/(Dec)
----------------- Year-to-date
3Q06 vs. 3Q06 vs. ---------------- Inc/
(In millions) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------- ------- ------- -------- -------- ------- ------- -------
Net Interest Income $ 16 $ 16 $ 16 $ - $ - $ 49 $ 49 $ -
Noninterest Income 135 137 112 (2) 23 401 338 63
Total Revenue 151 153 128 (2) 23 450 387 63
Provision for
Credit Losses - - 1 - (1) - 3 (3)
Noninterest Expense 104 99 80 5 24 293 237 56
Income Before Taxes 47 54 47 (7) - 157 147 10
Average Assets 2,414 2,448 2,207 (34) 207 2,468 2,210 258
Average Deposits 2,079 2,205 1,864 (126) 215 2,020 1,833 187
Nonperforming Assets - - 1 - (1) - 1 (1)
Net Charge-offs/
(Recoveries) - (1) - 1 - (1) - (1)
In the third quarter of 2006, income before taxes in the Private Bank &
BNY Asset Management Segment was $47 million, compared with $47 million in the
third quarter of 2005 and $54 million in the second quarter of 2006. On a
year-to-date basis, income before taxes was $157 million compared to $147
million in 2005. The improvement year-over-year is attributable to the
acquisitions of Alcentra and Urdang as well as higher fee levels in private
banking.
Noninterest income was $135 million in the third quarter of 2006, compared
with $112 million in the third quarter of 2005 and $137 million in the second
quarter of 2006. Private bank and asset management revenues in the third
quarter of 2006 were up year-over-year. The year-over-year growth reflects the
acquisitions of Alcentra and Urdang as well as organic growth. On a
sequential-quarter basis, the decrease is attributable to a decline in
activity-based fees in the private bank and lower performance fees for certain
asset management activities. The S&P 500 (registered trademark) Index was up 5%
sequentially for the quarter, with average daily price levels essentially flat
compared with the second quarter of 2006. Performance for the NASDAQ
(registered trademark) Composite Index was up 4% for the third quarter of 2006,
with average daily prices down by 4% from the second quarter of 2006.
The S&P 500 (registered trademark) Index and the NASDAQ (registered trademark)
Composite Index were up 9% and 5% respectively over the third quarter of 2005.
Assets Under Management - Asset Management Sector
-------------------------------------------------
(In billions)- Estimated 3Q06 2Q06 3Q05
------ ------ ------
Equity Securities $ 36 $ 36 $ 37
Fixed Income Securities 20 21 22
Alternative Investments 30 28 15
Liquid Assets 34 31 32
---- ---- ----
Total Assets Under Management $120 $116 $106
==== ==== ====
31
Assets under management ("AUM") were $120 billion at September 30, 2006,
compared with $106 billion at September 30, 2005, and $116 billion at June 30,
2006. The year-over-year increases in AUM primarily reflect the acquisition of
Alcentra and Urdang. The sequential-quarter growth reflects growth in money
market and alternative investments. Institutional clients represent 74% of AUM
while individual clients equal 26%. At September 30, 2006, such assets were
invested 30% in equities, 17% in fixed income, and 25% in alternative
investments, with the remaining amount invested in liquid assets.
Net interest income in the Private Bank & BNY Asset Management Segment was
$16 million in the third quarter of 2006, essentially flat in comparison to the
third quarter of 2005 and the second quarter of 2006. For the first nine months
of 2006 and 2005, net interest income was $49 million. Average deposits
generated by the Private Bank & BNY Asset Management Segment were $2.1 billion
in third quarter of 2006, compared with $1.9 billion in the third quarter of
2005 and $2.2 billion in the second quarter of 2006. For the first nine months
of 2006, average deposits were $2.0 billion compared with $1.8 billion in
2005. Average assets in the segment were $2.4 billion in the third quarter
of 2006, compared with $2.2 billion in the third quarter of 2005 and $2.4
billion in the second quarter of 2006. For the first nine months of 2006,
average assets were $2.5 billion compared with $2.2 billion in the first
nine months of 2005.
Noninterest expense was $104 million in the third quarter of 2006,
compared with $80 million in the third quarter of 2005 and $99 million in the
second quarter of 2006. For the first nine months of 2006, noninterest expense
was $293 million compared with $237 million in 2005. Relative to a year ago,
the increase reflects the acquisitions of Alcentra and Urdang as well as higher
compensation, technology, and pension costs. The increase in noninterest
expense on a sequential basis was primarily attributable to higher compensation
costs.
Net charge-offs were zero in the third quarter of 2006 and the third
quarter of 2005 and a recovery of $1 million in the second quarter of 2006. On
a year-to-date basis, net charge-offs were a recovery of $1 million in 2006
compared with zero in 2005. Nonperforming assets were zero at September 30,
2006, compared with $1 million at September 30, 2005, and zero at June 30,
2006.
Corporate and Other Segment
---------------------------
Inc/(Dec)
----------------- Year-to-date
3Q06 vs. 3Q06 vs. ---------------- Inc/
(In millions) 3Q06 2Q06 3Q05 2Q06 3Q05 2006 2005 (Dec)
------- ------- ------- -------- -------- ------- ------- -------
Net Interest Income $ 6 $ 5 $ 23 $ 1 $ (17) $ 18 $ 68 $ (50)
Noninterest Income 29 33 17 (4) 12 71 55 16
Total Revenue 35 38 40 (3) (5) 89 123 (34)
Provision for
Credit Losses (20) (17) (4) (3) (16) (53) (58) 5
Noninterest Expense 173 88 78 85 95 330 223 107
Income Before Taxes (118) (33) (34) (85) (84) (188) (42) (146)
Average Assets 11,154 11,279 8,666 (125) 2,488 10,900 8,545 2,355
Nonperforming Assets - 15 5 (15) (5) - 5 (5)
Net Charge-offs/
(Recoveries) - - - - - (3) - (3)
In the third quarter of 2006, income before taxes in the Corporate and
Other Segment was a loss of $118 million, compared with a loss of $34 million
in the third quarter of 2005 and a loss of $33 million in the second quarter of
2006. The increase in the loss reflects merger and integration costs associated
with the Acquired Corporate Trust Business.
Net interest income in the Corporate and Other Segment was $6 million in
the third quarter of 2006, compared with $23 million in the third quarter of
2005 and $5 million in the second quarter of 2006. For the first nine months of
2006, net interest income was $18 million compared with $68 million in 2005.
The decreases in net interest income over the 2005 periods reflect the impact
32
of accounting for the retail and regional middle market banking businesses as
discontinued operations and lower leasing income.
Noninterest income was $29 million in the third quarter of 2006, compared
with $17 million in the third quarter of 2005 and $33 million in the second
quarter of 2006. The increase in noninterest income over last year's third
quarter reflects higher securities and asset-related gains. The decrease in
noninterest income in the third quarter of 2006 over the second quarter of 2006
is attributable to lower securities gains. For the first nine months of 2006,
noninterest income was $71 million compared with $55 million in 2005.
Securities gains were $21 million in the third quarter of 2006, compared with
$15 million in the third quarter of 2005 and $23 million in the second quarter
of 2006. Securities gains on a year-to-date basis were $61 million in 2006
compared with $50 million in 2005.
Provision for credit losses was a credit of $20 million in the third
quarter of 2006, compared with a $4 million credit in the third quarter of 2005
and a $17 million credit in the second quarter of 2006. For the first nine
months of 2006, provision for credit losses was a $53 million credit compared
with a credit of $58 million in 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 includes unallocated corporate overhead, amortization
of goodwill, nonrecurring items including merger and integration costs, and
certain expenses previously allocated to the Retail and Middle Market Banking
Segment that are not included in the businesses sold to JPMorgan Chase.
Noninterest expense was $173 million in the third quarter of 2006, compared
with $78 million in the third quarter of 2005 and $88 million in the second
quarter of 2006. For the first nine months of 2006, noninterest expense was
$330 million compared with $223 million in 2005. The year-over-year growth
includes merger and integration costs and higher intangible amortization. The
sequential-quarter increase reflects merger and integration costs associated
with the Acquired Corporate Trust Business. The Company expects certain costs
previously allocated to the Retail and Middle Market Banking Segment now
included with Corporate and Other Segment will be reallocated to the
Institutional Services Segment as a result of the acquisition of the Acquired
Corporate Trust Business.
Net charge-offs were zero in the third quarter of 2006, the third quarter
of 2005 and the second quarter of 2006. On a year-to-date basis, net charge-
offs were a recovery of $3 million in 2006 compared with zero in 2005.
Nonperforming assets were zero at September 30, 2006, compared with $5 million
at September 30, 2005, and $15 million at June 30, 2006. The decrease in
nonperforming assets at September 30, 2006 from June 30, 2006, primarily
reflects the sale of an aircraft.
33
Significant other items related to the Corporate and Other Segment are
presented in the following table.
Year-to-date
------------------
(In millions) 3Q06 2Q06 3Q05 2006 2005
------------------------------- ---------- ---------- ---------- -------------------
Items impacting net interest income:
------------------------------------
Cost to Carry Goodwill
and Intangibles $ (26) $ (26) $ (25) $ (76) $ (75)
Tax Equivalent Basis (7) (7) (7) (21) (22)
Items impacting noninterest expense:
------------------------------------
Goodwill and
Intangibles Amortization $ 14 $ 15 $ 10 $ 42 $ 28
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 was allocated to
the other two 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
third quarter of 2006, these included merger and integration costs of $89
million associated with the Acquired Corporate Trust Business. In the second
quarter of 2006, these included a charge of $12 million associated with the
implementation of SFAS 123(R) related to the retirement provisions of equity
compensation programs.
34
The consolidating schedule below shows the contribution of the Company's
businesses to its overall profitability.
(Dollars in millions) Execution Private
Investor & & Sub-total Bank & Corporate Total
For the Quarter Ended Broker-Dealer Clearing Issuer Treasury Institutional BNY Asset and Continuing
September 30, 2006 Services Services Services Services Services Management Other Operations
------------------- -------- -------- --------- --------- ------------- ---------- -------- ----------
Net Interest Income $ 150 $ 69 $ 68 $ 42 $ 329 $ 16 $ 6 $ 351
Noninterest Income 480 336 221 58 1,095 135 29 1,259
Total Revenue 630 405 289 100 1,424 151 35 1,610
Provision for
Credit Losses 2 1 4 9 16 - (20) (4)
Noninterest Expense 436 298 134 47 915 104 173 1,192
-------- -------- -------- -------- ------- --------- ------ -------
Income Before Taxes $ 192 $ 106 $ 151 $ 44 $ 493 $ 47 $ (118) $ 422
======== ======== ======== ======== ======= ========= ====== =======
Contribution
Percentage (1) 36% 19% 28% 8% 91% 9%
Average Assets $ 39,729 $ 14,884 $ 15,409 $ 11,989 $82,011 $ 2,414 $11,154 $95,579
(Dollars in millions) Execution Private
Investor & & Sub-total Bank & Corporate Total
For the Quarter Ended Broker-Dealer Clearing Issuer Treasury Institutional BNY Asset and Continuing
June 30, 2006 Services Services Services Services Services Management Other Operations
------------------- -------- -------- --------- --------- ------------- ---------- -------- ----------
Net Interest Income $ 155 $ 66 $ 74 $ 42 $ 337 $ 16 $ 5 $ 358
Noninterest Income 524 359 240 73 1,196 137 33 1,366
Total Revenue 679 425 314 115 1,533 153 38 1,724
Provision for
Credit Losses 3 - 4 9 16 - (17) (1)
Noninterest Expense 458 302 135 52 947 99 88 1,134
-------- -------- -------- -------- ------- --------- ------- -------
Income Before Taxes $ 218 $ 123 $ 175 $ 54 $ 570 $ 54 $ (33) $ 591
======== ======== ======== ======== ======= ========= ====== =======
Contribution
Percentage (1) 35% 20% 28% 8% 91% 9%
Average Assets $ 39,839 $ 15,092 $ 15,549 $ 12,186 $82,666 $ 2,448 $11,279 $ 96,393
(Dollars in millions) Execution Private
Investor & & Sub-total Bank & Corporate Total
For the Quarter Ended Broker-Dealer Clearing Issuer Treasury Institutional BNY Asset and Continuing
September 30, 2005 Services Services Services Services Services Management Other Operations
------------------- -------- -------- --------- --------- ------------- ---------- -------- ----------
Net Interest Income $ 144 $ 55 $ 63 $ 45 $ 307 $ 16 $ 23 $ 346
Noninterest Income 455 339 197 65 1,056 112 17 1,185
Total Revenue 599 394 260 110 1,363 128 40 1,531
Provision for
Credit Losses 1 - 3 9 13 1 (4) 10
Noninterest Expense 408 301 115 49 873 80 78 1,031
-------- -------- -------- -------- ------- --------- ------- -------
Income Before Taxes $ 190 $ 93 $ 142 $ 52 $ 477 $ 47 $ (34) $ 490
======== ======== ======== ======== ======= ========= ======= =======
Contribution
Percentage (1) 36% 18% 27% 10% 91% 9%
Average Assets $ 36,282 $ 14,355 $ 13,800 $ 10,672 $75,109 $ 2,207 $8,666 $85,982
(1) As a percent of total income before tax excluding Corporate and Other.
35
(Dollars in millions) Execution Private
For the Investor & & Sub-total Bank & Corporate Total
Nine Months Ended Broker-Dealer Clearing Issuer Treasury Institutional BNY Asset and Continuing
September 30, 2006 Services Services Services Services Services Management Other Operations
------------------- -------- -------- --------- --------- ------------- ---------- -------- ----------
Net Interest Income $ 454 $ 196 $ 209 $ 122 $ 981 $ 49 $ 18 $ 1,048
Noninterest Income 1,494 1,085 641 194 3,414 401 71 3,886
Total Revenue 1,948 1,281 850 316 4,395 450 89 4,934
Provision for
Credit Losses 8 1 12 27 48 - (53) (5)
Noninterest Expense 1,332 897 391 148 2,768 293 330 3,391
-------- -------- -------- -------- ------- --------- ------ -------
Income Before Taxes $ 608 $ 383 $ 447 $ 141 $ 1,579 $ 157 $ (188) $ 1,548
======== ======== ======== ======== ======= ========= ====== =======
Contribution
Percentage (1) 35% 22% 26% 8% 91% 9%
Average Assets $ 39,250 $ 14,985 $ 15,185 $ 11,828 $81,248 $ 2,468 $10,900 $94,616
(Dollars in millions) Execution Private
For the Investor & & Sub-total Bank & Corporate Total
Nine Months Ended Broker-Dealer Clearing Issuer Treasury Institutional BNY Asset and Continuing
September 30, 2005 Services Services Services Services Services Management Other Operations
------------------- -------- -------- --------- --------- ------------- ---------- -------- ----------
Net Interest Income $ 421 $ 152 $ 173 $ 133 $ 879 $ 49 $ 68 $ 996
Noninterest Income 1,357 975 558 212 3,102 338 55 3,495
Total Revenue 1,778 1,127 731 345 3,981 387 123 4,491
Provision for
Credit Losses 5 - 9 31 45 3 (58) (10)
Noninterest Expense 1,212 858 341 152 2,563 237 223 3,023
-------- -------- -------- -------- ------- --------- ------- -------
Income Before Taxes $ 561 $ 269 $ 381 $ 162 $ 1,373 $ 147 $ (42) $ 1,478
======== ======== ======== ======== ======= ========= ====== =======
Contribution
Percentage (1) 37% 18% 25% 10% 90% 10%
Average Assets $ 35,969 $ 14,274 $ 13,465 $ 10,440 $74,148 $ 2,210 $ 8,545 $84,903
(1) As a percent of total income before tax excluding Corporate and Other.
36
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 ratings are generally
consistent with external ratings agencies' default databases. Loss
given default ratings are driven by the collateral, structure, and
seniority of each individual asset and are consistent with external loss
given default/recovery databases. The portion of the allowance related to
impaired credits is based on the present value of future cash flows. Changes
in the estimates of probability of default, risk ratings, loss given
default/recovery rates, and cash flows could have a direct impact on the
allocated allowance for loan losses.
To the extent actual results differ from forecasts or management's
judgment, the allowance for credit losses may be greater or less than future
charge-offs.
The Company considers it difficult to quantify the impact of changes in
forecast on its allowance for credit losses. Nevertheless, the Company
believes the following discussion may enable investors to better understand
the variables that drive the allowance for credit losses.
A key variable in determining the allowance is management's judgment in
determining the size of the unallocated allowance. At September 30, 2006, the
unallocated allowance was 22% of the total allowance. If the unallocated
allowance were five percent higher or lower, the allowance would have increased
or decreased by $24 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 $75 million, while if each credit were rated
one grade worse, the allowance would have increased by $143 million.
Similarly, if the loss given default were one rating worse, the allowance
would have increased by $45 million, while if the loss given default were one
rating better, the allowance would have decreased by $42 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.
37
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 September
30, 2006, approximately $1.8 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 $45
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 Combinations". Goodwill ($3,801 million at September 30, 2006) and
indefinite-lived intangible assets ($378 million at September 30, 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, indefinite-lived
intangibles, 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 intangible assets
($494 million at September 30, 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.
38
Fair value may be determined using: market prices, comparison to similar
assets, market multiples, discounted cash flow analysis and other
determinates. Estimated cash flows may extend far into the future and, by
their nature, are difficult to determine over an extended timeframe. Factors
that may significantly affect the estimates include, among others, competitive
forces, customer behaviors and attrition, changes in revenue growth trends,
cost structures and technology, and changes in discount rates and specific
industry or market sector conditions. Other key judgments in accounting for
intangibles include useful life and classification between goodwill and
indefinite-lived intangibles or other intangibles that require amortization.
See Note "Goodwill and Intangibles" in the Notes to Consolidated Financial
Statements for additional information regarding intangible assets.
To assist in assessing the impact of a goodwill, indefinite-lived
intangibles, or other intangible asset impairment charge, at September 30,
2006, the Company has $4.7 billion of goodwill, indefinite-lived intangibles,
and other intangible assets. The impact of a 5% impairment charge would
result in reduction in pre-tax income of approximately $234 million.
Pension Accounting
------------------
The Company has defined benefit plans covering approximately 13,900 U.S.
employees and approximately 3,175 non-U.S. 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:
(Dollars in millions, 2006 2005 2004 2003
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)(2) $ (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.
(2) Includes discontinued operations expense. Pension benefits expense
is estimated to include discontinued operations expense of $6 million for
both 2006 and 2005.
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
39
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 pension plans are based on high quality corporate bonds rates in
countries that have an active corporate bond market. In those countries with
no active corporate bond market, discount rates are based on local government
bond rates plus a credit spread.
The Company's expected long-term rate of return on plan assets is based on
anticipated returns for each asset class. For 2006 and 2005, 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 have resulted
in a further increase in 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 was up $16
million in the first nine months of 2006 and is expected to increase by
approximately $21 million for the year 2006.
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
40
CONSOLIDATED BALANCE SHEET REVIEW
Total assets were $106.6 billion at September 30, 2006, compared with
$101.8 billion at September 30, 2005 and $108.9 billion at June 30, 2006. The
increase in assets from September 30, 2005 reflects increases in foreign
deposits, which were invested in interest-bearing deposits in banks. Total
shareholders' equity was $10.5 billion at September 30, 2006, compared with
$9.6 billion at September 30, 2005 and $10.1 billion at June 30, 2006.
Return on average common equity for the third quarter of 2006 was 13.70%,
(16.56% excluding merger and integration costs) compared with 16.15% in the
third quarter of 2005 and 18.17% in the second quarter of 2006.
Return on average assets for the third quarter of 2006 was 1.29%, (1.55%
excluding merger and integration costs) compared with 1.53% in the third
quarter of 2005 and 1.63% in the second quarter of 2006.
Investment Securities
---------------------
The table below shows the distribution of the Company's securities
portfolio:
Investment Securities (at Fair Value)
(In millions) 9/30/06 12/31/05
---------- ----------
Fixed Income:
Mortgage-Backed Securities $ 17,665 $ 22,484
Asset-Backed Securities 381 305
Corporate Debt 1,305 1,034
Short-Term Money Market Instruments 509 975
U.S. Treasury Securities 155 226
U.S. Government Agencies 594 620
State and Political Subdivisions 216 224
Emerging Market Debt (Collateralized
By U.S. Treasury Zero Coupon Obligations) 117 117
Other Foreign Debt 10 363
---------- ----------
Subtotal Fixed Income 20,952 26,348
Equity Securities:
Money Market Funds 1,101 922
Other 61 31
---------- ----------
Subtotal Equity Securities 1,162 953
---------- ----------
Adjusted Securities 22,114 27,301
Securities of Discontinued Operations (1) (120) (108)
---------- ----------
Securities from Continuing Operations $ 21,994 $ 27,193
========== ==========
(1) Securities of State and Political Subdivisions.
Total investment securities were $22.0 billion at September 30, 2006,
compared with $26.1 billion at September 30, 2005, and $27.3 billion at June
30, 2006. Average adjusted investment securities were $25.5 billion in the
third quarter of 2006, compared with $25.6 billion in the third quarter of last
year and $27.3 billion in the second quarter of 2006. The Company sold $5.5
billion of investment securities in the third quarter as part of a portfolio
restructuring related to the Acquired Corporate Trust Business at a pre-tax
loss of $79 million. The Company's portfolio of highly rated mortgage-backed
securities, are 86% rated AAA, 10% AA, and 4% A. In replacing securities that
mature or are paid off, the Company has been adding either adjustable or short
life classes of structured mortgage-backed securities, both of which have short
durations. The effective duration of the Company's mortgage portfolio at
September 30, 2006 was approximately 1.89 years.
41
Net unrealized losses for securities available-for-sale was $4 million at
September 30, 2006, compared with net unrealized losses of $59 million at
September 30, 2005, and net unrealized losses of $274 million at June 30,
2006. The change in the value of available-for-sale securities at September
30, 2006 from June 30, 2006 reflects the decrease in long-term interest rates
over the quarter. The asymmetrical accounting treatment of the impact of a
change in interest rates on the Company's balance sheet may create a situation
in which an increase in interest rates can adversely affect reported equity and
regulatory capital, even though economically there may be no impact on the
economic capital position of the Company. For example, an increase in rates
will result in a decline in the value of the fixed rate portion of the
Company's fixed income investment portfolio, which will be reflected through
a reduction in other comprehensive income in the Company's shareholders'
equity, thereby affecting the tangible common equity ("TCE") ratio. Under
current accounting rules, there is no corresponding change in value of the
Company's fixed rate liabilities, even though economically these liabilities
are more valuable as rates rise.
Loans
-----
(Dollars in billions)
Quarterly Year-to-date
Continuing Operations Period End Average Average
------------------------- ------------------------- -------------------------
Total Non-Margin Margin Total Non-Margin Margin Total Non-Margin Margin
----- ---------- ------ ----- ---------- ------ ----- ---------- ------
September 30, 2006 $33.9 $ 29.2 $ 4.7 $33.6 $ 28.4 $ 5.2 $33.0 $ 27.6 $ 5.4
December 31, 2005 32.9 26.8 6.1 33.0 26.5 6.5 32.0 25.6 6.4
September 30, 2005 34.4 28.1 6.3 32.2 25.8 6.4 31.8 25.4 6.4
Total loans were $33.9 billion at September 30, 2006, compared with $32.9
billion at December 31, 2005. The increase in total loans from December 31,
2005 primarily reflects increased lending to securities servicing customers
partially offset by a decrease in margin loans reflecting the loss of a
significant customer at Pershing. Average total loans were $33.6 billion in
the third quarter of 2006, compared with $32.2 billion in the third quarter
of 2005. The increase in average loans from September 30, 2005 results
from purchases of residential mortgage loans and increased lending to
financial institutions.
The following tables provide additional details on the Company's credit
exposures and outstandings for continuing operations at September 30, 2006 in
comparison to December 31, 2005.
Overall Loan Portfolio
----------------------
September 30, 2006 December 31, 2005
----------------------------------------------------------
Unfunded Total Unfunded Total
(In billions) Loans Commitments Exposure Loans Commitments Exposure
---------------------------- ----------------------------
Financial Institutions $ 13.6 $ 26.4 $ 40.0 $ 13.0 $ 22.4 $ 35.4
Corporate 4.7 19.6 24.3 3.7 19.6 23.3
-------- -------- -------- -------- -------- --------
18.3 46.0 64.3 16.7 42.0 58.7
-------- -------- -------- -------- -------- --------
Consumer & Middle Market 4.0 0.3 4.3 3.2 0.3 3.5
Leasing Financings 5.5 0.1 5.6 5.5 0.1 5.6
Commercial Real Estate 1.4 1.4 2.8 1.4 1.2 2.6
Margin loans 4.7 - 4.7 6.1 - 6.1
-------- -------- -------- -------- -------- --------
Total $ 33.9 $ 47.8 $ 81.7 $ 32.9 $ 43.6 $ 76.5
======== ======== ======== ======== ======== ========
42
Financial Institutions
----------------------
The financial institutions portfolio exposure was $40.0 billion at
September 30, 2006, compared to $35.4 billion at December 31, 2005. The
increase in exposure from year-end 2005 reflects greater activity in the
capital markets in the third 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 76% expiring within one year
and are frequently secured. For example, mortgage banking, securities
industry, and investment managers often borrow against marketable securities
held in custody at the Company. The diversity of the portfolio is shown in
the accompanying table.
(In billions)
September 30, 2006 December 31, 2005
--------------------------------------- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Banks $ 5.0 $ 5.1 $ 10.1 68% 86% $ 5.0 $ 3.8 $ 8.8
Securities Industry 3.7 5.6 9.3 84 97 3.4 3.6 7.0
Insurance 0.4 5.8 6.2 100 42 0.4 4.9 5.3
Government 0.1 6.0 6.1 99 61 0.1 4.7 4.8
Asset Managers 4.1 2.0 6.1 85 83 3.8 3.6 7.4
Mortgage Banks 0.2 0.7 0.9 73 50 0.2 0.7 0.9
Endowments 0.1 1.2 1.3 100 61 0.1 1.1 1.2
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $13.6 $ 26.4 $ 40.0 85% 76% $13.0 $ 22.4 $ 35.4
===== =========== ========= ===== ===== ===== =========== =========
Corporate
---------
The corporate portfolio exposure increased to $24.3 billion at September
30, 2006 from $23.3 billion at year-end 2005. Approximately 73% of the
portfolio is investment grade while 16% of the portfolio matures within one
year.
(In billions)
September 30, 2006 December 31, 2005
--------------------------------------- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Media $ 1.2 $ 1.9 $ 3.1 60% 8% $ 1.0 $ 2.1 $ 3.1
Cable 0.3 0.4 0.7 52 9 0.4 0.5 0.9
Telecom 0.1 0.4 0.5 85 1 0.1 0.4 0.5
----- ----------- --------- ----- ----- ----- ----------- ---------
Subtotal 1.6 2.7 4.3 61 7 1.5 3.0 4.5
Energy 0.6 5.2 5.8 82 12 0.4 4.9 5.3
Retailing 0.2 2.0 2.2 79 26 0.1 2.1 2.2
Automotive (1) 0.1 1.0 1.1 55 35 0.1 1.2 1.3
Healthcare 0.4 1.7 2.1 78 10 0.3 1.7 2.0
Other (2) 1.8 7.0 8.8 73 20 1.3 6.7 8.0
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $ 4.7 $ 19.6 $ 24.3 73% 16% $ 3.7 $ 19.6 $ 23.3
===== =========== ========= ===== ===== ===== =========== =========
(1) 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.
(2) 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 $176 million at
September 30, 2006 compared with December 31, 2005. At September 30, 2006,
this broadly defined industry portfolio consists of exposures of $182 million
to Big Three automotive manufacturing, $179 million to finance subsidiaries,
$378 million to highly rated asset-backed securitization vehicles, $245 million
to suppliers, and $141 million of other.
43
The Company's exposure to the airline industry consists of a $328 million
leasing portfolio (including a $17 million real estate lease exposure). The
airline-leasing portfolio consists of $128 million to major U.S. carriers, $138
million to foreign airlines and $62 million to U.S. regionals.
During the third 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) 9/30/06 6/30/06 3/31/06 12/31/05 9/30/05
--------------------- ---------------------------------------------------
AAA to AA- 77% 77% 77% 74% 71%
A+ to A- 10 10 8 13 13
BBB+ to BBB- 7 6 9 9 13
Noninvestment Grade 6 7 6 4 3
-------- --------- ---------- --------- ----------
Total 100% 100% 100% 100% 100%
======== ========= ========== ========= ==========
(1) Represents credit rating agency equivalent of internal credit ratings.
44
Nonperforming Assets
--------------------
Change Percent
9/30/2006 vs. Inc/
(Dollars in millions) 9/30/2006 6/30/2006 6/30/2006 (Dec)
--------- --------- ----------- --------
Loans:
Commercial $ 28 $ 10 $ 18 180%
Foreign 10 10 - -
--------- --------- -----------
Total Nonperforming Loans 38 20 18 90
Other Assets Owned - 12 (12)
--------- --------- -----------
Nonperforming Assets on a
Continuing Operations Basis 38 32 6 19
--------- --------- -----------
Nonperforming Assets Related to
Discontinued Operations 25 42 (17) (40)
--------- --------- -----------
Adjusted Total
Nonperforming Assets $ 63 $ 74 $ (11) (15)
========= ========= ===========
Continuing Operations
---------------------
Nonperforming Assets Ratio 0.1% 0.1%
Allowance for Loan
Losses/Nonperforming Loans 892 1,685
Allowance for Loan
Losses/Nonperforming Assets 892 1,053
Total Allowance for Credit
Losses/Nonperforming Loans 1,253 2,400
Total Allowance for Credit
Losses/Nonperforming Assets 1,253 1,500
Adjusted
--------
Nonperforming Assets Ratio 0.2% 0.2%
Allowance for Loan
Losses/Nonperforming Loans 651 673
Allowance for Loan
Losses/Nonperforming Assets 651 564
Total Allowance for Credit
Losses/Nonperforming Loans 878 915
Total Allowance for Credit
Losses/Nonperforming Assets 878 766
The sequential-quarter increase in continuing nonperforming assets
primarily reflects the addition of an automotive supplier partially offset by
the sale of an aircraft.
45
Activity in Nonperforming Assets
(In millions) Quarter End Year-to-date
Continuing Operations September 30, 2006 September 30, 2006
--------------------- ------------------ ------------------
Balance at Beginning of Period $ 32 $ 39
Additions 21 33
Charge-offs - -
Paydowns/Sales (12) (31)
Other (3) (3)
------------------ ------------------
Balance at End of Period $ 38 $ 38
================== ==================
On a continuing operations basis, interest income would have been
increased by $0.3 million and $0.2 million for the third quarters of 2006 and
2005 if loans on nonaccrual status at September 30, 2006 and 2005 had been
performing for the entire period. On a year-to-date basis, interest income
would have increased by $1.1 million and $1.4 million for 2006 and 2005 had
loans on nonaccrual status at September 30, 2006 and 2005 been performing
for the entire period.
Impaired Loans
--------------
The table below sets forth information about the Company's impaired loans.
The Company uses the discounted cash flow, collateral value, or market price
methods for valuing its impaired loans:
September 30, June 30, September 30,
(In millions) 2006 2006 2005
------------ ------------ -----------
Impaired Loans with an Allowance $ 11 $ 12 $ 18
Impaired Loans without an Allowance(1) 19 - 22
------------ ------------ -----------
Impaired Loans on a
Continuing Operations basis 30 12 40
Impaired Loans related to
Discontinued Operations 12 27 30
------------ ------------ -----------
Adjusted Total Impaired Loans $ 42 $ 39 $ 70
============ ============ ===========
Continuing Operations
---------------------
Allowance for Impaired Loans(2) $ 2 $ 3 $ 5
Average Balance of Impaired Loans
during the Quarter 20 15 86
Interest Income Recognized on
Impaired Loans during the Quarter 0.3 - 0.4
Adjusted
--------
Allowance for Impaired Loans(2) $ 5 $ 10 $ 20
Average Balance of Impaired Loans
during the Quarter 42 42 120
Interest Income Recognized on
Impaired Loans during the Quarter 0.5 0.5 1.2
(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.
46
Allowance
---------
September 30, June 30, September 30,
(Dollars in millions) 2006 2006 2005
------------ ------------ ------------
Margin Loans $ 4,719 $ 5,096 $ 6,320
Non-Margin Loans 29,239 30,554 28,038
------------ ------------ ------------
Loans on a Continuing
Operations Basis 33,958 35,650 34,358
Margin Loans - - -
Non-Margin Loans 7,768 7,972 7,785
------------ ------------ ------------
Loans Related to Discontinued
Operations 7,768 7,972 7,785
------------ ------------ ------------
Adjusted Total Loans $ 41,726 $ 43,622 $ 42,143
============ ============ ============
Continuing Operations
---------------------
Allowance for Loan Losses $ 339 $ 337 $ 471
Allowance for Lending-Related
Commitments 137 143 136
------------ ------------ ------------
Allowance for Credit Losses
on a Continuing Operations Basis 476 480 607
------------ ------------ ------------
Discontinued Operations
-----------------------
Allowance for Loan Losses 71 80 90
Allowance for Lending-Related
Commitments 6 7 9
------------ ------------ ------------
Allowance for Credit Losses Related
to Discontinued Operations 77 87 99
------------ ------------ ------------
Adjusted Total Allowance for
Credit Losses $ 553 $ 567 $ 706
============ ============ ============
Continuing Operations
---------------------
Allowance for Loan Losses
As a Percent of Total Loans 1.00% 0.95% 1.37%
Allowance for Loan Losses
As a Percent of Non-Margin Loans 1.16 1.10 1.68
Total Allowance for Credit Losses
As a Percent of Total Loans 1.40 1.35 1.77
Total Allowance for Credit Losses
As a Percent of Non-Margin Loans 1.63 1.57 2.16
Adjusted
--------
Allowance for Loan Losses
As a Percent of Total Loans 0.98% 0.96% 1.33%
Allowance for Loan Losses
As a Percent of Non-Margin Loans 1.11 1.08 1.57
Total Allowance for Credit Losses
As a Percent of Total Loans 1.33 1.30 1.68
Total Allowance for Credit Losses
As a Percent of Non-Margin Loans 1.49 1.47 1.97
47
On a continuing operations basis, the total allowance for credit losses
was $476 million, or 1.40% of total loans at September 30, 2006, compared with
$607 million, or 1.77% of total loans at September 30, 2005 and $480 million,
or 1.35% of total loans at June 30, 2006. The decline in the allowance from
the third quarter of 2005 reflects the charge-off of aircraft leases in the
fourth quarter of 2005.
The Company has $4.7 billion of secured margin loans on its balance sheet
at September 30, 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.
On a continuing operations basis, the ratio of the total allowance for
credit losses to non-margin loans was 1.63% at September 30, 2006, compared
with 2.16% at September 30, 2005 and 1.57% at June 30, 2006, reflecting
improvement in the credit quality since the third quarter of 2005. The ratio
of the allowance for loan losses to nonperforming assets was 892% at September
30, 2006, compared with 796% at September 30, 2005, and 1,053% at June 30,
2006.
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;
48
* 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 on a continuing operations basis
as follows:
September 30, December 31,
2006 2005
------------ -----------
Domestic
Real Estate 1% 1%
Commercial 69 72
Consumer 6 4
Foreign 2 3
Unallocated 22 20
------------ -----------
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
--------
On a continuing operations basis, total deposits were $55.0 billion at
September 30, 2006, compared with $49.8 billion at December 31, 2005, and
$56.7 billion at June 30, 2006. The increase from December 31, 2005 was
primarily due to increased market activity levels, compared with year-end 2005
which resulted in higher levels of customer deposits. The sequential-quarter
decline was primarily due to a lower volume of securities servicing
transactions in the third quarter compared to the second quarter of 2006.
Noninterest-bearing deposits were $11.5 billion at September 30, 2006,
compared with $12.7 billion at December 31, 2005. Interest-bearing deposits
were $43.5 billion at September 30, 2006, compared with $37.1 billion at
December 31, 2005.
49
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 from the
Company's securities servicing businesses and private banking and asset
management 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 continuing operations 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 $14.0 billion and $12.4 billion on
an average basis for the first nine months of 2006 and 2005. Average foreign
deposits, primarily from the Company's European based securities servicing
business, were $32.2 billion and $25.9 billion for the first nine months of
2006 and 2005. The increase in foreign deposits reflects greater liquidity
from the Company's corporate trust and custody businesses. Domestic savings
and other time deposits were $1.1 billion on an average basis for the first
nine months of 2006 compared to $1.0 billion in 2005. On a year-to-date
basis, average payables to customers and broker-dealers decreased to $5.0
billion from $6.0 billion in 2005. The decline in payables to customers
and broker-dealers reflects the loss of a significant customer at Pershing.
Long-term debt averaged $8.2 billion and $7.2 billion for the first nine months
of 2006 and 2005, respectively. The increase in long-term debt reflects the
movement of Pershing from a subsidiary of the Bank to a subsidiary of the
Parent and the building of liquidity to pay debt maturing in 2007. A
significant reduction in the Company's securities servicing businesses would
reduce its access to deposits.
The Company's transaction with JPMorgan Chase altered the composition of
the balance sheet. When the Acquired Corporate Trust Business is fully
integrated in 2007, approximately $14 billion of U.S. dollar retail deposits
will have been replaced with approximately $11 billion to $14 billion of
institutional corporate trust deposits. Approximately $7 billion to $10
billion of deposits related to the Acquired Corporate Trust Business have
not yet transitioned to the Company. These deposits will transition to the
Company as regulatory approval is received to operate in certain foreign
locations and as the novation process proceeds in other foreign locations.
The Company expects the transition will be substantially complete by June
30, 2007. Until the transition is complete, JPMorgan Chase will pay the
Company for the net economic value of these deposits. These payments will
be recorded in noninterest income. 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 $2.25 billion. As a
result of the transaction, the Company expects its balance sheet footings
to decline.
The Parent has four major sources of liquidity: dividends from its
subsidiaries, the commercial paper market, a revolving credit agreement with
third party financial institutions, and access to the capital markets.
At September 30, 2006, the Bank can pay dividends of approximately $718
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 $258 million. These assets could be liquidated and
the proceeds delivered by dividend or loan to the Parent.
For the quarter ended September 30, 2006, the Parent's quarterly average
commercial paper borrowings were $109 million compared with $231 million in
2005. At September 30, 2006, the Parent had cash of $693 million compared
with $409 million at September 30, 2005 and $515 million at June 30, 2006.
Net of commercial paper outstanding, the Parent's cash position at September
30, 2006 increased by $391 million compared with September 30, 2005.
50
The Parent has a back-up line of credit of $275 million with 14 financial
institutions. This line of credit matured in October 2006. There were no
borrowings under the line of credit during the third quarters of 2006 and
2005. On October 10, 2006, the Company entered into a new credit agreement
of $250 million with 11 financial institutions. This line of credit matures
in October 2011.
The Parent also has the ability to access the capital markets. On June 5,
2006, the Company filed a new S-3 automatic shelf registration statement with
the SEC covering its existing debt, preferred stock, trust preferred
securities, and common stock.
Access to the capital markets is partially dependent on the
Company's credit ratings, which as of September 30, 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,
interest on its borrowings, acquisitions, and additional investment in its
subsidiaries.
The Parent does not have any long-term debt that becomes due in 2006
subsequent to September 30, 2006. The Parent has $700 million of long-term debt
that is due in 2007. In addition, the Parent periodically has the option to
call $152 million of subordinated debt in the remainder of 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 September 30, 2006 and 2005 was 103% and 104%,
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
third 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 $4 million, in aggregate, during the third quarter of 2006.
51
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 $23 million, in aggregate,
during the third 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 $48 million, in aggregate, during the
third quarter of 2006.
The following comments relate to the information disclosed in the
Consolidated Statements of Cash Flows.
Cash provided by operating activities was $4.8 billion for the first nine
months of 2006, compared with $0.2 billion used by operating activities through
September 30, 2005. The source of funds in 2006 was principally due to the
changes in trading activities and net income. The use of funds from operations
in 2005 was principally the result of changes in trading activities.
In the first nine months of 2006, cash used for investing activities was
$6.8 billion as compared to cash used for investing activities in the first
nine months of 2005 of $7.0 billion. In the first nine months of 2006,
purchases of securities available-for-sale and change in interest-bearing
deposits 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 September 30, 2006, cash provided by financing activities was $1.1
billion, compared to $6.5 billion in the first nine months of 2005. Primary
sources of funds in 2006 and 2005 include deposits and proceeds from the
issuance of long-term debt. In 2006, these sources were partially offset
by declines in federal funds purchased and securities sold under repurchase
agreements and payables to customers and broker-dealers.
52
CAPITAL RESOURCES
Shareholders' equity was $10,467 million at September 30, 2006, compared
with $10,056 million at June 30, 2006, and $9,876 million at December 31,
2005. During the third quarter of 2006, the Company retained $184 million
of earnings. In October 2006, the Company declared a quarterly common stock
dividend of 22 cents per share. Accumulated other comprehensive income
increased $165 million from June 30, 2006, primarily reflecting lower
unrealized mark-to-market losses in the securities available-for-sale
portfolio.
In the third quarter of 2006, the Company issued $90 million of callable
medium-term subordinated notes bearing interest at rates from 5.75% to 6.35%.
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.
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, among other things, qualify as well
capitalized. In addition, major bank holding companies such as the Parent are
expected by the regulators to be well capitalized. As of September 30, 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:
September 30, 2006 September 30, 2005 Well Adequately
------------------ ------------------ Company Capitalized Capitalized
Company Bank Company Bank Targets Guidelines Guidelines
--------- ------- --------- ------- ---------- ----------- -----------
Tier 1 (1) 8.17% 8.85% 7.93% 8.37% 7.75% 6% 4%
Total Capital (2) 12.32 11.59 12.20 11.52 11.75 10 8
Leverage 6.56 7.15 6.59 7.01 5 3-5
TCE 5.58 6.77 5.32 6.29 5.00 N.A. N.A.
(1) 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.
(2) 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 Tier 1 capital and Total Capital ratios were 8.17% and
12.32% at September 30, 2006, compared with 7.93% and 12.20% at September 30,
2005, and 7.96% and 12.06% at June 30, 2006. The leverage ratio was 6.56% at
September 30, 2006, compared with 6.59% at September 30, 2005, and 6.22% at
June 30, 2006. The Company's TCE as a percentage of total assets was 5.58% at
September 30, 2006, compared with 5.32% at September 30, 2005, and 5.07% at
June 30, 2006. The Company's Acquired Corporate Trust Business and certain
accounting charges, in the fourth quarter of 2006 and the first quarter of
2007, will reduce the Company's TCE ratio to a range of 4.25-4.75%. The
Company expects its TCE ratio to return to its target level in the fourth
quarter of 2007. The TCE 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. For year-
end 2006 and quarter-ends in 2007, the size of the balance sheet will
depend on the novation of deposits and the receipt of approval to open new
subsidiaries related to the Acquired Corporate Trust Business.
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.
53
On October 3, 2006, pursuant to a 10b5-1 plan, the Company repurchased 10
million shares of its common stock at an initial price of $35.33 from a broker-
dealer counterparty who borrowed the shares, as part of an accelerated share
repurchase program. The repurchase was triggered by the announcement of the
closing of the BNY ConvergEx transaction. 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. Also on October 3, 2006, the Company repurchased an
additional 2.1 million shares pursuant to a commitment previously entered into.
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 September 30, 2006 and 2005:
September 30,
------------------
(In millions) 2006 2005
------- -------
Shareholders' Equity $10,467 $ 9,608
Securities Valuation Allowance (8) 23
Trust Preferred Securities 1,150 1,150
Adjustments: Intangibles (4,779) (4,421)
Merchant Banking Investments (20) (8)
------- -------
Tier 1 Capital 6,810 6,352
------- -------
Qualifying Subordinated Debt 2,902 2,709
Qualifying Allowance for Loan Losses 553 706
------- -------
Tier 2 Capital 3,455 3,415
------- -------
Total Risk-Based Capital $10,265 $ 9,767
======= =======
Risk-Adjusted Assets $83,316 $80,065
======= =======
54
TRADING ACTIVITIES
The fair value and notional amounts of the Company's financial instruments
held for trading purposes at September 30, 2006 and 2005 are as follows:
September 30, 2006 3Q06 Average
--------------------------- ------------------
(In millions) Notional Fair Value Fair Value
------------------ ------------------
Trading Account Amount Assets Liabilities Assets Liabilities
--------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 74,313 $ - $ - $ - $ -
Swaps 310,105 1,192 741 1,562 1,068
Written Options 207,219 - 856 - 929
Purchased Options 169,122 211 - 215 -
Foreign Exchange Contracts:
Swaps 2,531 - - - -
Written Options 9,266 - 52 - 127
Purchased Options 11,719 45 - 192 -
Commitments to Purchase
and Sell Foreign Exchange 91,790 15 37 126 196
Debt Securities - 1,618 188 2,487 209
Credit Derivatives 1,539 3 9 3 9
Equities 13,044 182 219 127 135
------ ----------- ------ -----------
Total Trading Account $3,266 $ 2,102 $4,712 $ 2,673
====== =========== ====== ===========
September 30, 2005 3Q05 Average
--------------------------- ------------------
(In millions) Notional Fair Value Fair Value
------------------ ------------------
Trading Account Amount Assets Liabilities Assets Liabilities
--------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 29,868 $ - $ - $ - $ 9
Swaps 252,347 1,690 1,059 1,577 870
Written Options 203,688 - 1,201 - 1,222
Purchased Options 158,130 211 - 160 -
Foreign Exchange Contracts:
Swaps 3,087 - - - -
Written Options 5,316 - - - 2
Purchased Options 7,096 28 - 44 -
Commitments to Purchase
and Sell Foreign Exchange 79,491 522 471 422 398
Debt Securities - 3,642 124 3,359 104
Credit Derivatives 1,807 1 5 1 7
Equities 2,999 198 140 159 115
------ ----------- ------ -----------
Total Trading Account $6,292 $ 3,000 $5,722 $ 2,727
====== =========== ====== ===========
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.
55
As VAR methodology does not evaluate risk attributable to extraordinary
financial, economic or other occurrences, the risk assessment process includes
a number of stress scenarios based upon the risk factors in the portfolio and
management's assessment of market conditions. Additional stress scenarios based
upon historic market events are also tested. Stress tests by their design
incorporate the impact of reduced liquidity and the breakdown of observed
correlations. The results of these stress tests are reviewed weekly with senior
management.
The following table indicates the calculated VAR amounts for the trading
portfolio for the periods indicated.
(Dollars in millions) 3rd Quarter 2006 Year-to-date 2006
--------------------------- --------------------------- -------
Average Minimum Maximum Average Minimum Maximum 9/30/06
------- ------- ------- ------- ------- ------- -------
Interest rate $ 2.7 $ 1.9 $ 3.7 $ 2.9 $ 1.9 $ 7.6 $ 2.5
Foreign Exchange 1.0 0.6 1.7 1.1 0.6 1.8 1.0
Equity 1.1 0.5 2.6 1.0 0.5 3.7 1.3
Credit Derivatives 0.9 0.7 2.2 1.0 0.6 2.2 0.7
Diversification (1.6) NM NM (1.6) NM NM (1.6)
Overall Portfolio 4.1 3.0 5.8 4.4 3.0 6.7 3.9
(Dollars in millions) 3rd Quarter 2005 Year-to-date 2005
--------------------------- --------------------------- -------
Average Minimum Maximum Average Minimum Maximum 9/30/05
------- ------- ------- ------- ------- ------- -------
Interest rate $ 2.7 $ 1.8 $ 4.4 $ 2.8 $ 1.8 $ 4.6 $ 3.7
Foreign Exchange 1.1 0.4 2.9 1.6 0.4 4.1 0.8
Equity 0.5 0.3 0.8 0.6 0.3 1.1 0.7
Credit Derivatives 1.2 0.9 1.8 1.6 0.9 2.1 1.0
Diversification (1.0) NM NM (1.3) NM NM (1.2)
Overall Portfolio 4.5 3.2 7.0 5.3 3.2 9.1 5.0
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 third quarter of 2006, interest rate risk generated
approximately 44% of average VAR, credit derivatives generated 21% of
average VAR, foreign exchange accounted for 16% of average VAR, and equity
generated 19% of average VAR. During the third quarter and first nine months
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(1)
--------------------------
For the Quarter Ended
--------------------------------------------------
Revenue Range 9/30/06 6/30/06 3/31/06 12/31/05 9/30/05
--------------------------------------------------
(Dollars in millions) Number of Occurrences
---------------------- --------- --------- --------- ---------- ---------
Less than $(2.5) 0 0 0 0 0
$(2.5)~ $ 0 3 2 4 3 3
$ 0 ~ $ 2.5 52 39 40 44 51
$ 2.5 ~ $ 5.0 8 21 18 14 8
More than $5.0 0 2 0 0 2
(1) Based on revenues before deducting share of joint venture partner,
Susquehanna Trading.
56
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 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
--------------------------------------
Pro forma Adjusted
September 30, 2006 June 30, 2006
$ % $ %
--------- -------- ---------- ------
+200 Basis Point Ramp vs. Stable Rate $ (4) (0.2)% $ (62) (3.0)%
+100 Basis Point Ramp vs. Stable Rate 7 0.4 (28) (1.3)
-100 Basis Point Ramp vs. Stable Rate (11) (0.6) 15 0.7
-200 Basis Point Ramp vs. Stable Rate (37) (2.0) 9 0.5
57
The pro forma data in the above table reflects the swap with JPMorgan
Chase as if the transaction was fully integrated into the Company on September
30, 2006. The Company's swap with JPMorgan Chase would have resulted in a more
liability-sensitive balance sheet because corporate trust liabilities reprice
more quickly than retail deposits. Among other actions, the Company
restructured its investment portfolio to readjust its interest rate
sensitivity.
The base case scenario Fed Funds rate in the September 30, 2006 analysis
and the June 30, 2006 analysis was 5.25%. The 100 basis point ramp scenarios
assumes short-term rates change 25 basis points in each of the next four
quarters, while the 200 basis point ramp scenarios assumes a 50 basis point
per quarter change. Both the +100 basis point and the +200 basis point
September 30, 2006 scenarios assume parallel shifts of the yield curve. 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.
58
STATISTICAL INFORMATION
Operating Leverage
------------------
Operating leverage is measured by comparing the rate of increase in
revenue to the rate of increase in expenses. The tables below show the
computation of operating leverage. The 2006 results are also computed
excluding merger and integration costs and one-time costs associated with SFAS
123(R). The Company believes excluding these costs provides the reader with
supplemental information with which to assess the Company's future performance.
Including Merger and Integration Costs
3Q06 vs. 3Q05
-------------
(Dollars in million)
Continuing Operations Adjusted (a)
-------------------------------- ----------------------------
3Q 2006 3Q 2005 % Change 3Q 2006 3Q 2005 % Change
------- ------- -------- ------- -------- --------
Noninterest Income $ 1,259 $ 1,185 6.2% $ 1,325 $ 1,248 6.2%
Net Interest Income 351 346 1.4 506 492 2.8
Total Revenue 1,610 1,531 5.2 1,831 1,740 5.2
Total Expense 1,192 1,031 15.6 1,318 1,135 16.1
Operating Leverage (10.4)% (10.9)%
====== ======
3Q06 vs. 2Q06
-------------
(Dollars in million)
Continuing Operations Adjusted (a)
--------------------------------- -----------------------------
3Q 2006 2Q 2006 % Change 3Q 2006 2Q 2006 % Change
------- -------- -------- ------- -------- --------
Noninterest Income $ 1,259 $ 1,366 (7.8)% $ 1,325 $ 1,426 (7.1)%
Net Interest Income 351 358 (2.0) 506 512 (1.2)
Total Revenue 1,610 1,724 (6.6) 1,831 1,938 (5.5)
Total Expense 1,192 1,134 5.1 1,318 1,248 5.6
Operating Leverage (11.7)% (11.1)%
====== ======
YTD 2006 vs. YTD 2005
---------------------
(Dollars in million)
Continuing Operations Adjusted (a)
------------------------------ ------------------------------
YTD 2006 YTD 2005 % Change YTD 2006 YTD 2005 % Change
-------- -------- -------- -------- -------- --------
Noninterest Income $ 3,886 $ 3,495 11.2% $ 4,083 $ 3,682 10.9%
Net Interest Income 1,048 996 5.2 1,506 1,417 6.3
Total Revenue 4,934 4,491 9.9 5,589 5,099 9.6
Total Expense 3,391 3,023 12.2 3,744 3,335 12.3
Operating Leverage (2.3)% (2.7)%
===== =====
(a) Adjusted combines continuing and discontinued operations.
59
Excluding Merger and Integration Costs
3Q06 vs. 3Q05
-------------
(Dollars in million)
Continuing Operations Adjusted (a)
-------------------------------- ----------------------------
3Q 2006 3Q 2005 % Change 3Q 2006 3Q 2005 % Change
------- ------- -------- ------- -------- --------
Noninterest Income $ 1,259 $ 1,185 6.2% $ 1,325 $ 1,248 6.2%
Net Interest Income 351 346 1.4 506 492 2.8
Total Revenue 1,610 1,531 5.2 1,831 1,740 5.2
Total Expense 1,103 1,031 7.0 1,208 1,135 6.4
Operating Leverage (1.8)% (1.2)%
===== =====
3Q06 vs. 2Q06
-------------
(Dollars in million)
Continuing Operations Adjusted (a)
----------------------------------- --------------------------------
3Q 2006 2Q 2006(b) % Change 3Q2006 2Q 2006(b) % Change
------- ---------- -------- ------- ----------- --------
Noninterest Income $ 1,259 $ 1,366 (7.8)% $ 1,325 $ 1,426 (7.1)%
Net Interest Income 351 358 (2.0) 506 512 (1.2)
Total Revenue 1,610 1,724 (6.6) 1,831 1,938 (5.5)
Total Expense 1,103 1,117 (1.3) 1,208 1,231 (1.9)
Operating Leverage (5.3)% (3.6)%
===== =====
YTD 2006 vs. YTD 2005
---------------------
(Dollars in million)
Continuing Operations Adjusted (a)
-------------------------------- -----------------------------------
YTD 2006(b) YTD 2005 % Change YTD 2006(b) YTD 2005 % Change
----------- -------- -------- ------------ -------- --------
Noninterest Income $ 3,886 $ 3,495 11.2% $ 4,083 $ 3,682 10.9%
Net Interest Income 1,048 996 5.2 1,506 1,417 6.3
Total Revenue 4,934 4,491 9.9 5,589 5,099 9.6
Total Expense 3,285 3,023 8.7 3,617 3,335 8.5
Operating Leverage 1.2% 1.1%
===== =====
(a) Adjusted combines continuing and discontinued operations.
(b) Excludes the $12 million impact related to SFAS 123 (R) and charges and
accounting changes resulting from the JPMorgan Chase transaction.
60
Average Balances and Rates on a Taxable Equivalent Basis
--------------------------------------------------------
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the three months For the three months
ended September 30, 2006 ended September 30, 2005
---------------------------- ----------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
--------- -------- ------- --------- -------- -------
ASSETS
------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 16,033 $ 166 4.11% $ 8,629 $ 68 3.13%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 1,907 22 4.63 2,197 18 3.32
Margin Loans 5,158 85 6.54 6,392 71 4.40
Non-Margin Loans
Domestic Offices 17,258 199 4.61 15,293 151 3.96
Foreign Offices 11,136 168 5.96 10,561 121 4.53
--------- -------- --------- --------
Total Non-Margin Loans 28,394 367 5.14 25,854 272 4.19
--------- -------- --------- --------
Securities
U.S. Government Obligations 198 2 4.24 228 2 3.55
U.S. Government Agency Obligations 3,427 42 4.95 3,956 41 4.19
Obligations of States and
Political Subdivisions 99 2 8.67 134 3 9.40
Other Securities 18,395 251 5.48 17,109 187 4.38
Trading Securities 2,477 30 4.69 3,361 38 4.49
--------- -------- --------- --------
Total Securities 24,596 327 5.33 24,788 271 4.38
--------- -------- --------- --------
Total Interest-Earning Assets 76,088 967 5.07 67,860 700 4.12
-------- --------
Allowance for Credit Losses (346) (471)
Cash and Due from Banks 2,226 2,423
Other Assets 17,611 16,170
Assets of Discontinued Operations
Held for Sale 13,285 193 5.83 14,929 177 4.70
--------- -------- --------- --------
TOTAL ASSETS $ 108,864 $ 1,160 $ 100,911 $ 877
========= ========= ========= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 5,117 $ 36 2.83% $ 6,210 $ 29 1.84%
Savings 460 1 0.74 614 1 0.77
Certificates of Deposit of
$100,000 & Over 4,310 59 5.42 3,124 28 3.57
Other Time Deposits 294 4 5.03 783 7 3.37
Foreign Offices 33,724 291 3.43 25,887 152 2.33
--------- -------- --------- --------
Total Interest-Bearing Deposits 43,905 391 3.54 36,618 217 2.35
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 2,728 34 5.02 1,245 9 2.96
Other Borrowed Funds 1,834 27 5.99 1,716 13 3.10
Payables to Customers and Broker-Dealers 4,657 42 3.62 5,714 35 2.41
Long-Term Debt 8,339 115 5.37 7,568 73 3.81
--------- -------- --------- --------
Total Interest-Bearing Liabilities 61,463 609 3.93 52,861 347 2.60
-------- --------
Noninterest-Bearing Deposits 10,687 10,333
Other Liabilities 13,167 13,224
Common Shareholders' Equity 10,262 9,564
Liabilities of Discontinued Operations
Held for Sale 13,285 38 1.15 14,929 31 0.83
--------- -------- --------- --------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 108,864 $ 647 $ 100,911 $ 378
========= ========= ========= =======
Interest Earnings
and Interest Rate Spread (Continuing) $ 358 1.14% $ 353 1.52%
======== ======= ======== =======
Net Interest Margin (Continuing) 1.89% 2.09%
======= =======
(1) Average balances and rates have been impacted by allocations made to match assets of discontinued
operations held for sale with liabilities of discontinued operations held for sale.
61
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the nine months For the nine months
ended September 30, 2006 ended September 30, 2005
---------------------------- -----------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
--------- -------- ------- --------- -------- -------
ASSETS
------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 12,720 $ 372 3.91% $ 9,207 $ 206 2.99%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 1,775 52 3.99 2,610 51 2.59
Margin Loans 5,438 247 6.08 6,380 188 3.94
Non-Margin Loans
Domestic Offices 16,453 559 4.54 15,054 427 3.78
Foreign Offices 11,140 468 5.61 10,336 322 4.16
--------- -------- --------- --------
Total Non-Margin Loans 27,593 1,027 4.97 25,390 749 3.94
--------- -------- --------- --------
Securities
U.S. Government Obligations 213 7 4.23 289 7 3.23
U.S. Government Agency Obligations 3,795 132 4.65 3,690 110 3.97
Obligations of States and
Political Subdivisions 109 7 8.42 147 10 9.06
Other Securities 18,717 728 5.19 15,732 498 4.22
Trading Securities 3,878 132 4.55 3,084 99 4.30
--------- -------- --------- --------
Total Securities 26,712 1,006 5.03 22,942 724 4.21
--------- -------- --------- --------
Total Interest-Earning Assets 74,238 2,704 4.87 66,529 1,918 3.85
-------- --------
Allowance for Credit Losses (341) (473)
Cash and Due from Banks 3,187 2,752
Other Assets 17,532 16,095
Assets of Discontinued Operations
Held for Sale 13,856 568 5.48 15,309 504 4.40
--------- -------- --------- --------
TOTAL ASSETS $ 108,472 $ 3,272 $ 100,212 $ 2,422
========= ======== ========= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 5,251 $ 101 2.57% $ 6,263 $ 74 1.57%
Savings 461 4 1.29 624 4 0.84
Certificates of Deposit of
$100,000 & Over 4,221 159 5.03 3,016 70 3.10
Other Time Deposits 629 22 4.67 352 8 3.08
Foreign Offices 32,176 751 3.12 25,896 413 2.13
--------- -------- --------- --------
Total Interest-Bearing Deposits 42,738 1,037 3.25 36,151 569 2.10
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 2,532 88 4.65 1,262 23 2.44
Other Borrowed Funds 2,045 69 4.54 1,831 33 2.43
Payables to Customers and Broker-Dealers 4,972 124 3.34 6,025 88 1.95
Long-Term Debt 8,167 317 5.13 7,223 187 3.43
--------- -------- --------- --------
Total Interest-Bearing Liabilities 60,454 1,635 3.61 52,492 900 2.29
-------- --------
Noninterest-Bearing Deposits 10,561 9,910
Other Liabilities 13,589 13,104
Common Shareholders' Equity 10,012 9,397
Liabilities of Discontinued Operations
Held for Sale 13,856 111 1.07 15,309 83 0.73
--------- -------- --------- --------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 108,472 $ 1,746 $ 100,212 $ 983
========= ======== ========= =======
Interest Earnings
and Interest Rate Spread (Continuing) $ 1,069 1.26% $ 1,018 1.56%
======== ======= ======= =======
Net Interest Margin (Continuing) 1.93% 2.04%
======= =======
(1) Average balances and rates have been impacted by allocations made to match assets of discontinued
operations held for sale with liabilities of discontinued operations held for sale.
62
SUPPLEMENTAL DATA
THE BANK OF NEW YORK COMPANY, INC.
Adjusted(1) Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the three months For the three months
ended September 30, 2006 ended September 30, 2005
---------------------------- ---------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
--------- -------- ------- ------- -------- -------
ASSETS
------
Interest-Bearing Deposits in Banks
(primarily foreign) $ 16,033 $ 166 4.11% $ 8,629 $ 68 3.13%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 3,006 37 4.89 4,465 38 3.37
Margin Loans 5,158 85 6.54 6,392 71 4.40
Non-Margin Loans
Domestic Offices 25,174 343 5.44 22,955 271 4.69
Foreign Offices 11,135 168 5.96 10,561 121 4.53
--------- -------- ------- --------
Total Non-Margin Loans 36,309 511 5.60 33,516 392 4.64
--------- -------- ------- --------
Securities
U.S. Government Obligations 198 2 4.24 228 2 3.55
U.S. Government Agency Obligations 3,427 42 4.95 3,956 41 4.19
Obligations of States and
Political Subdivisions 220 4 7.06 231 4 6.59
Other Securities 21,616 284 5.26 21,227 224 4.23
Trading Securities 2,477 30 4.69 3,361 38 4.49
--------- -------- ------- --------
Total Securities 27,938 362 5.18 29,003 309 4.27
--------- -------- ------- --------
Total Interest-Earning Assets 88,444 1,161 5.23 82,005 878 4.25
-------- --------
Allowance for Credit Losses (417) (562)
Cash and Due from Banks 2,777 2,974
Other Assets 18,060 16,494
-------- --------
TOTAL ASSETS $108,864 $100,911
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 5,586 $ 37 2.64% $ 6,827 $ 30 1.74%
Savings 7,379 32 1.71 8,637 27 1.23
Certificates of Deposit of
$100,000 & Over 4,323 59 5.41 3,137 28 3.56
Other Time Deposits 1,052 10 3.74 1,529 11 2.84
Foreign Offices 33,724 291 3.43 25,887 152 2.33
--------- -------- ------- --------
Total Interest-Bearing Deposits 52,064 429 3.27 46,017 248 2.14
Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 2,728 34 5.02 1,245 9 2.96
Other Borrowed Funds 1,834 27 5.99 1,716 13 3.10
Payables to Customers and Broker-Dealers 4,657 42 3.62 5,714 35 2.41
Long-Term Debt 8,340 115 5.37 7,568 73 3.81
--------- -------- ------- --------
Total Interest-Bearing Liabilities 69,623 647 3.69 62,260 378 2.41
-------- --------
Noninterest-Bearing Deposits 15,743 15,815
Other Liabilities 13,236 13,272
Common Shareholders' Equity 10,262 9,564
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $108,864 $100,911
======== ========
Interest Earnings
and Interest Rate Spread $ 514 1.54% $ 500 1.84%
======== ======= ======== =======
Net Interest Margin 2.33% 2.42%
======= =======
Note:
(1) Adjusted results combine continuing and discontinued operations to provide continuity
with historical results.
63
THE BANK OF NEW YORK COMPANY, INC.
Adjusted (1) Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the nine months For the nine months
ended September 30, 2006 ended September 30, 2005
-------------------------- ---------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- -------
ASSETS
------
Interest-Bearing Deposits in Banks
(primarily foreign) $ 12,720 $ 372 3.91% $ 9,207 $ 206 2.99%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 3,098 102 4.42 4,813 102 2.82
Margin Loans 5,438 247 6.08 6,380 188 3.94
Non-Margin Loans
Domestic Offices 24,349 973 5.34 22,606 760 4.50
Foreign Offices 11,140 468 5.61 10,336 322 4.17
-------- -------- -------- --------
Total Non-Margin Loans 35,489 1,441 5.43 32,942 1,082 4.39
-------- -------- -------- --------
Securities
U.S. Government Obligations 213 7 4.23 289 7 3.23
U.S. Government Agency Obligations 3,795 132 4.65 3,690 110 3.97
Obligations of States and
Political Subdivisions 220 11 6.87 214 11 7.03
Other Securities 22,395 831 4.94 20,449 617 4.02
Trading Securities 3,878 132 4.55 3,084 98 4.30
-------- -------- -------- --------
Total Securities 30,501 1,113 4.87 27,726 843 4.06
-------- -------- -------- --------
Total Interest-Earning Assets 87,246 3,275 5.01 81,068 2,421 3.99
-------- --------
Allowance for Credit Losses (418) (578)
Cash and Due from Banks 3,784 3,342
Other Assets 17,860 16,380
-------- --------
TOTAL ASSETS $108,472 $100,212
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 5,795 $ 103 2.40% $ 6,939 $ 77 1.49%
Savings 7,786 95 1.63 8,824 72 1.09
Certificates of Deposit of
$100,000 & Over 4,233 159 5.02 3,028 70 3.09
Other Time Deposits 1,377 39 3.77 1,101 20 2.37
Foreign Offices 32,176 751 3.12 25,896 413 2.13
-------- -------- -------- --------
Total Interest-Bearing Deposits 51,367 1,147 2.99 45,788 652 1.90
Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 2,532 88 4.65 1,262 23 2.44
Other Borrowed Funds 2,045 70 4.54 1,831 33 2.43
Payables to Customers and Broker-Dealers 4,972 124 3.34 6,025 88 1.95
Long-Term Debt 8,166 317 5.12 7,223 187 3.42
-------- -------- -------- --------
Total Interest-Bearing Liabilities 69,082 1,746 3.37 62,129 983 2.12
-------- --------
Noninterest-Bearing Deposits 15,733 15,533
Other Liabilities 13,645 13,153
Common Shareholders' Equity 10,012 9,397
-------- --------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $108,472 $100,212
======== ========
Interest Earnings
and Interest Rate Spread $ 1,529 1.64% $ 1,438 1.87%
======== ======= ======== =======
Net Interest Margin 2.34% 2.37%
======= =======
Note:
(1) Adjusted results combine continuing and discontinued operations to provide continuity
with historical results.
64
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income- Supplemental Data
(Dollars in millions, except per share amounts)
(Unaudited)
Quarter Ended September 30, 2006
--------------------------------------------
Continuing Discontinued Adjusted
Operations Operations Results(1)
---------- ------------ ----------
Net Interest Income $ 351 $ 155 $ 506
-------------------
Provision for Credit Losses (4) (1) (5)
----- ----- -----
Net Interest Income After
Provision for
Credit Losses 355 156 511
----- ----- -----
Noninterest Income
------------------
Servicing Fees
Securities 839 - 839
Global Payment Services 66 8 74
----- ----- -----
905 8 913
Private Banking and
Asset Management Fees 134 11 145
Service Charges and Fees 52 38 90
Foreign Exchange and Other
Trading Activities 84 2 86
Securities Gains 21 - 21
Other 63 7 70
----- ----- -----
Total Noninterest Income 1,259 66 1,325
----- ----- -----
Noninterest Expense
-------------------
Salaries and Employee Benefits 644 62 706
Net Occupancy 70 18 88
Furniture and Equipment 46 2 48
Clearing 47 - 47
Sub-custodian Expenses 31 - 31
Software 53 1 54
Communications 26 1 27
Amortization of Intangibles 14 - 14
Merger and Integration Costs 89 21 110
Other 172 21 193
----- ----- -----
Total Noninterest Expense 1,192 126 1,318
----- ----- -----
Income Before Income Taxes, Including
Merger and Integration Costs 422 96 518
Income Taxes 124 42 166
----- ----- -----
Net Income Including Merger 298 54 352
and Integration Costs
Merger and Integration Costs, Net
of Taxes 62 12 74
----- ----- -----
Net Income Excluding Merger
and Integration Costs $ 360 $ 66 $ 426
===== ===== =====
Diluted Earnings Per Share $0.39 $0.07 $0.46
Diluted Earnings Per Share Excluding
Merger and Integration Costs $0.47 $0.09 $0.56
Note:
(1) Adjusted results combine continuing and discontinued operations to provide continuity
with historical results.
65
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income- Supplemental Data
(Dollars in millions, except per share amounts)
(Unaudited)
Quarter Ended September 30, 2005
--------------------------------------------
Continuing Discontinued Adjusted
Operations Operations Results(1)
---------- ------------ ----------
Net Interest Income $ 346 $ 146 $ 492
-------------------
Provision for Credit Losses 10 - 10
----- ----- -----
Net Interest Income After
Provision for
Credit Losses 336 146 482
----- ----- -----
Noninterest Income
------------------
Servicing Fees
Securities 806 - 806
Global Payment Services 67 8 75
----- ----- -----
873 8 881
Private Banking and
Asset Management Fees 109 11 120
Service Charges and Fees 54 39 93
Foreign Exchange and Other
Trading Activities 90 3 93
Securities Gains 15 - 15
Other 44 2 46
----- ----- -----
Total Noninterest Income 1,185 63 1,248
----- ----- -----
Noninterest Expense
-------------------
Salaries and Employee Benefits 585 59 644
Net Occupancy 60 19 79
Furniture and Equipment 50 2 52
Clearing 49 - 49
Sub-custodian Expenses 25 - 25
Software 54 - 54
Communications 23 1 24
Amortization of Intangibles 10 - 10
Other 175 23 198
----- ----- -----
Total Noninterest Expense 1,031 104 1,135
----- ----- -----
Income Before Income Taxes 490 105 595
Income Taxes 157 49 206
----- ----- -----
Net Income $ 333 $ 56 $ 389
===== ===== =====
Diluted Earnings Per Share $0.44 $0.07 $0.51
Note:
(1) Adjusted results combine continuing and discontinued operations to provide continuity
with historical results.
66
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income- Supplemental Data
(Dollars in millions, except per share amounts)
(Unaudited)
Quarter Ended June 30, 2006
--------------------------------------------
Continuing Discontinued Adjusted
Operations Operations Results(1)
---------- ------------ ----------
Net Interest Income $ 358 $ 154 $ 512
-------------------
Provision for Credit Losses (1) 1 -
----- ----- -----
Net Interest Income After
Provision for
Credit Losses 359 153 512
----- ----- -----
Noninterest Income
------------------
Servicing Fees
Securities 909 - 909
Global Payment Services 63 7 70
----- ----- -----
972 7 979
Private Banking and
Asset Management Fees 138 12 150
Service Charges and Fees 53 38 91
Trading Activities 130 2 132
Securities Gains 23 - 23
Other 50 1 51
----- ----- -----
Total Noninterest Income 1,366 60 1,426
----- ----- -----
Noninterest Expense
-------------------
Salaries and Employee Benefits 656 67 723
Net Occupancy 68 18 86
Furniture and Equipment 48 2 50
Clearing 53 - 53
Sub-custodian Expenses 36 - 36
Software 53 - 53
Communications 22 1 23
Amortization of Intangibles 15 - 15
Other 183 26 209
----- ----- -----
Total Noninterest Expense 1,134 114 1,248
----- ----- -----
Income Before Income Taxes 591 99 690
Income Taxes 200 42 242
----- ----- -----
Net Income $ 391 $ 57 $ 448
===== ===== =====
Diluted Earnings Per Share $0.52 $0.07 $0.59
Note:
(1) Adjusted results combine continuing and discontinued operations to provide continuity
with historical results.
67
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income- Supplemental Data
(Dollars in millions, except per share amounts)
(Unaudited)
Adjusted Results (1)
-------------------------------------------------------------------
Quarter Ended 9/30/06 9/30/06
September 30, September 30, June 30, vs. vs.
2006 2005 2006 9/30/05 6/30/06
------------- ------------- ---------- ---------- ---------
Net Interest Income $ 506 $ 492 $ 512 3% (1)%
-------------------
Provision for Credit Losses (5) 10 -
----- ----- -----
Net Interest Income After
Provision for
Credit Losses 511 482 512 6 -
----- ----- -----
Noninterest Income
------------------
Servicing Fees
Securities 839 806 909 4 (8)
Global Payment Services 74 75 70 (1) 6
----- ----- -----
913 881 979 4 (7)
Private Banking and
Asset Management Fees 145 120 150 21 (3)
Service Charges and Fees 90 93 91 (3) (1)
Foreign Exchange and Other
Trading Activities 86 93 132 (8) (35)
Securities Gains 21 15 23 40 (9)
Other 70 46 51 52 37
----- ----- -----
Total Noninterest Income 1,325 1,248 1,426 6 (7)
----- ----- -----
Noninterest Expense
-------------------
Salaries and Employee Benefits 706 644 723 10 (2)
Net Occupancy 88 79 86 11 2
Furniture and Equipment 48 52 50 (8) (4)
Clearing 47 49 53 (4) (11)
Sub-custodian Expenses 31 25 36 24 (14)
Software 54 54 53 - 2
Communications 27 24 23 13 17
Amortization of Intangibles 14 10 15 40 (7)
Merger and Integration Costs 110 - -
Other 193 198 209 (3) (8)
----- ----- -----
Total Noninterest Expense 1,318 1,135 1,248 16 6
----- ----- -----
Income Before Income Taxes, Including
Merger and Integration Costs 518 595 690 (13) (25)
Income Taxes 166 206 242 (19) (31)
----- ----- -----
Net Income Including Merger and
Integration Costs 352 389 448 (10) (21)
Merger and Integration Costs, Net
of Taxes 74 - -
----- ----- -----
Net Income Excluding Merger
and Integration Costs $ 426 $ 389 $ 448 10 (5)
===== ===== =====
Diluted Earnings Per Share $0.46 $0.51 $0.59 (10) (22)
Diluted Earnings Per Share, Excluding
Merger and Integration Costs $0.56 $0.51 $0.59 10 (5)
Note:
(1) Adjusted results combine continuing and discontinued operations to provide continuity
with historical results.
68
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income- Supplemental Data
(Dollars in millions, except per share amounts)
(Unaudited)
Nine Months Ended September 30,
---------------------------------------------------------------------
2006 2005 9/30/06
Continuing Discontinued Adjusted Adjusted vs.
Operations Operations Results(1) Results(1) 9/30/05
----------- ------------ ---------- ---------- --------
Net Interest Income $1,048 $ 458 $1,506 $1,417 6%
-------------------
Provision for Credit Losses (5) 5 - 5
------ ----- ------ ------
Net Interest Income After
Provision for
Credit Losses 1,053 453 1,506 1,412 7
------ ----- ------ ------
Noninterest Income
------------------
Servicing Fees
Securities 2,579 - 2,579 2,330 11
Global Payment Services 191 23 214 226 (5)
------ ----- ------ ------
2,770 23 2,793 2,556 9
Private Banking and
Asset Management Fees 402 34 436 366 19
Service Charges and Fees 157 113 270 288 (6)
Foreign Exchange and Other
Trading Activities 327 6 333 292 14
Securities Gains 61 - 61 50 22
Other 169 21 190 130 46
------ ----- ------ ------
Total Noninterest Income 3,886 197 4,083 3,682 11
------ ----- ------ ------
Noninterest Expense
-------------------
Salaries and Employee Benefits 1,904 193 2,097 1,902 10
Net Occupancy 206 56 262 239 10
Furniture and Equipment 145 6 151 155 (3)
Clearing 150 - 150 137 9
Sub-custodian Expenses 101 - 101 72 40
Software 161 2 163 162 1
Communications 74 3 77 69 12
Amortization of Intangibles 42 - 42 28 50
Merger and Integration Costs 89 21 110 -
Other 519 72 591 571 4
------ ----- ------ ------
Total Noninterest Expense 3,391 353 3,744 3,335 12
------ ----- ------ ------
Income Before Income Taxes,
Including Merger and
Integration Costs 1,548 297 1,845 1,759 5
Income Taxes 499 124 623 593 5
------ ----- ------ ------
Net Income Including Merger and
Integration Costs 1,049 173 1,222 1,166 5
Merger and Integration Costs, Net
of Taxes 62 12 74 -
------ ----- ------ ------
Net Income Excluding Merger
and Integration Costs $1,111 $ 185 $1,296 $1,166 11
====== ===== ====== =====
Diluted Earnings Per Share $1.36 $0.23 $1.59 $1.51 5
Diluted Earnings Per Share,
Excluding Merger and
Integration Costs 1.44 0.25 1.69 1.51 12
Note:
(1) Adjusted results combine continuing and discontinued operations to provide continuity
with historical results.
69
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income- Supplemental Data
(Dollars in millions, except per share amounts)
(Unaudited)
Nine Months Ended September 30, 2005
--------------------------------------------
2005
Continuing Discontinued Adjusted
Operations Operations Results(1)
---------- ------------ -----------
Net Interest Income $ 996 $ 421 $1,417
-------------------
Provision for Credit Losses (10) 15 5
------ ----- ------
Net Interest Income After
Provision for
Credit Losses 1,006 406 1,412
------ ----- ------
Noninterest Income
------------------
Servicing Fees
Securities 2,330 - 2,330
Global Payment Services 200 26 226
------ ----- ------
2,530 26 2,556
Private Banking and
Asset Management Fees 334 32 366
Service Charges and Fees 172 116 288
Foreign Exchange and Other
Trading Activities 283 9 292
Securities Gains 50 - 50
Other 126 4 130
------ ----- ------
Total Noninterest Income 3,495 187 3,682
------ ----- ------
Noninterest Expense
-------------------
Salaries and Employee Benefits 1,721 181 1,902
Net Occupancy 184 55 239
Furniture and Equipment 149 6 155
Clearing 137 - 137
Sub-custodian Expenses 72 - 72
Software 160 2 162
Communications 66 3 69
Amortization of Intangibles 28 - 28
Other 506 65 571
------ ----- ------
Total Noninterest Expense 3,023 312 3,335
------ ----- ------
Income Before Income Taxes 1,478 281 1,759
Income Taxes 474 119 593
------ ----- ------
Net Income $1,004 $ 162 $1,166
====== ===== ======
Diluted Earnings Per Share $1.30 $0.21 $1.51
(1) Adjusted results combine continuing and discontinued operations to provide continuity
with historical results.
70
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Balance Sheets - Supplemental Data
(In millions)
(Unaudited)
September 30, 2006 December 31, 2005
-------------------------------------- ---------------------------------------
Continuing Discontinued Continuing Discontinued
Operations Operations Adjusted Operations Operations Adjusted
---------- ------------ --------- ---------- ------------ -----------
Assets
------
Cash and Due from Banks $ 2,072 $ 578 $ 2,650 $ 2,882 $ 633 $ 3,515
Interest-Bearing
Deposits in Banks 16,753 - 16,753 8,644 - 8,644
Securities 22,015 120 22,135 27,218 108 27,326
Trading Assets
at Fair Value 3,266 - 3,266 5,930 - 5,930
Federal Funds Sold and
Securities Purchased
Under Resale Agreements 5,139 - 5,139 2,425 - 2,425
Loans 33,619 7,697 41,316 32,601 7,714 40,315
Premises and Equipment 1,009 113 1,122 960 100 1,060
Due from Customers
on Acceptances 311 - 311 212 21 233
Accrued Interest Receivable 406 49 455 363 28 391
Goodwill 3,801 109 3,910 3,510 109 3,619
Intangible Assets 872 - 872 811 - 811
Other Assets 8,545 162 8,707 7,710 95 7,805
-------- ------- -------- -------- ---------- ----------
Total Assets $ 97,808 $ 8,828 $106,636 $ 93,266 $ 8,808 $ 102,074
======== ======= ======== ======== ========== ==========
Liabilities and
Shareholders' Equity
----------------------
Deposits $ 54,953 $12,981 $ 67,934 $ 49,787 $ 14,637 $ 64,424
Federal Funds Purchased
and Securities Sold Under
Repurchase Agreements 1,040 - 1,040 834 - 834
Trading Liabilities 2,102 - 2,102 2,401 - 2,401
Payables to Customers
and Broker-Dealers 6,673 - 6,673 8,623 - 8,623
Other Borrowed Funds 1,121 - 1,121 860 - 860
Acceptances Outstanding 318 - 318 212 23 235
Accrued Taxes
and Other Expenses 4,140 34 4,174 4,123 1 4,124
Accrued Interest Payable 201 12 213 163 9 172
Other Liabilities 4,152 8 4,160 2,697 11 2,708
Long-Term Debt 8,434 - 8,434 7,817 - 7,817
-------- ------- -------- -------- ---------- ----------
Total Liabilities 83,134 13,035 96,169 77,517 14,681 92,198
-------- ------- -------- -------- ---------- ----------
Shareholders' Equity 10,467 - 10,467 9,876 - 9,876
-------- ------- -------- -------- ---------- ----------
Total Liabilities and
Shareholders' Equity $ 93,601 $13,035 $106,636 $ 87,393 $ 14,681 $ 102,074
======== ======= ======== ======== ========== ==========
Note: The balance sheet at December 31, 2005 has been derived from the audited financial statements
at that date.
71
OTHER DEVELOPMENTS
The Company completed two strategic transactions during the beginning of
the fourth quarter that sharpen its focus on securities servicing and asset
management, and enhance its ability to grow and generate attractive returns for
shareholders.
On October 1, 2006, the Company completed its acquisition of the JPMorgan
Chase Corporate Trust Business and the sale of its retail and regional middle
market banking businesses to JPMorgan Chase. The transaction significantly
strengthens the Company's leadership position in corporate trust, both in the
U.S. and internationally, as it now serves a combined client base with $8
trillion in total debt outstanding in 20 countries. The acquisition
diversifies the Company's growing revenue base by both geography and product
and expands its global footprint with the addition of seven new offices in
Europe, five in Asia, and three in Latin America.
On October 2, 2006, the Company completed the transaction that resulted in
the formation of BNY ConvergEx Group, LLC. The Company joined forces with Eze
Castle Software, LLC and GTCR Golder Rauner, LLC, a private equity firm, to
form BNY ConvergEx Group, in which the Company retains a 35% interest. BNY
ConvergEx Group brings together the Company's trade execution, commission
management, independent research and transition management businesses with
Eze Castle Software, a leading provider of trade order management and related
investment technologies. BNY ConvergEx Group's comprehensive suite of
services, advanced technology offerings and breadth of distribution channels
enable its customers to manage all aspects of the investment cycle, including
idea generation, research, trade analysis, execution and wholesale clearing,
risk management, commission management, transition management, compliance and
portfolio management. With approximately 635 employees worldwide, BNY
ConvergEx Group has a global presence in New York, Boston, San Francisco,
Chicago, Dallas, Stamford, London, Bermuda, Tokyo, Hong Kong, and Sydney.
On September 7, 2006, the Company reached an agreement to sell its
transfer agency software business, Rufus, to Bravura Solutions Limited
("Bravura"), a leading global supplier of wealth management applications
and professional services, for a maximum of GBP 32 million. Under the
agreement, Bravura will acquire all of the software and intellectual
property comprising Rufus, and all existing employees will transfer to
Bravura. The transaction is expected to be completed in the fourth quarter
of 2006, and is subject to approval by Bravura's shareholders.
72
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
expected results. Results 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 section "Forward-Looking
Statements and Risk Factors That Could Affect Future Results" in Part I, Item
1A of the Company's Annual Report on Form 10-K for the year ended December 31,
2005 and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2006
and June 30, 2006.
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.
GOVERNMENT MONETARY POLICIES AND COMPETITION
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 commercial
finance companies, 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.
73
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.
74
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Balance Sheets
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, 2006 December 31, 2005
------------------ -----------------
Assets
------
Cash and Due from Banks $ 2,072 $ 2,882
Interest-Bearing Deposits in Banks 16,753 8,644
Securities
Held-to-Maturity (fair value of $1,716 in 2006
and $1,847 in 2005) 1,737 1,872
Available-for-Sale 20,278 25,346
------------------ -----------------
Total Securities 22,015 27,218
Trading Assets at Fair Value 3,266 5,930
Federal Funds Sold and Securities Purchased
Under Resale Agreements 5,139 2,425
Loans (less allowance for loan losses of $339 in 2006
and $326 in 2005) 33,619 32,601
Premises and Equipment 1,009 960
Due from Customers on Acceptances 311 212
Accrued Interest Receivable 406 363
Goodwill 3,801 3,510
Intangible Assets 872 811
Other Assets 8,545 7,710
Assets of Discontinued Operations Held for Sale 8,828 8,808
------------------ -----------------
Total Assets $ 106,636 $ 102,074
================== =================
Liabilities and Shareholders' Equity
------------------------------------
Deposits
Noninterest-Bearing (principally domestic offices) $ 11,451 $ 12,706
Interest-Bearing
Domestic Offices 9,785 10,415
Foreign Offices 33,717 26,666
------------------ -----------------
Total Deposits 54,953 49,787
Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 1,040 834
Trading Liabilities 2,102 2,401
Payables to Customers and Broker-Dealers 6,673 8,623
Other Borrowed Funds 1,121 860
Acceptances Outstanding 318 212
Accrued Taxes and Other Expenses 4,140 4,123
Accrued Interest Payable 201 163
Other Liabilities (including allowance for
lending-related commitments of
$137 in 2006 and $144 in 2005) 4,152 2,697
Long-Term Debt 8,434 7,817
Liabilities of Discontinued Operations Held for Sale 13,035 14,681
------------------ -----------------
Total Liabilities 96,169 92,198
------------------ -----------------
Shareholders' Equity
Common Stock-par value $7.50 per share,
authorized 2,400,000,000 shares, issued
1,049,888,635 shares in 2006 and
1,044,994,517 shares in 2005 7,874 7,838
Additional Capital 2,015 1,826
Retained Earnings 7,820 7,089
Accumulated Other Comprehensive Income (66) (134)
------------------ -----------------
17,643 16,619
Less: Treasury Stock (285,692,282 shares in 2006
and 273,662,218 shares in 2005), at cost 7,169 6,736
Loan to ESOP (203,507 shares in 2006
and 203,507 shares in 2005), at cost 7 7
------------------ -----------------
Total Shareholders' Equity 10,467 9,876
------------------ -----------------
Total Liabilities and Shareholders' Equity $ 106,636 $ 102,074
================== =================
------------------------------------------------------------------------------------------------
Note: The balance sheet at December 31, 2005 has been derived from the audited financial statements at
that date.
See accompanying Notes to Consolidated Financial Statements.
75
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income
(In millions, except per share amounts)
(Unaudited)
Percent Inc/(Dec)
For the three For the nine -----------------
months ended months ended 3Q06 YTD 2006
September 30, September 30, vs. vs.
2006 2005 2006 2005 3Q05 YTD 2005
------ ------ ------ ------ ------ ----------
Interest Income
---------------
Loans $ 367 $ 272 $1,027 $ 749 35% 37%
Margin loans 85 71 247 188 20 31
Securities
Taxable 282 216 827 576 31 44
Exempt from Federal Income Taxes 10 10 28 28 - -
------ ------ ------ ------
292 226 855 604 29 42
Deposits in Banks 166 68 372 206 144 81
Federal Funds Sold and Securities Purchased
Under Resale Agreements 22 18 52 51 22 2
Trading Assets 28 38 130 98 (26) 33
------ ------ ------ ------
Total Interest Income 960 693 2,683 1,896 39 42
------ ------ ------ ------
Interest Expense
----------------
Deposits 391 217 1,037 569 80 82
Federal Funds Purchased and Securities Sold
Under Repurchase Agreements 34 9 88 23 278 283
Other Borrowed Funds 27 13 69 33 108 109
Customer Payables 42 35 124 88 20 41
Long-Term Debt 115 73 317 187 58 70
------ ------ ------ ------
Total Interest Expense 609 347 1,635 900 76 82
------ ------ ------ ------
Net Interest Income
------------------- 351 346 1,048 996 1 5
Provision for Credit Losses (4) 10 (5) (10)
------ ------ ------ ------
Net Interest Income After Provision for Credit Losses 355 336 1,053 1,006 6 5
------ ------ ------ ------
Noninterest Income
------------------
Servicing Fees
Securities 839 806 2,579 2,330 4 11
Global Payment Services 66 67 191 200 (1) (5)
------ ------ ------ ------
905 873 2,770 2,530 4 9
Private Banking and Asset Management Fees 134 109 402 334 23 20
Service Charges and Fees 52 54 157 172 (4) (9)
Foreign Exchange and Other Trading Activities 84 90 327 283 (7) 16
Securities Gains 21 15 61 50 40 22
Other 63 44 169 126 43 34
------ ------ ------ ------
Total Noninterest Income 1,259 1,185 3,886 3,495 6 11
------ ------ ------ ------
Noninterest Expense
-------------------
Salaries and Employee Benefits 644 585 1,904 1,721 10 11
Net Occupancy 70 60 206 184 17 12
Furniture and Equipment 46 50 145 149 (8) (3)
Clearing 47 49 150 137 (4) 9
Sub-custodian Expenses 31 25 101 72 24 40
Software 53 54 161 160 (2) 1
Communications 26 23 74 66 13 12
Amortization of Intangibles 14 10 42 28 40 50
Merger and Integration Costs 89 - 89 -
Other 172 175 519 506 (2) 3
------ ------ ------ ------
Total Noninterest Expense 1,192 1,031 3,391 3,023 16 12
------ ------ ------ ------
Income from Continuing Operations before Income Taxes 422 490 1,548 1,478 (14) 5
Income Taxes 124 157 499 474 (21) 5
------ ------ ------ ------
Income from Continuing Operations 298 333 1,049 1,004 (11) 4
------ ------ ------ ------
76
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income
(In millions, except per share amounts)
(Unaudited)
Percent Inc/(Dec)
For the three For the nine -----------------
months ended months ended 3Q06 YTD 2006
September 30, September 30, vs. vs.
2006 2005 2006 2005 3Q05 YTD 2005
------ ------ ------ ------ ------ ----------
Discontinued Operations
Income from Discontinued Operations $ 96 $ 105 $ 297 $ 281 (9)% 6%
Income Taxes 42 49 124 119 (14) 4
------ ------ ------ ------
Discontinued Operations, Net 54 56 173 162 (4) 7
------ ------ ------ ------
Net Income $ 352 $ 389 $1,222 $1,166 (10) 5
---------- ====== ====== ====== ======
Per Common Share Data:
----------------------
Basic Earnings
Income from Continuing Operations $ 0.40 $ 0.44 $ 1.38 $ 1.31 (9) 5
Income from Discontinued Operations, Net 0.07 0.07 0.23 0.21 - 10
Net Income 0.47 0.51 1.61 1.52 (8) 6
Diluted Earnings
Income from Continuing Operations $ 0.39 $ 0.44 $ 1.36 $ 1.30 (11) 5
Income from Discontinued Operations, Net 0.07 0.07 0.23 0.21 - 10
Net Income 0.46 0.51 1.59 1.51 (10) 5
Cash Dividends Paid 0.22 0.21 0.64 0.61 5 5
Diluted Shares Outstanding 767 769 768 773 - (1)
--------------------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
77
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statement of Changes in Shareholders' Equity
For the nine months ended September 30, 2006
(Dollars in millions)
(Unaudited)
Common Stock
Balance, January 1 $ 7,838
Issuances in Connection with Employee Benefit Plans 36
-------------
Balance, September 30 7,874
-------------
Additional Capital
Balance, January 1 1,826
Issuances in Connection with Employee Benefit Plans 189
-------------
Balance, September 30 2,015
-------------
Retained Earnings
Balance, January 1 7,089
Net Income $ 1,222 1,222
Cash Dividends on Common Stock (491)
-------------
Balance, September 30 7,820
-------------
Accumulated Other Comprehensive Income
Balance, January 1 (134)
Change in Fair Value of Securities Available-for-Sale,
Net of Taxes of $79 117 117
Reclassification Adjustment, Net of Taxes of $(36) (53) (53)
Foreign Currency Translation Adjustment,
Net of Taxes of $2 7 7
Net Unrealized Derivative loss on Cash Flow Hedges,
Net of Taxes of $2 2 2
Minimum Pension Liability Adjustment,
Net of Taxes of $(3) (5) (5)
----------- -------------
68
Balance, September 30 (66)
-------------
Total Comprehensive Income $ 1,290
===========
Less Treasury Stock
Balance, January 1 6,736
Issued (18)
Acquired 451
-------------
Balance, September 30 7,169
-------------
Less Loan to ESOP
Balance, January 1 7
Loan to ESOP -
-------------
Balance, September 30 7
-------------
Total Shareholders' Equity, September 30, 2006 $ 10,467
=============
-------------------------------------------------------------------------------------------
Comprehensive Income for the three months ended September 30, 2006 and 2005 was $517 and $306.
Comprehensive Income for the nine months ended September 30, 2006 and 2005 was $1,290 and $1,065.
See accompanying Notes to Consolidated Financial Statements.
78
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Cash Flows
(Dollars in millions)
(Unaudited)
For the nine months
ended September 30,
2006 2005
-------- --------
Operating Activities
Net Income $ 1,222 $ 1,166
Adjustments to Determine Net Cash Attributable to
Operating Activities:
Provision for Credit Losses
and Losses on Other Real Estate - 5
Depreciation and Amortization 350 370
Deferred Income Taxes 187 236
Securities Gains 18 (50)
Change in Trading Activities 3,085 (1,815)
Change in Accruals and Other, Net (99) (119)
-------- --------
Net Cash Provided by (Used for) Operating Activities 4,763 (207)
-------- --------
Investing Activities
Change in Interest-Bearing Deposits in Banks (7,784) 713
Change in Margin Loans 1,370 (262)
Purchases of Securities Held-to-Maturity (538) (508)
Paydowns of Securities Held-to-Maturity 193 277
Maturities of Securities Held-to-Maturity 97 38
Purchases of Securities Available-for-Sale (8,834) (13,018)
Sales of Securities Available-for-Sale 7,379 3,578
Paydowns of Securities Available-for-Sale 3,704 5,103
Maturities of Securities Available-for-Sale 3,091 1,787
Net Principal Disbursed on Loans to Customers (2,443) (6,687)
Sales of Loans and Other Real Estate 132 141
Change in Federal Funds Sold and Securities
Purchased Under Resale Agreements (2,714) 2,136
Purchases of Premises and Equipment (127) (71)
Acquisitions, Net of Cash Acquired (359) (257)
Proceeds from the Sale of Premises and Equipment 3 -
Other, Net 67 51
-------- --------
Net Cash Used for Investing Activities (6,763) (6,979)
-------- --------
Financing Activities
Change in Deposits 2,668 3,459
Change in Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 206 2,144
Change in Payables to Customers and Broker-Dealers (1,950) (560)
Change in Other Borrowed Funds 256 694
Proceeds from the Issuance of Long-Term Debt 1,208 1,589
Repayments of Long-Term Debt (556) (102)
Issuance of Common Stock 243 140
Treasury Stock Acquired (451) (406)
Cash Dividends Paid (491) (482)
-------- --------
Net Cash Provided by Financing Activities 1,133 6,476
-------- --------
Effect of Exchange Rate Changes on Cash 2 317
-------- --------
Change in Cash and Due From Banks (865) (393)
Cash and Due from Banks at Beginning of Period 3,515 3,886
Cash Related to Discontinued Operations (578) (558)
-------- --------
Cash and Due from Banks at End of Period $ 2,072 $ 2,935
======== ========
-------------------------------------------------------------------------------
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Period for:
Interest $ 1,703 $ 965
Income Taxes 469 273
Noncash Investing Activity
(Primarily Foreclosure of Real Estate) - -
-------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
79
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 U.S. 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. Certain other reclassifications have been made to
prior periods to place them on a basis comparable with current period
presentation.
2. Accounting Changes and New Accounting Pronouncements
----------------------------------------------------
The Company adopted Statement of Financial Accounting Standards ("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 ("APB 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 permitted three different methods of adopting fair value: (1) the
prospective method, (2) the modified prospective method, and (3) the
retroactive restatement method. Under the prospective method, options issued
after January 1, 2003 are expensed while all options granted prior to January
1, 2003 are accounted for under APB 25 using the intrinsic value method.
Consistent with industry practice, the Company elected the prospective method
of adopting fair value accounting.
During the nine months ended September 30, 2006, approximately 6.2 million
options were granted. In the third quarter and first nine months of 2006, the
Company recorded $10 million and $35 million of stock option expense.
The retroactive restatement method requires the Company's financial
statements to be restated as if fair value accounting had been adopted in 1995.
The following table discloses the pro forma effects on the Company's net income
and earnings per share as if the retroactive restatement method had been
adopted.
(Dollars in millions, Third Quarter Year-to-date
except per share amounts) 2006 2005 2006 2005
------ ------ ------ ------
Reported net income $ 352 $ 389 $1,222 $1,166
Stock based employee compensation costs,
using prospective method, net of tax 6 8 20 22
Stock based employee compensation costs,
using retroactive restatement method,
net of tax (6) (8) (20) (29)
------ ------ ------ ------
Pro forma net income $ 352 $ 389 $1,222 $1,159
====== ====== ====== ======
Reported diluted earnings per share $ 0.46 $ 0.51 $ 1.59 $ 1.51
Impact on diluted earnings per share - - - (0.01)
------ ------ ------ ------
Pro forma diluted earnings per share $ 0.46 $ 0.51 $ 1.59 $ 1.50
====== ====== ====== ======
80
The fair value of options granted in 2006 and 2005 were estimated at the
grant date using the following weighted average assumptions:
Year-to-date
2006 2005
------ ------
Dividend yield 2.77% 2.77%
Expected volatility 22.43 25.21
Risk free interest rates 4.72 4.18
Expected options lives (in years) 6 5
There were no stock options granted in the third quarter of 2006 and 2005.
In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123 (revised 2004) ("SFAS 123(R)"), "Share-Based Payment," which is a
revision of SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS
123(R) eliminates the ability to account for share-based compensation
transactions using APB 25 and requires that such transactions be accounted for
using a fair value-based method. SFAS 123(R) covers a wide range of share-
based compensation arrangements including share options, restricted share
plans, performance-based awards, share appreciation rights, and employee share
purchase plans. 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
SFAS 123(R) for all share-based payments granted after the effective date and
(b) based on the requirements of SFAS 123 for all awards granted to employees
prior to the effective date of SFAS 123(R) that remain unvested on the
effective date.
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) requires 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 adoption of SFAS 123(R) increased pre-tax expense
in 2006 by $12 million, which was recorded in the second quarter of 2006.
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 operations.
In February 2006, the FASB issued SFAS 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.
On October 25, 2006, the FASB announced plans to issue guidance, which will
impact the financial instruments covered by SFAS 155. Depending on which
financial instruments the statement applies to, the Company could experience
additional income statement volatility after adoption of SFAS 155. This
volatility could lead the Company to enter into hedging strategies or alter the
types of financial instruments it invests in.
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes." The Interpretation clarifies the accounting for
81
uncertain tax positions in accordance with SFAS No. 109, "Accounting for Income
Taxes." The Interpretation requires that a tax position meet a "more-likely-
than-not threshold" for the benefit of the uncertain tax position to be
recognized in the financial statements. A tax position that fails to meet a
more-likely-than-not recognition threshold will result in either reduction of
current or deferred tax assets, and/or recording of current or deferred tax
liabilities. The proposed Interpretation also provides guidance on measurement,
derecognition of tax benefits, classification, interim period accounting
disclosure, and transition requirements in accounting for uncertain tax
positions. The Company is assessing the impact of adopting the new
pronouncement, which will become effective January 1, 2007.
In July 2006, the FASB issued FASB Staff Position ("FSP") FAS 13-2,
"Accounting for a Change or Projected Change in the Timing of Cash Flows
Relating to Income Taxes Generated by a Leverage Lease Transaction," revising
the accounting guidance under SFAS No. 13 ("SFAS 13"), "Accounting for Leases,"
for leveraged leases. This FSP modifies existing interpretations of SFAS 13
and associated industry practice. As a result, in January 2007, the Company
expects to recognize a one-time after-tax charge to 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 Contingent Liabilities". However,
an amount approximating this one-time charge will be taken into income over the
remaining term of the affected leases.
In September 2006, the FASB issued SFAS No. 157 ("SFAS 157"), "Fair Value
Measurements." The Statement defines fair value, establishes a framework for
measuring fair value in accordance with generally accepted accounting
principles, and expands additional disclosures about fair value measurements.
SFAS 157 clarifies that fair value is the amount that would be exchanged to
sell an asset or transfer a liability, in an orderly transaction between market
participants. The Statement nullifies the consensus reached in EITF Issue
No. 02-3 prohibiting the recognition of day one gain or loss on derivative
contracts (and hybrid instruments measured at fair value under SFAS 133 as
modified by SFAS 155) where the Company cannot verify all of the significant
model inputs to observable market data and verify the model to market
transactions. However, SFAS 157 requires that a fair value measurement
technique include an adjustment for risks inherent in a particular valuation
technique (such as a pricing model) and/or the risks inherent in the inputs to
the model if market participants would also include such an adjustment. SFAS
157 will require the Company to consider the effect of its own credit standing
in determining the fair value of its liabilities. In addition, SFAS 157
prohibits the recognition of "block discounts" for large holdings of
unrestricted financial instruments where quoted prices are readily and
regularly available in an active market. The requirements of SFAS 157 are to be
applied prospectively, except for changes in fair value measurements that
result from the initial application of SFAS 157 to existing derivative
financial instruments measured under EITF Issue No. 02-3, existing hybrid
instruments measured at fair value, and block discounts, which are to be
recorded as an adjustment to opening retained earnings in the year of adoption.
SFAS 157 is effective for fiscal years beginning after November 15, 2007. The
Company is currently evaluating the impact of SFAS 157.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans - an amendment of
FASB Statements No. 87, 88, 106 and 132(R)." This statement would require the
Company to (a) recognize in its statement of financial position an asset for
a plan's overfunded status or a liability for a plan's underfunded status,
(b) measure a plan's assets and its obligations that determine its funded
status as of the end of the fiscal year, and (c) recognize changes in the
funded status of a defined postretirement plan in the year in which the changes
occur (reported in comprehensive income). The requirement to recognize the
funded status of a benefit plan and the disclosure requirements are effective
as of the end of the fiscal year ending after December 15, 2006. The
requirement to measure the plan assets and benefit obligations as of the
date of the employer's fiscal year-end statement of financial position is
effective for fiscal years ending after December 15, 2008. The Company
anticipates that the adoption of this statement will result in a material
charge to equity of approximately $400 million. However, the actual amount
will depend on the 2006 funded status of the
82
Company's pension and postretirement obligations and the manner in which the
Company adopts this statement.
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.
The Company announced four acquisitions in 2006. The total cost of
completed acquisitions in the third quarter and first nine months of 2006 was
zero and $325 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 completed acquisitions in the third quarter of 2006
and first nine months of 2006 was zero and $214 million, respectively. The tax-
deductible portion of goodwill related to completed acquisitions in the third
quarter and first nine months of 2006 was zero and $75 million, respectively.
At September 30, 2006, the Company was liable for potential contingent payments
related to acquisitions in the amount of $168 million. During the third quarter
and the first nine months of 2006, the Company paid or accrued $12 million and
$35 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 retained a 20 percent interest. Alcentra has
operations in London and Los Angeles and at acquisition managed 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 at acquisition managed approximately $3.0 billion in
direct investments and portfolios of REIT securities.
On June 12, 2006, the Company acquired the bond administration business of
TD Banknorth, N.A. The TD Banknorth portfolio includes bond trustee,
paying/fiscal agent, master trustee, transfer agent and registrar
appointments. The transaction involves the purchase of approximately 350 bond
trusteeships and agency appointments, representing $5.2 billion of principal
debt outstanding for an estimated 230 clients.
On October 1, 2006, the Company sold its retail and regional middle market
banking businesses to JPMorgan Chase for the net asset value plus a premium of
$2.3 billion. JPMorgan Chase sold its corporate trust business to the Company
for the net asset value plus a premium of $2.15 billion. The difference between
premiums resulted 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 "Discontinued Operations" Note.
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 Company recorded an after-tax gain of approximately $1.4 billion on
the businesses sold. The Company also expects to incur after-tax charges of
$150 million related to the acquisition. 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.
The Company's transaction with JPMorgan Chase altered the composition of
the balance sheet. When the Acquired Corporate Trust Business is fully
integrated in 2007, approximately $14 billion of U.S. dollar retail deposits
83
will have been replaced with approximately $11 to $14 billion of institutional
corporate trust deposits. Approximately $7 billion to $10 billion of deposits
related to the Acquired Corporate Trust Business have not yet transitioned to
the Company. These deposits will transition to the Company as regulatory
approval is received to operate in certain foreign locations and as the
novation process proceeds in other foreign locations. The Company expects the
transition will be substantially complete by June 30, 2007. Until the
transition is complete, JPMorgan Chase will pay the Company for the net
economic value of these deposits. These payments will be recorded in
noninterest income. 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 $2.25 billion. As a result of the
transaction, the Company expects its balance sheet footings to decline.
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 consisted of 338 branches in the tri-state
region, serving approximately 700,000 consumer households and small businesses
with $13 billion in deposits and $9 billion in assets at September 30, 2006.
The Company's regional middle market businesses provided financing, banking and
treasury services for middle market clients, serving more than 2,000 clients in
the tri-state region. Together, the units had 4,000 employees located in New
York, New Jersey, Connecticut and Delaware.
On October 2, 2006, the Company completed the transaction resulting in the
formation of BNY ConvergEx Group. BNY ConvergEx Group brings together BNY
Securities Group's trade execution, commission management, independent research
and transition management business with Eze Castle Software, a leading provider
of trade order management and related investment technologies. This transaction
enables the Company to achieve several objectives including repositioning its
execution services business for faster growth and enhancing the product
offering for the Company's client base, while allowing the Company to withdraw
capital committed to the business.
BNY ConvergEx Group will be a leading global agency brokerage and
technology company offering a complete spectrum of pre-trade, trade, and post-
trade solutions for traditional money managers, hedge funds, broker-dealers,
corporations and plan sponsors. BNY ConvergEx Group will have a global presence
in New York, Boston, San Francisco, Chicago, Dallas, Stamford, London, Bermuda,
Tokyo, Hong Kong, and Sydney.
The Company and GTCR Golder Rauner, LLC each hold a 35 percent stake in
BNY ConvergEx Group, with the balance held by Eze Castle Software's investors
and BNY ConvergEx Group's management team. BNY ConvergEx Group, with pro forma
2005 revenues of approximately $340 million, will be an affiliate of The Bank
of New York and will be reflected on the Company's financial statements as an
equity investment. After the use of the proceeds to repurchase 12.1 million
shares, the transaction is expected to be neutral to earnings per share.
The BNY Securities Group businesses to be included in BNY ConvergEx Group
will be BNY Brokerage, Lynch, Jones, & Ryan, G-Port, Westminster Research and
BNY Jaywalk. Each business will retain its respective brand name and continue
to operate as it does today, while taking advantage of the combined
capabilities of BNY ConvergEx Group. In addition, The Bank of New York's B-
Trade and G-Trade businesses are expected to become part of BNY ConvergEx Group
in 2008, although in the interim they will continue to be owned by The Bank of
New York. The Company's Pershing subsidiary, a leading global provider of
clearing and financial services outsourcing, is not included in this
transaction.
In September 2006, the Company reached an agreement to sell its transfer
agency software business, Rufus, to Bravura Solutions Limited ("Bravura"), a
leading global supplier of wealth management applications and professional
services, for a maximum of GBP 32 million. Under the agreement, Bravura will
84
acquire all of the software and intellectual property comprising Rufus, and all
existing employees will transfer to Bravura. The transaction is expected to be
completed in the fourth quarter of 2006, and is subject to approval by
Bravura's shareholders.
4. Discontinued Operations
In the second quarter of 2006, the Company adopted discontinued operations
accounting for its retail and regional middle market banking businesses sold to
JPMorgan Chase.
Results for all the retail and regional middle market banking businesses
are reported separately as discontinued operations for all periods presented.
The assets and liabilities of the businesses being sold are included in assets
of discontinued operations held for sale and liabilities of discontinued
operations held for sale on the consolidated balance sheet. Net interest
income has been computed by allocating investment securities and federal funds
sold and related interest income to discontinued operations to match the amount
and duration of the assets sold with the amount and duration of the liabilities
sold.
Also included in the sales agreement between the Company and JPMorgan
Chase are provisions related to transitional services that will be provided for
a period of up to 8 months after closing, subject to extensions.
Summarized financial information for discontinued operations related to
the sale of the retail and regional middle market banking businesses is as
follows:
Year-to-date
(In millions) 3Q06 2Q06 3Q05 2006 2005
---- ---- ---- ---------------
Net Interest Income $ 155 $ 154 $ 146 $ 458 $ 421
Noninterest Income 66 60 63 197 187
------ ----- ----- ------ ------
Total Revenue,
Net of Interest Expense $ 221 $ 214 $ 209 $ 655 $ 608
====== ===== ===== ====== ======
Income from
Discontinued Operations $ 96 $ 99 $ 105 $ 297 $ 281
Income Taxes 42 42 49 124 119
------ ----- ----- ------ -----
Income from Discontinued
Operations, Net of Taxes $ 54 $ 57 $ 56 $ 173 $ 162
====== ===== ===== ====== =====
The following is a summary of the assets and liabilities of discontinued
operations held for sale as of September 30, 2006 and December 31, 2005:
September 30, December 31,
(In millions) 2006 2005
------------ ------------
Assets
------
Cash and Due from Banks $ 578 $ 633
Securities 120 108
Loans 7,697 7,714
Goodwill 109 109
Other Assets 324 244
------- -------
Total Assets $ 8,828 $ 8,808
======= =======
Liabilities
-----------
Deposits $12,981 $14,637
Other Liabilities 54 44
------- -------
Total Liabilities $13,035 $14,681
======= =======
85
5. Goodwill and Intangibles
------------------------
Goodwill by reportable segment is as follows:
(In millions)
September 30, 2006 December 31, 2005
------------------ -----------------
Institutional Services $ 3,195 $ 3,121
Private Bank &
BNY Asset Management 606 389
Corporate & Other - -
------------------ -----------------
Consolidated Total $ 3,801 $ 3,510
================== =================
The Company's reporting units are tested annually for goodwill impairment.
Intangible Assets
-----------------
September 30, 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 630 (138) 492 15 531 (99) 432
Other Intangible
Assets 25 (23) 2 6 28 (19) 9
The aggregate amortization expense of intangibles was $14 million and $10
million for the quarters ended September 30, 2006 and 2005, respectively. The
aggregate amortization expense of intangibles was $42 million and $28 million
for the nine months ended September 30, 2006 and 2005. Estimated amortization
expense for current intangibles for the next five years is as follows:
For the Year Ended Amortization
(In millions) December 31, Expense
------------------ ------------
2006 $57
2007 54
2008 53
2009 51
2010 49
6. Allowance for Credit Losses
---------------------------
The allowance for credit losses is maintained at a level that, in
management's judgment, is adequate to absorb probable losses associated with
specifically identified loans, as well as estimated probable credit losses
inherent in the remainder of the loan portfolio at the balance sheet date.
Management's judgment includes the following factors, among others: risks of
individual credits; past experience; the volume, composition, and growth of the
loan portfolio; and economic conditions.
The Company conducts a quarterly portfolio review to determine the
adequacy of its allowance for credit losses. All commercial loans over $1
million are assigned to specific risk categories. Smaller commercial and
consumer loans are evaluated on a pooled basis and assigned to specific risk
categories. Following this review, senior management of the Company analyzes
the results and determines the allowance for credit losses. The Risk Committee
of the Company's Board of Directors reviews the allowance at the end of each
quarter.
The portion of the allowance for credit losses allocated to impaired loans
(nonaccrual commercial loans over $1 million) is measured by the difference
between their recorded value and fair value. Fair value is the present value
86
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:
Continuing Operations
---------------------
(In millions) Three Months Ended September 30, 2006
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 337 $ 143 $ 480
Charge-Offs - - -
Recoveries - - -
-------------- --------------- -------------
Net Charge-Offs - - -
Provision 2 (6) (4)
-------------- --------------- -------------
Balance, End of Period $ 339 $ 137 $ 476
============== =============== =============
(In millions) Three Months Ended September 30, 2005
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 463 $ 138 $ 601
Charge-Offs (4) - (4)
Recoveries - - -
-------------- --------------- -------------
Net Charge-Offs (4) - (4)
Provision 12 (2) 10
-------------- --------------- -------------
Balance, End of Period $ 471 $ 136 $ 607
============== =============== =============
87
(In millions) Nine Months Ended September 30, 2006
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 326 $ 145 $ 471
Charge-Offs (4) - (4)
Recoveries 14 - 14
-------------- --------------- -------------
Net Charge-Offs 10 - 10
Provision 3 (8) (5)
-------------- --------------- -------------
Balance, End of Period $ 339 $ 137 $ 476
============== =============== =============
(In millions) Nine Months Ended September 30, 2005
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, Beginning of Period $ 491 $ 136 $ 627
Charge-Offs (12) - (12)
Recoveries 2 - 2
-------------- --------------- -------------
Net Charge-Offs (10) - (10)
Provision (10) - (10)
-------------- --------------- -------------
Balance, End of Period $ 471 $ 136 $ 607
============== =============== =============
7. Capital Transactions
--------------------
The Company has 5 million authorized shares of Class A preferred stock
having a par value of $2.00 per share. At September 30, 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 September 30, 2006 and December 31, 2005, respectively.
On October 10, 2006, the Board of Directors declared a quarterly dividend
of 22 cents per share payable November 3, 2006 to shareholders of record on
October 25, 2006.
The Company repurchased 9,870 shares in the third quarter of 2006. On
October 3, 2006, the Company repurchased 12.1 million common shares including
10 million shares through an accelerated share repurchase program.
88
8. Earnings Per Share
------------------
The following table illustrates the computations of basic and diluted
earnings per share:
(Dollars in millions, Three Months Ended Nine Months Ended
except per share amounts) September 30, September 30,
------------------ ------------------
2006 2005 2006 2005
-------- -------- -------- --------
Income from Continuing Operations $ 298 $ 333 $ 1,049 $ 1,004
Income from Discontinued Operations 54 56 173 162
-------- -------- -------- --------
Net Income (1) $ 352 $ 389 $ 1,222 $ 1,166
======== ======== ======== ========
Basic Weighted Average
Shares Outstanding 757 761 758 766
Shares Issuable Upon Conversion
of Employee Stock Options 10 8 10 7
-------- -------- -------- --------
Diluted Weighted Average
Shares Outstanding 767 769 768 773
======== ======== ======== ========
Basic Earnings Per Share:
Income from Continuing Operations $ 0.40 $ 0.44 $ 1.38 $ 1.31
Income from Discontinued Operations 0.07 0.07 0.23 0.21
Net Income 0.47 0.51 1.61 1.52
Diluted Earnings Per Share:
Income from Continuing Operations $ 0.39 $ 0.44 $ 1.36 $ 1.30
Income from Discontinued Operations 0.07 0.07 0.23 0.21
Net Income 0.46 0.51 1.59 1.51
(1) Net income, net income available to common shareholders and diluted net income are the same
for all periods presented.
9. Employee Benefit Plans
----------------------
The components of net periodic benefit cost are as follows:
Pension Benefits Healthcare Benefits
-------------------------------------- ------------------------------------
Three Months Ended Nine Months Ended Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
--------------------------------------- ------------------ ----------------
Domestic Foreign Domestic Foreign Domestic Domestic
--------- --------- --------- --------- ------------------ ----------------
(In millions) 2006 2005 2006 2005 2006 2005 2006 2005 2006 2005 2006 2005
--------------------- ---- ---- ---- ---- ---- ---- ---- ---- -------- -------- -------- ------
Net Periodic Cost (Income)
Service Cost $ 13 $ 16 $ 2 $ 2 $ 37 $ 48 $ 7 $ 6 $ - $ - $ - $ 1
Interest Cost 13 14 3 2 40 42 9 7 2 2 8 6
Expected Return on Assets (25) (30) (4) (2) (75) (90) (11) (8) (1) (2) (3) (5)
Other 9 4 2 - 27 13 4 1 3 2 8 5
---- ---- ---- ---- ---- ---- ---- ---- ------- -------- ------- ------
Net Periodic Cost
(Income)(1) $ 10 $ 4 $ 3 $ 2 $ 29 $ 13 $ 9 $ 6 $ 4 $ 2 $ 13 $ 7
==== ==== ==== ==== ==== ==== ==== ==== ======= ======== ======= ======
(1) Includes discontinued operations expense. Pension benefits expense includes discontinued
operations expense of $1.5 million for the three months ended September 30 2006 and 2005, and $4.5
million for the nine months ended September 30, 2006 and 2005.
89
10. Income Taxes
------------
The statutory federal income tax rate is reconciled to the Company's
effective income tax rate on a continuing operations basis below:
Nine Months Ended
September 30,
-----------------
2006 2005
------ ------
Federal Rate 35.0% 35.0%
State and Local Income Taxes,
Net of Federal Income Tax Benefit 1.7 3.2
Nondeductible Expenses 0.2 0.6
Credit for Synthetic Fuel Investments (1.6) (2.2)
Credit for Low-Income Housing Investments (1.9) (1.9)
Tax-Exempt Income From Municipal Securities (0.1) (0.2)
Other Tax-Exempt Income (1.3) (1.3)
Foreign Operations (0.6) (0.2)
Other - Net 0.8 (0.9)
------ ------
Effective Rate 32.2% 32.1%
====== ======
11. Derivatives and Hedging Relationships
-------------------------------------
Derivative contracts, such as futures contracts, forwards, interest rate
swaps, foreign currency swaps and options and similar products used in trading
activities, are recorded at fair value. The Company does not recognize gains
or losses at the inception of derivative transactions if the fair value is not
determined based upon observable market transactions and market data. Gains
and losses are included in foreign exchange and other trading activities in
non-interest income. Unrealized gains and losses are reported on a gross basis
in trading account assets and trading liabilities, after taking into
consideration master netting agreements.
The Company enters into various derivative financial instruments for non-
trading purposes primarily as part of its asset/liability management ("ALM")
process. These derivatives are designated as fair value and cash flow hedges
of certain assets and liabilities when the Company enters into the derivative
contracts. Gains and losses associated with fair value hedges are recorded in
income as well as any change in the value of the related hedged item. Gains and
losses on cash flow hedges are recorded in other comprehensive income. If a
derivative used in ALM does not qualify as a hedge it is marked to market and
the gain or loss is included in net interest income.
The Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objectives and
strategy for undertaking various hedge transactions. This process includes
linking all derivatives that are designated as fair value hedges to specific
assets or liabilities on the balance sheet.
The Company formally assesses both at the hedge's inception and on an
ongoing basis whether the derivatives that are used in hedging transactions are
highly effective and whether those derivatives are expected to remain highly
effective in future periods. The Company evaluates ineffectiveness in terms of
amounts that could impact a hedge's ability to qualify for hedge accounting and
the risk that the hedge could result in more than a de minimus amount of
ineffectiveness. At inception, the potential causes of ineffectiveness related
to each of its hedges is assessed to determine if the Company can expect the
hedge to be highly effective over the life of the transaction and to determine
the method for evaluating effectiveness on an ongoing basis. Recognizing that
changes in the value of derivatives used for hedging or the value of hedged
items could result in significant ineffectiveness, the Company has processes in
90
place designed to identify and evaluate such changes when they occur.
Quarterly, the Company performs a quantitative effectiveness assessment and
records any ineffectiveness.
The Company utilizes interest rate swap agreements to manage its exposure
to interest rate fluctuations. For hedges of fixed rate loans, asset-backed
securities, deposits and long term debt, the hedge documentation specifies the
terms of the hedged items and interest rate swaps and indicates that the
derivative is hedging a fixed rate item and is a fair value hedge, that the
hedge exposure is to the changes in the fair value of the hedged item due to
changes in benchmark interest rates, and that the strategy is to eliminate fair
value variability by converting fixed rate interest payments to LIBOR.
The fixed rate loans hedged generally have a maturity of 1 to 10 years and
are not callable. These loans are hedged with "pay fixed rate, receive
variable rate" swaps with similar notional amounts, maturities, and fixed rate
coupons. The swaps are not callable. At September 30, 2006, $147 million of
loans were hedged with interest rate swaps which had notional values of $150
million.
The securities hedged generally have a weighted average life of 10 years
and are callable six months prior to maturity. These securities are hedged
with pay fixed rate, receive variable rate swaps of like maturity, repricing
and fixed rate coupon. The swaps are callable six months prior to maturity.
At September 30, 2006, $230 million of securities were hedged with interest
rate swaps which had notional values of $230 million.
The fixed rate deposits hedged generally have original maturities of 1 to
12 years (64% are one year deposits) and, except for three deposits, are not
callable. These deposits are hedged with receive fixed rate, pay variable rate
swaps of similar maturity, repricing and fixed rate coupon. The swaps are not
callable except for the three that hedge the callable deposits. At September
30, 2006, $1,958 million of deposits were hedged with interest rate swaps which
had notional values of $1,958 million.
The fixed rate long-term debt hedged generally has an original maturity of
5 to 30 years. The Company issues both callable and non-callable debt. The
non-callable debt is hedged with simple interest rate swaps similar to those
described for deposits. Callable debt is hedged with callable swaps where the
call dates of the swaps exactly match the call dates of the debt. At September
30, 2006, $5,489 million of debt was hedged with interest rate swaps which had
notional values of $5,514 million.
In addition to the fair value hedges discussed above, the Company has
three cash flow hedges utilizing interest rate swaps to hedge the variability
in expected future cash flows attributable to floating rates on an interest-
only strip, a deposit and a long-term debt issue. The hedge documentation
specifies the terms of the hedged items and interest rate swaps and indicates
that the derivative is hedging future variable interest payments and is a cash
flow hedge, that the hedge exposure is the variability in interest payments,
and that the strategy is to eliminate variability by converting floating rate
interest payments to fixed payments. For cash flow hedges the interest rate
swap is marked to market with the changes in value recorded in other
comprehensive income. The amount recognized as other comprehensive income for
the cash flow hedge is reclassified to net interest income as interest is
realized on the hedged item.
The Company has a $269 million interest-only strip of which $200 million
is hedged with a $200 million receive fixed rate, pay variable rate interest
rate swaps to remove the variability in the cash flows received from the
security. Payments on the interest-only strip are related to a money market
fund. During the next twelve months, net gains of $3 million (pre-tax) included
in other comprehensive income are expected to be reclassified to income.
The deposit hedged has a principal amount of $275 million and has a LIBOR
based floating rate and an 18 month maturity. The deposit is hedged with a
receive LIBOR, pay fixed rate swap with the same maturity and interest payment
dates as the deposit to eliminate the variability in interest payments on the
91
deposit. During the next twelve months, net losses of $1 million (pre-tax)
included in other comprehensive income are expected to be reclassified to
income.
The long term debt hedged has a principal amount of $400 million and has a
LIBOR based floating rate and a 2 year maturity. The debt is hedged with a
receive LIBOR, pay fixed rate swap with the same maturity and interest payment
dates as the debt to eliminate the variability in interest payments on the
debt. During the next twelve months, net losses of $1 million (pre-tax)
included in other comprehensive income are expected to be reclassified to
income.
In addition, the Company enters into foreign exchange hedges.
The Company uses forward foreign exchange contracts with maturities of 12
months or less to hedge its Sterling and Euro foreign exchange exposure with
respect to forecasted expense transactions in non-U.S. entities which have the
U.S. dollar as their functional currency. As of September 30, 2006, the hedged
forecasted foreign currency transactions and linked forwards were $96 million
with $2 million gains recorded in other comprehensive income. These gains are
expected to be reclassified to expense over the next twelve months.
Forward foreign exchange contracts are also used to hedge the value of the
Company's investments in foreign subsidiaries. These forward contracts have a
maturity of less than six months. The derivatives employed are designated as
net investment hedges of changes in value of the Company's foreign investment
due to exchange rates, such that changes in value of the forward exchange
contracts offset the changes in value of the foreign investments due to changes
in foreign exchange rates. The change in fair market value of these contracts
is deferred and reported within accumulated translation adjustments in
shareholders' equity, net of tax effects. At September 30, 2006, foreign
exchange contracts, with notional amounts totaling $1,678 million, were
designated as hedges of corresponding amounts of net investments.
The Company discontinues hedge accounting prospectively when it determines
that a derivative is no longer an effective hedge, the derivative expires or is
sold, or management discontinues the derivative's hedge designation.
Ineffectiveness related to derivatives and hedging relationships was
recorded in income as follows:
(In millions) Quarter End Year-to-Date
Hedges September 30, 2006 September 30, 2006
------------------------- ------------------ ------------------
Fair Value Hedge of Loans $ 0.1 $ 0.1
Fair Value Hedge
of Securities 0.1 0.1
Fair Value Hedge of Deposits
and Long-Term Debt 0.5 (0.1)
Cash Flow Hedges 0.1 (0.4)
Other 0.4 0.4
------------------ -----------------
Total $ 1.2 $ 0.1
================== =================
Other includes ineffectiveness recorded on foreign exchange hedges.
92
12. 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 September 30, 2006 and December 31,
2005 for continuing operations follows:
Off-Balance-Sheet Credit Risks
------------------------------
September 30, December 31,
(In millions) 2006 2005
----------------------------------- ------------ -----------
Lending Commitments $ 36,308 $ 33,407
Standby Letters of Credit 10,827 9,873
Commercial Letters of Credit 1,077 1,122
Securities Lending Indemnifications 388,371 310,970
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 September 30,
2006 and December 31, 2005 was $137 million and $144 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
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 September 30, 2006 and December
31, 2005, securities lending indemnifications were secured by collateral of
$406.5 billion and $317.4 billion, respectively.
Standby letters of credit principally support corporate obligations and
include $1.2 billion that were collateralized with cash and securities on
September 30, 2006 and $0.6 billion on December 31, 2005. At September 30,
2006, approximately $7.1 billion of the standby letters of credit will expire
within one year, and the remaining balance will expire 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.
93
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 does not
affect 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 U.S. 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.
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
94
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.
95
QUARTERLY REPORT ON FORM 10-Q
THE BANK OF NEW YORK COMPANY, INC.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended September 30, 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 October 31, 2006, The Bank of New York Company, Inc. had
751,841,679 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
September 30, 2006 and December 31, 2005 74
Consolidated Statements of Income for
the Three Months and Nine Months Ended
September 30, 2006 and 2005 75
Consolidated Statement of Changes in
Shareholders' Equity for the Nine Months
Ended September 30, 2006 77
Consolidated Statement of Cash Flows
for the Nine Months Ended
September 30, 2006 and 2005 78
Notes to Consolidated Financial Statements 79 - 94
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 6 - 73
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 54 - 57
96
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. There are inherent limitations to the
effectiveness of any system of disclosure controls and procedures, including
the possibility of human error and the circumvention or overriding of the
controls and procedures. Accordingly, even effective disclosure controls and
procedures can only provide reasonable assurance of achieving their control
objectives.
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"); 3) the trading activities of Pershing
97
Trading Company LP, a floor specialist, on two regional exchanges from 1999 to
2004; and 4) the Company's role as auction agent in connection with certain
auction rate securities.
As to the market-timing and auction agent matters, the Company has
reached agreements in principle with the SEC Staff; however, there can be no
assurance that settlements of these matters will be reached.
Because the conduct at issue in the Pershing market timing and floor
specialist investigations is alleged to have occurred largely during the period
when Pershing was owned by Credit Suisse (USA), Inc. ("CS"), the Company has
made claims for indemnification against CS relating to these matters under the
agreement relating to the acquisition of Pershing. CS is disputing these
claims for indemnification.
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." There have been no material changes to the risk
factors discussed in the Company's Annual Report on Form 10-K for the year
ended December 31, 2005 and the Company's Quarterly Reports on Form 10-Q for
the quarters ended March 31, 2006 and June 30, 2006.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES
------------------------------------------------
AND USE OF PROCEEDS
-------------------
(c) Under its stock repurchase program, the Company buys back shares from time
to time. The following table discloses the Company's repurchases of the
Company's common stock made during the third quarter of 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
-------------- ---------- ---------- --------------- ------------------
July 1-31 6,162 $ 32.65 6,162 20,270,352
August 1-31 3,708 33.58 3,708 20,266,644
September 1-30 - - - 20,266,644
---------- ---------------
Total 9,870 9,870
========== ===============
Shares were repurchased through the Company's stock repurchase programs
announced on July 12, 2005 and June 30, 2006, which permit the repurchase of 34
million shares.
98
ITEM 6. EXHIBITS
-----------------
Pursuant to the rules and regulations of the Securities and Exchange
Commission, the Company has filed certain agreements as exhibits to this
Quarterly Report on Form 10-Q. These agreements may contain representations and
warranties by the parties. These representations and warranties have been made
solely for the benefit of the other party or parties to such agreements and
(i) may have been qualified by disclosures made to such other party or parties,
(ii) were made only as of the date of such agreements or such other date(s) as
may be specified in such agreements and are subject to more recent
developments, which may not be fully reflected in the Company's public
disclosure, (iii) may reflect the allocation of risk among the parties to
such agreements and (iv) may apply materiality standards different from what
may be viewed as material to investors. Accordingly, these representations
and warranties may not describe the Company's actual state of affairs at the
date hereof and should not be relied upon.
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 of such instrument.
10.1 Purchase and Assumption Agreement, dated 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.
10.2 Amended and Restated Purchase and Assumption Agreement, dated as of
October 1, 2006, by and between The Bank of New York Company, Inc. and
JPMorgan Chase & Co.
12 Ratio of Earnings to Fixed Charges for the Three Months and Nine
Months Ended September 30, 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.
99
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
THE BANK OF NEW YORK COMPANY, INC.
----------------------------------
(Registrant)
Date: November 6, 2006 By: /s/ Thomas J. Mastro
---------------------------------
Name: Thomas J. Mastro
Title: Comptroller
100
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.
10.1 Purchase and Assumption Agreement, dated 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.
10.2 Amended and Restated Purchase and Assumption Agreement, dated as
of October 1, 2006, by and between The Bank of New York Company,
Inc. and JPMorgan Chase & Co.
12 Ratio of Earnings to Fixed Charges for the Three Months and Nine
Months Ended September 30, 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.