-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SSlyaNaQvebhANrhVrSBRM9DngkA5lm8ibA0dS8zxOnxp9UwZNoBA8gVjklXXtuj oLoWBCWj0FRXR93hpNfYEg== 0000950123-99-007738.txt : 19990817 0000950123-99-007738.hdr.sgml : 19990817 ACCESSION NUMBER: 0000950123-99-007738 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990816 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PAINE WEBBER GROUP INC CENTRAL INDEX KEY: 0000075754 STANDARD INDUSTRIAL CLASSIFICATION: SECURITY BROKERS, DEALERS & FLOTATION COMPANIES [6211] IRS NUMBER: 132760086 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-07367 FILM NUMBER: 99692671 BUSINESS ADDRESS: STREET 1: 1285 AVE OF THE AMERICAS CITY: NEW YORK STATE: NY ZIP: 10019 BUSINESS PHONE: 2127132000 MAIL ADDRESS: STREET 1: 1285 AVENUE OF THE AMERICAS CITY: NEW YORK STATE: NY ZIP: 10019 FORMER COMPANY: FORMER CONFORMED NAME: PAINE WEBBER INC DATE OF NAME CHANGE: 19840523 10-Q 1 PAINE WEBBER GROUP, INC. 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended June 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to COMMISSION FILE NUMBER 1-7367 PAINE WEBBER GROUP INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 13-2760086 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 1285 AVENUE OF THE AMERICAS NEW YORK, NEW YORK 10019 (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 713-2000 Indicate by check mark whether the Registrant (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 for 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. YES [X] NO [_] On August 6, 1999, the Registrant had outstanding 145,576,877 shares of common stock of $1 par value, which is the Registrant's only class of common stock. 2 PAINE WEBBER GROUP INC. FORM 10-Q JUNE 30, 1999 TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page Item 1. Financial Statements. Condensed Consolidated Statements of Income (unaudited) for the Three and Six Months Ended June 30, 1999 and 1998. 2 Condensed Consolidated Statements of Financial Condition (unaudited) at June 30, 1999 and December 31, 1998. 3 Condensed Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 1999 and 1998. 4 Notes to Condensed Consolidated Financial Statements (unaudited). 5-13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 14-22 PART II. OTHER INFORMATION Item 1. Legal Proceedings. 23 Item 6. Exhibits and Reports on Form 8-K. 23 Signature. 24
3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PAINE WEBBER GROUP INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (In thousands of dollars except share and per share amounts)
Three Months Ended Six Months Ended June 30, June 30, ------------------------ ------------------------ 1999 1998 1999 1998 ----------- ----------- ----------- ----------- REVENUES Commissions $ 488,878 $ 402,094 $ 967,751 $ 810,218 Principal transactions 279,846 244,146 594,054 521,109 Asset management 224,487 182,128 430,538 340,864 Investment banking 160,133 176,687 286,086 301,656 Interest 770,271 860,707 1,527,431 1,663,085 Other 47,363 34,521 88,428 68,461 ------------ ------------ ------------ ----------- Total revenues 1,970,978 1,900,283 3,894,288 3,705,393 Interest expense 623,071 738,115 1,231,490 1,428,248 ------------ ------------ ------------ ----------- Net revenues 1,347,907 1,162,168 2,662,798 2,277,145 ------------ ------------ ------------ ----------- NON-INTEREST EXPENSES Compensation and benefits 780,078 682,088 1,548,792 1,332,663 Office and equipment 89,330 74,862 170,782 147,402 Communications 42,645 37,140 84,848 74,896 Business development 28,534 26,290 52,401 48,369 Brokerage, clearing & exchange fees 23,487 22,081 47,877 47,577 Professional services 32,397 30,390 62,849 63,982 Other 81,769 77,318 160,563 152,062 ------------ ------------ ------------ ----------- Total non-interest expenses 1,078,240 950,169 2,128,112 1,866,951 ------------ ------------ ------------ ----------- INCOME BEFORE TAXES AND MINORITY INTEREST 269,667 211,999 534,686 410,194 Provision for income taxes 98,102 74,437 194,461 143,836 ------------ ------------ ------------ ----------- INCOME BEFORE MINORITY INTEREST 171,565 137,562 340,225 266,358 Minority interest 8,061 8,061 16,122 16,122 ------------ ------------ ------------ ----------- NET INCOME $ 163,504 $ 129,501 $ 324,103 $ 250,236 ============ ============ ============ =========== Net income applicable to common shares $ 157,555 $ 123,589 $ 312,205 $ 238,413 ============ ============ ============ =========== Earnings per common share: Basic $ 1.08 $ 0.88 $ 2.14 $ 1.71 Diluted $ 1.02 $ 0.82 $ 2.02 $ 1.59 Weighted-average common shares: Basic 145,742,741 140,032,972 145,631,920 139,609,704 Diluted 154,960,397 151,161,713 154,305,795 150,177,958 Dividends declared per common share $ 0.11 $ 0.11 $ 0.22 $ 0.22
See notes to condensed consolidated financial statements. 2 4 PAINE WEBBER GROUP INC. CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED) (In thousands of dollars except share and per share amounts)
June 30, December 31, 1999 1998 ------------ ------------- ASSETS Cash and cash equivalents $ 298,020 $ 228,359 Cash and securities segregated and on deposit for federal and other regulations 685,857 631,272 Trading assets 21,515,370 19,299,869 Securities received as collateral 988,079 1,189,331 ------------ ------------ Total trading assets, at fair value 22,503,449 20,489,200 Securities purchased under agreements to resell 14,523,964 14,217,062 Securities borrowed 8,914,986 8,717,476 Receivables, net of allowance for doubtful accounts of $18,222 and $20,496 at June 30, 1999 and December 31, 1998, respectively 8,906,407 7,876,619 Office equipment and leasehold improvements, net of accumulated depreciation and amortization of $475,815 and $431,460 at June 30, 1999 and December 31, 1998, respectively 492,462 434,895 Other assets 1,781,902 1,581,038 ------------ ------------ $ 58,107,047 $ 54,175,921 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Short-term borrowings $ 1,184,494 $ 1,417,783 Trading liabilities, at fair value 8,040,353 5,177,099 Securities sold under agreements to repurchase 25,646,267 23,948,872 Securities loaned 4,983,659 4,969,638 Obligation to return securities received as collateral 988,079 1,189,331 Payables 6,314,705 7,519,368 Other liabilities and accrued expenses 2,721,347 2,675,520 Long-term borrowings 4,942,785 4,255,802 ------------ ------------ 54,821,689 51,153,413 ------------ ------------ Commitments and contingencies Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts holding solely Company Guaranteed Related Subordinated Debt 393,750 393,750 Redeemable Preferred Stock 190,464 189,815 Stockholders' Equity: Common stock, $1 par value, 400,000,000 shares authorized, issued 192,585,042 shares and 191,047,151 shares at June 30, 1999 and December 31, 1998, respectively 192,585 191,047 Additional paid-in capital 1,601,052 1,525,938 Retained earnings 1,969,134 1,689,386 Treasury stock, at cost; 47,216,571 shares and 45,527,707 shares at June 30, 1999 and December 31, 1998, respectively (1,054,060) (962,792) Accumulated other comprehensive income (7,567) (4,636) ------------ ------------ 2,701,144 2,438,943 ------------ ------------ $ 58,107,047 $ 54,175,921 ============ ============
See notes to condensed consolidated financial statements. 3 5 PAINE WEBBER GROUP INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands of dollars)
Six Months Ended June 30, 1999 1998 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 324,103 $ 250,236 Adjustments to reconcile net income to cash used for operating activities: Noncash items included in net income: Depreciation and amortization 49,206 35,456 Deferred income taxes (10,317) 46,732 Amortization of deferred charges 51,736 53,559 (Increase) decrease in operating assets: Cash and securities on deposit (54,585) (24,932) Trading assets (2,200,354) (2,324,744) Securities purchased under agreements to resell (306,902) (1,857,032) Securities borrowed (197,510) 251,021 Receivables (1,032,062) (1,120,493) Other assets (243,111) (377,786) Increase (decrease) in operating liabilities: Trading liabilities 2,863,254 1,560,244 Securities sold under agreements to repurchase 1,697,395 1,902,372 Securities loaned 14,021 755,494 Payables (1,204,663) 235,781 Other 85,416 (28,027) -------------- -------------- Cash used for operating activities (164,373) (642,119) -------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Payments for: Office equipment and leasehold improvements (110,289) (90,833) ------------ ------------ Cash used for investing activities (110,289) (90,833) ------------ ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net (payments on) proceeds from short-term borrowings (233,289) 469,602 Proceeds from: Long-term borrowings 875,985 641,459 Employee stock transactions 56,593 35,741 Payments for: Long-term borrowings (190,180) (223,132) Repurchases of common stock (121,080) (59,465) Dividends (43,706) (42,068) -------------- ------------- Cash provided by financing activities 344,323 822,137 ------------ ------------ Increase in cash and cash equivalents 69,661 89,185 Cash and cash equivalents, beginning of period 228,359 233,787 ------------ ------------ Cash and cash equivalents, end of period $ 298,020 $ 322,972 =========== ===========
See notes to condensed consolidated financial statements. 4 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (In thousands of dollars except share and per share amounts) NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The condensed consolidated financial statements include the accounts of Paine Webber Group Inc. ("PWG") and its wholly owned subsidiaries, including its principal subsidiary PaineWebber Incorporated ("PWI") (collectively, the "Company"). All material intercompany balances and transactions have been eliminated. Certain reclassifications have been made to prior year amounts to conform to current year presentations. The December 31, 1998 Condensed Consolidated Statement of Financial Condition was derived from the audited consolidated financial statements of the Company. The financial information as of and for the periods ended June 30, 1999 and 1998 is unaudited. All normal recurring adjustments which, in the opinion of management, are necessary for a fair presentation have been made. Certain financial information that is normally in annual financial statements but is not required for interim reporting purposes has been condensed or omitted. The condensed consolidated financial statements are prepared in conformity with generally accepted accounting principles which require management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates. These financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 1998 and the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1999. The results of operations reported for interim periods are not necessarily indicative of the results of operations for the entire year. Statement of Cash Flows Total interest payments, which relate principally to agreements to repurchase, short-term borrowings, securities loaned and long-term borrowings, were $1,211,332 and $1,465,639 for the six months ended June 30, 1999 and 1998, respectively. Income taxes paid were $118,274 and $104,585 for the six months ended June 30, 1999 and 1998, respectively. Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes revised accounting and reporting standards for derivative instruments and for hedging activities. It requires that an entity measure all derivative instruments at fair value and recognize such instruments as either assets or liabilities in the consolidated statements of financial condition. The accounting for changes in the fair value of a derivative instrument will depend on the intended use of the derivative as either a fair value hedge, a cash flow hedge or a foreign currency hedge. The effect of the changes in fair value of the derivatives and, in certain cases, the hedged items are to be reflected in either the consolidated statements of income or as a component of other comprehensive income, based upon the resulting designation. As issued, SFAS No. 133 was effective for fiscal years beginning after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133." SFAS No. 137 defers the effective date of SFAS No. 133 for one year to fiscal years beginning after June 15, 2000. The Company has not yet determined the impact of this statement on the Company's Consolidated Financial Statements, taken as a whole. In March 1998, the Accounting Standards Executive Committee ("AcSEC") of the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 required the capitalization of certain costs incurred from developing or obtaining software for internal use. The Company early adopted SOP 98-1 in 1998, which did not have a material impact on the Company's consolidated financial statements, taken as a whole. In September 1998, the AcSEC of the AICPA issued SOP 98-5, "Reporting on the Costs of Start-up Activities." SOP 98-5 required the costs of certain start-up activities, which includes organizational costs, to be expensed as incurred. The Company early adopted SOP 98-5 in 1998, which did not have a material impact on the Company's consolidated financial statements, taken as a whole. 5 7 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2: TRADING ASSETS AND LIABILITIES At June 30, 1999 and December 31, 1998, trading assets and liabilities, recorded at fair value or amounts approximating fair value, consisted of the following:
June 30, December 31, 1999 1998 ------------- ------------- Trading assets: U.S. government and agencies $ 7,561,634 $ 4,858,189 Mortgages and mortgage-backed 8,665,234 8,861,944 Corporate debt 1,818,824 2,466,322 Commercial paper and other short-term debt 1,790,036 1,534,913 Equities 849,232 1,078,322 State and municipals 830,410 500,179 ------------ -------------- 21,515,370 19,299,869 Securities received as collateral 988,079 1,189,331 ------------ -------------- $ 22,503,449 $ 20,489,200 ============ ============ Trading liabilities: U.S. government and agencies $ 6,393,034 $ 4,031,254 Mortgages and mortgage-backed 232,272 79,521 Corporate debt 1,070,527 837,099 Equities 310,494 215,991 State and municipals 34,026 13,234 ------------- ------------- $ 8,040,353 $ 5,177,099 ============= =============
NOTE 3: LONG-TERM BORROWINGS Long-term borrowings at June 30, 1999 and December 31, 1998 consisted of the following:
June 30, December 31, 1999 1998 ------------- ------------- Fixed Rate Notes due 2000 - 2014 $ 2,487,009 $ 1,961,340 Fixed Rate Subordinated Notes due 2002 174,721 174,677 Medium-Term Senior Notes 2,122,855 1,936,835 Medium-Term Subordinated Notes 158,200 182,950 ------------- ------------- $ 4,942,785 $ 4,255,802 ============= =============
At June 30, 1999, interest rates on the fixed rate notes and fixed rate subordinated notes ranged from 6.38 percent to 9.25 percent and the weighted-average interest rate on these notes outstanding at June 30, 1999 was 7.16 percent. Interest on the notes is payable semi-annually. The fixed rate notes and fixed rate subordinated notes outstanding at June 30, 1999 had an average maturity of 5.6 years. At June 30, 1999, the Company had outstanding $1,355,905 of fixed rate Medium-Term Notes and $925,150 of variable rate Medium-Term Notes. The Medium-Term Notes outstanding at June 30, 1999 had an average maturity of 4.5 years and a weighted-average interest rate of 6.37 percent. At June 30, 1999 and December 31, 1998, the fair values of long-term borrowings were $4,904,753 and $4,325,014, respectively, as compared to the carrying amounts of $4,942,785 and $4,255,802, respectively. The estimated fair value of long-term borrowings is based upon quoted market prices for the same or similar issues and pricing models. However, for substantially all of its fixed rate debt, the Company enters into interest rate swap agreements to convert its fixed rate payments into floating rate payments. The net fair values of the interest rate swaps were $27,786 payable and $122,053 receivable at June 30, 1999 and December 31, 1998, respectively. The fair value of interest rate swaps used to hedge the Company's fixed rate debt is based upon the amounts the Company would receive or pay to terminate the agreements, taking into account current interest rates. 6 8 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The carrying amounts of the interest rate swap agreements included in the Company's Condensed Consolidated Statements of Financial Condition at June 30, 1999 and December 31, 1998 were net receivables of $12,564 and $8,827, respectively. See Note 5 for further discussion of interest rate swap agreements used for hedging purposes. NOTE 4: CAPITAL REQUIREMENTS PWI, a registered broker-dealer, is subject to the Securities and Exchange Commission Uniform Net Capital Rule and New York Stock Exchange Growth and Business Reduction capital requirements. Under the method of computing capital requirements adopted by PWI, minimum net capital shall not be less than 2 percent of combined aggregate debit items arising from client transactions, plus excess margin collected on securities purchased under agreements to resell, as defined. A reduction of business is required if net capital is less than 4 percent of such aggregate debit items. Business may not be expanded if net capital is less than 5 percent of such aggregate debit items. As of June 30, 1999, PWI's net capital of $1,144,367 was 12.1 percent of aggregate debit items and its net capital in excess of the minimum required was $946,736. NOTE 5: FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK Held or Issued for Trading Purposes Set forth below are the gross contract or notional amounts of the Company's outstanding off-balance-sheet derivative and other financial instruments held or issued for trading purposes. These amounts are not reflected in the Condensed Consolidated Statements of Financial Condition and are indicative only of the volume of activity at June 30, 1999 and December 31, 1998. They do not represent amounts subject to market risks, and in many cases, limit the Company's overall exposure to market losses by hedging other on- and off-balance-sheet transactions. The amounts are netted by counterparty only when specific conditions are met.
Notional or Contract Amount ----------------------------------------------------------------- June 30, 1999 December 31, 1998 ----------------------------- ---------------------------- Purchases Sales Purchases Sales --------- ----------- --------- ----------- Mortgage-backed forward contracts and options written and purchased $26,544,086 $32,791,507 $30,296,601 $35,558,370 Foreign currency forward contracts, futures contracts, and options written and purchased 1,994,790 2,001,660 2,709,421 2,628,824 Equity securities contracts including stock index futures, forwards, and options written and purchased 152,302 190,468 156,519 332,248 Other fixed income securities contracts including futures, forwards, and options written and purchased 4,993,292 2,059,055 3,890,619 4,336,300 Interest rate swaps and caps 1,295,880 459,898 1,292,620 282,546
7 9 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Set forth below are the fair values of derivative financial instruments held or issued for trading purposes as of June 30, 1999 and December 31, 1998.
Fair Value at Fair Value at June 30, 1999 December 31, 1998 ---------------------------- -------------------------- Assets Liabilities Assets Liabilities -------- ----------- ------ ----------- Mortgage-backed forward contracts and options written and purchased $180,667 $230,454 $ 85,995 $ 76,315 Foreign currency forward contracts, futures contracts, and options written and purchased 18,227 17,872 31,622 31,726 Equity securities contracts including stock index futures, forwards, and options written and purchased 67,452 41,226 26,806 46,606 Other fixed income securities contracts including futures, forwards, and options written and purchased 11,666 7,120 12,183 55,015 Interest rate swaps and caps 20,554 6,243 34,749 8,096
Set forth below are the average fair values of derivative financial instruments held or issued for trading purposes for the three months ended June 30, 1999 and the twelve months ended December 31, 1998. The average fair value is based on the average of the month-end balances during the periods indicated.
Average Fair Value Average Fair Value Three Months Ended Twelve Months Ended June 30, 1999 December 31, 1998 ------------- ----------------- Assets Liabilities Assets Liabilities ------ ----------- ------ ----------- Mortgage-backed forward contracts and options written and purchased $193,756 $180,962 $158,215 $146,522 Foreign currency forward contracts, futures contracts, and options written and purchased 19,856 19,804 46,222 45,895 Equity securities contracts including stock index futures, forwards, and options written and purchased 64,895 41,767 20,836 42,995 Other fixed income securities contracts including futures, forwards, and options written and purchased 9,881 44,546 16,547 41,786 Interest rate swaps and caps 17,238 5,165 13,423 40,760
The Company also enters into agreements to sell securities, at predetermined prices, which have not yet been purchased. The Company is exposed to market risk since to satisfy the obligation, the Company must acquire the securities at market prices, which may exceed the values reflected on the Condensed Consolidated Statements of Financial Condition. 8 10 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The off-balance-sheet derivative trading transactions are generally short-term. At June 30, 1999 approximately 98 percent of the off-balance-sheet trading-related derivative and other financial instruments had remaining maturities of less than one year. The Company's risk of loss in the event of counterparty default is limited to the current fair value or the replacement cost on contracts in which the Company has recorded an unrealized gain. These amounts are reflected as assets on the Company's Condensed Consolidated Statements of Financial Condition and amounted to $298,566 and $191,355 at June 30, 1999 and December 31, 1998, respectively. Options written do not expose the Company to credit risk since they do not obligate the counterparty to perform. Transactions in futures contracts are conducted through regulated exchanges which have margin requirements, and are settled in cash on a daily basis, thereby minimizing credit risk. The following table summarizes the Company's principal transactions revenues by business activity for the three months and six months ended June 30, 1999 and 1998. Principal transactions revenues include realized and unrealized gains and losses on trading positions, including hedges. In assessing the profitability of its trading activities, the Company views net interest and principal transactions revenues in the aggregate.
Principal Transactions Revenues ------------------------------- Three Months Six Months Ended June 30, Ended June 30, --------------------- ---------------------- 1999 1998 1999 1998 --------- --------- --------- --------- Taxable fixed income (includes futures, forwards, options contracts and other securities) $137,646 $132,635 $332,050 $274,118 Equities (includes stock index futures, forwards and options contracts) 107,424 74,794 192,331 179,090 Municipals 34,776 36,717 69,673 67,901 -------- -------- -------- -------- $279,846 $244,146 $594,054 $521,109 ======== ======== ======== ========
Held or Issued for Purposes Other Than Trading The Company enters into interest rate swap agreements to manage the interest rate characteristics of its assets and liabilities. As of June 30, 1999 and December 31, 1998, the Company had outstanding interest rate swap agreements with commercial banks with notional amounts of $3,693,985 and $3,096,985, respectively. These agreements effectively converted substantially all of the Company's fixed rate debt at June 30, 1999 into floating rate debt. The interest rate swap agreements entered into have had the effect of reducing net interest expense on the Company's fixed rate debt by $13,791 and $6,986 for the six months ended June 30, 1999 and 1998, respectively. The Company had no deferred gains or losses related to terminated swap agreements at June 30, 1999 and December 31, 1998 on its long-term borrowings. The Company is subject to market risk as interest rates fluctuate. The interest rate swaps contain credit risk to the extent the Company is in a receivable or gain position and the counterparty defaults. However, the counterparties to the agreements generally are large financial institutions, and the Company has not experienced defaults in the past, and management does not anticipate any counterparty defaults in the foreseeable future. See Note 3 for further discussion of interest rate swap agreements used for hedging purposes. NOTE 6: RISK MANAGEMENT Transactions involving derivative and non-derivative financial instruments involve varying degrees of both market and credit risk. The Company monitors its exposure to market and credit risk on a daily basis and through a variety of financial, security position and credit exposure reporting and control procedures. Market Risk Market risk is the potential change in value of the financial instrument caused by unfavorable changes in interest rates, equity prices, and foreign currency exchange rates. The Company has a variety of methods to monitor its market risk profile. The senior management of each business group is responsible for reviewing trading positions, exposures, profits and losses, and trading strategies. The Company also has an independent risk management group which reviews the Company's risk profile and aids in setting and monitoring risk management policies of the Company, including monitoring adherence to the established limits, performing market risk modeling, and reviewing trading positions and hedging strategies. The Asset/Liability Management Committee, comprised of senior corporate and business group managers, is responsible for establishing trading position and exposure limits. 9 11 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Market risk modeling is based on estimating loss exposure through sensitivity testing. These results are compared to established limits, and exceptions are subject to review and approval by senior management. Other market risk control procedures include monitoring inventory agings, reviewing traders' marks and regular meetings between the senior management of the business groups and the risk management group. Credit Risk in Proprietary Transactions Counterparties to the Company's proprietary trading, hedging, financing and arbitrage activities are primarily financial institutions, including banks, brokers and dealers, investment funds and insurance companies. Credit losses could arise should counterparties fail to perform and the value of any collateral proves inadequate. The Company manages credit risk by monitoring net exposure to individual counterparties on a daily basis, monitoring credit limits and requiring additional collateral where appropriate. Derivative credit exposures are calculated, aggregated and compared to established limits by the credit department. Credit reserve requirements are determined by senior management in conjunction with the Company's continuous credit monitoring procedures. Historically, reserve requirements arising from instruments with off-balance-sheet risk have not been material. Receivables and payables with brokers and dealers, agreements to resell and repurchase securities, and securities borrowed and loaned are generally collateralized by cash, government and government-agency securities, and letters of credit. The market value of the initial collateral received approximates or is greater than the contract value. Additional collateral is requested when considered necessary. The Company may pledge clients' margined securities as collateral in support of securities loaned and bank loans, as well as to satisfy margin requirements at clearing organizations. The amounts loaned or pledged are limited to the extent permitted by applicable margin regulations. Should the counterparty fail to return the clients' securities, the Company may be required to replace them at prevailing market prices. At June 30, 1999, the market value of client securities loaned to other brokers approximated the amounts due or collateral obtained. Credit Risk in Client Activities Client transactions are entered on either a cash or margin basis. In a margin transaction, the Company extends credit to a client for the purchase of securities, using the securities purchased and/or other securities in the client's account as collateral for amounts loaned. Receivables from customers are substantially collateralized by customer securities. Amounts loaned are limited by margin regulations of the Federal Reserve Board and other regulatory authorities and are subject to the Company's credit review and daily monitoring procedures. Market declines could, however, reduce the value of any collateral below the principal amount loaned, plus accrued interest, before the collateral can be sold. Client transactions include positions in commodities and financial futures, trading liabilities and written options. The risk to the Company's clients in these transactions can be substantial, principally due to price volatility which can reduce the clients' ability to meet their obligations. Margin deposit requirements pertaining to commodity futures and exchange-traded options transactions are generally lower than those for exchange-traded securities. To the extent clients are unable to meet their commitments to the Company and margin deposits are insufficient to cover outstanding liabilities, the Company may take market action and credit losses could be realized. Client trades are recorded on a settlement date basis. Should either the client or broker fail to perform, the Company may be required to complete the transaction at prevailing market prices. Trades pending at June 30, 1999 were settled without material adverse effect on the Company's consolidated financial statements, taken as a whole. Concentrations of Credit Risk Concentrations of credit risk that arise from financial instruments (whether on- or off-balance-sheet) exist for groups of counterparties when they have similar economic characteristics that would cause their ability to meet obligations to be similarly affected by economic, industry or geographic factors. As a major securities firm, the Company engages in underwriting and other financing activities with a broad range of customers, including other financial institutions, municipalities, governments, financing companies, and commercial real estate investors and operators. These activities could result in concentrations of credit risk with a particular counterparty, or with groups of counterparties operating in a particular geographic area or engaged in business in a particular industry. The Company seeks to control its credit risk and the potential for risk concentration through a variety of reporting and control procedures described above. 10 12 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company's most significant industry concentration, which arises within its normal course of business activities, is financial institutions including banks, brokers and dealers, investment funds and insurance companies. NOTE 7: COMMITMENTS AND CONTINGENCIES At June 30, 1999 and December 31, 1998, the Company was contingently liable under unsecured letters of credit totaling $185,551 and $159,647, respectively, which approximated fair value. At June 30, 1999 and December 31, 1998 certain of the Company's subsidiaries were contingently liable as issuer of approximately $45,000 of notes payable to managing general partners of various limited partnerships pursuant to certain partnership agreements. In addition, as part of the 1995 limited partnership settlements, the Company has agreed, under certain circumstances, to provide to class members additional consideration including assignment of fees the Company is entitled to receive from certain partnerships. In the opinion of management, these contingencies will not have a material adverse effect on the Company's consolidated financial statements, taken as a whole. In meeting the financing needs of certain of its clients, the Company may also issue standby letters of credit which are collateralized by customer margin securities. At June 30, 1999 and December 31, 1998, the Company had outstanding $90,300 and $78,787, respectively, of such standby letters of credit. At June 30, 1999 and December 31, 1998, securities with fair value of $171,132 and $139,445, respectively, had been loaned or pledged as collateral for securities borrowed of approximately equal fair value. In the normal course of business, the Company enters into when-issued transactions, underwriting and other commitments. Also, at June 30, 1999 and December 31, 1998, the Company had commitments of $1,019,179 and $929,713, respectively, consisting of secured credit lines to real estate operators, mortgage and asset-backed originators, and other commitments to investment partnerships. Settlement of these transactions at June 30, 1999 would not have had a material impact on the Company's consolidated financial statements, taken as a whole. The Company has been named as defendant in numerous legal actions in the ordinary course of business. While the outcome of such matters cannot be predicted with certainty, in the opinion of management of the Company, after consultation with various counsel handling such matters, these actions will be resolved with no material adverse effect on the Company's consolidated financial statements, taken as a whole. NOTE 8: COMPREHENSIVE INCOME Comprehensive income is calculated in accordance with SFAS No. 130, "Reporting Comprehensive Income." Comprehensive income combines net income and certain items that directly affect stockholders' equity, such as foreign currency translation adjustments. The components of comprehensive income for the three months and six months ended June 30, 1999 and 1998 were as follows:
Three Months Ended Six Months Ended June 30, June 30, ---------------------------- ---------------------------- 1999 1998 1999 1998 --------- --------- --------- --------- Net income $ 163,504 $ 129,501 $ 324,103 $ 250,236 Foreign currency translation adjustment (1,419) (229) (2,931) 797 --------- --------- --------- --------- Total comprehensive income $ 162,085 $ 129,272 $ 321,172 $ 251,033 ========= ========= ========= =========
11 13 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 9: EARNINGS PER COMMON SHARE Earnings per common share are computed in accordance with SFAS No. 128, "Earnings Per Share." Basic earnings per share excludes the dilutive effects of options and convertible securities and is calculated by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects all potentially dilutive securities. Set forth below is the reconciliation of net income applicable to common shares and weighted-average common and common equivalent shares of the basic and diluted earnings per common share computations:
Three Months Ended Six Months Ended ------------------ ---------------- June 30, June 30, -------- -------- 1999 1998 1999 1998 ------------ ------------- -------------- -------------- NUMERATOR: Net income $ 163,504 $ 129,501 $ 324,103 $ 250,236 Preferred stock dividends (5,949) (5,912) (11,898) (11,823) ------------- ------------- ------------- ------------- Net income applicable to common shares for basic earnings per share 157,555 123,589 312,205 238,413 Effect of dilutive securities: Interest savings on convertible debentures(1) -- 104 -- 209 ------------- ------------- ------------- ------------- Net income applicable to common shares for diluted earnings per share $ 157,555 $ 123,693 $ 312,205 $ 238,622 ============= ============= ============= ============= DENOMINATOR: Weighted-average common shares for basic earnings per share 145,742,741 140,032,972 145,631,920 139,609,704 Weighted-average effect of dilutive securities: Employee stock options and awards 9,217,656 9,881,681 8,673,875 9,231,916 Convertible debentures(1) -- 1,247,060 -- 1,336,338 ------------- ------------- ------------- ------------- Dilutive potential common shares 9,217,656 11,128,741 8,673,875 10,568,254 ------------- ------------- ------------- ------------- Weighted-average common and common equivalent shares for diluted earnings per share 154,960,397 151,161,713 154,305,795 150,177,958 ============= ============= ============= ============= EARNINGS PER SHARE: Basic $ 1.08 $ 0.88 $ 2.14 $ 1.71 ============= ============= ============= ============= Diluted $ 1.02 $ 0.82 $ 2.02 $ 1.59 ============= ============= ============= =============
NOTE 10: SEGMENT REPORTING DATA In 1998, the Company adopted SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information." The Company offers a wide variety of products and services, primarily those of a full service domestic broker-dealer to a domestic market, through its two operating segments: Individual and Institutional. The Individual segment offers brokerage services and products (such as the purchase and sale of securities, margin and securities lending, insurance annuity contracts, mutual funds, and wrap fee products), asset management and other investment advisory and portfolio management products and services, and execution and clearing services for transactions originated by individual investors. The Institutional segment principally includes capital market products and services (such as the placing of securities and other financial instruments for - and the execution of trades on behalf of - institutional clients, investment banking services such as the underwriting of debt and equity securities, and mergers and acquisitions advisory services). (1) In August 1998, the 6.5% convertible debentures were called for redemption by the Company and converted into common stock of the Company. 12 14 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Segment revenues and expenses in the table below consist of those that are directly attributable, combined with segment amounts based on Company allocation methodologies (for example, allocating a portion of investment banking revenues to the Individual segment; relative utilization of the Company's square footage for certain cost allocations).
Three months ended June 30, 1999 Three months ended June 30, 1998 -------------------------------- -------------------------------- Individual Institutional Total Individual Institutional Total ---------- ------------- ----- ---------- ------------- ----- Total revenues $1,135,946 $ 835,032 $1,970,978 $1,027,078 $ 873,205 $1,900,283 Net revenues 980,018 367,889 1,347,907 873,127 289,041 1,162,168 Income before taxes and minority interest 152,980 116,687 269,667 134,165 77,834 211,999
Six months ended June 30, 1999 Six months ended June 30, 1998 ------------------------------ ------------------------------ Individual Institutional Total Individual Institutional Total ---------- ------------- ----- ---------- ------------- ----- Total revenues $2,240,355 $1,653,933 $3,894,288 $1,984,055 $1,721,338 $3,705,393 Net revenues 1,935,131 727,667 2,662,798 1,699,389 577,756 2,277,145 Income before taxes and minority interest 304,873 229,813 534,686 252,943 157,251 410,194
Total assets for the Individual and Institutional segments were $20,997,189 and $37,109,858, respectively, at June 30, 1999 and $18,330,427 and $35,845,494, respectively at December 31, 1998. 13 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company's principal business activities are, by their nature, affected by many factors, including general economic and financial conditions, the level and volatility of interest rates, currency and security valuations, competitive conditions, counterparty risk, transactional volume, market liquidity and technological changes. As a result, revenues and profitability have been in the past, and are likely to continue to be, subject to fluctuations reflecting the impact of these factors. Certain statements included in this discussion and in other parts of this report include "forward-looking statements" that involve known and unknown risks and uncertainties including (without limitation) those mentioned above, the impact of current, pending and future legislation and regulation and other risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. The Company disclaims any obligation or undertaking to update publicly or revise any forward-looking statements. Market and economic conditions were mixed in the second quarter of 1999. On the negative side, bond yields rose and in June the Federal Reserve Board increased the overnight lending rate by 25 basis points. The yield on 90-day Treasury bills rose from 4.48 percent to 4.77 percent during the quarter while the yield on the 30-year Treasury bond rose from 5.63 percent to 5.98 percent. On the positive side, the U.S. equity market rallied as the economy continued to expand at a moderate rate and inflation remained subdued. The U.S. economy, as measured by real GDP, grew at a rate of 2.3 percent down from 4.3 percent in the first quarter. Inflation, as measured by the Consumer Price Index, increased at an annual rate of 2.9 percent from the first quarter to the second quarter of 1999. The Dow Jones Industrial Average increased 12.1 percent, the NASDAQ Composite index climbed 9.1 percent and the S&P 500 stock index rose 6.7 percent in the second quarter of 1999. Stock market volume remained relatively constant in the second quarter of 1999 versus the first quarter of 1999 with the New York Stock Exchange average daily volume increasing 1.0 percent to 803.5 million shares and the NASDAQ average daily volume increasing 3.9 percent to 977.0 million shares. The favorable economic and equity market conditions of the first six months of 1999 represent a continuation of the recovery from 1998's third quarter contraction. The Dow Jones Industrial Average increased 19.5 percent for the first six months of 1999 as compared to the 13.2 percent increase for the first six months of 1998. The NASDAQ Composite index advanced 22.5 percent for the first six months of 1999, up from the 20.7 percent increase in the first six months of 1998. The S&P 500 stock index appreciated 11.7 percent in the first six months of 1999, as compared to the increase of 16.8 percent for the first six months of 1998. Average daily volume on the New York Stock Exchange was 800.5 million shares for the first six months of 1999, versus 620.5 million shares for the prior year period. The NASDAQ average daily volume increased from 747.8 million shares for the first six months of 1998 to 973.0 million shares for the first six months of 1999. The yield on the 30-year Treasury bond rose 89 basis points during the first six months of 1999 compared to a 31 basis point decline in the prior year period. RESULTS OF OPERATIONS Quarter Ended June 30, 1999 compared to Quarter Ended June 30, 1998 For the quarter ended June 30, 1999, the Company achieved its strongest quarterly earnings and revenues in the firm's 119-year history. The Company's net income for the quarter ended June 30, 1999 was a record $163.5 million, or $1.08 per basic share ($1.02 per diluted share) compared to net income of $129.5 million, or $0.88 per basic share ($0.82 per diluted share) earned during the second quarter of 1998. During the second quarter of 1999, revenues, net of interest expense, were a record $1,347.9 million, 16.0 percent higher than the second quarter of 1998. Commission revenues earned during the second quarter of 1999 were a record $488.9 million, 21.6 percent higher than the $402.1 million earned during the prior year quarter. Commissions on the sale of listed securities and options increased $49.6 million or 21.0 percent, mutual fund and insurance commissions increased $18.2 million or 16.2 percent, and commissions from over-the-counter securities and commodities increased $19.0 million or 35.9 percent. Principal transactions revenues increased $35.7 million, or 14.6 percent, to $279.8 million primarily driven by improved trading results in equities and taxable fixed income partially offset by lower trading results in municipal securities. These results reflect the market and economic conditions described above. 14 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Asset management fees increased $42.4 million, or 23.3 percent to a record $224.5 million, reflecting higher revenues earned on managed accounts. Average assets in wrap and trust accounts during the second quarter of 1999 were approximately 42 percent higher than during the second quarter of 1998. At June 30, 1999, assets in wrap and trust accounts reached a record $37.9 billion. The increase also reflects higher investment advisory and distribution fees earned on assets managed in long-term and money market funds. The average assets under management in money market, institutional and long-term mutual funds were approximately $62 billion during the second quarter of 1999 and approximately $54 billion during the second quarter of 1998. In the second quarter, the Company divested ownership in Financial Counselors Inc., a subsidiary of Mitchell Hutchins Asset Management Inc., resulting in a decline in assets under management of approximately $2 billion. Investment banking revenues earned during the second quarter of 1999 were $160.1 million, $16.6 million lower than the record $176.7 million earned during the second quarter of 1998. The current year quarter reflects declines in underwriting fees, management fees and selling concessions on lower volume of lead-managed and co-managed corporate issues. Partially offsetting these declines were increases in private placement and other fees, and increases in municipal securities underwriting fees, management fees and selling concessions. The Municipal Securities Group ranked number one in the industry for lead-managed negotiated underwriting for the third consecutive quarter. Other income increased $12.8 million, 37.2 percent higher than the prior year period principally due to higher transaction fees earned on increased client volume and higher account fees on an increased number of IRA and RMA accounts. Net interest increased $24.6 million, or 20.1 percent to $147.2 million primarily due to more favorable interest rate spreads on fixed income positions and increased margin interest. Compensation and benefits expenses for the quarter ended June 30, 1999 were $780.1 million, a 14.4 percent increase as compared to $682.1 million during the prior year quarter. The number of employees at June 30, 1999 increased 1,407, or 8.3 percent, as compared to the June 30, 1998 reflecting an additional 567 Private Client Group financial advisors, related financial advisor support personnel, and technology specialists hired to implement our technology initiatives. Also, the Company's operating results for the second quarter of 1999 versus the prior year quarter resulted in higher production-based compensation to Private Client Group financial advisors, and higher performance-based compensation. The ratio of compensation and benefits as a percent of net revenues declined to 57.9 percent versus 58.7 percent in the prior year quarter, as growth in net revenues exceeded growth in these expenses. All other operating expenses increased $30.1 million, or 11.2 percent to $298.2 million, as compared to $268.1 million for the prior year quarter. Office and equipment expenses increased $14.5 million, or 19.3 percent principally due to an increase in office space and equipment necessary to support the additional headcount, as well as normal escalation costs. Communications expenses increased $5.5 million, or 14.8 percent principally due to the Company's implementation of advanced telecommunications technology related to the new fixed income and equity trading floors and the new ConsultWorks platforms, as well as additional employee headcount. Business development expenses increased $2.2 million, or 8.5 percent reflecting higher advertising costs associated with the Company's advertising campaign. Other expenses increased $4.5 million, or 5.8 percent principally due to increased bad debt and litigation-related expenses. The ratio of non-compensation expenses as a percentage of net revenues was 22.1 percent for the quarter ended June 30, 1999 compared to 23.1 percent for the prior year quarter. The effective income tax rate for the quarter ended June 30, 1999 was 36.4 percent compared to 35.1 percent from the prior year quarter reflecting an increase in state and local taxes and non-deductible expenses. Six Months Ended June 30, 1999 compared to Six Months Ended June 30, 1998 The Company's net income for the six months ended June 30, 1999 was a record $324.1 million, or $2.14 per basic share ($2.02 per diluted share) compared to net income of $250.2 million, or $1.71 per basic share ($1.59 per diluted share) earned during the first six months of 1998. During the first six months of 1999, revenues, net of interest expense, were a record $2,662.8 million, 16.9 percent higher than the corresponding period a year ago. 15 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Commission revenues earned during the first six months of 1999 were a record $967.8 million, 19.4 percent higher than the $810.2 million earned during the prior year period. Commissions on the sale of listed securities and options increased $90.3 million or 18.7 percent, mutual fund and insurance commissions increased $31.9 million or 14.3 percent, and commissions from over-the-counter securities and commodities increased $35.4 million or 33.9 percent. Principal transactions revenues increased $72.9 million, or 14.0 percent, to a record $594.1 million reflecting improved trading results principally in taxable fixed income and equities. These results reflect the market and economic conditions described above. Asset management fees increased $89.7 million, or 26.3 percent to a record $430.5 million, reflecting higher revenues earned on managed accounts. Average assets in wrap and trust accounts during the first six months of 1999 were approximately 42 percent higher than during the corresponding period of 1998. At June 30, 1999, assets in wrap and trust accounts reached a record $37.9 billion. The increase also reflects higher investment advisory and distribution fees earned on assets managed in long-term and money market funds. The average assets under management in money market, institutional and long-term mutual funds were approximately $62 billion during the first six months of 1999, up from the approximately $51 billion during the first six months of 1998. In the second quarter, the Company divested ownership in Financial Counselors Inc., a subsidiary of Mitchell Hutchins Asset Management Inc., resulting in a decline in assets under management of approximately $2 billion. Investment banking revenues earned during the first six months of 1999 were $286.1 million, $15.6 million lower than the record $301.7 million earned during the same period last year. The current year period reflects declines in underwriting fees, management fees and selling concessions on lower volume of lead-managed and co-managed corporate issues. Partially offsetting these declines were increases in private placement and other fees, and increases in municipal securities underwriting fees, management fees and selling concessions. Other income increased $20.0 million to a record $88.4 million principally due to higher transaction fees earned on increased client volume and higher account fees on an increased number of IRA and RMA accounts. Net interest increased $61.1 million, or 26.0 percent to a record $295.9 million primarily due to more favorable interest rate spreads on fixed income positions and increased margin interest. Compensation and benefits expenses for the six months ended June 30, 1999 were $1,548.8 million, a 16.2 percent increase as compared to $1,332.7 million during the prior year period. The number of employees at June 30, 1999 increased 1,407, or 8.3 percent, as compared to June 30, 1998 reflecting an additional 567 Private Client Group financial advisors, related financial advisor support personnel, and technology specialists hired to implement our technology initiatives. Also, the Company's improved operating results for the six months ended 1999 versus the prior year period resulted in higher production-based compensation to Private Client Group financial advisors, and higher performance-based compensation. The ratio of compensation and benefits as a percent of net revenues declined to 58.2 percent versus 58.5 percent in the prior year period, as growth in net revenues exceeded growth in these expenses. All other operating expenses increased $45.0 million, or 8.4 percent to $579.3 million, as compared to $534.3 million for the prior year period. Office and equipment expenses increased $23.4 million, or 15.9 percent principally due to an increase in office space and equipment necessary to support the additional headcount, as well as normal escalation costs. Communications expenses increased $10.0 million, or 13.3 percent principally due to the Company's implementation of advanced telecommunications technology related to the new fixed income and equity trading floors and the new ConsultWorks platforms, as well as additional employee headcount. Business development expenses increased $4.0 million, or 8.3 percent reflecting higher advertising costs associated with the Company's advertising campaign. Other expenses increased $8.5 million, or 5.6 percent principally due to increased bad debt and litigation-related expenses. The ratio of non-compensation expenses as a percentage of net revenues was 21.8 percent for the six months ended June 30, 1999 compared to 23.5 percent for the prior year period. The effective income tax rate for the six months ended June 30, 1999 was 36.4 percent compared to 35.1 percent from the prior year period reflecting an increase in state and local taxes and non-deductible expenses. 16 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) LIQUIDITY AND CAPITAL RESOURCES The primary objectives of the Company's funding policies are to insure ample liquidity at all times and a strong capital base. These objectives are met by maximization of self-funded assets, diversification of funding sources, maintenance of prudent liquidity and capital ratios, and contingency planning. Liquidity The Company maintains a highly liquid balance sheet with the majority of assets consisting of trading assets, securities purchased under agreements to resell, securities borrowed, and receivables from clients, brokers and dealers, which are readily convertible into cash. The nature of the Company's business as a securities dealer results in carrying significant levels of trading assets and liabilities in order to meet its client and proprietary trading needs. The Company's total assets may fluctuate from period to period as a result of changes in the level of trading positions held to facilitate client transactions, the volume of resale and repurchase transactions, and proprietary trading strategies. These fluctuations depend significantly upon economic and market conditions, and transactional volume. The Company's total assets at June 30, 1999 were $58.1 billion compared to $54.2 billion at December 31, 1998, primarily attributable to an increase in trading assets and receivables from clients. The majority of the Company's assets are financed by daily operations such as securities sold under agreements to repurchase, free credit balances in client accounts and securities lending activity. The Company regularly reviews its mix of assets and liabilities to maximize self-funding. Additional financing sources are available through bank loans and commercial paper, committed and uncommitted lines of credit, and long-term borrowings. The Company maintains committed and uncommitted credit facilities from a diverse group of banks. The Company has a $1.2 billion unsecured revolving credit agreement which extends through November 1999, with provisions for renewal through 2001. Certain of the Company's subsidiaries also have a secured revolving credit facility to provide up to an aggregate of $750 million through August 1999, with provisions for renewal through August 2000. This credit agreement is in the process of being renewed. The secured borrowings under this facility can be collateralized using a variety of securities. The facilities are available for general corporate purposes. At June 30, 1999, there were no outstanding borrowings under these credit facilities. Additionally, the Company had approximately $5.0 billion in uncommitted lines of credit at June 30, 1999. The Company maintains public shelf registration statements with the SEC for the issuance of debt securities of the Company and for the issuance of preferred securities of PWG Capital Trusts III, IV and V ("Preferred Trust Securities"), business trusts formed under the Delaware law which are wholly owned subsidiaries of the Company. During the second quarter of 1999, the Company issued $911.0 million of debt under these registration statements, including $525.0 million of 6 3/8% senior notes due 2004 and $180 million of medium-term notes which were included in short-term borrowings. At June 30, 1999, the Company had $1,690.1 million in debt securities available for issuance under a shelf registration statement and $706.2 million in Preferred Trust Securities and debt securities of the Company available for issuance under two other registration statements. Capital Resources and Capital Adequacy The Company's businesses are capital intensive. In addition to a funding policy which provides for diversification of funding sources and maximization of liquidity, the Company maintains a strong capital base. The Company's total capital base, which includes long-term borrowings, preferred securities and stockholders' equity, grew to a record $8.2 billion at June 30, 1999, an increase of $949.8 million from December 31, 1998. The growth in total capital was primarily due to the net increase in long-term borrowings of $687.0 million and a net increase in stockholders' equity of $262.2 million. 17 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The net increase in long-term borrowings primarily reflected the net issuance of medium-term notes of $174.2 million and the issuance of $525.0 million 6 3/8% senior notes due 2004. The increase in stockholders' equity was primarily the result of net income for the six months ended June 30, 1999 of $324.1 million and the issuance of approximately 2,899,000 shares of common stock related to employee compensation and stock purchase programs. Issuances and tax credits related to these programs had the net effect of increasing equity capital by $105.8 million in the first six months of 1999. These increases were offset by the repurchase in the first six months of 1999 of approximately 3,065,000 shares of common stock for $121.1 million and dividends accrued of $43.7 million. At June 30, 1999, the remaining number of shares authorized to be repurchased, in the open market or otherwise, under the Company's common stock repurchase program was approximately 22,881,000. On August 5, 1999, the Board of Directors declared a regular quarterly dividend on the Company's common stock of $0.11 per share payable on October 1, 1999 to stockholders of record on September 3, 1999. PWI is subject to the net capital requirements of the Securities and Exchange Commission, the New York Stock Exchange, Inc. and the Commodity Futures Trading Commission which are designed to measure the financial soundness and liquidity of broker-dealers. PWI has consistently maintained net capital in excess of the minimum requirements imposed by these agencies. In addition, the Company has other banking and securities subsidiaries, both domestic and foreign, which have also consistently maintained net regulatory capital in excess of requirements. Merchant Banking and Highly Leveraged Transactions In connection with its merchant banking, commercial real estate, and asset financing activities, the Company has provided financing and made investments in companies, some of which are involved in highly leveraged transactions. Positions taken or commitments made by the Company may involve credit or market risk from any one issuer or industry. At June 30, 1999, the Company had investments in merchant banking transactions which were affected by liquidity, reorganization or restructuring issues amounting to $23.4 million, net of reserves, compared to $19.4 million, net of reserves, at December 31, 1998. These investments have not had a material effect on the Company's results of operations. The Company's activities also include underwriting and market-making transactions in high-yield corporate debt and non-investment-grade mortgage-backed securities, and emerging market securities (collectively, "high-yield securities"). These securities generally involve greater risks than investment-grade corporate debt securities because these issuers usually have high levels of indebtedness or lower credit ratings and are, therefore, more vulnerable to general economic conditions. At June 30, 1999, the Company held $338.7 million of high-yield securities, with approximately 6 percent of such securities attributable to one issuer. The Company continually monitors its risk positions associated with high-yield securities and establishes limits with respect to overall market exposure, industry group and individual issuer. The Company accounts for these positions at fair value, with unrealized gains and losses reflected in "Principal transactions" revenues. These high-yield securities have not had a material effect on the Company's results of operations. DERIVATIVE FINANCIAL INSTRUMENTS A derivative financial instrument is a contractual agreement between counterparties that derives its value from changes in the value of some underlying asset such as the price of another security, interest rates, currency exchange rates, specified rates (e.g. LIBOR) or indices (e.g. S&P 500), or other value referenced in the contract. Derivatives, such as futures, certain option contracts and structured products (e.g. indexed warrants) are traded on exchanges, while derivatives such as forward contracts, certain option contracts, interest rate swaps, caps and floors, and other structured products are negotiated in over-the-counter markets. In the normal course of business, the Company engages in a variety of derivative transactions in connection with its proprietary trading activities and asset and liability management, as well as on behalf of its clients. As a dealer, the Company regularly makes a market in and trades a variety of securities. The Company is also engaged in creating structured products that are sold to clients. In connection with these activities, the Company attempts to reduce its exposure to market risk by entering into offsetting hedging transactions, which may include derivative financial instruments. The Company also enters into interest rate swap contracts to manage the interest rate characteristics of its assets and liabilities. 18 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The notional amount of a derivative contract is used to measure the volume of activity and is not reflected on the Condensed Consolidated Statement of Financial Condition. The Company had off-balance-sheet derivative contracts outstanding with gross notional amounts of $76.2 billion and $84.6 billion at June 30, 1999 and December 31, 1998, respectively. These amounts included $58.0 billion and $64.3 billion, respectively, related to "to be announced" mortgage-backed securities requiring forward settlement. Also included in these amounts were $3.7 billion and $3.1 billion notional amounts of interest rate swap agreements used to change the interest rate characteristics of the Company's fixed rate debt at June 30, 1999 and December 31, 1998, respectively. For further discussion on the Company's derivative financial instruments, see Note 5 in the Notes to Condensed Consolidated Financial Statements. The Company records any unrealized gains and losses on its derivative contracts used in a trading capacity by marking-to-market the contracts on a daily basis. The unrealized gain or loss is recorded on the Condensed Consolidated Statements of Financial Condition with the related profit or loss reflected in "Principal transactions" revenues. The Company accrues interest income and expense on interest rate swap agreements used to change the interest rate characteristics of the Company's fixed rate debt. These interest rate swap agreements had the effect of reducing net interest expense on the Company's fixed rate debt by $13.8 million and $7.0 million for the six months ended June 30, 1999 and 1998, respectively. The Company had no deferred gains or losses recorded at June 30, 1999 and December 31, 1998 related to terminated swap agreements on the Company's long-term borrowings. The fair value of an exchange-traded derivative financial instrument is determined by quoted market prices, while over-the-counter derivatives are valued based upon pricing models which consider time value and volatility, as well as other economic factors. The fair values of the Company's derivative financial instruments held for trading purposes at June 30, 1999 were $298.6 million and $302.9 million for assets and liabilities, respectively, and are reflected on the Condensed Consolidated Statements of Financial Condition. The fair values of these instruments at December 31, 1998 were $191.4 million and $217.8 million for assets and liabilities, respectively. The Company's exposure to market risk relates to changes in interest rates, equity prices, foreign currency exchange rates or the market values of the assets underlying the financial instruments. The Company's exposure to credit risk at any point is represented by the fair value or replacement cost on contracts in which the Company has recorded an unrealized gain. At June 30, 1999 and December 31, 1998, the fair values amounted to $298.6 million and $191.4 million, respectively. The risks inherent in derivative financial instruments are managed consistent with the Company's overall risk management policies. (See Risk Management section below) RISK MANAGEMENT Risk is an inherent part of the Company's principal business activities. Managing risk is critical to the Company's profitability and to reducing the likelihood of earnings volatility. The Company's risk management policies and procedures have been established to continually identify, monitor and manage risk. The Company's principal risks are market, credit, liquidity, legal and operating risks. Included below is a discussion on market risk. For further discussion on the Company's principal risks, see the Company's 1998 Annual Report to Stockholders. The Company seeks to manage risk and its impact on earnings volatility through strategic planning and by focusing on the diversification of its business activities. Through capital allocation, and the establishment of trading limits by product and credit limits by counterparty, the Company manages the risk associated with the various businesses. The Company may reallocate or deploy capital to the business groups based upon changes in market conditions or opportunities in the marketplace that are consistent with the Company's long-term strategy. The discussion of the Company's principal risks and the estimated amounts of the Company's market risk exposure generated from the sensitivity analysis performed by the Company are forward-looking statements assuming certain adverse conditions occur. Actual results in the future may differ materially from these projected results due to actual events in the markets in which the Company operates and other factors. The analysis methods used by the Company to assess and mitigate risks discussed below should not be considered projections of future events or losses. Market Risk All financial instruments involve market risk. Market risk is the potential change in value of the financial instrument caused by unfavorable changes in interest rates, equity prices and foreign currency exchange rates. Market risk is inherent to both derivative and non-derivative financial instruments. 19 21 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company actively monitors its market risk profile through a variety of control procedures including market risk modeling, review of trading positions and hedging strategies, and monitoring adherence to established limits. Each department's trading positions, exposures, profits and losses, and trading strategies are reviewed by the senior management of each business group. Independent of the trading departments is a risk management group. The Company's risk management group reviews the Company's risk profile and adherence to established trading limits, and aids in the development of risk management policies. In addition, the Company has in place committees and management controls to review inventory positions, other asset accounts and asset agings on a regular basis. Trading position and exposure limits are established by the Asset/Liability Management Committee, which meets regularly and is comprised of senior corporate and business group managers. The following is a discussion of the Company's primary market risk exposures at June 30, 1999 and December 31, 1998 and how those exposures are managed: Interest Rate Risk In connection with the Company's dealer activities, the Company is exposed to interest rate risk due to changes in the level or volatility of interest rates, changes in the yield curve, mortgage prepayments and credit spreads. The Company attempts to mitigate its exposure to interest rate risk by entering into hedging transactions such as U.S. government and Eurodollar forwards and futures contracts, options, and interest rate swap and cap agreements. The Company also issues fixed rate instruments in connection with its nontrading activities, which expose the Company to interest rate risk. The Company enters into interest rate swap agreements, which are designed to mitigate its exposure by effectively converting its fixed rate liabilities into floating rate liabilities. Equity Price Risk In connection with the Company's dealer activities, the Company buys and sells equity and equity derivative instruments. The Company is exposed to equity price risk due to changes in the level or volatility of equity prices. The Company attempts to mitigate its exposure to equity price risk by entering into hedging transactions including equity option agreements. Sensitivity Analysis For purposes of the SEC disclosure requirements, the Company has elected to use a sensitivity approach to express the potential loss in future earnings of its financial instruments. In preparing the analysis, the Company has combined both derivative and non-derivative financial instruments held for trading purposes with those held for purposes other than trading because the amounts were not material. The sensitivity calculation employed to analyze interest rate risk on fixed income financial instruments was based on a proprietary methodology which converted substantially all the Company's interest rate sensitive financial instruments at June 30, 1999 and December 31, 1998, into a uniform benchmark (a ten year U.S. Treasury note equivalent), and evaluated the impact assuming a 13 basis point change to the ten-year U.S. Treasury note at June 30, 1999 and December 31, 1998, respectively. The hypothetical basis point change was derived from a proprietary model which uses a one-day interval and a 95 percent confidence level, and was based on historical data over a one-year period. This analysis does not consider other factors that may influence these results, such as credit spread risk, prepayment risk on mortgage-backed securities or changes in the shape of the yield curve. The sensitivity calculation employed to analyze equity price risk on its equity financial instruments was based on a 2 percent move in the Dow Jones Industrial Average at June 30, 1999 and December 31, 1998, respectively, using a one-day interval and a 95 percent confidence level, and was based on historical data over a one-year period. Based upon the aforementioned methodologies, the Company's potential daily loss in future earnings at June 30, 1999 was approximately $4 million and $0.1 million for interest rate risk and equity price risk, respectively, and the Company's potential daily loss in future earnings at December 31, 1998 was approximately $9 million and $0.1 million for interest rate risk and equity price risk, respectively. 20 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) YEAR 2000 The Company uses a wide variety of computer programs and devices, some of which use only the last two digits of each year to represent the calendar year portion of dates. As a result, calculations performed with these abbreviated date fields may misinterpret the year 2000 as 1900, resulting in erroneous calculations or program failures that could cause significant disruptions in the Company's operations. The Company is now executing a comprehensive plan in an attempt to achieve Year 2000 compliance. The plan consists of tens of thousands of component tasks organized into five phases: Awareness, Inventory / Assessment, Remediation, Implementation and Testing. The Company has completed the Awareness and Inventory / Assessment phases, covering both information technology ("IT") hardware and software and other non-IT assets. The Inventory/Assessment phase involved more than 3,800 types of assets grouped into the following eight broad classes: Business Relationships, Systems (Software), External Interfaces, Hardware (including mainframe, distributed and desktop hardware), Market Data Services, Office Equipment, Facilities and Telecommunications. The Remediation and Implementation phases of the Company's plan specify a strategy for each asset type and assign remediation tasks to either third party resources, Company personnel or in some cases, original manufacturers. Certain assets may be replaced or retired. Remediation of the Company's application software is complete and all changes have been implemented. Remediation of Hardware, Office Equipment and Facilities assets, including desktop computers and servers, and implementation of necessary changes is materially complete. The remaining asset categories - Business Relationships, External Interfaces, Market Data Services and Telecommunications - are part of an extensive network of business partners and external providers of products and services that include the major securities and commodities exchanges, self-regulatory organizations, industry clearing and depository institutions, other broker-dealers, commercial banks with which the Company has multiple-user business relationships, and hardware and software technology providers. The Company has inquired whether they have made the necessary efforts to meet their own Year 2000 objectives and has received oral and written responses. The Company's assessment of these responses is complete. For crucial relationships, the Company's procedures have included joint testing of systems and site visits. The Testing phase of the plan is materially complete. Testing of external interfaces, including additional securities industry-wide testing is materially complete. Nearly every aspect of the Company's business depends on the accurate processing of date-related information. As a result, failure by the Company or one or more of its third-party relationships to successfully remediate systems for Year 2000 issues poses the risk of material disruption to operations and material financial loss. A failure on the part of the Company to identify and implement solutions to all Year 2000 issues could result in systems failures or outages, inaccuracies in processing trades or other transactions affecting customer or proprietary accounts, an inability to reconcile to and settle with counterparties and other business disruptions. In addition, third parties with whom the Company has a relationship could fail in some element of their Year 2000 efforts. The Company's operations are highly dependent on the services of the securities and commodities exchanges, depositories, certain banking relationships, electric utilities and telecommunications networks, and a failure by one of these institutions could disrupt the operations of the Company as well as the securities and commodities industries as a whole. The scope of the Company's relationship with individual customers, broker-dealer counterparties and vendors varies widely as does the resulting risk should any one of them fail to achieve Year 2000 compliance. The Company has ongoing communications with important third party relationships regarding third party Year 2000 risks. The success of such third parties achieving Year 2000 compliance can not be adequately gauged at this time. The Company has developed contingency plans to be executed should a Year 2000 failure affect the Company's own operations or those of a significant third party. There can be no assurance that alternative arrangements have been identified for all material risks or contingencies, or that these contingency plans will be effective. 21 23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company estimates the incremental cost of achieving Year 2000 compliance to be approximately $65 million of which approximately $53 million has been incurred through June 30, 1999. Costs relating to the Year 2000 conversion are expensed as incurred. The estimated cost to resolve the Year 2000 issue and the timing of achieving compliance are management's best estimates based on current assessments of the scope of efforts required, the availability and cost of trained personnel and of third party resources. Factors that could cause actual results to differ materially from management estimates of future costs and timing of remediation include, but are not limited to: the successful identification of Company system-wide two-digit year codes; the adequacy of labor rate and consulting fee estimates; the success of suppliers and counterparties in achieving Year 2000 compliance or delivering compliant products to the Company; and the success of securities and commodities exchanges, self-regulatory organizations, industry clearing and depository institutions, other broker-dealers, and commercial banks in achieving Year 2000 compliance. There can be no guarantee that future results will not differ materially from the plan, resulting in changes to actual costs incurred and the timing of compliance. 22 24 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS No significant events have occurred since the filing of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998 and Form 10-Q for the quarter ended March 31, 1999, except as described below: NEWTON V. MERRILL LYNCH, ET AL. SECURITIES LITIGATION On May 20, 1999, the District Court affirmed the Magistrate Judge's grant of plantiffs' motion to amend the complaint to add additional named class representatives and extend the class period covered by the complaint through August 28, 1996. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed herewith: Exhibit 12.1 - Computation of Ratio of Earnings to Fixed Charges Exhibit 12.2 - Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends Exhibit 27 - Financial Data Schedule (b) Reports on Form 8-K: The Company filed a Current Report on Form 8-K dated July 16, 1999 with the Securities and Exchange Commission reporting under "Item 5 - Other Events" and "Item 7 - Exhibits" relating to the Company's press release which, among other things, reported financial results for the six month period ending June 30, 1999. 23 25 SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Paine Webber Group Inc. ----------------------- (Registrant) Date: August 16, 1999 By: /s/ Regina A. Dolan ---------------- ----------------------- Regina A. Dolan Senior Vice President and Chief Financial Officer (principal financial and accounting officer) 24 EX-12.1 2 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES 1 EXHIBIT 12.1 PAINE WEBBER GROUP INC. COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (In thousands of dollars)
Six Months Ended June 30, Years Ended December 31, -------------------------------------------------------------------- 1999 * 1998 * 1997 * 1996 1995 1994 --------------- ----------- ----------- ----------- ----------- ----------- Income before taxes $ 518,564 $ 682,763 $ 644,075 $ 558,999 $ 102,677 $ 44,385 ------------ ------------ ----------- ----------- ------------ ------------ Fixed charges: Interest 1,247,612 2,876,712 2,573,582 1,971,788 1,969,811 1,428,653 Interest factor in rents 29,657 56,139 53,665 54,537 59,491 51,102 -------------- -------------- ------------- ------------- ------------- ------------- Total fixed charges 1,277,269 2,932,851 2,627,247 2,026,325 2,029,302 1,479,755 ------------ ------------ ----------- ----------- ----------- ----------- Income before taxes and fixed charges $ 1,795,833 $ 3,615,614 $3,271,322 $2,585,324 $2,131,979 $1,524,140 =========== =========== ========== ========== ========== ========== Ratio of earnings to fixed charges 1.4 1.2 1.2 1.3 1.1 1.0 =========== =========== ========== ========== ========== ==========
For purposes of computing the ratio of earnings to fixed charges, "earnings" consist of income before taxes and fixed charges. "Fixed charges" consist principally of interest expense incurred on securities sold under agreements to repurchase, short-term borrowings, long-term borrowings, preferred trust securities and that portion of rental expense estimated to be representative of the interest factor. * Income before taxes includes minority interest in wholly owned subsidiary trusts. EX-12.2 3 COMP. OF RATIOS: COM. FIXED CHRGS. & PRE. STCK DIV 1 EXHIBIT 12.2 PAINE WEBBER GROUP INC. COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS (In thousands of dollars)
Six Months Ended June 30, Years Ended December 31, ----------------------------------------------------------------------- 1999 * 1998 * 1997 * 1996 1995 1994 --------------- ---------- ----------- ----------- ----------- --------- Income before taxes $ 518,564 $ 682,763 $ 644,075 $ 558,999 $ 102,677 $ 44,385 ----------- ------------ ----------- ----------- ------------ ------------ Preferred stock dividends 18,000 35,433 44,186 43,712 36,260 1,710 ----------- ------------ ----------- ----------- ------------ ------------ Fixed charges: Interest 1,247,612 2,876,712 2,573,582 1,971,788 1,969,811 1,428,653 Interest factor in rents 29,657 56,139 53,665 54,537 59,491 51,102 ----------- ------------ ----------- ----------- ------------ ------------ Total fixed charges 1,277,269 2,932,851 2,627,247 2,026,325 2,029,302 1,479,755 ----------- ------------ ----------- ----------- ------------ ------------ Total fixed charges and preferred stock dividends 1,295,269 2,968,284 2,671,433 2,070,037 2,065,562 1,481,465 ----------- ------------ ----------- ----------- ------------ ------------ Income before taxes and fixed charges $ 1,795,833 $ 3,615,614 $3,271,322 $2,585,324 $2,131,979 $1,524,140 =========== =========== ========== ========== ========== ========== Ratio of earnings to fixed charges and preferred stock dividends 1.4 1.2 1.2 1.2 1.0 1.0 =========== =========== ========== ========== ========== ==========
For purposes of computing the ratio of earnings to combined fixed charges and preferred stock dividends (tax effected), "earnings" consist of income before taxes and fixed charges. "Fixed charges" consist principally of interest expense incurred on securities sold under agreements to repurchase, short-term borrowings, long-term borrowings, preferred trust securities and that portion of rental expense estimated to be representative of the interest factor. * Income before taxes includes minority interest in wholly owned subsidiary trusts. EX-27 4 FINANCIAL DATA SCHEDULE
BD This schedule contains summary financial information extracted from the financial statements of Paine Webber Group Inc. for the six months ended June 30, 1999 and is qualified in its entirety by reference to such financial statements. 1,000 6-MOS DEC-31-1999 JUN-30-1999 983,877 8,906,432 14,523,964 8,914,986 22,503,424 492,462 58,107,047 1,184,494 6,314,705 25,646,267 4,983,659 8,040,353 4,942,785 192,585 393,750 190,464 2,508,559 58,107,047 594,054 1,527,431 967,751 286,086 430,538 1,231,490 1,548,792 534,686 324,103 0 0 324,103 2.14 2.02
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