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Exhibit 99.1
THE CHARLES SCHWAB CORPORATION
Consolidated Financial Statements, Other Financial Information
and Independent Auditors' Reports
Table of Contents
Page
Selected Financial and Operating Data 1
Management's Discussion and Analysis of
Results of Operations and Financial Condition 2-19
Consolidated Financial Statements:
Statement of Income 20
Balance Sheet 21
Statement of Cash Flows 22
Statement of Stockholders' Equity 23
Notes to Consolidated Financial Statements 24-42
Independent Auditors' Report 43
Report of Independent Accountants 44
Condensed Financial Statements of the Registrant
(Parent-Company Only):
Statement of Income A-1
Balance Sheet A-2
Statement of Cash Flows A-3
Notes to Condensed Financial Information A-4 - A-5
Valuation and Qualifying Accounts A-6
Quarterly Financial Information (Unaudited) A-7
U.S. Trust Corporation Supplemental Financial Data (Unaudited) A-8 - A-13
---------------------------------------------------
Forward-Looking Statements - This Current Report on Form 8-K, including the
information incorporated by reference, contains "forward-looking statements"
within the meaning of Section 27A of the Securities Act, and Section 21E of the
Securities Exchange Act of 1934. Forward-looking statements are identified by
words such as "believe," "anticipate," "expect," "intend," "plan," "will," "may"
and other similar expressions. In addition, any statements that refer to
expectations, projections or other characterizations of future events or
circumstances are forward-looking statements. These forward-looking statements,
which reflect management's beliefs, objectives and expectations as of the date
hereof, are necessarily estimates based on the best judgment of our senior
management. These statements relate to, among other things, the ability to
successfully pursue the Company's strategy to attract and retain customer
assets, the ability of the Company to realize the expected benefits of a
business combination, the Company's status under the Bank Holding Company Act,
the decline in average commission per revenue trade, the impact on the Company's
results of operations of Internet trade pricing for independent investment
managers, the impact on the Company's results of operations of reduced pricing
on equity online trades for certain customers, the impact on the Company's
results of operations of fee adjustments related to minimum account balances,
the decline in average revenue per share traded, sources of liquidity,
development spending, capital expenditures and capital structure, the potential
for problem loans, market risk, revenue growth, after-tax profit margin, return
on stockholders' equity, the effects of increased competition and contingent
liabilities. Achievement of the expressed beliefs, objectives and expectations
is subject to certain risks and uncertainties that could cause actual results to
differ materially from those beliefs, objectives and expectations. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date of this Current Report on Form 8-K or, in the case of
documents incorporated by reference, as of the date of those documents. Unless
otherwise indicated, this report speaks as of December 31, 1999.
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Selected Financial and Operating Data The Charles Schwab Corporation
(In Millions, Except Per Share Amounts, Ratios,
Number of Branches, Average Commission and as Noted)
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Growth Rates
Compounded Annual
5-Year 1-Year
1994-1999 1998-1999 1999 1998 1997(1) 1996 1995(10)
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<S> <C> <C> <C> <C> <C> <C> <C>
Operating Results
Revenues 25% 41% $ 4,486 $ 3,178 $ 2,672 $ 2,174 $ 1,805
Expenses excluding interest 23% 35% $ 3,388 $ 2,500 $ 2,141 $ 1,710 $ 1,621
Net income (2) 34% 62% $ 666 $ 410 $ 321 $ 275 $ 122
Basic earnings per share (2, 3) 31% 59% $ .51 $ .32 $ .25 $ .22 $ .10
Diluted earnings per share (2, 3) 32% 58% $ .49 $ .31 $ .24 $ .21 $ .09
Dividends declared per common share (3, 4) 22% 4% $ .0373 $ .0360 $ .0311 $ .0267 $ .0207
Weighted-average common shares outstanding - diluted (3) 1,373 1,343 1,338 1,320 1,304
Trading revenues as a percentage of revenues (5) 53% 51% 54% 56% 53%
Non-trading revenues as a percentage of revenues (5) 47% 49% 46% 44% 47%
Effective income tax rate 39.4% 39.5% 39.5% 40.7% 33.5%
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Performance Measures
Revenue growth 41% 19% 23% 20% 22%
Pre-tax profit margin 24.5% 21.3% 19.9% 21.3% 10.2%
After-tax profit margin 14.9% 12.9% 12.0% 12.6% 6.8%
Return on stockholders' equity 31% 27% 26% 29% 16%
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Financial Condition (at year end)
Total assets 25% 30% $34,322 $26,407 $20,297 $17,256 $13,125
Long-term debt 17% 24% $ 518 $ 419 $ 433 $ 310 $ 275
Stockholder' equity 30% 54% $ 2,576 $ 1,673 $ 1,376 $ 1,069 $ 815
Assets to stockholders' equity ratio 13 16 15 16 16
Long-term debt to total financial capital
(long-term debt plus stockholders' equity) 17% 20% 24% 22% 25%
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Customer Information (at year end)
Active customer accounts (6) 17% 18% 6.6 5.6 4.8 4.1 3.4
Customer assets (in billions) 39% 42% $ 846.0 $ 594.3 $ 437.2 $ 324.1 $ 243.7
SchwabFunds(R) assets (in billions) (7) 36% 32% $ 107.9 $ 81.5 $ 55.8 $ 43.1 $ 31.7
Mutual Fund OneSource(R) assets (in billions) (8) 52% 46% $ 102.3 $ 69.9 $ 56.6 $ 39.2 $ 23.9
Total Mutual Fund Marketplace(R) assets (in billions) (8) 42% 37% $ 176.6 $ 129.1 $ 104.6 $ 74.6 $ 50.0
Active independent investment managers (in thousands) 4% 7% 5.8 5.4 5.3 4.8 5.6
Independent investment manager client accounts
(in thousands) 23% 23% 848.3 689.9 547.2 442.2 390.6
Independent investment manager client assets (in billions) 46% 46% $ 213.1 $ 146.4 $ 105.8 $ 72.9 $ 50.6
Number of Schwab domestic branch offices 10% 17% 340 291 272 235 226
Number of U.S. Trust offices 15% 17% 28 24 19 18 14
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Employee Information
Full-time equivalent employees (at year end, in thousands) 16% 33% 20.1 15.1 14.3 11.9 10.7
Revenues per average full-time equivalent employee
(in thousands) 9% 16% $ 249 $ 214 $ 204 $ 195 $ 182
Compensation and benefits expense as a percentage of
revenues 42.1% 43.3% 42.5% 42.1% 43.5%
====================================================================================================================================
Selected Cash Flow Highlights
Net income plus depreciation and amortization,
and goodwill amortization (2) 30% 49% $ 848 $ 569 $ 460 $ 385 $ 209
Capital expenditures - cash purchases of
equipment, office facilities and property, net 50% 86% $ 370 $ 199 $ 150 $ 173 $ 180
Capital expenditures as a percentage of revenues 8.3% 6.3% 5.6% 8.0% 10.0%
Cash dividends paid 12% 9% $ 61 $ 56 $ 48 $ 41 $ 39
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Customers' Daily Average Trading Volume (in thousands) (9)
Daily average revenue trades 41% 68% 163.1 97.2 71.8 54.0 40.8
Mutual Fund OneSource trades 26% 13% 45.6 40.3 34.2 27.2 17.8
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Daily average trades 37% 52% 208.7 137.5 106.0 81.2 58.6
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Average Commission Per Revenue Trade (9%) (15%) $ 45.55 $ 53.44 $ 64.27 $ 69.08 $ 73.11
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All periods have been restated to reflect the merger of The Charles Schwab Corporation (CSC) with U.S. Trust Corporation
(U.S. Trust). Additionally, certain prior years' revenues and expenses have been reclassified to conform to the 1999 presentation.
(1) 1997 includes charges for a litigation settlement of $24 million after-tax ($.02 per share for both basic and diluted earnings
per share).
(2) 1999 reflects an accounting change, which increased net income by $41 million ($.03 per share for both basic and diluted
earnings per share), for certain internal-use software development costs to conform with Statement of Position 98-1.
(3) All periods have been restated for the May 2000 three-for-two common stock split.
(4) Dividends declared per common share represent dividends declared by CSC prior to its merger with U.S. Trust.
(5) Trading revenues include commission and principal transaction revenues. Non-trading revenues include asset management and
administration fees, net interest revenue and other revenues.
(6) Effective in 1998, active accounts are defined as accounts with balances or activity within the preceding eight months instead
of twelve months as previously defined. This change in definition had the effect of decreasing the number of active accounts in
1998 by approximately 200,000. Prior years have not been restated.
(7) Includes money market, equity and bond funds.
(8) Excludes money market funds and all of Schwab's proprietary money market, equity and bond funds. Mutual Fund OneSource assets
are included in Total Mutual Fund Marketplace assets.
(9) Effective in 1997, revenue trades have been restated for all years presented to include all customer trades (both domestic and
international) that generate either commission revenue or revenue from principal markups.
(10) 1995 includes U.S. Trust's restruturing charges of $87 million after-tax ($.07 per share for both basic and diluted earnings
per share).
</TABLE>
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The Charles Schwab Corporation
Management's Discussion and Analysis
of Results of Operations and Financial Condition
DESCRIPTION OF BUSINESS
Merger with U.S. Trust Corporation
On May 31, 2000, The Charles Schwab Corporation (CSC) completed its merger
(the Merger) with U.S. Trust Corporation (U.S. Trust). Under the terms of the
merger agreement, U.S. Trust became a wholly owned subsidiary of CSC and U.S.
Trust shareholders received 5.1405 shares of CSC's common stock for each common
share of U.S. Trust. The Merger was treated as a non-taxable stock-for-stock
exchange and U.S. Trust's shareholders received 112,000,000 shares of CSC's
common stock. Upon consummation of the Merger, CSC became a financial holding
company and bank holding company subject to supervision and regulation by the
Board of Governors of the Federal Reserve System (Federal Reserve Board) under
the Bank Holding Company Act of 1956, as amended (the Act). The consolidated
financial statements and financial information in this Current Report on Form
8-K give retroactive effect to the Merger, which was accounted for as a pooling
of interests. The pooling of interests method of accounting requires the
restatement of all periods presented as if CSC and U.S. Trust had been operating
as a combined entity during such periods.
Certain reclassifications have been made to prior year amounts to conform to
the current presentation. All material intercompany balances and transactions
have been eliminated.
Stock Split
On May 3, 2000, the Board of Directors approved a three-for-two split of
CSC's common stock, which was effected in the form of a 50% stock dividend. The
stock dividend was distributed May 30, 2000 to stockholders of record May 12,
2000. Share and per share information presented throughout this report has been
restated to reflect the common stock split, including the common shares issued
to U.S. Trust shareholders pursuant to the exchange ratio described above.
The Company
CSC and its subsidiaries (collectively referred to as the Company) provide
securities brokerage and related financial services for 6.6 million active
customer accounts(a). Customer assets in these accounts totaled $846.0 billion
at December 31, 1999. CSC's principal subsidiary, Charles Schwab & Co., Inc.
(Schwab), is a securities broker-dealer with 340 domestic branch offices in 48
states, as well as branches in the Commonwealth of Puerto Rico and the U.S.
Virgin Islands. Another subsidiary, U.S. Trust, is an investment management firm
that also provides fiduciary services and private banking services with 28
offices in 10 states. Other subsidiaries include Charles Schwab Europe (CSE), a
retail securities brokerage firm located in the United Kingdom, Charles Schwab
Investment Management, Inc., the investment advisor for Schwab's proprietary
mutual funds, and Schwab Capital Markets L.P. (SCM) (prior to March 1, 2000,
this business was known as Mayer & Schweitzer, Inc.), a market maker in Nasdaq
and other securities providing trade execution services to broker-dealers and
institutional customers.
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(a) Accounts with balances or activity within the preceding eight months.
The Company provides financial services to individuals, institutional
customers and broker-dealers through four segments - Individual Investor,
Institutional Investor, Capital Markets and U.S. Trust. The Individual Investor
segment includes the Company's domestic and international retail operations. The
Institutional Investor segment provides custodial, trading and support services
to independent investment managers, and serves company 401(k) plan sponsors and
third-party administrators. The Capital Markets segment provides trade execution
services in Nasdaq, exchange-listed and other securities primarily to
broker-dealers and institutional customers. The U.S. Trust segment provides
investment management, fiduciary services and private banking services to
individual and institutional customers.
The Company's strategy is to attract and retain customer assets by focusing
on a number of areas within the financial services industry - retail brokerage,
mutual funds, support services for independent investment managers, 401(k)
defined contribution plans, equity securities market-making, investment
management, fiduciary services and private banking services.
To pursue its strategy and its objective of long-term profitable growth, the
Company plans to continue to leverage its competitive advantages. These
advantages include nationally recognized brands, a broad range of products and
services, multi-channel delivery systems and an ongoing investment in
technology. While the Company's business continues to be predominantly conducted
in the U.S., in 1999 the Company continued to selectively expand its
international presence.
Brand: The Company's nationwide advertising and marketing programs support
its strategy by continually reinforcing the strengths and key attributes of
Schwab's full-service offering and U.S. Trust's wealth management services. By
maintaining a consistent level of visibility in the marketplace, the Company
seeks to establish Schwab and U.S. Trust as leading and lasting financial
services brands in a focused and cost-effective manner. The Company primarily
uses a combination of network, cable and local television, print media, national
and local radio, and athletic event sponsorship in its advertising to investors.
Products and Services: The Company offers a broad range of value-oriented
products and services to meet customers' varying investment and financial needs,
including help and advice and access to extensive investment research, news and
information. The Company's approach to advice is based on long-term investment
strategies and guidance on portfolio diversification and asset allocation. The
Company strives to demystify investing by educating and assisting customers in
the development of investment plans. This approach is designed to be offered
consistently across all of Schwab's delivery channels and provides customers
with a wide selection of choices for their investment needs. Schwab's registered
representatives can assist investors in developing asset allocation strategies
and evaluating their investment choices, and refer investors who desire
additional guidance to independent investment managers through the Schwab
AdvisorSource(TM) service. In 1999, Schwab expanded the AdvisorSource referral
services program to include financial planners and certified public accountants.
Schwab also introduced customized portfolio guidance through Schwab investment
specialists and a range of new Web-based planning and investment evaluation
tools. Schwab's Mutual Fund Marketplace(R) provides customers with the ability
to invest in over 1,900 mutual funds from 316 fund families, including 1,143
Mutual Fund OneSource(R) funds. Schwab's share of the industry's net inflows to
direct-marketed mutual funds was 14% in 1999, down from 18% in 1998(b). Schwab's
share of the industry's direct-marketed mutual fund assets was 11% at December
31, 1999, up from 10% at December 31, 1998(b). Schwab also provides custodial,
trading and support services to approximately 5,800 independent investment
managers. As of December 31, 1999, these managers were guiding the investments
of 848,000 Schwab customer accounts containing $213.1 billion in assets.
------------------------
(b) Source: Strategic Insight Mutual Fund Research and Consulting, LLC.
The Company responds to changing customer needs with continued product,
technology and service innovations. In 1999, the Company launched the Schwab
Signature Services(TM) program and Velocity(TM). Schwab Signature Services
provides enhanced personal and online services for customers with higher asset
balances or trading volumes with Schwab. Velocity, an online trading system,
provides enhanced trade information and order execution for certain of Schwab's
customers who trade frequently. Also in 1999, Schwab introduced a number of
Web-based service offerings, including MyResearch(TM) report, which enables
customers to design their own research reports. Additionally, Schwab launched
two mutual fund research tools, Advanced Mutual Fund Screener and Fund Details,
which allow customers to access detailed information on all Morningstar, Inc.
rated funds. Further, Schwab enabled customers to open a new account, update
contact information, sign up for the Schwab MoneyLink(R) service and request a
check through automated Web-based processes. Continuing its practice of
leveraging technology to improve customer service, in 1999 Schwab launched
SchwabAlerts(TM), which delivers investment and market activity news to
customers via both wireless and regular e-mail. Also in 1999, Schwab introduced
eConfirms(TM), a service that delivers trade confirmations electronically.
Additionally, Schwab launched an online service, MySchwab(TM), allowing users to
customize a personal Schwab home page with content provided by Excite@Home. The
Company formed additional alliances during 1999 with Financial Engines, Inc. and
mPower.com, Inc. to provide participants in SchwabPlan(R), a bundled 401(k)
offering, with access to online investment guidance services; and with OffRoad
Capital to provide certain customers with access to private equity investment
opportunities. Further, during 1999, the Company and several major financial
services firms formed a new electronic communications network (ECN), REDIBook
ECN LLC, which utilizes technology developed by Spear, Leeds & Kellogg LP.
Participation in this ECN has enabled Schwab to launch an extended-hours trading
session for certain Nasdaq and selected exchange-listed stocks. Also in 1999,
the Company entered into an agreement with TD Waterhouse Group, Inc., Ameritrade
Holding Corporation, KPCB Holdings, Inc., Trident Capital Management, LLC and
Benchmark Capital Partners to form Epoch Partners, Inc., a new online investment
bank that intends to focus on information technology and Internet companies.
U.S. Trust provides an array of financial services for affluent individuals
and their families. These services include investment management, investment
consulting, trust, financial and estate planning and private banking, including
mortgage, personal lending and deposit products. U.S. Trust also provides
investment management, corporate trust and special fiduciary services for
corporations, endowments, foundations, pension plans and other institutional
clients.
Delivery Systems: The Company's multi-channel delivery systems allow
customers to choose how they prefer to do business with the Company. To enable
customers to obtain services in person with a Company representative, the
Company maintains a network of offices. Schwab's branch offices, which also
provide investors with access to the Internet, were expanded by 49 during 1999
to 340 at December 31, 1999. U.S. Trust's total offices were expanded by 4
during 1999 to 28 at December 31, 1999. Telephonic access to Schwab is provided
primarily through four regional customer telephone service centers and two
online customer support centers that operate both during and after normal market
hours. Additionally, customers are able to obtain financial information on an
automated basis through Schwab's automated telephonic and online channels.
Automated telephonic channels include TeleBroker(R), Schwab's touch-tone
telephone quote and trading service, and VoiceBroker(TM), Schwab's voice
recognition quote and trading service. Schwab's automated telephonic channels
handled over 70% of customer calls received in both 1999 and 1998. Schwab
handled a total of 110 million automated and live calls received in 1999, up 6%
from 1998. Online channels include the Charles Schwab Web Site(TM), an
information and trading service on the Internet at www.schwab.com, and PC-based
services such as SchwabLink(R), a service for investment managers. While the
online channel is the Company's fastest-growing channel, the Company continues
to stress the importance of Clicks and Mortar(TM) access - blending the power of
the Internet with personal service to create a full-service customer experience.
The Company's online channels handled 68% of total trades during 1999, up from
54% of total trades in 1998. Schwab's share of the industry's online assets was
39% at December 31, 1999, down from 42% at December 31, 1998(c). Schwab's share
of the industry's online trades was 24% in 1999, down from 30% in 1998(c).
Schwab provides every retail customer access to all delivery channels and
flat-fee pricing for Internet trades. To help improve multi-channel access for
independent investment managers and their customers, Schwab launched the
Signature Services Alliance(TM) during 1999. This service provides enhanced
personalized services, including access to a dedicated team of representatives,
a new Schwab Institutional Web site(TM) and flat-fee pricing for Internet
trades.
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(c) Source: U.S. Bancorp Piper Jaffray.
Technology: The Company's ongoing investment in technology is a key element
in expanding its product and service offerings, enhancing its delivery systems,
providing fast and consistent customer service, reducing processing costs, and
facilitating the Company's ability to handle significant increases in customer
activity without a corresponding rise in staffing levels. The Company uses
technology to empower its customers to manage their financial affairs and is a
leader in driving technological advancements in the financial services industry.
In 1999, the Company announced a joint effort with IBM to implement new systems
technology intended to help the Company's computers share their workload more
efficiently. Additionally in 1999, Schwab's investment in systems capacity,
which totaled $126 million, expanded Schwab's Web server, mainframe and data
storage capacity by 765%, 225% and 190%, respectively.
International Expansion: The Company moved to expand its international
presence through several transactions during 1999, including entering into a
joint venture agreement with The Tokio Marine and Fire Insurance Co., Limited
(TMI) and certain of its related companies (collectively, the TMI Group). The
Company and each member of the TMI Group are shareholders in a Japanese
corporation, Charles Schwab Tokio Marine Securities Co., Ltd. (CSTMS), in which
the Company has a 50% equity interest. CSTMS, whose business is expected to
commence in the first half of 2000, will initially provide retail brokerage and
investment services in U.S. dollar-denominated securities to residents of Japan.
CSTMS also expects to offer Japanese Yen-denominated securities in the future.
In 1999, the Company made an initial capital contribution of (Y)3.0 billion, or
approximately $27 million. The Company may, under certain circumstances, be
required to make additional capital contributions pursuant to the joint venture
agreements, including contributions to assure that CSTMS is in compliance with
regulatory requirements regarding capital adequacy. Also in 1999, the Company
completed the acquisitions of Canadian-based Priority Brokerage Inc. and
Porthmeor Securities Inc. These two companies were combined to create Charles
Schwab Canada, Co., a subsidiary of CSC. Additionally in 1999, the Company
signed a definitive agreement to form a joint venture with ecorp Limited to
provide financial services to Australian and New Zealand investors. The
transaction closed in February 2000. Further, during 1999 CSE extended online
and telephonic services to Swiss investors.
SUBSEQUENT EVENTS
On March 1, 2000, the Company acquired CyBerCorp, Inc. (CyBerCorp), an
electronic trading technology and brokerage firm providing Internet-based
services to highly active, online investors, for $517 million in a non-taxable
stock-for-stock exchange accounted for as a purchase. Pursuant to the
acquisition, CyBerCorp became a wholly owned subsidiary of CSC which resulted in
17,570,000 shares of CSC's common stock and 3,077,000 options to purchase CSC
common stock being exchanged for all of the outstanding shares, options and
equity rights of CyBerCorp.
See note "21 - Subsequent Events" in the Notes to Consolidated Financial
Statements for more information on the acquisition of CyBerCorp and other
subsequent events.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Current Report on Form 8-K
contains forward-looking statements that reflect management's beliefs,
objectives and expectations as of the date hereof. These statements relate to,
among other things, the ability to successfully pursue the Company's strategy to
attract and retain customer assets (see Description of Business), the ability of
the Company to realize the expected benefits of a business combination (see
Description of Business - Merger with U.S. Trust Corporation and Subsequent
Events), the Company's status under the Bank Holding Company Act (see Bank
Holding Company Act Requirements), the decline in average commission per revenue
trade (see Revenues - Commissions and Risk Management - Competition), the impact
on the Company's results of operations of Internet trade pricing for independent
investment managers and reduced pricing on equity online trades for certain
customers (see Revenues - Commissions), the impact on the Company's results of
operations of fee adjustments related to minimum account balances (see Revenues
- Asset Management and Administration Fees), the decline in average revenue per
share traded (see Revenues - Principal Transactions), sources of liquidity (see
Liquidity and Capital Resources - Liquidity), development spending (see
Liquidity and Capital Resources - Development Spending), capital expenditures
and capital structure (see Liquidity and Capital Resources - Cash Flows and
Capital Resources), the potential for problem loans (see Risk Management -
Credit Risk), market risk (see Risk Management - Market Risk), revenue growth,
after-tax profit margin and return on stockholders' equity (see Results of
Operations and Looking Ahead), the effects of increased competition (see Looking
Ahead), and contingent liabilities (see note "17 - Commitments and Contingent
Liabilities" in the Notes to Consolidated Financial Statements). Achievement of
the expressed beliefs, objectives and expectations described in these statements
is subject to certain risks and uncertainties that could cause actual results to
differ materially from the expressed objectives and expectations. Important
factors that may cause such differences include, but are not limited to: the
effect of customer trading patterns on Company revenues and earnings; the
inability to assimilate acquired companies and to achieve the anticipated
benefits; the Company's inability to attract and retain key personnel; changes
in the Company's level of personnel hiring, investment in new or existing
technology, or utilization of public media for advertising; changes in
technology; computer system failures and security breaches; the effects of
competitors' pricing, product and service decisions and intensified competition;
evolving regulation and changing industry practices adversely affecting the
Company; adverse results of litigation; the inability to obtain external
financing; changes in revenues and profit margin due to cyclical securities
markets and interest rates; the level and volatility of equity prices; a
significant downturn in the securities markets over a short period of time or a
sustained decline in securities prices and trading volumes; a significant
decline in the real estate market; and risks associated with international
expansion and operations. Certain of these factors are discussed in greater
detail in this Current Report on Form 8-K.
RESULTS OF OPERATIONS
Financial Overview
The Company achieved record revenues for the tenth consecutive year and
record earnings in 1999. One of the factors contributing to this record
performance was strong trading volumes in the securities markets during the
year. The combined daily average share volume for the New York Stock Exchange
(NYSE) and Nasdaq reached an all-time high of 1,864 million shares in 1999, a
28% increase over 1998. The Standard & Poor's 500 Index (on a dividend
reinvested basis) rose 21% during 1999.
Other key factors that contributed to the Company's financial performance
in 1999 include:
-- Assets in Schwab customer accounts rose $234.1 billion, or 48%, to a record
$725.2 billion. This increase resulted from net new customer assets of
$106.9 billion and net market gains of $127.2 billion.
-- A record 1,481,000 new Schwab customer accounts were opened, an increase of
7% from 1,380,000 opened in 1998.
-- U.S. Trust's customer assets rose $17.6 billion, or 17%, to $120.8 billion.
Trading activity reached record levels as shown in the following table (in
thousands):
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Daily Average Trades 1999 1998 1997
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Revenue Trades
Online 119.1 56.3 26.8
TeleBroker(R) and VoiceBroker(TM) 8.5 8.2 12.2
Regional customer telephone service centers,
branch offices and other 35.5 32.7 32.8
--------------------------------------------------------------------------------
Total 163.1 97.2 71.8
================================================================================
Mutual Fund OneSource(R) Trades
Online 23.3 18.0 12.8
TeleBroker and VoiceBroker 1.0 1.0 1.3
Regional customer telephone service centers,
branch offices and other 21.3 21.3 20.1
--------------------------------------------------------------------------------
Total 45.6 40.3 34.2
================================================================================
Total Daily Average Trades
Online 142.4 74.3 39.6
TeleBroker and VoiceBroker 9.5 9.2 13.5
Regional customer telephone service centers,
branch offices and other 56.8 54.0 52.9
--------------------------------------------------------------------------------
Total 208.7 137.5 106.0
================================================================================
Revenues increased mainly due to higher customer trading volume and an
increase in customer assets. Revenues of $4,486 million in 1999 grew $1,309
million, or 41%, from 1998 due to increases in revenues of $829 million, or 42%,
in the Individual Investor segment, $215 million, or 64%, in the Capital Markets
segment, $165 million, or 37%, in the Institutional Investor segment, and $100
million, or 23%, in the U.S. Trust segment. See note "19 - Segment Information"
in the Notes to Consolidated Financial Statements for financial information by
segment for the last three years.
The Company's operating expenses increased 35% during 1999 to $3,388 million,
primarily due to a 37% increase in compensation and benefits, a 55% increase in
advertising and market development, a 30% increase in occupancy and equipment
expenses and a 62% increase in professional services.
The Company's 1999 earnings rose 62% to $666 million, or $.49 per share, up
from $410 million, or $.31 per share, in 1998. All references to earnings per
share information in this report reflect diluted earnings per share unless
otherwise noted.
The Company's 1997 results include charges for the settlement of a
class-action lawsuit involving the Company's market-making subsidiary and other
firms engaged in making markets in Nasdaq securities. These charges totaled $24
million after-tax, or $.02 per share. Excluding these charges, the Company's
1998 earnings would have increased 19% from 1997.
The Company's after-tax profit margin for 1999 was 14.9%, which was higher
than the 12.9% margin in 1998, and above the Company's annual long-term
objective of 12%. During 1999, net income plus depreciation and amortization
including goodwill amortization increased 49% to $848 million and capital
expenditures increased 86% to $370 million.
Return on stockholders' equity was 31% in 1999, exceeding the Company's
annual long-term objective of 20%.
REVENUES
Revenues grew $1,309 million, or 41%, in 1999, exceeding management's annual
long-term objective of 20%, due to a 42% increase in commission revenues, a 30%
increase in asset management and administration fees, a 42% increase in interest
revenue, net of interest expense (referred to as net interest revenue) and a 75%
increase in principal transaction revenues. Non-trading revenues represented 47%
of total revenues for 1999, down from 49% for 1998 and up from 46% for 1997 as
shown in the table below.
--------------------------------------------------------------------------------
Composition of Revenues 1999 1998 1997
--------------------------------------------------------------------------------
Commissions 42% 41% 44%
Principal transactions 11 10 10
--------------------------------------------------------------------------------
Total trading revenues 53 51 54
--------------------------------------------------------------------------------
Asset management and administration fees 27 29 28
Net interest revenue 18 18 17
Other 2 2 1
--------------------------------------------------------------------------------
Total non-trading revenues 47 49 46
--------------------------------------------------------------------------------
Total 100% 100% 100%
================================================================================
Commissions
The Company earns commission revenues by executing customer trades primarily
through the Individual Investor and Institutional Investor segments. These
revenues are affected by the number of customer accounts that traded, the
average number of commission-generating trades per account, and the average
commission per trade. Commission revenues were $1,875 million in 1999, compared
to $1,318 million in 1998 and $1,183 million in 1997.
As illustrated in the table below, from 1997 to 1999, the total number of
customer revenue trades executed by the Company has increased 126% as the
Company's customer base has grown and the average number of trades per account
has increased. From 1997 to 1999, average commission per revenue trade decreased
29%. The 15% decrease from 1998 to 1999 was mainly due to an increase in the
proportion of trades placed through online channels, which have lower commission
rates than the Company's other channels. The 17% decrease from 1997 to 1998 was
mainly due to the Company's integration of its online and traditional brokerage
services and the resulting reduction of the price of online trades for most of
its customers in 1998. However, the increase in trading activity more than
offset the effect of the lower average commission per revenue trade. As more
customers migrate to online channels, average commission per revenue trade is
expected to continue to decline.
In November 1999, the Company began to provide independent investment
managers with flat-fee pricing for Internet trades. This price reduction is
designed to enhance the Company's competitive position and to align the pricing
of Internet trades for independent investment managers with that offered to most
of the Company's individual customers. While the effect of this price reduction
cannot be predicted with certainty, management expects that the impact of this
reduction on the Company's results of operations will be offset by the lower
cost of processing Internet trades and by expected growth in customer assets and
trading volumes associated with independent investment managers. This price
reduction will only affect the Institutional Investor segment and, based on
management's expectations, it will not have a material impact on that segment's
revenues.
In February 2000, the Company announced a plan to provide customers who meet
certain online equity trading criteria with reduced pricing. This price
reduction is designed to enhance the Company's competitive position with
actively trading investors. While the effect of this price reduction cannot be
predicted with certainty, management expects that the impact of this reduction
on the Company's results of operations will be offset over time with increased
trading volume and increased fees related to minimum account balances (see Asset
Management and Administration Fees). This price reduction will only affect the
Individual Investor segment and, based on management's expectations, will not
have a material impact on that segment's revenues.
--------------------------------------------------------------------------------
Commissions Earned on Customer Revenue Trades 1999 1998 1997
--------------------------------------------------------------------------------
Customer accounts that traded during the year
(in thousands) 3,349 2,783 2,380
Average customer revenue trades per account 12.3 8.8 7.6
Total revenue trades (in thousands) 41,116 24,508 18,169
Average commission per revenue trade $ 45.55 $ 53.44 $ 64.27
Commissions earned on customer revenue trades
(in millions) (1) $ 1,873 $ 1,309 $ 1,168
================================================================================
(1) Includes certain non-commission revenues relating to the execution of
customer trades totaling $39 million in 1999, $25 million in 1998 and $16
million in 1997. Excludes commissions on trades relating to specialist
operations totaling $29 million in 1999, $25 million in 1998 and $22
million in 1997. Excludes U.S. Trust commissions on trades totaling $12
million in 1999 and $9 million in both 1998 and 1997.
Asset Management and Administration Fees
Asset management and administration fees include mutual fund service fees, as
well as fees for other asset-based financial services provided to individual and
institutional customers. The Company earns mutual fund service fees for
recordkeeping and shareholder services provided to third-party funds, and for
transfer agent services, shareholder services, administration and investment
management provided to its proprietary funds. These mutual fund service fees are
based upon the daily balances of customer assets invested in third-party funds
and upon the average daily net assets of Schwab's proprietary funds. Mutual fund
service fees are earned primarily through the Individual Investor and
Institutional Investor segments. The Company also earns asset management and
administration fees for financial services, including investment management and
consulting, trust and fiduciary services, financial and estate planning, and
private banking services, provided to individual and institutional customers.
These fees are primarily based on the value and composition of assets under
management and are earned primarily through the U.S. Trust segment, as well as
the Individual Investor and Institutional Investor segments.
Asset management and administration fees were $1,220 million in 1999,
compared to $937 million in 1998 and $739 million in 1997, as shown in the
following table (in millions):
--------------------------------------------------------------------------------
Asset Management and Administration Fees 1999 1998 1997
--------------------------------------------------------------------------------
Mutual fund service fees:
SchwabFunds(R) $ 507 $373 $283
Mutual Fund OneSource(R) 229 175 135
Excelsior Funds(R) 35 28 22
Other 14 11 9
Asset management and related services 435 350 290
--------------------------------------------------------------------------------
Total $1,220 $937 $739
================================================================================
The increases from 1997 to 1999 were primarily due to significant increases
in customer assets in Schwab's proprietary funds, referred to as the
SchwabFunds, and increases in U.S. Trust's customer assets, as well as increases
in funds purchased through Schwab's Mutual Fund OneSource service.
The SchwabFunds include money market funds, equity index funds, bond funds,
asset allocation funds, and funds that primarily invest in stock, bond and money
market funds. Schwab customers may elect to have cash balances in their
brokerage accounts automatically invested in certain SchwabFunds money market
funds. Customer assets invested in the SchwabFunds were $107.9 billion, $81.5
billion and $55.8 billion at the end of 1999, 1998 and 1997, respectively.
At December 31, 1999, Schwab's Mutual Fund OneSource service enabled
customers to trade 1,143 mutual funds in 208 fund families without incurring
transaction fees. The service allows investors to access multiple mutual fund
companies, avoid brokerage transaction fees, and achieve investment diversity
among fund families. In addition, investors' recordkeeping and investment
monitoring are simplified through one consolidated statement. Customer assets
held by Schwab that have been purchased through the Mutual Fund OneSource
service, excluding SchwabFunds, were $102.3 billion, $69.9 billion and $56.6
billion at the end of 1999, 1998 and 1997, respectively.
Additionally, customer assets invested in the Mutual Fund Marketplace(R),
excluding the Mutual Fund OneSource service, were $74.3 billion, $59.2 billion
and $48.0 billion at the end of 1999, 1998 and 1997, respectively. Schwab
charges a transaction fee on trades placed in the funds included in the Mutual
Fund Marketplace (except on trades through the Mutual Fund OneSource service).
These fees are recorded as commission revenues.
Further, U.S. Trust's customer assets were $120.8 billion, $103.2 billion and
$83.5 billion at the end of 1999, 1998 and 1997, respectively. In addition, U.S.
Trust provides administrative services for corporations, municipalities, and
financial and other institutions through its corporate trust division. U.S.
Trust's customer assets do not include these assets under administration, which
were $330.7 billion, $300.5 billion and $248.6 billion at the end of 1999, 1998
and 1997, respectively.
In February 2000, the Company announced a plan to increase fees related to
minimum account balances (effective April 1, 2000). This fee adjustment is
designed to more effectively align account fees with the expanded and improved
services currently available to Schwab customers. While the effect of this fee
adjustment cannot be predicted with certainty, management expects that the
impact of this adjustment on the Company's results of operations will be more
than offset by the price reduction related to online equity trades for customers
who meet certain criteria for such trades (see Commissions). This fee adjustment
will only affect the Individual Investor segment and, based on management's
expectations, it will not have a material impact on that segment's revenues.
Net Interest Revenue
Net interest revenue is the difference between interest earned on assets
(mainly margin loans to customers, investments required to be segregated for
customers, securities available for sale and private banking loans) and interest
paid on liabilities (mainly brokerage customer cash balances and banking
deposits). Net interest revenue is affected by changes in the volume and mix of
these assets and liabilities, as well as by fluctuations in interest rates and
hedging strategies.
Most of the Company's net interest revenue is earned by Schwab through the
Individual Investor and Institutional Investor segments, as well as by U.S.
Trust through the U.S. Trust segment. In clearing its customers' trades, Schwab
holds cash balances payable to customers. In most cases, Schwab pays its
customers interest on cash balances awaiting investment, and may invest these
funds and earn interest revenue. Schwab also may lend funds to customers on a
secured basis to purchase qualified securities - a practice commonly known as
"margin lending." Pursuant to SEC regulations, customer cash balances that are
not used for margin lending are segregated into an investment account that is
maintained for the exclusive benefit of customers. U.S. Trust lends funds
primarily to its private banking customers.
When investing segregated customer cash balances, Schwab must adhere to SEC
regulations that restrict investments to U.S. government securities,
participation certificates and mortgage-backed securities guaranteed by the
Government National Mortgage Association, certificates of deposit issued by U.S.
banks and thrifts, and resale agreements collateralized by qualified securities.
Schwab's policies for credit quality and maximum maturity requirements are more
restrictive than these SEC regulations. In each of the last three years, resale
agreements accounted for over 70% of Schwab's investments of segregated customer
cash balances. The average maturities of Schwab's total investments of
segregated customer cash balances were 62 days in 1999, 66 days in 1998 and 63
days in 1997.
Net interest revenue was $820 million in 1999, compared to $578 million in
1998 and $444 million in 1997, as shown in the following table (in millions):
--------------------------------------------------------------------------------
1999 1998 1997
--------------------------------------------------------------------------------
Interest Revenue
Margin loans to customers $ 983 $ 671 $ 489
Investments, customer-related 404 400 376
Private banking loans 175 149 133
Securities available for sale 57 60 70
Other 99 72 43
--------------------------------------------------------------------------------
Total 1,718 1,352 1,111
--------------------------------------------------------------------------------
Interest Expense
Brokerage customer cash balances 689 580 481
Deposits from banking customers 117 108 100
Long-term debt 33 30 25
Stock-lending activities 32 37 37
Short-term borrowings 20 9 16
Other 7 10 8
--------------------------------------------------------------------------------
Total 898 774 667
--------------------------------------------------------------------------------
Net interest revenue $ 820 $ 578 $ 444
================================================================================
The Company's interest-earning assets are financed primarily by
interest-bearing brokerage customer cash balances and banking deposits. Other
funding sources include noninterest-bearing brokerage customer cash balances,
proceeds from stock-lending activities, short-term borrowings and long-term
debt, and stockholders' equity. Customer-related daily average balances,
interest rates, and average net interest spread are summarized as follows
(dollars in millions):
--------------------------------------------------------------------------------
1999 1998 1997
--------------------------------------------------------------------------------
Interest-Earning Assets (customer-related and other):
Margin loans to customers:
Average balance outstanding $13,172 $ 8,772 $ 6,367
Average interest rate 7.46% 7.65% 7.68%
Investments (customer-related):
Average balance outstanding $ 8,555 $ 7,687 $ 6,990
Average interest rate 4.72% 5.21% 5.38%
Private banking loans:
Average balance outstanding $ 2,404 $ 1,973 $ 1,738
Average interest rate 7.26% 7.58% 7.68%
Securities available for sale:
Average balance outstanding $ 997 $ 995 $ 1,138
Average interest rate 5.75% 5.99% 6.14%
Average yield on interest-earning assets 6.44% 6.59% 6.58%
Funding Sources (customer-related and other):
Interest-bearing brokerage customer cash balances:
Average balance outstanding $17,344 $13,278 $10,661
Average interest rate 3.97% 4.37% 4.51%
Interest-bearing banking deposits:
Average balance outstanding $ 2,779 $ 2,351 $ 2,073
Average interest rate 4.23% 4.59% 4.81%
Other interest-bearing sources:
Average balance outstanding $ 1,510 $ 1,299 $ 1,123
Average interest rate 3.85% 4.23% 4.44%
Average noninterest-bearing portion $ 3,495 $ 2,499 $ 2,376
Average interest rate on funding sources 3.44% 3.82% 3.88%
Summary:
Average yield on interest-earning assets 6.44% 6.59% 6.58%
Average interest rate on funding sources 3.44% 3.82% 3.88%
--------------------------------------------------------------------------------
Average net interest spread 3.00% 2.77% 2.70%
================================================================================
The increases in net interest revenue from 1997 to 1999 were primarily due to
higher levels of margin loans to customers, partially offset by higher average
customer cash balances.
Since the Company establishes the rates paid on brokerage customer cash
balances and certain banking deposits and the rates charged on margin and
private banking loans, a substantial portion of its net interest spread is
managed by the Company. However, the spread is highly influenced by external
factors such as the interest rate environment and competition. The Company's
average net interest spread increased from 1998 to 1999 as the average interest
rate on funding sources declined more than the decline in the average yield on
interest-earning assets. The Company's average net interest spread increased
from 1997 to 1998 as the average yield on interest-earning assets increased and
the average interest rate on funding sources declined.
Principal Transactions
Principal transaction revenues are primarily comprised of net gains from
market-making activities in Nasdaq and other securities effected through the
Capital Markets segment. Factors that influence principal transaction revenues
include the volume of customer trades, market price volatility, average revenue
per share traded and changes in regulations and industry practices as discussed
below. As a market maker in Nasdaq and other securities, SCM generally executes
customer trades as principal. While substantially all Nasdaq security trades
originated by the customers of Schwab are directed to SCM, a substantial portion
of SCM's trading volume comes from parties other than Schwab. Orders handled by
SCM represented approximately 8% of the total shares traded on Nasdaq in 1999,
up from 7% in 1998(d).
-----------------------
(d) Source: The Nasdaq Stock Market, Inc.
Principal transaction revenues were $500 million in 1999, compared to $287
million in 1998 and $258 million in 1997. The increases from 1997 to 1999 were
primarily due to significant increases in share volume handled by SCM. The
increase from 1997 to 1998 was partially offset by lower average revenue per
share traded.
Certain SEC rules and rule amendments, known as the Order Handling Rules,
have significantly altered the manner in which orders for both Nasdaq and
exchange-listed securities are handled. These rules were implemented in phases
between January 20, 1997 and October 13, 1997. Applicable laws and regulations
also limit SCM's ability to engage in principal transactions with certain
accounts where U.S. Trust acts as a fiduciary. Additionally, in June 1997, most
major U.S. securities markets, including Nasdaq and the NYSE, began quoting and
trading most securities in increments of one-sixteenth dollar per share instead
of one-eighth dollar per share. Mainly as a result of these regulatory changes
and changes in industry practices, SCM's average revenue per share traded
declined from 3.3(cents) in 1997 to 2.5(cents) in 1998. However, SCM's average
revenue per share traded increased to 2.8(cents) in 1999. An increase in the
market price volatility of technology stocks in 1999 contributed to SCM's higher
average revenue per share traded. The SEC has ordered the exchanges and Nasdaq
to submit a plan to phase in decimal pricing for certain listed stocks and
options starting on September 5, 2000, for certain Nasdaq securities starting on
March 12, 2001 and for all remaining equity securities and options by April 9,
2001. This change is likely to cause decreases in average revenue per share
traded, will only affect the Capital Markets segment and, based on management's
expectations, will not have a material impact on that segment's revenues.
See note "17 - Commitments and Contingent Liabilities" in the Notes to
Consolidated Financial Statements regarding certain civil litigation relating to
principal transaction activities.
Revenues relating to Schwab's specialist operations were $41 million in 1999,
$29 million in 1998 and $21 million in 1997. Higher revenues related to Schwab's
specialist operations and gains from the sale of fixed income securities owned
by Schwab for the purpose of facilitating customer orders also contributed to
the increase in principal transaction revenues from 1997 to 1998.
Other Revenues
Other revenues include fees for other financial services. Other revenues are
earned primarily through the Individual Investor, Institutional Investor and
U.S. Trust segments. These revenues were $71 million in 1999, compared to $59
million in 1998 and $47 million in 1997. The increase from 1998 to 1999 was due
to higher levels of trading volume-related revenues and financial services fees.
The increase from 1997 to 1998 was due to higher revenue from Schwab
AdvisorSource(TM) participation fees, software maintenance fees and higher
levels of trading volume-related revenues.
EXPENSES EXCLUDING INTEREST
--------------------------------------------------------------------------------
Expenses Excluding Interest as a Percentage of Revenues 1999 1998 1997
--------------------------------------------------------------------------------
Compensation and benefits 42% 43% 43%
Occupancy and equipment 7 7 7
Communications 6 7 7
Advertising and market development 6 5 5
Professional services 4 4 3
Depreciation and amortization 4 5 5
Commissions, clearance and floor brokerage 2 3 4
Other 5 5 6
--------------------------------------------------------------------------------
Total 76% 79% 80%
================================================================================
Compensation and Benefits
Compensation and benefits expense includes salaries and wages, variable
compensation, and related employee benefits and taxes. Employees receive
variable compensation that is tied to the achievement of specified objectives
relating primarily to revenue growth, profit margin and growth in customer
assets. Therefore, a significant portion of compensation and benefits expense
will fluctuate with these measures.
Compensation and benefits expense was $1,888 million in 1999, compared to
$1,374 million in 1998 and $1,135 million in 1997. The increases from 1997 to
1999 were generally due to a greater number of employees and higher variable
compensation expense resulting from the Company's financial performance. The
following table shows a comparison of certain compensation and benefits
components and employee data (in thousands):
--------------------------------------------------------------------------------
1999 1998 1997
--------------------------------------------------------------------------------
Variable compensation as a % of compensation and
benefits expense 30% 24% 23%
Compensation for temporary employees, contractors
and overtime hours as a % of compensation and
benefits expense 11% 12% 12%
Full-time equivalent employees(1) 20.1 15.1 14.3
Revenues per average full-time equivalent employee $249 $214 $204
================================================================================
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
The Company encourages and provides for employee ownership of the Company's
common stock through its profit sharing and employee stock ownership plan, its
stock incentive plans and an automatic investment plan. The Company's overall
compensation structure is intended to attract, retain and reward highly
qualified employees, and to align the interests of employees with those of
stockholders. To further this alignment and in recognition of the Company's
financial performance, the Company awarded all non-officer employees stock
option grants in 1999 and 1998 for options to buy shares of common stock
totaling 5,675,000 and 5,217,000 shares, respectively. (These stock options were
granted prior to the Merger, and therefore did not include U.S. Trust
employees.)
Occupancy and Equipment
Occupancy and equipment expense includes the costs of leasing and maintaining
the Company's office space, four regional customer telephone service centers,
two online customer support centers, two primary data centers, 340 Schwab
domestic branch offices and 28 U.S. Trust offices. It also includes lease and
rental expenses on computer and other equipment. Occupancy and equipment expense
was $307 million in 1999, compared to $236 million in 1998 and $192 million in
1997. This trend reflects the Company's continued growth and expansion, and its
commitment to customer service and investment in technology. The Company
expanded its office space in 1999, 1998 and 1997, and opened its second data
center in 1998. Schwab opened 49 new branch offices in 1999, 19 in 1998 and 40
in 1997. U.S. Trust opened 4 new offices in 1999, 5 in 1998 and 1 in 1997. The
increases in occupancy and equipment expense from 1997 to 1999 also reflect
higher lease and maintenance expenses on information technology equipment.
Communications
Communications expense includes telephone, postage and printing, and news and
quotation costs. This expense was $279 million in 1999, compared to $216 million
in 1998 and $191 million in 1997. The increases from 1997 to 1999 primarily
resulted from higher customer trading volumes, higher postage and printing costs
in connection with the growth in customer accounts, increased customer use of
automated telephonic and online channel news, quotation and information
services, additional leased telephone lines related to online service offerings,
and new branch offices.
Advertising and Market Development
Advertising and market development expense includes media, print and direct
mail advertising expenses, and related production, printing and postage costs.
This expense was $248 million in 1999, compared to $160 million in 1998 and $134
million in 1997. The increases from 1997 to 1999 were primarily a result of the
Company's increased brand-focused media spending. Advertising and market
development expense was 6% of revenues in 1999 and 5% in both 1998 and 1997.
Professional Services
Professional services expense includes fees paid to consultants engaged to
support product, service and information technology projects, and legal and
accounting fees. This expense was $184 million in 1999, compared to $114 million
in 1998 and $92 million in 1997. The increases from 1997 to 1999 were primarily
due to higher levels of consulting fees in many areas, including new and
expanded products and services, information technology projects, and capacity
expansion.
Depreciation and Amortization
Depreciation and amortization includes expenses relating to equipment and
office facilities, capitalized software, leasehold improvements, property and
other intangibles. This expense was $175 million in 1999, compared to $152
million in 1998 and $129 million in 1997. The increases from 1997 to 1999 were
primarily due to newly acquired information technology equipment that increased
the Company's customer service capacity. The increases from 1997 to 1999 also
reflect increased amortization of leasehold improvements for new branches and
expanded office space. Amortization expense related to intangible assets was $8
million in 1999, compared to $9 million in both 1998 and 1997. Amortization
expense decreased from 1997 to 1999 due to certain intangibles becoming fully
amortized.
Commissions, Clearance and Floor Brokerage
Commissions, clearance and floor brokerage expense includes fees paid to
stock and option exchanges for trade executions, fees paid by SCM to
broker-dealers for orders received for execution, and fees paid to clearing
entities for trade processing. This expense was $100 million in 1999, compared
to $87 million in 1998 and $96 million in 1997. The increase from 1998 to 1999
was primarily due to an increase in trading volume processed by SCM and Schwab.
The decrease from 1997 to 1998 was primarily due to a decrease in the fees paid
per share traded by SCM to broker-dealers for orders received for execution,
partially offset by an increase in trading volume processed by SCM and Schwab.
Goodwill Amortization
Goodwill represents the cost of acquired businesses in excess of fair value
of the related net assets at acquisition and is amortized on a straight-line
basis. Goodwill amortization expense was $6 million in both 1999 and 1998 and
$10 million in 1997.
Other Expenses
Other expenses include trade-related errors, travel and entertainment,
regulatory fees and dues, and other miscellaneous expenses. These other expenses
were $200 million in 1999, compared to $153 million in 1998 and $161 million in
1997. The change from 1998 to 1999 was primarily due to higher levels of travel
and related costs, volume-related regulatory fees and dues, an increase in
reserves for uncollectible accounts and contingent liabilities, and increased
trade-related errors resulting from system downtime. The decrease from 1997 to
1998 was primarily due to the $39 million pre-tax litigation settlement charges
in 1997, partially offset by higher trade-related errors and other
volume-related expenses in 1998.
Taxes on Income
The Company's effective income tax rate was 39.4% in 1999 and 39.5% in both
1998 and 1997.
New Accounting Pronouncement
In 1999, the Company adopted a new accounting standard related to
internal-use software development costs (see note "2 - Significant Accounting
Policies" in the Notes to Consolidated Financial Statements). As required by the
standard, in 1999 certain of the Company's costs, primarily compensation and
benefits, were capitalized and will be amortized over the software's estimated
useful life of three years. In prior years, these costs were expensed as
incurred. The Company capitalized $68 million in software development costs in
1999.
LIQUIDITY AND CAPITAL RESOURCES
CSC conducts virtually all business through its wholly owned subsidiaries.
The capital structure among CSC and its subsidiaries is designed to provide each
entity with capital and liquidity consistent with its operations. A description
of significant aspects of this structure for CSC and four of its subsidiaries,
Schwab, U.S. Trust, SCM and CSE, follows.
Liquidity
CSC
CSC's liquidity needs are generally met through cash generated by its
subsidiaries, as well as cash provided by external financing. As discussed
below, Schwab, SCM, CSE and CSC's bank subsidiaries are subject to regulatory
requirements that may restrict them from certain transactions with CSC.
Management believes that funds generated by the operations of CSC's subsidiaries
will continue to be the primary funding source in meeting CSC's liquidity needs,
maintaining CSC's bank subsidiaries' capital guidelines and maintaining Schwab's
and SCM's net capital. Based on their respective regulatory capital ratios at
December 31, 1999 and 1998, CSC and its bank subsidiaries are well capitalized.
See note "16 - Regulatory Requirements" in the Notes to Consolidated Financial
Statements.
CSC has liquidity needs that arise from its issued and outstanding $455
million Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as from
the funding of cash dividends, acquisitions and other investments. The
Medium-Term Notes have maturities ranging from 2000 to 2009 and fixed interest
rates ranging from 5.96% to 7.50% with interest payable semiannually. The
Medium-Term Notes are rated A3 by Moody's Investors Service and A- by Standard &
Poor's Ratings Group.
In June 1999, the SEC declared effective CSC's registration statement
covering the issuance of $395 million in Senior or Senior Subordinated
Medium-Term Notes, Series A (including $145 million of unissued notes previously
included in CSC's registration statement). At December 31, 1999, $311 million of
these notes remained unissued. See note "21 - Subsequent Events" in the Notes to
Consolidated Financial Statements.
CSC may borrow under its committed, unsecured credit facilities. CSC
maintains a $600 million facility with a group of fourteen banks which is
scheduled to expire in June 2000 and a $175 million facility with a group of
nine banks which is scheduled to expire in June 2001. See note "21 - Subsequent
Events" in the Notes to Consolidated Financial Statements. The funds under both
of these facilities are available for general corporate purposes and CSC pays a
commitment fee on the unused balance of these facilities. The financial
covenants in these facilities require CSC to maintain minimum levels of
stockholders' equity, and Schwab and SCM to maintain specified levels of net
capital, as defined. The Company believes that these restrictions will not have
a material effect on its ability to meet foreseeable dividend or funding
requirements. Other than an overnight borrowing to test the availability of the
$600 million facility, these facilities were unused in 1999.
CSC also has direct access to $685 million of the $795 million uncommitted,
unsecured bank credit lines, provided by nine banks, that are primarily utilized
by Schwab to manage short-term liquidity. The amount available to CSC under
these lines is lower than the amount available to Schwab because the credit line
provided by one of these banks is only available to Schwab, while the credit
line provided by another one of these banks includes a sub-limit on credit
available to CSC. These lines were not used by CSC in 1999.
Schwab
Most of Schwab's assets are liquid, consisting primarily of receivable from
brokerage customers, short-term (i.e., less than 90 days) investment-grade,
interest-earning investments (the majority of which are segregated for the
exclusive benefit of customers pursuant to regulatory requirements), and
receivable from brokers, dealers and clearing organizations. Customer margin
loans are demand loan obligations secured by readily marketable securities.
Receivable from and payable to brokers, dealers and clearing organizations
primarily represent current open transactions, which usually settle, or can be
closed out, within a few business days.
Liquidity needs relating to customer trading and margin borrowing activities
are met primarily through cash balances in brokerage customer accounts, which
were $23.0 billion, $17.5 billion and $12.7 billion at December 31, 1999, 1998
and 1997, respectively. Management believes that brokerage customer cash
balances and operating earnings will continue to be the primary sources of
liquidity for Schwab in the future.
Schwab is subject to regulatory requirements that are intended to ensure the
general financial soundness and liquidity of broker-dealers. These regulations
prohibit Schwab from repaying subordinated borrowings to CSC, paying cash
dividends, or making unsecured advances or loans to its parent or employees if
such payment would result in net capital of less than 5% of aggregate debit
balances or less than 120% of its minimum dollar amount requirement of $1
million. At December 31, 1999, Schwab's net capital was $1,766 million (10% of
aggregate debit balances), which was $1,421 million in excess of its minimum
required net capital and $903 million in excess of 5% of aggregate debit
balances. Schwab has historically targeted net capital to be 10% of its
aggregate debit balances, which primarily consist of customer margin loans. To
achieve this target, as customer margin loans have grown, an increasing amount
of cash flows have been retained to support aggregate debit balances.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$1,400 million subordinated revolving credit facility maturing in September
2001, of which $905 million was outstanding at December 31, 1999. At year end,
Schwab also had outstanding $25 million in fixed-rate subordinated term loans
from CSC maturing in 2001. Borrowings under these subordinated lending
arrangements qualify as regulatory capital for Schwab.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank
credit lines totaling $795 million at December 31, 1999 ($685 million of these
lines are also available for CSC to use). The need for short-term borrowings
arises primarily from timing differences between cash flow requirements and the
scheduled liquidation of interest-bearing investments. Schwab used such
borrowings for twenty-six days in 1999, six days in 1998 and eleven days in
1997, with the daily amounts borrowed averaging $125 million, $87 million and
$85 million, respectively. These lines were unused at December 31, 1999.
To satisfy the margin requirement of customer option transactions with the
Options Clearing Corporation (OCC), Schwab had unsecured letter of credit agree-
ments with eleven banks in favor of the OCC aggregating $905 million at December
31, 1999. Schwab pays a fee to maintain these letters of credit. No funds were
drawn under these letters of credit at December 31, 1999.
U.S. Trust
U.S. Trust's liquidity needs are generally met through earnings generated by
its operations.
U.S. Trust's liquidity is affected by the Federal Reserve Board's risk-based
and leverage capital guidelines. In addition, CSC's bank subsidiaries are
subject to limitations on the amount of dividends they can pay to U.S. Trust
without prior approval of the bank regulatory authorities. See note "16 -
Regulatory Requirements" in the Notes to Consolidated Financial Statements.
U.S. Trust has credit facilities totaling $80 million which are based on
LIBOR or Prime and mature in March 2002. At December 31, 1999, there was $35
million outstanding under these facilities. Upon completion of the Merger, these
facilities were terminated.
In addition to traditional funding sources such as deposits, federal funds
purchased and repurchase agreements, CSC's bank subsidiaries have established
their own external funding sources. At December 31, 1999, U.S. Trust had $50
million in Trust Preferred Capital Securities outstanding with a fixed interest
rate of 8.41%. Certain of CSC's bank subsidiaries have established credit
facilities with the Federal Home Loan Bank System (FHLB) totaling approximately
$426 million. At December 31, 1999, $13 million was outstanding under these
credit facilities.
SCM
SCM's liquidity needs are generally met through earnings generated by its
operations. Most of SCM's assets are liquid, consisting primarily of marketable
securities, receivable from brokers, dealers and clearing organizations, and
cash and cash equivalents.
SCM's liquidity is affected by the same net capital regulatory requirements
as Schwab (see discussion above). At December 31, 1999, SCM's net capital was
$13 million, which was $12 million in excess of its minimum required net
capital.
SCM may borrow up to $35 million under a subordinated lending arrangement
with CSC maturing in 2001. Borrowings under this arrangement qualify as reg-
ulatory capital for SCM. This facility was unused in 1999. In addition, CSC
provides SCM with a $25 million short-term credit facility. Borrowings under
this arrangement do not qualify as regulatory capital for SCM. This facility was
unused at December 31, 1999.
CSE
CSE's liquidity needs are generally met through earnings generated by its
operations. Most of CSE's assets are liquid, consisting primarily of cash and
investments required to be segregated, receivable from brokers, dealers and
clearing organizations, and receivable from brokerage customers and others.
CSE may borrow up to (pound)20 million, equivalent to $32 million at December
31, 1999, under subordinated lending arrangements with CSC. At December 31,
1999, CSE had outstanding (pound)18 million under these arrangements, equivalent
to $29 million, with (pound)5 million maturing in 2001 and (pound)13 million
maturing in 2003.
Development Spending
A significant portion of the Company's liquidity needs arises from ongoing
investments to support future growth. These investments, which the Company
refers to as development spending, are comprised of two categories: media
spending (including media and production expenses) and project spending. Project
spending is generally targeted towards enhancing future revenue growth, such as
improvements to the Company's Web site or branch expansion; enhancing the
Company's infrastructure, such as investments to improve customer statements or
its systems integration; and improving the firm's productivity, such as
enhancements to its telecommunications systems or operations processes. This
spending is imbedded throughout certain categories of the Company's non-interest
expenses.
Development spending in 1999 was approximately $450 million and management
currently anticipates an increase of approximately 30% in 2000, reflecting
management's belief that development spending is critical to strengthening the
Company's competitive advantages.
As has been the case in recent years, the Company may adjust its development
spending from period to period as business conditions change. In general, the
level of future spending will be influenced by the rate of growth in customer
assets and trading activities, the opportunities to invest in technology that
improve capacity, productivity or the customer experience, and the expected
return on these investments as compared to the Company's financial objectives
and cost of capital. While development spending is discretionary and can be
altered in response to business conditions, the Company views its development
spending as essential for future growth and therefore prefers to avoid major
adjustments in such spending unless faced with what it believes is a sustained
slowdown in revenue growth.
Cash Flows and Capital Resources
Net income plus depreciation and amortization including goodwill amortization
was $848 million in 1999, up 49% from $569 million in 1998, allowing the Company
to finance the majority of its growth with internally generated funds.
Depreciation and amortization expense related to equipment, office facilities
and property was $167 million in 1999 and $143 million in 1998. Amortization
expense related to intangible assets was $8 million in 1999 and $9 million in
1998. Goodwill amortization expense was $6 million in both 1999 and 1998.
The Company's capital expenditures were $373 million ($370 million net of
proceeds from the sale of fixed assets) in 1999 and $204 million ($199 million
net of proceeds) in 1998, or 8% and 6% of revenues, respectively. In 1999, 78%
of capital expenditures were for information technology and 22% for facilities
expansion and improvements. Capital expenditures as described above include the
capitalized costs for developing internal-use software of $68 million in 1999.
Schwab opened 49 new branch offices during 1999, compared to 19 in 1998. U.S.
Trust opened 4 new offices in 1999, compared to 5 in 1998. The Company continues
to view its office network as important to pursuing its strategy of attracting
customer assets.
Management currently anticipates that 2000 capital expenditures will be
approximately 90% higher than 1999 spending. Approximately 40% of the 2000
planned expenditures relate to facilities expansion and improvements and
approximately 60% relate to information technology. The significant increase in
2000 planned expenditures is primarily due to leasehold improvements to support
the Company's growth in employees, and the Company's plans to enhance systems
capacity and availability. As has been the case in recent years, the Company may
adjust its capital expenditures from period to period as business conditions
change.
During 1999, the Company:
-- Issued $144 million and repaid $45 million of long-term debt;
-- Paid common stock dividends of $61 million.
The Company monitors both the relative composition and absolute level of its
capital structure. The Company's total financial capital (long-term debt plus
stockholders' equity) at December 31, 1999 was $3,094 million, up $1,002
million, or 48%, from a year ago. At December 31, 1999, the Company had
long-term debt of $518 million, or 17% of total financial capital, bearing
interest at a weighted-average rate of 6.89%. At December 31, 1999, the
Company's stockholders' equity was $2,576 million, or 83% of total financial
capital. Management currently anticipates that long-term debt will remain below
30% of total financial capital.
Share Repurchases
CSC repurchased 3,371,100 shares of its common stock in 1999 for $54
million, 23,219,700 shares for $208 million in 1998 and 7,905,700 shares for $59
million in 1997. There is no current authorization for share repurchases.
Dividend Policy
Since the initial dividend in 1989, CSC has paid 43 consecutive quarterly
dividends and has increased the dividend 11 times. Since 1989, dividends have
increased by a 34% compounded annual growth rate. CSC paid common stock
dividends of $.0373 per share in 1999, $.0360 per share in 1998 and $.0311 per
share in 1997. Dividends declared per common share represent dividends declared
by CSC prior to the Merger. While the payment and amount of dividends are at the
discretion of the Company's Board of Directors, the Company targets its cash
dividend at approximately 5% to 10% of net income plus depreciation and
amortization.
YEAR 2000 CENTURY CHANGE
The Company's mission critical systems operated throughout the Year 2000
century change without material errors or interruptions when processing data and
transactions incorporating year 2000 dates, and the Company did not encounter
any material problems with any of its mission critical vendor-supplied systems,
services or products. Mission critical systems, services and products means
those systems, services and products critical to the ongoing operation of the
business.
Compliance Costs
As of December 31, 1999, the Company spent approximately $96 million of the
estimated cost for its Year 2000 project.
The Company has funded all Year 2000 related costs through operating cash
flows and a reallocation of the Company's overall development spending. This
reallocation did not result in the delay of any critical information technology
projects. In accordance with generally accepted accounting principles, Year 2000
expenditures are expensed as incurred.
RISK MANAGEMENT
Overview
The Company's business and activities expose it to different types of risks
including, but not limited to, those discussed below. Proper identification,
assessment and management of these risks are essential to the success and
financial soundness of the Company. Managing risk at the Company begins with the
expertise and experience of management at the business unit level. To supplement
risk management at the business unit level, the Company has formed a Global Risk
Steering Committee, and various other functional risk committees consisting of
members of senior management. The Global Risk Steering Committee takes an active
role in the oversight of the various risk committees by reviewing risk
exposures, leading in the continued development of the Company's risk management
practices, discussing changes in regulations and other risk-related
developments, and reporting regularly to the Audit Committee of the Company's
Board of Directors. Other risk committees include the Technology and Operations
Risk Committee, which focuses on the integrity of the Company's technology
systems and enhancements, and operating capacity; the Credit Oversight
Committee, which focuses on customer activity (i.e., margin lending activities
to customers and customer option activities), the investing activities of
certain of the Company's proprietary funds, and corporate credit activities
(i.e., counterparty and corporate investing activities); and the Financial Risk
Management Committee, which focuses on liquidity and capital resources, interest
rate risk, and securities owned. Additionally, the Finance, Compliance, and
Internal Audit Departments and the Office of Corporate Counsel assist management
and the various risk committees in evaluating and monitoring the Company's risk
profile.
In conjunction with the Merger, all committees have been realigned to focus
on risk management throughout the Company with appropriate representation of
U.S. Trust management. Additionally, as of the filing date of this report, a new
committee had been formed, the Fiduciary Risk Committee, which focuses on
financial or reputational risk caused by a potential breach of fiduciary duties
to a customer. Further, the U.S. Trust Risk Policy Committee, which has broad
responsibilities for the oversight of risk management at U.S. Trust, reports to
the Global Risk Steering Committee, as well as to the Board of Directors of U.S.
Trust.
The following discussion highlights the Company's principal risks and some of
the policies and procedures for risk identification, assessment and mitigation.
See Liquidity and Capital Resources for a discussion on liquidity risk and note
"18 - Financial Instruments with Off-Balance-Sheet and Credit Risk" in the Notes
to Consolidated Financial Statements for additional discussion on credit risk.
Given the nature of the Company's revenues, expenses and risk profile, the
Company's earnings and CSC's common stock price may be subject to significant
volatility from period to period. The Company's results for any period are not
necessarily indicative of results for a future period. Risk is inherent in the
Company's business. Consequently, despite the Company's attempts to identify
areas of risk, oversee operational areas involving risk and implement policies
and procedures designed to mitigate risk, there can be no assurance that the
Company will not suffer unexpected losses due to operating or other risks.
Competition
The Company faces significant competition from companies seeking to attract
customer financial assets, including traditional brokerage firms (particularly
firms that have started providing online trading services), discount brokerage
firms, online brokerage firms, mutual fund companies, banks, and asset
management companies. Certain of these competitors have greater financial
resources than the Company. The consolidation trend in the financial services
industry is likely to increase in light of the new financial modernization
legislation that became effective in March 2000. This new legislation allows
banks, securities firms and insurance companies more flexibility to affiliate
under one holding company. These holding companies can engage in activities and
acquire companies engaged in activities that are financial in nature. The
expansion and customer acceptance of conducting financial transactions online
has also attracted competition from providers of online services, software
development companies and other providers of financial services. Finally, the
growth of online trading has led to the creation of new ECNs and new exchanges,
and is causing major existing markets to consider converting to for-profit
status, all of which may intensify competition. The Company experienced declines
in its average commission per revenue trade in 1998 mainly due to the Company's
integration of its online and traditional brokerage services and reduction of
the price of online trades for most of its customers, resulting in an increase
in the proportion of trades placed through its online channels. The Company's
average commission per revenue trade declined in 1999 due to the continued
increase in the proportion of trades placed through its online channels. As the
Company focuses on further enhancements to its electronic service offering and
online trades increase, average commission per revenue trade is expected to
continue to decline.
Business Environment
The Company's business, like that of other securities brokerage and related
financial services firms, is directly affected by the fluctuations in securities
trading volumes and price levels that occur in fundamentally cyclical financial
markets, as well as by changes in government monetary policies that impact the
growth of bank loans and investments and the level of interest charged for loans
and paid on deposits and other funding sources. While the Company's non-trading
revenues have grown, transaction-based revenues continue to represent a majority
of the Company's revenues and the Company may experience significant variations
in revenues from period to period. The Company adjusts its expenses in
anticipation of and in response to changes in financial market conditions and
customer trading patterns. Certain of the Company's expenses (including variable
compensation, portions of communications, and commissions, clearance and floor
brokerage) vary directly with changes in financial performance or customer
trading activity. Expenses relating to the level of contractors, temporary
employees, overtime hours, advertising and market development, and professional
services are adjustable over the short term to help the Company achieve its
financial objectives. Additionally, development spending is discretionary and
can be altered in response to market conditions. However, a significant portion
of the Company's expenses such as salaries and wages, occupancy and equipment,
and depreciation and amortization do not vary directly, at least in the short
term, with fluctuations in revenues or securities trading volumes. Also, the
Company views its development spending as essential for future growth and
therefore prefers to avoid major adjustments in such spending unless faced with
a sustained slowdown in revenue growth.
Technology and Operating Risk
Technology and operating risk is the potential for loss due to deficiencies
in control processes or technology systems that constrain the Company's ability
to gather, process and communicate information efficiently and securely, without
interruptions. The Company's operations are highly dependent on the integrity of
its technology systems and the Company's success depends, in part, on its
ability to make timely enhancements and additions to its technology in
anticipation of customer demands. To the extent the Company experiences system
interruptions, errors or downtime (which could result from a variety of causes,
including changes in customer use patterns, technological failure, changes to
its systems, linkages with third-party systems, and power failures), the
Company's business and operations could be significantly negatively impacted.
Additionally, rapid increases in customer demand may strain the Company's
ability to enhance its technology and expand its operating capacity. To minimize
business interruptions, Schwab has two data centers intended, in part, to
further improve the recovery of business processing in the event of an
emergency. The Company attempts to mitigate technology and operating risk by
maintaining a comprehensive internal control system and by employing experienced
personnel. Also, the Company maintains backup and recovery functions, including
facilities for backup and communications, and conducts periodic testing of a
disaster recovery plan. The Company is committed to an ongoing process of
upgrading, enhancing and testing its technology systems. This effort is focused
on meeting customer demands, meeting market and regulatory changes, and
deploying standardized technology platforms.
Credit Risk
Credit risk is the potential for loss due to a customer or counterparty
failing to perform its contractual obligations. The Company's exposure to credit
risk mainly results from its margin lending activities, securities lending
activities, role as a counterparty in financial contracts, investing activities,
and the investing activities of certain of the Company's proprietary funds. To
mitigate the risks of such losses, the Company has established policies and
procedures which include: establishing and reviewing credit limits, monitoring
of credit limits and quality of counterparties, and increasing margin
requirements for certain securities. In addition, most of the Company's credit
extensions, such as margin loans to customers, securities lending agreements,
and resale agreements, are supported by collateral arrangements. These
arrangements are subject to requirements to provide additional collateral in the
event that market fluctuations result in declines in the value of collateral
received.
Additionally, the Company has exposure to credit risk associated with the
Company's private banking loan portfolio held at U.S. Trust. This counterparty
credit exposure is actively managed through individual and portfolio reviews
performed by account officers and senior line management. Periodic assessment of
the validity of credit ratings, credit quality and the credit management process
is conducted by a risk review department which is separate from the loan
origination and monitoring department. Management of the credit approval process
is premised on underwriting standards with clear lines of accountability and
authority. Counterparties that generate credit exposure are given empirical risk
ratings and are approved by appropriate senior officers depending on the
exposure level and/or risk rating. In addition, the U.S. Trust Risk Policy
Committee regularly reviews asset quality including concentrations,
delinquencies, non-performing private banking loans, losses and recoveries. All
are factors in the determination of an appropriate allowance for credit losses,
which is reviewed quarterly by senior management. See note "4 - Loans to Banking
Customers and Related Allowance for Credit Losses" in the Notes to Consolidated
Financial Statements for an analysis of the Company's loan portfolio and
allowance for credit losses.
There were no troubled debt restructurings at December 31, 1999 and 1998. As
of December 31, 1999, management is not aware of any significant potential
problem loans other than the amounts disclosed in the table in note "4 - Loans
to Banking Customers and Related Allowance for Credit Losses" in the Notes to
Consolidated Financial Statements.
Fiduciary Risk
Fiduciary risk is the potential for financial or reputational loss through
the breaching of fiduciary duties to a customer. Fiduciary activities include,
but are not limited to, individual and corporate trust, investment management,
custody and cash and securities processing. The Company attempts to mitigate
this risk by establishing procedures to ensure that obligations to customers are
discharged faithfully and in compliance with applicable legal and regulatory
requirements. Business units have the primary responsibility for adherence to
the procedures applicable to their business. Guidance and control is provided
through the creation, approval and ongoing review of applicable policies by
business units and the Fiduciary Risk Committee.
Market Risk
Market risk is the potential for loss due to a change in the value of a
financial instrument held by the Company as a result of fluctuations in interest
and currency exchange rates, and equity prices.
The Company is exposed to interest rate risk primarily from changes in the
interest rates on its interest-earning assets (mainly margin loans to customers,
investments, private banking loans, mortgage-backed securities and other fixed
rate investments) and its funding sources (including brokerage customer cash
balances, banking deposits, proceeds from stock-lending activities, long-term
debt, and stockholders' equity) which finance these assets. The Company attempts
to mitigate this risk by monitoring the net interest margin and average maturity
of its interest-earning assets and funding sources. The Company also has the
ability to adjust the rates paid on brokerage customer cash balances and certain
banking deposits and the rates charged on margin loans. Additionally, the
Company uses interest rate swaps (Swaps) to mitigate interest rate exposure
associated with short-term floating interest-rate deposits.
The Company is exposed to equity price risk through its role as a financial
intermediary in customer-related transactions, and by holding financial
instruments mainly in its capacity as a market maker and relating to its
specialists' operations. To mitigate the risk of losses, these financial
instruments are marked to market daily and are monitored by management to assure
compliance with limits established by the Company. Additionally, the Company
purchases from time to time exchange-traded option contracts to reduce market
risk on these inventories. The Company may also purchase futures contracts to
reduce this risk. The Company may enter into foreign currency contracts to
reduce currency exchange rate risk. However, the Company's exposure to currency
exchange risks through its international operations is not material.
Additional qualitative and quantitative disclosures about market risk are
summarized as follows.
Financial Instruments Held For Trading Purposes
The Company held government securities and certificates of deposit with a
fair value of approximately $22 million and $13 million at December 31, 1999 and
1998, respectively. These securities, and the associated interest rate risk, are
not material to the Company's financial position, results of operations or cash
flows.
Through Schwab and SCM, the Company maintains inventories in exchange-listed
and Nasdaq securities on both a long and short basis. The fair value of these
securities at December 31, 1999 was $107 million in long positions and $60
million in short positions. The fair value of these securities at December 31,
1998 was $60 million in long positions and $35 million in short positions. Using
a hypothetical 10% increase or decrease in prices, the potential loss or gain in
fair value is estimated to be approximately $5 million and $3 million at
December 31, 1999 and 1998, respectively, due to the offset of the change in
fair value in long and short positions. In addition, the Company generally
enters into exchange-traded option contracts to hedge against potential losses
in equity inventory positions, thus reducing this potential loss exposure. This
hypothetical 10% change in fair value of these securities at December 31, 1999
and 1998 would not be material to the Company's financial position, results of
operations or cash flows. The notional amount of option contracts was
approximately $103 million and $74 million at December 31, 1999 and 1998,
respectively. The fair value of such option contracts was not material to the
Company's consolidated balance sheets at December 31, 1999 and 1998.
Financial Instruments Held For Purposes Other Than Trading
For its working capital and reserves required to be segregated under federal
or other regulations, the Company invests in money market funds, resale
agreements, certificates of deposit and commercial paper.
The Company maintains investments primarily in mutual funds to fund
obligations under its deferred compensation plan, which is available to certain
employees. These investments were approximately $60 million and $50 million at
December 31, 1999 and 1998, respectively. Any decrease in the fair value of
these investments would result in a comparable decrease in the deferred
compensation plan obligation and would not affect the Company's financial
position, results of operations or cash flows.
Debt Issuances
At December 31, 1999, CSC had $455 million aggregate principal amount of
Medium-Term Notes outstanding, with fixed interest rates ranging from 5.96% to
7.50%. At December 31, 1998, CSC had $351 million aggregate principal amount of
Medium-Term Notes outstanding, with fixed interest rates ranging from 5.78% to
7.72%. At December 31, 1999 and 1998, U.S. Trust had $50 million Trust Preferred
Capital Securities outstanding, with a fixed interest rate of 8.41%. In
addition, at December 31, 1999 and 1998, U.S. Trust had $13 million and $14
million of FHLB borrowings outstanding, respectively. The FHLB borrowings had
fixed interest rates ranging from 6.59% to 6.76% at December 31, 1999 and from
6.25% to 6.76% at December 31, 1998.
The Company has fixed cash flow requirements regarding these long-term debt
obligations due to the fixed rate of interest. The estimated fair value of these
obligations at December 31, 1999 and 1998, based on estimates of market rates
for debt with similar terms and remaining maturities, was $498 million and $430
million, respectively, which approximated their carrying amounts of $518 million
and $419 million, respectively.
Net Interest Revenue Simulation
The Company uses net interest revenue simulation modeling techniques to
evaluate and manage the effect of changing interest rates. The simulation model
(the model) includes all interest-sensitive assets and liabilities and Swaps
utilized by U.S. Trust to hedge its interest rate risk. Key variables in the
model include assumed margin loan and brokerage customer cash balance growth,
changes to the level and term structure of interest rates, the repricing of
financial instruments, prepayment and reinvestment assumptions, loan, banking
deposit, and brokerage customer cash balance pricing and volume assumptions. The
simulations involve assumptions that are inherently uncertain and as a result,
the simulations cannot precisely estimate net interest revenue or precisely
predict the impact of changes in interest rates on net interest revenue. Actual
results may differ from simulated results due to the timing, magnitude and
frequency of interest rate changes as well as changes in market conditions and
management strategies, including changes in asset and liability mix.
The simulations in the table below assume that the asset and liability
structure of the consolidated balance sheet would not be changed as a result of
the simulated changes in interest rates. As the Company actively manages its
consolidated balance sheet and interest rate exposure, in all likelihood the
Company would take steps to manage any additional interest rate exposure that
could result from changes in the interest rate environment. The following table
shows the results of a 100 basis point increase or decrease in interest rates
and the effect on simulated net interest revenue over the next twelve months at
December 31, 1999 and 1998 (dollars in millions). The change in simulated net
interest revenue sensitivity from 1998 to 1999 was primarily due to increases in
the overall size of the balance sheet, driven by the growth in brokerage
customer cash balances.
--------------------------------------------------------------------------------
Impact on Net Interest Revenue
Increase (Decrease)
1999 1998
--------------- ----------------
December 31, Amount % Amount %
--------------------------------------------------------------------------------
Increase of 100 basis points $ 80 6.7% $ 41 5.9%
Decrease of 100 basis points (81) (6.8%) (43) (6.2%)
================================================================================
As demonstrated by the simulations presented, the Company manages the
consolidated balance sheet to produce increases in net interest revenue when
interest rates rise. This position partially offsets the potential for decreases
in trading activity, and therefore commission revenue, that may result during
periods of rising interest rates.
The impact of the Company's hedging activities upon net interest revenue for
the years ended December 31, 1999, 1998 and 1997 was immaterial to the Company's
results of operations.
Legal and Compliance Risk
Legal and compliance risk refers to the possibility that the Company will be
found, by a court, arbitration panel or regulatory authority, not to have
complied with an applicable legal or regulatory requirement. The Company may be
subject to lawsuits or arbitration claims by customers, employees or other third
parties in the different jurisdictions in which it conducts business. In
addition, the Company is subject to extensive regulation by the SEC, the
National Association of Securities Dealers, Inc., the NYSE, the Board of
Governors of the Federal Reserve System, the Federal Deposit Insurance
Corporation, the Superintendent of Banks of the State of New York, and other
federal, state and market regulators, as well as certain foreign regulatory
authorities. The Company attempts to mitigate legal and compliance risk through
policies and procedures that it believes are reasonably designed to prevent or
detect violations of applicable statutory and regulatory requirements (see note
"17 - Commitments and Contingent Liabilities" in the Notes to Consolidated
Financial Statements).
BANK HOLDING COMPANY ACT REQUIREMENTS
Upon consummation of the Merger, CSC became a financial holding company and
bank holding company subject to supervision and regulation by the Federal
Reserve Board under the Act.
The Gramm-Leach-Bliley Act (the GLB Act), which became effective in March
2000, permits qualifying bank holding companies to become financial holding
companies and thereby affiliate with a far broader range of financial companies
than has previously been permitted for a bank holding company. The GLB Act
identifies several activities as financial in nature, including securities
brokerage, underwriting, dealing in or making a market in securities, investment
management services and insurance activities. The Federal Reserve Board may
prohibit a financial holding company from engaging in new activities or
acquiring additional companies if the Federal Reserve Board concludes that the
financial holding company's capital or managerial resources are not adequate.
Federal Reserve Board regulations under the Act may also limit CSC's business or
impose additional costs or requirements.
Federal Reserve Board policy provides that a bank holding company generally
should not pay cash dividends unless its net income is sufficient to fully fund
the dividends and the Company's prospective retained earnings appear to be
sufficient to meet the capital needs, asset quality and overall financial
condition of the holding company and its bank subsidiaries.
CSC's primary bank subsidiary is United States Trust Company of New York
(U.S. Trust NY). The operations and financial condition of CSC's bank
subsidiaries are subject to regulation and supervision and to various
requirements and restrictions under Federal and state law, including
requirements governing: transactions with CSC and its nonbank subsidiaries,
including loans and other extensions of credit, investments or asset purchases,
or otherwise financing or supplying funds to CSC; dividends; investments; and
aspects of CSC's operations. The Federal banking agencies have broad powers to
enforce these regulations, including the power to terminate deposit insurance,
impose substantial fines and other civil and criminal penalties and appoint a
conservator or receiver. CSC, U.S. Trust and their U.S. insured depository
institution subsidiaries must meet regulatory capital guidelines adopted by the
federal banking agencies. The Federal Reserve Board has not indicated whether
the guidelines will be modified with respect to a bank holding company, such as
CSC, that also qualifies as a financial holding company. Under the Federal
Deposit Insurance Act, the banking regulatory agencies are permitted or, in
certain cases, required to take certain substantial restrictive actions with
respect to institutions falling within one of the lowest three of five capital
categories.
To remain a financial holding company, each of CSC's bank subsidiaries must
be well capitalized, well managed and meet requirements relating to the
provision of public services to the communities in which CSC's bank subsidiaries
operate. If CSC ceases to qualify as a financial holding company it will be
subject to substantial additional restrictions on its activities. See note "16 -
Regulatory Requirements" in the Notes to Consolidated Financial Statements.
LOOKING AHEAD
During 1999, the competitive environment in financial services intensified -
several traditional brokerage firms adjusted their pricing, enhanced their
online services and, along with a number of discount brokerage firms,
substantially increased their spending on advertising and marketing programs. In
addition, several firms offering wealth management services have expanded their
marketing efforts. While this trend of intensified competition is expected to
continue in 2000, management believes that the Company's competitive advantages
will enable the firm to pursue its strategy of attracting and retaining customer
assets. As described more fully in the Description of Business section above,
these competitive advantages include: nationally recognized brands, a broad line
of products and services offered at prices that management believes represent
superior value, multi-channel delivery systems, and the commitment and skills
necessary to invest in technology intended to empower customers and reduce
costs. Additionally, the Company's significant level of employee ownership
aligns the interests of management with those of stockholders.
During 2000, the Company expects to sustain its competitive advantages by
providing its customers with expanded and enhanced services, including a
broadened service offering for affluent investors. The Company intends to
leverage U.S. Trust's highly personalized service model, research capabilities,
trust and estate services, investment track record and reputation in wealth
management services to help complete the Company's offering to affluent
investors, as well as independent investment managers and their customers, by
providing them with access to a broad array of wealth management services. The
Company's acquisition of CyBerCorp is designed to help provide actively trading
investors with access to advanced order entry, routing and management
technology, as well as to support the Company's ongoing role as a leader in the
evolution of customer access to the capital markets. The Company also expects to
continue its focus on developing an enhanced help and advice offering for all
customers, and to continue its process of selective international expansion.
The Company's efforts to expand and enhance services are being driven by
evolving customer needs. A substantial portion of growth in investable assets in
coming years is anticipated to be concentrated with the "baby boom" generation.
As these investors continue to accumulate wealth, many will need more guidance
in managing their financial affairs, as well as access to more complex and
specialized services such as estate and tax planning, and trust and investment
management. As a result, the Company expects to continue evaluating the breadth
of its service offering relative to customer needs.
Management continues to believe that the key to sustaining the Company's
competitive advantages will be its ability to combine people and technology in
ways that provide investors with the access, information, guidance, advice and
control they expect - as well as superior service - all at a lower cost than
traditional providers of financial services. Accordingly, the Company expects to
remain in direct competition with traditional, online and discount brokerage
firms, investment management companies, banks and other providers of financial
products and services.
Capitalizing on and strengthening the Company's competitive advantages
requires significant development spending and capital expenditures. Management
believes that these ongoing investments are critical to increasing the Company's
market share and achieving its long-term financial objectives, which include
annual growth in revenues of 20%, an after-tax profit margin of 12%, and a
return on stockholders' equity of 20%.
<PAGE>
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Consolidated Statement of Income The Charles Schwab Corporation
(In Thousands, Except Per Share Amounts)
Year Ended December 31, 1999 1998 1997
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues
Commissions $1,874,594 $1,318,103 $1,182,901
Asset management and administration fees 1,220,346 936,796 739,323
Interest revenue, net of interest expense of $898,219 in 1999,
$773,998 in 1998 and $667,345 in 1997 819,790 577,643 444,461
Principal transactions 500,496 286,754 257,985
Other 71,193 58,574 46,896
------------------------------------------------------------------------------------------------------------------------------------
Total 4,486,419 3,177,870 2,671,566
------------------------------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 1,888,414 1,374,436 1,135,472
Occupancy and equipment 306,900 236,232 192,301
Communications 278,509 216,389 191,477
Advertising and market development 247,808 159,784 133,614
Professional services 184,470 114,097 92,168
Depreciation and amortization 174,651 152,107 128,941
Commissions, clearance and floor brokerage 100,132 87,273 95,560
Goodwill amortization 6,419 6,443 9,754
Other 200,201 153,471 161,373
------------------------------------------------------------------------------------------------------------------------------------
Total 3,387,504 2,500,232 2,140,660
------------------------------------------------------------------------------------------------------------------------------------
Income before taxes on income 1,098,915 677,638 530,906
Taxes on income 432,469 267,509 209,597
------------------------------------------------------------------------------------------------------------------------------------
Net Income $ 666,446 $ 410,129 $ 321,309
====================================================================================================================================
Weighted-Average Common Shares Outstanding - Diluted (1) 1,373,030 1,342,895 1,337,729
====================================================================================================================================
Earnings Per Share (1)
Basic $ .51 $ .32 $ .25
Diluted $ .49 $ .31 $ .24
====================================================================================================================================
Dividends Declared Per Common Share (1, 2) $ .0373 $ .0360 $ .0311
====================================================================================================================================
(1) All periods have been restated for the May 2000 three-for-two common stock split.
(2) Dividends declared per common share represent dividends declared by The Charles Schwab Corporation prior to its merger with
U.S. Trust Corporation.
See Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Consolidated Balance Sheet The Charles Schwab Corporation
(In Thousands, Except Per Share Amounts)
December 31, 1999 1998
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and cash equivalents $ 2,612,451 $ 1,720,908
Cash and investments required to be segregated under federal or other regulations
(including resale agreements of $6,165,043 in 1999 and $7,608,067 in 1998) 8,826,121 10,313,225
Securities owned - at market value 1,333,220 1,211,563
Receivable from brokers, dealers and clearing organizations 482,657 334,334
Receivable from brokerage customers - net 17,060,222 9,646,140
Loans to banking customers - net 2,689,205 2,171,393
Equipment, office facilities and property - net 678,208 473,566
Goodwill - net 53,723 53,372
Other assets 586,305 482,751
------------------------------------------------------------------------------------------------------------------------------------
Total $34,322,112 $26,407,252
====================================================================================================================================
Liabilities and Stockholders' Equity
Deposits from banking customers $ 4,204,943 $ 3,414,791
Drafts payable 467,758 324,597
Payable to brokers, dealers and clearing organizations 1,748,765 1,422,300
Payable to brokerage customers 23,422,592 18,119,622
Accrued expenses and other liabilities 1,243,121 892,987
Short-term borrowings 141,157 140,925
Long-term debt 518,000 418,773
------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 31,746,336 24,733,995
------------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock - 9,940 shares authorized; $.01 par value per share; none issued
Common stock - 2,000,000 and 500,000 shares authorized in 1999 and 1998,
respectively; $.01 par value per share; 1,336,636 and 1,308,314 shares issued
in 1999 and 1998, respectively* 13,366 13,083
Additional paid-in capital 595,282 251,158
Retained earnings 2,144,683 1,540,205
Treasury stock - 7,336 shares in 1999 and 7,722 shares in 1998, at cost* (96,742) (87,768)
Employee stock ownership plans (967) (4,861)
Unamortized restricted stock compensation (70,926) (43,882)
Accumulated other comprehensive (loss) income (8,920) 5,322
------------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 2,575,776 1,673,257
------------------------------------------------------------------------------------------------------------------------------------
Total $34,322,112 $26,407,252
====================================================================================================================================
* All periods have been restated for the May 2000 three-for-two common stock split.
See Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Consolidated Statement of Cash Flows The Charles Schwab Corporation
(In thousands)
Year Ended December 31, 1999 1998 1997
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net income $ 666,446 $ 410,129 $ 321,309
Noncash items included in net income:
Depreciation and amortization 174,651 152,107 128,941
Goodwill amortization 6,419 6,443 9,754
Net amortization of premium on securities available for sale 4,677 3,384 2,778
Compensation payable in common stock 34,977 30,891 25,580
Deferred income taxes (3,218) (9,498) (32,012)
Other 6,814 7,020 4,983
Net change in:
Cash and investments required to be segregated under federal or
other regulations 1,475,017 (3,500,320) 456,055
Securities owned (excluding securities available for sale) (97,519) 40,454 (154,699)
Receivable from brokers, dealers and clearing organizations (152,287) (65,978) (37,449)
Receivable from brokerage customers (7,419,482) (1,893,821) (2,741,796)
Other assets (30,723) 3,578 (61,943)
Drafts payable 144,006 56,028 43,908
Payable to brokers, dealers and clearing organizations 329,423 298,411 245,327
Payable to brokerage customers 5,317,093 5,010,081 1,935,507
Accrued expenses and other liabilities 548,508 225,649 178,351
------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,004,802 774,558 324,594
------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchases of securities available for sale (465,789) (367,762) (609,128)
Proceeds from sales of securities available for sale 10,019 20,804
Proceeds from maturities, calls and mandatory redemptions of securities
available for sale 413,454 429,929 616,571
Net change in loans to banking customers (517,865) (251,463) (249,912)
Purchase of equipment, office facilities and property - net (370,191) (199,168) (150,402)
Cash payments for business combinations and investments, net of cash received (25,568) (23,584) (1,200)
------------------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (955,940) (412,048) (373,267)
------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Net change in deposits from banking customers 790,152 340,889 310,112
Net change in short-term borrowings 232 (38,662) (60,695)
Proceeds from long-term debt 144,000 30,000 161,000
Repayment of long-term debt (44,853) (44,531) (37,862)
Dividends paid (61,107) (56,041) (48,240)
Purchase of treasury stock (53,924) (208,353) (58,726)
Proceeds from stock options exercised and other 65,799 36,015 18,497
------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 840,299 59,317 284,086
------------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 2,382 (160) 113
------------------------------------------------------------------------------------------------------------------------------------
Increase in Cash and Cash Equivalents 891,543 421,667 235,526
Cash and Cash Equivalents at Beginning of Year 1,720,908 1,299,241 1,063,715
------------------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 2,612,451 $ 1,720,908 $ 1,299,241
====================================================================================================================================
See Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Consolidated Statement of Stockholders' Equity The Charles Schwab Corporation
(In Thousands)
Common Accumu-
Un- Stock lated
Deferred amortized Issued to Other
Addi- Compen- Employee Restricted Deferred Compre-
Common tional Retained sation Stock Stock Compen- hensive
Stock Paid-In Earnings Stock Treasury Ownership Compen- sation Income
(1) Capital (1) Trust (2) Stock Plans sation Trust (2) (Loss) Total
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at
December 31,1996 $13,060 $223,052 $ 918,204 $ (65,005) $(15,985) $ (8,658) $ 3,985 $1,068,653
Comprehensive income:
Net income 321,309 321,309
Foreign currency
translation adjustment (2,360) (2,360)
Change in net unrealized
gain (loss) on
securities available
for sale 3,122 3,122
---------
Total comprehensive
income 322,071
Dividends declared on
common stock (48,670) (48,670)
Purchase of treasury
stock (58,726) (58,726)
Stock options exercised,
and shares issued for
restricted stock
compensation awards
and other employee
benefit plans 3 27,695 143 45,703 (14,179) 59,365
Issuance of shares
for acquisitions 10 7,137 7,147
Amortization of
restricted stock
compensation awards 5,609 5,609
Principal payment by
U.S. Trust
Corporation ESOP 3,214 3,214
ESOP shares released
for allocation 14,735 117 2,748 17,600
------------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1997 13,073 272,619 1,191,103 (78,028) (10,023) (17,228) 4,747 1,376,263
------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income 410,129 410,129
Foreign currency
translation adjustment 388 388
Change in net unrealized
gain (loss) on
securities available
for sale 187 187
---------
Total comprehensive
income 410,704
Dividends declared on
common stock (56,519) (56,519)
Purchase of treasury
stock (208,353) (208,353)
Stock options exercised,
and shares issued for
restricted stock
compensation awards
and other employee
benefit plans 10 (37,140) (4,284) 189,075 (42,153) 105,508
Issuance of shares
for acquisitions 2,917 9,538 12,455
Cash paid in lieu of
fractional shares as
a result of the
stock split (364) (364)
Amortization of
restricted stock
compensation awards 15,499 15,499
Principal payment by
U.S. Trust
Corporation ESOP 3,481 3,481
ESOP shares released
for allocation 12,762 140 1,681 14,583
------------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1998 13,083 251,158 1,540,205 (87,768) (4,861) (43,882) 5,322 1,673,257
------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income 666,446 666,446
Foreign currency
translation adjustment 2,606 2,606
Change in net unrealized
gain (loss) on
securities available
for sale (16,848) (16,848)
---------
Total comprehensive
income 652,204
Dividends declared on
common stock (61,868) (61,868)
Purchase of treasury
stock (53,924) (53,924)
Deferred compensation
liability settled by
issuing common stock 1 2,404 $2,405 $(2,405) 2,405
Stock options exercised,
and shares issued for
restricted stock
compensation awards
and other employee
benefit plans 282 325,279 (140) 12,769 (54,072) 284,118
Issuance of shares
for acquisitions 13,278 32,181 45,459
Amortization of
restricted stock
compensation awards 27,028 27,028
Principal payment by
U.S. Trust
Corporation ESOP 3,773 3,773
ESOP shares released
for allocation 3,163 40 121 3,324
------------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1999 $13,366 $595,282 $2,144,683 $2,405 $ (96,742) $ (967) $(70,926) $(2,405) $ (8,920) $2,575,776
====================================================================================================================================
(1) All periods have been restated for the three-for-two May 2000 common stock split.
(2) Deferred compensation stock trust accounts are presented net on the Consolidated Balance Sheet.
See Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
The Charles Schwab Corporation
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Per Share and Option Price Amounts)
1. Basis of Presentation
Merger with U.S. Trust Corporation
On May 31, 2000, The Charles Schwab Corporation (CSC) completed its merger
(the Merger) with U.S. Trust Corporation (U.S. Trust). Under the terms of the
merger agreement, U.S. Trust became a wholly owned subsidiary of CSC and U.S.
Trust shareholders received 5.1405 shares of CSC's common stock for each common
share of U.S. Trust. The Merger was treated as a non-taxable stock-for-stock
exchange and U.S. Trust's shareholders received 112,000,000 shares of CSC's
common stock. Upon consummation of the Merger, CSC became a financial holding
company and bank holding company subject to supervision and regulation by the
Board of Governors of the Federal Reserve System (Federal Reserve Board) under
the Bank Holding Company Act of 1956, as amended. The consolidated financial
statements, included in this Current Report on Form 8-K, give retroactive effect
to the Merger, which was accounted for as a pooling of interests. The pooling of
interests method of accounting requires the restatement of all periods presented
as if CSC and U.S. Trust had been operating as a combined entity during such
periods. For the years ended December 31, 1999, 1998 and 1997, stockholders'
equity and other per share information reflects the accounts of CSC and its
subsidiaries (collectively referred to as the Company) as if the common stock
had been issued during all of the periods presented. Dividends declared per
common share represent dividends declared by CSC prior to the Merger.
The separate results of operations for the Company and U.S. Trust during the
periods preceding the Merger that are included in the Company's restated
consolidated statement of income are as follows:
Year Ended December 31, 1999 1998 1997
--------------------------------------------------------------------------------
Revenues:
Company $3,944,822 $2,736,221 $2,298,750
U.S. Trust 541,597 441,649 372,816
--------------------------------------------------------------------------------
Combined $4,486,419 $3,177,870 $2,671,566
================================================================================
Net Income:
Company $ 588,877 $ 348,462 $ 270,277
U.S. Trust 77,569 61,667 51,032
--------------------------------------------------------------------------------
Combined $ 666,446 $ 410,129 $ 321,309
================================================================================
Stock Split
On May 3, 2000, the Board of Directors approved a three-for-two split of
CSC's common stock, which was effected in the form of a 50% stock dividend. The
stock dividend was distributed May 30, 2000 to stockholders of record May 12,
2000. Share and per share information presented in the consolidated financial
statements and related notes has been restated to reflect the common stock
split, including the common shares issued to U.S. Trust shareholders pursuant to
the exchange ratio described above.
The Company
The consolidated financial statements include CSC and its subsidiaries. CSC
is a financial holding company engaged, through its subsidiaries, in securities
brokerage and related financial services. CSC's principal subsidiary, Charles
Schwab & Co., Inc. (Schwab), is a securities broker-dealer with 340 domestic
branch offices in 48 states, as well as branches in the Commonwealth of Puerto
Rico and the U.S. Virgin Islands. Another subsidiary, U.S. Trust, is an
investment management firm that also provides fiduciary services and private
banking services with 28 offices in 10 states. Other subsidiaries include
Charles Schwab Europe (CSE), a retail securities brokerage firm located in the
United Kingdom, Charles Schwab Investment Management, Inc., the investment
advisor for Schwab's proprietary mutual funds, and Schwab Capital Markets L.P.
(SCM) (prior to March 1, 2000, this business was known as Mayer & Schweitzer,
Inc.), a market maker in Nasdaq and other securities providing trade execution
services to broker-dealers and institutional customers.
Certain items in prior years' financial statements have been reclassified to
conform to the 1999 presentation. All material intercompany balances and
transactions have been eliminated.
2. Significant Accounting Policies
Securities transactions: Customers' securities transactions are recorded on the
date that they settle, while the related commission revenues and expenses are
recorded on the date that the trade occurs. Principal transactions are recorded
on a trade date basis.
Use of estimates: The preparation of the consolidated financial statements in
conformity with accounting principles generally accepted in the U.S. requires
management to make certain estimates and assumptions that affect the reported
amounts in the accompanying financial statements. Such estimates relate to
useful lives of equipment, office facilities, buildings, intangible assets
and goodwill, fair value of financial instruments, allowance for credit losses
on banking loans, allowance for doubtful accounts of brokerage customers,
retirement and postretirement benefits, future tax benefits and legal reserves.
Actual results could differ from such estimates.
Cash and investments required to be segregated under federal or other
regulations consist primarily of securities purchased under agreements to
resell (resale agreements) and certificates of deposit. Certificates of
deposit are stated at cost, which approximates market.
Securities financing activities: Resale agreements are accounted for as
collateralized financing transactions and are recorded at their contractual
amounts. The Company obtains possession of collateral with a market value equal
to or in excess of the principal amount loaned under resale agreements.
Collateral is valued daily by the Company, with additional collateral obtained
or refunded when necessary.
Securities borrowed and securities loaned are reported as collateralized
financing transactions. Securities borrowed require the Company to deposit cash
with the lender and are included in receivable from brokers, dealers and
clearing organizations. For securities loaned, the Company receives collateral
in the form of cash in an amount generally equal to the market value of
securities loaned. Securities loaned are included in payable to brokers, dealers
and clearing organizations. The Company monitors the market value of securities
borrowed and loaned on a daily basis, with additional collateral obtained or
refunded when necessary.
Securities owned include securities available for sale that are recorded at
estimated fair value with unrealized gains and losses reported, net of taxes,
in accumulated other comprehensive income (loss) included in the consolidated
statement of stockholders' equity. Realized gains and losses from sales of
securities available for sale are determined on a specific identification
basis and are included in other revenues.
Securities owned also include equity and other securities, SchwabFunds(R)
money market funds and equity and bond mutual funds. These securities are
recorded at estimated fair value with unrealized gains and losses included in
principal transaction revenues.
Receivable from brokerage customers that remain unsecured for more than 30 days
or partially secured for more than 90 days are fully reserved for, and are
stated net of allowance for doubtful accounts of $11 million and $8 million
at December 31, 1999 and 1998, respectively.
Nonperforming assets included in the loan portfolio consist of financial
instruments and other real estate owned where the Company has stopped accruing
interest (non-accrual financial instruments). Interest accruals are discontinued
when principal or interest is contractually past due ninety days or more. In
addition, interest accruals may be discontinued when principal or interest is
contractually past due less than ninety days if, in the opinion of management,
the amount due is not likely to be paid in accordance with the terms of the
contractual agreement, even though the financial instruments are currently
performing. Any accrued but unpaid interest previously recorded on a non-accrual
financial instrument is reversed and recorded as a reduction of interest income.
Interest received on non-accrual financial instruments is applied either to the
outstanding principal balance or recorded as interest income, depending on
management's assessment of the ultimate collectibility of principal. Non-accrual
financial instruments are generally returned to accrual status only when all
delinquent principal and interest payments become current and the collectibility
of future principal and interest on a timely basis is reasonably assured.
Allowance for credit losses on banking loans is established through charges to
income based on management's evaluation of the adequacy of the allowance in
meeting losses in the existing credit portfolio.
The adequacy of the allowance is reviewed regularly by management, taking
into consideration current economic conditions, the present loan portfolio
composition, past loss experience and risks inherent in the credit portfolio,
including the value of impaired loans.
Equipment, office facilities and property: Equipment and office facilities
are depreciated on a straight-line basis over the estimated useful life of
the asset of two to fifteen years. Buildings are depreciated on a straight-
line basis over twenty years. Leasehold improvements are amortized on a
straight-line basis over the lesser of the estimated useful life of the
asset or the life of the lease. Software is amortized on a straight-line
basis over an estimated useful life of three years. Equipment, office facilities
and property are stated at cost net of accumulated depreciation and
amortization.
Goodwill, which represents the cost of acquired businesses in excess of fair
value of the related net assets at acquisition, is amortized on a straight-line
basis over a period generally not to exceed fifteen years. Goodwill is stated at
cost net of accumulated amortization of $31 million and $25 million at December
31, 1999 and 1998, respectively.
Estimated fair value of financial instruments: Substantially all of the
Company's financial instruments are recorded at estimated fair value or amounts
that approximate fair value.
The fair value of securities, loans and long-term debt are estimated using
quoted market prices, third-party pricing services, discounted cash flow
analyses utilizing discount rates currently available for similar instruments,
or other valuation techniques.
Derivative financial instruments: As part of its asset and liability management
activities, the Company uses interest rate swaps (Swaps) to mitigate the
interest rate risk associated with nontrading-related balance sheet financial
instruments. The Company utilizes Swaps solely as hedging instruments.
Swaps that qualify as hedges are accounted for under the accrual method,
whereby the interest component associated with Swaps is recognized over the life
of the contract in net interest revenue and there is no recognition of
unrealized gains and losses on Swaps in the consolidated balance sheet.
Other derivatives activities primarily consist of exchange-traded option
contracts to reduce market risk on inventories in Nasdaq and exchange-listed
securities. Options are recorded at market value, and gains and losses are
included in principal transaction revenues.
Foreign currency translation: Assets and liabilities denominated in foreign
currencies are translated at the exchange rate on the balance sheet date, while
revenues and expenses are translated at average rates of exchange prevailing
during the year. Translation adjustments are accumulated as other comprehensive
income (loss).
Income taxes: The Company files a consolidated U.S. federal income tax return
and uses the asset and liability method in providing for income tax expense.
Under this method, deferred tax assets and liabilities are recorded for
temporary differences between the tax basis of assets and liabilities and their
recorded amounts for financial reporting purposes, using currently enacted tax
law.
Cash flows: For purposes of reporting cash flows, the Company considers all
highly liquid investments (including resale agreements, interest-bearing
deposits with banks and federal funds sold) with maturities of three months
or less that are not required to be segregated under federal or other
regulations to be cash equivalents.
Accounting change: Statement of Position 98-1 - Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use, was adopted by the
Company effective January 1, 1999. This statement requires that certain costs
incurred for purchasing or developing software for internal use be capitalized
and amortized over the software's estimated useful life of three years. In
prior years, the Company capitalized costs incurred for purchasing internal-
use software, but expensed costs incurred for developing internal-use software.
In accordance with this statement, prior years' financial statements were not
adjusted to reflect this accounting change. Adoption of this statement resulted
in the capitalization of $68 million of internal-use software development
costs during 1999, which increased net income by $41 million, or $.03 diluted
earnings per share.
New accounting standard: Statement of Financial Accounting Standards (SFAS) No.
137, which amended the effective date of SFAS No. 133 - Accounting for
Derivative Instruments and Hedging Activities, was issued in June 1999. SFAS
No. 138, which also amended SFAS No. 133, was issued in June 2000. The Company
is required to adopt SFAS No. 133 by January 1, 2001. This statement establishes
accounting and reporting standards requiring that all derivative instruments are
recorded on the balance sheet as either an asset or a liability, measured at its
fair value. The statement requires that changes in the derivative's fair value
be recognized currently in earnings unless specific hedge accounting criteria
are met and such hedge accounting treatment is elected. While the Company
is currently evaluating the effects of this statement, its adoption is
not expected to have a material impact on the Company's financial position,
results of operations, earnings per share or cash flows.
3. Securities Owned
A summary of securities owned is as follows:
December 31, 1999 1998
--------------------------------------------------------------------------------
Securities available for sale $ 993,586 $ 969,448
Equity and other securities 129,830 73,226
SchwabFunds(R) money market funds 117,289 88,131
Equity and bond mutual funds 92,515 80,758
--------------------------------------------------------------------------------
Total $1,333,220 $1,211,563
================================================================================
The amortized cost, estimated fair value and gross unrealized gains and
losses on securities available for sale are as follows:
December 31, 1999 1998
--------------------------------------------------------------------------------
U.S. treasury securities:
Amortized cost $ 178,068 $274,553
Aggregate fair value $ 176,816 $276,562
Gross unrealized gains $ 24 $ 2,050
Gross unrealized losses $ 1,276 $ 41
U.S. government sponsored agencies and
corporations:
Amortized cost 690,450 561,095
Aggregate fair value 672,103 564,256
Gross unrealized gains 2,507 5,631
Gross unrealized losses 20,854 2,470
State and municipal obligations:
Amortized cost 119,633 98,726
Aggregate fair value 117,936 100,423
Gross unrealized gains 185 1,715
Gross unrealized losses 1,882 18
Collateralized mortgage obligations(1):
Amortized cost 5,185 10,076
Aggregate fair value 5,209 10,128
Gross unrealized gains 24 53
Gross unrealized losses 1
Other securities:
Amortized cost 22,086 17,768
Aggregate fair value 21,522 18,079
Gross unrealized gains 370 435
Gross unrealized losses 934 124
--------------------------------------------------------------------------------
Total securities available for sale:
Amortized cost $1,015,422 $962,218
Aggregate fair value $ 993,586 $969,448
Gross unrealized gains $ 3,110 $ 9,884
Gross unrealized losses $ 24,946 $ 2,654
================================================================================
(1)Collateralized by either GNMA, FNMA or FHLC obligations.
The maturities of securities available for sale as of December 31, 1999, and
the related weighted-average yield on such securities are as follows:
Within 1 - 5 5 - 10 Over 10
1 Year Years Years Years Total
--------------------------------------------------------------------------------
U.S. treasury securities $ 52,990 $125,078 $ 178,068
U.S. government sponsored
agencies and corporations 31,323 552,064 $ 63,666 $43,397 690,450
State and municipal
obligations 14,555 66,685 38,393 119,633
Collateralized mortgage
obligations(1) 5,185 5,185
Other securities 2,017 17,345 2,706 18 22,086
--------------------------------------------------------------------------------
Total at amortized cost 100,885 761,172 104,765 48,600 1,015,422
Estimated fair value 100,571 741,203 102,844 48,968 993,586
--------------------------------------------------------------------------------
Net unrealized gains (losses) $ (314) $(19,969) $ (1,921) $ 368 $ (21,836)
================================================================================
Weighted-average yield(2) 5.31% 6.04% 6.45% 6.35% 5.99%
================================================================================
(1) Collateralized mortgage obligations have been allocated over maturity
groupings based on contractual maturities. Expected maturities may differ
from contractual maturities because borrowers have the right to prepay
obligations with or without prepayment penalties.
(2) Yields have been computed by dividing annualized interest revenue, on a
taxable equivalent basis, by the amortized cost of the respective securities
as of December 31, 1999.
The components of net securities gains related to securities available for
sale are as follows:
December 31, 1999 1998 1997
--------------------------------------------------------------------------------
Gross realized gains from sales, maturities,
calls and mandatory redemptions $17 $4 $218
Gross realized losses from sales, maturities,
calls and mandatory redemptions (2)
--------------------------------------------------------------------------------
Securities gains, net $17 $4 $216
================================================================================
At December 31, 1999 and 1998, financial instruments in the amount of $254
million and $230 million, respectively, were pledged to secure public deposits,
to qualify for fiduciary powers and for other purposes or as collateral for
borrowings.
Equity and other securities include SCM's inventories in Nasdaq and other
securities and Schwab's inventories in exchange-listed securities relating to
its specialist operations. The Company's positions in SchwabFunds money market
funds arise from certain overnight funding of customers' redemption,
check-writing and debit card activities. Equity and bond mutual funds include
investments made by the Company for funding obligations under its deferred
compensation plan and for overnight funding of certain SchwabFunds customers'
transactions.
Securities sold, but not yet purchased, of $60 million and $35 million at
December 31, 1999 and 1998, respectively, consist of equity and other
securities, and are recorded at market value in accrued expenses and other
liabilities.
4. Loans to Banking Customers and Related Allowance for Credit Losses
An analysis of the composition of the loan portfolio is as follows:
December 31, 1999 1998
--------------------------------------------------------------------------------
Private banking:
Residential real estate mortgages $1,984,732 $1,630,500
Other 663,977 525,614
--------------------------------------------------------------------------------
Total private banking loans 2,648,709 2,156,114
--------------------------------------------------------------------------------
Loans to financial institutions for purchasing
and carrying securities 57,686 31,972
All other 2,979 2,721
--------------------------------------------------------------------------------
Total $2,709,374 $2,190,807
================================================================================
An analysis of nonperforming assets is as follows:
December 31, 1999 1998
--------------------------------------------------------------------------------
Non-accrual loans $1,673 $6,203
Other real estate owned, net 534
--------------------------------------------------------------------------------
Total $1,673 $6,737
================================================================================
Average non-accrual loans $ 832 $8,322
================================================================================
The Company considers all non-accrual loans impaired. For 1999 and 1998, the
impact of interest revenue which would have been earned on non-accrual loans
versus interest revenue recognized on these loans was not material to the
Company's results of operations.
The amount of loans accruing interest that were contractually 90 days or
more past due was less than $1 million at December 31, 1999. There was no such
amount at December 31, 1998.
An analysis of the allowance for credit losses on the loan portfolio is as
follows:
1999 1998 1997
--------------------------------------------------------------------------------
Balance at beginning of year $19,414 $18,294 $16,693
--------------------------------------------------------------------------------
Private banking charge-offs (292) (327) (160)
--------------------------------------------------------------------------------
Recoveries:
Private banking 1,047 800 684
Other 47 327
--------------------------------------------------------------------------------
Total recoveries 1,047 847 1,011
--------------------------------------------------------------------------------
Net recoveries 755 520 851
Provision charged to income 600 750
--------------------------------------------------------------------------------
Balance at end of year $20,169 $19,414 $18,294
================================================================================
The estimated fair value of the loan portfolio was $2,631 million and
$2,192 million at December 31, 1999 and 1998, respectively.
5. Equipment, Office Facilities and Property
Equipment, office facilities and property are detailed below:
December 31, 1999 1998
--------------------------------------------------------------------------------
Land $ 16,348 $ 16,348
Buildings 109,788 104,446
Leasehold improvements 281,669 230,098
Furniture and equipment 170,928 139,251
Telecommunications equipment 126,778 100,995
Information technology equipment and software 552,067 390,558
Construction in progress 56,932 7,696
--------------------------------------------------------------------------------
Subtotal 1,314,510 989,392
Accumulated depreciation and amortization 636,302 515,826
--------------------------------------------------------------------------------
Total $ 678,208 $473,566
================================================================================
6. Deposits from Banking Customers
Deposits from banking customers consist of money market and other savings
deposits, noninterest-bearing deposits and certificates of deposit. Deposits
from banking customers are as follows:
December 31, 1999 1998
--------------------------------------------------------------------------------
Interest-bearing deposits $2,957,691 $2,590,206
Noninterest-bearing deposits 1,247,252 824,585
--------------------------------------------------------------------------------
Total $4,204,943 $3,414,791
================================================================================
7. Payable to Brokers, Dealers and Clearing Organizations
Payable to brokers, dealers and clearing organizations consist primarily of
securities loaned of $1,421 million and $1,201 million at December 31, 1999 and
1998, respectively. The market value of securities pledged by counterparties
under securities lending transactions approximated amounts due.
8. Payable to Brokerage Customers
The principal source of funding for Schwab's margin lending is cash balances
in brokerage customer accounts. At December 31, 1999, Schwab was paying interest
at 4.5% on $19,565 million of cash balances in customer brokerage accounts,
which were included in payable to brokerage customers. At December 31, 1998,
Schwab was paying interest at 4.1% on $15,143 million of such cash balances.
9. Short-term Borrowings
CSC may borrow under its committed, unsecured credit facilities. CSC
maintains a $600 million facility with a group of fourteen banks which is
scheduled to expire in June 2000 and a $175 million facility with a group of
nine banks which is scheduled to expire in June 2001. See note "21 - Subsequent
Events." The funds under both of these facilities are available for general
corporate purposes and CSC pays a commitment fee on the unused balance of these
facilities. The financial covenants in these facilities require CSC to maintain
minimum levels of stockholders' equity, and Schwab and SCM to maintain specified
levels of net capital, as defined. The Company believes that these restrictions
will not have a material effect on its ability to meet foreseeable dividend or
funding requirements. Other than an overnight borrowing to test the availability
of the $600 million facility, these facilities were unused in 1999 and 1998.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank
credit lines which total $795 million and $545 million at December 31, 1999 and
1998, respectively. At December 31, 1999, CSC also has direct access to $685
million of the $795 million bank credit lines. The amount available to CSC under
these lines is lower than the amount available to Schwab because the credit line
provided by one of these banks is only available to Schwab, while the credit
line provided by another one of these banks includes a sub-limit on credit
available to CSC. At December 31, 1998, CSC has direct access to $545 million of
these bank credit lines. There were no borrowings outstanding under these lines
at December 31, 1999 and 1998.
To satisfy the margin requirement of customer option transactions with the
Options Clearing Corporation (OCC), Schwab had unsecured letter of credit
agreements with eleven banks in favor of the OCC aggregating $905 million at
December 31, 1999. Schwab pays a fee to maintain these letters of credit. No
funds were drawn under these letters of credit at December 31, 1999 and 1998.
Other short-term borrowings include federal funds purchased, securities sold
under agreements to repurchase and other borrowed funds with weighted-average
interest rates ranging from 4.50% to 6.62% at December 31, 1999 and 4.75% to
5.98% at December 31, 1998.
Included in other short-term borrowings at December 31, 1999 is the
utilization of $35 million of U.S. Trust's $80 million unsecured revolving
credit facilities. The weighted-average interest rate on these facilities is
6.62% at December 31, 1999. Upon completion of the Merger, these facilities were
terminated. At December 31, 1998, the amount outstanding under similar credit
facilities was $20 million at an interest rate of 5.98%.
10. Long-term Debt
Long-term debt consists of the following:
December 31, 1999 1998
--------------------------------------------------------------------------------
Senior Medium-Term Notes, Series A $455,000 $351,000
8.414% Trust Preferred Capital Securities 50,000 50,000
Other 13,000 17,773
--------------------------------------------------------------------------------
Total $518,000 $418,773
================================================================================
The $455 million aggregate principal amount of Senior Medium-Term Notes,
Series A (Medium-Term Notes) outstanding at December 31, 1999 have maturities
ranging from 2000 to 2009 and fixed interest rates ranging from 5.96% to 7.50%.
The Medium-Term Notes carry a weighted-average interest rate of 6.73%.
At December 31, 1999, CSC had $311 million in Senior or Senior Subordinated
Medium-Term Notes, Series A available to be issued. See note "21 - Subsequent
Events."
The Trust Preferred Capital Securities qualify as tier 1 capital under
guidelines of the Federal Reserve Board and have no voting rights. Holders of
the Trust Preferred Capital Securities are entitled to receive cumulative cash
distributions semi-annually. The Company has the right to redeem the Trust
Preferred Capital Securities prior to their stated maturity of February 1, 2027,
on or after February 1, 2007, upon approval (if then required) of the Federal
Reserve Board.
The estimated fair value of the long-term debt was $498 million and $430
million at December 31, 1999 and 1998, respectively.
Annual maturities on long-term debt outstanding at December 31, 1999 are as
follows:
--------------------------------------------------------------------------------
2000 $ 59,000
2001 40,000
2002 54,000
2003 49,000
2004 80,500
Thereafter 235,500
--------------------------------------------------------------------------------
Total $518,000
================================================================================
11. Taxes on Income
Income tax expense is as follows:
Year Ended December 31, 1999 1998 1997
--------------------------------------------------------------------------------
Current:
Federal $375,934 $241,420 $205,986
State 59,753 35,587 35,623
--------------------------------------------------------------------------------
Total current 435,687 277,007 241,609
--------------------------------------------------------------------------------
Deferred:
Federal (2,187) (8,969) (27,864)
State (1,031) (529) (4,148)
--------------------------------------------------------------------------------
Total deferred (3,218) (9,498) (32,012)
--------------------------------------------------------------------------------
Total taxes on income $432,469 $267,509 $209,597
================================================================================
The above amounts do not include tax benefits from the exercise of stock
options and the vesting of restricted stock awards, which for accounting
purposes are credited directly to additional paid-in capital. Such tax benefits
reduced income taxes paid by $215 million in 1999, $71 million in 1998 and $35
million in 1997. Additionally, the above deferred amounts do not include tax
expenses or benefits related to other comprehensive income (loss).
The temporary differences that created deferred tax assets and liabilities,
included in other assets, and accrued expenses and other liabilities, are
detailed below:
December 31, 1999 1998
--------------------------------------------------------------------------------
Deferred Tax Assets:
Deferred compensation and employee benefits $108,968 $ 86,533
Reserves and allowances 39,150 30,855
Trust and fiduciary activities 10,698 11,980
Net unrealized losses on securities
available for sale 9,002
Property and equipment leasing 7,007 9,433
Other 10,379 10,188
--------------------------------------------------------------------------------
Total deferred assets 185,204 148,989
--------------------------------------------------------------------------------
Deferred Tax Liabilities:
Depreciation and amortization (28,905) (9,216)
Net unrealized gains on securities
available for sale (3,214)
State and local taxes (2,469) (2,407)
Other (12,387) (8,144)
--------------------------------------------------------------------------------
Total deferred liabilities (43,761) (22,981)
--------------------------------------------------------------------------------
Net deferred tax asset $141,443 $126,008
================================================================================
The Company determined that no valuation allowance against deferred tax
assets at December 31, 1999 and 1998 was necessary.
The effective income tax rate differs from the amount computed by applying
the federal statutory income tax rate as follows:
Year Ended December 31, 1999 1998 1997
--------------------------------------------------------------------------------
Federal statutory income tax rate 35.0% 35.0% 35.0%
State income taxes, net of federal tax benefit 3.5 3.4 3.9
Other .9 1.1 .6
--------------------------------------------------------------------------------
Effective income tax rate 39.4% 39.5% 39.5%
================================================================================
12. Employee Incentive and Deferred Compensation Plans
The Company's employee incentive and deferred compensation plans consist of
CSC's and U.S. Trust's plans that were in effect prior to the Merger.
Accordingly, the following summarizes such plans.
Stock Option Plans
The Company's stock incentive plans provide for granting options to
employees, officers and directors. Options are granted for the purchase of
shares of common stock at an exercise price not less than market value on the
date of grant, and expire within either eight or ten years from the date of
grant. Options generally vest over a four-year period from the date of grant.
The Company granted to all non-officer employees 5,675,000 options in 1999
and 5,217,000 options in 1998(a).
A summary of option activity follows(a):
<TABLE>
<CAPTION>
1999 1998 1997
----------------------- ----------------------- -----------------------
Weighted- Weighted- Weighted-
Average Average Average
Number Exercise Number Exercise Number Exercise
of Options Price of Options Price of Options Price
--------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 100,104 $ 5.10 97,726 $ 2.71 97,075 $1.68
Granted (1) 18,781 $27.10 30,212 $10.03 18,150 $6.67
Exercised (25,882) $ 2.15 (23,878) $ 1.33 (15,631) $ .93
Canceled (2,619) $12.18 (3,956) $ 6.41 (1,868) $2.93
--------------------------------------------------------------------------------------------------------
Outstanding at
end of year 90,384 $10.31 100,104 $ 5.10 97,726 $2.71
========================================================================================================
Exercisable at
end of year 40,059 $ 3.71 51,802 $ 2.16 60,117 $1.40
========================================================================================================
Available for
future grant at
end of year 37,128 52,142 71,916
========================================================================================================
Weighted-average
fair value of
options granted
during the year (1) $12.34 $3.65 $2.96
========================================================================================================
(1) In 1998, 5,400,000 options were granted with an exercise price greater than
the fair market value of the Company's common stock on the date of grant.
The weighted-average exercise price of these options is $16.67 and the
weighted-average fair value is $2.84. The remaining 24,812,000 options were
granted with an exercise price equal to the fair market value of the
Company's common stock on the date of grant. The weighted-average exercise
price of these options is $8.59 and the weighted-average fair value is
$3.83.
</TABLE>
Options outstanding and exercisable are as follows(a):
<TABLE>
<CAPTION>
December 31, 1999
-------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
-------------------------------------- -------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices of Options Life (in years) Price of Options Price
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ .67 to $ 3.33 17,587 2.8 $ 1.24 17,437 $ 1.22
$ 3.34 to $ 5.33 16,679 6.2 $ 3.93 13,608 $ 3.82
$ 5.34 to $ 8.67 18,153 7.8 $ 7.23 6,233 $ 7.11
$ 8.68 to $14.00 16,204 8.2 $ 9.49 2,591 $ 9.37
$14.01 to $23.33 9,800 8.9 $21.52 9 $21.71
$23.34 to $38.67 11,961 9.5 $29.13 181 $35.46
-------------------------------------------------------------------------------------------
$ .67 to $38.67 90,384 6.9 $10.31 40,059 $ 3.71
===========================================================================================
</TABLE>
--------------------------
(a) These stock options were granted prior to the Merger, and therefore did not
include U.S. Trust employees.
The following tables summarize U.S. Trust's option activities. On the closing
date of the Merger, any unexercised U.S. Trust stock options were converted into
shares of CSC's common stock based upon the intrinsic value of the unexercised
stock options as of that date, net of the number of shares required to satisfy
the participant's payroll tax withholding obligation.
<TABLE>
<CAPTION>
1999 1998 1997
------------------------- ------------------------ -------------------------
Weighted- Weighted- Weighted-
Average Average Average
Number Exercise Number Exercise Number Exercise
of Options Price of Options Price of Options Price
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 11,694 $ 6.96 10,202 $ 5.84 7,626 $4.46
Granted 2,341 $14.86 1,983 $12.42 2,963 $9.29
Exercised (601) $ 5.37 (391) $ 4.98 (208) $4.23
Canceled (107) $10.44 (100) $ 8.78 (179) $6.05
---------------------------------------------------------------------------------------------------------
Outstanding at
end of year 13,327 $ 8.39 11,694 $ 6.96 10,202 $5.84
=========================================================================================================
Exercisable at
end of year 5,382 $ 6.19 3,562 $ 5.23 1,807 $4.21
=========================================================================================================
Available for
future grant at
end of year 2,576 4,484 6,161
=========================================================================================================
Weighted-average
fair value of
options granted
during the year $4.53 $3.01 $2.19
=========================================================================================================
</TABLE>
U.S. Trust's options outstanding and exercisable are as follows:
<TABLE>
<CAPTION>
December 31, 1999
------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------- -------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range of Number of Contractual Exercise Number Exercise
Exercise Prices Options Life (in years) Price of Options Price
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 4.02 to $ 5.37 6,445 5.9 $ 4.50 3,628 $ 4.27
$ 8.69 to $11.50 2,664 7.2 $ 9.31 1,285 $ 9.31
$12.18 to $15.23 4,089 8.7 $13.66 469 $12.46
$16.00 to $18.23 129 9.4 $16.98
------------------------------------------------------------------------------------------------
$ 4.02 to $18.23 13,327 7.0 $ 8.39 5,382 $ 6.19
================================================================================================
</TABLE>
The fair value of each option granted is estimated as of the grant date using
the Black-Scholes option-pricing model with the following assumptions:
Company(b) U.S. Trust
------------------- -------------------
1999 1998 1997 1999 1998 1997
--------------------------------------------------------------------------------
Dividend yield .50% .65% .75% 1.10% 2.60% 2.70%
Expected volatility 46% 45% 44% 29% 25% 22%
Risk-free interest rate 5.5% 5.6% 6.2% 4.6% 5.6% 6.4%
Expected life (in years) 5 5 - 8 5 5 5 5
--------------------------------------------------------------------------------
-----------------------------
(b) These assumptions relate to options granted prior to the Merger which did
not include U.S. Trust employees.
The Company applies Accounting Principles Board Opinion No. 25 - Accounting
for Stock Issued to Employees, and related Interpretations in accounting for its
stock option plans. Accordingly, no compensation expense has been recognized for
the Company's options. Had compensation expense for the Company's options been
determined based on the fair value at the grant dates for awards under those
plans consistent with the fair value method of SFAS No. 123 - Accounting for
Stock-Based Compensation, the Company's net income and earnings per share would
have been reduced to the pro forma amounts presented below:
Year Ended December 31, 1999 1998 1997
--------------------------------------------------------------------------------
Net Income: As reported $666,446 $410,129 $321,309
Pro forma $604,605 $379,035 $304,178
================================================================================
Basic Earnings
Per Share: As reported $ .51 $ .32 $ .25
Pro forma $ .46 $ .29 $ .24
Diluted Earnings
Per Share: As reported $ .49 $ .31 $ .24
Pro forma $ .44 $ .28 $ .23
================================================================================
Restricted Stock Plans
The Company
The Company's stock incentive plans provide for granting restricted stock
awards(c) to employees and officers. Restricted stock awards are restricted from
sale and generally vest over a four-year period, but some vest based upon the
Company achieving certain financial or other measures. The fair market value of
shares associated with the restricted stock awards is recorded as unamortized
restricted stock compensation in stockholders' equity and is amortized to
compensation expense over the vesting periods.
Restricted stock information is as follows(c):
1999 1998 1997
--------------------------------------------------------------------------------
Restricted stock awards 2,173 4,597 3,474
Average market price of awarded shares $ 24.99 $ 9.17 $ 5.63
Restricted stock cancellations 483 603 384
Restricted shares outstanding (at year end) 8,774 7,918 6,973
Restricted stock expense and amortization $24,617 $19,765 $10,296
================================================================================
----------------------
(c) These restricted stock awards were granted prior to the Merger, and
therefore did not include U.S. Trust employees.
U.S. Trust
Under the U.S. Trust Restricted Stock Unit Plan, the Company issues
restricted stock units (RSUs). RSUs accrue dividend equivalent credits and
generally cliff vest (the entire award typically vests at the end of a five-year
vesting period) at which time they may be converted into common stock. The fair
market value of the grant is amortized to compensation expense and recorded to
additional paid in capital ratably over the vesting period.
Upon consummation of the Merger, substantially all of U.S. Trust's RSUs were
converted into CSC's common stock pursuant to the exchange ratio, net of the
number of shares required to satisfy the participant's payroll tax withholding
obligation.
Restricted stock unit information is as follows:
1999 1998 1997
--------------------------------------------------------------------------------
Restricted stock unit grants 646 488 540
Average market price of granted units $15.22 $12.57 $ 9.29
Restricted stock unit cancellations 102 11
Restricted stock units outstanding (at year end) 1,768 1,209 722
Restricted stock unit amortization $4,190 $2,560 $1,133
================================================================================
Other Deferred Compensation Plans
The Company sponsors deferred compensation plans for both officers and
non-employee directors. The Company's unfunded deferred compensation plan for
officers permits participants to defer the payment of certain cash compensation.
The deferred compensation liability was $106 million and $82 million at December
31, 1999 and 1998, respectively. The Company's unfunded deferred compensation
plan for non-employee directors permits participants to defer receipt of all or
a portion of their directors' fees and to receive either a grant of stock
options, or upon ceasing to serve as a director, the number of shares of CSC's
common stock that would have resulted from investing the deferred fee amount
into CSC's common stock.
In 1999, the Company issued 111,000 shares of CSC's common stock and placed
such shares into a trust to settle the directors' deferred compensation
liability. In accordance with the Emerging Issues Task Force Issue 97-14 -
Accounting for Deferred Compensation Arrangements Where Amounts Earned are Held
in a Rabbi Trust and Invested, assets of the trust are consolidated with those
of the Company and the value of CSC's common stock held in the stock trust is
classified in stockholders' equity in a manner similar to treasury stock. The
shares and the corresponding obligation to directors are shown as separate
components of stockholders' equity in the Company's consolidated balance sheet.
13. Retirement and Other Employee Benefit Plans
The Company's retirement and other employee benefit plans consist of CSC's
and U.S. Trust's plans that were in effect prior to the Merger. Accordingly, the
following summarizes such plans.
Employee Stock Ownership Plans
The components of the Company's employee stock ownership plans, as recorded
on the consolidated balance sheet and consolidated statement of stockholders'
equity, are as follows:
December 31, 1999 1998
--------------------------------------------------------------------------------
Unearned ESOP shares $967 $1,088
Note Receivable from U.S. Trust ESOP 3,773
--------------------------------------------------------------------------------
Employee stock ownership plans $967 $4,861
================================================================================
The Company has a profit sharing and employee stock ownership plan (Profit
Sharing Plan(d)), including a 401(k) salary deferral component, for eligible
employees who have met certain service requirements. The Company matches certain
employee contributions; additional contributions to this plan are at the
discretion of the Company. Total Company contribution expense was $74 million in
1999, $46 million in 1998 and $44 million in 1997.
In 1993, the Profit Sharing Plan borrowed $15 million from the Company to
purchase approximately 15 million shares of CSC's common stock. The note
receivable from the Profit Sharing Plan had a balance of $1 million at both
December 31, 1999 and 1998, bears interest at 7.9% and is due in annual
installments through 2007. Shares are released for allocation to eligible
employees' accounts based on the proportion of principal and interest payments
made during the year as compared to the total of these payments and the
remaining principal and interest. In accordance with Statement of Position No.
93-6 - Employers' Accounting for Employee Stock Ownership Plans (the Statement),
the fair value of shares released for allocation to employees through the
employee stock ownership plan (ESOP) is recognized by the Company as
compensation and benefits expense - $3 million in 1999, $15 million in 1998 and
$17 million in 1997. At December 31, 1999, a $25 million accrued liability was
recorded for 1999 retirement benefits and will be contributed to the ESOP during
the first half of 2000 for the purchase from CSC of newly issued shares of CSC's
common stock. Only released ESOP shares are considered outstanding for basic and
diluted earnings per share computations. Dividends on allocated shares and
unallocated shares are charged to retained earnings and are used to make
principal and interest payments on the ESOP note receivable, respectively. The
unallocated shares are recorded as unearned ESOP shares included in employee
stock ownership plans on the consolidated balance sheet. Under the "grandfather"
provisions of the Statement, the Company did not apply the Statement to shares
purchased by the ESOP prior to 1993.
The ESOP(d) share information is as follows:
December 31, 1999 1998
--------------------------------------------------------------------------------
Allocated shares:
Purchased prior to 1993 28,826 47,585
Purchased in 1993 and after 18,150 16,338
Shares released for allocation:
Purchased in 1993 and after 143 1,812
Unreleased shares:
Purchased in 1993 and after 951 1,069
--------------------------------------------------------------------------------
Total ESOP shares 48,070 66,804
================================================================================
Fair value of unreleased shares $24,239 $20,028
================================================================================
------------------------
(d) The profit sharing plan and the ESOP were in place prior to the Merger, and
therefore did not include U.S. Trust employees.
U.S. Trust sponsors a 401(k) Plan and ESOP covering all U.S. Trust
employees who have met the specified service requirement. Effective January 1,
1999, U.S. Trust began matching certain employees' U.S. Trust 401(k) plan
contributions in the form of common stock. Total contribution expense under the
U.S. Trust 401(k) Plan was $3 million in 1999.
In 1989 and 1988, the U.S. Trust ESOP borrowed a total of $27 million to
purchase 7 million shares of common stock. The Company accounts for the U.S.
Trust ESOP shares in accordance with Statement of Position No. 76-3 - Accounting
Practices for Certain Employee Stock Ownership Plans. Accordingly, the loan to
the U.S. Trust ESOP is recorded as a reduction to stockholders' equity included
in employee stock ownership plans on the consolidated balance sheet. ESOP
compensation expense is based on the costs of the U.S. Trust ESOP shares and is
recorded as shares are released and allocated to participants' accounts. There
was no ESOP compensation expense in 1999. ESOP compensation expense was $3
million in both 1998 and 1997. Dividends on allocated and unallocated U.S. Trust
ESOP shares are used to make principal and interest payments on the U.S. Trust
ESOP loans and are recorded as a reduction to retained earnings. U.S. Trust ESOP
shares are allocated to participants' accounts ratably over the term of the
loans. The Company receives a tax benefit for dividends paid on U.S. Trust ESOP
shares. This tax benefit is recorded in the consolidated statement of income as
a reduction to income tax expense. All shares held by the U.S. Trust ESOP are
considered outstanding for basic and diluted earnings per share computations.
On February 1, 1999 the final payment on the U.S. Trust ESOP loan was made,
and all remaining shares were allocated to eligible participants. As of December
31, 1999 the U.S. Trust ESOP held a total of 7,802,000 shares of common stock.
Dividends on U.S. Trust ESOP shares used for debt repayment were less than $1
million in 1999 and $1 million in both 1998 and 1997.
The U.S. Trust ESOP share information is as follows:
December 31, 1999 1998
--------------------------------------------------------------------------------
Allocated shares 6,649 6,212
Shares released for allocation 1,153 1,523
Unreleased shares 1,153
--------------------------------------------------------------------------------
Total U.S. Trust ESOP shares 7,802 8,888
================================================================================
Other Benefit Plans
The Company is the beneficiary of a life insurance program covering some of
its employees. Under the program, the cash surrender value of insurance policies
is recorded net of policy loans in other assets. During 1999, the Company repaid
$65 million on the policy loans and received $65 million cash surrender value on
the insurance policies. At December 31, 1999 and 1998, policy loans with
interest rates of 8.2% and 7.1% totaled $15 million and $80 million,
respectively.
Pension and Other Postretirement Benefits
U.S. Trust provides a trusteed, noncontributory, qualified defined benefit
pension plan to substantially all U.S. Trust employees. Benefits are based upon
years of service, average compensation over the final years of service and the
social security covered compensation. U.S. Trust uses the projected unit credit
cost method to compute the vested benefit obligation, where the vested benefit
obligation is the actuarial present value of the vested benefits to which the
employee is entitled based on the employee's expected date of separation or
retirement.
In addition, U.S. Trust provides certain health care and life insurance
benefits for all employees, certain qualifying retired employees and their
dependents. Postretirement medical and life insurance benefits are accrued
during the years that the employee renders service to reflect the expected cost
of providing health care and life insurance and other benefits to an employee
upon retirement.
The following table summarizes the components of retirement and
postretirement benefit expenses (credits), the funded status of U.S. Trust's
qualified retirement plan, changes in the benefit obligations related to these
plans and the major assumptions used to determine these amounts.
<PAGE>
<TABLE>
<CAPTION>
1999 1998 1997
----------------------------------- -------------------------------- -------------------------------
Pension Health & Pension Health & Pension Health &
Plan Life Total Plan Life Total Plan Life Total
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Components of expense
(credit):
Service cost and
expenses $ 9,119 $ 238 $ 9,357 $ 6,617 $ 278 $ 6,895 $ 5,402 $ 309 $ 5,711
Interest cost 14,601 1,394 15,995 14,077 1,779 15,856 12,458 2,182 14,640
Amortization of prior
service cost 87 (391) (304) 177 (391) (214) 177 (391) (214)
Actual return on plan
assets (84,668) (84,668) (46,341) (46,341) (45,135) (45,135)
Other net amortizations
and deferrals(1) 58,987 34 59,021 30,541 (6,759) 23,782 24,455 285 24,740
Special termination
benefits charge 193 193
--------------------------------------------------------------------------------------------------------------------------------
Net expense (credit) (2) $ (1,681) $ 1,275 $ (406) $ 5,071 $ (5,093) $ (22) $ (2,643) $ 2,385 $ (258)
--------------------------------------------------------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan
assets at
beginning of year $ 291,128 $253,442 $216,070
Actual return on plan
assets 84,668 46,341 45,135
Employer contribution $ 1,630 $ 1,666 $ 1,688
Benefits and expenses
paid (9,008) (1,630) (8,655) (1,666) (7,763) (1,688)
--------------------------------------------------------------------------------------------------------------------------------
Fair value of plan
assets at end of year $ 366,788 $291,128 $253,442
--------------------------------------------------------------------------------------------------------------------------------
Change in benefit
obligation:
Benefit obligation at
beginning of year $ 220,715 $ 20,821 $192,352 $ 31,940 $170,045 $ 26,660
Service cost 8,919 238 6,417 278 5,402 309
Interest cost 14,601 1,394 14,077 1,779 12,458 2,182
Actuarial (gain)/
loss(1) (34,850) (1,822) 16,327 (11,510) 10,071 4,477
Benefits paid (8,717) (1,630) (8,458) (1,666) (7,763) (1,688)
Amendments (474) 2,139
Special termination
benefits charge 193
--------------------------------------------------------------------------------------------------------------------------------
Benefit obligation at
end of year $ 200,387 $ 19,001 $220,715 $ 20,821 $192,352 $ 31,940
--------------------------------------------------------------------------------------------------------------------------------
Prepaid/(accrued) cost:
Excess of plan assets
over benefit
obligation $ 166,401 $(19,001) $ 70,413 $(20,821) $ 61,090 $(31,940)
Unrecognized
cumulative
net (gains) losses (136,391) (1,261) (40,246) 595 (23,630) 5,346
Unrecognized prior
service cost 978 (1,582) 1,539 (1,973) 1,716 (2,364)
Unrecognized net
liability (asset)
at date of initial
application (4,797) (7,196) (9,595)
------------------------------------------------------------------------------------------------------------------------------
Prepaid (accrued) cost $ 26,191 $(21,844) $ 24,510 $(22,199) $ 29,581 $(28,958)
------------------------------------------------------------------------------------------------------------------------------
Discount rate 8.00% 8.00% 6.75% 6.75% 7.00% 7.00%
Rate of increase
in salary (3) 6.00% 6.00% 6.00% 6.00% 4.50% 4.50%
Health care cost
trend rate N/A 8.50% N/A 9.00% N/A 1.30%
Expected rate of return
on plan assets 9.00% N/A 9.00% N/A 9.00% N/A
------------------------------------------------------------------------------------------------------------------------------
(1) Pension plan expense in 1998 includes a charge of $7 million arising from the actuarial recalculation of certain
benefit obligations. Health & Life other net amortization and deferrals for the year ended December 31, 1998
includes a $7 million gain reflecting an actuarial gain arising from a change in actuarial assumptions with regard
to future retiree medical claims.
(2) The pension expense (credit) and postretirement benefit expense are determined using the assumptions as of the
beginning of the year. The benefit obligations and the funded status are determined using the assumptions as of the
end of the year.
(3) The rate of increase in compensation is based on an age-related table with assumed rates of increase in compensation
ranging from 9.0% to 3.5%. The amount shown is the average assumed rate of increase for the given plan year.
</TABLE>
<PAGE>
The assumed rate of future increases in per capita cost of health care
benefits (the health care cost trend rate) is 8.5% in 1999, decreasing gradually
to 5.5% in the year 2005. A one percentage point change in the assumed health
care cost trend rates would have the following effects:
1999 1998 1997
--------------------------------------------------------------------------------
Effect on total of service and interest cost components:
1% increase $ 17 $ 26 $ 80
1% decrease $ (16) $ (26) $ (80)
Effect on postretirement benefit obligation:
1% increase $ 208 $ 317 $ 950
1% decrease $(217) $(333) $(998)
--------------------------------------------------------------------------------
14. Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) represents cumulative gains and
losses that are not reflected in earnings. The components of accumulated other
comprehensive income (loss) are as follows:
1999 1998 1997
--------------------------------------------------------------------------------
Foreign currency translation
adjustment:
Beginning balance $ 1,308 $ 920 $ 3,280
Change during the year 2,606 388 (2,360)
--------------------------------------------------------------------------------
Ending balance $ 3,914 $1,308 $ 920
================================================================================
Net unrealized gain (loss) on
securities available for sale,
net of tax:
Beginning balance $ 4,014 $3,827 $ 705
Change during the year (16,848) 187 3,122
--------------------------------------------------------------------------------
Ending balance $(12,834) $4,014 $ 3,827
================================================================================
Total accumulated other
comprehensive income (loss),
net of tax:
Beginning balance $ 5,322 $4,747 $ 3,985
Change during the year (14,242) 575 762
--------------------------------------------------------------------------------
Ending balance $ (8,920) $5,322 $ 4,747
================================================================================
15. Earnings Per Share
Basic earnings per share (EPS) excludes dilution and is computed by dividing
net income by the weighted-average number of common shares outstanding for the
period. Diluted EPS reflects the potential reduction in EPS that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock. Earnings per share under the basic and diluted computations
are as follows:
Year ended December 31, 1999 1998 1997
--------------------------------------------------------------------------------
Net income $ 666,446 $ 410,129 $ 321,309
================================================================================
Weighted-average common
shares outstanding - basic 1,310,444 1,287,460 1,280,951
Common stock equivalent shares
related to stock incentive plans 62,586 55,435 56,778
--------------------------------------------------------------------------------
Weighted-average common
shares outstanding - diluted 1,373,030 1,342,895 1,337,729
================================================================================
Basic earnings per share $ .51 $ .32 $ .25
================================================================================
Diluted earnings per share $ .49 $ .31 $ .24
================================================================================
The computation of diluted EPS for the years ended December 31, 1999, 1998
and 1997, respectively, excludes outstanding stock options to purchase
8,069,000, 30,340,000 and 7,910,000 shares, respectively, because the exercise
prices for those options were greater than the average market price of the
common shares, and therefore the effect would be antidilutive.
16. Regulatory Requirements
Upon consummation of the Merger, CSC became a financial holding company and
bank holding company subject to supervision and regulation by the Federal
Reserve Board under the Bank Holding Company Act of 1956, as amended (the Act).
The Gramm-Leach-Bliley Act (the GLB Act), which became effective in March
2000, permits qualifying bank holding companies to become financial holding
companies and thereby affiliate with a far broader range of financial companies
than has previously been permitted for a bank holding company. The GLB Act
identifies several activities as financial in nature, including securities
brokerage, underwriting, dealing in or making a market in securities, investment
management services and insurance activities. The Federal Reserve Board may
prohibit a financial holding company from engaging in new activities or
acquiring additional companies if the Federal Reserve Board concludes that the
financial holding company's capital or managerial resources are not adequate.
Federal Reserve Board regulations under the Act may also limit CSC's business or
impose additional costs or requirements.
Federal Reserve Board policy provides that a bank holding company generally
should not pay cash dividends unless its net income is sufficient to fully fund
the dividends and the Company's prospective retained earnings appear to be
sufficient to meet the capital needs, asset quality and overall financial
condition of the holding company and its bank subsidiaries.
CSC's primary bank subsidiary is United States Trust Company of New York
(U.S. Trust NY). The operations and financial condition of CSC's bank
subsidiaries are subject to regulation and supervision and to various
requirements and restrictions under Federal and state law, including
requirements governing: transactions with CSC and its nonbank subsidiaries,
including loans and other extensions of credit, investments or asset purchases,
or otherwise financing or supplying funds to CSC; dividends; investments; and
aspects of CSC's operations. The Federal banking agencies have broad powers to
enforce these regulations, including the power to terminate deposit insurance,
impose substantial fines and other civil and criminal penalties and appoint a
conservator or receiver. CSC, U.S. Trust and their U.S. insured depository
institution subsidiaries must meet regulatory capital guidelines adopted by the
federal banking agencies. The Federal Reserve Board has not indicated whether
the guidelines will be modified with respect to a bank holding company, such as
CSC, that also qualifies as a financial holding company. Under the Federal
Deposit Insurance Act, the banking regulatory agencies are permitted or, in
certain cases, required to take certain substantial restrictive actions with
respect to institutions falling within one of the lowest three of five capital
categories.
The Act authorizes the Federal Reserve Board to establish consolidated
capital requirements for financial holding companies. The Act prohibits the
Federal Reserve Board from imposing capital requirements on functionally
regulated nonbank subsidiaries of a financial holding company, such as
broker-dealers and investment advisors. The Federal Reserve Board has not
published consolidated capital requirements specific to financial holding
companies, but may do so in the future.
The Company's, U.S. Trust's and U.S. Trust NY's regulatory capital and ratios
are as follows:
1999 1998
---------------- ----------------
December 31, Amount Ratio(1) Amount Ratio(1)
--------------------------------------------------------------------------------
Tier 1 Capital:
Company $2,500,831 11.0% $1,618,183 11.1%
U.S. Trust $ 272,044 11.8% $ 235,835 12.0%
U.S. Trust NY $ 186,360 9.7% $ 158,806 9.7%
Total Capital:
Company $2,532,352 11.2% $1,645,171 11.3%
U.S. Trust $ 292,213 12.7% $ 255,249 13.0%
U.S. Trust NY $ 204,153 10.7% $ 176,005 10.7%
Leverage:
Company $2,500,831 7.3% $1,618,183 6.2%
U.S. Trust $ 272,044 6.2% $ 235,835 6.2%
U.S. Trust NY $ 186,360 5.4% $ 158,806 5.1%
--------------------------------------------------------------------------------
(1) Minimum tier 1 capital, total capital and tier 1 leverage ratios are 4%, 8%
and 3%-5%, respectively, for bank holding companies and banks. Each of the
other bank subsidiaries of CSC currently has tier 1 capital, total capital
and leverage capital ratios at least equal to those of U.S. Trust and U.S.
Trust NY.
Based on their respective regulatory capital ratios at December 31, 1999 and
1998, the Company, U.S. Trust and U.S. Trust NY are well capitalized (the
highest category). There are no conditions or events that management believes
have changed the Company's, U.S. Trust's and U.S. Trust NY's well-capitalized
status.
To remain a financial holding company, each of CSC's bank subsidiaries must
be well capitalized, well managed and meet requirements relating to the
provision of public services to the communities in which CSC's bank subsidiaries
operate. If CSC ceases to qualify as a financial holding company it will be
subject to substantial additional restrictions on its activities.
CSC's Federal Deposit Insurance Corporation (FDIC) insured subsidiaries may
be required to reimburse the FDIC for any payments made in connection with the
receivership of any other of CSC's FDIC insured subsidiaries. CSC could also be
required to guarantee the capital plan of an undercapitalized banking subsidiary
or subject the bank to seizure by the FDIC; and such a guarantee would have a
priority over most other unsecured claims in bankruptcy. Additionally, under
Federal Reserve Board policy, CSC may be expected to act as a source of
financial strength to each of its bank subsidiaries and commit resources to
their support.
Subject to limited exceptions, the privacy provisions of the GLB Act prohibit
financial institutions from disclosing to unaffiliated third parties nonpublic
personal information regarding consumers and require financial institutions to
develop and disclose consumer privacy policies. Federal law does not preempt
state financial privacy laws that are stricter than the Federal provisions. CSC
and U.S. Trust may be required to amend their privacy policies and consumer
disclosures to comply with the GLB Act and its implementing regulations.
Schwab and SCM are subject to the Uniform Net Capital Rule under the
Securities Exchange Act of 1934 (the Rule). Schwab and SCM compute net capital
under the alternative method permitted by this Rule, which requires the
maintenance of minimum net capital, as defined, of the greater of 2% of
aggregate debit balances arising from customer transactions or a minimum dollar
amount, which is based on the type of business conducted by the broker-dealer.
The minimum dollar amount for both Schwab and SCM is $1 million. Under the
alternative method, a broker-dealer may not repay subordinated borrowings, pay
cash dividends, or make any unsecured advances or loans to its parent or
employees if such payment would result in net capital of less than 5% of
aggregate debit balances or less than 120% of its minimum dollar amount
requirement. At December 31, 1999, Schwab's net capital was $1,766 million (10%
of aggregate debit balances), which was $1,421 million in excess of its minimum
required net capital and $903 million in excess of 5% of aggregate debit
balances. Aggregate debit balances as of December 29, 1999 were used to
calculate Schwab's minimum required net capital at December 31, 1999, in
accordance with applicable regulations. At December 31, 1999, SCM's net capital
was $13 million, which was $12 million in excess of its minimum required net
capital.
Schwab, SCM and CSE had portions of their cash and investments segregated for
the exclusive benefit of customers at December 31, 1999, in accordance with
applicable regulations. Schwab elected to compute its reserve requirement, in
accordance with applicable regulations as of December 29, 1999 rather than
December 31, 1999. The amount held on deposit in the reserve bank account at
December 31, 1999 exceeded cash and investments required to be segregated under
federal or other regulations by approximately $200 million. This excess is
included in cash and cash equivalents.
17. Commitments and Contingent Liabilities
The Company has noncancelable operating leases for office space and
equipment. Future minimum rental commitments under these leases at December 31,
1999 are as follows:
--------------------------------------------------------------------------------
2000 $ 159,085
2001 153,522
2002 139,424
2003 104,649
2004 108,117
Thereafter 593,719
--------------------------------------------------------------------------------
Total $1,258,516
================================================================================
Certain leases contain provisions for renewal options and rent escalations
based on increases in certain costs incurred by the lessor. Rent expense was
$218 million in 1999, $164 million in 1998 and $134 million in 1997.
The Company may, under certain circumstances, be required to make additional
capital contributions pursuant to joint venture agreements with The Tokio Marine
Fire Insurance Co., Limited and certain of its related companies, including
contributions to assure that Charles Schwab Tokio Marine Securities Co., Ltd. is
in compliance with regulatory requirements regarding capital adequacy.
On November 9, 1998, the United States District Court for the Southern
District of New York granted final approval of the settlement agreement in the
consolidated class action, In re: Nasdaq Market-Makers Antitrust Litigation. The
settlement fully resolves alleged claims on behalf of certain persons who
purchased or sold Nasdaq securities during the period May 1, 1989 through July
17, 1996 concerning the width of spreads between the bid and ask prices of
certain Nasdaq securities. The Company recognized settlement charges in 1997 of
$39 million ($24 million after-tax), and does not expect to incur any further
charges relating to this settlement.
On May 30 and 31, 2000, a federal district court in New Orleans, Louisiana
held a hearing on the fairness of a settlement between Schwab and plaintiffs in
two class action lawsuits. Attorneys representing four Schwab customers who have
brought separate class action lawsuits against Schwab that are now pending in
federal court in California (the objectors) appeared at the hearing to object to
approval of the settlement. The district court has taken the matter under
consideration and is expected to issue a ruling late in 2000.
The lawsuits that are being settled were filed on behalf of a class
consisting of all individuals nationwide who purchased or sold securities
through Schwab from 1985 until July 1999. These lawsuits alleged that Schwab
improperly retained monetary payments for routing orders to market makers and
other third parties, and did not provide best execution to customer orders.
Schwab vigorously contested the allegations and had successfully obtained
dismissal of many of the plaintiffs' claims. However, in the interests of
avoiding the expense of further litigation, Schwab agreed to settle the cases on
the following terms: plaintiffs will dismiss the complaints with prejudice in
return for certain non-monetary relief from Schwab, including commitments to
implement various enhancements to its computerized trade handling and execution
systems; to adopt certain internal procedures to review order routing
arrangements and execution quality; and to conduct an investor education
campaign on trading and execution-related issues. In addition, Schwab agreed to
pay up to $900,000 in plaintiffs' attorneys' fees and costs. The settlement
would preclude any other claims on best execution or payment for order flow
issues during the class period, except for claimants who affirmatively opt out
of the settlement. Schwab believes that all class claims in the objectors' four
purported lawsuits on best execution issues, consolidated for pretrial
proceedings in the federal district court in San Francisco but in which no class
has been certified, would be precluded as a result of the Louisiana settlement.
Schwab recognized the cost of the attorneys' fees included in the settlement in
the second quarter of 1999.
The ultimate outcome of the legal proceedings described above and the various
other lawsuits, arbitration proceedings, and claims pending against the Company
cannot be determined at this time, and the results of these legal proceedings
cannot be predicted with certainty. There can be no assurance that these legal
proceedings will not have a material adverse effect on the Company's results of
operations in any future period, depending partly on the results for that
period, and a substantial judgment could have a material adverse impact on the
Company's financial condition and results of operations. However, it is the
opinion of management, after consultation with outside legal counsel, that the
ultimate outcome of these actions will not have a material adverse impact on the
financial condition or operating results of the Company.
18. Financial Instruments with Off-Balance-Sheet and Credit Risk
Through Schwab and SCM, the Company loans customer securities temporarily to
other brokers in connection with its securities lending activities. The Company
receives cash as collateral for the securities loaned. Increases in security
prices may cause the market value of the securities loaned to exceed the amount
of cash received as collateral. In the event the counterparty to these
transactions does not return the loaned securities, the Company may be exposed
to the risk of acquiring the securities at prevailing market prices in order to
satisfy its customer obligations. The Company mitigates this risk by requiring
credit approvals for counterparties, by monitoring the market value of
securities loaned on a daily basis and by requiring additional cash as
collateral when necessary.
The Company is obligated to settle transactions with brokers and other
financial institutions even if its customers fail to meet their obligations to
the Company. Customers are required to complete their transactions on settlement
date, generally three business days after trade date. If customers do not
fulfill their contractual obligations, the Company may incur losses. The Company
has established procedures to reduce this risk by requiring deposits from
customers in excess of amounts prescribed by regulatory requirements for certain
types of trades.
In the normal course of its margin lending activities, Schwab may be liable
for the margin requirement of customer margin securities transactions. As
customers write option contracts or sell securities short, the Company may incur
losses if the customers do not fulfill their obligations and the collateral in
customer accounts is not sufficient to fully cover losses which customers may
incur from these strategies. To mitigate this risk, the Company monitors
required margin levels daily and customers are required to deposit additional
collateral, or reduce positions, when necessary.
In its capacity as market maker, SCM maintains inventories in Nasdaq
securities on both a long and short basis. While long inventory positions
represent SCM's ownership of securities, short inventory positions represent
SCM's obligations to deliver specified securities at a contracted price, which
may differ from market prices prevailing at the time of completion of the
transaction. Accordingly, both long and short inventory positions may result in
losses or gains to SCM as market values of securities fluctuate. Also, Schwab
maintains inventories in exchange-listed securities on both a long and short
basis relating to its specialist operations and could incur losses or gains as a
result of changes in the market value of these securities. To mitigate the risk
of losses, long and short positions are marked to market daily and are monitored
by management to assure compliance with limits established by the Company.
Additionally, the Company may purchase exchange-traded option contracts to
reduce market risk on these inventories. The notional amount of such derivatives
was $103 million and $74 million at December 31, 1999 and 1998, respectively.
The estimated fair value of such derivatives was not material to the Company's
consolidated balance sheets at December 31, 1999 and 1998.
Schwab enters into collateralized resale agreements principally with other
broker-dealers, which could result in losses in the event the counterparty to
the transaction does not purchase the securities held as collateral for the cash
advanced and the market value of these securities declines. To mitigate this
risk, Schwab requires that the counterparty deliver securities to a custodian,
to be held as collateral, with a market value in excess of the resale price.
Schwab also sets standards for the credit quality of the counterparty, monitors
the market value of the underlying securities as compared to the related
receivable, including accrued interest, and requires additional collateral where
deemed appropriate.
In the normal course of business, U.S. Trust enters into various transactions
involving off-balance sheet financial instruments to meet the needs of its
customers and to reduce its own exposure to interest rate risk. The credit risk
associated with these instruments varies depending on the creditworthiness of
the customer and the value of any collateral held. Collateral requirements vary
by type of instrument. The contractual amounts of these instruments represent
the amounts at risk should the contract be fully drawn upon, the client default,
and the value of any existing collateral become worthless.
Credit-related financial instruments include firm commitments to extend
credit (firm commitments) and standby letters of credit. Firm commitments are
legally binding agreements to lend to a customer that generally have fixed
expiration dates or other termination clauses, may require payment of a fee and
are not secured by collateral until funds are advanced. Collateral held includes
marketable securities, real estate mortgages or other assets. The majority of
U.S. Trust's firm commitments are related to mortgage lending to private banking
clients. Firm commitments totaled $307 million and $249 million at December 31,
1999 and 1998, respectively. Standby letters of credit are conditional
commitments issued by U.S. Trust to guarantee the performance of a customer to a
third party. Standby letters of credit outstanding at December 31, 1999 and 1998
amounted to $80 million and $87 million, respectively. Standby letters of credit
are generally partially or fully collateralized by cash, marketable equity
securities, marketable debt securities (including corporate and U.S. Treasury
debt securities) and other assets.
As part of its overall asset and liability management process, U.S. Trust
utilizes Swaps as hedges. The market values of Swaps can vary depending on
movements in interest rates. The amounts at risk upon default are generally
limited to the unrealized market value gains of the Swaps, if any. The risk of
default depends on the creditworthiness of the counterparty. U.S. Trust
evaluates the creditworthiness of its counterparties as part of its normal
credit review procedures. At December 31, 1999 and 1998, the Company was a
counterparty to Swaps with a total notional principal amount of $1,070 million
and $560 million, respectively. Outstanding Swaps had a weighted-average
maturity of approximately 3.3 years at December 31, 1999 and 2.4 years at
December 31, 1998. The estimated fair value of the Swaps was not material to the
Company's consolidated balance sheet at December 31, 1999 and 1998.
19. Segment Information
Segments are defined as components of a company in which separate financial
information is evaluated regularly by the chief operating decision maker, or
decision-making group, in deciding how to allocate resources and in assessing
performance. The Company structures its segments according to its various types
of customers and the services provided to those customers. These segments have
been aggregated based on similarities in economic characteristics, types of
customers, services provided, distribution channels and regulatory environment,
into four reportable segments - Individual Investor, Institutional Investor,
Capital Markets and U.S. Trust. The Individual Investor segment includes
Schwab's domestic and international retail operations. The Institutional
Investor segment provides custodial, trading and support services to independent
investment managers, and serves company 401(k) plan sponsors and third-party
administrators. (The Company's mutual fund services are considered a product and
not a segment. Mutual fund service fees are included in both the Individual
Investor and Institutional Investor segments.) The Capital Markets segment
provides trade execution services in Nasdaq, exchange-listed and other
securities primarily to broker-dealers and institutional customers. The U.S.
Trust segment provides investment management, fiduciary services and private
banking services to individual and institutional customers.
The accounting policies of the segments are the same as those described in
note "2 - Significant Accounting Policies." The Company evaluates the
performance of its segments based on income before taxes on income. Segment
assets are not disclosed because they are not used for evaluating segment
performance and deciding how to allocate resources to segments. However, capital
expenditures are used in evaluating segment performance and are therefore
disclosed. Intersegment revenues, defined as revenues from transactions with
other segments within the Company, are immaterial and are therefore not
disclosed. Except for the U.S. Trust segment, for which expenses are directly
incurred, technology, corporate and general administrative expenses are
allocated to the remaining segments generally in proportion to either their
respective revenues or average full-time equivalent employees.
Fees received from Schwab's proprietary mutual funds represented
approximately 11% of the Company's consolidated revenues in 1999, 12% in 1998
and 11% in 1997. No single customer, except for Schwab's proprietary mutual
funds, accounted for more than 10% of the Company's consolidated revenues in
1999, 1998 and 1997. Substantially all of the Company's revenues and assets are
attributed to or located in the U.S. The percentage of Schwab's total customer
accounts located in California were approximately 25% as of both December 31,
1999 and 1998, and 28% as of December 31, 1997.
Financial information for the Company's reportable segments is presented in
the table below, and the totals are equal to the Company's consolidated amounts
as reported in the consolidated financial statements. Capital expenditures are
reported in total, as opposed to net of proceeds from the sale of fixed assets.
Year Ended December 31, 1999 1998 1997
--------------------------------------------------------------------------------
Revenues
Individual investor $2,782,790 $1,954,053 $1,675,424
Institutional investor 610,965 445,899 328,895
Capital markets 551,067 336,269 294,431
U.S. Trust 541,597 441,649 372,816
--------------------------------------------------------------------------------
Total $4,486,419 $3,177,870 $2,671,566
================================================================================
Interest Revenue, Net of
Interest Expense
Individual investor $ 598,136 $ 397,334 $ 300,741
Institutional investor 100,380 65,968 43,662
Capital markets 4,161 12,315 9,149
U.S. Trust 117,113 102,026 90,909
--------------------------------------------------------------------------------
Total $ 819,790 $ 577,643 $ 444,461
================================================================================
Income Before Taxes on Income
Individual investor $ 683,250 $ 395,009 $ 332,808
Institutional investor 164,523 99,613 48,111
Capital markets 123,466 81,922 66,328
U.S. Trust 127,676 101,094 83,659
--------------------------------------------------------------------------------
Total $1,098,915 $ 677,638 $ 530,906
================================================================================
Capital Expenditures
Individual investor $ 264,039 $ 145,394 $ 110,047
Institutional investor 51,762 24,944 18,633
Capital markets 37,793 19,905 11,518
U.S. Trust 19,216 13,673 10,986
--------------------------------------------------------------------------------
Total $ 372,810 $ 203,916 $ 151,184
================================================================================
Depreciation and Amortization (1)
Individual investor $ 116,394 $ 102,279 $ 91,727
Institutional investor 22,192 21,469 18,836
Capital markets 18,092 14,729 14,119
U.S. Trust 24,392 20,073 14,013
--------------------------------------------------------------------------------
Total $ 181,070 $ 158,550 $ 138,695
================================================================================
(1) Includes goodwill amortization.
20. Supplemental Cash Flow Information
Year Ended December 31, 1999 1998 1997
--------------------------------------------------------------------------------
Income taxes paid $182,019 $172,420 $201,145
================================================================================
Interest paid:
Brokerage customer cash balances $700,518 $579,477 $479,695
Deposits from banking customers 116,251 107,834 99,167
Stock-lending activities 30,905 38,118 36,939
Long-term debt 29,773 29,274 22,110
Short-term borrowings 7,267 11,159 16,257
Other 7,385 11,236 9,497
--------------------------------------------------------------------------------
Total interest paid $892,099 $777,098 $663,665
================================================================================
21. Subsequent Events
On March 1, 2000, the Company acquired CyBerCorp, Inc. (CyBerCorp) for $517
million in a non-taxable stock-for-stock exchange. Pursuant to the acquisition,
CyBerCorp became a wholly owned subsidiary of CSC which resulted in 17,570,000
shares of CSC's common stock and 3,077,000 options to purchase CSC common stock
being exchanged for all of the outstanding shares, options and equity rights of
CyBerCorp. Because the acquisition is accounted for using the purchase method,
the operating results of CyBerCorp are included in the consolidated results of
the Company since the acquisition date. The historical results of CyBerCorp are
not included in periods prior to the acquisition. The net assets acquired are
recorded at fair value and the excess of the purchase price over the fair value
of net assets acquired is recorded as goodwill. The Company recorded intangible
assets acquired of $512 million, including $482 million of goodwill. The
goodwill is amortized on a straight-line basis over a period of ten years. Other
intangible assets acquired, which consist primarily of purchased technology and
total $30 million, are amortized on a straight-line basis over a period of three
years.
At consummation of the merger with U.S. Trust, the Company incurred
merger-related costs of $50 million pre-tax, or $44 million after-tax, for
change in control related compensation payable to U.S. Trust employees and
professional fees. During the first half of 2000, these merger-related costs,
including costs incurred at the consummation, totaled $69 million pre-tax, or
$63 million after-tax. In addition, under the terms of the merger agreement, the
Company established a retention program for all U.S. Trust employees, whereby
the employees will receive cash compensation, contingent upon continued
employment, at the end of the two-year period following the completion of the
Merger. The Company plans to recognize the $125 million cost of the cash
component of the U.S. Trust retention program over this two-year period. In
addition, U.S. Trust employees will receive an aggregate of 2,718,000 stock
options of which 50% vest at the end of the three-year period following the
Merger and 50% vest at the end of the four-year period following the Merger.
During the first half of 2000, CSC issued the remaining $311 million in
Medium-Term Notes available under its current prospectus supplement on file with
the SEC. On May 19, 2000, CSC's Registration Statement under the Securities Act
of 1933 on Form S-3 relating to the issuance of up to $750 million aggregate
principal amount of debt securities was declared effective by the SEC. As of the
filing date of this Current Report on Form 8-K, no securities under this
Registration Statement have been issued. The proceeds from the sale of these
securities will be used for general corporate purposes.
On June 23, 2000, CSC entered into a $1.2 billion committed, unsecured credit
facility with several banks. The funds under this facility are available for
general corporate purposes. This facility has replaced both CSC's $600 million
committed, unsecured credit facility that was scheduled to expire in June 2000,
and CSC's $175 million committed, unsecured credit facility that was scheduled
to expire in June 2001. The financial convenants in the new facility require CSC
to maintain minimum levels of stockholders' equity, and Schwab and SCM to
maintain specified levels of net capital, as defined. As of the filing date of
this Current Report on Form 8-K, no amounts were borrowed under this facility.
<PAGE>
Independent Auditors' Report
To the Stockholders and Board of Directors of The Charles Schwab Corporation:
We have audited the accompanying consolidated balance sheets of The Charles
Schwab Corporation and subsidiaries (the Company) as of December 31, 1999 and
1998, and the related consolidated statements of income, stockholders' equity
and cash flows for each of the three years in the period ended December 31,
1999. Our audits also included the financial statement schedules of the Company
on pages A-1 through A-6. These financial statements and financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and financial statement
schedules based on our audits. The consolidated financial statements and
financial statement schedules give retroactive effect to the merger of the
Company and U.S. Trust Corporation and subsidiaries (U.S. Trust), which has been
accounted for as a pooling of interests as described in Note 1 to the
consolidated financial statements. We did not audit the consolidated statements
of condition of U.S. Trust as of December 31, 1999 and 1998, or the related
consolidated statements of income, stockholders' equity and cash flows of U.S.
Trust for each of the three years in the period ended December 31, 1999, which
statements reflect total assets of $5,023 million and $4,143 million as of
December 31, 1999 and 1998, respectively, and total revenues of $542 million,
$442 million and $373 million for the years ended December 31, 1999, 1998 and
1997, respectively. Those statements were audited by other auditors whose report
has been furnished to us, and our opinion, insofar as it relates to the amounts
included for U.S. Trust for such periods, is based solely on the report of such
other auditors.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits and the report of
the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
such consolidated financial statements present fairly, in all material respects,
the financial position of The Charles Schwab Corporation and subsidiaries at
December 31, 1999 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1999 in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, based on our audits and (as to the amounts
included for U.S. Trust) the report of the other auditors, such financial
statement schedules, when considered in relation to the basic consolidated
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in 1999
the Company changed its method of accounting for certain internal-use software
development costs to conform with Statement of Position 98-1.
/s/DELOITTE & TOUCHE LLP
------------------------
San Francisco, California
February 16, 2000
(July 17, 2000 as to Notes 1, 17 and 21)
<PAGE>
Report of Independent Accountants
To the Board of Directors and Stockholders of U.S. Trust Corporation:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, and changes in stockholders' equity
and of cash flows present fairly, in all material respects, the financial
position of U.S. Trust Corporation and its subsidiaries at December 31, 1999 and
1998, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1999, in conformity with accounting
principles generally accepted in the United States. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/PRICEWATERHOUSECOOPERS LLP
-----------------------------
New York, New York
January 31, 2000
<PAGE>
<TABLE>
<CAPTION>
=================================================================================================================
THE CHARLES SCHWAB CORPORATION
(PARENT COMPANY ONLY)
Condensed Financial Information of Registrant
Condensed Statement of Income
(In thousands)
Year Ended December 31, 1999 1998 1997
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest revenue $ 71,428 $ 42,780 $ 30,699
Interest expense (28,398) (25,429) (20,546)
-----------------------------------------------------------------------------------------------------------------
Net interest revenue 43,030 17,351 10,153
Other revenues 151 409 544
Other income (expenses) (25,392) (12,104) 4,423
-----------------------------------------------------------------------------------------------------------------
Income before income tax expense and equity
in earnings of subsidiaries 17,789 5,656 15,120
Income tax expense 6,885 2,092 5,692
-----------------------------------------------------------------------------------------------------------------
Income before equity in earnings of subsidiaries 10,904 3,564 9,428
Equity in earnings of subsidiaries
Equity in undistributed earnings of subsidiaries 496,662 105,607 239,752
Dividends paid by subsidiaries 158,880 300,958 72,129
-----------------------------------------------------------------------------------------------------------------
Total 655,542 406,565 311,881
Net income $666,446 $410,129 $321,309
=================================================================================================================
See Notes to Condensed Financial Information.
A-1
=================================================================================================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
================================================================================================================
THE CHARLES SCHWAB CORPORATION
(PARENT COMPANY ONLY)
Condensed Financial Information of Registrant
Condensed Balance Sheet
(In thousands)
December 31, 1999 1998
----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and cash equivalents $ 232,398 $ 180,025
Advances to subsidiaries 985,318 460,848
Investments in subsidiaries, at equity 2,101,872 1,468,052
Other assets 31,157 8,683
----------------------------------------------------------------------------------------------------------------
Total $3,350,745 $2,117,608
================================================================================================================
Liabilities and Stockholders' Equity
Drafts payable $ 200,008
Accrued expenses and other liabilities 119,961 $ 93,351
Long-term debt 455,000 351,000
----------------------------------------------------------------------------------------------------------------
Total liabilities 774,969 444,351
Stockholders' equity 2,575,776 1,673,257
----------------------------------------------------------------------------------------------------------------
Total $3,350,745 $2,117,608
================================================================================================================
See Notes to Condensed Financial Information.
A-2
================================================================================================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
================================================================================================================
THE CHARLES SCHWAB CORPORATION
(PARENT COMPANY ONLY)
Condensed Financial Information of Registrant
Condensed Statement of Cash Flows
(In thousands)
Year Ended December 31, 1999 1998 1997
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net income $ 666,446 $ 410,129 $ 321,309
Noncash items included in net income:
Equity in undistributed earnings of subsidiaries (496,662) (105,607) (239,752)
Net change in:
Other assets (10,995) (3,932) 279
Drafts payable 200,008
Accrued expenses and other liabilities 29,030 13,753 (4,122)
-----------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 387,827 314,343 77,714
-----------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Increase in net advances to subsidiaries (286,393) (26,465) (51,939)
Decrease (increase) in investments in subsidiaries (86,318) 52,124 (14,089)
Cash payments for business combinations and
investments, net of cash received (17,511) (1,400) (1,200)
-----------------------------------------------------------------------------------------------------------------
Net cash provided (used) by investing activities (390,222) 24,259 (67,228)
-----------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from long-term debt 144,000 30,000 111,000
Repayment of long-term debt (40,000) (40,000) (28,000)
Dividends paid (61,107) (56,041) (48,240)
Purchase of treasury stock (53,924) (208,353) (58,726)
Proceeds from stock options exercised and other 65,799 36,015 18,497
-----------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 54,768 (238,379) (5,469)
-----------------------------------------------------------------------------------------------------------------
Increase in Cash and Cash Equivalents 52,373 100,223 5,017
Cash and Cash Equivalents at Beginning of Year 180,025 79,802 74,785
-----------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 232,398 $ 180,025 $ 79,802
=================================================================================================================
See Notes to Condensed Financial Information.
A-3
================================================================================================================
</TABLE>
<PAGE>
The Charles Schwab Corporation
(PARENT COMPANY ONLY)
Condensed Financial Information of Registrant
Notes to Condensed Financial Information
1. Introduction and basis of presentation
On May 31, 2000, The Charles Schwab Corporation (CSC) completed its merger
(the Merger) with U.S. Trust Corporation (U.S. Trust). Under the terms of the
merger agreement, U.S. Trust became a wholly owned subsidiary of CSC and U.S.
Trust shareholders received 5.1405 shares of CSC's common stock for each common
share of U.S. Trust. The Merger was treated as a non-taxable stock-for-stock
exchange and U.S. Trust's shareholders received 112,000,000 shares of CSC's
common stock. The condensed financial statements, included in this Current
Report on Form 8-K, give retroactive effect to the Merger, which was accounted
for as a pooling of interests. The pooling of interests method of accounting
requires the restatement of all periods presented as if CSC and U.S. Trust had
been operating as a combined entity during such periods.
The condensed financial information of The Charles Schwab Corporation (the
Parent Company) should be read in conjunction with the consolidated financial
statements of The Charles Schwab Corporation and subsidiaries (the Company) and
notes thereto included in Exhibit 99.1 of this Current Report on Form 8-K.
2. Supplemental cash flow information
During 1998, the Parent Company recorded a non-cash capital contribution of
$69 million to its subsidiary, Charles Schwab & Co., Inc. (Schwab), through the
assumption of indebtedness.
Certain information affecting the cash flows of the Parent Company follows
(in thousands):
Year ended December 31,
1999 1998 1997
----------------------------------
Income taxes paid $11,264 $ 5,539 $ 2,608
======= ======= =======
Interest paid:
Long-term debt $24,644 $23,757 $18,332
Other 809 667 814
------- ------- -------
Total interest paid $25,453 $24,424 $19,146
======= ======= =======
3. Common stock split
On May 3, 2000, the Board of Directors approved a three-for-two split of
CSC's common stock, which was effected in the form of a 50% stock dividend. The
stock dividend was distributed May 30, 2000 to stockholders of record May 12,
2000. Share and per share information presented throughout this report has been
restated to reflect the common stock split, including the common shares issued
to U.S. Trust shareholders pursuant to the exchange ratio described above.
4. Long-term debt
Long-term debt consists of Senior Medium-Term Notes, Series A (Medium-Term
Notes). At December 31, 1999, CSC had $455 million aggregate principal amount of
Medium-Term Notes outstanding, with fixed interest rates ranging from 5.96% to
7.50%. At December 31, 1998, CSC had $351 million aggregate Medium-Term Notes
outstanding, with fixed interest rates ranging from 5.78% to 7.72%. Annual
maturities on long-term debt outstanding at December 31, 1999 are as follows (in
thousands):
--------------------------------------------------------------------------------
2000 $ 48,000
2001 39,000
2002 53,000
2003 49,000
2004 80,500
Thereafter 185,500
--------------------------------------------------------------------------------
Total $455,000
================================================================================
A-4
<PAGE>
5. Related party transactions
The Parent Company provides subordinated revolving credit facilities to its
subsidiaries, Schwab, Schwab Capital Markets L.P. (SCM) (prior to March 1, 2000,
this business was known as Mayer & Schweitzer, Inc.) and Charles Schwab Europe
(CSE).
Schwab had a $1,400 million subordinated revolving credit facility maturing
in September 2001, of which $905 million was outstanding at December 31, 1999.
This credit facility was $450 million at the end of 1998, of which $405 million
was outstanding at December 31, 1998. At year end 1999, Schwab also had
outstanding $25 million in fixed-rate subordinated term loans from the Parent
Company maturing in 2001. The outstanding balance of these term loans was also
$25 million at year end 1998.
SCM had a $35 million subordinated lending arrangement maturing in 2001,
which was not used in 1999 or 1998. SCM also had a $25 million short-term credit
facility established in 1999, which was not used at December 31, 1999.
CSE had a (pound)20 million, equivalent to $32 million, subordinated
lending arrangement with the Parent Company. At December 31, 1999, CSE had
outstanding (pound)18 million under these arrangements, equivalent to $29
million, with (pound)5 million maturing in 2001 and (pound)13 million maturing
in 2003. This lending arrangement was (pound)5 million, equivalent to $8
million, at the end of 1998, all of which was outstanding at December 31, 1998.
Interest earned by the Parent Company from these subordinated lending
arrangements totaled $60 million in 1999, $37 million in 1998 and $26 million in
1997.
A-5
<PAGE>
<TABLE>
<CAPTION>
===========================================================================================================================
THE CHARLES SCHWAB CORPORATION
Valuation and Qualifying Accounts
(In thousands)
Additions
Balance at -------------------- Balance
Beginning Charged at End
Description of Year to Expense Other* Written off of Year
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
For the year ended
December 31, 1999:
Allowance for doubtful accounts of brokerage customers $7,575 $15,848 $917 $(12,988) $11,352
===========================================================
For the year ended
December 31, 1998:
Allowance for doubtful accounts of brokerage customers $7,717 $ 4,752 $231 $ (5,125) $ 7,575
===========================================================
For the year ended
December 31, 1997:
Allowance for doubtful accounts of brokerage customers $5,518 $ 3,896 $195 $ (1,892) $ 7,717
===========================================================
This information excludes banking-related valuation and qualifing accounts. See note "4 - Loans to Banking Customers and
Related Allowance for Credit Losses" in the Notes to Consolidated Financial Statements for such banking-related information.
* Represents collections of previously written-off accounts.
A-6
============================================================================================================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
====================================================================================================================================
Quarterly Financial Information (Unaudited) The Charles Schwab Corporation
(In Millions, Except Per Share Data and Ratios)
------------------------------------------------------------------------------------------------------------------------------------
Weighted- Basic Diluted Dividends
Net Average Earnings Earnings Declared Range Range
Expenses Income Common (Loss) (Loss) Per of Common of Price/
Excluding (Loss) Shares - Per Per Common Stock Price Earnings
Revenues (1) Interest (2) Diluted Share (2) Share (2) Share (3) Per Share Ratio (4)
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1999 by Quarter
Fourth $1,274.0 $959.3 $190.5 1,374.2 $ .15 $ .14 $.0094 $31.17 - 17.96 64 - 37
Third stock split $1,015.7 $779.8 $144.2 1,375.7 .11 .11 .0093 37.67 - 21.33 84 - 47
Second $1,116.2 $834.3 $170.5 1,377.0 .13 .12 .0093 51.67 - 26.67 123 - 64
First $1,080.5 $814.1 $161.2 1,365.6 .12 .12 .0093 32.67 - 16.96 88 - 46
------------------------------------------------------------------------------------------------------------------------------------
1998 by Quarter
Fourth dividend increase /
stock split $ 904.7 $703.0 $122.1 1,349.0 $ .10 $ .10 $.0093 $22.83 - 7.03 74 - 23
Third $ 818.9 $630.4 $113.7 1,339.2 .08 .08 .0089 10.22 - 6.17 38 - 23
Second $ 745.9 $594.9 $ 91.6 1,337.9 .08 .07 .0089 8.89 - 6.58 36 - 26
First $ 708.4 $572.0 $ 82.7 1,345.5 .06 .06 .0089 9.32 - 7.58 39 - 32
------------------------------------------------------------------------------------------------------------------------------------
1997 by Quarter (5)
Fourth dividend increase $ 720.8 $594.2 $ 76.7 1,345.9 $ .06 $ .06 $.0089 $ 9.83 - 6.50 41 - 27
Third stock split $ 705.8 $557.5 $ 89.6 1,339.4 .07 .06 .0074 8.13 - 5.93 34 - 25
Second $ 620.8 $494.6 $ 76.4 1,333.3 .06 .06 .0074 6.35 - 4.50 28 - 20
First $ 624.2 $494.3 $ 78.6 1,332.4 .06 .06 .0074 6.22 - 4.50 27 - 20
------------------------------------------------------------------------------------------------------------------------------------
1996 by Quarter
Fourth $ 566.5 $448.9 $ 70.9 1,324.5 $ .06 $ .06 $.0074 $ 4.87 - 3.33 23 - 16
Third dividend increase $ 511.7 $397.7 $ 67.3 1,321.2 .05 .05 .0074 3.98 - 2.94 21 - 15
Second $ 571.2 $435.6 $ 80.0 1,318.9 .07 .06 .0060 3.93 - 3.24 33 - 27
First $ 524.2 $428.1 $ 56.5 1,315.5 .04 .04 .0059 4.06 - 2.76 45 - 31
------------------------------------------------------------------------------------------------------------------------------------
1995 by Quarter (6)
Fourth $ 468.8 $390.2 $ 51.8 1,322.0 $ .04 $ .04 $.0059 $ 3.95 - 2.46 44 - 27
Third dividend increase /
stock split $ 488.5 $543.4 $(26.5) 1,312.5 (.02) (.02) .0059 4.30 - 3.07 72 - 51
Second $ 446.5 $364.3 $ 49.8 1,308.9 .04 .03 .0045 3.39 - 2.19 28 - 18
First dividend increase /
stock split $ 400.9 $323.1 $ 47.0 1,294.6 .04 .04 .0044 2.44 - 1.63 20 - 14
------------------------------------------------------------------------------------------------------------------------------------
All periods have been restated to reflect the merger of The Charles Schwab Corporation (CSC) with U.S. Trust Corporation (U.S.
Trust). Additionally, all share and per share data have been restated for the May 2000 three-for-two common stock split.
(1) Revenues are presented net of interest expense.
(2) 1999 reflects an accounting change, which increased net income by $41 million ($.03 per share for both basic and diluted
earnings per share), for certain internal-use software development costs to conform with Statement of Position 98-1.
(3) Dividends declared per common share represent dividends declared by CSC prior to its merger with U.S. Trust.
(4) Price/earnings ratio is computed by dividing the high and low market prices by diluted earnings per share for the 12-month
period ended on the last day of the quarter presented.
(5) 1997 includes charges for a litigation settlement of $23.6 million after-tax ($.02 per share for both basic and diluted
earnings per share).
(6) 1995 includes U.S. Trust's restructuring charges of $87 million after-tax ($.07 per share for both basic and diluted earnings
per share).
</TABLE>
A-7
<PAGE>
The Charles Schwab Corporation
U.S. Trust Corporation Supplemental Financial Data (Unaudited)
The following supplemental financial data is presented in accordance with
the Securities Exchange Act of 1934, Industry Guide 3 - Statistical Disclosure
by Bank Holding Companies. The accompanying unaudited financial information only
includes U.S. Trust Corporation, a subsidiary of The Charles Schwab Corporation,
which is an investment management firm that also provides fiduciary and private
banking services.
--------------------------------------------------------------------------------
1. Analysis of Change in Net Interest Revenue
An analysis of the year-to-year changes in the categories of interest revenue
and interest expense resulting from changes in volume and rate, on a taxable
equivalent basis, is as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
1999 Compared to 1998 1998 Compared to 1997
Increase (Decrease) Due to Increase (Decrease) Due to
Change in: Change in:
------------------------------- -----------------------------
Average Average Average Average
(Dollars in Thousands) Balance Rate Total Balance Rate Total
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Cash equivalents $ 335 $ (938) $ (603) $ 5,636 $ (193) $ 5,443
Loans to banking customers(1)(2) 32,659 (7,638) 25,021 18,074 (2,014) 16,060
Securities available for sale(3)
U.S. treasury securities (9,329) (342) (9,671) (7,285) 615 (6,670)
U.S. government sponsored agencies and corporations 8,160 (1,390) 6,770 (1,703) (1,702) (3,405)
State and municipal obligations 1,805 (535) 1,270 765 (1,040) (275)
Collateralized mortgage obligations (277) (62) (339) (431) 18 (413)
Other securities 260 (19) 241 (67) (80) (147)
------------------------------------------------------------------------
Total securities available for sale 619 (2,348) (1,729) (8,721) (2,189) (10,910)
------------------------------------------------------------------------
Other interest-earning assets 195 72 267 858 240 1,098
------------------------------------------------------------------------
Total interest-earning assets 33,808 (10,852) 22,956 15,847 (4,156) 11,691
------------------------------------------------------------------------
Interest-bearing sources of funds:
Interest-bearing deposits from banking customers 19,643 (10,000) 9,643 13,371 (5,148) 8,223
Short-term borrowings (1,083) (474) (1,557) (6,195) (764) (6,959)
Long-term debt (332) (55) (387) (41) 32 (9)
------------------------------------------------------------------------
Total sources on which interest is paid 18,228 (10,529) 7,699 7,135 (5,880) 1,255
------------------------------------------------------------------------
Change in net interest revenue-taxable equivalent basis $15,580 $ (323) $15,257 $ 8,712 $ 1,724 $10,436
======= ========= ======= =======
Tax equivalent adjustment (770) 531
-------- --------
Change in net interest revenue $14,487 $10,967
======== ========
------------------------------------------------------------------------------------------------------------------------------------
Changes that are not due solely to volume or rate have been allocated ratably to their respective categories.
(1) The average principal balances of non-accrual and reduced rate loans are included in the above figures.
(2) Loans include the loan to the U.S. Trust Corporation ESOP, which was paid off in the first quarter of 1999, and had an average
balance of $4 million in 1998 and $8 million in 1997.
(3) The average balance and average rate for securities available for sale have been calculated using their amortized cost.
</TABLE>
A-8
<PAGE>
2. Three-Year Net Interest Revenue (Tax Equivalent Basis) and Average Balances
<TABLE>
------------------------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1999 1998 1997
------------------------------ ------------------------------ ------------------------------
Average Average Average Average Average Average
(Dollars in Thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets
Cash equivalents $ 274,405 $ 13,569 4.94% $ 268,074 $ 14,172 5.29% $ 162,923 $ 8,729 5.36%
Securities available for sale (1)(2) 996,534 60,746 6.10% 994,680 62,475 6.28% 1,138,256 73,305 6.44%
Loans to banking customers (3)(4) 2,404,082 174,514 7.26% 1,973,027 149,493 7.58% 1,737,652 133,433 7.68%
Other interest-earning assets 23,691 1,771 7.48% 20,971 1,504 7.17% 7,585 486 6.41%
---------------------- ----- --------------------- ----- --------------------- -----
Total interest-earning assets 3,698,712 250,600 6.78% 3,256,752 227,644 6.99% 3,046,416 215,953 7.09%
---------------------- ----- --------------------- ----- --------------------- -----
Non-interest-earning assets 484,240 414,516 390,678
---------- ---------- ----------
Total assets $4,182,952 $3,671,268 $3,437,094
========== ========== ==========
Liabilities and Stockholders' Equity
Interest-bearing deposits from
banking customers 2,779,141 117,489 4.23% 2,350,945 107,846 4.59% 2,072,750 99,623 4.81%
Short-term borrowings 146,523 7,198 4.91% 168,156 8,755 5.21% 286,451 15,714 5.49%
Long-term debt 63,430 5,129 8.09% 68,396 5,516 8.06% 69,754 5,525 7.92%
---------------------- ----- --------------------- ----- --------------------- -----
Total sources on which interest
is paid 2,989,094 129,816 4.34% 2,587,497 122,117 4.72% 2,428,955 120,862 4.98%
---------------------- ----- --------------------- ----- --------------------- -----
Non-interest-bearing deposits 641,437 571,928 527,206
Non-interest-bearing liabilities 286,973 272,427 249,128
Stockholders' equity 265,448 239,416 231,805
---------- ---------- ----------
Total liabilities and
stockholders' equity $4,182,952 $3,671,268 $3,437,094
========== ========== ==========
Net interest revenue-taxable
equivalent basis 120,784 105,527 95,091
Net free funds (4) $ 709,618 $ 669,255 $ 617,461
---------- ---------- ----------
Provision for credit losses (600) (750)
Tax equivalent adjustment (2) (3,671) (2,901) (3,432)
--------- --------- ---------
$117,113 $102,026 $ 90,909
========= ========= =========
Net yield on interest earning assets 3.26% 3.24% 3.12%
------------------------------------------------------------------------------------------------------------------------------------
(1) The average balance and average rate for securities available for sale has been calculated using their amortized cost.
(2) Yields on state and municipal obligations are stated on a taxable equivalent basis, employing the Federal statutory income tax
rate adjusted for the effect of state and local taxes, resulting in a marginal tax rate of approximately 47% for 1999, 1998 and
1997.
(3) The average principal balances of non-accrual and reduced rate loans are included in the above figures.
(4) Loans and stockholders' equity include the loan to the U.S. Trust Corporation ESOP, which was paid off in the first quarter of
1999, and had an average balance of $4 million in 1998 and $8 million in 1997.
</TABLE>
A-9
<PAGE>
3. Securities Available for Sale
The amortized cost, estimated fair value and gross unrealized gains and losses
on securities available for sale are as follows (in thousands):
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998 1997
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
U.S. treasury securities:
Amortized cost $ 178,068 $274,553 $ 417,545
Aggregate fair value $ 176,816 $276,562 $ 419,189
Gross unrealized gains $ 24 $ 2,050 $ 1,832
Gross unrealized losses $ 1,276 $ 41 $ 188
U.S. government sponsored agencies and corporations:
Amortized cost 690,450 561,095 508,389
Aggregate fair value 672,103 564,256 512,442
Gross unrealized gains 2,507 5,631 7,047
Gross unrealized losses 20,854 2,470 2,994
State and municipal obligations:
Amortized cost 119,633 98,726 72,650
Aggregate fair value 117,936 100,423 73,658
Gross unrealized gains 185 1,715 1,009
Gross unrealized losses 1,882 18 1
Collateralized mortgage obligations(1):
Amortized cost 5,185 10,076 15,186
Aggregate fair value 5,209 10,128 15,299
Gross unrealized gains 24 53 113
Gross unrealized losses 1
Other securities:
Amortized cost 22,086 17,768 13,971
Aggregate fair value 21,522 18,079 14,157
Gross unrealized gains 370 435 234
Gross unrealized losses 934 124 48
--------------------------------------------------------------------------------------------------------------------------
Total securities available for sale:
Amortized cost $1,015,422 $962,218 $1,027,741
Aggregate fair value $ 993,586 $969,448 $1,034,745
Gross unrealized gains $ 3,110 $ 9,884 $ 10,235
Gross unrealized losses $ 24,946 $ 2,654 $ 3,231
==========================================================================================================================
(1) Collateralized by either GNMA, FNMA or FHLC obligations.
</TABLE>
A-10
<PAGE>
4. Loans to Banking Customers and Related Allowance for Credit Losses
An analysis of the composition of the loan portfolio is as follows (in
thousands):
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998 1997 1996 1995
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Private banking:
Residential real estate mortgages $1,984,732 $1,630,500 $1,358,003 $1,093,107 $ 937,856
Other 663,977 525,614 537,024 525,446 457,843
---------------------------------------------------------------------------------------------------------------------
Total private banking loans 2,648,709 2,156,114 1,895,027 1,618,553 1,395,699
---------------------------------------------------------------------------------------------------------------------
Loans to financial institutions
for purchasing and carrying securities 57,686 31,972 41,064 62,866 61,372
All other 2,979 2,721 2,758 6,722 2,624
---------------------------------------------------------------------------------------------------------------------
Total $2,709,374 $2,190,807 $1,938,849 $1,688,141 $1,459,695
=====================================================================================================================
</TABLE>
An analysis of nonperforming assets is as follows (in thousands):
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998 1997 1996 1995
-----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-accrual loans $1,673 $6,203 $9,666 $ 8,882 $13,285
Other real estate owned, net 534 727 9,586
-----------------------------------------------------------------------------------------------------------------------
Total $1,673 $6,737 $9,666 $ 9,609 $22,871
=======================================================================================================================
Average non-accrual loans $ 832 $8,322 $8,829 $12,261 $ 8,475
=======================================================================================================================
</TABLE>
An analysis of the allowance for credit losses on the loan portfolio is as
follows (in thousands):
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of year $19,414 $18,294 $16,693 $16,086 $14,699
---------------------------------------------------------------------------------------------------------------------
Charge-offs:
Private banking (292) (327) (160) (658) (1,910)
Other (517) (1,520)
---------------------------------------------------------------------------------------------------------------------
Total charge-offs (292) (327) (160) (1,175) (3,430)
---------------------------------------------------------------------------------------------------------------------
Recoveries:
Private banking 1,047 800 684 702 2,844
Other 47 327 80 373
---------------------------------------------------------------------------------------------------------------------
Total recoveries 1,047 847 1,011 782 3,217
---------------------------------------------------------------------------------------------------------------------
Net (charge-offs) recoveries 755 520 851 (393) (213)
Provision charged to income 600 750 1,000 1,600
---------------------------------------------------------------------------------------------------------------------
Balance at end of year $20,169 $19,414 $18,294 $16,693 $16,086
=====================================================================================================================
</TABLE>
A-11
<PAGE>
The maturities of the loan portfolio is as follows:
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------
Within 1-5 Over
(Dollars in Thousands) 1 Year Years 5 Years Total
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Maturity schedule of loans at December 31, 1999:
Private banking:
Residential real estate mortgages (1) $ 89,892 $161,262 $1,733,578 $1,984,732
Other 607,678 32,801 23,498 663,977
--------- -------- ---------- ----------
Total private banking loans 697,570 194,063 1,757,076 2,648,709
--------- -------- ---------- ----------
Loans to financial institutions for purchasing and
carrying securities 57,686 57,686
All other 158 525 2,296 2,979
--------- -------- ---------- ----------
Total $755,414 $194,588 $1,759,372 $2,709,374
========= ======== ========== ==========
Interest sensitivity of loans at December 31, 1999:
Loans with predetermined interest rates $158,489 $1,095,097 $1,253,586
Loans with floating or adjustable interest rates 36,099 664,275 700,374
-------- ---------- ----------
Total $194,588 $1,759,372 $1,953,960
======== ========== ==========
--------------------------------------------------------------------------------------------------------------------------
(1) Maturities are based upon the contractual terms of the loans.
</TABLE>
5. Summary of Credit Loss on Banking Loans Experience
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands) 1999 1998 1997 1996 1995
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Average loans $2,404,082 $1,968,978 $1,730,134 $1,511,527 $1,354,975
Allowance to period end loans .74% .89% .94% .99% 1.10%
Allowance to nonperforming loans N/M 312.98% 189.26% 187.94% 121.08%
Net (charge-offs) recoveries to average loans .02% .03% .05% (.03)% (.02)%
Nonperforming assets to average
loans and real estate owned .07% .34% .56% .64% 1.68%
-------------------------------------------------------------------------------------------------------------------------
N/M - Not meaningful, greater than one thousand percent
At December 31, 1999, the loan portfolio included loans to individuals involved
in the financial services industry of approximately $733 million. Recoveries
exceeded charge-offs from loans to individuals involved in the financial
services industry in 1997 through 1999. Net charge-offs from loans to
individuals involved in the financial services industry amounted to $471,000 in
1996 and $353,000 in 1995. Such net charge-offs as a percentage of average total
loans amounted to three basis points in both 1996 and 1995.
</TABLE>
6. Deposits from Banking Customers
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
1999 1998 1997
------------------- ------------------- -----------------
(Dollars in Millions) Amount Rate Amount Rate Amount Rate
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Analysis of average daily deposits:
Noninterest-bearing deposits $ 642 $ 572 $ 527
Certificates of deposits of $100,000 or more 69 4.62% 56 5.00% 66 5.08%
Money market and other savings deposits 2,710 4.22% 2,295 4.58% 2,007 4.80%
------ ------ ------
Total deposits $3,421 $2,923 $2,600
====== ====== ======
------------------------------------------------------------------------------------------------------------------
</TABLE>
A-12
<PAGE>
----------------------------------------------------------------------------
Certificates Other
(Dollars in Millions) of Deposit Deposits
----------------------------------------------------------------------------
Maturity distribution of interest bearing
deposits in amounts of $100,000 or
more at December 31, 1999:
Three months or less $45 $2,258
Three through six months 9
Six through twelve months 7
Over twelve months 1
--- ------
Total $62 $2,258
=== ======
----------------------------------------------------------------------------
7. Short-Term Borrowings
An analysis of outstanding short-term borrowings is as follows (in thousands):
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
December 31, 1999 1998 1997
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal funds purchased:
Year-end balance $ 14,630 $ 30,250 $ 10,175
Daily average balance 51,830 45,271 63,965
Maximum month-end balance 127,690 34,075 194,765
Weighted-average interest rate during the year 4.96% 5.37% 5.48%
Weighted-average interest rate at year end 4.50% 4.75% 6.65%
----------------------------------------------------------------------------------------------------------------
Securities sold under agreements to repurchase:
Year-end balance $ 64,429 $ 90,309 $169,413
Daily average balance 79,306 116,740 108,007
Maximum month-end balance 104,164 148,185 177,851
Weighted-average interest rate during the year 4.76% 5.11% 5.29%
Weighted-average interest rate at year end 4.50% 4.86% 5.87%
--------------------------------------------------------------------------------------------------------------
Other borrowed funds:
Year-end balance $ 62,098 $ 20,366
Daily average balance 15,388 6,145 $114,479
Maximum month-end balance 62,098 50,066 163,086
Weighted-average interest rate during the year 5.72% 5.94% 5.68%
Weighted-average interest rate at year end 6.62% 5.98%
----------------------------------------------------------------------------------------------------------------
</TABLE>
8. Ratios
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 1999 1998 1997 1996 1995
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Return on average stockholders' equity 29.22% 26.20% 22.75% 20.99% (23.10)%
Return on average total assets 1.85% 1.68% 1.49% 1.42% (1.52)%
Average stockholders' equity as a percentage of
average total assets 6.35% 6.42% 6.54% 6.76% 6.60%
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
A-13
