<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to __________.
COMMISSION FILE NUMBER 1-7367
PAINE WEBBER GROUP INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-2760086
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 713-2000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [_]
On October 30, 2000 the Registrant had outstanding 163,223,418 shares of common
stock of $1 par value.
<PAGE> 2
PAINE WEBBER GROUP INC.
FORM 10-Q
SEPTEMBER 30, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page
--------------------- ----
<S> <C> <C>
Item 1. Financial Statements.
Condensed Consolidated Statements of Income
(unaudited) for the Three and Nine Months Ended
September 30, 2000 and 1999. 2
Condensed Consolidated Statements of Financial
Condition (unaudited) at September 30, 2000
and December 31, 1999. 3
Condensed Consolidated Statements of Cash Flows
(unaudited) for the Nine Months Ended
September 30, 2000 and 1999. 4
Notes to Condensed Consolidated Financial Statements
(unaudited). 5-13
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations. 14-20
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings. 21
Item 6. Exhibits and Reports on Form 8-K. 21
Signature. 22
</TABLE>
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PAINE WEBBER GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands of dollars except share and per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES
Commissions $ 528,948 $ 451,341 $ 1,765,630 $ 1,419,092
Principal transactions 287,931 235,914 778,648 829,968
Asset management 314,083 235,712 893,076 666,250
Investment banking 107,502 134,235 385,329 420,321
Interest 1,167,415 762,205 3,223,170 2,289,636
Other 39,367 40,785 120,940 129,213
---------- ---------- ----------- -----------
Total revenues 2,445,246 1,860,192 7,166,793 5,754,480
Interest expense 1,002,567 623,025 2,715,837 1,854,515
---------- ---------- ----------- -----------
Net revenues 1,442,679 1,237,167 4,450,956 3,899,965
---------- ---------- ----------- -----------
NON-INTEREST EXPENSES
Compensation and benefits 875,012 711,783 2,664,401 2,260,575
Office and equipment 111,933 89,159 308,220 259,941
Communications 49,408 42,331 140,338 127,179
Business development 34,172 30,861 114,849 83,262
Brokerage, clearing & exchange fees 16,203 23,391 63,806 71,268
Professional services 42,215 33,469 142,096 96,318
Other 93,536 80,188 294,757 240,751
---------- ---------- ----------- -----------
Total non-interest expenses 1,222,479 1,011,182 3,728,467 3,139,294
---------- ---------- ----------- -----------
INCOME BEFORE TAXES AND MINORITY INTEREST 220,200 225,985 722,489 760,671
Provision for income taxes 76,370 79,722 258,682 274,183
---------- ---------- ----------- -----------
INCOME BEFORE MINORITY INTEREST 143,830 146,263 463,807 486,488
Minority interest 8,061 8,061 24,183 24,183
---------- ---------- ----------- -----------
NET INCOME $ 135,769 $ 138,202 $ 439,624 $ 462,305
========== ========== =========== ===========
Net income applicable to common shares $ 135,769 $ 132,253 $ 439,624 $ 444,458
========== ========== =========== ===========
Earnings per common share:
Basic $ 0.92 $ 0.91 $ 3.01 $ 3.05
Diluted $ 0.85 $ 0.86 $ 2.83 $ 2.88
Weighted-average common shares:
Basic 148,019,200 145,633,697 146,143,267 145,583,134
Diluted 159,911,113 153,857,503 155,100,328 154,106,985
Dividends declared per common share $ 0.12 $ 0.11 $ 0.36 $ 0.33
</TABLE>
See notes to condensed consolidated financial statements.
2
<PAGE> 4
PAINE WEBBER GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
(In thousands of dollars except share and per share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 214,593 $ 176,401
Cash and securities segregated and on deposit for
federal and other regulations 1,426,661 823,059
Financial instruments owned 23,793,940 21,144,830
Securities received as collateral 894,448 1,079,976
Securities purchased under agreements to resell 15,678,483 15,923,948
Securities borrowed 10,260,714 10,526,638
Receivables, net of allowance for doubtful accounts of
$18,903 and $30,039 at September 30, 2000 and
December 31, 1999, respectively 12,367,901 10,287,937
Office equipment and leasehold improvements, net of accumulated
depreciation and amortization of $622,888 and $527,718 at
September 30, 2000 and December 31, 1999, respectively 823,326 579,819
Other assets 1,988,201 1,069,768
------------ ------------
$ 67,448,267 $ 61,612,376
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings $ 1,810,822 $ 1,884,250
Financial instruments sold, not yet purchased 3,467,766 7,099,208
Securities sold under agreements to repurchase 29,377,087 25,740,196
Securities loaned 6,419,531 5,661,200
Obligation to return securities received as collateral 894,448 1,079,976
Payables 13,514,944 8,448,217
Other liabilities and accrued expenses 3,233,534 3,164,496
Long-term borrowings 4,943,484 5,223,826
------------ ------------
63,661,616 58,301,369
------------ ------------
Commitments and contingencies
Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary
Trusts holding solely Company Guaranteed Related Subordinated Debt 393,750 393,750
Stockholders' Equity:
Common stock, $1 par value, 400,000,000 shares authorized, issued
197,727,238 shares and 193,145,152 shares at
September 30, 2000 and December 31, 1999, respectively 197,727 193,145
Additional paid-in capital 1,833,623 1,672,085
Retained earnings 2,557,928 2,171,080
Treasury stock, at cost; 48,752,322 shares and 47,557,064 shares at
September 30, 2000 and December 31, 1999, respectively (1,186,605) (1,113,736)
Accumulated other comprehensive income (9,772) (5,317)
------------ ------------
3,392,901 2,917,257
------------ ------------
$ 67,448,267 $ 61,612,376
============ ============
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE> 5
PAINE WEBBER GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands of dollars)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------------
2000 1999
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 439,624 $ 462,305
Adjustments to reconcile net income to cash provided by
(used for) operating activities:
Noncash items included in net income:
Depreciation and amortization 105,370 73,035
Deferred income taxes 2,138 (45,757)
Amortization of deferred charges 99,584 81,708
Stock-based compensation (5,116) 12,680
(Increase) decrease in operating assets:
Cash and securities on deposit (603,325) (87,157)
Financial instruments owned (2,366,989) (1,582,711)
Securities purchased under agreements to resell 245,465 1,405,018
Securities borrowed 491,110 (651,622)
Receivables (1,180,787) (1,548,063)
Other assets (360,248) (282,626)
Increase (decrease) in operating liabilities:
Financial instruments sold, not yet purchased (3,631,443) 445,507
Securities sold under agreements to repurchase 3,636,891 2,227,316
Securities loaned 490,408 199,468
Payables 4,236,051 (1,249,085)
Other (168,013) 134,438
----------- -----------
Cash provided by (used for) operating activities 1,430,720 (405,546)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for:
Net assets acquired in business acquisition (621,667) --
Office equipment and leasehold improvements (306,217) (179,731)
----------- -----------
Cash used for investing activities (927,884) (179,731)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from (payments on) short-term borrowings (107,630) 10,483
Proceeds from:
Long-term borrowings 471,761 1,010,984
Employee stock transactions 130,917 72,410
Payments for:
Long-term borrowings (792,150) (300,575)
Repurchases of common stock (114,767) (151,446)
Dividends (52,775) (65,373)
----------- -----------
Cash (used for) provided by financing activities (464,644) 576,483
----------- -----------
Increase (decrease) in cash and cash equivalents 38,192 (8,794)
Cash and cash equivalents, beginning of period 176,401 228,359
----------- -----------
Cash and cash equivalents, end of period $ 214,593 $ 219,565
=========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE> 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The condensed consolidated financial statements include the accounts of Paine
Webber Group Inc. ("PWG") and its wholly owned subsidiaries, including its
principal subsidiary PaineWebber Incorporated ("PWI") (collectively, the
"Company"). All material intercompany balances and transactions have been
eliminated. Certain reclassifications have been made to prior year amounts to
conform to current year presentations. The December 31, 1999 Condensed
Consolidated Statement of Financial Condition was derived from the audited
consolidated financial statements of the Company. The financial information as
of and for the periods ended September 30, 2000 and 1999 is unaudited. All
normal recurring adjustments which, in the opinion of management, are necessary
for a fair presentation have been made.
Certain financial information that is normally in annual financial statements
but is not required for interim reporting purposes has been condensed or
omitted. The condensed consolidated financial statements are prepared in
conformity with accounting principles generally accepted in the United States
which require management to make estimates and assumptions that affect the
amounts reported in the condensed consolidated financial statements and
accompanying notes. Actual results could differ from those estimates. These
financial statements should be read in conjunction with the Company's Annual
Report on Form 10-K for the year ended December 31, 1999 and the Company's
Quarterly Reports on Form 10-Q for the quarters ended June 30, and March 31,
2000. The results of operations reported for interim periods are not necessarily
indicative of the results of operations for the entire year.
Statement of Cash Flows
Total interest payments, which relate principally to agreements to repurchase,
short-term borrowings, securities loaned and long-term borrowings, were
$2,782,961 and $1,834,039 for the nine months ended September 30, 2000 and 1999,
respectively. Income taxes paid were $232,558 and $268,289 for the nine months
ended September 30, 2000 and 1999, respectively.
Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes revised accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity measure all derivative instruments at fair value and
recognize such instruments as either assets or liabilities in the consolidated
statements of financial condition. The accounting for changes in the fair value
of a derivative instrument will depend on the intended use of the derivative as
either a fair value hedge, a cash flow hedge or a foreign currency hedge. The
effect of the changes in fair value of the derivatives and, in certain cases,
the hedged items are to be reflected in either the consolidated statements of
income or as a component of other comprehensive income, based upon the resulting
designation. As issued, SFAS No. 133 was effective for fiscal years beginning
after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date of
FASB Statement No. 133." SFAS No. 137 defers the effective date of SFAS No. 133
for one year to fiscal years beginning after June 15, 2000. In June 2000, the
FASB issued Statement No. 138, "Accounting for Certain Derivative Instruments
and Certain Hedging Activities--an Amendment to FASB Statement No. 133". The
Company expects that the adoption of these statements will not have a material
effect on the Company's Consolidated Financial Statements, taken as a whole.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," which
replaces SFAS No. 125, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities". SFAS No. 140 revises the standards
for accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures, but carries over most of the
provisions of SFAS No. 125. SFAS No. 140 is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001 and is effective for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. The Company has not
yet determined the impact of this statement on the Company's Consolidated
Financial Statements, taken as a whole.
5
<PAGE> 7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2: RECENT EVENTS
On October 23, 2000, the stockholders of PWG adopted the Agreement and Plan of
Merger (the "Merger Agreement"), dated as of July 12, 2000, by and among PWG,
UBS AG ("UBS") and a subsidiary of UBS, pursuant to which PWG will merge with
and into that subsidiary. Under the terms of the agreement, PWG's stockholders
will have the right to elect to receive either $73.50 in cash or 0.4954 of an
ordinary share of UBS AG stock for each share of PWG's common stock, $1 par
value ("common stock") that they own. The percentage of PWG's common stock that
will be converted into the right to receive UBS AG stock is fixed at 50 percent.
Adjustments to elections may therefore be necessary so that, in the aggregate,
50 percent of the shares of PWG's common stock is converted into the right to
receive UBS AG stock, and 50 percent is converted into the right to receive
cash. The transaction, which is expected to be completed in November of 2000, is
subject to customary closing conditions, including certain regulatory approvals.
NOTE 3: MERGER WITH J.C. BRADFORD
On June 9, 2000, the Company completed its merger with J.C. Bradford & Co.
L.L.C. ("J.C. Bradford"), a leading privately-held brokerage firm in the
Southeastern U.S., for approximately $622,000 in cash. The merger was accounted
for as a purchase and, accordingly, the excess of the purchase cost over the
fair value of the net assets acquired of approximately $185,000, resulted in the
Company recording $560,000 in goodwill, which is being amortized over 25 years
on a straight-line basis. The consolidated financial statements of the Company
include the results of J.C. Bradford from the closing date. As a result of the
merger, in the second quarter of 2000, the Company recorded after-tax costs of
approximately $18,800 ($30,000 pre-tax) relating primarily to the elimination of
the Company's duplicate facilities, severance and other costs.
NOTE 4: FINANCIAL INSTRUMENTS OWNED AND SOLD, NOT YET PURCHASED
At September 30, 2000 and December 31, 1999, financial instruments owned and
financial instruments sold, not yet purchased consisted of the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- -------------
<S> <C> <C>
Financial instruments owned:
U.S. government and agencies $ 7,724,521 $ 5,864,331
Mortgages and mortgage-backed 10,426,454 9,012,415
Corporate debt 671,925 1,875,361
Commercial paper and other short-term debt 1,890,638 1,744,036
Equities and other 2,363,490 2,030,986
State and municipals 716,912 617,701
------------- -------------
$ 23,793,940 $ 21,144,830
============= =============
Financial instruments sold, not yet purchased:
U.S. government and agencies $ 2,768,820 $ 5,804,259
Mortgages and mortgage-backed 145,255 123,049
Corporate debt 283,084 785,890
Equities 257,343 348,485
State and municipals 13,264 37,525
------------- -------------
$ 3,467,766 $ 7,099,208
============= =============
</TABLE>
NOTE 5: LONG-TERM BORROWINGS
Long-term borrowings at September 30, 2000 and December 31, 1999 consisted of
the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- -------------
<S> <C> <C>
U.S. Dollar-Denominated:
Fixed Rate Notes $ 2,607,009 $ 2,757,851
Fixed Rate Subordinated Notes 174,831 174,765
Medium-Term Senior Notes 1,950,850 2,143,010
Medium-Term Subordinated Notes 84,200 148,200
Other 10,044 -
Non-U.S. Dollar-Denominated:
Medium-Term Notes 116,550 -
------------- -------------
$ 4,943,484 $ 5,223,826
============= =============
</TABLE>
6
<PAGE> 8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At September 30, 2000, interest rates on the U.S. dollar-denominated fixed rate
notes and fixed rate subordinated notes ranged from 6.25 percent to 9.25 percent
and the weighted-average interest rate was 7.19 percent. Interest on the notes
is payable semi-annually. The fixed rate notes and fixed rate subordinated notes
outstanding at September 30, 2000 had an average maturity of 5.3 years.
At September 30, 2000, the Company had outstanding U.S. dollar-denominated fixed
rate Medium-Term Notes of $1,071,100 and variable rate Medium-Term Notes of
$963,950. The Medium-Term Notes outstanding at September 30, 2000 had an average
maturity of 4.2 years and a weighted-average interest rate of 5.97 percent.
At September 30, 2000, the Non-U.S. dollar-denominated Medium-Term Notes
outstanding had a weighted-average interest rate of 1.18 percent and an average
maturity of 2.16 years.
In 2000, the Company issued to certain employees, 6.25% Convertible Debentures
due 2007 (the "Debentures"). The Debentures were initially convertible, at the
option of the holders beginning on January 20, 2003, into 1,931,250 shares of
Convertible Preferred Stock, which were then convertible into 1,931,250 shares
of common stock of the Company.
As a result of the Company entering into the Merger Agreement, the Debentures
became convertible effective upon the adoption by the stockholders of the
Company of the Merger Agreement, which occurred on October 23, 2000. Pursuant
to their terms, on October 16, 2000, the Company called for redemption on
October 23, 2000 all of the outstanding Debentures. All outstanding Debentures
were converted into common stock.
At September 30, 2000 and December 31, 1999, the fair values of long-term
borrowings were $4,924,528 and $5,140,331, respectively, as compared to the
carrying amounts of $4,943,484 and $5,223,826, respectively. The estimated fair
value of long-term borrowings is based upon quoted market prices for the same or
similar issues and pricing models. However, for substantially all of its fixed
rate debt, the Company enters into interest rate swap agreements to convert its
fixed rate payments into floating rate payments.
The net fair values of the interest rate swaps were $61,739 and $127,097 payable
at September 30, 2000 and December 31, 1999, respectively. The fair value of
interest rate swaps used to hedge the Company's long-term borrowings is based
upon the amounts the Company would receive or pay to terminate the agreements,
taking into account current interest rates.
The carrying amounts of the interest rate swap agreements included in the
Company's Condensed Consolidated Statements of Financial Condition at September
30, 2000 and December 31, 1999 were net receivables of $4,780 and $12,075,
respectively. See Note 7 for further discussion of interest rate swap agreements
used for hedging purposes.
NOTE 6: CAPITAL REQUIREMENTS
PWI, a registered broker-dealer, is subject to the Securities and Exchange
Commission Uniform Net Capital Rule and New York Stock Exchange Growth and
Business Reduction capital requirements. Under the method of computing capital
requirements adopted by PWI, minimum net capital shall not be less than 2
percent of combined aggregate debit items arising from client transactions, plus
excess margin collected on securities purchased under agreements to resell, as
defined. A reduction of business is required if net capital is less than 4
percent of such aggregate debit items. Business may not be expanded if net
capital is less than 5 percent of such aggregate debit items. As of September
30, 2000, PWI's net capital of $1,608,364 was 10.1 percent of aggregate debit
items and its net capital in excess of the minimum required was $1,281,410.
7
<PAGE> 9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7: FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
Held or Issued for Trading Purposes
Set forth below are the gross contract or notional amounts of the Company's
outstanding off-balance-sheet derivative and other financial instruments held or
issued for trading purposes. These amounts are not reflected in the Condensed
Consolidated Statements of Financial Condition and are indicative only of the
volume of activity at September 30, 2000 and December 31, 1999. They do not
represent amounts subject to market risks, and in many cases, limit the
Company's overall exposure to market losses by hedging other on- and
off-balance-sheet transactions.
<TABLE>
<CAPTION>
Notional or Contract Amount
------------------------------------------------------------------------
September 30, 2000 December 31, 1999
--------------------------------- ---------------------------------
Purchases Sales Purchases Sales
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Mortgage-backed forward contracts
and options written and purchased $18,963,831 $26,909,451 $14,417,186 $17,540,786
Foreign currency forward contracts,
futures contracts, and options
written and purchased 2,119,724 2,133,310 1,380,925 1,373,981
Equity securities contracts including
stock index futures, forwards, and
options written and purchased 184,066 271,879 144,034 239,682
Other fixed income securities contracts
including futures, forwards, and options
written and purchased 1,742,936 4,252,001 3,557,193 5,538,887
Interest rate swaps and caps 1,850,008 3,643,008 1,688,762 419,989
</TABLE>
Set forth below are the fair values of derivative financial instruments held or
issued for trading purposes as of September 30, 2000 and December 31, 1999. The
fair value amounts are netted by counterparty when specific conditions are met.
<TABLE>
<CAPTION>
Fair Value at Fair Value at
September 30, 2000 December 31, 1999
--------------------------------- ---------------------------------
Assets Liabilities Assets Liabilities
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Mortgage-backed forward contracts and
options written and purchased $88,571 $105,027 $159,228 $114,838
Foreign currency forward contracts,
futures contracts, and options
written and purchased 20,304 17,001 20,274 20,158
Equity securities contracts including
stock index futures, forwards, and
options written and purchased 16,074 16,246 152,024 48,835
Other fixed income securities contracts
including futures, forwards, and options
written and purchased 2,100 378 29,584 20,177
Interest rate swaps and caps 20,022 46,841 31,569 11,087
</TABLE>
8
<PAGE> 10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Set forth below are the average fair values of derivative financial instruments
held or issued for trading purposes for the three months ended September 30,
2000 and the twelve months ended December 31, 1999. The average fair value is
based on the average of the month-end balances during the periods indicated.
<TABLE>
<CAPTION>
Average Fair Value Average Fair Value
September 30, 2000 December 31, 1999
--------------------------------- ---------------------------------
Assets Liabilities Assets Liabilities
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Mortgage-backed forward contracts and
options written and purchased $65,054 $69,284 $171,113 $163,954
Foreign currency forward contracts,
futures contracts, and options
written and purchased 25,445 25,016 22,549 22,377
Equity securities contracts including
stock index futures, forwards, and
options written and purchased 60,256 19,098 63,624 40,321
Other fixed income securities contracts
including futures, forwards, and options
written and purchased 3,686 23 11,932 49,800
Interest rate swaps and caps 19,871 43,877 18,593 6,754
</TABLE>
The Company also sells securities, at predetermined prices, which have not yet
been purchased. The Company is exposed to market risk since to satisfy the
obligation, the Company must acquire the securities at market prices, which may
exceed the values reflected on the Condensed Consolidated Statements of
Financial Condition.
The off-balance-sheet derivative trading transactions are generally short-term.
At September 30, 2000 substantially all of the off-balance-sheet trading-related
derivative and other financial instruments had remaining maturities of less than
one year.
The Company's risk of loss in the event of counterparty default is limited to
the current fair value or the replacement cost on contracts in which the Company
has recorded an unrealized gain. These amounts are reflected as assets on the
Company's Condensed Consolidated Statements of Financial Condition and amounted
to $147,071 and $392,679 at September 30, 2000 and December 31, 1999,
respectively. Options written do not expose the Company to credit risk since
they do not obligate the counterparty to perform. Transactions in futures
contracts are conducted through regulated exchanges which have margin
requirements, and are settled in cash on a daily basis, thereby minimizing
credit risk.
The following table summarizes the Company's principal transactions revenues by
business activity for the three months and nine months ended September 30, 2000
and 1999. Principal transactions revenues include realized and unrealized gains
and losses on trading positions and principal investing activities, including
hedges. In assessing the profitability of its trading activities, the Company
views net interest and principal transactions revenues in the aggregate.
<TABLE>
<CAPTION>
Principal Transactions Revenues
----------------------------------------------------
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------- ----------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Taxable fixed income (includes futures, forwards,
options contracts and other securities) $ 64,685 $ 72,228 $184,357 $404,278
Equities (includes stock index futures, forwards and options contracts) 179,232 119,968 458,037 312,299
Municipals (includes futures and options contracts) 44,014 43,718 136,254 113,391
-------- -------- -------- --------
$287,931 $235,914 $778,648 $829,968
======== ======== ======== ========
</TABLE>
9
<PAGE> 11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Held or Issued for Purposes Other Than Trading
The Company enters into interest rate swap agreements to manage the interest
rate characteristics of its assets and liabilities. As of September 30, 2000 and
December 31, 1999, the Company had outstanding interest rate swap agreements
with commercial banks with notional amounts of $3,706,010 and $4,206,010,
respectively. These agreements effectively converted substantially all of the
Company's fixed rate debt at September 30, 2000 into floating rate debt. The
interest rate swap agreements entered into have had the effect of increasing net
interest expense on the Company's fixed rate debt by $7,737 for the nine months
ended September 30, 2000, and decreasing net interest expense by $20,370 for the
nine months ended September 30, 1999. The Company had no deferred gains or
losses related to terminated swap agreements on the Company's long-term
borrowings at September 30, 2000 and December 31, 1999. The Company is subject
to market risk as interest rates fluctuate. The interest rate swaps contain
credit risk to the extent the Company is in a receivable or gain position and
the counterparty defaults. However, the counterparties to the agreements
generally are large financial institutions, and the Company has not experienced
defaults in the past, and management does not anticipate any counterparty
defaults in the foreseeable future. See Note 5 for further discussion of
interest rate swap agreements used for hedging purposes.
NOTE 8: RISK MANAGEMENT
Transactions involving derivative and non-derivative financial instruments
involve varying degrees of both market and credit risk. The Company monitors its
exposure to market and credit risk on a daily basis and through a variety of
financial, security position and credit exposure reporting and control
procedures.
Market Risk
Market risk is the potential change in value of the financial instrument caused
by unfavorable changes in interest rates, equity prices, and foreign currency
exchange rates. The Company has a variety of methods to monitor its market risk
profile. The senior management of each business group is responsible for
reviewing trading positions, exposures, profits and losses, and trading
strategies. The Company also has an independent risk management group which
reviews the Company's risk profile and aids in setting and monitoring risk
management policies of the Company, including monitoring adherence to the
established limits, performing market risk modeling, and reviewing trading
positions and hedging strategies. The Asset/Liability Management Committee,
comprised of senior corporate and business group managers, is responsible for
establishing trading position and exposure limits.
Market risk modeling is based on estimating loss exposure through sensitivity
testing. These results are compared to established limits, and exceptions are
subject to review and approval by senior management. Other market risk control
procedures include monitoring inventory agings, reviewing traders' marks and
holding regular meetings between the senior management of the business groups
and the risk management group.
Credit Risk in Proprietary Transactions
Counterparties to the Company's proprietary trading, hedging, financing and
arbitrage activities are primarily financial institutions, including banks,
brokers and dealers, investment funds and insurance companies. Credit losses
could arise should counterparties fail to perform and the value of any
collateral proves inadequate. The Company manages credit risk by monitoring net
exposure to individual counterparties on a daily basis, monitoring credit limits
and requiring additional collateral where appropriate.
Derivative credit exposures are calculated, aggregated and compared to
established limits by the credit department. Credit reserve requirements are
determined by senior management in conjunction with the Company's continuous
credit monitoring procedures. Historically, reserve requirements arising from
instruments with off-balance-sheet risk have not been material.
Receivables and payables with brokers and dealers, agreements to resell and
repurchase securities, and securities borrowed and loaned are generally
collateralized by cash, government and government-agency securities, and letters
of credit. The market value of the initial collateral received approximates or
is greater than the contract value. Additional collateral is requested when
considered necessary. The Company may pledge clients' margined securities as
collateral in support of securities loaned and bank loans, as well as to satisfy
margin requirements at clearing organizations. The amounts loaned or pledged are
limited to the extent permitted by applicable margin regulations. Should the
counterparty fail to return the clients' securities, the Company may be required
to replace them at prevailing market prices. At September 30, 2000, the market
value of client securities loaned to other brokers approximated the amounts due
or collateral obtained.
10
<PAGE> 12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Credit Risk in Client Activities
Client transactions are entered on either a cash or margin basis. In a margin
transaction, the Company extends credit to a client for the purchase of
securities, using the securities purchased and/or other securities in the
client's account as collateral for amounts loaned. Receivables from customers
are substantially collateralized by customer securities. Amounts loaned are
limited by margin regulations of the Federal Reserve Board and other regulatory
authorities and are subject to the Company's credit review and daily monitoring
procedures. Market declines could, however, reduce the value of any collateral
below the principal amount loaned, plus accrued interest, before the collateral
can be sold.
Client transactions include positions in commodities and financial futures,
trading liabilities and written options. The risk to the Company's clients in
these transactions can be substantial, principally due to price volatility which
can reduce the clients' ability to meet their obligations. Margin deposit
requirements pertaining to commodity futures and exchange-traded options
transactions are generally lower than those for exchange-traded securities. To
the extent clients are unable to meet their commitments to the Company and
margin deposits are insufficient to cover outstanding liabilities, the Company
may take market action and credit losses could be realized.
Client trades are recorded on a settlement date basis. Should either the client
or broker fail to perform, the Company may be required to complete the
transaction at prevailing market prices. Trades pending at September 30, 2000
were settled without material adverse effect on the Company's consolidated
financial statements, taken as a whole.
Concentrations of Credit Risk
Concentrations of credit risk that arise from financial instruments (whether on-
or off-balance-sheet) exist for groups of counterparties when they have similar
economic characteristics that would cause their ability to meet obligations to
be similarly affected by economic, industry or geographic factors. As a major
securities firm, the Company engages in underwriting and other financing
activities with a broad range of clients, including other financial
institutions, municipalities, governments, financing companies, and commercial
real estate investors and operators. These activities could result in
concentrations of credit risk with a particular counterparty, or group of
counterparties operating in a particular geographic area or engaged in business
in a particular industry. The Company seeks to control its credit risk and the
potential for risk concentration through a variety of reporting and control
procedures described above.
The Company's most significant industry concentration, which arises within its
normal course of business activities, is financial institutions including banks,
brokers and dealers, investment funds, and insurance companies.
NOTE 9: COMMITMENTS AND CONTINGENCIES
At September 30, 2000 and December 31, 1999, the Company was contingently liable
under unsecured letters of credit totaling $298,498 and $139,156, respectively,
which approximated fair value. At September 30, 2000 and December 31, 1999
certain of the Company's subsidiaries were contingently liable as issuer of
approximately $45,000 of notes payable to managing general partners of various
limited partnerships pursuant to certain partnership agreements. In addition, as
part of the 1995 limited partnership settlements, the Company has agreed, under
certain circumstances, to provide to class members additional consideration
including assignment of fees the Company is entitled to receive from certain
partnerships. In the opinion of management, these contingencies will not have a
material adverse effect on the Company's consolidated financial statements,
taken as a whole.
In meeting the financing needs of certain of its clients, the Company may also
issue standby letters of credit which are collateralized by customer margin
securities. At September 30, 2000 and December 31, 1999, the Company had
outstanding $182,712 and $101,400, respectively, of such standby letters of
credit. At September 30, 2000 and December 31, 1999, securities with fair value
of $2,416,428 and $2,536,073, respectively, had been loaned or pledged as
collateral for securities borrowed of approximately equal fair value.
In the normal course of business, the Company enters into when-issued
transactions, underwriting and other commitments. Also, at September 30, 2000
and December 31, 1999, the Company had commitments of $1,176,781 and $858,122,
respectively, consisting of secured credit lines to real estate operators,
mortgage and asset-backed originators, and commitments to investment
partnerships, in certain of which key employees are limited partners. Settlement
of these transactions at September 30, 2000 would not have had a material impact
on the Company's consolidated financial statements, taken as a whole.
11
<PAGE> 13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company has been named as defendant in numerous legal actions in the
ordinary course of business. While the outcome of such matters cannot be
predicted with certainty, in the opinion of management of the Company, after
consultation with various counsel handling such matters, these actions will be
resolved with no material adverse effect on the Company's consolidated financial
statements, taken as a whole.
NOTE 10: COMPREHENSIVE INCOME
Comprehensive income is calculated in accordance with SFAS No. 130, "Reporting
Comprehensive Income." Comprehensive income combines net income and certain
items that directly affect stockholders' equity, such as foreign currency
translation adjustments. The components of comprehensive income for the three
months and nine months ended September 30, 2000 and 1999 were as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------- -----------------------------------
2000 1999 2000 1999
--------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net income $135,769 $ 138,202 $439,624 $462,305
Foreign currency translation adjustment (1,177) 2,046 (4,455) (885)
--------------- -------------- -------------- --------------
Total comprehensive income $134,592 $ 140,248 $435,169 $461,420
=============== ============== ============== ==============
</TABLE>
NOTE 11: EARNINGS PER COMMON SHARE
Earnings per common share are computed in accordance with SFAS No. 128,
"Earnings Per Share." Basic earnings per share excludes the dilutive effects of
options and convertible securities and is calculated by dividing income
available to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects all potentially
dilutive securities.
Set forth below is the reconciliation of net income applicable to common shares
and weighted-average common and common equivalent shares of the basic and
diluted earnings per common share computations:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30,
------------- -------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
NUMERATOR:
Net income $ 135,769 $ 138,202 $ 439,624 $ 462,305
Preferred stock dividends -- (5,949) -- (17,847)
------------- ------------- ------------- -------------
Net income applicable to common shares
for basic earnings per share 135,769 132,253 439,624 444,458
============= ============= ============= =============
Net income applicable to common shares
for diluted earnings per share $ 135,769 $ 132,253 $ 439,624 $ 444,458
============= ============= ============= =============
DENOMINATOR:
Weighted-average common shares for basic
earnings per share 148,019,200 145,633,697 146,143,267 145,583,134
Weighted-average effect of dilutive
employee stock options and awards 11,891,913 8,223,806 8,957,061 8,523,851
------------- ------------- ------------- -------------
Weighted-average common and common equivalent
shares for diluted earnings per share 159,911,113 153,857,503 155,100,328 154,106,985
============= ============= ============= =============
EARNINGS PER SHARE:
Basic $ 0.92 $ 0.91 $ 3.01 $ 3.05
============= ============= ============= =============
Diluted $ 0.85 $ 0.86 $ 2.83 $ 2.88
============= ============= ============= =============
</TABLE>
12
<PAGE> 14
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Pursuant to the terms and conditions of the Company's various Stock Option and
Award Plans which provide for the granting to officers and other key employees
nonqualified stock options, restricted stock awards, restricted stock units and
other stock based awards (the "Awards"), effective October 23, 2000, the date
the shareholders of the Company approved the Merger Agreement, the Awards that
were previously unvested or restricted became fully vested and no longer subject
to restrictions on sales and transfers.
NOTE 12: SEGMENT REPORTING DATA
The Company offers a wide variety of products and services, primarily those of a
full service domestic broker-dealer to a domestic market, through its two
operating segments: Individual and Institutional. The Individual segment offers
brokerage services and products (such as the purchase and sale of securities,
insurance annuity contracts, mutual funds, wrap fee products, and margin and
securities lending), asset management and other investment advisory and
portfolio management products and services, and execution and clearing services
for transactions originated by individual investors. The Institutional segment
principally includes capital market products and services (such as the placing
of securities and other financial instruments for - and the execution of trades
on behalf of - institutional clients, investment banking services such as the
underwriting of debt and equity securities, and mergers and acquisitions
advisory services).
Segment revenues and expenses in the table below consist of those that are
directly attributable to the segment under which they are reported, combined
with segment amounts based on Company allocation methodologies (for example,
allocating a portion of investment banking revenues to the Individual segment;
relative utilization of the Company's square footage for certain cost
allocations).
<TABLE>
<CAPTION>
Three months ended September 30, 2000 Three months ended September 30, 1999
------------------------------------- -------------------------------------
Individual Institutional Total Individual Institutional Total
------------ ------------- ------------ ------------ ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Total revenues $1,556,834 $ 888,412 $2,445,246 $1,167,330 $692,862 $1,860,192
Net revenues 1,204,463 238,216 1,442,679 1,010,919 226,248 1,237,167
Income before taxes and
minority interest 171,842 48,358 220,200 186,513 39,472 225,985
<CAPTION>
Nine months ended September 30, 2000 Nine months ended September 30, 1999
------------------------------------ ---------------------------------------
Individual Institutional Total Individual Institutional Total
------------ ------------- ------------ ------------ ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Total revenues $4,449,646 $2,717,147 $7,166,793 $3,407,685 $2,346,795 $5,754,480
Net revenues 3,598,490 852,466 4,450,956 2,946,050 953,915 3,899,965
Income before taxes and
minority interest 570,086 152,403 722,489 491,386 269,285 760,671
</TABLE>
Total assets for the Individual and Institutional segments were $30,141,208 and
$37,307,059, respectively, at September 30, 2000 and $21,828,324 and
$39,784,052, respectively at December 31, 1999.
13
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company's principal business activities are, by their nature, affected by
many factors, including general economic and financial conditions, the level and
volatility of interest rates, currency and security valuations, competitive
conditions, counterparty risk, transactional volume, market liquidity and
technological changes. As a result, revenues and profitability have been in the
past, and are likely to continue to be, subject to fluctuations reflecting the
impact of these factors.
Certain statements included in this discussion and in other parts of this report
include "forward-looking statements" that involve known and unknown risks and
uncertainties including (without limitation) those mentioned above, the impact
of current, pending and future legislation and regulation, and other risks and
uncertainties. Actual results could differ materially from those projected in
the forward-looking statements. The Company disclaims any obligation or
undertaking to update publicly or revise any forward-looking statements.
During the third quarter of 2000, economic conditions in the U.S. were generally
positive, but the performance of the financial markets was mixed. The annualized
rate of U.S. Real Gross Domestic Product growth in the third quarter was 2.7
percent, versus 5.6 percent in the second quarter of 2000 and 5.7 percent in the
third quarter of 1999. Inflation was above year-ago levels. The Consumer Price
Index rose 3.5 percent in the third quarter of 2000, as compared to the 3.7
percent rate in the second quarter of 2000 and 2.6 percent in the third quarter
of 1999. After tightening monetary policy in the first half of 2000, the Federal
Reserve neither tightened nor loosened policy in the third quarter. Interest
rates were mixed. The yield on the 90-day U.S. Treasury bill increased 35 basis
points from 5.88 percent to 6.23 percent, but the yield on the 10-year Treasury
bond declined 23 basis points, from 6.03 percent to 5.80 percent.
The equity market was somewhat weak during the third quarter of 2000. The Dow
Jones Industrial Average increased 1.9 percent during the third quarter of 2000,
compared to a 5.8 percent decline during the third quarter of 1999. However, the
S&P 500 declined 1.2 percent as compared to a 6.6 percent decline during the
third quarter of 1999. The NASDAQ Composite Index fell 7.4 percent in the third
quarter of 2000, as compared to a 2.2 percent gain in the third quarter of 1999.
Despite fairly weak stock prices, equity market volume was heavy, easily beating
the 1999 figures. Average daily volume on the New York Stock Exchange was 945
million shares in the third quarter of 2000, as compared with 742 million in the
year-ago quarter. NASDAQ volume was 1.5 billion shares per day in the third
quarter of 2000, 53 percent above the volume in the third quarter of 1999.
RECENT EVENTS
On October 23, 2000, the stockholders of PWG adopted the Agreement and Plan of
Merger (the "Merger Agreement"), dated as of July 12, 2000, by and among PWG,
UBS AG ("UBS") and a subsidiary of UBS, pursuant to which PWG will merge with
and into that subsidiary. Under the terms of the agreement, PWG's stockholders
will have the right to elect to receive either $73.50 in cash or 0.4954 of an
ordinary share of UBS AG stock for each share of PWG's common stock, $1 par
value ("common stock") that they own. The percentage of PWG's common stock that
will be converted into the right to receive UBS AG stock is fixed at 50 percent.
Adjustments to elections may therefore be necessary so that, in the aggregate,
50 percent of the shares of PWG's common stock is converted into the right to
receive UBS AG stock, and 50 percent is converted into the right to receive
cash. The transaction, which is expected to be completed in November of 2000, is
subject to customary closing conditions, including certain regulatory approvals.
MERGER WITH J.C. BRADFORD
On June 9, 2000, the Company completed its merger with J.C. Bradford & Co.
L.L.C. ("J.C. Bradford"), a leading privately-held brokerage firm in the
Southeastern U.S., for approximately $622,000 in cash. The merger was accounted
for as a purchase and, accordingly, the excess of the purchase cost over the
fair value of the net assets acquired of approximately $185,000, resulted in the
Company recording $560,000 in goodwill, which is being amortized over 25 years
on a straight-line basis. The consolidated financial statements of the Company
include the results of J.C. Bradford from the closing date. As a result of the
merger, in the second quarter of 2000, the Company recorded after-tax costs of
approximately $18,800 ($30,000 pre-tax) relating primarily to the elimination of
the Company's duplicate facilities, severance and other costs.
14
<PAGE> 16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS
Quarter Ended September 30, 2000 compared to Quarter Ended September 30, 1999
The Company's net income for the quarter ended September 30, 2000, was $135.8
million, or $0.92 per basic share ($0.85 per diluted share). This compares to
net income of $138.2 million, or $0.91 per basic share ($0.86 per diluted share)
earned during the third quarter of 1999. During the third quarter of 2000,
revenues, net of interest expense, were $1,442.7 million, 16.6% higher than the
third quarter of 1999.
Commission revenues earned during the third quarter of 2000 were $528.9 million,
17.2 percent higher than the $451.3 million earned during the prior year
quarter. Mutual fund and insurance commissions increased $52.0 million or 37.7
percent, commissions from over-the-counter securities and commodities increased
$18.8 million or 30.9 percent and commissions on the sale of listed securities
and options increased $6.9 million or 2.7 percent compared to the prior year
quarter.
Principal transactions revenues increased from the third quarter of 1999 to
$287.9 million from $235.9 million, or 22.0 percent. The increase was primarily
attributable to improved results in equities slightly offset by a decrease in
taxable fixed income. The increase in equities includes gains on certain
investing activities, including e-commerce investments. Also included in the
results was a gain on a real estate investment transaction.
Asset management fees increased $78.4 million, or 33.2 percent to a record
$314.1 million, reflecting higher revenues earned on managed accounts. Average
assets in wrap and trust accounts during the third quarter of 2000 were
approximately 60 percent higher than during the third quarter of 1999. At
September 30, 2000, assets in wrap and trust accounts reached a record $61.2
billion. The increase in revenues also reflects higher investment advisory fees
earned on assets managed in long-term and money market funds. The average assets
under management in money market, institutional and long-term mutual funds were
approximately $74 billion during the third quarter of 2000 and approximately $60
billion during the third quarter of 1999. At September 30, 2000, assets under
management were $75.9 billion.
Investment banking revenues earned during the third quarter of 2000 were $107.5
million, $26.7 million less than the $134.2 million earned during the third
quarter of 1999. The current year quarter reflects decreases in corporate
securities underwriting fees, management fees and selling concessions on lower
volume of lead-managed and co-managed issues while municipal securities
underwriting fees, and private placement and other fees were slightly improved
quarter to quarter.
Net interest increased $25.7 million, or 18.4 percent to $164.8 million
primarily due to an increased level of margin lending to clients during the
period and increased inventory levels.
Compensation and benefits expenses for the quarter ended September 30, 2000 were
$875.0 million, a 22.9 percent increase as compared to $711.8 million during the
prior year quarter. The number of employees at September 30, 2000 increased
approximately 3,900, or 20 percent, as compared to September 30, 1999 reflecting
an additional 1,439 Private Client Group financial advisors (including
approximately 800 J.C. Bradford financial advisors), related financial advisor
support personnel, and technology specialists hired to implement the Company's
technology initiatives. The ratio of compensation and benefits as a percent of
net revenues increased to 60.7 percent versus 57.5 percent in the prior year
quarter.
All other operating expenses increased $48.1 million, or 16.1 percent to $347.5
million, as compared to $299.4 million for the prior year quarter. Office and
equipment expenses increased $22.8 million, or 25.5 percent principally due to
an increase in office space and equipment necessary to support the additional
headcount. Professional services expenses increased $8.7 million, or 26.1
percent principally due to consultants used in the Company's advanced technology
implementation, recruiting fees and other consulting expenses. Other expenses
increased $13.3 million, or 16.6 percent principally due to increased
office-related expenses associated with increased business activities. The ratio
of non-compensation expenses as a percentage of net revenues was 24.1 percent
for the quarter ended September 30, 2000 compared to 24.2 percent for the prior
year quarter.
15
<PAGE> 17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The effective income tax rate was 34.6 percent for the quarter ended September
30, 2000 which was comparable to the 35.3 percent from the prior year quarter.
Nine Months Ended September 30, 2000 compared to Nine Months Ended September 30,
1999
The Company's net income was $439.6 million, for the nine months ended September
30, 2000, or $3.01 per basic share ($2.83 per diluted share). This compares to
net income of $462.3 million, or $3.05 per basic share ($2.88 per diluted share)
earned during the first nine months of 1999. During the first nine months of
2000, revenues, net of interest expense, were a record $4,451.0 million, 14.1
percent higher than the corresponding period a year ago.
Commission revenues earned during the first nine months of 2000 were a record
$1,765.6 million, 24.4 percent higher than the $1,419.1 million earned during
the prior year period. Mutual fund and insurance commissions increased $174.8
million or 44.4 percent, commissions from over-the-counter securities and
commodities increased $98.9 million or 49.3 percent, and commissions on the sale
of listed securities and options increased $72.3 million or 8.8 percent.
Principal transactions revenues decreased $51.3 million, or 6.2 percent, to
$778.6 million attributable to lower results in taxable fixed income and
municipals offset by an increase in equities.
Asset management fees increased $226.8 million, or 34.0 percent to a record
$893.1 million, reflecting higher revenues earned on managed accounts. Average
assets in wrap and trust accounts during the first nine months of 2000 were
approximately 54 percent higher than during the corresponding period of 1999. At
September 30, 2000, assets in wrap and trust accounts reached a record $61.2
billion. The increase also reflects higher investment advisory and distribution
fees earned on assets managed in long-term and money market funds. The average
assets under management in money market, institutional and long-term mutual
funds were approximately $72 billion during the first nine months of 2000, up
from the approximately $60 billion during the first nine months of 1999.
Investment banking revenues earned during the first nine months of 2000 were
$385.3 million, $35.0 million lower than the $420.3 million earned during the
same period last year. The current year period reflects declines in corporate
and municipal underwriting fees, management fees and selling concessions on
lower volume of lead-managed and co-managed corporate issues. Partially
offsetting these declines were increases in private placement and other fees.
Net interest increased $72.2 million, or 16.6 percent to a record $507.3 million
reflecting primarily an increased level of margin lending to clients during the
period and increased inventory levels.
In June 2000, the Company recorded $30.0 million in pre-tax costs associated
with the Company's merger with J.C. Bradford. These costs relate primarily to
elimination of the Company's duplicate facilities, severance and other costs and
are reflected in compensation and benefits, office and equipment and other
operating expenses.
Compensation and benefits expenses for the nine months ended September 30, 2000
were $2,664.4 million, a 17.9 percent increase as compared to $2,260.6 million
during the prior year period. The number of employees at September 30, 2000
increased approximately 3,900, or 20 percent, as compared to September 30, 1999
reflecting an additional 1,439 Private Client Group financial advisors, related
financial advisor support personnel, and technology specialists hired to
implement the Company's technology initiatives. The ratio of compensation and
benefits as a percent of net revenues increased to 59.9 percent versus 58.0
percent in the prior year period.
All other operating expenses increased $185.3 million, or 21.1 percent to
$1,064.1 million, as compared to $878.7 million for the prior year period.
Office and equipment expenses increased $48.3 million, or 18.6 percent
principally due to an increase in office space and equipment necessary to
support the additional headcount and J.C. Bradford merger-related costs.
Professional services expenses increased $45.8 million, or 47.5 percent
principally due to consultants used in the Company's advanced technology
implementation, recruiting fees and other consulting expenses. Business
development expenses increased $31.6 million, or 37.9 percent reflecting higher
promotional costs associated with PaineWebber EDGE and PaineWebber InsightOne
and other expenses associated with increased business activities. Other expenses
increased $54.0 million, or 22.4 percent principally due to increased meeting
and seminar expenses and other office-related expenses associated with increased
business activities, as well as J.C. Bradford merger-related costs. The ratio of
non-compensation expenses as a percentage of net revenues was 23.9 percent for
the nine months ended September 30, 2000 compared to 22.5 percent for the prior
year period.
16
<PAGE> 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The effective income tax rate for the nine months ended September 30, 2000 was
35.9 percent which was comparable to the 36.0 percent from the prior year
period.
LIQUIDITY AND CAPITAL RESOURCES
The primary objectives of the Company's funding policies are to ensure ample
liquidity at all times and a strong capital base. These objectives are met by
maximization of self-funded assets, diversification of funding sources,
maintenance of prudent liquidity and capital ratios, and contingency planning.
Liquidity
The Company maintains a highly liquid balance sheet with the majority of assets
consisting of trading assets, securities purchased under agreements to resell,
securities borrowed, and receivables from clients, brokers and dealers, which
are readily convertible into cash. The nature of the Company's business as a
securities dealer results in carrying significant levels of trading assets and
liabilities in order to meet its client and proprietary trading needs. The
Company's total assets may fluctuate from period to period as the result of
changes in the level of trading positions held to facilitate client
transactions, the volume of resale and repurchase transactions, and proprietary
trading strategies. These fluctuations depend significantly upon economic and
market conditions, and transactional volume.
The Company's total assets at September 30, 2000 were $67.4 billion compared to
$61.6 billion at December 31, 1999, primarily attributable to an increase in
receivables from clients and financial instruments owned. The majority of the
Company's assets are financed by daily operations such as securities sold under
agreements to repurchase, free credit balances in client accounts and securities
lending activity. The Company regularly reviews its mix of assets and
liabilities to maximize self-funding. Additional financing sources are available
through bank loans and commercial paper, committed and uncommitted lines of
credit, and long-term borrowings.
The Company maintains committed and uncommitted credit facilities from a diverse
group of banks. The Company has a $1.2 billion unsecured revolving credit
agreement, which extends through September 2001, with provisions for renewal
through 2002. Certain of the Company's subsidiaries also have a secured
revolving credit facility to provide up to an aggregate of $1.0 billion through
August 2001, with provisions for renewal through 2002. The secured borrowings
under this facility can be collateralized using a variety of securities. The
facilities are available for general corporate purposes and are tested on a
regular basis. At September 30, 2000, there were no outstanding borrowings under
either facility. Additionally, the Company had $5.4 billion in uncommitted lines
of credit at September 30, 2000.
The Company maintains public shelf registration statements with the SEC for the
issuance of debt securities of the Company and for the issuance of preferred
securities of PWG Capital Trusts III, IV and V ("Preferred Trust Securities"),
business trusts formed under the Delaware law which are wholly owned
subsidiaries of the Company. During the third quarter of 2000, the Company
issued $125.0 million of debt under these registration statements. At September
30, 2000, the Company had $632.6 million in debt securities available for
issuance under a shelf registration statement and $706.2 million in Preferred
Trust Securities and debt securities of the Company available for issuance under
another registration statement.
Capital Resources and Capital Adequacy
The Company's businesses are capital intensive. In addition to a funding policy
that provides for diversification of funding sources and maximization of
liquidity, the Company maintains a strong capital base.
The Company's total capital base, which includes long-term borrowings, Preferred
Trust Securities and stockholders' equity, grew to $8.7 billion, an increase of
$195.3 million from December 31, 1999. The growth in total capital is primarily
due to the net increase in stockholders' equity of $475.6 million offset by a
net decrease in long-term borrowings of $280.3 million.
17
<PAGE> 19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The net decrease in long-term borrowings primarily reflected the maturity of
$200 million U.S. dollar-denominated 7 percent senior notes on March 1, 2000 and
maturities of U.S. dollar-denominated medium-term notes of $261.7 million,
partially offset by the issuance of $119.2 million non-U.S. dollar-denominated
medium-term notes and the issuance of $73.5 million U.S. dollar-denominated 6.25
percent convertible debentures due 2007. The increase in stockholders' equity
was primarily the result of net income for the nine months ended September 30,
2000 of $439.6 million and the issuance of approximately 6,364,000 shares of
common stock related to employee compensation and stock purchase programs.
Issuances and tax credits related to these programs had the net effect of
increasing equity capital by $206.2 million in the first nine months of 2000.
These increases were offset by the repurchase in the first nine months of 2000
of approximately 3,000,000 shares of common stock for $114.8 million and
dividends of $52.8 million. At September 30, 2000, the remaining number of
shares authorized to be repurchased, in the open market or otherwise, under the
Company's common stock repurchase program was approximately 34 million.
PWI is subject to the net capital requirements of the Securities and Exchange
Commission, the New York Stock Exchange, Inc. and the Commodity Futures Trading
Commission which are designed to measure the financial soundness and liquidity
of broker-dealers. PWI has consistently maintained net capital in excess of the
minimum requirements imposed by these agencies. In addition, the Company has
other banking and securities subsidiaries, both domestic and foreign, which have
also consistently maintained net regulatory capital in excess of requirements.
Effective June 9, 2000, the Company merged with J.C. Bradford, a registered
broker-dealer, which is subject to net capital requirements similar to PWI.
Merchant Banking and Highly Leveraged Transactions
In connection with its merchant banking, principal investing, commercial real
estate, and asset finance activities, the Company has provided financing and
made investments in companies and other entities, some of which are involved in
highly leveraged transactions. Positions taken or commitments made by the
Company may involve credit or market risk from any one issuer or industry.
At September 30, 2000, the Company had investments which were affected by
liquidity, reorganization or restructuring issues amounting to $136.2 million.
These investments have not had a material effect on the Company's results of
operations.
The Company's activities include underwriting and market-making transactions in
high-yield corporate debt and non-investment-grade mortgage-backed securities,
and emerging market securities (collectively, "high-yield securities"). These
securities generally involve greater risks than investment-grade corporate debt
securities because these issuers usually have high levels of indebtedness and
lower credit ratings and are, therefore, more vulnerable to general economic
conditions. At September 30, 2000, the Company held $147.4 million of high-yield
securities, with approximately 25 percent of such securities attributable to
three issuers. The Company continually monitors its risk positions associated
with high-yield securities and establishes limits with respect to overall market
exposure, industry group and individual issuer. The Company accounts for these
positions at fair value, with unrealized gains and losses reflected in principal
transactions revenues. These high-yield securities have not had a material
effect on the Company's results of operations.
DERIVATIVE FINANCIAL INSTRUMENTS
A derivative financial instrument is a contractual agreement between
counterparties that derives its value from changes in the value of some
underlying asset such as the price of another security, interest rates, currency
exchange rates, specified rates (e.g. LIBOR) or indices (e.g. S&P 500), or other
value referenced in the contract. Derivatives, such as futures, certain option
contracts and structured products (e.g. indexed warrants) are traded on
exchanges, while derivatives such as forward contracts, certain option
contracts, interest rate swaps, caps and floors, and other structured products
are negotiated in over-the-counter markets.
18
<PAGE> 20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
In the normal course of business, the Company engages in a variety of derivative
transactions in connection with its proprietary trading activities and asset and
liability management, as well as on behalf of its clients. As a dealer, the
Company regularly makes a market in and trades a variety of securities. The
Company is also engaged in creating structured products that are sold to
clients. In connection with these activities, the Company attempts to reduce its
exposure to market risk by entering into offsetting hedging transactions, which
may include derivative financial instruments. The Company also enters into
interest rate swap contracts to manage the interest rate characteristics of its
assets and liabilities.
The notional amount of a derivative contract is used to measure the volume of
activity and is not reflected on the Condensed Consolidated Statement of
Financial Condition. The Company had off-balance-sheet derivative contracts
outstanding with gross notional amounts of $65.8 billion and $50.5 billion at
September 30, 2000 and December 31, 1999, respectively. These amounts included
$43.3 billion and $30.9 billion, respectively, related to "to be announced"
mortgage-backed securities requiring forward settlement. Also included in these
amounts were $3.7 billion and $4.2 billion notional amounts of interest rate
swap agreements used to change the interest rate characteristics of the
Company's fixed rate debt at September 30, 2000 and December 31, 1999,
respectively. For further discussion on the Company's derivative financial
instruments, see Note 7 in the Notes to Condensed Consolidated Financial
Statements.
The Company records any unrealized gains and losses on its derivative contracts
used in a trading capacity by marking-to-market the contracts on a daily basis.
The unrealized gain or loss is recorded on the Condensed Consolidated Statements
of Financial Condition with the related profit or loss reflected in principal
transactions revenues. The Company accrues interest income and expense on
interest rate swap agreements used to change the interest rate characteristics
of the Company's fixed rate debt. These interest rate swap agreements had the
effect of increasing net interest expense on the Company's fixed rate debt by
$7.7 million for the nine months ended September 30, 2000 and of reducing net
interest expense on the Company's fixed rate debt by $20.4 million for the nine
months ended September 30, 1999, respectively. The Company had no deferred gains
or losses recorded at September 30, 2000 and December 31, 1999 related to
terminated swap agreements on the Company's long-term borrowings.
The fair value of an exchange-traded derivative financial instrument is
determined by quoted market prices, while over-the-counter derivatives are
valued based upon pricing models which consider time value and volatility, as
well as other economic factors. The fair values of the Company's derivative
financial instruments held for trading purposes at September 30, 2000 were
$147.1 million and $185.5 million for assets and liabilities, respectively, and
are reflected on the Condensed Consolidated Statements of Financial Condition.
The fair values of these instruments at December 31, 1999 were $392.7 million
and $215.1 million for assets and liabilities, respectively.
The Company's exposure to market risk relates to changes in interest rates,
equity prices, foreign currency exchange rates or the market values of the
assets underlying the financial instruments. The Company's exposure to credit
risk at any point is represented by the fair value or replacement cost on
contracts in which the Company has recorded an unrealized gain. At September 30,
2000 and December 31, 1999, the fair values amounted to $147.1 million and
$392.7 million, respectively. The risks inherent in derivative financial
instruments are managed consistent with the Company's overall risk management
policies. (See Risk Management section below)
RISK MANAGEMENT
Risk is an inherent part of the Company's principal business activities.
Managing risk is critical to the Company's profitability and to reducing the
likelihood of earnings volatility. The Company's risk management policies and
procedures have been established to continually identify, monitor and manage
risk. The Company's principal risks are market, credit, liquidity, legal and
operating risks. Included below is a discussion on market risk. For further
discussion on the Company's principal risks, see the Company's 1999 Annual
Report to Stockholders.
The Company seeks to manage risk and its impact on earnings volatility through
strategic planning and by focusing on the diversification of its business
activities. Through capital allocation, and the establishment of trading limits
by product and credit limits by counterparty, the Company manages the risk
associated with the various businesses. The Company may reallocate or deploy
capital to the business groups based upon changes in market conditions or
opportunities in the marketplace that are consistent with the Company's
long-term strategy.
The discussion of the Company's principal risks and the estimated amounts of the
Company's market risk exposure generated from the sensitivity analysis performed
by the Company are forward-looking statements assuming certain adverse
conditions occur. Actual results in the future may differ materially from these
projected results due to actual
19
<PAGE> 21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
events in the markets in which the Company operates and other factors. The
analysis methods used by the Company to assess and mitigate risks discussed
below should not be considered projections of future events or losses.
Market Risk
All financial instruments involve market risk. Market risk is the potential
change in value of the financial instrument caused by unfavorable changes in
interest rates, equity prices and foreign currency exchange rates. Market risk
is inherent to both derivative and non-derivative financial instruments.
The Company actively monitors its market risk profile through a variety of
control procedures including market risk modeling, review of trading positions
and hedging strategies, and monitoring adherence to established limits. Each
department's trading positions, exposures, profits and losses, and trading
strategies are reviewed by the senior management of each business group.
Independent of the trading departments is a risk management group. The Company's
risk management group reviews the Company's risk profile and adherence to
established trading limits, and aids in the development of risk management
policies. In addition, the Company has in place committees and management
controls to review inventory positions, other asset accounts and asset agings on
a regular basis.
Trading position and exposure limits are established by the Asset/Liability
Management Committee, which meets regularly and is comprised of senior corporate
and business group managers.
The following is a discussion of the Company's primary market risk exposures at
September 30, 2000 and December 31, 1999 and how those exposures are managed:
Interest Rate Risk
In connection with the Company's dealer activities, the Company is exposed to
interest rate risk due to changes in the level or volatility of interest rates,
changes in the yield curve, mortgage prepayments and credit spreads. The Company
attempts to mitigate its exposure to interest rate risk by entering into hedging
transactions such as U.S. government and Eurodollar forwards and futures
contracts, options, and interest rate swap and cap agreements. The Company also
issues fixed rate instruments in connection with its nontrading activities,
which expose the Company to interest rate risk. The Company enters into interest
rate swap agreements that are designed to mitigate its exposure by effectively
converting its fixed rate liabilities into floating rate liabilities.
Equity Price Risk
In connection with the Company's dealer activities, the Company buys and sells
equity and equity derivative instruments. The Company is exposed to equity price
risk due to changes in the level or volatility of equity prices. The Company
attempts to mitigate its exposure to equity price risk by entering into hedging
transactions including equity option agreements.
Sensitivity Analysis
For purposes of the SEC disclosure requirements, the Company has elected to use
a sensitivity approach to express the potential loss in future earnings of its
financial instruments. In preparing the analysis, the Company has combined both
derivative and non-derivative financial instruments held for trading purposes
with those held for purposes other than trading because the amounts were not
material.
The sensitivity calculation employed to analyze interest rate risk on its fixed
income financial instruments was based on a proprietary methodology which
converted substantially all the Company's interest rate sensitive financial
instruments at September 30, 2000 and December 31, 1999, into a uniform
benchmark (a ten year U.S. Treasury note equivalent), and evaluated the impact
assuming an 11 basis point change to the ten-year U.S. Treasury note at
September 30, 2000 and December 31, 1999, respectively. The hypothetical basis
point change was derived from a proprietary model which uses a one-day interval
and a 95 percent confidence level, and was based on historical data over a
one-year period. This analysis does not consider other factors that may
influence these results, such as credit spread risk, prepayment risk on
mortgage-backed securities or changes in the shape of the yield curve. The
sensitivity calculation employed to analyze equity price risk on its equity
financial instruments was based on a proprietary model which stress tests the
firm inventory positions by shocking those positions for a two standard
deviation move in the market (95 percent confidence interval) using historical
data over a one-year period. Based upon the aforementioned methodologies, the
Company's potential daily loss in future earnings at September 30, 2000 was
approximately $4 million and $1.5 million for interest rate risk and equity
price risk, respectively, and the Company's potential daily loss in future
earnings at December 31, 1999 was approximately $3 million and $0.1 million for
interest rate risk and equity price risk, respectively.
20
<PAGE> 22
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
No significant events have occurred since the filing of the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1999 and Quarterly
Reports on Form 10-Q for the quarters ended March 31, 2000 and June 30, 2000.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed herewith:
Exhibit 12.1 - Computation of Ratio of Earnings to Fixed Charges
Exhibit 12.2 - Computation of Ratio of Earnings to Combined Fixed
Charges and Preferred Stock Dividends
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed a Current Report on Form 8-K dated October 23, 2000
with the Securities and Exchange Commission reporting under "Item 5 -
Other Events" and "Item 7 - Exhibits" relating to the Company's press
release which reported the approval by PWG shareholders of the merger
agreement entered into and between the Company, UBS AG and a subsidiary
of UBS AG.
The Company filed a Current Report on Form 8-K dated October 11, 2000
with the Securities and Exchange Commission reporting under "Item 5 -
Other Events" and "Item 7 - Exhibits" relating to the Company's press
release which, among other things, reported financial results for the
three and nine month periods ended September 30, 2000.
The Company filed a Current Report on Form 8-K/A dated September 14, 2000
with the Securities and Exchange Commission amending and restating the
Current Report on Form 8-K dated August 30, 2000.
The Company filed a Current Report on Form 8-K dated August 30, 2000 with
the Securities and Exchange Commission reporting under "Item 5 - Other
Events" and "Item 7 - Exhibits" relating to the merger agreement entered
into between the Company, UBS AG and Neptune Merger Subsidiary, Inc., a
subsidiary of UBS AG.
21
<PAGE> 23
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Paine Webber Group Inc.
------------------------
(Registrant)
Date: November 2, 2000 By: /s/ Jerome T. Fadden
----------------- --------------------------
Jerome T. Fadden
Senior Vice President and
Chief Financial Officer
(principal financial and
accounting officer)
22
