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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 1998
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-9466
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LEHMAN BROTHERS HOLDINGS INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 13-3216325
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
3 WORLD FINANCIAL CENTER 10285
NEW YORK, NEW YORK (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 526-7000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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<S> <C>
Common Stock, $.10 par value New York Stock Exchange
Pacific Exchange
Depositary Shares representing 5.94% Cumulative Preferred Stock,
Series C New York Stock Exchange
Depositary Shares representing 5.67% Cumulative Preferred Stock,
Series D New York Stock Exchange
8% Trust Preferred Securities, Series I of Subsidiary Trust (and
Registrant's guarantee thereof) New York Stock Exchange
Global Telecommunications Stock Upside Note Securities(SM) Due 2000 American Stock Exchange
8 3/4% Notes Due 2002 New York Stock Exchange
8.30% Quarterly Income Capital Securities Series A, Due December 31,
2035 New York Stock Exchange
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. /X/
Aggregate market value of the voting and nonvoting common equity held by
non-affiliates of the Registrant at February 9, 1999 was approximately
$5,822,446.36. For purposes of this information, the outstanding shares of
common stock owned by certain executive officers of the Registrant were deemed
to be shares of common stock held by affiliates. As of February 9, 1999,
119,411,161 shares of the Registrant's Common Stock, $.10 par value per share,
were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
(1) Lehman Brothers Holdings Inc. 1998 Annual Report to Stockholders (the "1998
Annual Report")-- Incorporated in part in Parts II and IV.
(2) Lehman Brothers Holdings Inc. Proxy Statement for its 1999 Annual Meeting of
Stockholders (the "Proxy Statement")--Incorporated in part in Parts I and
III.
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PART I
ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
As used herein, "Holdings" or the "Registrant" means Lehman Brothers
Holdings Inc., a Delaware corporation, incorporated on December 29, 1983.
Holdings and its subsidiaries are collectively referred to as the "Company," the
"Firm" or "Lehman Brothers," and Lehman Brothers Inc., a Delaware corporation
and the principal subsidiary of Holdings, is referred to herein as "LBI."
The Company is one of the leading global investment banks serving
institutional, corporate, government and high-net-worth individual clients and
customers. Its executive offices are located at 3 World Financial Center, New
York, New York 10285, and its telephone number is (212) 526-7000.
LEHMAN BROTHERS
Lehman Brothers is one of the leading global investment banks, serving
institutional, corporate, government and high-net-worth individual clients and
customers. The Company's worldwide headquarters in New York and regional
headquarters in London and Tokyo are complemented by offices in additional
locations in the United States, Europe, the Middle East, Latin America and the
Asia Pacific region. The Company is engaged primarily in providing financial
services. Other businesses in which the Company is engaged represent less than
10 percent of consolidated assets, revenues or pre-tax income.
The Company's business includes capital raising for clients through
securities underwriting and direct placements, corporate finance and strategic
advisory services, merchant banking, securities sales and trading, research, and
the trading of foreign exchange, derivative products and certain commodities.
The Company acts as a market-maker in all major equity and fixed income products
in both the domestic and international markets. Lehman Brothers is a member of
all principal securities and commodities exchanges in the United States, as well
as the National Association of Securities Dealers, Inc. ("NASD"), and holds
memberships or associate memberships on several principal international
securities and commodities exchanges, including the London, Tokyo, Hong Kong,
Frankfurt, Paris and Milan stock exchanges.
The Company's business activities are highly integrated and constitute a
single industry segment. Financial information concerning the Company for the
fiscal years ended November 30, 1998, November 30, 1997 and November 30, 1996,
including the amount of revenue contributed by each class of similar products or
services that accounted for 10% or more of the Company's consolidated revenues
in any one of those periods, is set forth in the Consolidated Financial
Statements and the Notes thereto in the 1998 Annual Report and is incorporated
herein by reference. Information with respect to the Company's operations by
geographic area is set forth in Note 15 to the Notes to Consolidated Financial
Statements on pages 90-91 of the 1998 Annual Report and is incorporated herein
by reference.
Since 1990, Lehman Brothers has focused on a "client/customer-driven"
strategy. Under this strategy, Lehman Brothers concentrates on serving the needs
of major issuing and advisory clients and investing customers worldwide to build
an increasing "flow" of business that leverages the Company's research,
underwriting and distribution capabilities. Customer flow continues to be the
primary source of the Company's net revenues. Developing long-term relationships
with issuing clients and investing customers is a central premise of the
Company's client/customer-driven strategy. Based on management's belief that
each client and customer directs a majority of its financial transactions to a
limited number of investment banks, Lehman Brothers' investment banking and
institutional and private client sales professionals focus on a targeted group
of clients and customers worldwide to identify and develop lead relationships.
The Company believes that such relationships position Lehman Brothers to receive
a substantial portion of its clients' and customers' financial business and
lessen the volatility of revenues generally associated with the financial
services industry.
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LEHMAN BUSINESSES
Lehman Brothers is a leading underwriter and market-maker of global fixed
income and equity securities in the public and private markets. The Company is
also a prominent advisor for corporations and governments around the world.
INVESTMENT BANKING
Lehman Brothers' Investment Banking professionals are responsible for
developing and maintaining relationships with issuing clients, gaining a
thorough understanding of their specific needs and bringing together the full
resources of Lehman Brothers to accomplish their financial objectives.
Investment Banking is organized into industry, geographic and product coverage
groups, enabling individual bankers to develop specific expertise in particular
industries and markets. Industry coverage groups include Financial Institutions,
Health Care, Industrial/Consumer, Media/Telecommunications, Natural Resources,
Power, Real Estate, Retailing and Technology. Where appropriate, specialized
product groups are partnered with the global industry and geographic groups to
provide tailor-made solutions for Lehman Brothers' clients. These product groups
include Equity Capital Markets, which includes equity and equity-related
securities and derivatives; Debt Capital Markets, which incorporates expertise
in syndicate, liability management, derivatives and private placements; Mergers
and Acquisitions; Leveraged Finance, which includes high yield debt and bank
loan syndication; Private Placements; and Financial Sponsors, which structures
and executes leveraged acquisitions. Geographically, Lehman Brothers maintains
investment banking offices in five cities in the U.S. and in twenty cities in
Europe, the Middle East, Asia and Latin America.
MERGERS AND ACQUISITIONS/STRATEGIC ADVISORY. Lehman Brothers has a long
history of providing strategic advisory services to corporate, institutional and
government clients around the world on a wide range of financial matters,
including mergers and acquisitions, restructurings and spin-offs, targeted stock
transactions, share repurchase strategies, takeover defenses and tax
optimization strategies. During 1998, the Company expanded its global mergers
and acquisitions presence, advising on 66 cross-border transactions. Linkages
between strategic advisory services and the Firm's foreign exchange, derivatives
and leveraged financing products are widely utilized.
FIXED INCOME
Lehman Brothers actively participates in all key fixed income markets
worldwide and maintains a 24-hour trading presence in global fixed income
securities. The Company combines professionals from the distribution, research
and trading areas of the Fixed Income Division, together with investment
bankers, into teams to serve the financial needs of the Company's clients and
customers. The Company is a leading underwriter of new issues, and is also a
preeminent market-maker in these and other fixed income securities. The
Company's global presence facilitates client and customer transactions and
provides liquidity in marketable fixed and floating rate debt securities.
Fixed Income businesses include the following:
GOVERNMENT AND AGENCY OBLIGATIONS. Lehman Brothers is one of the leading
primary dealers in U.S. government securities, as designated by the Federal
Reserve Bank of New York, participating in the underwriting and market-making of
U.S. Treasury bills, notes and bonds, and securities of federal agencies. The
Company is also a market-maker in the government securities of all G7 countries,
and participates in other major European and Asian government bond markets. The
Company is active in France as a reporting dealer and in Italy as a
super-primary dealer.
CORPORATE DEBT SECURITIES. Lehman Brothers engages in the underwriting and
market making of fixed and floating rate investment grade debt worldwide. The
Company is also a major participant in the preferred stock market, managing
numerous offerings of long-term and perpetual preferreds and auction rate
securities.
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HIGH YIELD SECURITIES AND BANK LOANS. The Company also underwrites and
makes markets in non-investment grade debt securities and bank loans. The
Company provides "one-stop" leveraged finance solutions for corporate and
financial acquirers and high yield issuers, including multi-step, multiproduct
acquisition financing.
MONEY MARKET PRODUCTS. Lehman Brothers holds dominant market positions in
the origination and distribution of medium-term notes and commercial paper. The
Company is an appointed dealer for over 600 active commercial paper programs on
behalf of companies and government agencies worldwide.
MORTGAGE AND ASSET-BACKED SECURITIES. The Company is a leading underwriter
of and market-maker in residential and commercial mortgage- and asset-backed
securities and is active in all areas of secured lending, structured finance and
securitized products. Lehman Brothers underwrites and makes markets in the full
range of U.S. agency-backed mortgage products, mortgage-backed securities,
asset-backed securities and whole loan products. Internationally, the Firm has
expanded its capabilities in mortgage and asset-backed securities, leases,
mortgages, multi-family financing and commercial loans.
MUNICIPAL AND TAX-EXEMPT SECURITIES. Lehman Brothers is a major dealer in
municipal and tax-exempt securities, including general obligation and revenue
bonds, notes issued by states, counties, cities, and state and local
governmental agencies, municipal leases, tax-exempt commercial paper and put
bonds. Lehman Brothers is also a leader in the structuring, underwriting and
sale of tax-exempt and taxable securities and derivative products for city,
state, not-for-profit and other public sector clients.
EMERGING MARKET SECURITIES. The Company engages in the trading, structuring
and underwriting of Latin American, Eastern European, and Asian dollar and local
currency instruments.
FINANCING. The Company's Financing unit engages in three primary functions:
managing the Company's matched book activities, supplying secured financing to
customers, and providing funding for the Company's activities. Matched book
funding involves lending cash on a short-term basis to institutional customers
collateralized by marketable securities, typically government or government
agency securities. The Company enters into these agreements in various
currencies and seeks to generate profits from the difference between interest
earned and interest paid. The Financing unit works with the Company's
institutional sales force to identify customers that have cash to invest and/or
securities to pledge to meet the financing and investment objectives of the
Company and its customers. Financing also coordinates with the Company's
Treasury area to provide collateralized financing for a large portion of the
Company's securities and other financial instruments owned. In addition to its
activities on behalf of its U.S. clients and customers, the Company is a major
participant in the European and Asian repurchase agreement markets, providing
secured financing for the Firm's customers in those regions.
FIXED INCOME DERIVATIVES. The Company offers a broad range of derivative
product services in all major currencies on a 24-hour-per-day global basis.
Derivatives professionals are integrated into all of the Company's fixed income
areas in response to the worldwide convergence of the cash and derivative
markets.
FOREIGN EXCHANGE. Lehman Brothers' global foreign exchange operations
provide market access and liquidity in all currencies for spot, forward and
over-the-counter options markets on a 24-hour-per-day basis. Lehman Brothers
offers its customers superior execution, market intelligence, analysis and
hedging capabilities, utilizing foreign exchange as well as foreign exchange
options and derivatives. In collaboration with the Firm's emerging markets unit,
the Firm's foreign exchange activities have diversified into Latin American,
Eastern European and Asian currencies. Lehman Brothers also provides advisory
services to central banks, corporations, investors worldwide, structuring
innovative products to fit their specific needs. The Firm makes extensive use of
its worldwide macroeconomics research to advise clients on the appropriate
strategies to minimize interest rate and currency risk. In addition to the
Company's traditional client/customer-driven foreign exchange activities, Lehman
Brothers also trades foreign currencies for its own account.
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EQUITIES
Lehman Brothers combines professionals from the sales, trading, investment
banking and research areas of its Equities Division into teams to serve the
financial needs of the Company's equity clients and customers. The Company's
equity expertise and the integrated nature of the Company's global operations
enable Lehman Brothers to structure and execute global equity transactions for
clients worldwide. The Company is a leading underwriter of initial public and
secondary offerings of equity and equity-related securities. Lehman Brothers
also makes markets in these and other securities, and executes block trades on
behalf of clients and customers. The Company also actively participates in
assisting governments around the world in raising equity capital as part of
their privatization programs.
The Equities group is responsible for the Company's equity operations and
all dollar and non-dollar equity and equity-related products worldwide. These
products include listed and over-the-counter ("OTC") securities, American
Depositary Receipts, convertibles, options, warrants and derivatives. The
Company participates in the global equity and equity-related markets in all
major currencies through its worldwide presence and membership in major stock
exchanges, including, among others, those in New York, London, Tokyo, Hong Kong,
Frankfurt, Paris and Milan.
EQUITY DERIVATIVES. Lehman Brothers offers equity derivative capabilities
across a wide spectrum of products and currencies, including domestic and
international program trading, listed options and futures and structured
derivatives. The Firm's equity derivatives business is organized into two major
product areas--a global volatility business, encompassing options-related
products, and a global portfolio trading business that specializes in index
arbitrage, agency/risk baskets and other structured products.
EQUITY FINANCE. Lehman Brothers maintains an integrated Equity Financing
and Prime Broker business to provide liquidity to its clients and customers and
supply a source of secured financing for the Firm.
MERCHANT BANKING AND PRIVATE EQUITY
Lehman Brothers' merchant banking activities include making principal
investments in partnership with clients of the Firm, raising capital from
institutional and high-net-worth investors and managing these investments until
they are realized. The Firm's Merchant Banking group has more than 20 dedicated
professionals based in New York and London. Through its merchant banking funds,
the Company invests in established companies worldwide. In 1998, the Company
also formalized its venture capital activities, investing a total of $37 million
in 10 companies across a broad range of industries. In addition, Lehman Brothers
engages in select equity and equity-related investments in commercial and
residential properties. Further information is contained in "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Merchant Banking and Related Lending Activities" on page 48 of the
1998 Annual Report.
GLOBAL DISTRIBUTION
Lehman Brothers' institutional and private client sales organizations
encompass distinct global sales forces that have been integrated into the Fixed
Income and Equities businesses to provide investors with the full array of
products and research offered by the Firm.
FIXED INCOME SALES. The Firm's Fixed Income sales force is one of the most
productive in the industry, with approximately 278 professionals in 12 locations
worldwide, serving the investing and liquidity needs of major institutional
investors. Employing a relationship management approach that provides superior
information flow and product opportunities for the Firm's customers, the Fixed
Income sales organization covers the major share of the buying power in the
global fixed income markets.
EQUITY SALES. Lehman Brothers' institutional Equity sales group of over 345
professionals provides an extensive range of services to institutional investors
through locations in the U.S., Europe and Asia. The
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Equity sales organization focuses on developing long-term relationships though a
comprehensive understanding of customers' investment objectives, while providing
proficient execution and consistent liquidity in a wide range of global equity
securities and derivatives.
PRIVATE CLIENT SALES. The Company's Private Client Services group of 293
professionals serves the investment needs of private investors with substantial
assets as well as over 1,000 mid-sized institutional accounts worldwide. The
group has a global presence with investment representatives located in 11
offices worldwide. Among other services, investment professionals provide their
clients with direct access to fixed income, equity, foreign exchange and
derivative products, as well as the Firm's research and execution capabilities,
thereby serving as a valuable extension of the Firm's institutional sales force.
RESEARCH
FIXED INCOME RESEARCH. Fixed Income research at Lehman Brothers encompasses
the full range of research disciplines: quantitative, economic, strategic,
credit, portfolio, relative value and market-specific analysis. Fixed Income
research is integrated with the Company's investment banking, sales and trading
activities. An important objective of Fixed Income research is to have in place
high quality research analysts covering industry, geographic and economic
sectors that support the activities of the Company's clients and customers. The
department's 291 specialists provide expertise in U.S., European and Asian
government and agency securities, derivatives, sovereign issues, corporate
securities, high yield, asset- and mortgage-backed securities, real estate,
emerging market debt and municipal securities.
EQUITY RESEARCH. The Equity Research department, comprised of 120 analysts,
is integrated with and supports the Company's investment banking, sales and
trading activities. To ensure in-depth expertise within various markets, Equity
Research has established regional teams on a worldwide basis that are staffed
with industry and strategy specialists.
OTHER BUSINESS ACTIVITIES
While Lehman Brothers concentrates on its client/customer-driven strategy,
the Company also participates in business opportunities such as arbitrage and
proprietary trading that leverage the Company's expertise, infrastructure and
resources. These businesses may generate substantial revenues but generally
entail a higher degree of risk as the Company trades for its own account.
ASSET MANAGEMENT. The Firm has several asset management related businesses.
These include Investment Consulting Services, a wrap-fee series of third party
managed products and management of multiple manager funds onshore and offshore.
The Firm also has dealer agreements with a large number of mutual fund families.
In addition, the Company packages internally managed product with emphasis on
the various sectors of the private equity markets.
ARBITRAGE. Lehman Brothers engages in a variety of arbitrage activities
including "riskless" arbitrage, where the Company seeks to benefit from
temporary price discrepancies that occur when a security is traded in two or
more markets and "risk" arbitrage activities, which involve the purchase of
securities at discounts from the expected values that would be realized if
certain proposed or anticipated corporate transactions (such as mergers,
acquisitions, recapitalizations, exchange offers, reorganizations, bankruptcies,
liquidations or spin-offs) were to occur. To the extent that these anticipated
transactions do not materialize in a manner consistent with the Company's
expectations, the Company is subject to the risk that the value of these
investments will decline. Lehman Brothers' arbitrage activities benefit from the
Company's presence in the global capital markets, access to advanced information
technology, in-depth market research, proprietary risk management tools and
general experience in assessing rapidly changing market conditions.
PROPRIETARY TRADING. In addition to its customer-flow activities, Lehman
Brothers also takes proprietary positions in interest rates, foreign exchange,
various securities, derivatives and commodities for its own
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account. The Company's proprietary trading activities bring together various
research and trading disciplines allowing it to take market positions, which at
times may be significant, consistent with the Company's expectations of future
events (such as movements in the level of interest rates, changes in the shape
of yield curves and changes in the value of currencies). The Company is subject
to the risk that actual market events will be different from the Company's
expectations, which may result in significant losses associated with such
proprietary positions.
TRADING SERVICES AND CORPORATE
The Company's Trading Services and Corporate divisions provide support to
its businesses through the processing of certain securities and commodities
transactions; receipt, identification and delivery of funds and securities;
safeguarding of customers' securities; and compliance with regulatory and legal
requirements. In addition, this staff is responsible for technology
infrastructure and systems development, treasury operations, financial control
and analysis, tax planning and compliance, internal audit, expense management,
career development and recruiting and other support functions.
TECHNOLOGY AND YEAR 2000 READINESS
During 1998, considerable technology resources were devoted to ensuring the
Company's successful conversion to the Euro and addressing the Year 2000 issue.
The Company's response to the Year 2000 issue is described under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000 Readiness Disclosure" on pages 53-56 of the 1998 Annual
Report.
RISK MANAGEMENT
As a leading global investment banking company, risk is an inherent part of
all of Lehman Brothers' businesses and activities. Lehman Brothers has developed
policies and procedures to identify, measure and monitor each of the various
types of risks involved in its trading, brokerage and investment banking
activities on a global basis. The principal risks involved in Lehman Brothers'
activities are market risk, credit or counterparty risk, liquidity, legal and
operational risks. Lehman Brothers has developed a control infrastructure to
monitor and manage each type of risk on a global basis throughout the Company. A
full description of the Firm's Risk Management procedures is contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Risk Management" on pages 51-53 of the 1998 Annual Report, and is
incorporated herein by reference.
COMPETITION
All aspects of the Company's business are highly competitive. The Company
competes in domestic and international markets directly with numerous other
brokers and dealers in securities and commodities, investment banking firms,
investment advisors and certain commercial banks and, indirectly for investment
funds, with insurance companies and others.
The financial services industry has become considerably more concentrated as
numerous securities firms have either ceased operations or have been acquired by
or merged into other firms. In addition, several small and specialized
securities firms have been successful in raising significant amounts of capital
for their merger and acquisition activities and merchant banking investment
vehicles and for their own accounts. These developments have increased
competition from other firms, many of whom have significantly greater equity
capital than the Company. Pending legislative and regulatory changes in the
United States may allow commercial banks to enter business previously limited to
investment banks, further increasing competition.
REGULATION
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. LBI and certain other subsidiaries
of Holdings are registered as broker-dealers and investment
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advisors with the Commission and as such are subject to regulation by the
Securities and Exchange Commission (the "SEC") and by self-regulatory
organizations, principally the NASD and national securities exchanges such as
the New York Stock Exchange, which has been designated by the SEC as LBl's
primary regulator, and the Municipal Securities Rulemaking Board. Securities
firms are also subject to regulation by state securities administrators in those
states in which they conduct business. LBI is a registered broker-dealer in all
50 states, the District of Columbia and the Commonwealth of Puerto Rico. The
SEC, self-regulatory organizations and state securities commissions may conduct
administrative proceedings, which may result in censure, fine, the issuance of
cease-and-desist orders or suspension or expulsion of a broker-dealer or an
investment advisor, its officers or employees.
LBI is registered with the Commodity Futures Trading Commission (the "CFTC")
as a futures commission merchant and is subject to regulation as such by the
CFTC and various domestic boards of trade and other commodity exchanges. The
Company's U.S. commodity futures and options business is also regulated by the
National Futures Association, a not-for-profit membership corporation which has
been designated as a registered futures association by the CFTC.
The Company does business in the international fixed income, equity and
commodity markets and undertakes investment banking activities through its
London subsidiaries. The U.K Financial Services Act of 1986 (the "Financial
Services Act") governs all aspects of the United Kingdom investment business,
including regulatory capital, sales and trading practices, use and safekeeping
of customer funds and securities, record keeping, margin practices and
procedures, registration standards for individuals, periodic reporting and
settlement procedures. Pursuant to the Financial Services Act, the Company is
subject to regulations administered by The Securities and Futures Authority
Limited, a self regulatory organization of financial services companies (which
regulates the Company's equity, fixed income, commodities and investment banking
activities) and the Bank of England (which regulates its wholesale money market,
bullion and foreign exchange businesses).
Holdings' subsidiary, Lehman Brothers Japan Inc., is a licensed securities
company in Japan and a member of the Tokyo Stock Exchange, the Osaka Stock
Exchange and the Tokyo Financial Futures Exchange and, as such, is regulated by
the Japanese Ministry of Finance, the Japan Securities Dealers Association and
such exchanges.
The Company believes that it is in material compliance with the regulations
described herein.
CAPITAL REQUIREMENTS
LBI, Lehman Brothers International (Europe) ("LBIE"), the Tokyo branch of
Lehman Brothers Japan Inc. ("LBJTB") and other of Holdings' subsidiaries are
subject to various securities, commodities and banking regulations and capital
adequacy requirements promulgated by the regulatory and exchange authorities of
the countries in which they operate. Reference is made to "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Regulatory Capital" on pages 46-47 of the 1998 Annual Report, and
Note 9 of Notes to Consolidated Financial Statements.
EMPLOYEES
As of November 30, 1998 the Company employed approximately 8,873 persons,
including 6,316 in the Americas and 2,557 internationally. The Company considers
its relationship with its employees to be good.
ITEM 2. PROPERTIES
The Company's headquarters occupy approximately 1.1 million square feet of
space at 3 World Financial Center in New York, New York, which is owned by the
Company as tenants-in-common with American Express and various other American
Express subsidiaries, approximately 78,000 square feet of which has been
subleased.
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The Company entered into a lease for approximately 400,000 square feet for
offices located at 101 Hudson Street in Jersey City, New Jersey (the "Operations
Center"), of which approximately 67,000 square feet has been subleased. The
Operations Center is used by systems, operations, and certain administrative
personnel and contains certain back-up trading systems. The lease term expires
in December, 2010.
The Company leases approximately 338,000 square feet of office space in
London, England of which approximately 105,000 square feet has been subleased
and which lease expires in January 2017. Most of the Company's other offices are
located in leased premises, the leases for which expire at various dates through
the year 2007.
Facilities owned or occupied by the Company and its subsidiaries are
believed to be adequate for the purposes for which they are currently used and
are well maintained.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in a number of judicial, regulatory and arbitration
proceedings concerning matters arising in connection with the conduct of its
business. Such proceedings include actions brought against the Company and
others with respect to transactions in which the Company acted as an underwriter
or financial advisor, actions arising out of the Company's activities as a
broker or dealer in securities and commodities and actions brought on behalf of
various classes of claimants against many securities and commodities firms,
including the Company.
Although there can be no assurance as to the ultimate outcome, the Company
has denied, or believes it has a meritorious defense and will deny, liability in
all significant cases pending against it including the matters described below,
and intends to defend vigorously each such case. Although there can be no
assurance as to the ultimate outcome, based on information currently available
and established reserves, the Company believes that the eventual outcome of the
actions against it, including the matters described below, will not, in the
aggregate, have a material adverse effect on the consolidated financial
condition of the Company.
BAMAODAH V. E.F. HUTTON & COMPANY INC.
In April 1986, Ahmed and Saleh Bamaodah commenced an action against E.F.
Hutton & Company Inc., ("EFH") to recover all losses the Bamaodahs had incurred
since May 1981 in the trading of commodity futures contracts in a
nondiscretionary EFH trading account. The Dubai Civil Court ruled that the
trading of commodity futures contracts constituted illegal gambling under
Islamic law and that therefore the brokerage contract was void. In January 1987,
a judgment was rendered against EFH in the amount of $48,656,000. On January 5,
1991, the Dubai Court of Appeals affirmed the judgment. On March 22, 1992, the
Court of Cassation, Dubai's highest court, revoked and quashed the decision of
the Court of Appeals and ordered that the case be remanded to the Court of
Appeals for a further review. On April 26, 1994, the Dubai Court of Appeals
again affirmed the judgment of the Dubai Civil Court. The Company appealed the
judgment to the Court of Cassation, which reversed the Court of Appeals on
November 27, 1994 and ordered that a new expert be appointed to review the case.
A new expert was appointed, who returned a report favorable to EFH. The Court
ordered a review of additional documents and has set an April 1999 hearing date.
ACTIONS RELATING TO FIRST CAPITAL HOLDINGS INC.
Concurrent with the bankruptcy filing of First Capital Holdings ("FCH") in
May, 1991 and the conservatorship and receivership of its two life insurance
subsidiaries, First Capital Life Insurance Company and Fidelity Bankers Life
Insurance Company ("Fidelity Bankers Life"), a number of lawsuits were
commenced, naming one or more of Holdings, Lehman Brothers and American Express
as defendants. Most of these actions have been subsequently settled and/or
dismissed. The only material matter still pending is described below.
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THE VIRGINIA COMMISSIONER OF INSURANCE ACTION. On December 9, 1992, a
complaint was filed in the United States District Court for the Eastern District
of Virginia (the "Virginia Court") by Steven Foster, the Virginia Commissioner
of Insurance (the "Commissioner") as Deputy Receiver of Fidelity Bankers Life.
The Complaint names Holdings and Weingarten, Ginsberg and Leonard Gubar, a
former director of FCH and Fidelity Bankers Life, as defendants. The Complaint
alleged that Holdings acquiesced in and approved the continued mismanagement of
Fidelity Bankers Life and that it participated in directing the investment of
Fidelity Bankers Life assets. The complaint asserted claims under the federal
securities laws and asserts common law claims including fraud, negligence and
breach of fiduciary duty and alleged violations of the Virginia Securities laws
by Holdings. It sought no less than $220 million in damages to Fidelity Bankers
Life and its present and former policyholders and creditors and punitive
damages. On May 21, 1998, after trial, the Court entered a Judgment Order in
accord with the jury verdict, ordering that the plaintiffs recover nothing and
dismissing the complaint. On July 7, 1998, the Commissioner filed a Notice of
Appeal to the United States Court of Appeals for the Fourth Circuit from such
Judgment Order.
EASTON & CO. V. MUTUAL BENEFIT LIFE INSURANCE CO., ET AL., EASTON & CO. V.
LEHMAN BROTHERS INC.
Lehman Brothers was named as a defendant in two consolidated class action
complaints pending in the United States District Court for the District of New
Jersey (the "N.J. District Court"). Easton & Co. v. Mutual Benefit Life
Insurance Co., et al. ("Easton I"), and EASTON & CO. V. LEHMAN BROTHERS INC.
("Easton II"). The plaintiff in both of these actions is Easton & Co., which is
a broker-dealer located in Fort Lee, New Jersey. Both of these actions allege
federal securities law claims and pendent common law claims in connection with
the sale of certain municipal bonds as to which Mutual Benefit Life Insurance
Company ("MBLI") has guaranteed the payment of principal and interest. MBLI is
an insurance company which was placed in rehabilitation proceedings under the
supervision of the New Jersey Insurance Department on or about July 16, 1991.
Easton I was commenced on or about September 17, 1991. The litigation was
purportedly brought on behalf of a class consisting of all persons and entities
who purchased DeKalb, Georgia Housing Authority MultiFamily Housing Revenue
Refunding Bonds (North Hill Ltd. Project), Series 1991, due November 30, 1994
(the "DeKalb Bonds") during the period from May 3, 1991 (when the DeKalb bonds
were issued) through July 16, 1991. Lehman Brothers acted as underwriter for
this bond issue, which was in the aggregate principal amount of $18.7 million.
Easton II was commenced on or about May 18, 1992, and named Lehman Brothers
as the only defendant. Plaintiff purported to bring this second lawsuit on
behalf of a class composed of all persons who purchased "MBLI-backed Bonds" from
Lehman Brothers during the period April 19, 1991 through July 16, 1991. On or
about February 9, 1993, the N.J. District Court granted plaintiffs' motion for
class certification in Easton I. The parties agreed to certification of a class
in Easton II for purchases of certain fixed-rate MBLI-backed bonds during the
class period. LBI, together with the other defendants in Easton I and Easton II,
has agreed to settle both cases, subject to court approval.
ACTIONS RELATING TO THE SALES AND MARKETING OF LIMITED PARTNERSHIPS
Under the terms of an agreement between American Express and Holdings,
American Express has agreed to indemnify Holdings for liabilities which it may
incur in connection with any action relating to any business conducted by The
Balcor Company, a former Lehman Brothers subsidiary ("Balcor"), in which
Holdings is named as a parent company or control person of Balcor. Holdings
believes that some of the allegations in certain of the actions described below
are covered by this indemnity.
IN RE LEHMAN BROTHERS LIMITED PARTNERSHIP LITIGATION. On October 18, 1996,
a purported first consolidated and amended class action complaint was filed in
the Court of Chancery of the State of Delaware in and for New Castle County on
behalf of all persons who purchased units in various public, proprietary limited
partnerships organized by Shearson or E.F. Hutton & Co. or operated by
affiliates of those entities between 1981 and the present (with certain
exceptions). Defendants are LBI and 56
9
<PAGE>
Lehman-affiliated general partners. The complaint alleges that defendants
breached their fiduciary duties or aided and abetted such a breach by allegedly
misrepresenting and or failing to disclose the nature of the risks and the
status and financial condition of the partnerships; collecting excessive fees;
failing to exercise due care in selecting investments for the partnerships; and
recommending and selling the partnerships as suitable investments. The complaint
seeks, among other things (1) to certify the case as a class action; (2) to
declare that defendants breached their duties; (3) to enjoin defendants from
operating the partnerships for their own benefit, (4) to account for all profits
and impose a constructive trust on them; and (5) to award compensatory damages,
costs and expenses and attorneys' fees.
KLEIN, ET AL. V. LEHMAN BROTHERS, INC., ET AL. On January 15, 1998, a
purported third amended class action complaint was filed in the Superior Court
of New Jersey, Law Division: Union County on behalf of investors in certain
specified limited partnerships sponsored by Balcor and sold by various entities,
including, among others, Shearson and certain of its affiliates. Named as
defendants are LBI, various affiliates of LBI, American Express Company, Smith
Barney Holdings, Inc., Balcor, a number of Balcor-originated limited
partnerships and various individuals and entities affiliated with Balcor. The
complaint alleges claims in connection with the marketing, sale and operation of
the limited partnerships for common law fraud and deceit, equitable fraud,
negligent misrepresentation, breach of fiduciary duty and contract and violation
of certain New Jersey statutes relating to the sale of securities. The complaint
seeks compensatory damages for lost principal and interest, general damages and
punitive damages, treble damages under the New Jersey statutes, and costs and
attorneys' fees. On September 24, 1998, the Court filed an opinion dismissing
the complaint, and plaintiffs have appealed that dismissal.
BRUSS, ET AL. V. LEHMAN BROTHERS INC., ET AL. On January 25, 1999 a
purported class action complaint was filed in the Superior Court of New Jersey,
Law Division: Essex County on behalf of investors in certain specified limited
partnerships sponsored by Balcor and sold by various entities, including, among
others, Shearson and certain of its affiliates. The complaint mirrors the claims
raised, the relief sought and the defendants named in KLEIN, ET AL. V. LEHMAN
BROTHERS, INC., ET AL.
COUNTY OF ORANGE ET AL. V. BEAR STEARNS & CO. ET AL.
On December 6, 1996, the County of Orange, California (the "County") filed a
complaint in the United States Bankruptcy Court for the Central District of
California (the "Complaint"), naming 15 broker-dealers, along with various
subsidiaries, including LBI, Lehman Brothers International (Europe), Lehman
Capital Corp and Lehman Commercial Paper, Inc. (the "Lehman defendants"), as
defendants. The Complaint alleges that defendants sold the County unsuitable
securities and entered into unsuitable reverse repurchase transactions with the
County that were ULTRA VIRES. The County seeks a declaration that the reverse
repurchase agreements are void and unenforceable and violated the California
Constitution and Government Code, and it claims that the defendants violated the
California Constitution and Government Code and committed negligence. No damages
are specified, and restitution is sought. Immediately after filing the
Complaint, the parties entered into a stay of the action.
On July 1, 1998, the case was transferred to the United States District
Court for the Central District of California, and on August 21, 1998 the stay
was lifted. On November 10, 1998 the Lehman defendants answered the Complaint,
denying its material allegations. On December 21, 1998, the County moved to
amend the Complaint to add breach of fiduciary duty and aiding and abetting
breach of fiduciary duty claims, and the Court has ruled that plaintiff may file
the amended complaint (the "Amended Complaint"). On January 5, 1999, the Court
entered an order granting summary judgment for defendants on the ULTRA VIRES
claims.
LEHMAN BROTHERS COMMERCIAL CORPORATION AND LEHMAN BROTHERS SPECIAL FINANCING
INC. V. MINMETALS INTERNATIONAL NON-FERROUS METALS TRADING COMPANY
On November 15, 1994, two Lehman Brothers subsidiaries, Lehman Brothers
Commercial Corporation ("LBCC") and Lehman Brothers Special Financing Inc.
("LBSF"), commenced an action against
10
<PAGE>
Minmetals International Non-Ferrous Metals Trading Company ("Minmetals") and
China National Metals and Minerals Import and Export Company ("CNM") in the
United States District Court for the Southern District of New York alleging
breach of contract against Minmetals and breach of guarantee against CNM. The
litigation arose from the refusal by Minmetals and CNM to honor their
obligations with respect to certain foreign exchange and swap transactions. LBCC
and LBSF seek to recover approximately $52.5 million from Minmetals and/or CNM.
On June 26, 1995, the court granted CNM's motion to dismiss the claims against
it, but also granted LBCC and LBSF leave to replead. Minmetals filed fourteen
counterclaims against Lehman entities based on violations of federal securities
and commodities laws and rules, and theories of fraud, breach of fiduciary duty
and conversion. The court denied a motion by the Lehman counterclaim defendants
to dismiss the six fraud-based counterclaims. On June 24, 1996, the court
granted the motion of LBCC and LBSF to file an amended complaint naming CNM as
an additional defendant. Discovery is complete, and summary judgment motions are
pending before the court.
ACTIONS RELATING TO NATIONAL ASSOCIATION OF SECURITIES DEALERS AUTOMATED
QUOTATIONS SYSTEM ("NASDAQ") MARKET MAKER ANTITRUST AND SECURITIES LITIGATION.
Beginning in May, 1994, several class actions were filed in various state
and federal courts against various broker-dealers making markets in NASDAQ
securities, including LBI. Plaintiffs in these cases alleged violations of the
antitrust laws, securities laws and have pled a variety of other statutory and
common law claims. All of these actions were based on the theory that because
odd-eighth quotes occur less often than quarter quotes, NASDAQ market makers
must be colluding wrongfully to maintain a wider spread. By Order filed October
14, 1994, the Judicial Panel on Multidistrict Litigation consolidated these
actions in the Southern District of New York and ordered that all related
actions be transferred and coordinated for all pretrial purposes. The case is
captioned In Re NASDAQ Market-Makers Antitrust Litigation, MDL No. 1023.
On December 16, 1994, plaintiffs served a consolidated Amended Complaint
naming 33 defendants including LBI. Plaintiffs claim violations of the federal
antitrust laws including Section I of the Sherman Antitrust Act. Plaintiffs seek
unspecified compensatory damages trebled in accordance with the antitrust laws,
costs including attorneys' fees as well as injunctive relief. The court
dismissed the action with leave to replead, stating that the complaint failed to
identify the securities involved with sufficient specificity. The plaintiffs
repled and the defendants answered the amended complaint on November 17, 1995.
On December 23, 1997, LBI settled the class action along with 29 other
broker-dealers. The Court entered a Final Judgment and Order of Dismissal on
November 9, 1998.
AIA HOLDING SA ET AL. V. LEHMAN BROTHERS INC. AND BEAR STEARNS & CO., INC.
On July 9, 1997, LBI was served with a complaint in the U.S. District Court
for the Southern District of New York in which 277 named plaintiffs assert 24
causes of action against LBI and Bear Stearns & Co., Inc. The amount of damages
claimed is unspecified. The claims arise from the activities of an individual
named Ahmad Daouk, who was employed by an introducing broker which introduced
accounts to Shearson Lehman Hutton between 1988 and 1992. Daouk allegedly
perpetrated a fraud upon the claimants, who are mostly investors of Middle
Eastern origin, and the complaint alleges that Shearson breached various
contractual and common law duties owed to the investors. On March 27, 1998, the
District Court dismissed without prejudice 18 of the 24 counts pleaded in the
complaint. On July 3, 1998 the plaintiffs served their First Amended Complaint
containing 18 causes of action against LBI and/or Bear Stearns.
ACTIONS RELATING TO BRE-X MINERALS LTD.
MCNAMARA ET AL. V. BRE-X MINERALS LTD. ET AL. On July 25, 1997, an Amended
Class Action Complaint was filed in the United States District Court for the
Eastern District of Texas against 16 defendants, including LBI, which seeks
unspecified compensatory damages, interest, costs and attorney's fees on behalf
11
<PAGE>
of purchasers of Bre-X common stock and/or Bresea common stock. The Complaint
raises claims under the federal securities laws and the common law of fraud and
negligent misrepresentation. The Complaint's stated basis for naming LBI is that
one of its securities analysts published research on Bre-X. On or about November
21, 1997, several defendants, including LBI, moved to dismiss the Complaint, or,
in the alternative, to transfer venue to the Southern District of New York.
Plaintiffs have also filed a motion for class certification, which is stayed
pending resolution of the motions to dismiss. On January 6, 1999, the Court
issued an order dismissing the claims of Canadian plaintiffs who bought their
shares on Canadian exchanges. The remaining motions to dismiss are still
pending.
KLAASEN V. LEHMAN BROTHERS INC. ET AL. On October 2, 1997, William L.
Klaasen, "individually and for all those similarly situated within the State of
California," filed a Complaint against LBI in the Superior Court for the State
of California in and for the County of San Diego. The Complaint raises a claim
for common law negligence, and seeks, on behalf of California purchasers of
Bre-X and Bresea stock, class certification, rescission, interest, compensatory
and punitive damages, disgorgement and restitution of profits and compensation
received by LBI, and costs. The action is currently stayed by consent until the
earlier of April 1, 1998 or 30 days following the decision on the motion to
dismiss in the MCNAMARA case.
CHOW ET AL. V. BRE-X MINERALS LTD. ET AL. On October 10, 1997, 125 named
plaintiffs filed an action in the Court of Queen's Bench of Alberta, in Calgary,
Canada, against 35 named defendants, including LBI. Plaintiffs claim against
LBI, which has not yet been served, is for common law negligence.
IN RE MOBILEMEDIA SECURITIES LITIGATION
LBI was named as a defendant in several purported class actions filed in
December, 1996 in the United States District Court for the District of New
Jersey in connection with (I) a November 7, 1995 offering of common stock of
MobileMedia Corporation; and (ii) a November 7, 1995 offering of 9 3/8% senior
subordinated notes of MobileMedia Communications Inc. due in 2007. On November
3, 1997, a consolidated amended class action complaint was filed naming certain
of MobileMedia Corporation's officers and directors and the four co-lead
underwriters of these offerings, including LBI. MobileMedia filed for Chapter 11
bankruptcy protection on January 30, 1997, and therefore is not named as a
defendant. The complaint alleges that the underwriters violated Sections 11 and
12 of the Securities Act. Plaintiffs seek rescission and unspecified
compensatory damages.
HAROLD GILLET, ET AL. V. GOLDMAN SACHS & CO., ET AL., YAKOV PRAGER, ET AL. V.
GOLDMAN, SACHS & CO., ET AL., DAVID HOLZMAN, ET AL. V. GOLDMAN, SACHS & CO.,
ET AL.
Beginning in November, 1998, three class actions were filed in the United
States District Court for the Southern District of New York against in excess of
25 underwriters of IPO securities including LBI. Plaintiffs in these cases seek
compensatory and injunctive relief for alleged violations of the antitrust laws
based on the theory that the defendant underwriters fixed and maintained fees
for underwriting certain IPO securities at supracompetitive levels. Plaintiffs
plan to file a Consolidated Amended Complaint.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
12
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The approximate number of holders of record of the Registrant's Common Stock
was 28,137 at February 9, 1999. Information concerning the market for the
Registrant's common equity and related stockholder matters is set forth on page
96 of the 1998 Annual Report and is hereby incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data contained on pages 93-94 of the 1998 Annual Report
is deemed a part of this Annual Report on Form 10-K and is hereby incorporated
herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations is set forth under the same caption on pages 35-57 of the 1998 Annual
Report. Such information is hereby incorporated herein by reference and should
be read in conjunction with the Consolidated Financial Statements and the Notes
thereto contained on pages 59-92 of the 1998 Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Risk Management" on pages 51-53
of the 1998 Annual Report is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Registrant and its Subsidiaries
together with the Notes thereto and the Report of Independent Auditors thereon
required by this Item are contained in the 1998 Annual Report on pages 58-92 and
are hereby incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
13
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to Directors of the Registrant is set forth under the
caption "Election of Directors" on pages 5-8 of the Proxy Statement and
information relating to Executive Officers of the Registrant is set forth under
the caption "Executive Officers of the Company" on pages 10 and 11 of the Proxy
Statement and is hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to executive compensation is set forth under the
captions "Compensation of Directors", "Compensation Committee Report on
Executive Officer Compensation", "Compensation of Executive Officers", "Pension
Benefits" and "Employment Contracts, Termination of Employment and Change of
Control Arrangements" on pages 9 and 13-18 of the Proxy Statement and is hereby
incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information relating to security ownership of management and certain
beneficial owners is set forth under the caption "Security Ownership of
Directors and Executive Officers" on page 12 of the Proxy Statement and is
hereby incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to certain relationships and related transactions is
set forth under the captions "Certain Transactions and Agreements with Directors
and Executive Officers", "Certain Transactions and Agreements with American
Express and Subsidiaries" and "Certain Transactions with Other Institutional
Investors and Their Subsidiaries" on pages 20-22 of the Proxy Statement and is
hereby incorporated herein by reference.
14
<PAGE>
PART IV
ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements:
The Financial Statements and the Notes thereto and the Report of Independent
Auditors thereon and filed as a part hereof are listed on page F-1 hereof by
reference to the corresponding page number in the Annual Report.
2. Financial Statement Schedules:
The financial statement schedule and the notes thereto filed as a part
hereof are listed on page F-1 hereof.
3. Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NO.
- -----------
<C> <S>
3.1 Restated Certificate of Incorporation of the Registrant dated May 27, 1994 (incorporated by reference to
Exhibit 3.1 of the Registrant's Transition Report on Form 10-K for the eleven months ended November 30,
1994).
3.2 Certificate of Designations with respect to the Registrant's 5.94% Cumulative Preferred Stock, Series C
(incorporated by reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K filed with the
Commission on May 13, 1998)
3.3 Certificate of Designations with respect to the Registrant's 5.67% Cumulative Preferred Stock, Series D
(incorporated by reference to Exhibit 4.2 to the Registrant's Current Report on Form 8-K filed with the
Commission on July 23, 1998)
3.4 By-Laws of the Registrant, amended as of March 26, 1997 ((incorporated by reference to Exhibit 10 of the
Registrant's Quarterly Report on Form 10-Q for the quarter ended February 28, 1997).
4.1 The instruments defining the rights of holders of the long-term debt securities of the Registrant and its
subsidiaries are omitted pursuant to section (b) (4) (iii) (A) of Item 601 of Regulation S-K. The
Registrant hereby agrees to furnish copies of these instruments to the Securities and Exchange Commission
upon request.
10.1 Agreement of Tenants-In-Common by and among American Express Company, American Express Bank Ltd.,
American Express Travel Related Services Company, Inc., Shearson Lehman Brothers Inc., Shearson Lehman
Government Securities, Inc. and Shearson Lehman Commercial Paper Incorporated (incorporated by reference
to Exhibit 10.1 of the Registrant's Transition Report on Form 10-K for the eleven months ended November
30, 1994).
10.2 Tax Allocation Agreement between Shearson Lehman Brothers Holdings Inc. and American Express Company
(incorporated by reference to Exhibit 10.2 of the Registrant's Transition Report on Form 10-K for the
eleven months ended November 30, 1994).
10.3 Transaction Support Services Agreement dated as of September 30, 1994 by and between Bear, Stearns
Securities Corp. and Lehman Brothers Inc. (incorporated by reference to Exhibit 10.15 of the Registrant's
Transition Report on Form 10-K for the eleven months ended November 30, 1994).
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO.
- -----------
<C> <S>
10.4 Lease dated as of October 13, 1993 between 101 Hudson Leasing Associates and Lehman Brothers Holdings
Inc. (incorporated by reference to Exhibit 10 of Holdings' Quarterly Report on Form 10-Q for the quarter
ended September 30, 1993).
10.5 Lehman Brothers Inc. Executive and Select Employees Plan (incorporated by reference to Exhibit 10.4 of
the Registrant's Registration Statement on Form S-1 (Reg. No. 33-12976)).
10.6 Lehman Brothers Holdings Inc. Deferred Compensation Plan for Non-Employee Directors (incorporated by
reference to Exhibit 10.11 of the Registrant's Registration Statement on Form S-1 (Reg. No. 33-12976)).
10.7 Amended and Restated Agreements of Limited Partnership of Shearson Lehman Hutton Capital Partners II
(incorporated by reference to Exhibit 10.48 of the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1988).
10.8 Lehman Brothers Holdings Inc. 1994 Management Ownership Plan (incorporated by reference to Exhibit 10.25
of the Registrant's Registration Statement on Form S-1 (Reg. No. 33-52977)).
10.9 Lehman Brothers Holdings Inc. 1996 Management Ownership Plan (incorporated by reference to Exhibit 10.1
of the Registrant's Quarterly Report on Form 10-Q for the quarter ended August 31, 1996).
10.10+ Lehman Brothers Holdings Inc. Short-Term Executive Compensation Plan (incorporated by reference to
Exhibit 10.2 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended August 31, 1996).
10.11+ Lehman Brothers Holdings Inc. 1996 Short-Term Executive Compensation Plan (incorporated by reference to
Exhibit 10.26 of the Registrant's Registration Statement on Form S-1 (Reg. No. 33-52977)).
10.12+ Lehman Brothers Holdings Inc. 1994 Employee Stock Purchase Plan (incorporated by reference to Exhibit
10.27 of the Registrant's Registration Statement on Form S-1 (Reg. No. 33-52977)).
10.13 Option Agreement, dated May 27, 1994, by and among American Express Company, American Express Bank Ltd.,
American Express Travel Related Services Company, Inc., Lehman Brothers Inc., Lehman Government
Securities, Inc. and Lehman Commercial Paper Incorporated. (incorporated by reference to Exhibit 10.31 of
the Registrant's Transition Report Form 10-K for the Eleven Months ended November 30, 1994).
10.14+ Lehman Brothers Inc. Voluntary Deferred Compensation Plan (For Select Executives) (incorporated by
reference to Exhibit 10.33 of the Registrant's Registration Statement on Form S-1 (Reg. No. 33-52977)).
10.15+ Lehman Brothers Inc. Voluntary Deferred Compensation Plan (For Transferred Participants' Vested Amounts
as of July 31, 1993) (incorporated by reference to Exhibit 10.34 of the Registrant's Registration
Statement on Form S-1 (Reg. No. 33-52977)).
10.16+ Lehman Brothers Inc. Executive and Select Employees Plan (For Transferred Participants) (incorporated by
reference to Exhibit 10.35 of the Registrant's Registration Statement on Form S-1 (Reg. No. 33-52977)).
10.17+ Lehman Brothers Holdings Inc. Cash Award Plan. (incorporated by reference to Exhibit 10.36 of the
Registrant's Transition Report on Form 10-K for the Eleven Months ended November 30, 1994).
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO.
- -----------
<C> <S>
10.18 Amended and Restated Agreement of Limited Partnership of Lehman Brothers Capital Partners III, L.P.
(incorporated by reference to Exhibit 10.27 to the Registrant's Annual Report on Form 10-K for the fiscal
year ended November 30, 1995).
10.19+ Lehman Brothers Holdings Inc. Merchant Banking Long-Term Incentive Plan (for U.S. participants)
(incorporated by reference to Exhibit 10.28 to the Registrant's Annual Report on Form 10-K for the fiscal
year ended November 30, 1996).
10.20+ Lehman Brothers Holdings Inc. Merchant Banking Discretionary Incentive Compensation Plan (for non-U.S.
participants) (incorporated by reference to Exhibit 10.29 to the Registrant's Annual Report on Form 10-K
for the fiscal year ended November 30, 1996).
10.21 Agreement of Limited Partnership of Lehman Brothers Capital Partners IV, L.P. (incorporated by reference
to Exhibit 10.30 to the Registrant's Annual Report on Form 10-K for the fiscal year ended November 30,
1997)
12.1 Computation in support of ratio of earnings to fixed charges.*
12.2 Computation in support of ratio of earnings to combined fixed charges and preferred dividends.*
13. The following portions of the Company's 1998 Annual Report to Stockholders, which are incorporated by
reference herein:
13.1 "Management's Discussion and Analysis of Financial Condition and Results of Operations", pages 35-57.*
13.2 "Consolidated Financial Statements", pages 59-92.*
13.3 "Market for Registrant"s Common Equity and Related Stockholder Matters", page 96.*
21. List of the Registrant's Subsidiaries*.*
23. Consent of Ernst & Young LLP.*
24. Powers of Attorney.*
27. Financial Data Schedule.*
</TABLE>
(b) Reports on Form 8-K.
1. Form 8-K dated September 4, 1997, Item 7.
2. Form 8-K dated September 23, 1998, Items 5 and 7.
3. Form 8-K dated September 28, 1998, Items 5 and 7.
4. Form 8-K dated October 5, 1998, Items 5 and 7.
- ------------------------
* Filed herewith.
+ Management contract or compensatory plan or arrangement reqired to be filed
as an exhibit to this Form 10-K pursuant to Item 14(c)
** To be filed by amendment.
17
<PAGE>
SIGNATURES
Pursuant to the Requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
LEHMAN BROTHERS HOLDINGS INC.
(REGISTRANT)
FEBRUARY 26, 1999
By: /s/ KAREN M. MULLER
-----------------------------------------
Title: VICE PRESIDENT
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURES TITLE DATE
- ------------------------------ --------------------------- -------------------
Chief Executive Officer and
* Chairman of the Board of
- ------------------------------ Directors (principal February 26, 1999
Richard S. Fuld, Jr. executive officer)
Chief Financial and
* Administrative Officer
- ------------------------------ (principal financial and February 26, 1999
John L. Cecil accounting officer)
* Director
- ------------------------------ February 26, 1999
Michael L. Ainslie
* Director
- ------------------------------ February 26, 1999
John F. Akers
* Director
- ------------------------------ February 26, 1999
Roger S. Berlind
* Director
- ------------------------------ February 26, 1999
Thomas H. Cruikshank
* Director
- ------------------------------ February 26, 1999
Henry Kaufman
18
<PAGE>
SIGNATURES TITLE DATE
- ------------------------------ --------------------------- -------------------
* Director
- ------------------------------ February 26, 1999
Hideichiro Kobayashi
* Director
- ------------------------------ February 26, 1999
John D. Macomber
* Director
- ------------------------------ February 26, 1999
Dina Merrill
/s/ KAREN M. MULLER Director
- ------------------------------
Karen M. Muller February 26, 1999
(ATTORNEY-IN-FACT)
February 26, 1999
19
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
<TABLE>
<CAPTION>
PAGE
----------------------------------
FORM 10-K ANNUAL REPORT
------------- -------------------
<S> <C> <C>
FINANCIAL STATEMENTS
Report of Independent Auditors........................................................ 58
Consolidated Statement of Income for the Twelve Months Ended November 30, 1998, 1997,
and 1996............................................................................ 59
Consolidated Statement of Financial Condition at November 30, 1998 and 1997........... 60
Consolidated Statement of Changes in Stockholders' Equity for the Twelve Months Ended
November 30, 1998, 1997, and 1996................................................... 62
Consolidated Statement of Cash Flows for the Twelve Months Ended November 30, 1998,
1997, and 1996...................................................................... 64
Notes to Consolidated Financial Statements............................................ 66
FINANCIAL STATEMENT SCHEDULE
Schedule I--Condensed Financial Information........................................... F-2
</TABLE>
F-1
<PAGE>
SCHEDULE I
LEHMAN BROTHERS HOLDINGS INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENT OF INCOME
(PARENT COMPANY ONLY)
(IN MILLIONS)
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED
NOVEMBER 30
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Revenues
Investment banking........................................................ $ 37 $ 140 $ 90
Principal transactions.................................................... (80) 193 23
Interest and dividends.................................................... 2,254 1,271 882
Other..................................................................... (71) 8 6
--------- --------- ---------
Total revenues........................................................ 2,140 1,612 1,001
Interest expense.......................................................... 2,252 1,304 966
--------- --------- ---------
Net revenues.......................................................... (112) 308 35
--------- --------- ---------
Equity in net income of subsidiaries........................................ 942 492 454
--------- --------- ---------
Non-interest expenses
Compensation and benefits................................................. 135 113 64
Other..................................................................... 121 116 105
Management fees........................................................... 14 (28) (81)
Severance charge.......................................................... 50
--------- --------- ---------
Total non -interest expenses.......................................... 270 201 138
--------- --------- ---------
Income before taxes......................................................... 560 599 351
Benefit from income taxes................................................. 176 48 65
--------- --------- ---------
Net income.................................................................. $ 736 $ 647 $ 416
--------- --------- ---------
--------- --------- ---------
Net income applicable to common stock....................................... $ 649 $ 572 $ 378
--------- --------- ---------
--------- --------- ---------
</TABLE>
See notes to condensed financial information of Registrant.
F-2
<PAGE>
SCHEDULE I
LEHMAN BROTHERS HOLDINGS INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEET
(PARENT COMPANY ONLY)
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
NOVEMBER 30
--------------------
<S> <C> <C>
1998 1997
--------- ---------
ASSETS
Cash and cash equivalents................................................................... $ 1,152
Securities and other financial instruments owned............................................ 10,561 $ 8,751
Securities purchased under agreements to resell............................................. 244
Equity in net assets of subsidiaries........................................................ 5,174 3,922
Accounts receivable and accrued interest.................................................... 490 596
Due from subsidiaries....................................................................... 23,149 17,230
Other assets................................................................................ 1,137 693
--------- ---------
Total assets............................................................................ $ 41,907 $ 31,192
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Commercial paper and short-term debt........................................................ $ 3,596 $ 4,472
Securities and other financial instruments sold but not yet purchased....................... 81 122
Securities sold under agreeements to repurchase............................................. 11,162 8,758
Accrued liabilities, due to subsidiaries and other payables................................. 4,718 1,586
Senior notes................................................................................ 16,737 11,531
Subordinated indebtedness................................................................... 200 200
--------- ---------
Total liabilities....................................................................... 36,494 26,669
--------- ---------
Commitments and Contingencies
Stockholders' equity:
Preferred stock........................................................................... 908 508
Common stock, $0.10 par value; 300,000,000 shares authorized; Shares issued: 121,801,123
in 1998 and 119,513,337 in 1997; Shares outstanding: 113,657,877 in 1998 and 116,612,074
in 1997................................................................................. 12 12
Additional paid-in capital................................................................ 3,534 3,436
Accumulated other comprehensive income (net of tax)....................................... 15 12
Retained earnings......................................................................... 1,105 498
Other stockholders' equity, net........................................................... 269 155
Common stock in treasury, at cost: 8,143,246 shares in 1998 and 2,901,263 shares in
1997.................................................................................... (430) (98)
--------- ---------
Total stockholders' equity.............................................................. 5,413 4,523
--------- ---------
Total liabilities and stockholders' equity.............................................. $ 41,907 $ 31,192
--------- ---------
</TABLE>
See notes to condensed financial information of Registrant.
F-3
<PAGE>
SCHEDULE I
LEHMAN BROTHERS HOLDINGS INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENT OF CASH FLOWS
(PARENT COMPANY ONLY)
(IN MILLIONS)
<TABLE>
<CAPTION>
TWELVE MONTHS
ENDED
NOVEMBER 30
-------------------------------
<S> <C> <C> <C>
1998 1997 1996
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income......................................................................... $ 736 $ 647 $ 416
Adjustments to reconcile net income to net cash provided by (used in)operating
activities:
Equity in net income of subsidiaries............................................. (942) (492) (454)
Severance charge................................................................. 50
Compensation payable in common stock............................................. 221 162 136
Other adjustments................................................................ 178 24 (5)
Net change in:
Securities and other financial instruments owned................................. (1,810) (5,211) (945)
Accounts receivable and accrued interest, due from subsidiaries and other
assets......................................................................... (6,261) (6,380) (1,262)
Securities and other financial instruments sold but not yet purchased............ (41) (76) 22
Accrued liabilities, due to subsidiaries and other payables...................... 2,978 770 (84)
Dividends and capital distributions received..................................... 141 304 609
--------- --------- ---------
Net cash provided by (used in) operating activities............................ (4,800) (10,252) (1,517)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of senior notes............................................. 8,298 3,925 2,686
Principal payments of senior notes................................................. (3,101) (1,689) (1,778)
Proceeds from issuance of subordinated indebtedness................................ 200
Payments for commercial paper and short-term debt, net............................. (876) 1,297 1,073
Resale agreements net of repurchase agreements..................................... 2,160 6,140 545
Payment for repurchase of preferred stock.......................................... (50) (200)
Payment for treasury stock purchases............................................... (411) (77) (130)
Dividends paid..................................................................... (122) (58) (55)
Issuances of common stock.......................................................... 61 23 6
Issuances of preferred stock....................................................... 444
--------- --------- ---------
Net cash provided by (used in) financing activities............................ 6,403 9,561 2,347
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Equity in net assets of subsidiaries............................................... (451) 16 (173)
--------- --------- ---------
Net cash provided by (used in) investing activities............................ (451) 16 (173)
--------- --------- ---------
Net change in cash and cash equivalents........................................ 1,152 (675) 657
Cash and cash equivalents, beginning of period..................................... 675 18
--------- --------- ---------
Cash and cash equivalents, end of period......................................... $ 1,152 $ 0 $ 675
--------- --------- ---------
--------- --------- ---------
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS)
Interest paid totaled $2,121 in 1998, $1,277 in 1997 and $933 in 1996. Income
taxes (received) paid totaled $(91) in 1998, $33 in 1997 and $(48) in 1996.
See notes to condensed financial information of Registrant.
F-4
<PAGE>
LEHMAN BROTHERS HOLDINGS INC.
NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)
SCHEDULE I
NOTE 1. BASIS OF PRESENTATION
The condensed financial statements of Lehman Brothers Holdings Inc.
("Holdings") should be read in conjunction with the consolidated financial
statements of Lehman Brothers Holdings Inc. and subsidiaries and the notes
thereto.
Certain amounts reflect reclassifications to conform to the current period's
presentation.
NOTE 2. LONG-TERM DEBT
<TABLE>
<CAPTION>
U.S. DOLLAR NON-U.S. DOLLAR NOVEMBER 30
---------------------- ---------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
FIXED FLOATING FIXED FLOATING
RATE RATE RATE RATE 1998 1997
--------- ----------- --------- ----------- --------- ---------
<CAPTION>
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Senior Notes
Maturing in Fiscal 1998............................. $ 2,069
Maturing in Fiscal 1999............................. $ 1,536 $ 2,518 $ 623 $ 20 $ 4,697 2,612
Maturing in Fiscal 2000............................. 3,086 1,814 32 4,932 2,848
Maturing in Fiscal 2001............................. 1,017 608 1,625 510
Maturing in Fiscal 2002............................. 1,349 195 1,544 1,330
Maturing in Fiscal 2003............................. 1,660 383 15 2,058 489
December 1, 2003 and thereafter..................... 1,792 33 51 5 1,881 1,673
--------- ----------- --------- ----- --------- ---------
Senior Notes...................................... 10,440 5,551 721 25 16,737 11,531
--------- ----------- --------- ----- --------- ---------
Subordinated Indebtedness
December 1, 2003 and thereafter................... 200 200 200
--------- ----------- --------- ----- --------- ---------
Long-Term Debt...................................... $ 10,640 $ 5,551 $ 721 $ 25 $ 16,937 $ 11,731
--------- ----------- --------- ----- --------- ---------
--------- ----------- --------- ----- --------- ---------
</TABLE>
Of the Company's long-term debt outstanding as of November 30, 1998, $600
million is repayable prior to maturity at the option of the holder, at par
value. These obligations are reflected in the above table at their put dates,
which range from fiscal 1999 to fiscal 2002, rather than at their contractual
maturities, which range from fiscal 2000 to fiscal 2019. In addition, $920
million of the Company's long-term debt is redeemable prior to maturity at the
option of the Company under various terms and conditions. These obligations are
reflected in the above table at their contractual maturity dates.
As of November 30, 1998, the Company's U.S. dollar and non-U.S. dollar debt
portfolios included approximately $238 million and $54 million, respectively, of
debt for which the interest rates and/or redemption values have been linked to
various indices including industry baskets of stocks or commodities. Generally,
such rates are issued as floating rate notes or the interest rates on such index
notes are effectively converted to floating rates based primarily on LIBOR
through the use of interest rate and currency swaps.
END USER DERIVATIVE ACTIVITIES
The Company utilizes a variety of derivative products including interest
rate and currency swaps, and swaptions as an end user to modify the interest
rate characteristics of its long-term debt portfolio. The
F-5
<PAGE>
LEHMAN BROTHERS HOLDINGS INC.
NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
(PARENT COMPANY ONLY)
Company actively manages the interest rate exposure on its long-term debt
portfolio to more closely match the terms of its debt portfolio to the assets
being funded and to minimize interest rate risk. In addition, the Company
utilizes cross-currency swaps to hedge its exposure to foreign currency risk as
a result of its non-U.S. dollar debt obligations, after consideration of
non-U.S. dollar assets which are funded with long-term debt obligations in the
same currency. In certain instances, two or more derivative contracts may be
utilized by the Company to manage the interest rate nature and/or currency
exposure of an individual long-term debt issuance. In these cases, the notional
value of the derivative contracts may exceed the carrying value of the related
long-term debt issuance.
At November 30, 1998 and November 30, 1997, the notional values of the
Company's interest rate and currency swaps related to its long-term debt
obligations were approximately $15.3 billion and $10.5 billion, respectively. In
terms of notional amounts outstanding, these derivative products mature as
follows:
<TABLE>
<CAPTION>
NOVEMBER
NON- U.S. CROSS --------------------
U.S. DOLLAR DOLLAR CURRENCY 1998 1997
----------- ----------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C>
(IN MILLIONS)
Maturing in Fiscal 1998..................................... $ 1,760
Maturing in Fiscal 1999..................................... $ 2,864 $ 624 $ 3,488 2,324
Maturing in Fiscal 2000..................................... 4,709 32 4,741 2,454
Maturing in Fiscal 2001..................................... 1,579 1,579 468
Maturing in Fiscal 2002..................................... 1,609 1,609 1,167
Maturing in Fiscal 2003..................................... 1,968 $ 4 11 1,983 489
December 1, 2003 and thereafter............................. 1,921 56 1,977 1,812
----------- --- ----- --------- ---------
Total....................................................... $ 14,650 $ 4 $ 723 $ 15,377 $ 10,474
----------- --- ----- --------- ---------
Weighted-average interest rate at November 30:(1)
Receive rate................................................ 6.54% 3.32% 4.43% 6.44% 6.97%
Pay rate.................................................... 5.85% 0.64% 5.93% 5.86% 6.48%
</TABLE>
The Company's end user derivative activities resulted in the following
changes to the Company's mix of fixed and floating rate debt and effective
weighted-average rates of interest:
<TABLE>
<CAPTION>
NOVEMBER 30, 1998
----------------------------------------------------
<S> <C> <C> <C> <C>
LONG-TERM DEBT WEIGHTED-AVERAGE(1)
------------------------ --------------------------
<CAPTION>
EFFECTIVE
RATE
BEFORE AFTER CONTRACTUAL AFTER END
END USER END USER INTEREST USER
ACTIVITIES ACTIVITIES RATE ACTIVITIES
----------- ----------- ----------- -------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
USD Obligations
Fixed Rate................................................... $ 10,640 $ 156
Floating Rate................................................ 5,551 16,758
----------- -----------
16,191 16,914
Non-USD Obligations............................................ 746 23
----------- ----------- ----------- ------
Total.......................................................... $ 16,937 $ 16,937 6.47% 5.93%
----------- ----------- ----------- ------
</TABLE>
- ------------------------
(1) Weighted-average interest rates were calculated utilizing non-U.S. dollar
interest rates, where applicable.
F-6
<PAGE>
LEHMAN BROTHERS HOLDINGS INC.
NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
(PARENT COMPANY ONLY)
<TABLE>
<CAPTION>
NOVEMBER 30, 1997
------------------------------------------------------
<S> <C> <C> <C> <C>
LONG-TERM DEBT WEIGHTED-AVERAGE(1)
------------------------ ----------------------------
<CAPTION>
BEFORE AFTER CONTRACTUAL EFFECTIVE RATE
END USER END USER INTEREST AFTER END USER
ACTIVITIES ACTIVITIES RATE ACTIVITIES
----------- ----------- ----------- ---------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
USD Obligations
Fixed Rate................................................. $ 9,115 $ 86
Floating Rate.............................................. 1,712 11,602
----------- -----------
10,827 11,688
Non-USD Obligations.......................................... 904 43
----------- ----------- ----------- ------
Total........................................................ $ 11,731 $ 11,731 6.93% 6.48%
----------- ----------- ----------- ------
</TABLE>
- ------------------------
(1) Weighted-average interest rates were calculated utilizing non-US dollar
interest rates, where applicable.
NOTE 3. DIVIDENDS
Dividends and capital distributions declared to Holdings by its subsidiaries
and affiliates were $141 million in 1998, $304 million in 1997, and $609 million
in 1996.
NOTE 4. 1996 SEVERANCE CHARGE
In the fourth quarter of 1996, Lehman Brothers Holdings Inc. and
subsidiaries (collectively, "LBHI") recorded an $84 million severance charge
($50 million aftertax) related to certain strategic actions taken to improve
on-going profitability. The severance charge reflected the culmination of LBHI's
worldwide business unit economic performance review that was undertaken in the
fourth quarter of 1996 to focus LBHI on its core investment banking, equity and
fixed income sales and trading areas. This formalized review resulted in
personnel reductions of approximately 270 people across a number of
underperforming fixed income and equity businesses, including exiting the
precious metals business in the U.S., Europe and Asia; exiting energy trading in
the U.S. and Europe, consolidating Asian fixed income risk management activities
into one center in Tokyo; refocusing foreign exchange trading activities and
combining the Firm's New York Private Client Services offices. Additionally, the
charge reflects various other strategic personnel reductions aimed at delayering
management.
The Company recorded a $50 million severance charge ($30 million aftertax)
in the fourth quarter of 1996 related to these actions. The Company's cash
outlays relating to the charge were approximately $9 million in the fourth
quarter of 1996 and approximately $38 million during fiscal 1997. The remaining
residual payments were paid as deferred payment arrangements were completed.
NOTE 5. MANAGEMENT FEES
The Company incurs charges including occupancy, administration and computer
processing, which are related to its activities and that of certain of its
subsidiaries (the "Related Parties"). Such charges are allocated between the
Related Parties, based upon specific identification and allocation methods. The
allocation of such charges to other affiliates is recognized as management fees.
NOTE 6. COMMITMENTS AND CONTINGENCIES
The Company has guaranteed certain of its subsidiaries' unsecured lines of
credit and other contractual obligations.
F-7
<PAGE>
EXHIBIT 12.1
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
COMPUTATION IN SUPPORT OF RATIO OF EARNINGS TO FIXED CHARGES
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FOR THE FOR THE FOR THE FOR THE FOR THE
ELEVEN MONTHS TWELVE TWELVE TWELVE TWELVE
ENDED MONTHS ENDED MONTHS ENDED MONTHS ENDED MONTHS ENDED
NOVEMBER 30 NOVEMBER 30 NOVEMBER 30 NOVEMBER 30 NOVEMBER 30
1994 1995 1996 1997 1998
------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Fixed Charges:
Interest expense:
Subordinated indebtedness............... $ 158 $ 206 $ 220 $ 240 $ 245
Bank loans and other
borrowings*........................... 6,294 10,199 10,596 12,770 15,536
Interest component of rentals of office
and equipment......................... 42 44 34 32 32
Other adjustments**..................... 4 28 16 9 15
------ ------------ ------------ ------------ ------------
TOTAL (A)............................. $ 6,498 $ 10,477 $ 10,866 $ 13,051 $ 15,828
------ ------------ ------------ ------------ ------------
------ ------------ ------------ ------------ ------------
Earnings:
Pretax income (loss) from continuing
operations............................ $ 193 $ 369 $ 637 $ 937 $ 1,052
Fixed charges........................... 6,498 10,477 10,866 13,051 15,828
Other adjustments***.................... (4) (28) (14) (8) (15)
------ ------------ ------------ ------------ ------------
TOTAL (B)............................. $ 6,687 $ 10,818 $ 11,489 $ 13,980 $ 16,865
------ ------------ ------------ ------------ ------------
------ ------------ ------------ ------------ ------------
(B / A)................................... 1.03 1.03 1.06 1.07 1.07
</TABLE>
- ------------------------
* Includes amortization of long-term debt discount.
** Other adjustments include capitalized interest and debt issuance costs and
amortization of capitalized interest.
*** Other adjustments include adding the net loss of affiliates accounted for at
equity whose debt is not guaranteed by the Company and subtracting
capitalized interest and debt issuance costs and undistributed net income of
affiliates accounted for at equity.
<PAGE>
EXHIBIT 12.2
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
COMPUTATION IN SUPPORT OF RATIO OF EARNINGS TO
COMBINED FIXED CHARGES
AND PREFERRED DIVIDENDS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FOR THE FOR THE FOR THE FOR THE FOR THE
ELEVEN MONTHS TWELVE TWELVE TWELVE TWELVE
ENDED MONTHS ENDED MONTHS ENDED MONTHS ENDED MONTHS ENDED
NOVEMBER 30 NOVEMBER 30 NOVEMBER 30 NOVEMBER 30 NOVEMBER 30
1994 1995 1996 1997 1998
------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Combined Fixed Charges and Preferred
Dividends:
Interest expense:
Subordinated indebtedness............... $ 158 $ 206 $ 220 $ 240 $ 245
Bank loans and other borrowings*........ 6,294 10,199 10,596 12,770 15,536
Interest component of rentals of office
and equipment......................... 42 44 34 32 32
Other adjustments**..................... 4 28 16 9 15
------ ------------ ------------ ------------ ------------
Total fixed charges..................... 6,498 10,477 10,866 13,051 15,828
Preferred dividends (tax equivalent
basis)................................ 58 64 58 109 124
------ ------------ ------------ ------------ ------------
TOTAL (A)............................. $ 6,556 $ 10,541 $ 10,924 $ 13,160 $ 15,952
------ ------------ ------------ ------------ ------------
------ ------------ ------------ ------------ ------------
Earnings:
Pretax income (loss) from continuing
operations............................ $ 193 $ 369 $ 637 $ 937 $ 1,052
Fixed charges........................... 6,498 10,477 10,866 13,051 15,828
Other adjustments***.................... (4) (28) (14) (8) (15)
------ ------------ ------------ ------------ ------------
TOTAL (B)............................. $ 6,687 $ 10,818 $ 11,489 $ 13,980 $ 16,865
------ ------------ ------------ ------------ ------------
------ ------------ ------------ ------------ ------------
(B / A)................................... 1.02 1.03 1.05 1.06 1.06
</TABLE>
- ------------------------
* Includes amortization of long-term debt discount.
** Other adjustments include capitalized interest and debt issuance costs and
amortization of capitalized interest.
*** Other adjustments include adding the net loss of affiliates accounted for at
equity whose debt is not guaranteed by the Company and subtracting
capitalized interest and debt issuance costs and undistributed net income of
affiliates accounted for at equity.
<PAGE>
Exhibit 13.1
- ---------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- ---------------------------------------------------------------
BUSINESS ENVIRONMENT
The principal business activities of Lehman Brothers Holdings Inc. ("Holdings")
and subsidiaries (collectively, the "Company" or "Lehman Brothers") are
investment banking and securities trading and sales, which by their nature are
subject to volatility, primarily due to changes in interest and foreign exchange
rates and security valuations, global economic and political trends and industry
competition. As a result, revenues and earnings may vary significantly from
quarter to quarter and from year to year.
The generally favorable market and economic conditions that characterized fiscal
1997 continued throughout most of 1998, leading to increased industrywide
revenues and to record levels of earnings and net revenues for the Company. The
first eight months of fiscal 1998 were characterized by favorable fixed income
spreads, strong investor demand, high valuations, low interest rates and
significant merger and acquisition activity. However, by mid-August, instability
in various emerging markets surfaced and dramatically changed the market
landscape over the course of the next three months as spreads widened in core
U.S. fixed income markets and major equity market indices experienced sharp
declines. As a result of these factors, the IPO market was virtually halted in
September, as investors sought safe havens.
In response to fears that the global capital markets turmoil would impact the
U.S. economy, the Federal Reserve (the "Fed") reduced interest rates three
times. A number of European central banks also engaged in a coordinated series
of interest rate cuts. The equity markets responded positively to the Fed
easings, with the Dow Jones returning 21%, the S&P 22%, and the NASDAQ 30% from
August 31 to November 30. The equity new issue market was revived in late
October, initially by large, liquid issues and later by Internet-related IPOs.
Despite the record levels of equity and equity- related issuance during the
first eight months of fiscal 1998, total equity underwriting volume was
significantly affected by the August-October slowdown. The total completed
volume of equity-related offerings was 6.4% lower in fiscal 1998 than in fiscal
1997.
FIXED INCOME Following relative stability for the first half of the year,
turmoil erupted in many emerging markets in mid-August. Markets were buffeted by
concerns about the lingering Asian economic troubles, which spread to Russia and
still threaten Latin America, as well as political uncertainty in Washington.
The trigger concerns were exacerbated by a Russian technical default on certain
types of ruble-denominated debt and an effective devaluation of the ruble. As
investors sought safe havens, U.S. Treasury and European government bond yields
moved sharply lower, while spreads on core fixed income products widened
dramatically.
The widening of bond spreads prompted further concerns about a credit crunch
that could threaten the continued expansion of the U.S. economy. The Fed, taking
note of the increasing risks, stepped in to aggressively ease the Federal Funds
rate by 75 basis points within two months to alleviate concern about the growth
and stability of the U.S. and global economies.
These factors influenced U.S. and European government bond markets. Ten-year
U.S. Treasury yields touched a new historic low of 4.2% in early October -- a
fall of 155 basis points from the beginning of the fiscal year before ending the
year at just over 4.71%. The Fed's rate cuts coincided with a wave of
international cuts that helped stabilize the higher yielding markets. Yields on
ten-year German Bunds fell even more than comparable Treasuries -- by just under
170 basis points, to a new low of 3.77% before ending the fiscal year slightly
off their global lows of 4%.
EQUITIES In 1998, the U.S. equity markets experienced the most volatile year
since the crash of 1987. Still, the major stock market indices established new
records in 1998 despite suffering a 20% peak-to-trough decline that almost
equaled the recession-related decline in 1990. For the year ended November 30,
1998, the S&P 500 Index returned 22%. Equity prices continued to be helped by a
benign inflation and interest rate environment. Inflation remained below 2% for
the year ended November 1998, while long-term interest rates declined. Given
that there was no appreciable earnings growth, price/earnings multiple expansion
was the primary driver of market performance.
<PAGE>
European equity markets performed strongly over the 12 months to November 1998,
with the FT/S&P European Index achieving a handsome return of 27% in dollar
terms. The domestic environment was highly supportive, with regional bond yields
declining over 150 basis points in aggregate. However, the crisis across
emerging markets and, in particular, events in Russia, resulted in extremely
turbulent market conditions in the last four months of the year. From their peak
in mid-July, European equities lost 26% of their value before recouping over
half these losses, as a series of policy initiatives rebuilt market confidence.
Despite the turmoil, European trading volumes remained healthy, with average
turnover levels up on the previous year.
Outside Europe, equity returns were negative for the year as a whole. In the Far
East, equities lost 4% of their value in dollar terms (as measured by the FT/S&P
Pacific Basin Index), although the equity markets outside of Japan experienced a
dramatic turnaround in the last quarter. Sharp decreases in local interest and
inflation rates, alongside some tentative signs of cyclical improvement and
progress on fundamental reform allowed the region's equity markets to rise 46%
from their trough at the start of September. The Japanese market failed to enjoy
such a rebound, as economic output continued to contract and much of the
corporate sector remained mired in excessive balance sheet leverage and low
profitability. Latin American equities fared the worst over the year, declining
23% in dollar terms (as measured by the IFC Latin America Investable Index) as
the Russian crises prompted investors to turn their attention to the fundamental
imbalances in the region, especially Brazil's large fiscal deficit.
CORPORATE FINANCE ADVISORY Corporate Finance Advisory activities continued at
record levels throughout fiscal 1998, despite the global market turmoil caused
by economic uncertainties throughout the world. Coming off a strong pace in
1997, the volume of announced transactions surged in 1998 to over $2.5 trillion
while the volume of completed transactions totaled a record $2.1 trillion. This
record volume of merger and acquisition activity continued to reflect the trend
of consolidation, deregulation and globalization across industry sectors and
across borders.
The financial services industry is cyclical. Fiscal 1998 results reflected this
as the Company alternated between eight strong months followed by three weak
months only to end the year on a high note. As a result, the Company's
businesses are evaluated across market cycles for operating profitability and
their contribution to the Company's long-term strategic objectives. The Company
strives to minimize the effects of economic downturns through its diversified
revenue base; stringent cost controls, global presence, and risk management
practices.
- --------------------------------------------------------------------------------
Note: Except for the historical information contained herein, this Management's
Discussion and Analysis of Financial Condition and Results of Operations
contains forward-looking statements that are based on current expectations,
estimates and projections about the industries in which the Company operates.
These statements are not guarantees of future performance and involve certain
risks, uncertainties and assumptions which are difficult to predict. The Company
undertakes no obligation to update publicly any forward-looking statements,
whether as a result of new information, future events or otherwise.
RESULTS OF OPERATIONS
SUMMARY The Company reported record net income of $736 million and record
earnings per share of $5.19 for 1998. These results built on the strong
foundations for growth and profitability established in earlier years and
demonstrate the impact of the Company's strategy to grow its high margin
businesses within investment banking, equities, certain fixed income products,
merchant banking and the high-net-worth retail business. The Company's shift in
revenue mix in favor of these high margin businesses resulted in a more
diversified revenue base and helped increase the Company's operating margin to
25.6% in 1998 from 24.2% in 1997. Also contributing to these record results was
the Company's continued aggressive management of expenses. Non-personnel
expenses were relatively flat even though revenues increased 6%. The
compensation and benefits ratio remained constant at 50.7% of net revenues.
For 1997, the Company reported net income of $647 million and earnings per share
of $4.72, driven by continued strength in all of the Company's major businesses
including equities, fixed income and investment banking. The Company began to
realize the benefits associated with its strategy to grow certain high margin
businesses. These results were achieved in worldwide markets which were
extremely favorable during the early portion of the year and became volatile in
the latter
<PAGE>
portion of the year. The overall favorable market conditions led to a second
straight year of near-record industrywide underwriting volumes and a record year
in worldwide merger and acquisition activity.
For 1996, the Company reported net income of $416 million, including a $50
million after-tax severance charge. The Company's 1996 results reflected strong
performances across all of the Company's major businesses. Fixed income sales
and trading and investment banking activities were responsible for the majority
of the increased net revenues and net income compared to 1995. The Company's
results were positively affected by favorable market conditions, which led to
near record underwriting volumes, record levels for many worldwide equity
indices and a record year in worldwide merger and acquisition activity.
NET REVENUES Net revenues were $4,113 million for 1998, $3,873 million for 1997
and $3,444 million for 1996. During 1998, the Company continued to build its
global franchise. The increase in net revenues from 1997 levels reflects the
Company's long-term strategy of growing high margin businesses, such as
investment banking, equities and private client services. These businesses
enjoyed strong results and helped to offset a difficult fixed income
environment.
In 1997, net revenues increased in all of the major business units led by
increased customer flow activity, a strong global market for mergers and
acquisitions and increased levels of worldwide debt and equity underwriting. The
increase in net revenues in 1996 reflected a general strengthening in customer-
related trading activities in a number of fixed income product areas, increased
levels of worldwide debt and equity underwriting, and improved merger and
acquisition results.
Since 1990, Lehman Brothers has focused on a "client/customer-driven" strategy.
Under this strategy, Lehman Brothers concentrates on serving the needs of major
issuing and advisory clients and investing customers worldwide to build an
increasing flow of business that leverages the Company's research, underwriting
and distribution capabilities. Customer flow continues to be the primary source
of the Company's net revenues. In addition to its customer flow activities, the
Company also takes proprietary positions based upon expected movements in
interest rate, foreign exchange, equity and commodity markets in both the short-
and long-term. The Company's success in this area is dependent upon its ability
to anticipate economic and market trends and to develop trading strategies that
capitalize on these anticipated changes. Consistent with the Company's
client/customer-driven strategy, proprietary trading activities accounted for
only approximately 10% of net revenues in 1998, and 14% in both 1997 and 1996.
The Company believes its client/customer-driven strategy has historically
mitigated the level of net trading revenue volatility.
The Company, through its subsidiaries, is a market-maker in all major equity and
fixed income products in both the domestic and international markets. In order
to facilitate its trading activities, the Company is a member of all principal
securities and commodities exchanges in the United States and holds memberships
or associate memberships on several principal international securities and
commodities exchanges, including the London, Tokyo, Hong Kong, Frankfurt, Milan
and Paris stock exchanges. Net revenues from non-U.S. sources as a percentage of
total net revenues were 35% for 1998. As part of its market-making activities,
the Company maintains inventory positions of varying amounts across a broad
range of financial instruments, which are marked-to-market on a daily basis and,
along with the Company's proprietary trading positions, give rise to principal
transactions revenues.
Net revenues from the Company's market-making and trading activities in fixed
income and equity products are recognized as either principal transactions or
net interest revenues, depending upon the method of financing and/or hedging
related to specific inventory positions. The Company evaluates its trading
strategies on an overall profitability basis which combines both principal
transactions revenues and net interest. Therefore, changes in net interest
should not be viewed in isolation but should be viewed in conjunction with
revenues from principal transactions. During 1998, combined principal
transactions and net interest revenues decreased slightly from 1997. Principal
transactions revenues declined due to decreased customer flow in fixed income
driven by the severe spread widening in core U.S. fixed income markets in the
later portion of the year. This was offset by improved performance in foreign
exchange, high yield and equity derivatives. Net interest
<PAGE>
revenues increased as a result of an increase in interest bearing assets and a
shift in the composition of the Company's fixed income portfolio towards higher
yielding products.
Combined principal transactions and net interest revenues were relatively flat
in 1997 as compared to 1996. Increased principal transactions and net interest
revenues across many of the Company's fixed income and equity product lines were
offset by lower results in certain fixed income and equity derivative products
in Europe and Asia and with higher interest expenses resulting from the
Company's increased level of long-term debt outstanding.
In the following table, the Company has been segregated into four major business
units: Fixed Income, Equity, Corporate Finance Advisory and Merchant Banking.
Each business unit represents a grouping of financial activities and products
with similar characteristics. These business activities result in revenues from
both institutional and high-net worth retail clients and customers that are
recognized in multiple revenue categories contained in the Company's
Consolidated Statement of Income. Net revenues by business unit contain certain
internal allocations, including funding costs, which are centrally managed.
<TABLE>
<CAPTION>
Twelve Months Ended November 30, 1998
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fixed Income $1,638 $ 38 $ 581 $ (65) $2,192
Equity 351 458 309 3 1,121
Corporate Finance Advisory (5) 511 506
Merchant Banking (18) 181 163
Other 27 17 87 131
- ----------------------------------------------------------------------------------------------------
$1,993 $ 513 $1,582 $ 25 $4,113
- ----------------------------------------------------------------------------------------------------
<CAPTION>
Twelve Months Ended November 30, 1997
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fixed Income $1,749 $ 41 $ 380 $ 16 $2,186
Equity 296 365 342 7 1,010
Corporate Finance Advisory (5) 328 323
Merchant Banking (6) 266 260
Other 9 17 2 66 94
- ----------------------------------------------------------------------------------------------------
$2,043 $ 423 $1,318 $ 89 $3,873
- ----------------------------------------------------------------------------------------------------
<CAPTION>
Twelve Months Ended November 30, 1996
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fixed Income $1,793 $ 57 $ 307 $ 8 $2,165
Equity 275 286 280 3 844
Corporate Finance Advisory 249 249
Merchant Banking (18) 138 120
Other 11 19 7 29 66
- ----------------------------------------------------------------------------------------------------
$2,061 $ 362 $ 981 $ 40 $3,444
- ----------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
The following discussion provides an analysis of the Company's net revenues
based upon the various business units which generated these revenues.
FIXED INCOME The Company's fixed income revenues reflect customer flow
activities (both institutional and high-net-worth retail), secondary trading,
debt underwriting, syndicate and financing activities related to fixed income
products. Fixed income products include dollar and non-dollar government
securities, mortgage- and asset-backed securities, money market products, dollar
and non-dollar corporate debt securities, emerging market securities, municipal
securities, financing (global access to debt financing sources including
repurchase and reverse repurchase agreements), foreign exchange, and fixed
income derivative products. Lehman Brothers is one of the leading primary
dealers in U.S. government securities and is a market-maker in the government
securities of all major industrial countries. The Company, through its
subsidiaries, is also a dominant market-maker for a broad range of fixed income
products.
Fixed income revenues were $2,192 million for 1998, $2,186 million for 1997 and
$2,165 million for 1996. During 1998 and 1997, the Company continued to focus
its resources and efforts towards growing its market share in higher margin
products. The Company's fixed income business benefited in 1998 from improved
performance in high yield, primarily due to increased syndicate activity and
increased revenues in foreign exchange from strong customer flow activity. High
yield benefited from an increased volume of lead managed underwritings. Lehman
acted as lead-manager for over $7.9 billion offerings in calendar 1998 up from
$6.3 billion in calendar 1997. These improvements were offset in the latter part
of the year by severe spread widening in core U.S. fixed income markets.
Investment banking revenues as a component of fixed income revenues, increased
to $581 million for the year ended 1998 from $380 million for the year ended
1997 primarily due to increased high yield related issuances. Lehman Brothers
lead-managed fixed income offerings in calendar 1998 increased 38% with
underwritings of $183 billion compared to underwritings of $133 billion in
calendar 1997 based on information supplied by Securities Data Company.
The Company's fixed income business benefited in 1997 from active customer
trading combined with increased levels of worldwide debt underwriting which
resulted from the favorable U.S. macroeconomic environment. Mortgage revenues
increased significantly during 1997 as the Company profited from its diversified
product mix including several large conduit transactions, commercial
mortgage-backed deals and real estate transactions. Revenues from the emerging
markets business improved significantly during 1997 as a result of the Company's
successful expansion into new European markets. These improvements were
partially offset by reduced contributions from fixed income derivatives and
foreign exchange which were negatively impacted by significant volatility in the
Asian markets.
EQUITY Equity net revenues reflect customer flow activities (both institutional
and high-net-worth retail), secondary trading, equity underwriting, equity
finance, equity derivatives and arbitrage activities. Equity revenues were
$1,121 million for 1998, $1,010 million for 1997 and $844 million for 1996.
Equity revenues increased 11% versus fiscal 1997 primarily due to the successful
redirection of the company's resources into higher margin businesses such as
equity derivatives and equity finance, coupled with an overall favorable
equities environment. Overall performance in equities withstood the economic
turbulence suffered late in the year due to increased institutional and private
client customer flow and favorable trading strategies, as well as the continued
growth of the equity derivatives business.
Equity cash products benefited in 1997 from the record-setting year in many of
the world's financial markets which was fueled by a benign inflation and
interest rate environment accompanied by strong earnings growth in the U.S. In
particular, the Company's equity cash product revenues improved in 1997
primarily from an increased level of institutional and retail customer flow.
During 1997, the revenues from the Company's equity financing business also
improved as a result of
<PAGE>
successful trading strategies implemented in the United Kingdom. The equity
derivative revenues in 1997 were reduced from the prior year's level due to the
market volatility experienced in Asia.
CORPORATE FINANCE ADVISORY Corporate finance advisory net revenues, classified
in the Consolidated Statement of Income as a component of investment banking
revenues, result primarily from fees earned by the Company in its role as
strategic advisor to its clients. This role primarily consists of advising
clients on mergers and acquisitions, divestitures, leveraged buyouts, financial
restructurings, and a variety of cross-border transactions. The net revenues for
corporate finance advisory increased in 1998 to $506 million from $323 million
in 1997 and from $249 million in 1996. The increased revenues reflected improved
market share as a result of the Company's decision to invest additional
resources in this business as well as continued strength in the overall merger
and acquisition market environment. For completed M&A transactions, Lehman has
improved its worldwide ranking from #10 to #6, increasing its market share from
5.2% to 13.2%, for the 1998 calendar year based on data supplied by Securities
Data Company. The Company ended fiscal 1998 with a transaction pipeline which
stood at $55 billion in terms of total dollar value based on information
supplied by Securities Data Company.
MERCHANT BANKING The Company is the general partner for nine active merchant
banking partnerships. Current merchant banking investments held by the
partnerships include both publicly traded and privately held companies. Merchant
banking net revenues represent the Company's proportionate share of net realized
and unrealized gains and losses from the sale and revaluation of investments
held by the partnerships and advisory fees earned in its capacity as general
partner to the partnerships. These gains generally fluctuate based on the
number, type, age and performance of the underlying investments. Such amounts
are classified in the Consolidated Statement of Income as a component of
investment banking revenues. Merchant banking net revenues also reflect the net
interest expense relating to the financing of the Company's investments in the
partnerships. Merchant banking net revenues were $163 million, $260 million and
$120 million for 1998, 1997 and 1996, respectively.
NON-INTEREST EXPENSES During 1998, the Company's non-interest expenses totaled
$3,061 million, an increase of 4% over 1997's non-interest expenses of $2,936
million. Non-interest expenses were $2,807 million for 1996, including a
severance charge of $84 million. Excluding this special charge, non-interest
expenses were $2,723 million for 1996.
Twelve months ended
November 30
[in millions] 1998 1997 1996
- ----------------------------------------------------------------------
Compensation and benefits $2,086 $1,964 $1,747
Nonpersonnel(1) 975 972 976
Severance 84
- ----------------------------------------------------------------------
Total non-interest expenses $3,061 $2,936 $2,807
- ----------------------------------------------------------------------
Compensation and benefits/
Net revenues 50.7% 50.7% 50.7%
Nonpersonnel expenses(1)/
Net revenues 23.7% 25.1% 28.3%
(1) Nonpersonnel expenses excluding severance charge.
Compensation and benefits expenses increased in 1998 to $2,086 million from
$1,964 million in 1997 and $1,747 million in 1996 as a result of higher net
revenues. However, the Company maintained its compensation and benefits expense
to net revenue ratio at 50.7% for 1998, 1997 and 1996. Nonpersonnel expenses
were relatively unchanged at $975 million, $972 million and $976 million for
1998, 1997 and 1996, respectively. More significantly, the Company was able to
effectively control its level of nonpersonnel expenses as evidenced by a decline
in the nonpersonnel expense to net revenue ratio reflecting the continued focus
on expense management. This was all accomplished while net revenues increased 6%
in 1998 compared to
<PAGE>
1997 and 12% in 1997 compared to 1996. The benefits of the Company's reduction
of its nonpersonnel expense level are that profit margins and earnings have
improved significantly.
1996 SEVERANCE CHARGE The Company recorded an $84 million severance charge ($50
million after-tax) in the fourth quarter of 1996 related to certain strategic
actions taken to improve ongoing profitability. The 1996 severance charge
reflected the culmination of a worldwide business unit economic performance
review that was undertaken in the fourth quarter of 1996 to focus the Company on
its core investment banking, equity and fixed income sales and trading areas.
This formalized review resulted in personnel reductions of approximately 270
people across a number of underperforming fixed income and equity businesses,
including exiting the precious metals business in the U.S., Europe and Asia;
exiting energy trading in the U.S. and Europe; consolidating Asian fixed income
risk management activities into one center in Tokyo; refocusing foreign exchange
trading activities, and combining the Company's New York Private Client Services
offices. Additionally, the charge reflects various other strategic personnel
reductions aimed at delayering management. Cash outlays relating to the charge
were approximately $19 million in the fourth quarter of 1996 and approximately
$59 million during 1997. The remaining residual payments were paid as deferred
payment arrangements were completed.
INCOME TAXES The Company had an income tax provision of $316 million, $290
million and $221 million for 1998, 1997 and 1996, respectively. The effective
tax rate for the Company was 30% for 1998, 31% for 1997 and 35% for 1996. The
lower effective tax rates in 1998 and 1997 reflect an increase in tax-exempt
income. The 1996 income tax provision includes a tax benefit of $34 million
related to the 1996 severance charge.
The Company's net deferred tax assets increased by $281 million to $596 million
at November 30, 1998 from $315 million at November 30, 1997. It is anticipated
that the Company's net deferred tax assets will be realized through future
earnings.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW As a leading global investment bank that actively participates in the
global capital markets, the Company has large and diverse capital requirements.
Many of the business lines in which the Company operates are capital intensive.
Capital is required to finance, among other things, the portion of the Company's
securities inventories not funded on a secured basis, merchant banking
activities and investments in fixed assets. The Company's primary activities are
based on the execution of customer-related transactions. This flow of customer
business supports the rapid asset turnover rate of the Company's inventory.
The Company's balance sheet consists primarily of cash and cash equivalents,
securities and other financial instruments owned, and collateralized short-term
financing agreements. The liquid nature of these assets provides the Company
with flexibility in financing and managing its business. The majority of these
assets are funded on a secured basis through collateralized short-term financing
agreements with the remaining assets being funded through unsecured financing
and Capital.
FUNDING AND CAPITAL POLICIES The Company's Finance Committee is responsible for
establishing and managing the funding and liquidity policies of the Company.
These policies include recommendations for capital and balance sheet size as
well as the allocation of capital and balance sheet to product areas. Members of
the Company's treasury department and business unit financing groups work with
the Finance Committee to ensure coordination of global funding efforts and
implementation of the funding and liquidity policies. Regional asset and
liability committees aligned with the Company's geographic funding centers are
responsible for implementing funding strategies for their respective regions.
<PAGE>
The primary goal of the Company's funding policies is to provide sufficient
liquidity and availability of funding sources to meet the needs of the Company's
businesses. The key elements of these policies are to:
[GRAPHIC OMITTED] (1) Maintain a Total Capital structure
that supports the business activities in
which the Company is engaged.
The Company is one of the most highly
capitalized global investment banking
firms with $32.8 billion in Total
Capital. The Company manages Total
Capital, defined as long-term debt,
preferred stock and common stockholders'
equity, on a business and product level.
The determination of the amount of Total
Capital assigned to each business and
product is a function of asset quality,
market risk, liquidity and regulatory
capital requirements. The Company
reallocates its capital to businesses
based upon their ability to obtain
targeted returns, perceived
opportunities in the marketplace and the
Company's long-term strategy. The
Company strives to have sufficient Total
Capital to meet its anticipated
long-term capital needs which are driven
by cash capital (liquidity), regulatory
capital and market and credit risk
requirements, and continually monitors
its Total Capital needs by employing
models which measure its market, credit
and liquidity risks.
(2) Minimize liquidity and refinancing
risk by funding the Company's assets on a global basis primarily with secured
liabilities.
The Company continually reviews its mix of long- and short-term borrowings as it
relates to maturity matching and the availability of secured and unsecured
financing. In general, the Company finances its equity investments in its
subsidiaries with stockholders' equity and the subordinated capital of
subsidiaries is financed with a combination of subordinated and senior long-term
debt. Inventories and other short-term assets are financed with a combination of
short-term funding, long-term debt and stockholders' equity. Fixed assets,
property, plant and equipment are generally financed with longer-dated fixed
rate debt. Where the Company deems it to be appropriate and to minimize currency
risks, foreign currency denominated assets are financed with corresponding
foreign currency denominated liabilities.
(3) Obtain diversified funding through a global investor base which increases
liquidity and reduces concentration risk.
The Company obtains global funding from both the banking community and short-
and long-term investors through its centers in New York, London, Tokyo, Hong
Kong and Frankfurt. In addition to maintaining geographic diversification, the
Company also utilizes a broad range of debt instruments, which it issues in
varying maturities and currencies.
The Company issues both commercial paper and other short-term debt instruments,
including master notes, corporate and retail deposits, and bank borrowings under
uncommitted lines of credit and other uncommitted arrangements. To reduce
liquidity and concentration risk, the Company limits its exposure to any single
investor or type of investor.
(4) Maintain funding availability in excess of actual utilization.
The Company maintains sizable uncommitted lines of credit from a broad range of
banks and financial institutions from which it draws funds in a variety of
currencies and which provide an additional source of liquidity. Uncommitted
lines consist of facilities that the Company has been advised are available but
for which no contractual lending obligations exist. Additionally, the Company
maintains secured and unsecured committed revolving credit facilities as
discussed in the following section.
<PAGE>
(5) Maintain sufficient financial resources to enable the Company to meet its
obligations in periods of financial stress through a combination of
collateralized short-term financings and Total Capital. Financial stress is
defined as any event which severely constrains the Company's access to unsecured
funding sources.
To achieve this objective, the Company strives to maximize its use of global
collateralized borrowing sources and reduce its reliance upon short-term
unsecured borrowings. In this regard, the Company believes that increasing Total
Capital will provide additional liquidity to cover periods of financial stress
and further advance the Company's liquidity management objectives. Lastly, the
Company periodically tests its secured and unsecured credit facilities to ensure
availability and operational readiness. These policies position the Company to
meet its liquidity requirements in all periods including those of financial
stress.
SHORT-TERM FUNDING The Company strives to maximize the portion of the Company's
balance sheet that is funded through collateralized borrowing sources, which in
turn minimizes the reliance placed upon unsecured short-term debt.
Collateralized borrowing sources include cash market securities and other
financial instruments sold but not yet purchased, as well as collateralized
short-term financings, defined as securities sold under agreements to repurchase
("repos") and securities loaned. Because of their secured nature, OECD
government repos and other investment grade types of collateralized borrowings
are less credit-sensitive and have historically been a stable financing source
irrespective of market conditions.
The amount of the Company's collateralized borrowing activities will vary
reflecting changes in the mix and overall levels of securities and other
financial instruments owned which are driven by strategic business objectives
and global market conditions. The majority of the Company's assets are funded
with collateralized borrowing sources. At November 30, 1998 and 1997, $92
billion and $94 billion, respectively, of the Company's total balance sheet of
$154 billion and $152 billion at November 30, 1998 and 1997, respectively, were
financed using collateralized borrowing sources.
As of November 30, 1998 and 1997, commercial paper and short-term debt
outstanding was $6.7 billion and $7.8 billion, respectively. Of these amounts,
commercial paper outstanding as of November 30, 1998 was $3.6 billion compared
to $3.9 billion as of November 30, 1997.
Holdings maintains a Revolving Credit Agreement (the "Credit Agreement") with a
syndicate of banks. Under the terms of the Credit Agreement, the banks have
committed to provide up to $2 billion for up to 364 days. Any loans outstanding
on the commitment termination date may be extended for up to an additional year
at the option of Holdings. The Credit Agreement contains covenants which
require, among other things, that the Company maintain specified levels of
liquidity and tangible net worth, as defined.
In July 1998, the Company entered into a new $1 billion Committed Securities
Repurchase Facility (the "Facility") for LBIE, the Company's major operating
entity in Europe. The Facility provides secured multi-currency financing for a
broader range of collateral types than LBIE's previous committed secured credit
facility. Under the terms of the Facility, the bank group will agree to provide
funding for up to one year on a secured basis. Any loans outstanding on the
commitment termination date may be extended for up to an additional year at the
option of Holdings. The Facility contains covenants which require, among other
things, that LBIE maintain specified levels of tangible net worth.
There are no borrowings outstanding under either the Credit Agreement or the
Facility. The Company may use the Credit Agreement and the Facility for general
corporate purposes from time to time. The Company has maintained compliance with
the applicable covenants for both the Credit Agreement and the Facility at all
times.
<PAGE>
TOTAL CAPITAL As part of the Company's liquidity plan, the Company increased
its Total Capital base in 1998 to $32.8 billion at November 30, 1998 from $24.8
billion at November 30, 1997 primarily due to an increase in long-term debt,
preferred equity and the retention of earnings.
November 30
[in millions] 1998 1997 1996
- ----------------------------------------------------------------------
LONG-TERM DEBT
Senior Notes $23,873 $17,049 $12,571
Subordinated Indebtedness 3,468 3,212 3,351
- ----------------------------------------------------------------------
27,341 20,261 15,922
STOCKHOLDERS' EQUITY
Preferred Equity 908 508 508
Common Equity 4,505 4,015 3,366
- ----------------------------------------------------------------------
5,413 4,523 3,874
- ----------------------------------------------------------------------
Total Capital $32,754 $24,784 $19,796
- ----------------------------------------------------------------------
[GRAPHIC OMITTED] During 1998, the Company issued $11.7
billion in long-term debt, which was
$7.0 billion in excess of its maturing
debt. Long-term debt increased to $27.3
billion at November 30, 1998 from $20.3
billion at November 30, 1997 with a
weighted-average maturity of 3.5 years
at November 30, 1998 and 4.1 years at
November 30, 1997.
At November 30, 1998, the Company had
approximately $9.1 billion available for
the issuance of debt securities under
various shelf registrations and debt
programs.
The increase in Total Capital also
reflects an increase in stockholders'
equity to $5.4 billion at November 30,
1998 from $4.5 billion at November 30,
1997. The net increase in stockholders'
equity was primarily due to the
retention of earnings, the issuance of
Preferred Stock (Series C and D) and
amortization of RSU awards under the
Company's employee stock award plans,
partially offset by the repurchase of
treasury stock and the payment of both
common and preferred dividends.
To broaden and increase the level of employee ownership in Holdings, the Company
utilizes several stock-based compensation plans. Since 1994, the Company has
made Restricted Stock Unit ("RSU") awards to its employees as a portion of total
compensation in lieu of cash, subject to vesting and transfer restrictions.
Approximately 5.9 million, 3.8 million and 5.2 million RSUs were amortized into
stockholders' equity in 1998, 1997 and 1996, respectively. RSU amortization was
$221 million, $162 million and $136 million in 1998, 1997 and 1996,
respectively, net of cancellations. During 1998 and 1997, the Company
repurchased or acquired shares of its Common Stock at an aggregate cost of $469
million and $77 million (approximately 8.6 million shares and 1.6 million
shares, respectively). These shares are being reserved for future issuances
under employee stock-based compensation plans.
<PAGE>
During 1997, the Company established a trust (the "RSU Trust") in order to
provide common stock voting rights to employees who hold outstanding RSUs and to
encourage employees to think and act like owners. The RSU Trust was initially
funded with a total of 16 million shares valued at $325 million consisting of 5
million treasury shares, for RSU awards under the Employee Incentive Plan and 11
million new issue shares of Common Stock, for RSU awards under the 1994
Management Ownership Plan. In 1998, the Company transferred an additional 2.5
million shares into the RSU Trust valued at $107 million. At November 30, 1998,
approximately 18.1 million shares were held in the RSU Trust.
In January 1998, the Company announced its intention to repurchase up to 4.5
million common shares during the fiscal year and to increase the common dividend
by 25%. In September 1998, the Company announced its intention to repurchase an
additional 7.5 million common shares. During 1998 the Company completed the
repurchase of 8.6 million shares as part of its ongoing program to actively
manage its capital position and common shares outstanding. In January 1999, the
Company announced it was extending its previously announced 7.5 million share
buyback program by an additional 2.0 million shares. Also announced in January
1999 was a 20% increase in the Company's dividend to $0.36 per share from $0.30
per share.
[GRAPHIC OMITTED]
CAPITAL RESOURCES AND CAPITAL ADEQUACY Balance sheet leverage ratios are one
measure used to evaluate the capital adequacy of a company. Leverage ratios are
commonly calculated using either total assets or adjusted total assets divided
by total stockholders' equity. The Company believes that the adjusted leverage
ratio is a more effective measure of financial risk when comparing companies in
the securities industry. Adjusted total assets represent total assets less the
lower of securities purchased under agreements to resell or securities sold
under agreements to repurchase. The Company's adjusted leverage ratios based on
adjusted total assets were 20.6x and 23.9x at November 30, 1998 and 1997,
respectively. The Company's average adjusted leverage ratio was 26.6x and 28.9x
for the years ended November 30, 1998 and 1997, respectively.
Due to the nature of the Company's sales and trading activities, the overall
size of the Company's assets and liabilities fluctuates from time to time and at
specific points in time may be higher than the fiscal quarter ends or the
quarterly averages.
The Company also closely monitors its primary double leverage ratio. A primary
double leverage ratio in excess of 1.0 arises from the funding of equity
investments in subsidiaries with the debt of the parent. One of the Company's
objectives is to maintain its primary double leverage ratio at no more than 1.0.
Primary double leverage, defined as Holdings' investment in subsidiaries divided
by Holdings' stockholders' equity, was 0.96 at November 30, 1998 compared to
0.87 at November 30, 1997.
CREDIT RATINGS The Company, like other companies in the securities industry,
relies on external sources to finance a significant portion of its day-to-day
operations. The Company's access to and cost of funding is generally dependent
upon its short- and long-term debt ratings. On May 8, 1998, Thomson Bank Watch
upgraded its ratings on the senior debt of LBHI to A from A-. On September 21,
Moody's reaffirmed its "stable" long-term debt ratings of LBHI and changed its
outlook
<PAGE>
on the Company from positive to stable. In December 1998, Standard & Poor's
reaffirmed its long-term rating of LBHI at A. As of November 30, 1998, the
short- and long-term senior debt ratings of Holdings and Lehman Brothers Inc.
("LBI") were as follows:
Holdings LBI
--------------------- ------------------------
Short-term Long-term Short-term Long-term**
- ------------------------------------------------------------------------------
Duff & Phelps Credit Rating Co. D-1 A D-1 A/A-
Fitch IBCA, Inc. F-1 A F-1 A/A-
Moody's P2 Baa1 P2 A3*/Baa1
S&P A-1 A A-1 A+*/A
Thomson BankWatch TBW-1 A TBW-1 A+/A
- ------------------------------------------------------------------------------
* Provisional ratings on shelf registration
** Senior/subordinated
INSURANCE SUBSIDIARY The Company has established a new subsidiary to underwrite
and accumulate insurance and reinsurance risks. The new subsidiary, Lehman Re
Ltd., is a Bermuda licensed Class 4 and long-term insurance company. Lehman Re
Ltd. intends to underwrite property and casualty, as well as life and annuity
insurance risks. It expects to focus its business initially in four areas:
finite and structured financial products; political risk and trade credit
insurance; property catastrophe reinsurance; and life and annuity reinsurance.
LEHMAN BROTHERS DERIVATIVE PRODUCTS On July 16, 1998, the Company announced
that it had established a special purpose subsidiary that will provide
counterparties around the world with a wide variety of derivative products and
services. The new company, Lehman Brothers Derivative Products Inc. ("LBDP") has
been assigned Aaa and AAAt credit ratings by Moody's Investor Services Inc. and
Standard & Poor's Corporation, respectively. LBDP was created to provide clients
with the most efficient delivery of a broad range of derivative product
opportunities. Its termination structure compliments the continuation structure
of Lehman Brothers Financial Products Inc. ("LBFP").
REGULATORY CAPITAL The Company operates globally through a network of
subsidiaries with several subject to regulatory requirements. In the United
States, LBI, as a registered broker dealer, is subject to the Securities and
Exchange Commission ("SEC") Rule 15c3-1, the Net Capital Rule, which requires
LBI to maintain net capital of not less than the greater of 2% of aggregate
debit items arising from customer transactions, as defined, or 4% of funds
required to be segregated for customers' regulated commodity accounts, as
defined. At November 30, 1998, LBI's regulatory net capital, as defined, of
$1,406 million exceeded the minimum requirement by $1,320 million.
In addition to amounts presented in the accompanying Consolidated Statement of
Financial Condition as cash and securities segregated and on deposit for
regulatory and other purposes, securities with a market value of approximately
$1,332 million and $1,290 million at November 30, 1998 and 1997, respectively,
primarily collateralizing securities purchased under agreements to resell, have
been segregated in a special reserve bank account for the exclusive benefit of
customers pursuant to the Reserve Formula requirements of SEC Rule 15c3-3.
Lehman Brothers International (Europe) ("LBIE"), a United Kingdom registered
broker-dealer and subsidiary of Holdings, is subject to the capital requirements
of the Securities and Futures Authority ("SFA") of the United Kingdom. Financial
resources, as defined, must exceed the total financial resources requirement of
the SFA. At November 30, 1998, LBIE's financial resources of approximately $2.5
billion exceeded the minimum requirement by approximately $900 million. Lehman
Brothers Japan Inc.'s Tokyo branch, a regulated broker-dealer, is subject to the
capital requirements of the Japanese Ministry of Finance and at November 30,
1998, had net capital of approximately $320 million which was approximately $95
million in excess of the specified levels required. Certain other non-U.S.
subsidiaries are subject to various securities,
<PAGE>
commodities and banking regulations and capital adequacy requirements
promulgated by the regulatory and exchange authorities of the countries in which
they operate. At November 30, 1998, these other subsidiaries were in compliance
with their applicable local capital adequacy requirements. The Company's "AAA"
rated derivatives subsidiaries, LBFP and LBDP, have established certain capital
and operating restrictions which are reviewed by various rating agencies. At
November 30, 1998, LBFP and LBDP each had capital which exceeded the requirement
of the most stringent rating agency by approximately $135 million and $27
million, respectively.
The regulatory rules referred to above, and certain covenants contained in
various debt agreements may restrict Holdings' ability to withdraw capital from
its regulated subsidiaries, which in turn could limit its ability to pay
dividends to shareholders. At November 30, 1998, approximately $3.5 billion of
net assets of subsidiaries were restricted as to the payment of dividends to
Holdings.
CASH FLOWS Cash and cash equivalents increased $1,370 million in 1998 to $3,055
million, as the net cash provided by financing activities exceeded the net cash
used in operating and investing activities. Net cash used in operating
activities of $10,060 million included income adjusted for non-cash items of
$1,099 million for 1998. Net cash provided by financing activities was $11,549
million and net cash used in investing activities was $119 million.
Cash and cash equivalents decreased $464 million in 1997 to $1,685 million, as
net cash was used in operating, financing and investing activities. Net cash
used in operating activities of $264 million included income adjusted for
non-cash items of $675 million for 1997. Net cash used in financing activities
was $126 million and net cash used in investing activities was $74 million.
Cash and cash equivalents increased $1,275 million in 1996 to $2,149 million, as
the net cash provided by financing activities exceeded the net cash used in
operating and investing activities. Net cash used in operating activities of
$4,375 million included income adjusted for non-cash items of $889 million for
1996. Net cash provided by financing activities was $5,708 million and net cash
used in investing activities was $58 million.
HIGH YIELD SECURITIES The Company underwrites, trades, invests and makes
markets in high yield corporate debt securities. The Company also syndicates,
trades and invests in loans to below investment grade-rated companies. For
purposes of this discussion, high yield debt instruments are defined as
securities or loans to companies rated BB+ or lower, or equivalent ratings by
recognized credit rating agencies, as well as non-rated securities or loans
which, in the opinion of management, are non-investment grade. Non-investment
grade securities generally involve greater risks than investment grade
securities due to the issuer's creditworthiness and the liquidity of the market
for such securities. In addition, these issuers have higher levels of
indebtedness, resulting in an increased sensitivity to adverse economic
conditions. The Company recognizes these risks and aims to reduce market and
credit risk through the diversification of its products and counterparties. High
yield debt instruments are carried at market value, and unrealized gains or
losses for these securities are reflected in the Company's Consolidated
Statement of Income. The Company's portfolio of such instruments at November 30,
1998 and 1997 included long positions with an aggregate market value of
approximately $2.3 billion and $3.2 billion, respectively, and short positions
with an aggregate market value of approximately $217 million and $172 million,
respectively. The Company may, from time to time, mitigate its net exposure to
any single issuer through the use of derivatives and other financial
instruments.
The Company, through its high yield sales and trading activities, makes
commitments to extend credit in loan syndication transactions principally to
below investment grade borrowers and participates out a significant portion of
these commitments. These commitments, which are net of syndications and
participations totaled $2.0 billion at November 30, 1998 and $1.6 billion at
November 30, 1997, are typically secured against the borrower's assets and have
fixed maturity dates. The utilization of these facilities is generally
contingent upon certain representations, warranties and contractual conditions
of the
<PAGE>
borrower. Total commitments may not be indicative of actual risk or funding
requirements as the commitments may not be drawn or fully utilized and the
Company intends to continue syndicating, selling, and/or participating in these
commitments.
The Company also had lending commitments to high grade borrowers of $675 million
at November 30, 1998. These commitments are typically secured against the
borrower's assets, have fixed maturity dates, and are generally contingent upon
certain representations, warranties and contractual conditions of the borrower.
In addition to these specific commitments, the Company had various other
commitments of approximately $335 million at November 30, 1998.
MERCHANT BANKING AND RELATED LENDING ACTIVITIES The Company's merchant banking
activities include investments in nine partnerships, for which the Company acts
as general partner, as well as direct investments. At November 30, 1998 and
1997, investments in merchant banking partnerships totaled $245 million and $167
million, respectively while direct investments totaled $207 million and $75
million, respectively. The Company's policy is to carry its investments,
including its partnership interests, at fair value based upon the Company's
assessment of the underlying investments.
At November 30, 1998, the Company had commitments to invest up to $379 million
in the partnerships, which in turn will make direct merchant banking related
investments. These commitments will be funded as required through the end of the
respective partnerships' investment periods, principally expiring in 2004.
In addition, at November 30, 1998, the Company had no direct short-term bridge
financings outstanding.
NON-CORE ACTIVITIES AND INVESTMENTS In March 1990, the Company discontinued the
origination of partnerships (the assets of which are primarily real estate) and
investments in real estate. Currently, the Company acts as a general partner or
co-general partner for approximately $1.6 billion of partnership investment
capital and manages the remaining real estate investment portfolio. At November
30, 1998, the Company had $30 million of net exposure to these real estate
activities, including investments, commitments and contingent liabilities under
guarantees and credit enhancements. The Company believes any exposure under
these commitments and contingent liabilities has been adequately reserved. In
certain circumstances, the Company has elected to provide financial and other
support and assistance to such investments to maintain investment values. There
is no contractual requirement that the Company continue to provide this support.
Management's intention with regard to non-core assets is the prudent liquidation
of these investments as and when possible.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES
OVERVIEW Derivatives are financial instruments, which include swaps, options,
futures, forwards and warrants, whose value is based upon an underlying asset
(e.g., treasury bond), index (e.g., S&P 500) or reference rate (e.g., LIBOR). A
derivative contract may be traded on an exchange or negotiated in the
over-the-counter markets. Exchange-traded derivatives are standardized and
include futures, warrants and certain option contracts listed on an exchange.
Over-the-counter ("OTC") derivative contracts are individually negotiated
between contracting parties and include forwards, swaps and certain options,
including caps, collars and floors. The use of derivative financial instruments
has expanded significantly over the past decade. One reason for this expansion
is that derivatives provide a cost effective alternative for managing market
risk. In this regard, derivative contracts provide a reduced funding alternative
for managing market risk since derivatives are based upon notional amounts,
which are generally not exchanged, but rather are used merely as a basis for
exchanging cash flows during the duration of the contract. Derivatives are also
utilized extensively as highly effective tools that enable users to adjust risk
profiles, such as interest rate, currency, or other market risks, or to take
proprietary trading positions, since OTC derivative instruments can be tailored
to meet individual client needs. Additionally, derivatives provide users with
access to market risk management tools which are often unavailable in
traditional cash instruments.
<PAGE>
Derivatives are subject to various risks similar to non-derivative financial
instruments including market, credit and operational risk. Market risk is the
potential for a financial loss due to changes in the value of derivative
financial instruments due to market changes, including changes in interest
rates, foreign exchange rates and equity and commodity prices. Credit risk
results from the possibility that a counterparty to a derivative transaction may
fail to perform according to the terms of the contract. Therefore, the Company's
exposure to credit risk is represented by its net receivable from derivative
counterparties, after consideration of collateral. Operational risk is the
possibility of financial loss resulting from a deficiency in the Company's
systems for executing derivative transactions. In addition to these risks,
counterparties to derivative financial instruments may also be exposed to legal
risks related to derivative activities, including the possibility that a
transaction may be unenforceable under applicable law. The risks of derivatives
should not be viewed in isolation but rather should be considered on an
aggregate basis along with the Company's other trading-related activities.
As derivative products have continued to expand in volume, so has market
participation and competition. As a result, additional liquidity has been added
into the markets for conventional derivative products, such as interest rate
swaps. Competition has also contributed to the development of more complex
products structured for specific clients. It is this rapid growth and complexity
of certain derivative products which has led to the perception, by some, that
derivative products are unduly risky to users and the financial markets. In
order to remove the public perception that derivatives may be unduly risky and
to ensure ongoing liquidity of derivatives in the marketplace, the Company
supports the efforts of the regulators in striving for enhanced risk management
disclosures which consider the effects of both derivative products and cash
instruments. In addition, the Company supports the activities of regulators
which are designed to ensure that users of derivatives are fully aware of the
nature of risks inherent within derivative transactions. As evidence of this
support, the Company is an active participant in the Derivative Policy Group and
has been actively involved with the various regulatory and accounting
authorities in the development of additional enhanced reporting requirements
related to derivatives. The Company strongly believes that derivatives provide
significant value to the financial markets and is committed to providing its
clients with innovative products to meet their financial needs.
LEHMAN BROTHERS' USE OF DERIVATIVE INSTRUMENTS In the normal course of
business, the Company enters into derivative transactions both in a trading
capacity and as an end user. As an end user, the Company utilizes derivative
products to adjust the interest rate nature of its funding sources from fixed to
floating interest rates and vice versa, and to change the index upon which
floating interest rates are based (e.g., Prime to LIBOR) (collectively, "End
User Derivative Activities"). For a further discussion of the Company's End User
Derivative Activities see Note 12 to the Consolidated Financial Statements.
The Company utilizes derivative products in a trading capacity both as a dealer
to satisfy the financial needs of its clients and in each of its trading
businesses (collectively, "Trading-Related Derivative Activities"). The
Company's use of derivative products in its trading businesses is combined with
cash instruments to fully execute various trading strategies.
The Company conducts its derivative activities through a number of wholly owned
subsidiaries. The Company's fixed income derivative products business is
conducted through its special purpose subsidiary, Lehman Brothers Special
Financing Inc., and separately capitalized "AAA" rated subsidiaries, Lehman
Brothers Financial Products Inc. and Lehman Brothers Derivative Products Inc.
The Company's equity derivative product business is conducted through Lehman
Brothers Finance S.A. In addition, as a global investment bank, the Company is
also a market-maker in a number of foreign currencies and actively trades in the
global commodity markets. Counterparties to the Company's derivative product
transactions are primarily financial intermediaries (U.S. and foreign banks),
securities firms, corporations, governments and their agencies, finance
companies, insurance companies, investment companies and pension funds.
The Company manages the risks associated with derivatives on an aggregate basis,
along with the risks associated with its proprietary trading and market-making
activities in cash instruments, as part of its firmwide risk management
policies. For a further discussion of the Company's risk management policies
refer to Management's Discussion and Analysis pages 51-53.
<PAGE>
The Company's Trading-Related Derivative Activities have increased during the
current year to a notional amount of $2,398 billion at November 30, 1998 from
$1,855 billion at November 30, 1997, primarily as a result of growth in the
Company's activities as a dealer in fixed income derivative products. Notional
amounts are not recorded on the balance sheet and are not indicative of actual
or potential risk, but rather they provide a measure of the Company's
involvement with such instruments.
As a result of the Company's Trading-Related Derivative activities, the Company
is subject to credit risk. With respect to OTC derivative contracts, the
Company's credit exposure is directly with its counterparties and extends
through the duration of the derivative contracts. The Company views its net
credit exposure to be $6,939 million at November 30, 1998, representing the fair
value of the Company's OTC contracts in an unrealized gain position, after
consideration of collateral and master netting agreements. Collateral held
related to OTC contracts generally includes cash and U.S. government and federal
agency securities. At November 30, 1998 approximately 76% of the Company's net
credit risk exposure related to OTC contracts was with counterparties rated "A-"
or better.
Additionally, the Company is exposed to credit risk related to its
exchange-traded derivative contracts. Exchange-traded derivative contracts
include futures contracts, warrants and certain options. Futures contracts and
options on futures are transacted on the respective exchange. The exchange
clearinghouse is a counterparty to the futures contracts and options. As a
clearing member firm, the Company is required by the exchange clearinghouse to
deposit cash or other securities as collateral for its obligation upon the
origination of the contract and for any daily changes in the market value of
open futures contracts. Unlike OTC derivatives which involve numerous
counterparties, the number of counterparties from exchange-traded derivatives
includes only those exchange clearinghouses of which the Company is a clearing
member firm or other member firms the Company utilizes as agents. Substantially
all of the Company's exchange-traded derivatives are transacted on exchanges of
which the Company is a clearing member firm. To protect against the potential
for a default, all exchange clearinghouses impose net capital requirements for
their membership. Therefore, the potential for losses from exchange-traded
products is limited. As of November 30, 1998, the Company had approximately
$1,448 million on deposit with futures exchanges consisting of cash and
securities (customer and proprietary), and had posted approximately $127 million
of letters of credit.
See Note 12 to the Consolidated Financial Statements for a further discussion of
the Company's Trading-Related Derivative Activities.
ACCOUNTING AND VALUATION The Company's accounting methodology for derivatives
depends on both the type and purpose of the derivative financial instrument. The
Company records its Trading-Related Derivative Activities on a mark-to-market or
fair value basis. Under mark-to-market or fair value accounting, realized and
unrealized gains and losses are recognized currently in Principal transactions,
and resulting assets and liabilities are recorded in the Consolidated Statement
of Financial Condition as Derivatives and other contractual agreements, as
applicable. Derivative assets and liabilities are netted by counterparty, when
permitted under a legally enforceable master netting agreement. Derivatives
utilized in conjunction with the Company's End User Derivative Activities are
generally recorded on an accrual basis. Interest is accrued into income or
expense over the life of the contract, resulting in the net interest impact of
the derivative and the underlying hedged item being recognized in income
throughout the hedge period.
Market or fair value for Trading-Related Derivative Activities is generally
determined by either quoted market prices or pricing models. Pricing models
utilize a series of market inputs to determine the present value of future cash
flows, with adjustments, as required, for credit risk and liquidity risk.
Further valuation adjustments may be recorded, as deemed appropriate, for new or
complex products or for significant positions. These adjustments are integral
components of the mark-to-market process.
<PAGE>
RISK MANAGEMENT
As a leading global investment banking company, risk is an inherent part of the
Company's businesses. Global markets, by their nature, are prone to uncertainty
and subject participants to a variety of risks. The Company has developed
policies and procedures to identify, measure and monitor each of the risks
involved in its trading, brokerage and investment banking activities on a global
basis. The principal risks of Lehman Brothers are market, credit, liquidity,
legal and operational risks. Risk Management is considered to be of paramount
importance. The Company devotes significant resources across all of its
worldwide trading operations to the measurement, management and analysis of
risk, including investments in personnel and technology.
The Company seeks to reduce risk through the diversification of its businesses,
counterparties and activities in geographic regions. The Company accomplishes
this objective by allocating the usage of capital to each of its businesses,
establishing trading limits for individual products and traders and setting
credit limits for individual counterparties, including regional concentrations.
The Company seeks to achieve adequate returns from each of its businesses
commensurate with the risks that they assume.
Overall risk management policy is established by a Risk Management Committee
(the "Committee") comprised of the Chief Executive Officer, the Global Risk
Manager, the Chief Financial and Administrative Officer, the Head of Equities,
the Head of Fixed Income, the Head of Global Sales and Research and the Co-Heads
of Investment Banking. The Committee brings together senior management with the
sole intent of discussing risk related issues and provides an effective forum
for managing risk at the highest levels within the Company. The Committee meets
on a monthly basis, or more frequently if required, to discuss, among other
matters, significant market exposures, concentrations of positions (e.g.,
counterparty, market risk), potential new transactions or positions and risk
limit exceptions.
The Global Risk Management Group (the "Group") supports the Committee, is
independent of the trading areas and reports directly to the Chief Executive
Officer. The Group combines two departments, credit risk management and market
risk management, into one unit. This facilitates the analysis of counterparty
credit and market risk exposures and leverages personnel and information
technology resources in a cost-efficient manner. The Group maintains staff in
each of the Company's regional trading centers and has daily contact with
trading staff at all levels within the Company. These discussions include a
review of trading positions and risk exposures.
CREDIT RISK Credit risk represents the possibility that a counterparty will be
unable to honor its contractual obligations to the Company. Credit risk
management is therefore an integral component of the Company's overall risk
management framework. The Credit Risk Management Department ("CRM Department")
has global responsibility for implementing the Company's overall credit risk
management framework.
The CRM Department manages the credit exposure related to trading activities by
giving initial credit approval for counterparties, establishing credit limits by
counterparty, country and industry group and by requiring collateral in
appropriate circumstances. In addition, the CRM Department strives to ensure
that master netting agreements are obtained whenever possible. The CRM
Department also considers the duration of transactions in making its credit
decisions, along with the potential credit exposure for complex derivative
transactions. The CRM Department is responsible for the continuous monitoring
and review of counterparty credit exposure and creditworthiness and
recommending, where appropriate, credit reserves. Credit limits and reserves are
reviewed periodically to ensure that they remain appropriate in light of market
events or the counterparty's financial condition.
MARKET RISK Market risk represents the potential change in value of a portfolio
of financial instruments due to changes in market rates, prices, and
volatilities. Market risk management also is an essential component of the
Company's overall risk management framework. The Market Risk Management
Department ("MRM Department") has global responsibility for
<PAGE>
implementing the Company's overall market risk management framework. It is
responsible for the preparation and dissemination of risk reports, developing
and implementing the firmwide Risk Management Guidelines and evaluating
adherence to these guidelines. These guidelines provide a clear framework for
risk management decision-making. To that end the MRM Department identifies and
quantifies risk exposures, develops limits, and reports and monitors these risks
with respect to the approved limits. The identification of material market risks
inherent in positions includes, but is not limited to, interest rate, equity,
and foreign exchange risk exposures. In addition to these risks, the MRM
Department also evaluates liquidity risks, credit and sovereign concentrations.
The MRM Department utilizes qualitative as well as quantitative information in
managing trading risk, believing that a combination of the two approaches
results in a more robust and complete approach to the management of trading
risk. Quantitative information is developed from a variety of risk methodologies
based upon established statistical principles. To ensure high standards of
qualitative analysis, the MRM Department has retained seasoned risk managers
with the requisite experience and academic and professional credentials.
Market risk is present in cash products, derivatives, and contingent claim
structures that exhibit linear as well as non-linear profit and loss
sensitivity. The Company's exposure to market risk varies in accordance with the
volume of client driven market-making transactions, the size of the Company's
proprietary and arbitrage positions, and the volatility of financial instruments
traded. The Company seeks to mitigate, whenever possible, excess market risk
exposures through the use of futures and option contracts and offsetting cash
market instruments.
The Company participates globally in interest rate, equity, and foreign exchange
markets. The Company's Fixed Income division has a broadly diversified market
presence in U.S. and foreign government bond trading, emerging market
securities, corporate debt (investment and non-investment grade), money market
instruments, mortgages and mortgage-backed securities, asset-backed securities,
municipal bonds, and interest rate derivatives. The Company's Equities division
facilitates domestic and foreign trading in equity instruments, indices, and
related derivatives. The Company's foreign exchange businesses are involved in
trading currencies on a spot and forward basis as well as through derivative
products and contracts.
The Company incurs short-term interest rate risk when facilitating the orderly
flow of customer transactions through the maintenance of government and
high-grade corporate bond inventories. Market-making in high yield instruments
exposes the Company to additional risk due to potential variations in credit
spreads. Trading in international markets exposes the Company to spread risk
between the term structure of interest rates in differing countries.
Mortgage-related securities are subject to prepayment risk and changes in the
level of interest rates. Trading in derivatives and structured products exposes
the Company to changes in the level and volatility of interest rates. The
Company actively manages interest rate risk through the use of interest rate
futures, options, swaps, forwards, and offsetting cash market instruments.
Inventory holdings, concentrations, and agings are monitored closely and used by
management to selectively hedge or liquidate undesirable exposures.
The Company is a significant intermediary in the global equity markets by making
markets in U.S. and non-U.S. equity securities, including common stock,
convertible debt, exchange-traded and OTC equity options, equity swaps and
warrants. These activities expose the Company to market risk as a result of
price and volatility changes in its equity inventory. Inventory holdings are
also subject to market risk resulting from concentrations, aging and liquidity
that may adversely impact its market valuation. Equity market risk is actively
managed through the use of index futures, exchange-traded and OTC options, swaps
and cash instruments. Equity risk exposures are aggregated and reported to
management on a regular basis.
The Company enters into foreign exchange transactions in order to facilitate the
purchase and sale of non-dollar instruments, including equity and interest rate
securities. The Company is exposed to foreign exchange risk on its holdings of
non-dollar assets and liabilities. The Company is active in many foreign
exchange markets and has exposure to the Euro, Japanese yen, British pound,
Swiss franc, and Canadian dollar, as well as, a variety of developed and
emerging market currencies. The Company hedges its risk exposures primarily
through the use of currency forwards, swaps, futures, and options.
<PAGE>
COMMERCIAL MORTGAGE BUSINESS The Company has one of the premier commercial
mortgage-backed securities businesses. In this business, the Company buys
commercial mortgages, converts them to securities, and then sells those
securities. The Company's operating practices have served to mitigate a number
of the risks in this business. First, the Company securitizes its commercial
mortgage inventory frequently. This shortens holding periods and increases the
turnover rate of the Company's mortgage inventory. Second, the bulk of the
Company's origination has been floating rate mortgage product. Of the Company's
current commercial mortgage inventory, approximately 85 percent is floating
rate, or has been swapped into floating rates. These loans hold their value much
better than fixed rate loans or hybrid products.
VALUE AT RISK For purposes of Securities and Exchange Commission risk
disclosure requirements, the Company disclosed an entity-wide value at risk
analysis of virtually all of the Company's trading activities. The value at risk
calculation measures the potential loss in expected revenues with a 95%
confidence level. The methodology incorporates actual trading revenues over a
standardized historical period. A confidence level of 95% implies, on average,
that daily trading revenues or losses will exceed daily expected trading
revenues by an amount greater than value at risk one out of every 20 trading
days.
Value at risk is one measurement of potential losses in revenues that may result
from adverse market movements over a specified period of time with a selected
likelihood of occurrence. Value at risk has substantial limitations, including
its reliance on historical performance and data as valid predictors of the
future. Consequently, value at risk is only one of a number of tools the Company
utilizes in its daily risk management activities.
The Company's average value at risk for each component of market risk, and in
total was as follows:
November 30
[in millions] 1998 1997
- -------------------------------------------------------
Interest rate risk $15.0 $12.8
Equity price risk 9.5 5.6
Foreign exchange risk 3.9 5.3
Diversification benefit (9.8) (8.6)
- -------------------------------------------------------
Total Company $18.6 $15.1
- -------------------------------------------------------
During 1998, the Company's value at risk varied from a high of $32.8 million to
a low of $14.2 million. During 1997, the Company's value at risk varied from a
high of $16.4 million to a low of $13.7 million. Average value at risk during
1998 includes the effects of the extreme market volatility experienced during
the August-October 1998 time period. Value at risk at November 30, 1998 and 1997
was $31.7 million and $14.8 million, respectively. Average daily trading revenue
decreased to $8.6 million in 1998 from $10.0 million in 1997 as a result of
difficult market conditions during the August-October period.
As discussed throughout Management's Discussion and Analysis, the Company seeks
to reduce risk through the diversification of its businesses and a focus on
customer flow activities. This diversification and focus, combined with the
Company's risk management controls and processes, helps mitigate the net revenue
volatility inherent in the Company's trading activities. Although historical
performance is not necessarily indicative of future performance, the Company
believes its focus on business diversification and customer flow activities
should continue to help mitigate the volatility of future net trading revenues.
YEAR 2000 READINESS DISCLOSURE
The year 2000 issue originates from computer programs and imbedded chips using
two digits rather than four to define the year. Computer programs that have
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000.
<PAGE>
If not addressed and completed on a timely basis, failure of the Company's
computer systems to process year 2000 related data correctly could have a
material adverse effect on the Company's operations and financial condition.
Failures of this kind could, for example, lead to incomplete or inaccurate
accounting, settlement failures, trade processing or recording errors in
securities, currencies, commodities or other assets. It could also lead to
uncertainty regarding risk, exposures and liquidity. If not addressed, the
potential risks to the Company include financial loss, legal liability,
interruption of business and regulatory actions.
The Company established a team in 1996 to modify or replace and then test the
appropriate software and equipment to ensure that year 2000 issues are
addressed. The Company presently believes that with modifications to existing
software and conversions to new software, the year 2000 issue will be resolved
for all the Company's own systems worldwide.
In its approach to the year 2000 problem, Lehman Brothers has been guided by a
three-step methodology. The steps are:
- INVENTORY AND ASSESSMENT
- REMEDIATION
- TESTING
Inventory and assessment consisted of initial technical and functional analysis
across the Company's applications. Initial analysis identified systems and
applications. Each application was then reviewed and classified as highly
critical, critical or non-critical. This process is complete.
Remediation is divided into three phases. Applications specified as year 2000
non-compliant have been analyzed to determine business impact and those that
have been deemed critical were targeted for remediation. Selected Lehman
Brothers mainframe applications were sent to an outside vendor for remediation,
while the remaining applications have been repaired internally. It is 99%
complete as of the end of 1998 and is expected to be 100% complete by the end of
the first quarter of 1999.
All remediated applications are tested for non-year 2000 functionality to
confirm they still run correctly prior to year 2000 testing. At the time of
remediation, applications are logged into a change management system to further
ensure any additional changes are monitored and re-tested for year 2000
compliance.
Testing for year 2000 compliance was also organized into three phases. Phase one
involves testing individual applications or groups of applications on mainframe
or on distributed platforms. Consultants were engaged to assist with the testing
of distributed applications classified as highly critical. Phase two involves
real-time testing across platforms (integration testing). Phase three involves
testing applications between firms (external testing).
Each of these phases has been pursued in a worldwide effort coordinated in New
York, London and Tokyo where project teams and segregated lab environments have
been established. The remediation and testing has been largely completed for
core databases.
External testing itself is being performed in three steps. "Point-to-point"
testing confirms that application interfaces between the Company and individual
services and utilities function correctly. Point-to-point testing began in
February 1998. "Beta" testing for a product follows point-to-point testing and
is a dress rehearsal for industrywide testing. Beta testing is only performed in
the U.S. Many of the markets are not providing industrywide testing, but they
are providing some amount of end-to-end testing, where data is passed to more
than one exchange or utility. Industrywide testing follows beta testing as the
final external testing step.
In 1998, the Company participated in two Beta tests in the U.S., for the SIA and
for the Futures Industry Association (FIA). The Company has also participated in
the SIA Money Market Beta Test, the Mortgage-Backed Securities Clearing
Corporation Test, the Participant Trust Company Mortgage Test and the Government
Securities Clearing Corporation
<PAGE>
Test. Overseas tests in which the Company has participated include the Central
Gilts Office (CGO) and CREST in the United Kingdom and the Singapore
International Monetary Exchange (SIMEX) test in Singapore.
The Company is scheduled to participate in numerous domestic tests in 1999,
including the SIA Market Data Beta Test in February, the SIA Industrywide Test
in March and April, the SIA Money Market and Stock Loan tests in May and the SIA
Industrywide Market Data Test in May. In addition the Company is scheduled to
participate in a wide range of overseas tests in 1999, specifically, Hong Kong
and Tokyo tests planned for the first and second quarters. The Company plans to
participate in European tests as they are announced. Industrywide testing is
currently expected to be completed in the third quarter.
The Company has taken a lead in the industry's efforts to deal with the year
2000 issue by actively participating and in some cases leading, industrywide
testing efforts. Lehman Brothers chairs the Participants' Industrywide Testing
Subcommittee of the Securities Industry Association (SIA) which with partners
such as exchanges, depositories, market data vendors and buy-side firms sets up,
refines and coordinates industrywide testing in the United States. Industrywide
testing is the forum in which firms within the financial industry test the
applications that transfer data between them. These tests are scheduled to start
in March 1999.
In addition to its leadership in U.S. testing efforts, through membership in the
Executive Committee of Global 2000, a group of international financial firms,
the Company is participating in the coordination of global year 2000 readiness
in the financial community. The Company is also pursuing separate point-to-point
testing with firms not participating in industrywide testing. Lehman Brothers
also serves as a member of the Custody 2000 Working Group whose goal is to
assist the financial community in the assessment of year 2000 readiness of
custodians in a variety of global markets. The Custody 2000 Working Group will
also conduct proxy testing of selected sub-custodians in a number of markets
globally.
Year 2000 also affects building and infrastructure systems. The Company is
engaged in a global effort to address facilities issues. Critical areas include
facilities components such as building management systems, elevators, heating
systems, security and fire alarm systems, electrical and other building
services. Facilities staff is surveying and testing equipment and components
and, with the Third Party Vendor team, is working to ensure their vendors and
suppliers are year 2000 ready.
However, even if these changes are successful, the Company remains at risk from
year 2000 failures caused by third parties. Externally, the Company is an active
participant in the SIA Third Party Vendor Committee. Internally, the Company is
evaluating efforts of key counterparties, banks, exchanges, agencies, utilities
and suppliers, among others, to assess and remediate their year 2000 issues. As
part of this effort the Third Party Vendor team has inventoried and has sent
surveys to vendors whose software and hardware products the Company uses and
whose services the Company employs to determine their year 2000 readiness. The
team is also testing critical software and hardware products to ensure year 2000
readiness. To date the Company has received information from 95% of its vendors,
including overseas vendors whose year 2000 awareness seems to be less advanced
than in the United States.
Examples of problems that could result from the failure by third parties with
whom the Company interacts to remediate year 2000 bugs include: (i) in the case
of exchanges and clearing agents, funding disruptions, failure to trade in
certain markets and settlement failures; (ii) in the case of counterparties and
clients, accounting and financial difficulties to those parties that may expose
the Company to increased credit risk and lost business; (iii) in the case of
vendors, service failures such as power, telecommunications, elevator operations
and loss of security access control; (iv) in the case of banks and other
lenders, the potential for liquidity stress due to disruptions to funding flows;
and, (v) in the case of data providers, inaccurate or out of date information
would impair the Company's ability to perform critical functions such as pricing
securities and currencies.
Additionally, general uncertainty regarding the success of remediation may cause
many market participants to reduce their market activities temporarily as they
address and assess their year 2000 efforts in 1999. This could result in a
general
<PAGE>
reduction in market activities and revenue opportunities in late 1999 and early
2000. Management cannot predict the magnitude of any such reduction or its
impact on the Company's financial results. However, the Company's Risk
Management Department has undertaken a comprehensive review of third party and
credit risks posed by year 2000. Recognizing the uncertainty of external
dependencies, the Company is also preparing a contingency plan that identifies
potential problems, actions to minimize the likelihood of them occurring and
action plans to be invoked should they occur. These plans will include backup
processes that do not rely on computer systems, where appropriate. The
contingency plan will be complete by the end of April 1999.
However, as stated above, there can be no guarantee or assurance that the
systems of other companies on which the Company's systems rely will be
remediated in a timely manner. This or a failure to remediate by another company
or a remediation that is incompatible with the Company's systems may well have a
material adverse effect on the Company.
The Company has established an internal auditing plan to record results and
ensure ongoing compliance of tested applications. It should be noted that
efforts focused on addressing EMU have delayed the finalization of internal and
industrywide testing in Europe.
The Company's total year 2000 project cost is based on presently available
information. The total remaining cost of the year 2000 project is estimated at
approximately $38 million which will be funded through operating cash flows and
expensed as incurred over the next one and one-half years. The Company has
incurred and expensed approximately $16 million in 1997 and an additional $31
million through November 30, 1998, related to the year 2000 project.
The costs of year 2000 testing, modifications and/or replacements and the date
on which the Company plans to complete the project are based on management's
best estimates. These estimates were derived using numerous assumptions of
future events including the continued availability of certain resources, third
party modification plans and other factors.
EMU
As of January 1, 1999, 11 European countries entered into the European economic
and monetary union (the "EMU") and replaced their local currencies with a single
currency, the Euro. The countries currently in the EMU are: Austria, Belgium,
Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal,
and Spain. During a three-year transition period, the national currencies will
continue to circulate but only as fixed denominations of the Euro. On January 1,
1999, the Euro became the predominant currency to settle non-cash transactions
previously denominated in the participating national currencies. The Company
needed to convert certain of its systems and processes to accommodate this
currency change.
In addition to systems changes, the Company reviewed all of its documentation in
light of the changes arising from the introduction of the Euro. Documents
affected by the conversion were revised and distributed to affected
counterparties. The Company has adopted the EMU protocol agreement established
by the International Swaps and Derivatives Association, Inc., and intends to
participate in other market-initiated EMU annexes and amendments as they are
developed by relevant industry associations.
Many areas of the Company were affected by the introduction of the single
currency. The conversion was completed well within the time frame of the planned
conversion weekend. As transaction volumes had been reduced market-wide, the
process actually ran more quickly than expected at approximately 56 hours.
Success was over 98% and less than 100 positions/trades required manual
adjustments. Of those, all were fixed by Monday morning on January 4.
The changes to the Company's data and computer systems affected its clearance,
settlement and financial reporting activities, among other key operations of the
Company. The Company is also dependent for proper transactions clearance and
reporting on many third parties, including counterparties, clearing agents,
banks, exchanges, clearinghouses and providers
<PAGE>
of information. While the Company cannot guarantee that these third parties'
systems all appropriately reflect the introduction of the Euro, to date Lehman
has experienced no material post conversion problems, either with internal or
external systems. In addition, the European markets have reacted favorably to
the introduction of the Euro.
While conversion to the Euro has reduced client demand for certain transactions,
which has impacted our foreign exchange and fixed income activities in Europe,
the Company anticipates that new opportunities in Europe will be created through
an expansion of activities in both the investment grade and high yield debt
capital markets as well as investment banking opportunities. Overall, management
anticipates that the formation of EMU will not have a material adverse effect on
the trend of earnings of the Company.
The Company has incurred and expects to continue to incur expenses for the
internal technology staff, as well as costs for outside consultants, in order to
implement its EMU conversion plan and handle the aftermath of the conversion.
Management currently estimates that the cost of its EMU conversion program will
be approximately $30 million, of which approximately $23 million has been
incurred to date.
NEW ACCOUNTING DEVELOPMENTS
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. SFAS No. 131 is effective for financial statements for fiscal years
beginning after December 15, 1997 (Fiscal 1999 for the Company). Financial
statement disclosures for prior periods are required to be restated. The
adoption of SFAS No. 131 will have no impact on the Company's consolidated
statement of income, financial condition or cash flows.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and for Hedging Activities." SFAS No. 133 is effective for fiscal
years beginning after June 15, 1999 (Fiscal 2000 for the Company). SFAS No. 133
is a complex accounting standard that requires all derivatives to be recorded at
fair value on the balance sheet. Changes in the fair value of derivatives are to
be recorded each period in earnings or Accumulated other comprehensive income, a
classification within stockholders' equity, depending on the nature of the risks
being hedged. As the Company already accounts for derivatives associated with
its trading activities on a fair value basis, SFAS No. 133 will only impact the
accounting for the Company's End User Derivative Activities. As an end user, the
Company utilizes derivatives primarily to manage interest rate risk associated
with its long-term debt and secured financing activities. (See Note 4 and Note
12 for a further discussion of the Company's End User Derivative Activities.)
The Company has not yet determined the impact of adopting SFAS No. 133, which is
difficult to predict, because the actual impact ultimately will hinge on market
values at the date of adoption. However, the Company does not expect that
adoption will have a material effect on its earnings or financial condition.
EFFECTS OF INFLATION
Because the Company's assets are, to a large extent, liquid in nature, they are
not significantly affected by inflation. However, the rate of inflation affects
the Company's expenses, such as employee compensation, office space leasing
costs and communications charges, which may not be readily recoverable in the
price of services offered by the Company. To the extent inflation results in
rising interest rates and has other adverse effects upon the securities markets,
it may adversely affect the Company's financial position and results of
operations in certain businesses.
<PAGE>
Exhibit 13.2
- --------------------------------
CONSOLIDATED STATEMENT OF INCOME
- --------------------------------
<TABLE>
<CAPTION>
Twelve months ended
November 30
-------------------------------------
[in millions, except per share data] 1998 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES
Investment banking $ 1,582 $ 1,318 $ 981
Principal transactions 1,232 1,418 1,579
Commissions 513 423 362
Interest and dividends 16,542 13,635 11,298
Other 25 89 40
- ------------------------------------------------------------------------------------------
Total revenues 19,894 16,883 14,260
Interest expense 15,781 13,010 10,816
- ------------------------------------------------------------------------------------------
Net revenues 4,113 3,873 3,444
- ------------------------------------------------------------------------------------------
NON-INTEREST EXPENSES
Compensation and benefits 2,086 1,964 1,747
Brokerage, commissions and clearance fees 229 224 241
Professional services 171 173 150
Communications 146 141 147
Occupancy and equipment 138 141 151
Business development 115 103 101
Depreciation and amortization 91 86 91
Other 85 104 95
Severance charge 84
- ------------------------------------------------------------------------------------------
Total non-interest expenses 3,061 2,936 2,807
- ------------------------------------------------------------------------------------------
Income before taxes 1,052 937 637
Provision for income taxes 316 290 221
- ------------------------------------------------------------------------------------------
Net income $ 736 $ 647 $ 416
- ------------------------------------------------------------------------------------------
Net income applicable to common stock $ 649 $ 572 $ 378
- ------------------------------------------------------------------------------------------
Weighted-average shares
Basic 120.9 118.2 115.3
Diluted 125.0 121.1 116.7
- ------------------------------------------------------------------------------------------
Earnings per common share
Basic $ 5.37 $ 4.84 $ 3.27
Diluted $ 5.19 $ 4.72 $ 3.24
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
- ---------------------------------------------
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
- ---------------------------------------------
<TABLE>
<CAPTION>
November 30
----------------------
[in millions] 1998 1997
- ---------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 3,055 $ 1,685
Cash and securities segregated and on deposit
for regulatory and other purposes 1,183 1,149
Securities and other financial instruments owned:
Mortgages and mortgage-backed 23,458 11,455
Governments and agencies 23,000 33,037
Corporate debt and other 11,160 10,892
Derivatives and other contractual agreements 9,883 8,353
Corporate equities 8,217 10,877
Certificates of deposit and other money
market instruments 1,282 2,248
- ---------------------------------------------------------------------------
77,000 76,862
- ---------------------------------------------------------------------------
Collateralized short-term agreements:
Securities purchased under agreements to resell 42,381 43,606
Securities borrowed 16,341 14,146
Receivables:
Brokers, dealers and clearing organizations 2,298 2,193
Customers 7,758 9,105
Others 1,909 1,540
Property, equipment and leasehold improvements
(net of accumulated depreciation and amortization
of $810 in 1998 and $735 in 1997) 505 468
Other assets 1,297 787
Excess of cost over fair value of net assets
acquired (net of accumulated amortization
of $120 in 1998 and $111 in 1997) 163 164
- ---------------------------------------------------------------------------
Total assets $153,890 $151,705
- ---------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
- ---------------------------------------------------------
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION (continued)
- ---------------------------------------------------------
<TABLE>
<CAPTION>
November 30
-----------------------
[in millions, except share data] 1998 1997
- ---------------------------------------------------------------------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Commercial paper and short-term debt $ 6,657 $ 7,818
Securities and other financial instruments
sold but not yet purchased:
Governments and agencies 14,963 16,201
Derivatives and other contractual agreements 8,064 7,367
Corporate equities 3,828 4,293
Corporate debt and other 1,948 2,219
- ---------------------------------------------------------------------------
28,803 30,080
- ---------------------------------------------------------------------------
Collateralized short-term financing:
Securities sold under agreements to repurchase 67,730 63,204
Securities loaned 3,165 7,846
Payables:
Brokers, dealers and clearing organizations 1,322 2,155
Customers 9,203 11,702
Accrued liabilities and other payables 4,256 4,116
Long-term debt:
Senior notes 23,873 17,049
Subordinated indebtedness 3,468 3,212
- ---------------------------------------------------------------------------
Total liabilities 148,477 147,182
- ---------------------------------------------------------------------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock 908 508
Common stock, $0.10 par value; 300,000,000
shares authorized; Shares issued: 121,801,123
in 1998 and 119,513,337 in 1997; Shares
outstanding: 113,657,877 in 1998 and
116,612,074 in 1997 12 12
Additional paid-in capital 3,534 3,436
Accumulated other comprehensive income
(net of tax) 15 12
Retained earnings 1,105 498
Other stockholders' equity, net 269 155
Common stock in treasury, at cost:
8,143,246 shares in 1998 and 2,901,263
shares in 1997 (430) (98)
- ---------------------------------------------------------------------------
Total stockholders' equity 5,413 4,523
- ---------------------------------------------------------------------------
Total liabilities and stockholders' equity $153,890 $151,705
- ---------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
- ---------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Twelve months ended November 30
------------------------------------
[in millions] 1998 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
PREFERRED STOCK
5% Cumulative Convertible Voting, Series A:
Beginning balance $ 1 $ 508 $ 508
Series A exchanged for Series B (507)
- ------------------------------------------------------------------------------------------
Ending balance 1 1 508
- ------------------------------------------------------------------------------------------
5% Cumulative Convertible Voting, Series B:
Beginning balance 507
Series A exchanged for Series B 507
Repurchase (50)
- ------------------------------------------------------------------------------------------
Ending balance 457 507
- ------------------------------------------------------------------------------------------
5.94% Cumulative, Series C:
Beginning balance
Shares issued 250
- ------------------------------------------------------------------------------------------
Ending balance 250
- ------------------------------------------------------------------------------------------
5.67% Cumulative, Series D:
Beginning balance
Shares issued 200
- ------------------------------------------------------------------------------------------
Ending balance 200
- ------------------------------------------------------------------------------------------
8.44% Cumulative Voting:
Beginning balance 200
Repurchase (200)
- ------------------------------------------------------------------------------------------
Ending balance
- ------------------------------------------------------------------------------------------
Redeemable Voting:
Beginning and ending balance
- ------------------------------------------------------------------------------------------
Total Preferred Stock, ending balance 908 508 508
- ------------------------------------------------------------------------------------------
COMMON STOCK
Beginning balance 12 11 11
Shares issued to RSU Trust 1
- ------------------------------------------------------------------------------------------
Ending balance 12 12 11
- ------------------------------------------------------------------------------------------
ADDITIONAL PAID-IN CAPITAL
Beginning balance 3,436 3,198 3,172
RSUs exchanged for Common Stock 8 21
Stock options exercised 99 33 6
Employee stock purchase plan (3) (3) (3)
Shares issued to RSU Trust 199
Other, net 2 1 2
- ------------------------------------------------------------------------------------------
Ending balance 3,534 3,436 3,198
- ------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Beginning balance 12 20 9
Translation adjustment, net(1) 3 (8) 11
- ------------------------------------------------------------------------------------------
Ending balance 15 12 20
- ------------------------------------------------------------------------------------------
</TABLE>
(1) Net of income taxes of $2 in 1998, $8 in 1997, and $(11) in 1996.
See Notes to Consolidated Financial Statements.
<PAGE>
- ---------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (continued)
- ---------------------------------------------------------------------
<TABLE>
<CAPTION>
Twelve months ended November 30
------------------------------------
[in millions] 1998 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
RETAINED EARNINGS (ACCUMULATED DEFICIT)
Beginning balance $ 498 $ (43) $ (397)
Net income 736 647 416
Dividends declared:
5% Cumulative Convertible Voting Series A
and B Preferred Stock (25) (25) (25)
5.94% Cumulative, Series C Preferred Stock (8)
5.67% Cumulative, Series D Preferred Stock (4)
8.44% Cumulative Voting Preferred Stock (3)
Redeemable Voting Preferred Stock (50) (50) (8)
Common Stock (37) (31) (24)
Premium for repurchase of 8.44% Cumulative Voting
Preferred Stock (2)
Other (5)
- ------------------------------------------------------------------------------------------
Ending balance 1,105 498 (43)
- ------------------------------------------------------------------------------------------
COMMON STOCK ISSUABLE
Beginning balance 911 532 302
RSUs exchanged for Common Stock (10) (8) (21)
Deferred stock awards granted 417 387 251
- ------------------------------------------------------------------------------------------
Ending balance 1,318 911 532
- ------------------------------------------------------------------------------------------
COMMON STOCK HELD IN RSU TRUST
Beginning balance (325)
Shares issued to RSU Trust (107) (325)
Shares issued from RSU Trust 10
- ------------------------------------------------------------------------------------------
Ending balance (422) (325)
- ------------------------------------------------------------------------------------------
DEFERRED STOCK COMPENSATION
Beginning balance (431) (206) (91)
Deferred stock awards granted (417) (387) (251)
Amortization of deferred compensation, net 221 162 136
- ------------------------------------------------------------------------------------------
Ending balance (627) (431) (206)
- ------------------------------------------------------------------------------------------
COMMON STOCK IN TREASURY, AT COST
Beginning balance (98) (146) (16)
Treasury stock purchased (469) (77) (130)
Stock options exercised 30
Shares issued to RSU Trust 107 125
- ------------------------------------------------------------------------------------------
Ending balance (430) (98) (146)
- ------------------------------------------------------------------------------------------
Total Stockholders' Equity $5,413 $4,523 $3,874
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
- ------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
- ------------------------------------
<TABLE>
<CAPTION>
Twelve months ended November 30
------------------------------------
[in millions] 1998 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 736 $ 647 $ 416
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 91 86 91
Severance charge 84
Provisions for losses and other reserves 292 52 42
Deferred tax provision (benefit) (284) (60) 72
Compensation payable in common stock 221 162 136
Other adjustments 43 (212) 48
Net change in:
Cash and securities segregated and on deposit (34) (461) 257
Securities and other financial instruments owned (138) (15,409) (8,432)
Securities borrowed (2,195) 6,505 (4,361)
Receivables from brokers, dealers and
clearing organizations (105) 685 (1,318)
Receivables from customers 1,347 (3,292) (2,336)
Securities and other financial instruments sold
but not yet purchased (1,277) 3,716 4,550
Securities loaned (4,681) 1,550 4,330
Payables to brokers, dealers and
clearing organizations (833) 1,151 (99)
Payables to customers (2,499) 4,120 1,821
Accrued liabilities and other payables (152) 782 217
Other operating assets and liabilities, net (592) (286) 107
- ------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities $(10,060) $(264) $(4,375)
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
- ------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS (continued)
- ------------------------------------------------
<TABLE>
<CAPTION>
Twelve months ended November 30
------------------------------------
[in millions] 1998 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuances of senior notes $ 11,091 $ 7,242 $ 4,455
Principal payments of senior notes (4,298) (2,548) (2,411)
Proceeds from issuances of subordinated indebtedness 600 407 1,330
Principal payments of subordinated indebtedness (356) (550) (246)
Net proceeds from (payments for) commercial paper
and short-term debt (1,161) (384) 1,981
Resale agreements net of repurchase agreements 5,751 (4,181) 978
Payment for repurchase of preferred stock (50) (200)
Payments for treasury stock purchases (411) (77) (130)
Issuances of common stock 61 23 6
Issuances of preferred stock 444
Dividends paid (122) (58) (55)
- ------------------------------------------------------------------------------------------
Net cash provided by (used in)
financing activities 11,549 (126) 5,708
- ------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and
leasehold improvements, net (119) (74) (58)
- ------------------------------------------------------------------------------------------
Net cash used in investing activities (119) (74) (58)
- ------------------------------------------------------------------------------------------
Net change in cash and cash equivalents 1,370 (464) 1,275
- ------------------------------------------------------------------------------------------
Cash and cash equivalents, beginning of period 1,685 2,149 874
- ------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 3,055 $ 1,685 $ 2,149
- ------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF
CASH FLOW INFORMATION [in millions]
Interest paid totaled $15,473 in 1998, $12,900 in 1997 and $10,852 in 1996.
Income taxes paid totaled $541 in 1998, $371 in 1997 and $79 in 1996.
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
- ------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------
------
NOTE 1
------
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION The consolidated financial statements include the
accounts of Lehman Brothers Holdings Inc. ("Holdings") and subsidiaries
(collectively, the "Company" or "Lehman Brothers"). Lehman Brothers is one of
the leading global investment banks serving institutional, corporate, government
and high-net-worth individual clients and customers. The Company's worldwide
headquarters in New York and regional headquarters in London and Tokyo are
complemented by offices in additional locations in North America, Europe, the
Middle East, Latin America and the Asia Pacific Region. The Company is engaged
primarily in providing financial services. The principal U.S. subsidiary of
Holdings is Lehman Brothers Inc. ("LBI"), a registered broker-dealer. All
material intercompany accounts and transactions have been eliminated in
consolidation.
The consolidated financial statements are prepared in conformity with generally
accepted accounting principles which require management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Management believes that the estimates utilized in preparing
its financial statements are reasonable and prudent. Actual results could differ
from these estimates.
The Company uses the trade date basis of accounting.
Certain prior period amounts reflect reclassifications to conform to the current
period's presentation.
TRANSLATION OF FOREIGN CURRENCIES Assets and liabilities of foreign
subsidiaries having non-U.S. dollar functional currencies are translated at
exchange rates at the statement of financial condition date. Revenues and
expenses are translated at average exchange rates during the period. The gains
or losses resulting from translating foreign currency financial statements into
U.S. dollars, net of hedging gains or losses and related tax effects, are
included in Accumulated other comprehensive income, a separate component of
stockholders' equity. Gains or losses resulting from foreign currency
transactions are included in the Consolidated Statement of Income.
SECURITIES AND OTHER FINANCIAL INSTRUMENTS Securities and other financial
instruments owned and securities and other financial instruments sold but not
yet purchased are valued at market or fair value, as appropriate, with
unrealized gains and losses reflected in Principal transactions in the
Consolidated Statement of Income. Market value is generally based on listed
market prices. If listed market prices are not available, fair value is
determined based on other relevant factors, including broker or dealer price
quotations and valuation pricing models which take into account time value and
volatility factors underlying the financial instruments.
DERIVATIVE FINANCIAL INSTRUMENTS Derivatives, typically defined as instruments
whose value is "derived" from an underlying instrument, index or rate, include
futures, forwards, swaps and options and other similar instruments. A derivative
contract generally represents future commitments to exchange interest or other
payment streams based on the contract or notional amount or to purchase or sell
financial instruments at specified terms and future dates. In the normal course
of business, the Company enters into derivative transactions both in a trading
capacity and as an end user. Acting in a trading capacity, the Company enters
into derivative transactions to satisfy the needs of its clients and to manage
the Company's own exposure to market and credit risks resulting from its trading
activities (collectively, "Trading-Related Derivative Activities"). The
Company's accounting methodology for derivatives depends on both the type and
purpose of the derivative financial instrument.
<PAGE>
Derivative transactions entered into for Trading-Related Derivative Activities
are recorded at market or fair value with realized and unrealized gains and
losses recognized currently in Principal transactions in the Consolidated
Statement of Income. Market or fair value for trading related instruments is
generally determined by either quoted market prices (for exchange-traded futures
and options) or pricing models (for over-the-counter swaps, forwards and
options). Pricing models utilize a series of market inputs to determine the
present value of future cash flows, with adjustments, as required for credit
risk and liquidity risk. Further valuation adjustments may be recorded, as
deemed appropriate for new or complex products or for positions with significant
concentrations. These adjustments are integral components of the mark-to-market
process.
The market or fair value associated with derivatives utilized for trading
purposes is recorded in the Consolidated Statement of Financial Condition on a
net by counterparty basis where a legal right of set-off exists and is netted
across products when such provisions are stated in the master netting agreement.
The market or fair value of swap agreements, caps and floors, and forward
contracts in an unrealized gain position, as well as options owned and warrants
held, are reported in the Consolidated Statement of Financial Condition as
assets in Derivatives and other contractual agreements. Similarly, swap
agreements, caps and floors, and forward contracts in an unrealized loss
position, as well as options written and warrants issued, are reported in the
Consolidated Statement of Financial Condition as liabilities in Derivatives and
other contractual agreements. Margin on futures contracts is included in
receivables and payables, as applicable.
In addition to Trading-Related Derivative Activities, the Company enters into
various derivative financial instruments for non-trading purposes as an end user
to modify the market risk exposures of certain assets and liabilities. In this
regard, the Company utilizes interest rate swaps, caps, collars and floors to
manage the interest rate exposure associated with its long-term debt obligations
and secured financing activities, including securities purchased under
agreements to resell, securities borrowed, securities sold under agreements to
repurchase and securities loaned. The Company also utilizes cross-currency swaps
to hedge its exposure to foreign currency risk as a result of its non-U.S.
dollar debt obligations, after consideration of non-U.S. dollar assets which are
funded with long-term debt obligations in the same currency. The Company also
utilizes equity derivatives to hedge its exposure to equity price risk embedded
in certain of its debt obligations.
In addition to modifying the interest rate and foreign currency exposure of
existing assets and liabilities, the Company utilizes derivative financial
instruments as an end user to modify the interest rate characteristics of
certain anticipated transactions related to its secured financing activities,
where there is a high degree of certainty that the Company will enter into such
contracts. The Company actively monitors the level of anticipated secured
financing transactions to ensure there is a high degree of certainty that such
secured financing transactions will be executed at levels at least equal to the
designated derivative product transactions.
The Company also utilizes foreign exchange forward contracts to manage the
currency exposure related to its net monetary investment in non-U.S. dollar
functional currency operations. The gain or loss from revaluing these contracts
is deferred and reported within Accumulated other comprehensive income in
stockholders' equity. The related unrealized receivables or payables due from or
to counterparties are included in receivables from or payables to brokers,
dealers and clearing organizations.
Derivatives that have been designated as non-trading related positions and are
effective in modifying the interest rate characteristics of existing assets and
liabilities or anticipated transactions are accounted for on an accrual basis.
Under the accrual basis, interest is accrued into income or expense over the
life of the contract, resulting in the net interest impact of the derivative and
the underlying hedged item being recognized in income throughout the hedge
period. Related unrealized receivables or payables due from or to counterparties
are included in receivables from or payables to brokers, dealers and clearing
organizations.
<PAGE>
The Company monitors the effectiveness of its end user hedging activities by
periodically comparing the change in the value of the hedge instrument to the
underlying item being hedged, and reassessing the likelihood of the occurrence
of anticipated transactions. In the event the Company determines that a hedge is
no longer effective, such as upon extinguishment of the underlying asset or
liability or a change in circumstances whereby there is not a high degree of
certainty that the anticipated transaction will occur, the derivative
transaction is no longer accounted for as a hedge. Instead, the Company
immediately recognizes the market or fair value of the derivative financial
instrument through earnings. Changes in the fair value of the derivative
contract would then be accounted for as a derivative used for trading purposes
as discussed above. In the event that a derivative designated as a hedge is
terminated early, any realized gain or loss on the termination would be deferred
and amortized to interest income or interest expense over the remaining life of
the instrument being hedged.
REPURCHASE AND RESALE AGREEMENTS Securities purchased under agreements to
resell and securities sold under agreements to repurchase, which are treated as
financing transactions for financial reporting purposes, are collateralized
primarily by government and government agency securities and are carried net by
counterparty, when permitted, at the amounts at which the securities will be
subsequently resold or repurchased plus accrued interest. It is the policy of
the Company to take possession of securities purchased under agreements to
resell. The Company monitors the market value of the underlying positions on a
daily basis as compared to the related receivable or payable balances, including
accrued interest. The Company requires counterparties to deposit additional
collateral or return collateral pledged as necessary, to ensure that the market
value of the underlying collateral remains sufficient. Securities and other
financial instruments owned that are financed under repurchase agreements are
carried at market value with changes in market value reflected in the
Consolidated Statement of Income.
SECURITIES BORROWED AND LOANED Securities borrowed and securities loaned are
carried at the amount of cash collateral advanced or received plus accrued
interest. It is the Company's policy to value the securities borrowed and loaned
on a daily basis, and to obtain additional cash as necessary to ensure such
transactions are adequately collateralized.
MERCHANT BANKING INVESTMENTS The Company carries its merchant banking
investments, including its partnership interests, at fair value based upon the
Company's assessment of the underlying investments.
INVESTMENT BANKING Underwriting revenues and fees for merger and acquisition
advisory services are recognized when services for the transactions are
substantially completed. Transaction-related expenses are deferred and
subsequently expensed to match revenue recognition.
INCOME TAXES The Company accounts for income taxes under the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for
Income Taxes." The Company recognizes the current and deferred tax consequences
of all transactions that have been recognized in the financial statements using
the provisions of the enacted tax laws. In this regard, deferred tax assets are
recognized for temporary differences that will result in deductible amounts in
future years and for tax loss carryforwards, if in the opinion of management, it
is more likely than not that the deferred tax asset will be realized. SFAS 109
requires companies to set up a valuation allowance for that component of net
deferred tax assets which does not meet the "more likely than not" criterion for
realization. Deferred tax liabilities are recognized for temporary differences
that will result in taxable income in future years.
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS Property, equipment, and
leasehold improvements are recorded at historical cost, net of accumulated
depreciation and amortization. Depreciation is recognized on a straight-line
basis over the estimated useful lives of the related assets. Leasehold
improvements are amortized over the lesser of their economic useful lives or the
terms of the underlying leases.
<PAGE>
GOODWILL Excess of cost over fair value of net assets acquired (goodwill) is
amortized using the straight-line method over periods not exceeding 35 years.
Goodwill is evaluated periodically for impairment and also is reduced upon the
recognition of certain acquired net operating loss carryforward benefits.
STATEMENT OF CASH FLOWS The Company defines cash equivalents as highly liquid
investments with original maturities of three months or less, other than those
held for sale in the ordinary course of business.
EARNINGS PER COMMON SHARE The Company computes earnings per common share in
accordance with SFAS No. 128, "Earnings Per Share." Basic earnings per share is
computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the assumed conversion of all dilutive securities.
------
NOTE 2
------
RECENTLY ISSUED ACCOUNTING STANDARDS
In 1997, the Financial Accounting Standards Board (the "FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," which
is effective for fiscal periods ending after December 15, 1997. SFAS No. 128
replaced the presentation of primary and fully diluted earnings per common share
("EPS") with basic and diluted EPS. The Company adopted SFAS No. 128 during the
first quarter of 1998 and restated EPS data for the prior periods to conform
with the provisions of the Statement.
On January 1, 1998, SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" became fully effective.
Previously, the FASB had deferred until that date certain provisions of SFAS No.
125 pertaining to repurchase agreements, securities lending and similar
financing transactions. As a result of adopting the deferred provisions of SFAS
No. 125, the Company has recognized on its November 30, 1998 Consolidated
Statement of Financial Condition, approximately $1.4 billion of collateral
controlled on certain financing transactions and a corresponding obligation to
return such collateral at the termination of such transactions.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" (the "SOP"). The SOP requires that certain costs incurred in
connection with developing or obtaining software for internal use be capitalized
and subsequently amortized over the software's estimated useful life. The SOP
requires prospective application as of the beginning of an entity's fiscal year
without adjustment for costs that would have been capitalized had the SOP been
in effect in prior periods. The Company has elected early adoption of this
accounting pronouncement effective as of the beginning of its 1998 fiscal year
and capitalized approximately $33.7 million of purchased software and other
internal use software costs during fiscal 1998.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income."
SFAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components in the financial statements. SFAS No.
130 is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided is
required for comparative purposes. The Company has elected early adoption of
SFAS No. 130 for fiscal 1998. The adoption of SFAS No. 130 has no impact on the
Company's consolidated statement of income, financial condition or cash flows.
The only component of Accumulated other comprehensive income relates to foreign
currency translation adjustments.
<PAGE>
SFAS No. 132, "Employer's Disclosures about Pensions and Other Postretirement
Benefits," was issued in February 1998, and is effective for fiscal years
beginning after December 15, 1997. SFAS No. 132 eliminates certain existing
disclosures (such as the requirement to provide a description of the plan,
including employee groups covered, type of benefit formula, funding policy, or
the requirement to disclose alternative measures of the benefit obligation),
but, at the same time, adds new disclosures (such as the requirement to disclose
a reconciliation of beginning and ending balances of the benefit obligation and
the fair value of plan assets). The Company has elected early adoption of this
accounting pronouncement effective for its 1998 fiscal year.
------
NOTE 3
------
SHORT-TERM FINANCINGS
The Company obtains short-term financing on both a secured and unsecured basis.
The secured financing is obtained through the use of repurchase agreements and
securities loaned agreements, which are primarily collateralized by government,
agency and equity securities. The unsecured financing is generally obtained
through short-term debt and the issuance of commercial paper.
The Company's commercial paper and short-term debt financing is comprised of the
following:
<TABLE>
<CAPTION>
November 30
---------------------
[in millions] 1998 1997
- ---------------------------------------------------------------------------
<S> <C> <C>
Commercial paper $3,550 $3,866
Short-term debt
Bank loans 1,288 959
Payables to banks 1,039 786
Other short-term debt(1) 780 2,207
- ---------------------------------------------------------------------------
Total $6,657 $7,818
- ---------------------------------------------------------------------------
</TABLE>
The Company's weighted-average interest rates were as follows:
<TABLE>
<CAPTION>
November 30
-------------------
[in millions] 1998 1997
- ---------------------------------------------------------------------------
<S> <C> <C>
Commercial paper(2) 5.5% 5.9%
Short-term debt(3) 5.4% 4.7%
Securities sold under agreements to repurchase 5.2% 5.0%
</TABLE>
(1) Includes master notes, corporate loans, short-term medium-term notes and
other short-term financings.
(2) Including weighted-average interest rates of 5.6% and 2.6% as of November
30, 1998 and 6.0% and 2.2% as of November 30, 1997 related to U.S. dollar
and non-U.S. dollar obligations, respectively.
(3) Including weighted-average interest rates of 5.5% and 5.1% as of
November 30, 1998 and 5.7% and 3.4% as of November 30, 1997 related to U.S.
dollar and non-U.S. dollar obligations, respectively.
Holdings maintains a Revolving Credit Agreement (the "Credit Agreement") with a
syndicate of banks. Under the terms of the Credit Agreement, the banks have
committed to provide up to $2 billion for up to 364 days. Any loans outstanding
on the commitment termination date may be extended for up to an additional year
at the option of Holdings. The Credit Agreement contains covenants which
require, among other things, that the Company maintain specified levels of
liquidity and tangible net worth, as defined.
<PAGE>
In July 1998, the Company entered into a new $1 billion Committed Securities
Repurchase Facility (the "Facility") for LBIE, the Company's major operating
entity in Europe. The Facility provides secured multi-currency financing for a
broader range of collateral types than LBIE's previous committed secured credit
facility. Under the terms of the Facility, the bank group will agree to provide
funding for up to one year on a secured basis. Any loans outstanding on the
commitment termination date may be extended for up to an additional year at the
option of Holdings. The Facility contains covenants which require among other
things, that LBIE maintain specified levels of tangible net worth.
There have been no borrowings outstanding under either the Credit Agreement or
the Facility. The Company may use the Credit Agreement and the Facility for
general corporate purposes from time to time. The Company has maintained
compliance with the applicable covenants for both the Credit Agreement and the
Facility at all times.
------
NOTE 4
------
<TABLE>
<CAPTION>
LONG-TERM DEBT
U.S. Dollar Non-U.S. Dollar
------------------- ----------------- November 30
Fixed Floating Fixed Floating ----------------
[in millions] Rate Rate Rate Rate 1998 1997
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SENIOR NOTES
Maturing in Fiscal 1998 $ 2,710
Maturing in Fiscal 1999 $ 1,560 $ 2,664 $ 939 $ 172 $ 5,335 3,207
Maturing in Fiscal 2000 3,178 2,875 524 309 6,886 3,629
Maturing in Fiscal 2001 1,281 793 115 198 2,387 1,025
Maturing in Fiscal 2002 1,349 886 39 799 3,073 2,998
Maturing in Fiscal 2003 1,661 506 119 573 2,859 747
December 1, 2003 and thereafter 1,836 411 749 337 3,333 2,733
- ------------------------------------------------------------------------------------------
Senior Notes 10,865 8,135 2,485 2,388 23,873 17,049
- ------------------------------------------------------------------------------------------
SUBORDINATED INDEBTEDNESS
Maturing in Fiscal 1998 359
Maturing in Fiscal 1999 334 7 341 334
Maturing in Fiscal 2000 192 192 192
Maturing in Fiscal 2001 194 194 200
Maturing in Fiscal 2002 250 42 292 291
Maturing in Fiscal 2003 475 475 475
December 1, 2003 and thereafter 1,755 201 18 1,974 1,361
- ------------------------------------------------------------------------------------------
Subordinated Indebtedness 3,200 250 18 3,468 3,212
- ------------------------------------------------------------------------------------------
Long-Term Debt $14,065 $ 8,385 $ 2,503 $ 2,388 $27,341 $20,261
- ------------------------------------------------------------------------------------------
</TABLE>
Of the Company's long-term debt outstanding as of November 30, 1998, $800
million is repayable prior to maturity at the option of the holder, at par
value. These obligations are reflected in the above table as maturing at their
put dates, which range from fiscal 1999 to fiscal 2003, rather than at their
contractual maturities, which range from fiscal 2000 to fiscal 2026. In
addition, $1,693 million of the Company's long-term debt is redeemable prior to
maturity at the option of the Company under various terms and conditions. These
obligations are reflected in the above table at their contractual maturity
dates.
<PAGE>
The Company's interest in 3 World Financial Center is financed with U.S. dollar
fixed rate senior notes totaling $175 million as of November 30, 1998. These
notes are unconditionally guaranteed by American Express and collateralized by a
first mortgage on the property.
As of November 30, 1998, the Company had $9.1 billion available for the issuance
of debt securities under various shelf registrations and debt programs, which
includes $3.3 billion of issuance availability under the Company's Euro
medium-term note program.
As of November 30, 1998, the Company's U.S. dollar and non-U.S. dollar debt
portfolios included approximately $940 million and $1,004 million, respectively,
of debt for which the interest rates and/or redemption values or maturity have
been linked to the performance of various indices including industry baskets of
stocks or commodities or events. Generally such notes are issued as floating
rate notes or the interest rates on such index notes are effectively converted
to floating rates based primarily on LIBOR through the use of interest rate,
currency and equity swaps.
END USER DERIVATIVE ACTIVITIES The Company utilizes a variety of derivative
products including interest rate, currency and equity swaps as an end user to
modify the interest rate characteristics of its long-term debt portfolio. The
Company actively manages the interest rate exposure on its long-term debt
portfolio to more closely match the terms of its debt portfolio to the assets
being funded and to minimize interest rate risk. In addition, the Company
utilizes cross-currency swaps to hedge its exposure to foreign currency risk as
a result of its non-U.S. dollar debt obligations, after consideration of
non-U.S. dollar assets which are funded with long-term debt obligations in the
same currency. In certain instances, two or more derivative contracts may be
utilized by the Company to manage the interest rate nature and/or currency
exposure of an individual long-term debt issuance. In these cases, the notional
amount of the derivative contracts may exceed the carrying value of the related
long-term debt issuance.
At November 30, 1998 and 1997, the notional amounts of the Company's interest
rate, currency and equity swaps related to its long-term debt obligations were
approximately $24.3 billion and $17.3 billion, respectively. In terms of
notional amounts outstanding, these derivative products mature as follows:
<TABLE>
<CAPTION>
November 30
U.S. Non-U.S. Cross- ----------------------
[in millions] Dollar Dollar Currency 1998 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Maturing in Fiscal 1998 $ 2,592
Maturing in Fiscal 1999 $ 3,689 $ 144 $1,147 $ 4,980 3,248
Maturing in Fiscal 2000 5,588 43 662 6,293 3,427
Maturing in Fiscal 2001 1,963 72 264 2,299 935
Maturing in Fiscal 2002 2,614 450 215 3,279 2,489
Maturing in Fiscal 2003 2,566 101 166 2,833 1,180
December 1, 2003 and thereafter 3,563 605 469 4,637 3,443
- ----------------------------------------------------------------------------------------------------
Total $19,983 $1,415 $2,923 $24,321 $17,314
- ----------------------------------------------------------------------------------------------------
Weighted-average interest rate
at November 30(1):
Receive rate 6.63% 5.93% 3.92% 6.26% 6.82%
Pay rate 5.87% 3.99% 5.53% 5.72% 6.39%
</TABLE>
(1) Weighted-average interest rates were calculated utilizing non-U.S. dollar
interest rates, where applicable.
<PAGE>
On an overall basis, the Company's long-term debt related end user
derivative activities resulted in reduced interest expense of approximately
$84 million, $68 million and $81 million in 1998, 1997 and 1996,
respectively. In addition, the Company's end user derivative activities
resulted in the following changes to the Company's mix of fixed and
floating rate debt and effective weighted-average rates of interest:
<TABLE>
<CAPTION>
November 30, 1998
----------------------------------------------------------------------
LONG-TERM DEBT WEIGHTED-AVERAGE(1)
------------------------------- ------------------------------
BEFORE AFTER CONTRACTUAL EFFECTIVE RATE
END USER END USER INTEREST AFTER END USER
[in millions] ACTIVITIES ACTIVITIES RATE ACTIVITIES
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
USD Obligations
Fixed rate $14,065 $420
Floating rate 8,385 24,106
- ----------------------------------------------------------------------------------------------------
22,450 24,526
- ----------------------------------------------------------------------------------------------------
Non-USD Obligations 4,891 2,815
- ----------------------------------------------------------------------------------------------------
Total $27,341 $27,341 6.33% 5.83%
- ----------------------------------------------------------------------------------------------------
<CAPTION>
November 30, 1997
----------------------------------------------------------------------
LONG-TERM DEBT WEIGHTED-AVERAGE(1)
------------------------------- ------------------------------
BEFORE AFTER CONTRACTUAL EFFECTIVE RATE
END USER END USER INTEREST AFTER END USER
[in millions] ACTIVITIES ACTIVITIES RATE ACTIVITIES
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
USD Obligations
Fixed rate $12,252 $308
Floating rate 4,368 18,334
16,620 18,642
- ----------------------------------------------------------------------------------------------------
Non-USD Obligations 3,641 1,619
- ----------------------------------------------------------------------------------------------------
Total $20,261 $20,261 6.78% 6.42%
- ----------------------------------------------------------------------------------------------------
</TABLE>
(1) weighted-average interest rates were calculated using non-U.S. dollar
interest rates, where applicable.
------
NOTE 5
------
PREFERRED STOCK
Holdings is authorized to issue a total of 38,000,000 shares of preferred stock.
At November 30, 1998 and 1997, Holdings had 12,261,228 and 13,000,000
respectively, of such shares authorized, issued and outstanding under various
series as described below. All preferred stock has a dividend preference over
Holdings' common stock in the paying of dividends and a preference in the
liquidation of assets.
CUMULATIVE CONVERTIBLE VOTING, SERIES A AND SERIES B The Cumulative Convertible
Voting Preferred Stock, Series A and Series B (together the "Convertible Voting
Preferred") have a liquidation preference of $39.10 per share. The Series A was
issued in 1987. The Series B was issued in exchange for the Series A on July 11,
1997. As of November 30, 1998, 12,800 shares of the Series A and 11,708,428
shares of the Series B were outstanding.
The holders of the Convertible Voting Preferred are entitled to receive
preferred dividends at an annual rate of 5%, on the liquidation preference,
payable quarterly before any dividends are paid to the holders of common stock.
As of November 30, 1998 Holdings has the right to redeem up to 3,836,317
Convertible Voting Preferred shares at the liquidation price, subject to
adjustment and restrictions on redemption when dividends are in arrears.
<PAGE>
Each share of the Convertible Voting Preferred is convertible, at any time prior
to the date of redemption, into 0.3178313 of a share of common stock. The Series
A is convertible provided that at least 250,000 shares (or such lesser number of
such shares then outstanding) are converted each time. Each share of the Series
B is convertible without limitations. In each case, the conversion rate at
November 30, 1998 was $123.02.
During 1998, Holdings repurchased 1,278,772 shares of the Series B.
SERIES C On May 11, 1998, Holdings issued 5,000,000 Depository Shares (each
representing 1/10th of a share) of 5.94% Cumulative Preferred Stock, Series C
("Series C Preferred Stock"), $1.00 par value. These shares have a redemption
price of $500 per share, together with accrued and unpaid dividends. Holdings
may redeem any or all of the outstanding shares of Series C Preferred Stock
after May 31, 2008. The $250 million redemption value of the shares outstanding
at November 30, 1998 is classified on the Company's Consolidated Statement of
Financial Condition as a component of Preferred stock.
SERIES D On July 21, 1998, Holdings issued 4,000,000 Depository Shares (each
representing 1/100th of a share) of 5.67% Cumulative Preferred Stock, Series D
("Series D Preferred Stock"), $1.00 par value. The Series D Preferred Stock has
a redemption price of $5,000 per share, together with accrued and unpaid
dividends. Holdings may redeem any or all of the outstanding shares of Series D
Preferred Stock after August 31, 2008. The $200 million redemption value of the
shares outstanding at November 30, 1998 is classified on the Company's
Consolidated Statement of Financial Condition as a component of Preferred stock.
REDEEMABLE VOTING In 1994, Holdings issued the Redeemable Preferred Stock to
American Express and Nippon Life for $1,000. The holders of the Redeemable
Preferred Stock are entitled to receive annual dividends through May 31, 2002 in
an amount equal to 50% of the amount, if any, by which the Company's net income
for the preceding year exceeds $400 million, up to a maximum of $50 million,
prorated in the case of the last dividend period, which runs from December 1,
2001 to May 31, 2002. For the years ended November 30, 1998 and 1997, the
Company's net income of $736 million and $647 million, respectively, resulted in
the recognition of dividends in the amount of $50 million on the Redeemable
Voting Preferred Stock.
Holdings may not redeem shares of the Redeemable Preferred Stock prior to the
final dividend payment date. However, in the event of a change of control of the
Company, holders of the Redeemable Preferred Stock will have the right to
require Holdings to redeem all of this stock for an aggregate redemption price
equal to $150 million if such change of control occurs prior to November 30,
1999, declining by $50 million per year in each of the three years thereafter.
If a change of control is not approved by a majority of Holdings' Board of
Directors, the funds for redemption must be raised by an offering of Holdings'
equity securities which are not redeemable. These shares are not convertible
into common stock.
------
NOTE 6
------
COMMON STOCK
Changes in shares of Holdings' common stock (the "Common Stock") outstanding are
as follows:
<TABLE>
<CAPTION>
November 30
---------------------------------------------------
1998 1997 1996
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Shares outstanding, beginning of period 116,612,074 100,449,144 104,565,875
Exercise of stock options and other share issuances 3,129,883 1,719,799 1,108,973
Treasury stock purchases (8,584,080) (1,556,869) (5,225,704)
Issuance of shares to the RSU Trust 2,500,000 16,000,000
- ---------------------------------------------------------------------------------------------------------
Shares outstanding, end of period 113,657,877 116,612,074 100,449,144
- ---------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
The Company has reserved for issuance approximately 1.2 million shares of Common
Stock for conversion of the Convertible Voting Preferred.
During the years ended November 30, 1998, 1997 and 1996, the Company repurchased
or acquired shares of its Common Stock at an aggregate cost of approximately
$469 million, $77 million and $130 million, respectively. These shares were
acquired in the open market and from employees who had tendered mature shares to
pay for the exercise cost of stock options and related tax withholding
obligations. These shares are being reserved for future issuances under employee
stock-based compensation plans.
In 1997, the Company established an irrevocable grantor trust (the "RSU Trust")
in order to provide common stock voting rights to employees who hold outstanding
restricted stock units and to encourage employees to think and act like owners.
The RSU Trust was initially funded in 1997 with a total of 16 million shares
consisting of 5 million treasury shares for restricted stock unit ("RSU") awards
under the Employee Incentive Plan and 11 million new issue shares of Common
Stock for RSU awards under the 1994 Management Ownership Plan. In 1998, 2.5
million treasury shares were transferred into the RSU Trust.
Shares transferred to the RSU Trust do not impact the total number of shares
used in the computation of earnings per common share because the Company has
historically viewed the RSUs as common stock equivalents for purposes of these
computations. Accordingly, the establishment of the RSU Trust has had no effect
on the total equity, net income or earnings per share of the Company.
During fiscal year 1998, the FASB's Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 97-14, "Accounting for Deferred Compensation Arrangements
Where Amounts Earned are Held in a Rabbi Trust and Invested" (EITF 97-14). The
Task Force concluded that consolidation of irrevocable grantor trusts is
required and that shares held by the grantor trust should be classified and
accounted for in equity, such that changes in fair value are not recognized.
Accordingly, the Company has adopted EITF 97-14. Adoption had no effect on net
income, total assets or total equity of the Company.
------
NOTE 7
------
INCENTIVE PLANS
EMPLOYEE STOCK PURCHASE PLAN The Employee Stock Purchase Plan (the "ESPP")
allows employees to purchase Common Stock at a 15% discount from market value,
with a maximum of $25,000 in annual aggregate purchases by any one individual.
The number of shares of Common Stock authorized for purchase by eligible
employees is 6 million. As of November 30, 1998 and 1997, 2.0 million shares and
1.6 million shares, respectively, of Common Stock had been purchased by eligible
employees through the ESPP.
1994 INCENTIVE PLANS The 1994 Management Replacement Plan (the "Replacement
Plan") provided awards similar to the American Express common shares granted to
Company employees which were canceled as of the date of the spin-off from
American Express. Through November 30, 1998, a total of 2.0 million awards had
been granted under the Replacement Plan, including both stock options and
restricted stock; 0.5 million were outstanding at November 30, 1998. No future
awards will be granted under this plan.
The Lehman Brothers Holdings Inc. 1994 Management Ownership Plan (the "1994
Plan") provides for the issuance of RSUs, performance stock units ("PSUs"),
stock options and other equity awards for a period of up to ten years to
eligible employees. A total of 16.6 million shares of Common Stock may be
granted under the 1994 Plan. At November 30, 1998,
<PAGE>
RSU and stock option awards with respect to 15.6 million shares of Common Stock
have been made under the 1994 Plan of which 12.8 million are outstanding and 2.8
million have been converted to freely transferable Common Stock. The Company
will utilize the remaining authorization of 1.0 million shares to satisfy
dividend reinvestment requirements for outstanding awards and to fund the annual
RSU awards for the Company's non-employee directors.
1996 MANAGEMENT OWNERSHIP PLAN During 1996, the Company's stockholders approved
the 1996 Management Ownership Plan (the "1996 Plan") under which awards similar
to those of the 1994 Plan may be granted, and under which up to 15.5 million
shares of Common Stock may be subject to awards. At November 30, 1998, RSU, PSU
and stock option awards with respect to 8.4 million shares of Common Stock have
been made under the 1996 Plan of which 6.9 million are outstanding and 1.5
million have been converted to freely transferable Common Stock.
EMPLOYEE INCENTIVE PLAN The Employee Incentive Plan ("EIP") has provisions
similar to the 1994 Plan and the 1996 Plan, and authorization for up to 50
million shares of Common Stock which may be subject to awards. At November 30,
1998, awards with respect to 33.6 million shares of Common Stock have been made
under the EIP of which 32.7 million are outstanding and 0.9 million have been
converted to freely transferable Common Stock. Approximately 26.9 million of the
outstanding awards consist of RSUs and PSUs which have vesting and transfer
restrictions extending through the year 2004.
The following is a summary of RSUs outstanding under Holdings' stock-based
incentive plans:
<TABLE>
<CAPTION>
RESTRICTED STOCK UNITS
1994 1996
Plan Plan EIP Total
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance, November 30, 1995 12,040,797 2,039,220 14,080,017
Granted 419,614 7,130,720 7,550,334
Canceled (801,614) (405,575) (1,207,189)
Exchanged for stock without
restrictions (474,222) (474,222)
- -----------------------------------------------------------------------------------------------
Balance, November 30, 1996 11,184,575 8,764,365 19,948,940
- -----------------------------------------------------------------------------------------------
Granted 1,814,685 1,332,250 8,810,609 11,957,544
Canceled (846,191) (1,530,562) (2,376,753)
Exchanged for stock without
restrictions (254,894) (139,371) (55,825) (450,090)
- -----------------------------------------------------------------------------------------------
Balance, November 30, 1997 11,898,175 1,192,879 15,988,587 29,079,641
- -----------------------------------------------------------------------------------------------
Granted 83,866 611,400 11,400,151 12,095,417
Canceled (42,734) (112,477) (403,299) (558,510)
Exchanged for stock without
restrictions (243,791) (105,564) (90,317) (439,672)
- -----------------------------------------------------------------------------------------------
Balance, November 30, 1998 11,695,516 1,586,238 26,895,122 40,176,876
- -----------------------------------------------------------------------------------------------
</TABLE>
Eligible employees receive RSUs as a portion of their total compensation in lieu
of cash. There is no further cost to employees associated with the RSU awards.
The Company records compensation expense for RSUs based on the market value of
its Common Stock and the applicable vesting provisions. RSU awards made to
employees have various vesting provisions and generally convert to unrestricted
freely transferable Common Stock five years from the grant date. Holdings pays a
dividend equivalent on each RSU outstanding based on dividends paid on its
Common Stock.
Of the RSUs outstanding at November 30, 1998, approximately 13.0 million RSUs
were vested, approximately 2.6 million RSUs will vest during fiscal 1999, and
the remaining RSUs will vest subsequent to November 30, 1999.
Total compensation cost recognized during 1998, 1997 and 1996 for the Company's
stock-based awards was approximately $221 million, $162 million and $136
million, respectively.
<PAGE>
In addition to the RSUs included in the previous table, the Company has awarded
PSUs under the EIP to certain senior officers. The number of PSUs which may be
earned is dependent upon the achievement of certain performance levels within
predetermined performance periods. At the end of a performance period, any PSUs
earned will convert one-for-one to RSUs which then vest in three, four or five
years. As of December 31, 1998, approximately 0.7 million PSUs have been earned
to date, subject to vesting and transfer restrictions. The compensation cost for
the RSUs payable in satisfaction of PSUs is accrued over the combined
performance and vesting periods.
STOCK OPTIONS
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
1994 REPLACEMENT 1996 EXERCISE EXPIRATION
PLAN PLAN PLAN EIP TOTAL PRICE DATES
<S> <C> <C> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, November 30, 1995 3,078,680 1,429,185 1,400,000 5,907,865 $ 18.68 5/96-5/04
- -----------------------------------------------------------------------------------------------------------------------------------
Granted 825,000 2,650,000 3,475,000 $ 24.16 3/01-5/01
Exercised (93,333) (251,909) (345,242) $ 18.00
Canceled (116,667) (22,247) (850,000) (988,914) $ 22.83
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, November 30, 1996 2,868,680 1,155,029 825,000 3,200,000 8,048,709 $ 20.58 2/97- 5/04
- -----------------------------------------------------------------------------------------------------------------------------------
Granted 2,250,000 2,250,000 $ 30.52 1/02-3/02
Exercised (743,040) (521,192) (1,264,232) $ 18.85
Canceled (4,943) (150,000) (154,943) $ 23.81
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, November 30, 1997 2,125,640 628,894 3,075,000 3,050,000 8,879,534 $ 23.64 1/98-5/04
- -----------------------------------------------------------------------------------------------------------------------------------
Granted 7,212 3,475,000 7,374,170 10,856,382 $ 49.721 2/02-11/08
Exercised (989,401) (156,324) (1,275,165) (706,000) (3,126,890) $ 23.17
Canceled (417) (3,946,500) (3,946,917) $ 60.47
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, November 30, 1998 1,143,451 472,153 5,274,835 5,771,670 12,662,109 $ 34.64 2/99-11/08
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
At November 30, 1998 and 1997, approximately 8.3 million and 8.9 million stock
options, respectively, were exercisable at weighted-average prices of $31.42 and
$23.64, respectively. The weighted-average remaining contractual life of the
stock options outstanding at November 30, 1998 is 5.30 years. The exercise price
for all stock options awarded has been equal to 100% of the market price of
Common Stock on the day of grant.
The following table provides further details relating to Holdings' stock options
outstanding as of November 30, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-----------------------------------------------------------------------------------------------
WEIGHTED- WEIGHTED-
WEIGHTED- AVERAGE WEIGHTED- AVERAGE
AVERAGE REMAINING AVERAGE REMAINING
RANGE OF NUMBER EXERCISE CONTRACTUAL NUMBER EXERCISE CONTRACTUAL
EXERCISE PRICES OUTSTANDING PRICE LIFE (IN YEARS) EXERCISABLE PRICE LIFE (IN YEARS)
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
$18.00-$19.99 1,138,392 $ 18.00 2.06 1,138,392 $ 18.00 2.06
$20.00-$29.99 2,813,835 $ 22.69 2.14 2,813,835 $ 22.69 2.14
$30.00-$39.99 2,050,000 $ 30.80 3.24 1,900,000 $ 30.53 3.11
$40.00-$49.99 6,659,882 $ 43.68 7.83 2,425,000 $ 48.56 4.03
- -------------------------------------------------------------------------------------------------------------------
12,662,109 $ 34.64 5.30 8,277,227 $ 31.42 2.91
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
SFAS No. 123, "Accounting for Stock-Based Compensation," established financial
accounting and reporting standards for stock-based employee compensation plans.
The financial accounting standards of SFAS No. 123 permit companies to either
continue accounting for stock-based compensation under existing rules or adopt
SFAS No. 123 and begin reflecting the fair value of stock options and other
forms of stock-based compensation in the results of operations as additional
expense.
<PAGE>
The disclosure requirements of SFAS No. 123 require companies which elect not to
record the fair value in the Consolidated Statement of Income to provide pro
forma disclosures of net income and earnings per share in the notes to the
consolidated financial statements as if the fair value of stock-based
compensation had been recorded.
The Company will continue to follow Accounting Principles Board No. 25 and its
related interpretations in accounting for its stock-based compensation plans.
Accordingly, no compensation cost has been recognized in the Consolidated
Statement of Income for its stock option awards and employee stock purchase
plan.
The Company utilized the Black-Scholes option-pricing model to quantify the pro
forma effects on net income and earnings per common share of the fair value of
the stock options granted and outstanding during 1998 and 1997. Based on the
results of the model, the weighted-average fair value of the stock options
granted was $12.36 and $7.14 for 1998 and 1997, respectively. The
weighted-average assumptions which were used for 1998 and 1997 included
risk-free interest rates of 5.01% and 6.14%, an expected life of 4 and 3 years,
and expected volatility of 30% and 29%, respectively. In addition, annual
dividends of $0.30 and $0.24 were assumed for the 1998 and 1997 options,
respectively.
The Company's 1998, 1997 and 1996 pro forma net income would have been $723
million, $629 million and $413 million, respectively, compared to actual net
income of $736 million, $647 million and $416 million, respectively. Pro forma
earnings per common share for 1998, 1997 and 1996 would have been $5.09, $4.57
and $3.22, respectively, compared to actual earnings per common share of $5.19,
$4.72 and $3.24, respectively. The pro forma amounts reflect the effects of the
1998 and 1997 stock option grants and the 15% purchase discount from market
value offered to the Company's employees who participate in the ESPP.
NOTE 8
Earnings Per Common Share
Earnings per share was calculated as follows:
<TABLE>
<CAPTION>
Three years ended
[in millions, except for per share data] 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Numerator:
Net income $ 7 $ 6 $ 416
Preferred stock dividends 87 75 38
- ---------------------------------------------------------------------------------------------------------------
Numerator for basic and diluted earnings per share =
income available to common stockholders 649 572 378
- ---------------------------------------------------------------------------------------------------------------
Denominator:
Denominator for basic earnings per share = weighted-average shares 120.9 118.2 115.3
Effect of dilutive securities:
Employee stock options 2.4 1.9 0.9
Common stock equivalents 1.7 1.0 0.5
- ---------------------------------------------------------------------------------------------------------------
Dilutive potential common shares 4.1 2.9 1.4
- ---------------------------------------------------------------------------------------------------------------
Denominator for diluted earnings per share =
adjusted weighted-average shares 125.0 121.1 116.7
- ---------------------------------------------------------------------------------------------------------------
Basic earnings per share $ 5.37 $ 4.84 $ 3.27
- ---------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 5.19 $ 4.72 $ 3.24
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
NOTE 9
Capital Requirements
The Company operates globally through a network of subsidiaries with several
subject to regulatory requirements. In the United States, LBI, as a registered
broker dealer, is subject to the Securities and Exchange Commission ("SEC") Rule
15c3-1, the Net Capital Rule, which requires LBI to maintain net capital of not
less than the greater of 2% of aggregate debit items arising from customer
transactions, as defined, or 4% of funds required to be segregated for
customers' regulated commodity accounts, as defined. At November 30, 1998, LBI's
regulatory net capital, as defined, of $1,406 million exceeded the minimum
requirement by $1,320 million.
In addition to amounts presented in the accompanying Consolidated Statement of
Financial Condition as cash and securities segregated and on deposit for
regulatory and other purposes, securities with a market value of approximately
$1,332 million and $1,290 million at November 30, 1998 and 1997, respectively,
primarily collateralizing securities purchased under agreements to resell, have
been segregated in a special reserve bank account for the exclusive benefit of
customers pursuant to the Reserve Formula requirements of SEC Rule 15c3-3.
Lehman Brothers International (Europe) ("LBIE"), a United Kingdom registered
broker-dealer and subsidiary of Holdings, is subject to the capital requirements
of the Securities and Futures Authority ("SFA") of the United Kingdom. Financial
resources, as defined, must exceed the total financial resources requirement of
the SFA. At November 30, 1998, LBIE's financial resources of approximately $2.5
billion exceeded the minimum requirement by approximately $900 million. Lehman
Brothers Japan Inc.'s Tokyo branch, a regulated broker-dealer, is subject to the
capital requirements of the Japanese Ministry of Finance and at November 30,
1998, had net capital of approximately $320 million which was approximately $95
million in excess of the specified levels required. Certain other non-U.S.
subsidiaries are subject to various securities, commodities and banking
regulations and capital adequacy requirements promulgated by the regulatory and
exchange authorities of the countries in which they operate. At November 30,
1998, these other subsidiaries were in compliance with their applicable local
capital adequacy requirements. The Company's "AAA" rated derivatives
subsidiaries, Lehman Brothers Financial Products Inc. ("LBFP") and Lehman
Brothers Derivative Products Inc. ("LBDP"), have established certain capital and
operating restrictions which are reviewed by various rating agencies. At
November 30, 1998, LBFP and LBDP each had capital which exceeded the requirement
of the most stringent rating agency by approximately $135 million and $27
million, respectively.
The regulatory rules referred to above, and certain covenants contained in
various debt agreements may restrict Holdings' ability to withdraw capital from
its regulated subsidiaries, which in turn could limit its ability to pay
dividends to shareholders. At November 30, 1998, approximately $3.5 billion of
net assets of subsidiaries were restricted as to the payment of dividends to
Holdings.
<PAGE>
NOTE 10
Employee Benefit Plans
The Company provides various pension plans for the majority of its employees
worldwide. In addition, the Company provides certain other postretirement
benefits, primarily health care and life insurance, to eligible employees. The
following summarizes these plans:
<TABLE>
<CAPTION>
PENSION Postretirement
BENEFITS Benefits
November 30 November 30
[in millions, except for weighted-average] 1998 1997 1998 1997
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Change in benefit obligation
Benefit obligation at beginning of year $ 551 $ 479 $ 49 $ 49
Service cost before expenses 23 21 1 1
Interest cost 38 36 3 3
Actuarial (gain) loss 60 36 (1)
Benefits paid (20) (21) (3) (3)
Benefit obligation at end of year $ 652 $ 551 $ 50 $ 49
Change in plan assets
Fair value of plan assets at beginning of year $ 747 $ 665
Actual return on plan assets, net of expenses 82 91
Employer contribution 9 13
Benefits paid (20) (21)
Foreign currency exchange rate changes (1) (1)
Fair value of plan assets at end of year $ 817 $ 747
Funded status (underfunded) $ 165 $ 196 $ (50) $ (49)
Unrecognized net actuarial (gain) loss 79 39 (21) (22)
Unrecognized prior service cost (credit) 2 (6) (7)
Prepaid (accrued) benefit cost $ 246 $ 235 $ (77) $ (78)
Weighted-average assumptions
Discount rate 6.7% 7.2% 6.7% 7.0%
Expected return on plan assets 8.8% 9.3%
Rate of compensation increase 5.0% 5.1% 5.0% 5.1%
</TABLE>
For measurement purposes, the annual health care cost trend rate was assumed to
be 8.0% for the year ended November 30, 1999. The rate was assumed to decrease
at the rate of 0.5% per year to 5.5% in the year ended November 30, 2004 and
remain at that level thereafter.
<TABLE>
<CAPTION>
PENSION Benefits Postretirement Benefits
Twelve months ended November 30 Twelve months ended November 30
[in millions] 1998 1997 1996 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Components of net periodic
benefit cost
Service cost $ 24 $ 22 $ 18 $ 1 $ 1 $ 1
Interest cost 38 36 34 3 3 3
Expected return on plan assets (67) (63) (56)
Recognized net actuarial (gain) loss (1) (1) 2 (1) (2) (1)
- ----------------------------------------------------------------------------------------------------------------------------
Net periodic benefit (income) cost $ (6) $ (6) $ (2) $ 3 $ 2 $ 3
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
Assumed health care cost trend rates have a significant effect on the amount
reported for postretirement benefits. A one-percentage-point change in assumed
health care cost trend rates would have the following effects:
<TABLE>
<CAPTION>
[in millions] 1% POINT INCREASE 1% POINT DECREASE
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Effect on total service and interest cost components in fiscal 1998 $ 0.4 $ (0.3)
- --------------------------------------------------------------------------------------------------------------------
Effect on postretirement benefit obligation at November 30, 1998 $ 4.7 $ (4.5)
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE 11
INCOME TAXES
The Company files a consolidated U.S. federal income tax return reflecting the
income of Holdings and its subsidiaries.
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
Twelve months ended November 30
[in millions] 1998 1997 1996
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
Current
Federal $ 238 $ 110 $ (20)
State 63 58 36
Foreign 299 182 133
- --------------------------------------------------------------------------------
600 350 149
- --------------------------------------------------------------------------------
Deferred
Federal (239) (6) 61
State (6) (4) 11
Foreign (39) (50)
(284) (60) 72
- --------------------------------------------------------------------------------
$ 316 $ 290 $ 221
- --------------------------------------------------------------------------------
</TABLE>
Income before taxes included $270 million, $121 million, and $335 million that
has also been subject to income taxes of foreign jurisdictions for 1998, 1997
and 1996, respectively.
The income tax provision (benefit) differs from that computed by using the
statutory federal income tax rate for the reasons shown below:
<TABLE>
<CAPTION>
Twelve months ended November 30
[in millions] 1998 1997 1996
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal income taxes at statutory rate $ 368 $ 328 $ 223
State and local taxes 37 35 31
Tax-exempt income (71) (60) (24)
Amortization of goodwill 3 3 3
Foreign operations 3 (3) (26)
Other, net (24) (13) 14
- -------------------------------------------------------------------------------------------------
$ 316 $ 290 $ 221
- -------------------------------------------------------------------------------------------------
</TABLE>
Deferred income taxes are provided for the differences between the tax basis of
assets and liabilities and their reported amounts in the consolidated financial
statements. These temporary differences will result in future income or
deductions
<PAGE>
for income tax purposes and are measured using the enacted tax rates
that will be in effect when such items are expected to reverse. The Company
provides for deferred income taxes on undistributed earnings of foreign
subsidiaries.
At November 30, 1998 and 1997 the deferred tax assets and liabilities consisted
of the following:
<TABLE>
<CAPTION>
November 30
[in millions] 1998 1997
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets
Reserves not currently deductible $ 233 $ 185
Deferred compensation 413 325
Foreign tax credits 92
NOL carryforwards 9 15
Other 85 10
- ---------------------------------------------------------------------------------------------------
832 535
Less: Valuation allowance 19 43
- ---------------------------------------------------------------------------------------------------
Total deferred tax assets net of valuation allowance $ 813 $ 492
- ---------------------------------------------------------------------------------------------------
Deferred tax liabilities
Excess tax over financial depreciation $ 114 $ 112
Pension and retirement costs 52 46
Unrealized trading and investment activity 39 8
Undistributed earnings of foreign subsidiaries (net of credits) (9) 7
Other 21 4
- ---------------------------------------------------------------------------------------------------
Total deferred tax liabilities $ 217 $ 177
- ---------------------------------------------------------------------------------------------------
Net deferred tax assets $ 596 $ 315
- ---------------------------------------------------------------------------------------------------
</TABLE>
The net deferred tax assets are included in Other assets in the accompanying
Consolidated Statement of Financial Condition. At November 30, 1998, the
valuation allowance recorded against deferred tax assets was $19 million
compared to $43 million at November 30, 1997, of which approximately $19 million
and $27 million, respectively, will reduce goodwill if future circumstances
permit recognition. The Company's Consolidated Statement of Income includes a
$10 million net benefit from the reversal of a portion of this valuation
allowance; the remaining decrease in the valuation allowance is associated with
a corresponding decrease in the Company's net deferred tax assets.
For tax return purposes, the Company has approximately $25 million of NOL
carryforwards, substantially all of which are attributable to the 1988
acquisition of E.F. Hutton Group, Inc., (now known as LB I Group Inc.).
Substantially all of the NOLs are scheduled to expire in the years 1999 through
2009.
NOTE 12
DERIVATIVE FINANCIAL INSTRUMENTS
Derivatives are financial instruments whose value is based upon an underlying
asset (e.g., treasury bond), index (e.g., S&P 500) or reference rate (e.g.,
LIBOR). Over-the-counter ("OTC") derivative products are privately negotiated
contractual agreements that can be tailored to meet individual client needs and
include forwards, swaps and certain options including caps, collars and floors.
Exchange-traded derivative products are standardized contracts transacted
through regulated exchanges and include futures and certain option contracts
listed on an exchange.
In the normal course of business, the Company enters into derivative
transactions both in a trading capacity and as an end user. Acting in a trading
capacity, the Company enters into derivative transactions to satisfy the needs
of its clients and to
<PAGE>
manage the Company's own exposure to market and credit risk resulting from its
trading activities (collectively, "Trading-Related Derivative Activities"). As
an end user, the Company primarily enters into interest rate swap and option
contracts to adjust the interest rate nature of its funding sources from fixed
to floating rates and vice versa, and to change the index upon which floating
interest rates are based (e.g., Prime to LIBOR) (collectively, "End User
Derivative Activities").
There is an extensive volume of derivative products available in the
marketplace, which can vary from a simple forward foreign exchange contract to a
complex derivative instrument with multiple risk characteristics involving the
aggregation of the risk characteristics of a number of derivative product types
including swap products, options and forwards. Listed below are examples of
various derivative product types along with a brief discussion of the
performance mechanics of certain specific derivative instruments.
SWAP PRODUCTS Interest rate swap products include interest rate and currency
swaps, leveraged swaps, swap options, and other interest rate option products
including caps, collars, and floors. An interest rate swap is a negotiated OTC
contract in which two parties agree to exchange periodic interest payments for a
defined period, calculated based upon a predetermined notional amount. Interest
payments are usually exchanged on a net basis throughout the duration of the
swap contract. A currency swap is an OTC agreement to exchange a fixed amount of
one currency for a specified amount of a second currency at the outset and
completion of the swap term. Leveraged swaps involve the multiplication of the
interest rate factor upon which the interest payment streams are based (e.g.,
Party A pays 3 times the six month LIBOR). Caps are contractual commitments that
require the writer to pay the purchaser the amount by which an interest
reference rate exceeds a defined contractual rate, if any, at specified times
during the contract. Conversely, a floor is a contractual commitment that
requires the writer to pay the amount by which a defined contractual rate
exceeds an interest reference rate at specified times over the life of the
contract, if any. Equity swaps are contractual agreements whereby one party
agrees to receive the appreciation (or depreciation) value over a strike price
on an equity investment in return for paying another rate, which is usually
based upon equity index movements or interest rates. Commodity swaps are
contractual commitments to exchange the fixed price of a commodity for a
floating price (which is usually the prevailing spot price) throughout the swap
term.
OPTIONS Option contracts provide the option purchaser (holder) with the right
but not the obligation to buy or sell a financial instrument, commodity or
currency at a predetermined exercise price (strike price) during a defined
period (American Option) or at a specified date (European Option). The option
purchaser pays a premium to the option seller (writer) for the right to exercise
the option. The option seller is obligated to buy (put) or sell (call) the item
underlying the contract at a set price, if the option purchaser chooses to
exercise. Option contracts also exist for various indices and are similar to
options on a security or other instrument except that, rather than settling
physical with delivery of the underlying instrument, they are cash settled. As a
purchaser of an option contract, the Company is subject to credit risk, since
the counterparty is obligated to make payments under the terms of the option
contract, if the Company exercises the option. As the writer of an option
contract, the Company is not subject to credit risk but is subject to market
risk, since the Company is obligated to make payments under the terms of the
option contract if exercised.
Option contracts may be exchange-traded or OTC. Exchange-traded options are the
obligations of the exchange and generally have standardized terms and
performance mechanics. In contrast, all of the terms of an OTC option including
the method of settlement, term, strike price, premium and security are
determined by negotiation of the parties.
FUTURES AND FORWARDS Futures contracts are exchange-traded contractual
commitments to either receive (purchase) or deliver (sell) a standard amount or
value of a financial instrument or commodity at a specified future date and
price. Maintaining a futures contract requires the Company to deposit with the
exchange an amount of cash or other specified assets as security for its
obligation. Additionally, futures exchanges generally require the daily cash
settlement of unrealized gains/losses on open contracts with the futures
exchange. Therefore, futures contracts provide a reduced funding alternative to
purchasing the underlying cash position in the marketplace. Futures contracts
may be settled by physical delivery of the
<PAGE>
underlying asset or cash settlement (for index futures) on the settlement date
or by entering into an offsetting futures contract with the futures exchange
prior to the settlement date.
Forwards are OTC contractual commitments to purchase or sell a specified amount
of a financial instrument, foreign currency or commodity at a future date at a
predetermined price. TBAs are forward contracts which give the purchaser/seller
an obligation to obtain/deliver mortgage securities in the future. Therefore,
TBAs subject the holder to both interest rate risk and principal prepayment
risk.
TRADING-RELATED DERIVATIVE ACTIVITIES Derivatives are subject to various risks
similar to other financial instruments including market, credit, and operational
risk. In addition, the Company may also be exposed to legal risks related to its
derivative activities including the possibility that a transaction may be
unenforceable under applicable law. The risks of derivatives should not be
viewed in isolation, but rather should be considered on an aggregate basis along
with the Company's other trading-related activities. The Company manages the
risks associated with derivatives on an aggregate basis along with the risks
associated with its proprietary trading and market-making activities in cash
instruments as part of its firmwide risk management policies.
Derivatives are generally based upon notional amounts. Notional amounts are not
recorded on-balance sheet, but rather are utilized solely as a basis for
determining future cash flows to be exchanged. Therefore, notional amounts
provide a measure of the Company's involvement with such instruments, but are
not indicative of actual or potential risk.
The following table reflects the notional/contract amounts of the Company's
Trading-Related Derivative Activities:
Trading-Related Derivative Financial Instruments
<TABLE>
<CAPTION>
NOTIONAL/ 1998
CONTRACT WEIGHTED-
AMOUNTS AVERAGE
November 30 November 30 MATURITY
[in millions] 1998 1997 (IN YEARS)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest rate and currency swaps and options
(including caps, collars and floors) $1,590,115 $ 961,762 4.77
Foreign exchange forward and future contracts and options 389,416 478,899 .32
Other fixed income securities contracts
(including futures contracts and options,
mortgage-backed securities forward contracts and options) 328,116 364,009 .71
Equity contracts (including equity swaps, futures, warrants and options) 88,604 40,522 .84
Commodity contracts (including swaps, futures, forwards and options) 1,544 10,292 1.72
- -----------------------------------------------------------------------------------------------------------------------
Total $2,397,795 $1,855,484 3.35
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
Of the total notional amounts at November 30, 1998 and 1997, approximately
$2,152 billion and $1,615 billion are over-the-counter and $246 billion and $240
billion are exchange-traded, respectively. The total weighted-average maturity
at November 30, 1998, for over-the-counter and exchange-traded contracts was
3.62 years and 0.96 years, respectively. Approximately $1,053 billion of the
notional/contract amount of the Company's Trading-Related Derivative Activities
mature within the year ended November 30, 1999, of which approximately 30% have
maturities of less than one month.
The Company records its Trading-Related Derivative Activities on a
mark-to-market basis with realized and unrealized gains and losses recognized
currently in Principal transactions in the Consolidated Statement of Income.
Unrealized gains and losses on derivative contracts are recorded on a net basis
in the Consolidated Statement of Financial Condition for those transactions with
counterparties executed under a legally enforceable master netting agreement and
are netted across
<PAGE>
products when such provisions are stated in the master netting
agreement. The Company offers equity, fixed income and foreign exchange products
to its customers. Because of the integrated nature of the market for such
products, each product area trades cash instruments as well as related
derivative products.
Principal transactions and net interest revenues related to the Company's fixed
income business (which includes foreign exchange) were $1,638 million for 1998,
$1,749 million for 1997 and $1,793 million for 1996. Principal transactions and
net interest revenues related to the Company's equity business were $351 million
for 1998, $296 million for 1997 and $275 million for 1996.
Listed in the following table is the fair value of the Company's Trading-Related
Derivative Activities as of November 30, 1998 and 1997 as well as the average
fair value of these instruments. Average fair values of these instruments were
calculated based upon month-end statement of financial condition values, which
the Company believes do not vary significantly from the average fair value
calculated on a more frequent basis. Variances between average fair values and
period-end values are due to changes in the volume of activities in these
instruments and changes in the valuation of these instruments due to variations
in market and credit conditions.
FAIR VALUE OF TRADING-RELATED
DERIVATIVE FINANCIAL INSTRUMENTS
<TABLE>
<CAPTION>
AVERAGE FAIR VALUE*
FAIR VALUE* Twelve months ended
November 30, 1998 November 30, 1998
[in millions] Assets Liabilities Assets Liabilities
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate and currency swaps and options
(including caps, collars and floors) $5,877 $3,240 $ 5,550 $3,361
Foreign exchange forward contracts and options 1,583 1,367 1,724 1,558
Options on other fixed income securities,
mortgage-backed securities forward contracts
and options 224 214 288 264
Equity contracts (including equity swaps,
warrants and options) 2,128 3,167 2,218 2,946
Commodity contracts (including swaps,
forwards, and options) 71 76 147 146
- --------------------------------------------------------------------------------------------------------------------------------
Total $9,883 $8,064 $9,927 $8,275
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE FAIR VALUE*
FAIR VALUE* Twelve months ended
November 30, 1997 November 30, 1997
----------------- -------------------
[in millions] Assets Liabilities Assets Liabilities
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate and currency swaps and options
(including caps, collars and floors) $4,704 $3,303 $4,306 $3,224
Foreign exchange forward contracts and options 1,840 1,885 1,236 1,532
Options on other fixed income securities,
mortgage-backed securities forward contracts
and options 310 297 275 246
Equity contracts (including equity swaps,
warrants and options) 1,304 1,696 2,134 1,681
Commodity contracts (including swaps,
forwards, and options) 195 186 304 465
- --------------------------------------------------------------------------------------------------------------------------
Total $8,353 $7,367 $8,255 $7,148
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Amounts represent carrying value (exclusive of non-cash collateral) and do not
include receivables or payables related to exchange-traded futures contracts.
<PAGE>
Assets included in the preceding table represent the Company's unrealized gains,
net of unrealized losses for situations in which the Company has a master
netting agreement. Similarly, liabilities represent net amounts owed to
counterparties. Therefore, the fair value of assets/liabilities related to
derivative contracts at November 30, 1998 represents the Company's net
receivable/payable for derivative financial instruments before consideration of
collateral. Included within the $9,883 million fair value of assets at November
30, 1998 was $9,211 million related to swaps and other OTC contracts and $672
million related to exchange-traded option and warrant contracts. Included within
the $8,353 million fair value of assets at November 30, 1997 was $8,016 million
related to swaps and other OTC contracts and $337 million related to
exchange-traded option and warrant contracts.
The primary difference in risks related to OTC and exchange-traded contracts is
credit risk. OTC contracts contain credit risk for unrealized gains from various
counterparties for the duration of the contract, net of collateral.
With respect to OTC contracts, including swaps, the Company views its net credit
exposure to be $6,939 million at November 30, 1998, representing the fair value
of the Company's OTC contracts in an unrealized gain position, after
consideration of collateral.
Counterparties to the Company's OTC derivative products are primarily financial
intermediaries (U.S. and foreign banks), securities firms, corporations,
governments and their agencies, finance companies, insurance companies,
investment companies and pension funds. Collateral held related to OTC contracts
generally includes cash and U.S. government and federal agency securities.
Presented below is an analysis of the Company's net credit exposure at November
30, 1998 for OTC contracts based upon actual ratings made by external rating
agencies or by equivalent ratings established and utilized by the Company's
Credit Risk Management Department.
<TABLE>
<CAPTION>
COUNTERPARTY S&P/MOODY'S NET CREDIT
RISK RATING EQUIVALENT EXPOSURE
- --------------------------------------------------------------
<S> <C> <C>
1 AAA/Aaa 15%
2 AA-/Aa3 or higher 25%
3 A-/A3 or higher 36%
4 BBB-/Baa3 or higher 12%
5 BB-/Ba3 or higher 5%
6 B+/B1 or lower 7%
</TABLE>
The Company is also subject to credit risk related to its exchange-traded
derivative contracts. Exchange-traded contracts, including futures and certain
options, are transacted directly on the exchange. To protect against the
potential for a default, all exchange clearinghouses impose net capital
requirements for their membership. Additionally, the exchange clearinghouse
requires counterparties to futures contracts to post margin upon the origination
of the contract and for any changes in the market value of the contract on a
daily basis (certain foreign exchanges provide for settlement within three
days). Therefore, the potential for losses from exchange-traded products is
limited.
END USER DERIVATIVE ACTIVITIES The Company utilizes a variety of derivative
products as an end user to modify the interest rate characteristics of its
long-term debt portfolio. The Company actively manages the interest rate
exposure on its long-term debt portfolio to more closely match the terms of its
debt portfolio to the assets being funded and to minimize interest rate risk. At
November 30, 1998 and 1997, the notional amounts of the Company's end user
activities related to its long-term debt obligations were approximately $24.3
billion and $17.3 billion, respectively. (For a further discussion of the
Company's long-term debt related end user derivative activities see Note 4.)
<PAGE>
The Company also utilizes derivative products as an end user to modify its
interest rate exposure associated with its secured financing activities,
including securities purchased under agreements to resell, securities borrowed,
securities sold under agreements to repurchase and securities loaned. At
November 30, 1998 and 1997, the Company had $130 billion and $129 billion,
respectively, of such secured financing activities. As with the Company's
long-term debt, its secured financing activities expose the Company to interest
rate risk. The Company, as an end user, manages the interest rate risk related
to these activities by utilizing derivative financial instruments, including
interest rate swaps and purchased options. The Company designates certain
specific derivative transactions against specific assets and liabilities with
matching maturities. In addition, the Company manages the interest rate risk of
anticipated secured financing transactions with derivative products. The Company
actively monitors the level of anticipated secured financing transactions to
ensure there is a high degree of certainty that such secured financing
transactions will be executed at levels at least equal to the designated
derivative product transactions. At November 30, 1998 and 1997, the Company, as
an end user, utilized derivative financial instruments with an aggregate
notional amount of $73.4 billion and $38.7 billion, respectively, to modify the
interest rate characteristics of its secured financing activities. The total
notional amount of these agreements had a weighted-average maturity of 1.0 years
and 0.5 years as of November 30, 1998 and 1997, respectively.
The Company terminated certain swaps designated as hedges of the Company's
secured financing activities. At November 30, 1998 and 1997, a loss of
approximately $2.8 million and $12.0 million, respectively, from these
terminated contracts was deferred and will be amortized to interest expense over
the original period of the hedge. On an overall basis, the Company's secured
financing end user derivative activities increased (decreased) net revenues by
approximately $4 million, $(10) million and $16 million for 1998, 1997 and 1996,
respectively.
NOTE 13
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 "Disclosures about Fair Value of Financial Instruments" requires
the Company to report the fair value of financial instruments, as defined.
Assets and liabilities that are carried at fair value include all of the
Company's trading assets and liabilities including derivative financial
instruments used for trading purposes as described in Note 1, which are recorded
as securities and other financial instruments owned and securities and other
financial instruments sold but not yet purchased.
Assets and liabilities, which are recorded at contractual amounts that
approximate market or fair value include cash and cash equivalents, cash and
securities segregated and on deposit for regulatory and other purposes,
receivables, certain other assets, commercial paper and short-term debt, and
payables. The market value of such items are not materially sensitive to shifts
in market interest rates because of the limited term to maturity of these
instruments and their variable interest rates.
Financial instruments which are recorded at amounts that do not necessarily
approximate market or fair value include long-term debt, certain secured
financing activities and the related financial instruments utilized by the
Company as an end user to manage the interest rate risk of these exposures. The
Company's long-term debt is recorded at contractual or historical amounts. The
following table provides a summary of the fair value of the Company's long-term
debt and related end user derivative activities. The fair value of the Company's
long-term debt was estimated using either quoted market prices or discounted
cash flow analyses based on the Company's current borrowing rates for similar
types of borrowing arrangements. The unrecognized net gain (loss) related to the
Company's end user derivative activities reflects the esti-
<PAGE>
mated amounts the Company would receive (pay) if the derivative financial
instruments were terminated based on market rates at November 30, 1998 and 1997,
respectively.
<TABLE>
<CAPTION>
November 30
----------------------------
[in millions] 1998 1997
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
Carrying value of long-term debt $ 27,341 $ 20,261
Fair value of long-term debt 27,376 20,688
- ------------------------------------------------------------------------------------------------------
Unrecognized net gain (loss) on long-term debt $ (35) $ (427)
- ------------------------------------------------------------------------------------------------------
Unrecognized net gain (loss) on long-term debt end user activities $ 385 $ 188
- ------------------------------------------------------------------------------------------------------
</TABLE>
The Company carries its secured financing activities, including securities
purchased under agreements to resell, securities borrowed, securities sold under
agreements to repurchase, and securities loaned, at their original contract
amount plus accrued interest. The majority of such financing activities are
short-term in nature which approximates fair value. At November 30, 1998 and
1997, the Company had $130 billion and $129 billion, respectively, of such
secured financing activities. As with the Company's long-term debt, its secured
financing activities expose the Company to interest rate risk.
At November 30, 1998 and 1997, the Company, as an end user, utilized derivative
financial instruments with an aggregate notional amount of $73.4 billion and
$38.7 billion, respectively, to modify the interest rate characteristics of its
secured financing activities. The unrecognized net losses related to these
derivative financial instruments were $110 million and $6 million at November
30, 1998 and 1997, respectively, which were substantially offset by unrecognized
net gains on the Company's secured financing activities. Additionally, at
November 30, 1998 the Company had approximately $84 million of unrecognized
losses related to approximately $4.4 billion of long-term fixed rate repurchase
agreements.
NOTE 14
OTHER COMMITMENTS AND CONTINGENCIES
As of November 30, 1998 and 1997, the Company was contingently liable for $2.9
billion and $4.2 billion, respectively, of letters of credit, primarily used to
provide collateral for securities and commodities borrowed and to satisfy margin
deposits at option and commodity exchanges, and other guarantees.
As of November 30, 1998 and 1997, in connection with its financing activities,
the Company had outstanding commitments under certain lending arrangements of
approximately $3.7 billion and $2.4 billion, respectively. These commitments
require borrowers to provide acceptable collateral, as defined in the
agreements, when amounts are drawn under the lending facilities. Advances made
under the above lending arrangements are typically at variable interest rates
and generally provide for over-collateralization based upon the borrowers'
creditworthiness.
As of November 30, 1998, the Company had pledged securities, primarily fixed
income, having a market value of approximately $24.4 billion, as collateral for
securities borrowed having a market value of approximately $23.8 billion.
Securities and other financial instruments sold but not yet purchased represent
obligations of the Company to purchase the securities at prevailing market
prices. Therefore, the future satisfaction of such obligations may be for an
amount greater or less than the amount recorded. The ultimate gain or loss is
dependent upon the price at which the underlying financial instrument is
purchased to settle its obligation under the sale commitment.
<PAGE>
In the normal course of business, the Company is exposed to off-balance sheet
credit and market risk as a result of executing, financing and settling various
customer security and commodity transactions. Off-balance sheet risk arises from
the potential that customers or counterparties fail to satisfy their obligations
and that the collateral obtained is insufficient. In such instances, the Company
may be required to purchase or sell financial instruments at unfavorable market
prices. The Company seeks to control these risks by obtaining margin balances
and other collateral in accordance with regulatory and internal guidelines.
The Company, through its high yield sales and trading activities, makes
commitments to extend credit in loan syndication transactions principally to
below investment grade borrowers and then participates a significant portion of
these commitments. These commitments, net of syndications and participations,
totaled $2.0 billion and $1.6 billion at November 30, 1998 and 1997,
respectively, and are typically secured against the borrower's assets and have
fixed maturity dates. The draw down of these facilities is generally contingent
upon certain representations, warranties and contractual conditions of the
borrower. Total commitments may not be indicative of actual risk or funding
requirements as the commitments may not be drawn or fully utilized and the
Company intends to continue syndicating, selling and/or participating in these
commitments.
The Company also had lending commitments to high grade borrowers of $675 million
and $140 million at November 30, 1998 and 1997, respectively. These commitments
also are typically secured against the borrower's assets, have fixed maturity
dates, and are generally contingent upon certain representations, warranties and
contractual conditions of the borrower.
At November 30, 1998 and 1997, the Company had commitments to invest up to $379
million and $498 million in partnerships, respectively, which in turn will make
direct merchant banking related investments. These commitments will be funded as
required through the end of the respective partnerships' investment periods,
principally expiring in 2004.
In addition to these specific commitments, the Company had various other
commitments of approximately $335 million at November 30, 1998.
Subsidiaries of the Company, as general partner, are contingently liable for the
obligations of certain public and private limited partnerships organized as
pooled investment funds or engaged primarily in real estate activities. In the
opinion of the Company, contingent liabilities, if any, for the obligations of
such partnerships will not in the aggregate have a material adverse effect on
the Company's consolidated financial position or results of operations.
In the normal course of its business, the Company has been named a defendant in
a number of lawsuits and other legal proceedings. After considering all relevant
facts, available insurance coverage and the advice of outside counsel, in the
opinion of the Company such litigation will not, in the aggregate, have a
material adverse effect on the Company's consolidated financial position or
results of operations.
CONCENTRATIONS OF CREDIT RISK As one of the leading global investment banks, the
Company is actively involved in securities underwriting, brokerage, distribution
and trading. These and other related services are provided on a worldwide basis
to a large and diversified group of clients and customers, including
multinational corporations, governments, emerging growth companies, financial
institutions and individual investors.
A substantial portion of the Company's securities and commodities transactions
is collateralized and is executed with, and on behalf of, commercial banks and
other institutional investors, including other brokers and dealers. The
Company's exposure to credit risk associated with the non-performance of these
customers and counterparties in fulfilling their contractual obligations
pursuant to securities transactions can be directly impacted by volatile or
illiquid trading markets, which may impair the ability of customers and
counterparties to satisfy their obligations to the Company.
<PAGE>
Securities and other financial instruments owned by the Company include U.S.
government and agency securities, and securities issued by non-U.S. governments
which, in the aggregate, represented 15% of the Company's total assets at
November 30, 1998. In addition, primarily all of the collateral held by the
Company for resale agreements or securities borrowed, which together represented
38% of total assets at November 30, 1998, consisted of securities issued by the
U.S. government, federal agencies or non-U.S. governments. The Company's most
significant industry concentration is financial institutions, which include
other brokers and dealers, commercial banks and institutional clients. This
concentration arises in the normal course of the Company's business.
LEASE COMMITMENTS The Company leases office space and equipment throughout the
world and is a party to a ground lease with the Battery Park City Authority
covering its headquarters at 3 World Financial Center which extends through
2069. Total rent expense for 1998, 1997 and 1996 was $39 million, $42 million
and $48 million, respectively. Certain leases on office space contain escalation
clauses providing for additional rentals based upon maintenance, utility and tax
increases.
Minimum future rental commitments under non-cancellable operating leases (net of
subleases of $102 million) are as follows:
<TABLE>
<CAPTION>
[in millions]
- -------------------------------------------------------------------------------
<S> <C>
Fiscal 1999 $ 36
Fiscal 2000 35
Fiscal 2001 34
Fiscal 2002 34
Fiscal 2003 30
December 1, 2003 and thereafter 444
- -------------------------------------------------------------------------------
$ 613
- -------------------------------------------------------------------------------
</TABLE>
NOTE 15
INTERNATIONAL OPERATIONS
Although the Company's business activities are highly integrated and constitute
a single industry segment for the purposes of SFAS No. 14, "Financial Reporting
for Segments of a Business Enterprise," they can be broadly categorized into the
three major geographic areas in which it conducts operations: the Americas,
Europe and Asia Pacific.
The Company manages its businesses with the goal of maximizing worldwide
profitability by product line. Activities such as the global distribution of
underwritings and the twenty-four hour risk management of trading positions
render geographic profitability to be highly subjective, since it is the result
of numerous estimates and assumptions.
The following amounts provide a broad indication of each region's contribution
to the consolidated results. The method of allocation is as follows: Gross and
Net Revenues, if syndicate or trading-related, have been distributed based upon
the location where the primary or secondary position was fundamentally risk
managed; if fee-related, by the location of the senior coverage banker; if
commission-related, by the location of the salespeople. In addition, certain
revenues associated with domestic products and services which resulted from
relationships with international clients and customers have been reclassified as
international revenues using an allocation consistent with the Company's
internal reporting. The expenses
<PAGE>
associated with these revenues have also been reclassified. Income (Loss) Before
Taxes includes expenses associated with generating the revenues reflected in
each region. Identifiable Assets represent essentially those recorded in the
legal entities in which the Company does business within the respective region.
<TABLE>
<CAPTION>
GROSS NET INCOME (LOSS) IDENTIFIABLE
[in millions] REVENUES REVENUES BEFORE TAXES ASSETS
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Twelve months ended November 30, 1998
International operations:
Europe $ 1,378 $ 870 $ 111 $ 32,363
Asia Pacific 554 496 205 3,455
- ----------------------------------------------------------------------------------------------------------------------
Total international 1,932 1,366 316 35,818
Americas(1) 17,962 2,747 736 118,072
- ----------------------------------------------------------------------------------------------------------------------
Total $ 19,894 $ 4,113 $ 1,052 $ 153,890
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
GROSS NET INCOME (LOSS) IDENTIFIABLE
[in millions] REVENUES REVENUES BEFORE TAXES ASSETS
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Twelve months ended November 30, 1997
International operations:
Europe $ 1,190 $ 812 $ 179 $ 37,571
Asia Pacific 330 282 (36) 7,875
- ----------------------------------------------------------------------------------------------------------------------
Total international 1,520 1,094 143 45,446
Americas(1) 15,363 2,779 794 106,259
- ----------------------------------------------------------------------------------------------------------------------
Total $ 16,883 $ 3,873 $ 937 $ 151,705
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
GROSS NET INCOME (LOSS) IDENTIFIABLE
[in millions] REVENUES REVENUES BEFORE TAXES ASSETS
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Twelve months ended November 30, 1996
International operations:
Europe $ 1,373 $ 972 $ 346 $ 25,553
Asia Pacific 559 413 100 6,829
- ----------------------------------------------------------------------------------------------------------------------
Total international 1,932 1,385 446 32,382
Americas(1) 12,328 2,059 191(2) 96,214
- ----------------------------------------------------------------------------------------------------------------------
Total $ 14,260 $ 3,444 $ 637 $ 128,596
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes non-U.S. revenues of $55 million, $67 million and $42 million in
1998, 1997 and 1996, respectively.
(2) Includes $84 million severance charge.
NOTE 16
1996 Severance Charge
The Company recorded an $84 million severance charge ($50 million after-tax) in
the fourth quarter of 1996 related to certain strategic actions taken to improve
ongoing profitability. The severance charge reflected the culmination of a
worldwide business unit economic performance review that was undertaken in the
fourth quarter of 1996 to focus the Company on its core investment banking,
equity and fixed income sales and trading areas. This formalized review resulted
in personnel
<PAGE>
reductions of approximately 270 people across a number of underperforming fixed
income and equity businesses, including exiting the precious metals business in
the U.S., Europe and Asia; exiting energy trading in the U.S. and Europe;
consolidating Asian fixed income risk management activities into one center in
Tokyo; refocusing foreign exchange trading activities, and combining the
Company's New York Private Client Services offices. Additionally, the charge
reflects various other strategic personnel reductions aimed at delayering
management.
Cash outlays relating to the charge were approximately $19 million in the fourth
quarter of 1996 and approximately $59 million during fiscal 1997. The remaining
residual payments were paid as deferred payment arrangements were completed.
NOTE 17
QUARTERLY INFORMATION (UNAUDITED)
The following information represents the Company's unaudited quarterly results
of operations for 1998 and 1997. Certain amounts reflect reclassifications to
conform to the current period's presentation. These quarterly results reflect
all normal recurring adjustments which are, in the opinion of management,
necessary for a fair presentation of the results. Revenues and earnings of the
Company can vary significantly from quarter to quarter due to the nature of the
Company's business activities.
<TABLE>
<CAPTION>
1998 1997
-----------------------------------------------------------------------------------------
[in millions, except per share amounts] Nov. 30 Aug. 31 May 31 Feb. 28 Nov. 30 Aug. 31 May 31 Feb. 28
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total revenues $3,797 $5,963 $5,554 $4,580 $4,609 $4,469 $3,806 $3,999
Interest expense 3,132 5,033 4,081 3,535 3,586 3,398 2,952 3,074
- -----------------------------------------------------------------------------------------------------------------------------------
Net revenues 665 930 1,473 1,045 1,023 1,071 854 925
Non-interest expenses:
Compensation and benefits 337 472 747 530 519 543 433 469
Other expenses 234 251 250 240 239 247 249 237
- -----------------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 571 723 997 770 758 790 682 706
- -----------------------------------------------------------------------------------------------------------------------------------
Income before taxes 94 207 476 275 265 281 172 219
Provision for income taxes 20 56 152 88 80 84 51 75
- -----------------------------------------------------------------------------------------------------------------------------------
Net income $ 74 $ 151 $ 324 $ 187 $ 185 $ 197 $ 121 $ 144
- -----------------------------------------------------------------------------------------------------------------------------------
Net income applicable to common stock $ 62 $ 139 $ 268 $ 180 $ 160 $ 160 $ 114 $ 138
- -----------------------------------------------------------------------------------------------------------------------------------
Weighted-average shares
Basic 120.7 121.5 120.6 120.6 119.0 118.7 118.0 117.0
Diluted 122.5 126.2 126.3 124.8 123.0 122.4 120.4 118.5
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings per common share
Basic $ 0.51 $ 1.15 $ 2.22 $ 1.49 $ 1.34 $ 1.34 $ 0.97 $ 1.18
Diluted $ 0.51 $ 1.10 $ 2.12 $ 1.44 $ 1.30 $ 1.30 $ 0.95 $ 1.16
- -----------------------------------------------------------------------------------------------------------------------------------
Dividends per common share $0.075 $0.075 $0.075 $0.075 $ 0.06 $ 0.06 $ 0.06 $ 0.06
Book value per common share
(at period end) $37.06 $36.35 $35.93 $34.56 $33.39 $31.86 $30.67 $29.76
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
SELECTED FINANCIAL DATA
The following table summarizes certain consolidated financial information
included in the audited consolidated financial statements.
The Company's 1994 results presented below are for the eleven-month period ended
November 30, due to the Company's decision to change its year-end from December
31. For this reason, the Company's 1994 results are not fully comparable with
the other periods presented.
<TABLE>
<CAPTION>
Tweleve months ended Eleven
November 30 months ended
November 30
[in millions, except Per share, Other data and Financial ratios]1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
CONSOLODATED STATEMENT OF INCOME
Revenues:
Principal transactions $1,232 $1,418 $1,579 $1,393 $1,345
Investment banking 1,582 1,318 981 801 572
Commissions 513 423 362 450 445
Interest and dividends 16,542 13,635 11,298 10,788 6,761
Other 25 89 40 44 67
- ---------------------------------------------------------------------------------------------------------------------------
Total revenues 19,894 16,883 14,260 13,476 9,190
Interest expense 15,781 13,010 10,816 10,405 6,452
- ---------------------------------------------------------------------------------------------------------------------------
Net revenues 4,113 3,873 3,444 3,071 2,738
- ---------------------------------------------------------------------------------------------------------------------------
Non-interest expenses:
Compensation and benefits 2,086 1,964 1,747 1,544 1,413
Other expenses 975 972 976 1,061 1,084
Severance and other charges 84 97 48
- ---------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 3,061 2,936 2,807 2,702 2,545
- ---------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before taxes and
cummulative effect of change in accounting principle 1,052 937 637 369 193
Provision for income taxes 316 290 221 127 67
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
cummulative effect of change in accounting principle 736 647 416 242 126
Cummulative effect of change in accounting principle,
net of taxes (13)
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) $736 $647 $416 $242 $113
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common stock $649 $572 $378 $200 $75
- ---------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF
FINANCIAL CONDITION (AT PERIOD END)
<S> <C> <C> <C> <C> <C>
Total assets $153,890 $151,705 $128,596 $115,303 $109,947
Total assets excluding matched book(a) 111,509 108,099 96,256 79,069 72,457
Long-term debt(b) 27,341 20,261 15,922 12,765 11,321
Total stockholders' equity 5,413 4,523 3,874 3,698 3,395
Total capital(c) 32,754 24,784 19,796 16,463 14,716
- ---------------------------------------------------------------------------------------------------------------------------
PER SHARE DATA
Income (loss) from continuing operations before
cumulative effect of change in accounting principle $5.19 $4.72 $3.24 $1.76 $0.81
Cumulative effect of change in accounting principle (0.12)
Net income (loss) $5.19 $4.72 $3.24 $1.76 $0.69
Dividends declared per common share 0.30 0.24 0.20 0.20 0.175
Book value per common share (at period end) 37.06 33.39 28.84 25.67 24.35
- ---------------------------------------------------------------------------------------------------------------------------
OTHER DATA (AT PERIOD END)
Ratio of total assets to total stockholders' equity 28.4x 33.5x 33.2x 31.2x 32.4x
Ratio of total assets excluding matched book to
total stockholders' equity(a) 20.6x 23.9x 24.8x 21.4x 21.3x
Employees 8,873 8,340 7,556 7,771 8,512
FINANCIAL RATIOS (%)
Compensation and benefits/net revenues(d) 50.7 50.7 50.7 50.8 51.6
Pretax operating margin 25.6 24.2 18.5 12.0 7.0
Effective tax rate(d) 30.0 30.9 35.4 34.5 33.7
Return on common equity (annualized) 15.2 15.6 12.1 7.1 4.0
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
(a) Matched book represents "securites purchased under agreements to resell"
("reverse repos") to the extent that such balance is less than "securities
sold under agreements to repurchase " ("repos") as of the statement of
financial condition date. Several nationally recognized rating agencies
consider such reverse repos to be a proxy for matched book assets when
evaluating the Company's capital strength and financial ratios. Such agencies
consider matched book assets to have a low risk profile and exclude such
amounts in the calculation of leverage (total assets divided by total
stockholders' equity). Although there are other assets with similar risk
characteristics on the Company's Consolidated Statement of Financial
Condition, the exclusion of reverse repos from total assets in this
calculation reflects the fact that these assets are matched against
liabilities of a simialr nature, and therefore require minimal amounts of
capital support. Accordingly, the Company believes the ratio of total assets
excluding matched book to total stockholders' equity to be a more meaningful
measure of the Company's leverage.
(b) Long-term debt includes senior notes and subordinated indebtedness.
(c) Total capital includes total stockholders' equity and long-term debt.
(d) For the twelve months ended November 30, 1995, excludes the effect of the
sale of Omnitel.
<PAGE>
O T H E R S T O C K H O L D E R I N F O R M A T I O N
CORPORATE HEADQUARTERS
Lehman Brothers Holdings Inc.
3 World Financial Center
New York, New York 10285
(212) 526-7000
(800) 666-2388
Fax Number: (212) 526-3738
ANNUAL MEETING
The annual meeting of stockholders of Lehman Brothers will be held on
Tuesday, March 30, 1999 at 10:30 a.m. at 3 World Financial Center, 26th
Floor, 200 Vesey Street, New York, New York 10285.
TRANSFER AGENT AND REGISTRAR
Questions regarding dividends, transfer requirements, lost certificates,
changes of address, direct deposit of dividends, the direct purchase and
dividend reinvestment plan, or other inquiries should be directed to:
The Bank of New York
Shareholders Service Department
P.O. Box 11258
Church Street Station
New York, New York 10286-1258
Telephone: (800) 824-5707
E-mail: [email protected]
Website: http://stock.bankofny.com
DIVIDEND PAYMENTS
Dividends on common stock are generally payable, following declaration by the
Board of Directors, on the last business day of February, May, August and
November. The annual dividend rate for fiscal 1998 was $0.30 per common
share. The Company recently announced an increase in the fiscal 1999 common
stock dividend to $0.36 per share. Direct deposit of dividends is available
to registered stockholders with U.S. bank accounts. For more information
regarding this program, contact the Company's Transfer Agent listed above.
DIRECT PURCHASE AND DIVIDEND
REINVESTMENT PLAN
Lehman Brothers' Direct Purchase and Dividend Reinvestment Plan provides both
existing stockholders and interested first-time investors an alternative
means of buying the Company's stock. The plan has no minimum stock ownership
requirements for eligibility and enrollment. Plan participants may reinvest
all or a portion of cash dividends and/or make optional cash purchases up to
a maximum of $175,000 per year without incurring commission or service
charges. Additional information and enrollment forms can be obtained from the
Company's Transfer Agent listed above.
ANNUAL REPORT AND FORM 10-K
Lehman Brothers will make available upon request copies of this Annual Report
and the Annual Report on Form 10-K as filed with the Securities and Exchange
Commission. Requests may be directed to:
Jennifer Marre
Corporate Secretary
Lehman Brothers Holdings Inc.
3 World Financial Center, 24th Floor
New York, New York 10285
Telephone: (212) 526-1936
E-mail: [email protected]
CONTACTS
Investor Relations:
Shaun K. Butler
(212) 526-8381
Media Relations:
William J. Ahearn
(212) 526-4379
WEBSITE ADDRESS
Financial statement filings, stockholder information, press releases and
general news about the Company also may be accessed via the World Wide Web at
the following address:
http://www.lehman.com
P R I C E R A N G E OF C O M M O N S T O C K
The common stock of Lehman Brothers Holdings Inc. is listed on the New York
and Pacific Stock Exchanges under the trading symbol LEH. As of January 19,
1999, there were 25,816 holders of record of the Company's common stock. On
January 19, 1999, the last reported sales price of the Company's common stock
was $51.125.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------------------------------------
1998 1997
-----------------------------------------------------------------------------------
Nov. 30 Aug. 31 May 31 Feb. 28 Nov. 30 Aug. 31 May 31 Feb. 28
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
High $54 1/2 $85 $83 7/16 $63 1/2 $56 1/8 $52 $41 $36 3/8
Low $24 3/4 $39 3/8 $62 5/8 $47 3/4 $43 1/8 $37 3/4 $29 $29 1/8
</TABLE>
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this 1998 Annual Report on
Form 10-K of Lehman Brothers Holdings Inc. (the "Company") of our report dated
January 7, 1999, included in the 1998 Annual Report to Stockholders of Lehman
Brothers Holdings Inc.
Our audits also included the financial statement schedule of Lehman Brothers
Holdings Inc. listed in Item 14(a). This schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
We also consent to the incorporation by reference in the Registration
Statements and Post Effective Amendments on Form S-3 File Nos. 333-50197,
33-53651, 333-57238, 333-07875 and 33-53923 of Lehman Brothers Holdings Inc. and
in the related Prospectuses, of our report dated January 7, 1999 with respect to
the consolidated financial statements and financial statement schedule of Lehman
Brothers Holdings Inc. included or incorporated by reference in this 1998 Annual
Report on Form 10-K for the year ended November 30, 1998.
/s/ Ernst & Young LLP
ERNST & YOUNG LLP
New York, New York
February 26, 1999
<PAGE>
EXHIBIT 24
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Thomas A. Russo, Karen M. Muller and Jennifer
Marre and each of them, his or her true and lawful attorneys-in-fact and agents,
with full power of substitution and resubstitution, for him or her and in his or
her name, place and stead, in any and all capacities, to sign the Annual Report
on Form 10-K of Lehman Brothers Holdings Inc., for the fiscal year ended
November 30, 1998 and any and all amendments thereto, and to file the same, with
all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done, as fully to all intents
and purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or any of them, or their
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Dated: As of February 26, 1999
<TABLE>
<CAPTION>
SIGNATURES TITLE
- ------------------------------ --------------------------
<C> <S>
Chief Executive Officer
and
/s/ RICHARD S. FULD, JR. Chairman of the Board of
- ------------------------------ Directors
Richard S. Fuld Jr. (principal executive
officer)
Chief Financial and
/s/ JOHN L. CECIL Administrative Officer
- ------------------------------ (principal financial and
John L. Cecil accounting officer)
/s/ MICHAEL L. AINSLIE
- ------------------------------ Director
Michael L. Ainslie
/s/ JOHN F. AKERS
- ------------------------------ Director
John F. Akers
/s/ ROGER S. BERLIND
- ------------------------------ Director
Roger S. Berlind
/s/ THOMAS H. CRUIKSHANK
- ------------------------------ Director
Thomas H. Cruikshank
/s/ HENRY KAUFMAN
- ------------------------------ Director
Henry Kaufman
/s/ HIDEICHIRO KOBAYASHI
- ------------------------------ Director
Hideichiro Kobayashi
/s/ JOHN D. MACOMBER
- ------------------------------ Director
John D. Macomber
/s/ DINA MERRILL
- ------------------------------ Director
Dina Merrill
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<LEGEND>
This Schedule contains summary financial information extracted from the
Company's Consolidated Statement of Financial Condition at November 30, 1998 and
the Consolidated Statement of Income for the twelve months ended November 30,
1998 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> NOV-30-1998
<PERIOD-START> DEC-01-1997
<PERIOD-END> NOV-30-1998
<CASH> 4,238
<RECEIVABLES> 11,965
<SECURITIES-RESALE> 42,381
<SECURITIES-BORROWED> 16,341
<INSTRUMENTS-OWNED> 77,000
<PP&E> 505
<TOTAL-ASSETS> 153,890
<SHORT-TERM> 6,657
<PAYABLES> 10,525
<REPOS-SOLD> 67,730
<SECURITIES-LOANED> 3,165
<INSTRUMENTS-SOLD> 28,803
<LONG-TERM> 27,341
0
908
<COMMON> 12
<OTHER-SE> 4,493
<TOTAL-LIABILITY-AND-EQUITY> 153,890
<TRADING-REVENUE> 1,232
<INTEREST-DIVIDENDS> 16,542
<COMMISSIONS> 513
<INVESTMENT-BANKING-REVENUES> 1,582
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 15,781
<COMPENSATION> 2,086
<INCOME-PRETAX> 1,052
<INCOME-PRE-EXTRAORDINARY> 736
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 736
<EPS-PRIMARY> 5.37
<EPS-DILUTED> 5.19
</TABLE>
