-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EAvIxQVxsc73BZjFyD7UqKUHZAUySwillY0Qbz9sss9hRPHWzaUyZVE2HBqypGDO f8L+9m71CMNTBU/ZX7N1Xw== 0000950123-97-006534.txt : 19970808 0000950123-97-006534.hdr.sgml : 19970808 ACCESSION NUMBER: 0000950123-97-006534 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970807 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PAINE WEBBER GROUP INC CENTRAL INDEX KEY: 0000075754 STANDARD INDUSTRIAL CLASSIFICATION: SECURITY BROKERS, DEALERS & FLOTATION COMPANIES [6211] IRS NUMBER: 132760086 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-07367 FILM NUMBER: 97653331 BUSINESS ADDRESS: STREET 1: 1285 AVE OF THE AMERICAS CITY: NEW YORK STATE: NY ZIP: 10019 BUSINESS PHONE: 2127132000 FORMER COMPANY: FORMER CONFORMED NAME: PAINE WEBBER INC DATE OF NAME CHANGE: 19840523 10-Q 1 PAINE WEBBR GROUP INC. 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 ------------------------ FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission file number 1-7367 PAINE WEBBER GROUP INC. (Exact name of Registrant as specified in its charter) Delaware 13-2760086 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 1285 Avenue of the Americas, New York, N.Y. 10019 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 713-2000 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- ----------------------- On August 1, 1997 the Registrant had outstanding 91,470,935 shares of common stock of $1 par value, which is the Registrant's only class of common stock. 2 PAINE WEBBER GROUP INC. FORM 10-Q JUNE 30, 1997 TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page --------------------- ---- Item 1. Financial Statements. Consolidated Statements of Income (unaudited) for the Three Months and Six Months Ended June 30, 1997 and 1996. 2 Consolidated Statements of Financial Condition (unaudited) at June 30, 1997 and December 31, 1996. 3 Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 1997 and 1996. 4 Notes to Consolidated Financial Statements (unaudited). 5-14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 15-18 PART II. OTHER INFORMATION Item 1. Legal Proceedings. 19 Item 6. Exhibits and Reports on Form 8-K. 19 Signature. 20
3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PAINE WEBBER GROUP INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (In thousands of dollars except share and per share amounts)
Three Months Ended Six Months Ended June 30, June 30, ------------------------------- ------------------------------- 1997 1996 1997 1996 ------------ ------------ ------------ ------------ REVENUES Commissions $ 346,911 $ 362,695 $ 717,297 $ 730,880 Principal transactions 255,225 251,848 511,761 548,224 Asset management 125,327 111,392 246,295 219,047 Investment banking 110,938 102,077 208,712 183,932 Other 34,230 40,962 72,304 71,458 Interest 747,138 562,190 1,391,091 1,107,649 ------------ ------------ ------------ ------------ Total revenues 1,619,769 1,431,164 3,147,460 2,861,190 Interest expense 643,829 481,541 1,186,686 948,932 ------------ ------------ ------------ ------------ Net revenues 975,940 949,623 1,960,774 1,912,258 ------------ ------------ ------------ ------------ NON-INTEREST EXPENSES Compensation and benefits 574,231 568,690 1,148,248 1,135,681 Office and equipment 68,757 65,233 136,824 133,974 Communications 37,762 39,821 75,969 78,512 Business development 18,190 18,965 36,810 37,516 Brokerage, clearing & exchange fees 21,507 21,248 44,062 46,740 Professional services 29,276 25,052 56,816 48,627 Other 74,890 70,288 145,814 136,266 ------------ ------------ ------------ ------------ Total non-interest expenses 824,613 809,297 1,644,543 1,617,316 ------------ ------------ ------------ ------------ INCOME BEFORE TAXES AND MINORITY INTEREST 151,327 140,326 316,231 294,942 ------------ ------------ ------------ ------------ PROVISION FOR INCOME TAXES: Federal 35,075 38,933 80,934 76,286 State, local and foreign 15,067 9,181 28,428 25,943 ------------ ------------ ------------ ------------ 50,142 48,114 109,362 102,229 ------------ ------------ ------------ ------------ INCOME BEFORE MINORITY INTEREST $ 101,185 $ 92,212 $ 206,869 $ 192,713 Minority interest 8,061 -- 12,910 -- ------------ ------------ ------------ ------------ NET INCOME $ 93,124 $ 92,212 $ 193,959 $ 192,713 ============ ============ ============ ============ Net income applicable to common shares $ 85,972 $ 86,088 $ 179,760 $ 180,435 ============ ============ ============ ============ Earnings per common share: Primary $ 0.91 $ 0.90 $ 1.91 $ 1.87 Fully diluted $ 0.87 $ 0.86 $ 1.82 $ 1.76 Weighted-average common shares: Primary 94,541,828 95,198,040 94,228,362 96,476,520 Fully diluted 100,262,593 102,317,004 100,414,256 103,958,404 Dividends declared per common share $ 0.15 $ 0.12 $ 0.30 $ 0.24
See notes to consolidated financial statements. 2 4 PAINE WEBBER GROUP INC. CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED) (In thousands of dollars except share and per share amounts)
June 30, December 31, 1997 1996 ------------ ------------ ASSETS Cash and cash equivalents $ 226,973 $ 383,856 Cash and securities segregated and on deposit for federal and other regulations 492,890 499,761 Trading assets, at fair value 16,316,357 16,823,307 Securities purchased under agreements to resell 23,160,177 20,746,831 Securities borrowed 9,118,209 7,380,374 Receivables: Clients, net of allowance for doubtful accounts of $20,833 and $12,109 at June 30, 1997 and December 31, 1996, respectively 4,657,961 4,327,996 Brokers and dealers 282,597 273,737 Dividends and interest 384,123 350,796 Fees and other 141,894 136,545 Office equipment and leasehold improvements, net of accumulated depreciation and amortization of $370,173 and $343,322 at June 30, 1997 and December 31, 1996, respectively 316,200 313,261 Other assets 1,366,152 1,277,036 ------------ ------------ $ 56,463,533 $ 52,513,500 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Short-term borrowings $ 1,691,112 $ 1,337,646 Trading liabilities, at fair value 7,133,355 6,621,891 Securities sold under agreements to repurchase 30,333,462 28,797,276 Securities loaned 4,678,835 3,459,860 Payables: Clients 4,718,059 4,883,344 Brokers and dealers 310,626 205,437 Dividends and interest 329,436 285,341 Other liabilities and accrued expenses 1,147,878 1,290,555 Accrued compensation and benefits 635,771 737,376 ------------ ------------ 50,978,534 47,618,726 Long-term borrowings 3,059,814 2,781,694 ------------ ------------ 54,038,348 50,400,420 ------------ ------------ Commitments and contingencies Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts holding solely Company Guaranteed Related Subordinated Debt 393,750 195,000 Redeemable Preferred Stock 188,162 187,655 Stockholders' Equity: Convertible Preferred Stock 100,000 100,000 Common stock, $1 par value, 200,000,000 shares authorized; issued 109,430,782 shares and 108,358,178 shares at June 30, 1997 and December 31, 1996, respectively 109,431 108,358 Additional paid-in capital 957,406 913,927 Retained earnings 1,161,154 1,009,448 ------------ ------------ 2,327,991 2,131,733 Treasury stock, at cost; 17,952,578 shares at June 30, 1997 and 15,366,234 shares at December 31, 1996, respectively (433,507) (331,907) Unamortized cost of restricted stock (46,665) (67,533) Foreign currency translation adjustment (4,546) (1,868) ------------ ------------ 1,843,273 1,730,425 ------------ ------------ $ 56,463,533 $ 52,513,500 ============ ============
See notes to consolidated financial statements. 3 5 PAINE WEBBER GROUP INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands of dollars)
Six Months Ended June 30, ------------------------------ 1997 1996 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 193,959 $ 192,713 Adjustments to reconcile net income to cash used for operating activities: Noncash items included in net income: Depreciation and amortization 35,274 29,891 Deferred income taxes 10,571 89,047 Amortization of deferred charges 84,809 79,448 Other 37,111 18,992 (Increase) decrease in operating receivables: Clients (321,241) (150,640) Brokers and dealers (8,860) 22,402 Dividends and interest (33,327) (58,297) Fees and other (5,349) (127,381) Increase (decrease) in operating payables: Clients (165,285) (74,775) Brokers and dealers 105,189 86,083 Dividends and interest 44,095 10,515 Other (254,961) (187,583) (Increase) decrease in: Trading assets 506,950 (179,017) Securities purchased under agreements to resell (2,413,346) (4,348,129) Securities borrowed (1,737,835) 289,462 Cash and securities on deposit 6,871 (7,974) Other assets (167,373) (207,782) Increase (decrease) in: Trading liabilities 511,464 (207,895) Securities sold under agreements to repurchase 1,536,186 3,521,420 Securities loaned 1,218,975 826,846 ----------- ----------- Cash used for operating activities (816,123) (382,654) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: (Payments for) proceeds from: Sales of investments -- 122,032 Office equipment and leasehold improvements (36,682) (24,812) ----------- ----------- Cash (used for) provided by investing activities (36,682) 97,220 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from short-term borrowings 353,466 238,245 Proceeds from: Long-term borrowings 399,645 160,126 Employee stock transactions 41,781 19,341 Issuance of Preferred Trust Securities 198,750 -- Payments for: Long-term borrowings (122,596) (44,840) Repurchases of common stock (133,380) (121,646) Dividends (41,744) (37,452) ----------- ----------- Cash provided by financing activities 695,922 213,774 ----------- ----------- Decrease in cash and cash equivalents (156,883) (71,660) Cash and cash equivalents, beginning of period 383,856 222,497 ----------- ----------- Cash and cash equivalents, end of period $ 226,973 $ 150,837 =========== ===========
See notes to consolidated financial statements. 4 6 PAINE WEBBER GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (In thousands of dollars except share and per share amounts) NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The consolidated financial statements include the accounts of Paine Webber Group Inc. ("PWG") and its wholly owned subsidiaries, including its principal subsidiary, PaineWebber Incorporated ("PWI") (collectively, the "Company"). All material intercompany balances and transactions have been eliminated. The financial information as of and for the periods ended June 30, 1997 and 1996 is unaudited. All normal recurring adjustments which, in the opinion of management, are necessary for a fair presentation have been made. 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 consolidated financial statements and accompanying notes. Actual results could differ from those estimates. These financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 1996 and the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997. The results of operations reported for interim periods are not necessarily indicative of the results of operations for the entire year. The Company's principal line of business is to serve the investment and capital needs of individual, corporate, institutional and public agency clients. Trading Instruments Trading assets and liabilities are recorded in the Consolidated Statement of Financial Condition on a trade date basis at June 30, 1997 and a settlement date basis at December 31, 1996. The difference between trade date and settlement date basis was not material. Derivative Financial Instruments A derivative is typically defined as an instrument whose value is "derived" from an underlying instrument or index such as a forward, future, swap or option contract and other financial instruments with similar characteristics. A derivative financial instrument also includes firm or standby commitments for the purchase of securities. The derivative definition does not include cash instruments whose values are derived from changes in the value of some asset or index, such as mortgage backed securities and structured notes. Derivative contracts generally represent future commitments to exchange interest payment streams based on the gross contract or notional amount or to purchase or sell financial instruments at specified terms and future dates. In connection with the Company's market risk management and trading activities, the Company may enter into a derivative contract to manage the risk arising from other financial instruments or to take a position based upon expected future market conditions. The Company also takes positions to facilitate client transactions. Derivative instruments held or issued for trading purposes are marked to market daily with the resulting unrealized gains and losses recorded on the Consolidated Statement of Financial Condition in trading assets or liabilities and the related profit or loss reflected in principal transactions. The fair value of an exchange-traded derivative such as futures and certain option contracts is determined by quoted market prices while the fair value of derivatives negotiated in over-the-counter markets are valued based upon pricing models which consider time value and volatility, as well as other economic factors. A large portion of the Company's derivative financial instruments are "to be announced" mortgage securities requiring forward settlement. As a principal in the mortgage-backed securities business, the Company has outstanding forward purchase and sale agreements committing the Company to receive or deliver mortgage-backed securities. These forward contracts are generally short term with maturity or settlement dates ranging from 30 to 90 days. The forward contracts are marked to market daily, with unrealized gains and losses recorded in trading assets or liabilities on the Consolidated Statement of Financial Condition and the related profit or loss reflected in principal transactions revenues. The fair value of these contracts are determined based upon quoted market prices and pricing models. 5 7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company also enters into interest rate swap agreements to modify the interest rate characteristics of its outstanding debt. These agreements involve the exchange of amounts based on a fixed interest rate for amounts based on a variable interest rate over the life of the agreement without the exchange of the notional amount upon which the payments are based. The Company accounts for interest rate swap agreements used for hedging purposes on the accrual method. The difference to be paid or received on the swap agreements is accrued as an adjustment to interest expense as incurred. The related receivable from or payable to counterparties is reflected as an asset or liability, accordingly. The fair value of the swap agreements are not recognized in the financial statements. Any gains and losses on early terminations of swap agreements are deferred as an adjustment to the carrying amount of the debt and amortized as an adjustment to interest expense over the remaining term of the original contract life of the terminated swap agreement. In the event of the early extinguishment of debt, any realized or unrealized gain or loss from the related swap would be recognized in income coincident with the extinguishment. Accounting Changes In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 125 introduces the financial-components approach which focuses on the recognition of financial assets an entity controls and the derecognition of financial assets for which control has been transferred. In December 1996, the FASB issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of SFAS No. 125", which delays until January 1, 1998 the implementation of SFAS No. 125 as it relates to 1) secured borrowings and collateral, and 2) for the transfer of financial assets that are part of repurchase agreements, dollar-roll, securities lending and similar transactions. Effective January 1, 1997 the Company adopted portions of SFAS No. 125 (those not deferred by SFAS. No 127) which did not have a material impact on the Company's consolidated financial statements, taken as a whole. The Company does not expect the adoption of the portions of SFAS No. 125 deferred by SFAS No. 127 to have a material impact on the Company's consolidated financial statements, taken as a whole. In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share," which is effective for financial statements issued for periods ending after December 15, 1997 and requires restatement of all prior periods. SFAS No. 128 was issued to simplify the standards for calculating earnings per share ("EPS") previously found in APB No. 15, "Earnings Per Share." Under the new requirements for calculating EPS, the presentation of primary EPS will be replaced with basic EPS and fully diluted EPS will be replaced with diluted EPS. Basic EPS excludes dilution and is calculated by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS will reflect all potential dilutive securities (similar to fully diluted EPS under APB No. 15). If this statement had been in effect, basic EPS would have been $0.08 and $0.07 higher for the quarters ended June 30, 1997 and 1996, respectively and $0.16 and $0.14 higher for the six month periods ended June 30, 1997 and 1996, respectively. The difference between diluted and fully diluted would not have been material. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", which are effective for fiscal years beginning after December 15, 1997. SFAS No. 130 establishes standards for the reporting and display of comprehensive income. SFAS No. 131 establishes standards for disclosures about the Company's reportable operating segments. The adoption of these statements will not have an effect on the Company's consolidated financial statements. NOTE 2: FAIR VALUE OF FINANCIAL INSTRUMENTS Substantially all of the Company's financial instruments are carried at fair value or amounts approximating fair value. Assets, including cash and cash equivalents, cash and securities segregated for regulatory purposes, trading assets, resale agreements, securities borrowed, and certain receivables, are carried at fair value or contracted amounts which approximate fair value. Similarly, liabilities, including short-term borrowings, trading liabilities, repurchase agreements, securities loaned, and certain payables, are carried at fair value or contracted amounts approximating fair value. 6 8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) At June 30, 1997 and December 31, 1996, the fair values of long-term borrowings were $3,070,813 and $2,813,699, respectively, as compared to the carrying amounts of $3,059,814 and $2,781,694, respectively. The estimated fair value of long-term borrowings is based upon quoted market prices for the same or similar issues and pricing models. However, for substantially all of its fixed rate debt, the Company enters into interest rate swap agreements to convert its fixed rate payments into floating rate payments, which partially offset the effect of the changes in interest rates on the fair value of the Company's long-term borrowings. The fair value of interest rate swaps used to hedge the Company's long-term borrowings is based upon the amounts the Company would receive or pay to terminate the agreements, taking into account current interest rates and creditworthiness of the counterparties. The fair values of the interest rate swaps were $30,383 and $21,170 payable at June 30, 1997 and December 31, 1996, respectively. The carrying amounts of the interest rate swap agreements at June 30, 1997 and December 31, 1996 were net receivables of $3,636 and $3,252, respectively, and are included in "Dividends and interest" in the Company's Consolidated Statement of Financial Condition. See Notes 1 and 9 for further discussion of interest rate swap agreements used for hedging purposes. NOTE 3: TRADING INVENTORIES Trading assets and liabilities, recorded at fair value, consisted of the following:
June 30, December 31, 1997 1996 ----------- ----------- Trading assets: U.S. government and agency obligations $ 4,494,691 $ 4,767,991 Mortgages and mortgage-backed securities 5,774,269 5,968,704 Corporate debt securities 3,323,412 3,284,235 Commercial paper and other short-term debt 1,400,027 1,457,226 Corporate equity securities 842,487 776,352 State and municipal obligations 481,471 568,799 ----------- ----------- $16,316,357 $16,823,307 =========== =========== Trading liabilities: U.S. government and agency obligations $ 5,533,217 $ 5,118,658 Corporate equity securities 726,666 756,686 Corporate debt securities 726,072 672,683 Mortgages and mortgage-backed securities 84,783 53,845 State and municipal obligations 62,617 20,019 ----------- ----------- $ 7,133,355 $ 6,621,891 =========== ===========
NOTE 4: SHORT-TERM BORROWINGS The Company meets its short-term financing needs by obtaining bank loans on either a secured or unsecured basis; by issuing commercial paper and medium-term notes; by entering into agreements to repurchase, whereby securities are sold with a commitment to repurchase at a future date; and through securities lending activity. Short-term borrowings at June 30, 1997 and December 31, 1996 consisted of the following:
June 30, December 31, 1997 1996 ---------- ------------ Commercial paper $ 652,094 $ 688,910 Bank loans and other 844,018 648,736 Medium-Term Notes 195,000 -- ---------- ---------- $1,691,112 $1,337,646 ========== ==========
7 9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 5: LONG-TERM BORROWINGS Long-term borrowings at June 30, 1997 and December 31, 1996 consisted of the following:
June 30, December 31, 1997 1996 ---------- ------------ Fixed Rate Notes due 1998 - 2014 $1,547,608 $1,547,398 Fixed Rate Subordinated Notes due 2002 174,544 174,500 Medium-Term Senior Notes 1,096,425 747,725 Medium-Term Subordinated Notes 214,150 276,150 Other 27,087 35,921 ---------- ---------- $3,059,814 $2,781,694 ========== ==========
At June 30, 1997, interest rates on the remaining fixed rate notes and subordinated notes due 1998 - 2014 range from 6 1/4% to 9 1/4% and the weighted-average interest rate on these notes outstanding at June 30, 1997 was 7.52%. Interest on the notes is payable semi-annually. At June 30, 1997, the Company had outstanding $846,925 of fixed rate Medium-Term Notes and $463,650 of variable rate Medium-Term Notes, with maturities of one year to thirty years from the date of issuance. The Medium-Term Notes outstanding at June 30, 1997 had an average maturity of 4.9 years and a weighted-average interest rate of 6.87%. Total interest payments relating to agreements to repurchase, short-term borrowings, securities loaned and long-term borrowings were $1,145,274 and $938,439 for the six months ended June 30, 1997 and 1996, respectively. NOTE 6: PREFERRED STOCK Preferred stock, including preferred securities issued by subsidiary trusts, at June 30, 1997 and December 31, 1996 consisted of the following:
June 30, December 31, 1997 1996 -------- ------------ 9% Cumulative Redeemable Preferred Stock, Series C, $100.00 liquidation value; 2,500,000 shares authorized, issued and outstanding $188,162 $187,655 6% Cumulative Convertible Redeemable Preferred Stock, Series A, $100.00 liquidation value; 1,000,000 shares authorized, issued and outstanding $100,000 $100,000 Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts holding solely Company Guaranteed Related Subordinated Debt $393,750 $195,000
PREFERRED SECURITIES ISSUED BY SUBSIDIARY TRUSTS Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts holding solely Company Guaranteed Related Subordinated Debt In March 1997, PWG Capital Trust II, a business trust formed under Delaware law and a wholly owned subsidiary of the Company, issued $198,750 (7,950,000 securities) of 8.08% Preferred Trust Securities to the public at $25.00 per security and $6,147 (245,877 securities) of 8.08% Common Trust Securities to the Company at $25.00 per security. In December 1996, PWG Capital Trust I, a business trust formed under Delaware law and a wholly owned subsidiary of the Company, issued $195,000 (7,800,000 securities) of 8.30% Preferred Trust Securities to the public at $25.00 per security and $6,031 (241,238 securities) of 8.30% Common Trust Securities to the Company at $25.00 per security. 8 10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) PWG Capital Trust I and II each exists for the sole purpose of issuing Preferred Trust Securities and Common Trust Securities (the "Trust Securities") and investing the proceeds in an equivalent amount of junior subordinated debentures of the Company. At June 30, 1997, the sole assets of PWG Capital Trust I and II, respectively, were $201,031 of 8.30% Junior Subordinated Debentures due December 1, 2036 and $204,897 of 8.08% Junior Subordinated Debentures due March 1, 2037 (collectively, the "Junior Subordinated Debentures"). The Company guarantees payments due from PWG Capital Trust I and II to the holders of the Preferred Trust Securities, on a subordinated basis, to the extent the Company has made principal and interest payments on the Junior Subordinated Debentures. These guarantees, together with the Company's obligations under the Junior Subordinated Debentures, provide a full and unconditional guarantee on a subordinated basis of amounts due on the Preferred Trust Securities. Distributions on the Preferred Trust Securities have been classified as minority interest in the Company's Consolidated Statement of Income. The Trust Securities have a stated liquidation value of $25.00 per security. NOTE 7: COMMON STOCK On August 7, 1997, the Board of Directors declared a regular quarterly dividend on the Company's common stock of $0.15 per share payable on October 3, 1997 to stockholders of record on September 4, 1997. As of June 30, 1997, the Company had 33,985,555 authorized shares of common stock reserved for issuance in connection with convertible securities and stock option and stock award plans. On August 7, 1997, the Company entered into an agreement with General Electric Capital Services to acquire a subsidiary. The principal effect of the transaction is the purchase of 6,000,000 shares of the Company's common stock for $219,000 ($36.50 per share) in cash. NOTE 8: CAPITAL REQUIREMENTS PWI, a registered broker-dealer, is subject to the Securities and Exchange Commission Uniform Net Capital Rule and New York Stock Exchange Growth and Business Reduction capital requirements. Under the method of computing capital requirements adopted by PWI, minimum net capital shall not be less than 2% of combined aggregate debit items arising from client transactions, plus excess margin collected on securities purchased under agreements to resell, as defined. A reduction of business is required if net capital is less than 4% of such aggregate debit items. Business may not be expanded if net capital is less than 5% of such aggregate debit items. As of June 30, 1997, PWI's net capital of $961,010 was 15% of aggregate debit items and its net capital in excess of the minimum required was $829,450. NOTE 9: FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK Held or Issued for Trading Purposes In order to measure derivative activity, notional or contract amounts are frequently utilized. Set forth below are the gross contract or notional amounts of the Company's outstanding derivative financial instruments held or issued for trading purposes. These amounts are not reflected in the Consolidated Statements of Financial Condition and are indicative only of the volume of activity at June 30, 1997 and December 31, 1996. They do not represent amounts subject to market risks, and in many cases, limit the Company's overall exposure to market losses by hedging other on- and off-balance-sheet transactions.
Notional or Contract Amount ----------------------------------------------------------------- June 30, 1997 December 31, 1996 ----------------------------- ----------------------------- Purchases Sales Purchases Sales ----------- ----------- ----------- ----------- Mortgage-backed forward contracts and options written and purchased $20,629,699 $22,757,554 $13,443,158 $16,383,162 Foreign currency forward contracts, futures contracts, and options written and purchased 921,019 976,027 440,864 434,072 Equity securities contracts including futures, forwards, and options written and purchased 588,728 1,094,976 442,500 888,784 Other fixed income securities contracts including futures, forwards, and options written and purchased 3,649,676 2,528,433 2,916,929 3,183,749 Interest rate swaps and caps 167,847 96,997 438,562 415,597
9 11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Set forth below are the fair values of derivative financial instruments held or issued for trading purposes as of June 30, 1997 and December 31, 1996. The fair value amounts are determined by quoted market prices and pricing models which consider the time value and volatility of the underlying instruments. Changes in fair value are reflected in principal transactions revenues as incurred. The amounts are netted by counterparty only when the criteria of FASB Interpretation No. 39, "Offsetting of Amounts Related to Certain Contracts," are met.
Fair Value at Fair Value at June 30, 1997 December 31, 1996 ----------------------- ------------------------ Assets Liabilities Assets Liabilities ------ ----------- ------ ----------- Mortgage-backed forward contracts and options written and purchased $84,307 $83,804 $78,800 $ 50,480 Foreign currency forward contracts, futures contracts, and options written and purchased 20,415 20,106 21,857 21,647 Equity securities contracts including futures, forwards, and options written and purchased 64,242 33,868 56,679 30,919 Other fixed income securities contracts including futures, forwards, and options written and purchased 12,973 68,132 15,431 131,088 Interest rate swaps and caps 6,284 2,345 12,654 8,216
Set forth below are the average fair values of derivative financial instruments held or issued for trading purposes for the three months ended June 30, 1997 and the twelve months ended December 31, 1996. The average fair value is based upon the average of the month-end balances during the periods indicated.
Average Fair Value Average Fair Value Three Months Ended Twelve Months Ended June 30, 1997 December 31, 1996 ------------------------ ------------------------ Assets Liabilities Assets Liabilities ------ ----------- ------ ----------- Mortgage-backed forward contracts and options written and purchased $98,369 $109,156 $150,053 $145,396 Foreign currency forward contracts, futures contracts, and options written and purchased 22,372 22,006 37,872 43,132 Equity securities contracts including futures, forwards, and options written and purchased 48,053 27,915 34,583 20,699 Other fixed income securities contracts including futures, forwards, and options written and purchased 10,614 117,596 25,027 90,877 Interest rate swaps and caps 6,271 3,300 5,407 1,782
The Company also enters into agreements to sell securities, at predetermined prices, which have not yet been purchased. The Company is exposed to market risk since to satisfy the obligation, the Company must acquire the securities at market prices, which may exceed the values reflected on the Consolidated Statements of Financial Condition. See Note 1 for further discussion of derivative financial instruments. 10 12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The off-balance-sheet derivative trading transactions are generally short-term. At June 30, 1997 approximately 99% of the off-balance-sheet derivative trading financial instruments had remaining maturities of less than one year. The Company's risk of loss in the event of counterparty default is limited to the current fair value or the replacement cost on contracts in which the Company has recorded an unrealized gain. These amounts are reflected as assets on the Company's Consolidated Statements of Financial Condition and amounted to $188,221 and $185,421 at June 30, 1997 and December 31, 1996, respectively. Options written do not expose the Company to credit risk since they do not obligate the counterparty to perform. Transactions in futures contracts are conducted through regulated exchanges which have margin requirements, and are settled in cash on a daily basis, thereby minimizing credit risk. The table below summarizes the Company's principal transaction revenues by business activity for the three months and six months ended June 30, 1997 and 1996. Principal transaction revenues include realized and unrealized gains and losses on trading positions, including hedges. In assessing the profitability of its trading activities, the Company views net interest and principal transactions revenues in the aggregate.
Principal Transaction Revenue ----------------------------------------------------- Three Months Six Months Ended June 30, Ended June 30, ----------------------- ----------------------- 1997 1996 1997 1996 -------- -------- -------- -------- Taxable fixed income (included futures and options contracts, mortgage-backed forwards, foreign currency forwards, and other securities) $119,175 $121,158 $251,764 $278,641 Equities (includes equity index futures, equity index options and swaps, and equity options contracts) 98,411 89,423 191,698 195,445 Municipals 37,639 41,267 68,299 74,138 -------- -------- -------- -------- $255,225 $251,848 $511,761 $548,224 ======== ======== ======== ========
Held or Issued for Purposes Other Than Trading The Company enters into interest rate swap agreements to modify the interest rate characteristics of its outstanding debt. As of June 30, 1997 and December 31, 1996, the Company had outstanding interest rate swap agreements with commercial banks with notional principal amounts of $2,480,625 and $2,112,200, respectively. These agreements effectively converted substantially all of the Company's fixed rate debt at June 30, 1997 into floating rate debt. The interest rate swap agreements entered into have had the effect of reducing net interest expense on the Company's long-term borrowings by $6,373 and $4,870 for the six months ended June 30, 1997 and 1996. The Company had no deferred gains or losses related to terminated swap agreements at June 30, 1997 and December 31, 1996. The Company is subject to market risk as interest rates fluctuate. The interest rate swaps contain credit risk to the extent the Company is in a receivable or gain position and the counterparty defaults. However, the counterparties to the agreements are large financial institutions and the Company has not experienced defaults in the past and management does not anticipate any counterparty defaults in the foreseeable future. See Notes 1 and 2 for further discussion of interest rate swap agreements used for hedging purposes. NOTE 10: RISK MANAGEMENT Transactions involving derivative and non-derivative financial instruments involve varying degrees of both market and credit risk. The Company monitors its exposure to market and credit risk on a daily basis and through a variety of financial, security position and credit exposure reporting and control procedures. Market Risk Market risk is the potential change in value of the financial instrument caused by unfavorable changes in interest rates, foreign currency exchange rates or the fair values of the securities underlying the instrument. The Company has a variety of methods to monitor its market risk profile. The senior management of each business group is responsible for reviewing trading positions, exposures, profits and losses, and trading strategies on a daily basis. The Company also has an independent risk management group which aids in setting and monitoring risk management policies of the Company, including monitoring adherence to the established limits, performing market risk modeling, and reviewing 11 13 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) trading positions and hedging strategies. The Asset/Liability Management Committee, comprised of senior corporate and business unit managers, is responsible for establishing trading position and exposure limits. Market risk modeling is based on estimating loss exposure through stress testing. These results are compared to established limits, and exceptions are subject to review and approval by senior management. Other market risk control procedures include monitoring inventory agings, reviewing traders' marks and regular meetings between the senior management of the business groups and the risk management group. Credit Risk in Proprietary Transactions Counterparties to the Company's proprietary trading, hedging, financing and arbitrage activities are primarily financial institutions, including brokers and dealers, banks and institutional clients. Credit losses could arise should counterparties fail to perform and the value of any collateral proves inadequate. The Company manages credit risk by monitoring net exposure to individual counterparties on a daily basis, monitoring credit limits and requiring additional collateral where appropriate. Derivative credit exposures are calculated, aggregated and compared to established limits by the credit department. Credit reserve requirements are determined by senior management in conjunction with the Company's continuous credit monitoring procedures. Historically, reserve requirements arising from instruments with off-balance-sheet risk have not been material. Receivables and payables with brokers and dealers, and agreements to resell and repurchase securities are generally collateralized by cash, U.S. government and government-agency securities, and letters of credit. The market value of the initial collateral received is, at a minimum, equal to the contract value. Additional collateral is requested when considered necessary. The Company may pledge clients' margined securities as collateral in support of securities loaned and bank loans, as well as to satisfy margin requirements at clearing organizations. The amounts loaned or pledged are limited to the extent permitted by applicable margin regulations. Should the counterparty fail to return the clients' securities, the Company may be required to replace them at prevailing market prices. At June 30, 1997, the market value of client securities loaned to other brokers approximated the amounts due or collateral obtained. Credit Risk in Client and Other Activities Client transactions are entered on either a cash or margin basis. In a margin transaction, the Company extends credit to a client for the purchase of securities, using the securities purchased and/or other securities in the client's account as collateral for amounts loaned. Amounts loaned are limited by margin regulations of the Federal Reserve Board and other regulatory authorities and are subject to the Company's credit review and daily monitoring procedures. Market declines could, however, reduce the value of any collateral below the principal amount loaned, plus accrued interest, before the collateral can be sold. Client transactions include positions in commodities and financial futures, trading liabilities and written options. The risk to the Company's clients in these transactions can be substantial, principally due to price volatility which can reduce the clients' ability to meet their obligations. Margin deposit requirements pertaining to commodity futures and options transactions are generally lower than those for exchange-traded securities. To the extent clients are unable to meet their commitments to the Company and margin deposits are insufficient to cover outstanding liabilities, the Company may take market action and credit losses could be realized. Client trades are recorded on a settlement date basis. Should either the client or broker fail to perform, the Company may be required to complete the transaction at prevailing market prices. Trades pending at June 30, 1997 were settled without material adverse effect on the Company's consolidated financial statements, taken as a whole. 12 14 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Concentrations of Credit Risk Concentrations of credit risk that arise from financial instruments (whether on- or off-balance-sheet) exist for groups of counterparties when they have similar economic characteristics that would cause their ability to meet obligations to be similarly affected by economic, industry or geographic factors. As a major securities firm, the Company engages in activities with a broad range of corporations, governments, and institutional and individual investors. The Company has no significant exposure to any individual counterparty. The Company seeks to control its credit risk and the potential for risk concentration through a variety of reporting and control procedures described above. The Company's most significant industry concentration, which arises within its normal course of business activities, is financial institutions including banks, brokers and dealers, mutual funds and insurance companies. NOTE 11: COMMITMENTS AND CONTINGENCIES At June 30, 1997 and December 31, 1996, the Company was contingently liable under unsecured letters of credit totaling $269,816 and $303,543, respectively, which approximates fair value. At June 30, 1997, certain of the Company's subsidiaries were contingently liable as issuer of $55,974 of notes payable to managing general partners of various limited partnerships pursuant to certain partnership agreements. In addition, as part of the 1995 limited partnership settlements, the Company has agreed, under certain circumstances, to provide to class members additional consideration including assignment of any and all fees the Company is entitled to receive from certain partnerships. In the opinion of management, these contingencies will not have a material adverse effect on the Company's consolidated financial statements, taken as a whole. In February 1996, two limited partnerships, in which a subsidiary of the Company serves as the general partner and certain key employees serve as the limited partners, entered into two unsecured credit facilities with a commercial bank under which the bank agreed to make unsecured loans to the limited partnerships of up to $77,525. The Company entered into an agreement with the bank to purchase the loans under certain specific circumstances. At June 30, 1997, $54,177 had been loaned to the limited partnerships. In meeting the financing needs of certain of its clients, the Company may also issue standby letters of credit which are fully collateralized by marginable securities. At June 30, 1997, the Company had outstanding $31,888 of such standby letters of credit. At June 30, 1997 and December 31, 1996, securities with fair value of $134,889 and $215,286, respectively, had been loaned or pledged as collateral for securities borrowed of approximately equal fair value. In the normal course of business, the Company enters into when-issued transactions, underwriting and other commitments. Also, clients may be extended lines of credit collateralized by mortgages and other real estate interests. These commitments are generally entered into at variable rates of interest based on LIBOR. At June 30, 1997, the unused portion of such lines of credit amounted to $1,308,110, relating to commercial real estate commitments. Settlement of these transactions at June 30, 1997 would not have had a material impact on the Company's consolidated financial statements, taken as a whole. The Company has been named as defendant in numerous legal actions in the ordinary course of business. While the outcome of such matters cannot be predicted with certainty, in the opinion of management of the Company, after consultation with various counsel handling such matters, these actions will be resolved with no material adverse effect on the Company's consolidated financial statements, taken as a whole. 13 15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 12: INCOME TAXES The reconciliation of income taxes, computed at the statutory federal rates, to the provision for income taxes recorded is as follows:
Three Months Ended Six Months Ended June 30 June 30 ------- ------- 1997 1996 1997 1996 ---- ---- ---- ---- Tax at statutory federal rates 35.0% 35.0% 35.0% 35.0% State and local income taxes, net of federal tax benefit 4.0 4.6 4.0 4.4 Foreign rate differential 1.8 (1.2) 0.3 (1.0) Nontaxable dividends & interest (1.0) (2.0) (0.9) (1.5) Minority Interest (2.0) - (1.5) - Other, net (4.7) (2.2) (2.3) (2.3) ----- ----- ----- ----- 33.1% 34.2% 34.6% 34.6% ===== ===== ===== =====
Income taxes paid were $125,849 and $66,195 for the six months ended June 30, 1997 and 1996, respectively. NOTE 13: EARNINGS PER COMMON SHARE For the three months and six months ended June 30, 1997 and 1996, the Company computed its earnings per common share under the modified treasury stock method in accordance with APB Opinion No. 15, "Earnings Per Share", by dividing net income, adjusted for preferred stock dividends and any interest savings, by the weighted-average common and common equivalent shares outstanding during each period presented. Common equivalent shares include common shares issuable under the Company's stock option and award plans, the conversion of convertible debentures and convertible preferred stock, and restricted stock outstanding. 14 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company's principal business activities are, by their nature, affected by many factors, including general economic and financial conditions, the level and volatility of interest rates, currency and security valuations, competitive conditions, counterparty risk, transactional volume and market liquidity. As a result, revenues and profitability have been in the past, and are likely to continue to be, subject to fluctuations reflecting the impact of these factors. Business conditions were generally favorable for the securities industry in the second quarter of 1997. The annual rate of real GDP declined from 4.9% in the first quarter of 1997 to 2.2% in the second quarter indicating a slow down of U.S. economic growth. Bond yields declined as concerns in the financial markets over increases in short-term rates eased. The yield on the 30-year Treasury bond declined from 7.2% at March 31, 1997 to 6.8% at June 30, 1997. After a sell-off late in the first quarter, stock prices rallied sharply due to declining interest rates and continued healthy profit growth. RESULTS OF OPERATIONS Quarter Ended June 30, 1997 compared to Quarter Ended June 30, 1996 The Company's net income for the quarter ended June 30, 1997 was $93.1 million, or $0.91 per primary share ($0.87 per fully diluted share) compared to net income of $92.2 million, or $0.90 per primary share ($0.86 per fully diluted share) earned during the second quarter of 1996. During the second quarter of 1997, revenues, net of interest expense, were $975.9 million, 2.8% higher than the second quarter of 1996. Commission revenues earned during the second quarter of 1997 were $346.9 million, as compared to $362.7 million earned during the prior year quarter. Commissions on the sale of over-the-counter securities decreased $11.8 million or 27.0%. Commissions on the sale of listed securities decreased $4.4 million or 2.3% and mutual funds and insurance commissions decreased $2.7 million or 2.7%. These decreases were partially offset by an increase in commodities and options commissions. Principal transactions revenues increased $3.4 million, or 1.3% from the prior period. For financial reporting purposes, realized and unrealized gains and losses on trading positions, including hedges, are recorded in principal transactions revenues. The increase from the prior period reflects improved trading results in equity securities partially offset by lower results in taxable fixed income and municipal securities. Asset management fees increased 12.5% to $125.3 million, due to higher revenues earned on managed or "wrap" and trust accounts. Average assets in wrap and trust accounts during the second quarter of 1997 were approximately 34% higher than during the second quarter of 1996. The average assets under management in money market, institutional and long-term mutual funds were approximately $43.8 billion during the second quarter of 1997. Investment banking revenues were $110.9 million, 8.7% higher than the $102.1 million earned during the second quarter of 1996 reflecting an increase in merger and financial advisory activity as well as an increased level of municipal underwritings. Net interest increased $22.7 million, or 28.1% primarily due to increased margin lending to customers and an increased level of fixed income positions offset by higher interest expense on increased borrowings. Compensation and benefits for the quarter ended June 30, 1997 were $574.2 million as compared to $568.7 million during the prior year quarter. Compensation increased primarily due to normal salary increases. Compensation and benefits as a percent of net revenues were 58.8% during the second quarter of 1997, as compared to 59.9% during the comparable period in 1996. All other operating expenses were $250.4 million, as compared to $240.6 million for the prior year quarter. Principal drivers of the increase in non-compensation costs were technology costs associated with preparations for the millenium. 15 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Six Months Ended June 30, 1997 compared to Six Months Ended June 30, 1996 The Company's net income for the six months ended June 30, 1997 was $194.0 million, or $1.91 per primary share ($1.82 per fully diluted share) compared to net income of $192.7 million, or $1.87 per primary share ($1.76 per fully diluted share) earned during the first six months of 1996. During the first six months of 1997, revenues, net of interest expense, were $1,960.8 million, as compared to $1,912.3 during the first six months of 1996. Commission revenues were $717.3 million, as compared to the $730.9 million earned during the first six months of 1996. Commissions on the sale of listed securities decreased $11.8 million or 3.0% and commissions on the sale of over-the-counter securities decreased $6.6 million or 8.7%. This decrease was partially offset by an increase in commodities and options commissions. Principal transactions revenues decreased $36.5 million, or 6.7% reflecting lower overall trading results in taxable fixed income, equity and municipal securities. Asset management fees increased 12.4% to $246.3 million primarily due to higher revenues earned on wrap and trust accounts and higher advisory fees earned on money market accounts. Investment banking revenues were $208.7 million, 13.5% higher than the $183.9 million earned during the first six months of 1996, reflecting an increase in merger and financial advisory activity. In addition, the results in the first six months of 1997 reflect an increased level of municipal underwritings. Net interest increased $45.7 million, or 28.8% primarily due to increased margin lending to customers and an increased level of fixed income positions offset by higher interest expense on increased borrowings. Compensation and benefits for the six months ended June 30, 1997 were $1,148.2 million as compared to $1,135.7 million during the prior year period. Compensation increased primarily due to normal salary increases. Compensation and benefits as a percent of net revenues were 58.6% during the first six months of 1997, as compared to 59.4% during the comparable period in 1996. All other operating expenses increased 3.1% to $496.3 million primarily due to increased technology costs associated with preparations for the millenium. LIQUIDITY AND CAPITAL RESOURCES The primary objectives of the Company's funding policies are to insure ample liquidity at all times and a strong capital base. These objectives are met by maximization of self-funded assets, diversification of funding sources, maintenance of prudent liquidity and capital ratios, and contingency planning. Liquidity The Company maintains a highly liquid balance sheet with the majority of assets consisting of trading assets, securities purchased under agreements to resell, securities borrowed, and receivables from clients, brokers and dealers, which are readily convertible into cash. The nature of the Company's business as a securities dealer results in carrying significant levels of trading inventories in order to meet its client and proprietary trading needs. The Company's total assets may fluctuate from period to period as a result of changes in the level of trading positions held to facilitate client transactions, the volume of resale and repurchase transactions, and proprietary trading strategies. These fluctuations depend significantly upon economic and market conditions, and transactional volume. The Company's total assets at June 30, 1997 were $56.5 billion compared to $52.5 billion at December 31, 1996, reflecting increases primarily in securities purchased under agreements to resell and securities borrowed. The majority of the Company's assets are financed by daily operations such as securities sold under agreements to repurchase, free credit balances in client accounts and securities lending activity. Additional financing sources are available through bank loans and commercial paper, committed and uncommitted lines of credit, and long-term borrowings. 16 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company maintains committed and uncommitted credit facilities from a diverse group of banks. The Company has a committed unsecured senior revolving credit agreement to provide up to $1.2 billion through December 1997. Certain of the Company's subsidiaries have a committed secured revolving credit facility to provide up to an aggregate of $750.0 million through August 1997, with provisions for renewal through August 2000. The Company is in the process of renewing this credit agreement through August 1998. The secured borrowings under this facility can be collateralized using a variety of financial instruments. The facilities are available for general corporate purposes. At June 30, 1997, there were no outstanding borrowings under these credit facilities. Additionally, the Company had approximately $5.1 billion in uncommitted lines of credit at June 30, 1997. The Company maintains public shelf registration statements with the SEC for the issuance of debt securities. During the second quarter of 1997, the Company issued $135.5 million of Medium-Term Senior Notes under these registration statements. At June 30, 1997, the Company had approximately $1.9 billion in debt securities available for issuance under these registration statements. The Company maintains a public shelf registration statement with the SEC for the issuance of preferred trust securities of PWG Capital Trusts I, II, III, and IV ("Preferred Trust Securities"), business trusts formed under the Delaware law which are wholly owned subsidiaries of the Company, and debt securities of the Company. At June 30, 1997, $106.5 million in Preferred Trust Securities and debt securities of the Company were available for issuance under this registration statement. (For further discussion on the Preferred Trust Securities, see Note 6 in the Company's Notes to Consolidated Financial Statements.) Capital Resources and Capital Adequacy The Company's businesses are capital intensive. In addition to a funding policy which provides for diversification of funding sources and maximization of liquidity, the Company maintains a strong capital base. The Company's total capital base, which includes long-term borrowings, preferred stock and stockholders' equity, grew to $5.5 billion at June 30, 1997, an increase of $590.2 million from December 31, 1996. The growth in capital is primarily due to the net increase in long-term borrowings of $278.1 million, the issuance of $198.8 million of Preferred Trust Securities and an increase in stockholders' equity of $112.8 million. During 1997, the Company issued 2,472,000 shares of common stock related to employee compensation programs. Activity related to these programs had the effect of increasing equity capital by more than $97.1 million. Offsetting this increase were dividends accrued of $41.7 million and the repurchase of 3,988,000 shares of the Company's common stock, at an aggregate cost of $133.4 million. At June 30, 1997, the remaining number of common shares authorized to be repurchased by the Company's Board of Directors was 10.0 million. PWI is subject to the net capital requirements of the Securities and Exchange Commission, the New York Stock Exchange, Inc. and the Commodity Futures Trading Commission which are designed to measure the financial soundness and liquidity of broker-dealers. PWI has consistently maintained net capital in excess of the minimum requirements imposed by these agencies. In addition, the Company has other banking and securities subsidiaries, both domestic and foreign, which have also consistently maintained net regulatory capital in excess of requirements. On August 7, 1997, the Company entered into an agreement with General Electric Capital Services to acquire a subsidiary. The principal effect of the transaction is the purchase of 6 million shares of the Company's common stock for $36.50 per share. This transaction will result in a charge to Stockholders' Equity of $219,000. Merchant Banking and Highly Leveraged Transactions In connection with its merchant banking and commercial real estate activities, the Company has provided financing and made investments in companies, some of which are involved in highly leveraged transactions. Positions taken or commitments made by the Company may involve credit or market risk from any one issuer or industry The Company's activities include underwriting and market-making transactions in high-yield and emerging market securities (collectively, "high yield securities"). These securities generally involve greater risks than investment-grade corporate debt securities because these issuers usually have high levels of indebtedness and lower credit ratings and are, therefore, more vulnerable to general economic conditions. At June 30, 1997, the Company held $475 million of high-yield securities, with approximately 37% of such securities attributable to three issuers. The Company continually monitors its risk positions associated with high-yield securities and establishes limits with respect to overall market exposure, industry group and individual issuer. The Company accounts for these positions at fair value, with unrealized gains and losses reflected in revenues. 17 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) DERIVATIVE FINANCIAL INSTRUMENTS A derivative financial instrument represents a contractual agreement between counterparties and has value that is derived from changes in the value of some other underlying asset such as the price of another security, interest rates, currency exchange rates, specified rates (e.g. LIBOR) or indices (e.g. S&P 500), or the value referenced in the contract. Derivatives, such as futures, certain options contracts and structured products (e.g. indexed warrants) are traded on exchanges, while derivatives such as forward contracts, certain option contracts, interest rate swaps, caps and floors, and other structured products are negotiated in over-the-counter markets. In the normal course of business, the Company engages in a variety of derivative transactions in connection with its proprietary trading activities and asset and liability management, as well as on behalf of its clients. As a dealer, the Company regularly makes a market in and trades in a variety of securities. The Company is also engaged in creating structured products which are sold to clients. In connection with these activities, the Company attempts to reduce its exposure to market risk by entering into offsetting hedging transactions which may include derivative financial instruments. The Company also enters into interest rate swap contracts to hedge its fixed rate borrowings and reduce overall borrowing costs. The notional amount of a derivative contract is used to measure the volume of activity and is not reflected on the Consolidated Statement of Financial Condition. The Company had off-balance-sheet derivative contracts outstanding with gross notional amounts of $55.9 billion and $41.1 billion at June 30, 1997 and December 31, 1996, respectively. These amounts included $41.6 billion and $22.4 billion, respectively, related to "to be announced" mortgage-backed securities requiring forward settlement. Also included in these amounts were $2.5 billion and $2.1 billion notional amounts used to hedge the Company's long-term borrowings at June 30, 1997 and December 31, 1996, respectively. For a more detailed discussion and disclosure on derivative financial instruments, see Note 9 "Financial Instruments with Off-Balance-Sheet Risk" and Note 10 "Risk Management" in the Notes to Consolidated Financial Statements. 18 20 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is involved in a number of proceedings concerning matters arising in connection with the conduct of its business. The Company has denied, or believes it has legitimate defenses and will deny, liability in all significant cases pending against it, and intends to defend actively each such case. The following material developments have occurred in the cases below, which were previously reported in the Company's Annual Report on Form 10-K for the year ended December 31, 1996 and Quarterly Report on Form 10-Q for the quarter ended March 31, 1997. LIMITED PARTNERSHIP PROCEEDINGS On July 30, 1997, the United States Court of Appeals for the Second Circuit affirmed the judgment approving the settlement. IN RE NASDAQ MARKET-MAKER LITIGATIONS A notice of appeal to the United States Court of Appeals for the Second Circuit has been filed from the approval by the United States District Court for the Southern District of New York of the Stipulation and Order among various firms, including PaineWebber Incorporated, and the United States Department of Justice resolving a civil complaint filed by the Department of Justice. On June 19, 1997, a panel of the United States Court of Appeals for the Third Circuit affirmed the District Court's grant of defendants' motions for summary judgment in In Re Merrill Lynch, et al. Securities Litigation. On July 30, 1997, the Third Circuit Court of Appeals vacated the prior Third Circuit opinion and listed the case for rehearing en banc. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed herewith: Exhibit 11 - Computation of Earnings per Common Share Exhibit 12.1 - Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends Exhibit 12.2 - Computation of Ratio of Earnings to Fixed Charges Exhibit 27 - Financial Data Schedule (b) Reports on Form 8-K: None 19 21 SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Paine Webber Group Inc. ----------------------- (Registrant) Date: August 7, 1997 By: /s/ Regina A. Dolan --------------- ----------------------- Regina A. Dolan Vice President, Chief Financial Officer 20 22 EXHIBIT INDEX ------------- Exhibit No. Description ----------- ----------- Exhibit 11 - Computation of Earnings per Common Share Exhibit 12.1 - Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends Exhibit 12.2 - Computation of Ratio of Earnings to Fixed Charges Exhibit 27 - Financial Data Schedule EX-11 2 COMPUTATION OF EARNINGS PER COMMON SHARE 1 EXHIBIT 11 PAINE WEBBER GROUP INC. COMPUTATION OF EARNINGS PER COMMON SHARE (In thousands of dollars except share and per share amounts)
Three Months Ended June 30, Six Months Ended June 30, --------------------------- ------------------------- 1997 1996 1997 1996 ---- ---- ---- ---- PRIMARY: Weighted-average common shares outstanding 86,583,003 87,315,131 86,774,107 88,593,710 Incremental stock options and awards 7,958,825 7,882,909 7,454,255 7,882,810 ------------- ------------- ------------- ------------- Weighted-average common and common equivalent share 94,541,828 95,198,040 94,228,362 96,476,520 ============= ============= ============= ============= Net income $ 93,124 $ 92,212 $ 193,959 $ 192,713 Interest savings on convertible debentures and short-term borrowings 227 1,225 558 2,578 Preferred dividend requirements (7,379) (7,349) (14,757) (14,856) ------------- ------------- ------------- ------------- Net income applicable to common shares $ 85,972 $ 86,088 $ 179,760 $ 180,435 ============= ============= ============= ============= Primary earnings per common share $ 0.91 $ 0.90 $ 1.91 $ 1.87 ============= ============= ============= ============= FULLY DILUTED: Weighted-average common shares outstanding 86,583,003 87,315,131 86,774,107 88,593,710 Incremental stock options and awards 8,163,870 8,804,960 8,072,466 9,037,513 Weighted-average common shares issuable assuming conversion of 8% Convertible Debentures and 6% Cumulative Convertible Redeemable Preferred Stock 5,515,720 6,196,913 5,567,683 6,327,181 ------------- ------------- ------------- ------------- Weighted-average common and common equivalent shares 100,262,593 102,317,004 100,414,256 103,958,404 ============= ============= ============= ============= Net income $ 93,124 $ 92,212 $ 193,959 $ 192,713 Interest savings on convertible debentures and short-term borrowings 227 1,140 576 2,262 Preferred dividend requirements (5,878) (5,849) (11,756) (11,823) ------------- ------------- ------------- ------------- Net income applicable to common shares $ 87,473 $ 87,503 $ 182,779 $ 183,152 ============= ============= ============= ============= Fully diluted earnings per common share $ 0.87 $ 0.86 $ 1.82 $ 1.76 ============= ============= ============= =============
EX-12.1 3 COMPUTATION OF RATIO OF EARNINGS 1 EXHIBIT 12.1 PAINE WEBBER GROUP INC. COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS (In thousands of dollars)
Six Months Years Ended December 31, Ended June 30, ----------------------------------------------------------------------- 1997 * 1996 * 1995 1994 1993 1992 ------ ------ ---- ---- ---- ---- Income before taxes $ 303,321 $ 558,999 $ 102,677 $ 44,385 407,576 $339,115 ---------- ---------- ---------- ---------- ------- -------- Preferred stock dividends 22,619 43,712 36,260 1,710 5,828 27,789 ---------- ---------- ---------- ---------- ------- -------- Fixed charges: Interest 1,186,686 1,971,788 1,969,811 1,428,653 1,130,712 879,242 Interest factor in rents 28,313 54,537 59,491 51,102 50,133 45,962 ---------- ---------- ---------- ---------- ------- -------- Total fixed charges 1,214,999 2,026,325 2,029,302 1,479,755 1,180,845 925,204 ---------- ---------- ---------- ---------- ------- -------- Total fixed charges and preferred stock dividends 1,237,618 2,070,037 2,065,562 1,481,465 1,186,673 952,993 ---------- ---------- ---------- ---------- ------- -------- Income before taxes and fixed charges $1,518,320 $2,585,324 $2,131,979 $1,524,140 $1,588,421 $1,264,319 ========== =========== =========== =========== ========== ========== Ratio of earnings to fixed charges and preferred stock dividends 1.2 1.2 1.0 1.0 1.3 1.3 =========== ========== ========== =========== ============ ===========
For purposes of computing the ratio of earnings to combined fixed charges and preferred stock dividends (tax effected), "earnings" consist of income before taxes and fixed charges. "Fixed charges" consist of interest expense incurred on securities sold under agreements to repurchase, short-term borrowings, long-term borrowings, preferred trust securities and that portion of rental expense estimated to be representative of the interest factor. * Income before taxes includes minority interest in wholly owned subsidiary trusts. EX-12.2 4 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES 1 EXHIBIT 12.2 PAINE WEBBER GROUP INC. COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (In thousands of dollars)
Six Months Years Ended December 31, Ended June 30, ------------------------------------------------------------------- 1997 * 1996 * 1995 1994 1993 1992 ---------- ---------- ---------- ---------- ---------- ---------- Income before taxes $ 303,321 $ 558,999 $ 102,677 $ 44,385 $ 407,576 $ 339,115 ---------- ---------- ---------- ---------- ---------- ---------- Fixed charges: Interest 1,186,686 1,971,788 1,969,811 1,428,653 1,130,712 879,242 Interest factor in rents 28,313 54,537 59,491 51,102 50,133 45,962 ---------- ---------- ---------- ---------- ---------- ---------- Total fixed charges 1,214,999 2,026,325 2,029,302 1,479,755 1,180,845 925,204 ---------- ---------- ---------- ---------- ---------- ---------- Income before taxes and fixed charges $1,518,320 $2,585,324 $2,131,979 $1,524,140 $1,588,421 $1,264,319 ========== ========== ========== ========== ========== ========== Ratio of earnings to fixed charges 1.2 1.3 1.1 1.0 1.3 1.4 ========== ========== ========== ========== ========== ==========
For purposes of computing the ratio of earnings to fixed charges, "earnings" consist of income before taxes and fixed charges. "Fixed charges" consist of interest expense incurred on securities sold under agreements to repurchase, short-term borrowings, long-term borrowings, preferred trust securities and that portion of rental expense estimated to be representative of the interest factor. * Income before taxes includes minority interest in wholly owned subsidiary trusts. EX-27 5 FINANCIAL DATA SCHEDULE
BD THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF PAINE WEBBER GROUP INC. FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 6-MOS DEC-31-1997 JUN-30-1997 719,863 6,832,727 23,160,177 9,118,209 16,316,357 316,200 56,463,533 1,691,112 7,141,770 30,333,462 4,678,835 7,133,355 3,059,814 581,912 100,000 109,431 1,633,842 56,463,533 511,761 1,391,091 717,297 208,712 246,295 1,186,686 1,148,248 316,231 193,959 0 0 193,959 1.91 1.82
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