Banking, Investment Banking and Securities

T H E
S T A T E T H E
O F I N D U S T R Y
B A N K I N G
B a n k i n g
a n d B a n k i n g & S e c u r i t i e s
I n v e s t m e n t
A p r i l
J u n e
3 0 ,
2 0 0 3
F I N A N C I A L
S E R V I C E S
T H E B a n k i n g
S T A T E a n d
O F
T H E
B A N K I N G B a n k i n g
I N D U S T R Y & S e c u r i t i e s
I n v e s t m e n t
A p r i l
t h r o u g h
J u n e
3 0 ,
2 0 0 3
P u b l i s h e d
A u g u s t
2 0 0 3
The State of the Banking Industry is published by KPMGs Banking practice for members of the Banking and Investment Banking and Securities Industries. Information and statistics contained in this document were obtained from publicly available materials. The information provided here is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without the appropriate professional advice after a thorough examination of the facts of the particular situation. For additional information on KPMG, please go to our Web site at www.us.kpmg.com.
F I N A N C I A L
S E R V I C E S
2003 KPMG LLP the U.S. member firm of KPMG International, a Swiss nonoperating association. , All rights reserved. BearingPoint, Inc., formerly KPMG Consulting Inc., is an independent consulting firm and is not affiliated with KPMG International or any KPMG member firm.
T A B L E
O F
C O N T E N T S
Quarterly Updates
General Highlights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2 6 11
Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Accounting Standards and Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Mark et Forces
Broker/Dealers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Consolidation and Convergence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 International Focus and Globalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 e-Business and Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Risk Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
K P M G s B a n k i n g I n s i d e r
Analysis and Commentary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Q U A R T E R L Y
U P D A T E S
General Highlights On May 8, 2003, the Public Company Accounting Oversight Board announced that Thomas Ray is joining the Boards staff as Deputy Chief Auditor who will work closely with Chief Auditor Douglas R. Carmichael. Mr. Ray, a partner in KPMG LLPs Department of Professional Practice Assurance, has been the chairman of the International Auditing Standards Subcommittee of the AICPA, a member of the AICPA Internal Control Reporting Task Force, and a member of the International Auditing and Assurance Standards Board Quality Control Task Force. (PCAOB press release, May 8, 2003) On June 2, 2003, NASD announced that it has agreed to principle terms to sell the American Stock Exchange to GTCR Golder Rauner LLC, a Chicago based private equity firm for approximately $110 million, subject to completion of definitive sale documents and various approvals. In line with NASDs key goals to exit ownership of exchanges and focus on its core mission as a regulator to promote market integrity and protect investors, NASD began the process by spinning off Nasdaq in 2000. (NASD press release, June 2, 2003) The final report and recommendations of the NYSE/NASD IPO Advisory Committee was issued on May 29, 2003 and proposes 20 steps to enhance public confidence in the integrity of the IPO process. The Committee, formed in October 2002 by the New York Stock Exchange and NASD at the request of the SEC, included corporate, financial and academic leaders. Recommendations of the Committee are intended to complement the numerous recent legislative and regulatory initiatives, including the Global Settlement among regulators and major investment banks. Overall: The IPO process must promote transparency in pricing and avoid aftermarket distortions. Abusive allocation practices must be eliminated.
The flow of, and access to, information regarding IPOs must be improved. (NASD/NYSE press release, May 29, 2003) On June 5, the NYSEs board of directors adopted initial recommendations of its Special Committee on Governance of the NYSE that would annually disclose director and senior executive compensation, prohibit NYSE officers from serving on the boards of listed companies, and provide that the NYSEs compensation committee consist only of non-securities industry directors. These were among ten initial steps to be put into effect immediately to ensure that the NYSEs governance structure and practices best serve the 85 million people who invest, directly or indirectly, through the NYSE. (NYSE press release, June 5, 2003) New Tillinghast-Towers Perrin research indicates that there is going to be a considerable increase in the sale of financial services products through the workplace, particularly in the areas of critical illness, health insurance, and banking products such as personal loans, credit cards and mortgages. Reasons behind the expected growth include the relatively low customer acquisition costs; the increasing interest in flexible benefit schemes of employers as they look to reduce their costs while adding choice; the need to educate consumers on financial issues as the Government seeks ways in which to reduce the retirement savings gap; and the potential change from occupational pension schemes to individual plans. (Tillinghast press release, June 2, 2003) Weiss Ratings, Inc. noted that in 2002 the banking industry set a new record for profits, earning $105.3 billion, outpacing its previous record of $87.5 billion in 2001. With interest rates at near record lows, the surge in consumer demand for loans more than offset the decline in commercial lending. Banks saw more profitable net interest margins, higher values for bond holdings and increased consumer demand for mortgages, home equity and credit card loans and other consumer borrowing. There was a 9.7 percent increase in both home mortgage lending and consumer loans and a 39.1
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
Q U A R T E R L Y
U P D A T E S
percent increase in home equity loans in 2002, while commercial and industrial lending saw a decline of 5.3 percent for the year. For the week ended June 27, 2003, the U.S. 30-year fixed rate mortgage averaged 5.24 percent vs. 6.55 percent a year ago; 15-year rates averaged 4.63 percent vs. 5.99 percent at this time last year; and one-year adjustable rate mortgages averaged 3.45 percent vs. 4.61 percent a year ago. (Weiss Ratings, Inc. press release, May 12, 2003; Freddie Mac press release, June 26, 2003) The Office of Federal Housing Enterprise Oversight reports in its latest quarterly House Price Index that average prices for U.S. homes increased 6.48 percent from the first quarter of 2002 through the first quarter of 2003. At the same time, the quarterly national average price appreciation continued deceleration at 0.94 percent from 1.3 percent last quarter. In the current quarter, all U.S. states experienced positive growth, with California continuing to dominate the ranks of the Top 20. (Office of Federal Housing Enterprise Oversight press release, June 9, 2003) On July 16th Sanford I. Weill announced his decision to step down as head of Citigroup, effective in January 2004. Charles O. Prince will become Citigroups new Chief Executive Officer and Robert B. Willumstad, President, will become Chief Operating Officer. Mr. Weill will remain Chairman of the Board until the 2006 Annual Meeting of Citigroup shareholders. (Citigroup press release, July 16, 2003)
was $1.87 billion, compared to $1.59 billion in the second quarter of 2002. Total revenue for BofA's credit card operation in the second quarter of 2003 was $1.04 billion, compared to $806 million a year earlier. Return on assets was 1.42 percent, compared to 1.38 percent in the second quarter 2002, while return on equity was 21.86 percent, compared to 18.47 percent for the yearearlier quarter. Assets on June 30 were $769 billion.
Bank of New York: The closing of Pershing

lowered Bank of New Yorks reported net income to $295 million for the second quarter, compared to $361 million in the second quarter of 2002. Return on assets was 1.30 percent, compared to 1.82 percent a year earlier, while return on equity was 15.56 percent, compared to 22.59 percent a year ago. The bank's noninterest income was $996 million, compared to $855 million in the second quarter last year, while net interest income was $398 million, compared to $423 million a year earlier. Assets on June 30 were $99.8 billion.
Bank One Corp.: Reported 2003 second-quarter

net income of $856 million, compared to $803 million in the second quarter of 2002 (excluding a $40 million after-tax benefit from a restructuring charge reversal in the second quarter of 2002). Bank One's retail line of business recorded net income of $373 million (excluding $11 million after-tax benefit from a restructuring charge reversal a year earlier), compared to $371 million a year earlier, while its commercial banking business had net income of $249 million (excluding the $3 million aftertax benefit from a restructuring charge reversal in the prior year), compared to $147 million in the second quarter of 2002. Return on assets totaled 1.24 percent, compared to 1.32 percent a year earlier, while return on equity was 15.3 percent, compared to 15.7 percent in the year-ago quarter. Reported total assets on June 30 were $299 billion.
I N D U S T R Y
B A N K I N G
Earnings U.S. Bank Earnings Bank of America Corp.: With a strong

performance in most product lines such as mortgage, debit and credit cards, deposits and loans, Bank of America reported record earnings of $2.74 billion in the second quarter of 2003, compared to $2.22 billion for the same quarter a year ago. Net income for Bank of America's consumer and commercial banking segment
O F
T H E
S T A T E
Citigroup: Helped by its strong consumer business,

the nation's largest financial services company reported second-quarter operating earnings of $4.3 billion, compared to $3.83 billion a year earlier. Net income was
T H E
Q U A R T E R L Y
U P D A T E S
also $4.3 billion, compared to $4.08 billion a year earlier. Citi's consumer cards operation had income of $768 million for the quarter, compared to $722 million a year ago, while its retail banking operations had income of $1.05 billion, compared to $645 million in 2002's second quarter. Income for Citigroup's total global corporate and investment bank was $1.34 billion, compared to $1.32 billion a year earlier. Return on equity was 19.2 percent, compared to 19.5 percent in the second quarter of 2002. Assets on June 30 were $1.19 trillion.
earnings for J.P. Morgan's investment bank operation was $1.09 billion, up 114 percent from second quarter 2002, and its Chase Financial Services business reported record operating earnings of $883 million, an increase of 36 percent from 2002's second quarter. Return on assets was 0.96 percent, compared to 0.56 percent in the year-ago quarter, and second-quarter return on equity was 17 percent, compared to 10 percent a year ago. Assets on June 30 were $803 billion.
FleetBoston Financial: Reported net income of

$624 million for the second quarter of 2003, compared to a net loss of $386 million for the second quarter last year, mainly due to the banks position of becoming more consumer-oriented after suffering losses from its Argentine business and reducing its risk. Net chargeoffs to average loans was 1.59 percent, compared to 3.29 percent in the second quarter of 2002. Return on average assets was 1.27 percent and return on equity was 14.47 percent. Assets on June 30 were $197.1 billion.
Mellon Financial Corp.: Reported second quarter operating income of $173 million, compared to $106 million for the second quarter last year. Net income was $175 million, compared to $109 million in the yearago quarter. Total non-interest revenue was $874 million, compared to $923 million in the second quarter of 2002; investment management fee revenue was $334 million in the quarter, compared to $355 million a year earlier. Return on equity was 19.5 percent, compared to 12.6 percent in 2002's second quarter. Assets on June 30 were $38.9 billion. Merrill Lynch: Reported second quarter 2003 net
earnings of $1.02 billion, compared to $634 million for the comparable quarter in 2002, an increase of 61 percent mainly due to strong bond trading, cutting costs and increasing profit margins. The earnings per diluted share were $1.05 compared to $0.66 in last years quarter. Noninterest expenses declined by 3.7 percent or $150 million in the quarter. The Global Markets and Investment Banking group produced quarterly pre-tax earnings of $1.11 billion, 72 percent over last years second quarter. Return on average common equity was 17.0 percent in the second quarter 2003, compared to 12.0 percent a year earlier.
Goldman Sachs : Reported second-quarter 2003

net earnings of $695 million, compared to $563 million for the comparable quarter in 2002, an increase of 23 percent resulting from solid operations from the Fixed Income, Currency and Commodities franchise. The earnings per diluted share were $1.36 compared to $1.06 in last years quarter. According to Goldman Sachs, Fixed Income, Currency and Commodities (FICC) produced quarterly net revenues of $1.59 billion, 39 percent over last years second quarter. Annualized return on average tangible shareholders equity was 18.7 percent, and annualized return on average shareholders equity 14.1 percent for second quarter 2003. Total capital as of May 30 was approximately $71.3 billion.
First quarter ended May 31, 2003
T H E
J.P. Morgan Chase & Co.: Boosted by bond trading and consumer banking, J.P. Morgan Chase reported operating earnings and net income of $1.8 billion in the second quarter, compared to operating earnings of $1.18 billion and net income of $1.0 billion a year earlier that included merger and restructuring costs. Operating
net income of $599 million, including a pre-tax asset impairment charge of $287 million from Morgan Stanleys aircraft financing business, compared to $797 million for the comparable quarter in 2002, a decrease of 25 percent. The earnings per diluted share were $0.55
S T A T E
O F
T H E
Morgan Stanley : Reported second quarter 2003
B A N K I N G
I N D U S T R Y
Q U A R T E R L Y
U P D A T E S
compared to $0.72 in last years quarter. Institutional Securities posted quarterly net income of $298 million, 33 percent below last years second quarter. The Fixed Income Sales & Trading net revenues increased yearover-year by 48 percent to $1.3 billion. Return on average common equity was 10.6 percent in the second quarter 2003, compared to 15.1 percent a year earlier. Total capital as of May 31, 2003 was $78.7 billion.
quarter. Net chargeoffs to average loans was 0.44 percent, compared to 0.62 percent in the second quarter of 2002. Return on average assets was 1.11 percent, compared to 1.29 percent in the same quarter last year, and return on equity was 14.95 percent, compared to 15.77 percent in 2002's second quarter. Assets on June 30 were $120.9 billion.
National City Corp.: Helped by a strong core

deposit, consumer loan and mortgage results, National City Corp. reported net income of $617 million for the second quarter, compared to $393 million for the same period a year earlier. Net interest income after provisions for loan losses was $919 million, compared to $806 million in 2002's second quarter, and fees and other income totaled $1.03 billion, compared to $729 million for the year-ago quarter. Return on assets was 2.08 percent, compared to 1.61 percent a year ago, and return on equity was 28.10 percent, compared to 19.98 percent for the second quarter of 2002. Assets on June 30 were $123.4 billion.
U.S. Bancorp: Reported second-quarter net income of $954 million, compared to $823 million a year ago. Net interest income in the second quarter was $1.81 billion, compared to $1.69 billion in the same quarter last year; non-interest income was $1.67 billion, compared to $1.44 billion in 2002's second quarter. Return on assets was 2.04 percent, compared to 1.95 a year earlier, while return on equity was 20.0 percent, compared to 20.0 percent in the second quarter of 2002. Assets on June 30 were $195 billion. Wachovia Corp.: Reported second-quarter net
income of $1.03 billion, compared to $849 million for the same quarter a year ago. Non-performing assets as a percentage of total loans was 1.04 percent for the quarter, compared to 1.24 percent a year earlier; chargeoffs were 0.43 percent, compared to 0.97 percent in the second quarter of 2002. Average core deposits were $179 billion during the second quarter, compared to $165 billion a year ago. Return on assets was 1.21 percent, compared to 1.09 percent in the year-ago quarter; return on equity was 12.78 percent, compared to 11.52 percent in the second quarter of 2002. Assets on June 30 were $364 billion.
B A N K I N G
State Street Corp.: State Street reported net loss of $23 million on revenue of $1.1 billion that included pre-tax restructuring charges of $292 million from its expense-reduction program, a $13 million pretax charge relating to an agreement to sell some real estate in suburban Boston and a $18 million pre-tax merger and integration cost related to the business it acquired from Deutsche Bank. State Street also finished a tax issue relating to its REIT with the Massachusetts Department of Revenue that produced a tax benefit of $13 million. For second quarter 2002, net income was $178 million, and revenue was $1.0 billion. Assets on June 30 were $83.1 billion. SunTrust Banks Inc .: SunTrust reported net
income of $330 million for the second quarter of 2003, compared to net income of $344 million for the second quarter of 2002. The bank holding company reported net interest income after loan loss provisions of $717 million, compared to $702 million in the year-ago
I N D U S T R Y
T H E
Washington Mutual Inc .: Boosted by branch growth and mortgage lending, Washington Mutual reported net income in 2003's second quarter of $1.02 billion, compared to $990 million for the same quarter a year ago. Net interest income after provisions for loan and lease losses was $1.91 billion for the quarter, compared to $1.94 billion in the second quarter of 2002. Wamu's non-interest income was $1.63 billion for the second quarter of 2003, compared to $1.21 billion a year earlier. Return on assets was 1.44 percent, compared to
S T A T E
O F
T H E
Q U A R T E R L Y
U P D A T E S
1.48 percent in 2002's second quarter, while return on equity was 19.25 percent, compared to 20.37 percent for the same quarter a year ago. Assets on June 30 were $283 billion.
moderately counteracted by lower West Indies revenue as a result of the change to equity accounting and lower trading revenue. Return on equity was 11.9 percent, compared to 8.0 percent in the year-ago quarter. Assets on April 30, 2003 were $280 billion.
Wells Fargo & Co.: With strong results in

consumer lending, Wells Fargo reported net income of $1.53 billion in the second quarter of 2003, compared to net income of $1.42 billion for the same quarter a year ago. Return on assets was 1.63 percent, compared to 1.83 percent a year ago, while return on equity was 19.60 percent, compared to 19.72 percent in 2002's second quarter. Net interest income after loan losses was $3.62 billion, compared to $3.23 billion a year earlier, while non-interest income was $2.71 billion in the second quarter, up from $2.38 billion in the second quarter of 2002. Assets on June 30 were $370 billion.
Royal Bank of Canada announced second

quarter record net income of $689 million compared to $710 million during the same period a year ago. Net income from U.S. acquisitions (RBC Centura, RBC Dain Rauscher and RBC Liberty Insurance) was $58 million. Total revenues dropped by 4 percent in the quarter to $3.75 billion from $3.91 billion in the second quarter of 2002, due to a net gain on credit derivatives that was recorded in last years second quarter, and a decline in revenue this quarter due to the appreciation of the Canadian dollar in comparison to the U.S. dollar. Interest income was $1.70 billion for the quarter down from prior years quarter of $1.72 billion. Return on equity was 15.4 percent, compared to 16.8 percent in the year-ago quarter. Assets on April 30, 2003 were $398 billion.
Canadian Bank Earnings* Bank of Montreal announced a second quarter

net income of $409 million compared to $301 million during the same period a year ago. Revenues for the quarter decreased by 1 percent over the second quarter of 2002 to $2.2 billion due to the fact that volume growth and improved net interest margins in Canadian retail and business banking were offset by the effects of low client transaction volumes in other operating groups and the weaker U.S. dollar. Net interest income after provision of credit losses was $1.09 billion. Return on equity was 15.2 percent, compared to 11.6 percent in the year-ago quarter. Assets on April 30, 2003 were $258 billion.
Scotiabank announced second quarter net income

of $596 million compared with $598 million during the same period a year ago. Revenues for the quarter were $2.57 billion compared to $2.77 billion in the second quarter of 2002. This decline mainly resulted from lower securities gains and foreign currency funding spread as well as the sales of Scotiabank Quilmes and the Banks merchant acquirer business last year. Net interest income was $1.54 billion compared to $1.65 billion in the prior years quarter. Return on equity was17.2 percent, compared to 18.3 percent in the year-ago quarter. Assets on April 30, 2003 were $292 billion.
CIBC announced a second quarter net income of $320

million compared to $227 million during the same period a year ago. Total revenues reported on a tax equivalent basis were $2.7 billion in the quarter. Net interest income rose to $1.36 billion in the second quarter of 2003 from $1.32 billion in the same quarter of 2002 due to increases in loan volume, residential mortgages and volume growth and improved spreads in cards and Presidents Choice Financial which were
T H E
TD Bank Financial Group reported a net income on operating cash basis loss of $146 million in the second quarter of 2003, compared to net income on an operating cash basis of $316 million in the same quarter of 2002 which reflects the steps the Bank is taking to restructure its wealth management business outside North America and the U.S. equity option arm of
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
Q U A R T E R L Y
U P D A T E S
its wholesale banking operation. Net interest income (TEB) grew from $1.37 billion in the second quarter of 2002 to $1.47 billion in this years second quarter. Return on equity on an operating cash basis was negative 6.0 percent, compared to 9.7 percent in the year-ago quarter. Assets on April 30, 2003 were $322 billion.
* Canadian financial information reported in Canadian currency. Second quarter ended April 30, 2003.
is the subject of the lease stripping transaction. The fact that parties that were unrelated up to and including the time of a transaction engage in that transaction in an attempt to arbitrarily shift income or deductions among themselves does not by itself evidence the type of control necessary to satisfy the acting in concert or with a common goal or purpose requirement of section 1.482-1(i)(4). The IRS also noted that it will challenge lease stripping transactions on other legal grounds. Rev. Rul. 2003-96 will appear in Internal Revenue Bulletin 2003-34, dated August 25, 2003. (KPMGs TaxNewsFlash, No. 2003-234, July 21, 2003) IRS Identifies Lease Stripping Transactions as "Listed Transactions" On July 21, 2003, the IRS released an advance copy of Notice 2003-55, relating to lease strips and other stripping transactions. With this notice, the IRS stated that transactions that are the same as or substantially similar to the lease strips described in the notice are "listed transactions" for purposes of the tax shelter regulations. Listed Transaction - The IRS concluded that lease strips improperly separate income from related deductions and generally do not produce the tax consequences desired by the participants. Therefore, transactions that are the same as, or substantially similar to, the lease strips described in Notice 2003-55 are "listed transactions" for purposes of Reg. sections 1.6011-4(b)(2), 301.6111-2(b)(2), and 301.6112-1(b)(2). Moreover, according to the notice, these transactions may already be subject to the disclosure requirements, the tax shelter registration requirements, or the list maintenance requirements under the regulations. Finally, the IRS warns that accuracyrelated penalties may be imposed on participants in lease strip transactions.
(Source: Company financial reports)
The information contained in this Earnings section was obtained from the individual company financial statements. KPMG LLP has not verified any information stated herein and does not endorse any of the numerical information provided.
Ta x a t i o n
IRS Rules Section 482 Cannot Be Used to Allocate Income, Deductions From Lease Stripping Transactions On July 21, 2003, the IRS released an advance copy of Rev. Rul. 2003-96, concerning whether the transfer pricing rules can be used to allow allocations of income and deductions under a lease stripping arrangement entered into among unrelated parties, under a plan promoted to realize tax benefits for one or more of the parties, solely on the basis that at the time the parties entered into the transaction, they had a common goal to shift income or deductions among themselves. The IRS ruled that under the facts presented, section 482 could not be used to allow the allocation of income and deductions arising from property that is the subject of a lease stripping transaction. According to the IRS, the facts in the revenue ruling: . . . described up to and including the time the income is stripped from the leases do not support the application of section 482 to allow the allocation among the parties of the income and deductions arising from the property that
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
Q U A R T E R L Y
U P D A T E S
The IRS further stated that it was currently evaluating other situations in which tax benefits are claimed as a result of transactions in which the ownership of property has been separated from the right to income from the property. For example, the IRS reported that it is evaluating situations in which, in exchange for consideration, one participant assigns its interest in property but retains the right to income from the property, and, by allocating all of its basis to the transferred property and none to the retained future payments, the transferor claims a loss on the transfer. Notice 2003-55 modifies and supersedes Notice 95-53, and will appear in Internal Revenue Bulletin 2003-34, dated August 25, 2003. (KPMGs TaxNewsFlash, No. 2003-233, July 21, 2003) Proposed Accounting Rules for REMIC Inducement Fees On July 18, 2003, the Treasury Department and IRS released proposed regulations (REG-162625-02) with accounting rules for taking into income any fees received to induce the acquisition of noneconomic residual interests in real estate mortgage investment conduits (REMICs). Under the proposed accounting rules, inducement fees would be taken into income over a period that is related to the period during which the applicable REMIC is expected to generate taxable income or net loss allocable to the holder of the noneconomic residual interest. In general, the proposed regulations: Provide that an inducement fee may not be taken into account in a single tax year, but must be included in income over a period that is reasonably related to the period during which the REMIC is expected to generate taxable income or net loss allocable to the holder of the noneconomic residual interest. Establish two safe harbor methods of accounting for inducement fees:
(1) A book method, under which the inducement fee is recognized for federal income tax purposes in the same amounts and over the same period in which that fee is included in income by the taxpayer for financial reporting purposes (provided that period is not shorter than the period over which the REMIC is expected to generate taxable income). (2) A method under which the inducement fee is recognized for federal income tax purposes ratably over the remaining anticipated weighted average life of the REMIC determined as of the time the noneconomic residual interest is transferred to the taxpayer. Provide a rule that applies if a holder of a residual interest sells or otherwise disposes of the residual interest. Include a rule clarifying that an inducement fee is income from sources within the United States. If the regulations are finalized as proposed, the timing for including inducement fees in income would apply for tax years ending on or after the publication of final regulations in the Federal Register. Comments are requested. The proposed rules also note that a taxpayer may not change its method of accounting for inducement fees without securing the prior consent of the Commissioner. Treasury and the IRS request comments as to how best to effect any change in method of accounting under these regulations. REG-162625-02 is scheduled to be published in the Federal Register, July 21, 2003. (KPMGs TaxNewsFlash, No. 2003-230, July 18, 2003)
I N D U S T R Y
T H E
S T A T E
O F
T H E
B A N K I N G
Q U A R T E R L Y
U P D A T E S
IRS Issues Guidance for REITs and Taxable REIT Subsidiaries On July 16, 2003, the IRS released the following guidance concerning real estate investment trusts (REITs): Rev. Rul. 2003-86 addresses whether a joint venture partnership between a taxable REIT subsidiary and a corporation that qualifies as an independent contractor of the REIT can provide noncustomary services to tenants of the REIT without causing the rents paid to the REIT to fail to qualify as rents from real property under section 856(d). Rev. Proc. 2003-66 describes the conditions under which payments to a REIT from a joint venture between a taxable REIT subsidiary and an unrelated third party for space at property owned by the REIT will be treated as rents from property under section 856(d). Rev. Rul. 2003-86 - Under the facts considered in the July 16th revenue ruling, the IRS ruled that the joint venture partnership between the unrelated independent contractor and the taxable REIT subsidiary may provide certain noncustomary services (primarily for the convenience of the REIT tenants) to such tenants without causing the related rents paid to the REIT to fail to qualify as rents from real property. Rev. Rul. 2003-86 will appear in Internal Revenue Bulletin 2003-32, dated August 11, 2003. Rev. Proc. 2003-66 provides the rules under which the IRS will treat rents from a qualifying joint venture as rents from real property, where the amounts paid to the REIT by the joint venture are substantially comparable to rents paid by other tenants at the REIT's property for comparable space and at least 90 percent of the leased space of the REIT's property is rented to persons other than (1) taxable REIT subsidiaries and (2) related parties as described in section 856(d)(2)(B). The revenue
procedure is effective for leases in effect or entered into on or after January 1, 2001, and will appear in Internal Revenue Bulletin 2003-33, dated August 18, 2003. (KPMGs TaxNewsFlash, No. 2003-223, July 16, 2003) IRS Establishes Safe Harbor for Loan by REIT to Be Treated as Real Estate Asset On July 11, 2003, the IRS released an advance copy of Rev. Proc. 2003-65, establishing a safe harbor for a loan made by a real estate investment trust (REIT) to be treated as a real estate asset for purposes of sections 856(c)(4)(A) and 856(c)(5)(B), even though the loan is not directly secured by a mortgage on real property. In addition, if the criteria for the safe harbor are satisfied, the IRS states that interest on such loans will be treated as interest on an obligation secured by a mortgage on real property or on an interest in real property for purposes of section 856(c)(3)(B). Background - Many REITs invest in real estate by making loans that are secured by real property. In certain cases, because of financing arrangements and restrictive loan covenants, REITs make loans to the owners of entities that hold real property, instead of making loans that are secured directly by real property. The loans are secured by a pledge of the borrowers' ownership interests in the property-owning entities. Section 856, however, requires that certain tests must be met for the entity to qualify as a REIT. These tests include requirements that: 75 percent of the value of the REIT's total assets is represented by real estate assets (including mortgages on real property), cash and cash items, and government securities. 75 percent of the REIT's gross income is derived from certain items including interest on obligations secured by mortgages on real property or on interests in real property.
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
Q U A R T E R L Y
U P D A T E S
Rev. Proc. 2003-65 - With the July 11th revenue procedure, the IRS provides a safe harbor for treating a loan as a qualified real estate asset under the REIT qualification rules, even though the loan is not directly secured by a mortgage on real property. To qualify for the safe harbor, the following requirements must be met: The borrower is either a partner or a partnership, or the sole member of an eligible entity that has not elected to be treated as a corporation for federal tax purposes (and therefore is disregarded as an entity separate from its owner). The loan is nonrecourse. The lender has a first priority security interest in the pledged ownership interest. On default and foreclosure of the secured loan, the lender will replace the borrower as a partner in the partnership or as the sole member of the disregarded entity. On the date that the lender's commitment to make the loan is binding, the partnership or disregarded entity holds real property and if any of this property is sold or transferred, the loan is immediately due and payable. On each testing date, the value of the subject real property is at least 85 percent of the value of all of the assets of the partnership or disregarded entity. The loan value of the real property owned by the partnership or disregarded entity equals or exceeds the amount of the loan as determined under Reg. section 1.856-5(c)(2). Interest on the loan includes only an amount that constitutes compensation for the use or forbearance of money. A loan that satisfies these eight requirements will be treated as a real estate asset for purposes of sections 856(c)(4)(A) and 856(c)(5)(B), and the interest on the loan will be treated as interest on an obligation secured
by a mortgage on real property or on an interest in real property for purposes of section 856(c)(3)(B). Rev. Proc. 2003-65 is effective August 11, 2003, and will appear in Internal Revenue Bulletin 2003-32, dated August 11, 2003. (KPMGs TaxNewsFlash, No. 2003-219, July 11, 2003) Final IRS Guidance on Withholding Rules for Foreign Partnerships and Foreign Trusts On July 10, 2003, the IRS issued Rev. Proc. 2003-64, concerning the withholding and reporting obligations for payments of income made to foreign partnerships and foreign simple or grantor trusts. The IRS stated that the purpose of this guidance is to simplify these withholding and reporting obligations. Accordingly, Rev. Proc. 2003-64: Provides final withholding foreign partnership (WP) and withholding foreign trust (WT) agreements, as described in Reg. section 1.1441-5(c)(2)(ii) and (e)(5)(v), and the application procedures for entering into such agreements. Amends the Qualified Intermediary (QI) withholding agreement of Rev. Proc. 2000-12 by including new section 4A -i.e., additional rules for QIs for withholding and reporting on certain small or related foreign partnerships and foreign simple or grantor trusts that do not enter into WP or WT agreements. Similar rules are part of the final WP and WT agreements. Rev. Proc. 2003-64 provides that a WP or WT agreement entered into during a calendar year may be made effective as of the first day of that calendar year. Therefore, a QI may apply the provisions of section 4A as of the beginning of the 2003 calendar year. Background - In Notice 2001-4, the IRS provided important transitional relief and guidance related to the section 1441 regulations (as amended in May 2000) for foreign partnerships for calendar year 2001 (see KPMGs TaxNewsFlash 2000-207). The transitional relief was extended through calendar year 2002.
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
Q U A R T E R L Y
U P D A T E S
In Notice 2002-41, the IRS proposed WP and WT agreements with streamlined procedures designed to simplify documentation and reporting (see KPMGs TaxNewsFlash 2002-120). As proposed, a WP or WT was to provide the withholding agent with a Form W-8IMY as a WP or WT without attached documentation from partners, beneficiaries, or owners. The WP or WT would receive gross payments from the withholding agent, and then withhold and deposit tax (if any) based on the Forms W-8 or W-9 received from the partners, beneficiaries, or owners. The WP or WT would report payments to, and tax withheld from, its direct foreign partners, beneficiaries, or owners on Form 1042S on an individual basis or, by election, on a pooled basis. Thus, a WP or WT would be relieved of having to disclose to a withholding agent any documentation and payment information for partners, beneficiaries, or owners. A withholding agent would be relieved of the responsibility for collecting documentation, withholding, and reporting payment information for partners, beneficiaries, or owners of a WP or WT. Rev. Proc. 2003-64 - According to the July 10th revenue procedure, no further extensions of the transitional relief for foreign partnerships are required. With respect to the documentation and reporting relief for foreign simple and grantor trusts, comprehensive guidance is included in the revenue procedure; however, for the year 2003, a QI may apply the earlier rules of Notice 2001-4 or the rules of this revenue procedure. Concerning WP and WT agreements, several provisions of the WP and WT agreements have been amended, and a new set of provisions for certain smaller foreign partnerships and trusts and for certain foreign partnerships and trusts that are related to a QI, WP, or WT have been developed. Other changes concern the:: Term of the Agreement: The six-year renewable term is still available, but the WP or WT may elect to use a longer non-renewable term of up to 15 years. Automatic Termination: The final WP or WT agreements (1) extend the date for curing
documentation failures from January 31 to March 15 and (2) add an alternative method for curing failure. Withholding on Distributions: The WP or WT may compute the amount of withholding on a distribution by using a reasonable estimate of the partner, beneficiary, or owner's distributive share of income subject to withholding for the year. Application to Direct Partners, Beneficiaries, or Owner: The final WP and WT agreements contain two new provisions for application to indirect partners, beneficiaries, or owners (1) that are small partnerships and trusts (streamlined rules similar to the U.S. rules for joint account holders) and (2) that are partnerships or trusts that are related to the WP or WT (rules similar to those for private arrangement intermediaries (PAIs) under the QI agreement) Frequency of Audit: The WP and WT agreements have been amended to conform the audit cycle for the six-year agreement to the audit cycle under the QI agreement. If the WP or WT elects pooled reporting and a six-year term, it must agree to have the external auditor conduct an audit of the second and fifth full calendar year that the agreement is in effect. The twoyear audit cycle is retained for a WP or WT that elects pooled reporting and a non-renewable term of up to 15 years. Yet, for the most part, the final WP and WT agreements are substantially the same as originally proposed in Notice 2002-41. For example, the WP and WT agreements continue to require payments to partners, beneficiaries, or owners to be documented solely with Forms W-8 and W-9 and do not permit reliance on the presumption rules. Rev. Proc. 2003-64 also includes new rules for: A small foreign partnership or simple or grantor trust that is an account holder of a QI. A foreign partnership or trust that is related to a QI, WP, or WT to provide information necessary for the QI, WP, or WT to withhold and report on reportable amounts.
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
10
Q U A R T E R L Y
U P D A T E S
Rev. Proc. 2003-64 is effective, July 10, 2003, and will appear in Internal Revenue Bulletin 2002-32, dated August 11, 2003. (KPMGs TaxNewsFlash, No. 2003-217, July10, 2003) New Regulations Governing Section 338(h)(10) Elections and Multi-Step Transactions A Brave New World On July 8, 2003, the Treasury Department and IRS released an advance copy of final and temporary regulations (T.D. 9071) and, by cross reference, proposed regulations (REG-143679-02), giving effect to section 338(h)(10) elections in certain multi-step transactions as contemplated by Rev. Rul. 2001-46. The regulations provide that the step-transaction doctrine will not be applied if a taxpayer makes a valid section 338(h)(10) election with respect to a step in a multi-step transaction, even if the transaction would otherwise qualify as a reorganization, if the step, viewed independently, is a qualified stock purchase. Background - Rev. Rul. 2001-46 applied the steptransaction doctrine to treat a series of transactions occurring pursuant to a single plan - encompassing a first step acquisition merger of a subsidiary of Acquiring into Target that would otherwise constitute a qualified stock purchase, followed by a second step upstream merger of Target into Acquiring - as a single statutory merger of Target into Acquiring (see KPMGs TaxNewsFlash 2001-187). Final and Temporary Regulations - As contemplated by Rev. Rul. 2001-46, the July 8th release adopts new final and temporary regulations to give effect to section 338(h)(10) elections in multi-step transactions where the purchasing corporation's acquisition of the target's stock, viewed independently, constitutes a qualified stock purchase. The regulations provide that if a section 338(h)(10) election is made in these circumstances, the purchasing
corporation's acquisition of target's stock will be treated as a qualified stock purchase for all federal tax purposes, even if the overall transaction would be integrated and treated as a single reorganization qualifying under section 368(a) in the absence of a section 338(h)(10) election. Effective Date - The final and temporary regulations are applicable to acquisitions of stock occurring on or after the date of publication of the regulations in the Federal Register (scheduled to be July 9, 2003). KPMG Observation - The regulations provide taxpayers flexibility in structuring and planning the tax consequences of an acquisition, and represent a novel approach by the Treasury in which tax-free reorganization treatment is, in certain circumstances, elective. One may wonder if this may be an initial foray into a check-the-box regime for tax-free reorganization treatment. (KPMGs TaxNewsFlash, No. 2003-214, July 8, 2003)
For electronic versions of the releases mentioned above or for additional tax-related information, see KPMGs TaxNewsFlash publications at www.kpmgtax.com.
Re g u l a t i o n
FinCEN and the SEC issued joint final rules that require broker-dealers and mutual funds to take steps to verify the identities of their customers. They became effective on June 9. These institutions must fully implement their customer identification programs (CIPs) by October 1. These rules were issued concurrently with other final regulations affecting banks, savings associations, credit unions, and certain non-federally regulated banks, as well as futures commission merchants and introducing brokers. Collectively, the rules are intended to be uniform throughout the financial services industry. FinCEN and the SEC collaborated on the broker-dealer and mutual fund CIP rules, which are intended to implement Section 326 of the United and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA
I N D U S T R Y
11
T H E
S T A T E
O F
T H E
B A N K I N G
Q U A R T E R L Y
U P D A T E S
PATRIOT Act). They aim to strengthen ongoing efforts by these agencies to prevent, detect and prosecute money laundering and the financing of terrorism. FinCEN issued a notice of proposed rulemaking that would amend Bank Secrecy Act (BSA) rules to add futures commission merchants and introducing brokers in commodities to the regulatory definition of financial institution, and require that they report suspicious transactions to FinCEN. These institutions are considered at risk for certain money laundering activities due to their respective business activities and importance in the global economy. The proposal is intended to implement provisions of the BSA in order to further the efforts of Treasury and other financial regulators to prevent, detect and prosecute money laundering and the financing of terrorism. In developing the proposed and amended rules, FinCEN consulted extensively with the Chicago Futures Trading Commission, which, with designated self regulatory organizations, would be responsible for oversight and enforcement of the rules. The changes would become effective 180 days after the final version of the rule is adopted. The SEC, New York Attorney General, North American Securities Administrators Association, NASD, NYSE, and state securities regulators jointly announced the finalization of an approximate $1.4 billion settlement with ten large broker-dealers, in connection with allegations of conflicts of interest between research and investment banking interests at these firms, supervisory deficiencies and allegations of spinning. The action represents finalization of the so-called global settlement that was reached in principle in December 2002. The terms require payments of penalties, disgorgement and funds for independent research and investment education, as well as significant structural reforms to increase the integrity of equity research. The SEC, the Board of Governors of the Federal Reserve System (Fed), and the Office of the Comptroller of the Currency (OCC), in cooperation with the Federal Reserve Bank of New York, issued an Interagency Paper
on Sound Practices to Strengthen the Resilience of the U.S. Financial System. The paper identifies three new business continuity objectives that are of special importance to financial institutions in the postSeptember 11 environment, and four sound practices which are intended to strengthen the resilience of critical U.S. financial markets by minimizing the immediate systemic effects of a wide-scale disruption. The paper applies most directly to core clearing and settlement organizations and firms that play significant roles in critical financial markets. The agencies expect these institutions to adopt the sound practices discussed in the paper within designated time frames. The SEC issued a notice that it approved an order to extend the temporary exemption of banks, savings associations and savings banks from the definitions of broker under Section 3(a)(4) of the Securities and Exchange Act of 1934 (Exchange Act) until November 12, 2004. The SEC adopted an amendment to Rule 15c3-3(b)(3) under the Exchange Act, which provides that brokerdealers must provide full collateral consisting of certain specified financial instruments or cash when they borrow fully paid and excess margin securities from customers. The rule change will allow firms to pledge other collateral as the SEC designates as permissible by order of the SECs Division of Market Regulation. The change became effective on April 16. The SEC issued an interpretive release regarding its books and records regulations (Rules 17a-3 and 17a-4 under the Exchange Act) in order to clarify certain issues raised by industry participants. Amendments to these rules, which were adopted on October 26, 2001, recently became effective on May 2. The interpretation became effective on May 29. NASD announced a proposal to amend Rule 3010 to require the Chief Executive Officer and Chief Compliance Officer of each member firm to make annual, joint certifications regarding the adequacy of
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
12
Q U A R T E R L Y
U P D A T E S
the firms compliance and supervisory procedures. NASD also proposed the adoption of related interpretive material to describe the purpose of the proposed rule and provide clarification regarding the obligations and liabilities associated with the certification requirement. The SEC requested public comment on a petition filed by The Nasdaq Stock Market, Inc., relative to trading in Nasdaq-listed securities. Nasdaq has asked the SEC to take multiple actions in order to address unequal and inadequate regulation by various national and regional exchanges that trade these securities. NASD established a one-time global extension for all firms subject to the requirement to complete a self-assessment of front-end load mutual fund transactions. This review was required in connection with recent regulatory, Congressional and industry attention to potential problems in this area.
Sources: KPMGs Compliance & Regulatory Focus, April-July 2003; KPMGs Washington Report, March-July 2003. Federal Register and Web sites of the issuing agencies including: www.treas.gov/fincen, www.sec.gov, www.nasd.com, www.nyse.com, www.nasaa.org and www.gao.gov.
committee that would include the Treasury secretary as chairman, the chairman of the Board of Governors of the Federal Reserve System, the comptroller of the currency, the chairman of the Federal Deposit Insurance Corporation, and the chairman of the Office of Thrift Supervision. The Financial Policy Committee would be responsible for constructing uniform United States positions on proposals made to, and issues before, the Basel Committee on Banking Supervision that may affect U.S. financial institutions. If the bill passed tomorrow, it would force regulators to form a uniform policy on the Basel II accord. According to a committee press release, several members of the Committee questioned the wisdom of making operational risk a mandatory capital charge under Pillar I of the Basel Accord a provision which is included under the current Basel proposal. Several members also expressed their desire for continued Congressional oversight of the Basel process. The House Committee on Financial Services has yet to schedule a markup on the bill. Further, there is no companion legislation in the Senate as of yet. The text of H.R. 2043 is available on the Library of Congress Web site. (KPMGs Washington Report, July 21, 2003) FACT Act Passes House Financial Services Committee
I N D U S T R Y
KPMG hosts Regulatory Perspectives, a quarterly teleconference briefing for clients on important legislative and regulatory activities specific to the financial services industry. For more information about Regulatory Perspectives, or to register for future teleconferences, please send an e-mail to kwall@kpmg.com. The e-mail should include your name, title, company name, and your e-mail address. You will be notified via e-mail regarding future teleconferences.
Legislation
Basel Bill Passes House Subcommittee The House Financial Services Subcommittee on Financial Institutions passes H.R. 2043, the United States Financial Policy Committee For Fair Capital Standards Act, by voice vote on July 16. The bill would create an interagency financial policy The House Committee on Financial Services passed H.R. 2622, the Fair and Accurate Credit Transactions Act (FACT), by a 61-3 vote. H.R. 2622 would renew preemption provisions in the Fair Credit Reporting Act (FCRA) that allow financial and retail firms to share certain customer data among their affiliates. These provisions are set to expire on January 1, 2004. The bill also strengthens rules to fight identity theft. The Committee passed a number of amendments to the bill
13
T H E
S T A T E
O F
T H E
B A N K I N G
Q U A R T E R L Y
U P D A T E S
that would: Require consumer reporting agencies to employ a fraud alert system to help victims of identity theft to ensure that credit is not extended to identity thieves. Ban businesses from sharing negative information about a consumer if they have received a copy of a police report indicating an illegal transaction following an identity theft. Require the General Accounting Office to conduct a study on the role of race and gender in the credit granting process. Require credit bureaus to notify users of consumer reports when discrepancies exist in connection with addresses. Require federal bank regulators to issue guidance on how lenders should treat credit reports when there is confusion about a consumers address. Ban the passing on of consumer information to credit bureaus if the information furnisher has substantial doubts about the accuracy of the information. Permit consumers to reinvestigate consumer disputes directly through resellers of credit reporting information. Define a fraud alert as a statement that notified users of the file that the consumer does not want credit offered without permission through a preauthorized procedure. The fraud alert system created by the bill is composed of three tiers: an initial alert; an extended alert; and a special military alert. When a consumer reporting agency creates an alert, it would automatically be communicated to other consumer reporting agencies and would exclude the consumer from pre-screened offers of credit or insurance. Further, no user of a consumer report with a fraud alert in it may issue or extend credit in the name of the consumer to a
I N D U S T R Y
person other than the consumer without first attempting to obtain the authorization or preauthorization of the consumer in the manner contained in the fraud alert. The FACT Act now heads to the House Floor for consideration. Congressman Oxley (R-OH), Chairman of the House Committee on Financial Services, would like the House to complete action on the bill before the end of September. Congressman Frank (D-MA) predicted the bill would pass the Senate before January 1, 2004. The text of H.R. 2622 is available on the Library of Congress Web site at http://thomas.loc.gov. (KPMGs Washington Report, July 28, 2003)
To subscribe to KPMGs regulatory and legislative reports, please send an e-mail message to fsregpubs@kpmg.com for any of the following publications: Washington Reports Regulatory Practice Letters Legislative Practice Letters Compliance and Regulatory Focus These reports can also be accessed through KPMGs Web site at www.us.kpmg.com (Financial Services industry). Back issues may be obtained by sending an e-mail message to pajones@kpmg.com.
Accounting Standards and Developments

Financial Accounting Standards Board (FASB) The FASB has issued for public comment an Exposure Draft, Qualifying Special-Purpose Entities and Isolation of Transferred Assets, which would amend FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. The purpose of the proposal is to provide more specific guidance on the accounting for transfers of financial assets from a company to an off-balance sheet structure known as a qualifying special-purpose entity (QSPE). The Boards objective is to improve the accounting for
T H E
S T A T E
O F
T H E
B A N K I N G
14
Q U A R T E R L Y
U P D A T E S
QSPEs in several key respects. First, it would prohibit an entity from being a QSPE if a company that transfers assets to the entity enters into a commitment (such as a financial guarantee, liquidity commitment or total return swap) to provide additional cash or other assets to fulfill the QSPEs obligations to its beneficial interest holders. Second, if an entity can reissue beneficial interests, the proposed Statement would prohibit that entity from being a QSPE if any party involved with the entity has certain risks or combinations of risks and decisionmaking abilities. Third, the proposed Statement would prohibit an entity from being a QSPE if it holds equity instruments, such as shares or partnership interests. Finally, the proposed Statement would clarify certain of the requirements in Statement 140 related to legally isolating assets and surrendering control of assets. The comment period ends July 31, 2003. FASB has issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The Statement improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. The new Statement requires that those instruments be classified as liabilities (or, in certain circumstances, as assets) in statements of financial position. Statement 150 affects the issuers accounting for mandatorily redeemable shares that the issuing company is obligated to buy back in exchange for cash or other assets, instruments that do or may require issuers to buy back shares in exchange for cash or other assets, and obligations that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the value of the issuers shares. Statement 150 does not apply to features embedded in a financial instrument that is not a derivative in its entirety. Most of the guidance in Statement 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003,
except that for private companies, mandatorily redeemable financial instruments are subject to the provisions of this Statement for the fiscal period beginning after December 15, 2003. FASB issued Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The Statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. The amendments set forth in Statement 149 are intended to improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. In particular, this Statement: (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative as discussed in paragraph 6(b) of Statement 133; (2) clarifies when a derivative contains a financing component; (3) clarifies the definition of an underlying to conform it to language used in FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others; and (4) amends certain other existing pronouncements. In addition to other changes, this Statement: Removes from the scope of Statement 133 contracts for the purchase or sale of securities referred to as when-issued securities or other securities that do not yet exist if the contracts meet all three criteria in paragraph 59(a) of Statement 133. Significantly modifies DIG Issue C13 by excluding from the exemption from Statement 133, as well as from the automatic inclusion, commitments to purchase loans. Holders and issuers of commitments to purchase loans now will need to evaluate the terms of the contracts to conclude whether they otherwise meet the characteristics of a derivative.
15
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
Q U A R T E R L Y
U P D A T E S
Clarifies the use of the short-cut method by requiring that the interest rate swap has a fair value of zero at inception of the hedging relationship if the hedging instrument is solely an interest rate swap. If the hedging instrument is a compound derivative, that is when the hedged item is callable, the premium for the mirror-image call option compounded with the swap must be paid or received in the same manner as the premium on the call option embedded in the hedged item. Clarifies the accounting for option-based contracts used as hedging instruments in a cash flow hedge of the variability of the functional-currency-equivalent cash flows for a recognized foreign-currencydenominated asset or liability that is remeasured at spot exchange rates. Clarifies those financial guarantee contracts within the scope exception. This Statement is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. The guidance should be applied prospectively. The provisions of this Statement that relate to Statement 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to existing contracts as well as new contracts entered into after June 30, 2003. The FASB decided on April 22, 2003 to require all companies to expense the value of employee stock options. Companies will be required to measure the cost according to the fair value of the options. At the May 7, 2003 Board meeting, the Board decided that: (1) compensation cost would be recognized over
the service period; (2) stock-based compensation awards would be accounted for using the modified grant-date measurement approach in FASB Statement No. 123, Accounting for Stock-Based Compensation; therefore, compensation cost would be adjusted to reflect actual forfeitures and outcomes of performance conditions; (3) the method of attribution would be consistent with the approach presented in Statement 123 which requires attribution over the period the employee provides the service; and (4) for awards with service conditions, an enterprise would base accruals of compensation cost on the best available estimate of the number of equity instruments that are expected to vest and to revise that estimate, if necessary, if subsequent information indicates that actual forfeitures are likely to differ from initial estimates. Securities and Exchange Commission (SEC) Companies will be delisted if they fail to comply with the audit committee requirements of the Sarbanes-Oxley Act and implementing SEC regulations, according to a recent release that mandates changes in the listing standards. The release contains new audit committee requirements; conforming provisions by the national securities exchanges and the national securities association must be approved by the SEC by December 1, 2003; and listed issuers other than small-business and foreign-private issuers must be in compliance with the new provisions by the date of their first shareholders meeting after January 15, 2004, but in any event no later than October 31, 2004. Foreign-private and smallbusiness issuers are given more time. The exchanges and securities association will be obligated to delist companies that are not in compliance with several sets of requirements and do not successfully cure violations. The requirements cover audit committees independence; responsibilities with respect to public accounting firms; procedures for handling complaints on auditing, accounting, and control matters; authority to engage independent counsel and other advisors; and funding.
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
16
Q U A R T E R L Y
U P D A T E S
The SEC has released final rules governing managements report on internal control over financial reporting and revisions to certifications of disclosure in Exchange Act periodic reports. The rules pertaining to Section 302 and Section 906 certifications, including changes relative to registered investment companies, become effective on August 14, 2003 (the due date for June 30, 2003 quarterly filings). The Commission staff has indicated their intent to apply the revised Section 302 certification to all quarterly filings for the quarter ended June 30, 2003, regardless of the date actually filed. Section 302 certifications may temporarily omit certain references to internal control over financial reporting until the compliance date for managements report on internal control over financial reporting. Managements report on internal control over financial reporting will be required by issuers, other than foreign private issuers, that meet the definition of an accelerated filer in Exchange Act Rule 12b-2, for fiscal years ending on or after June 15, 2004 (December 31, 2004, for calendar-year accelerated filers). Accelerated filers are generally U.S. companies that have public float over $75 million and have filed an annual report with the Commission. All other issuers, including small-business and foreign-private issuers, will be required to comply with the requirements of Section 404 for their fiscal years ending on or after April 15, 2005 (December 31, 2005, for calendar-year issuers). Voluntary early compliance is permitted. On April 24, 2003, the SEC voted to require that reports by insiders disclosing their securities holdings be filed electronically with the SEC. The Commission also voted to adopt rules prohibiting company officials from improperly influencing auditors of financial statements. These new rules and amendments will become effective on June 30, 2003.
American Institute of Certified Public Accountants (AICPA) The AICPAs Accounting Standards Executive Committee has issued an exposure draft of a proposed Statement of Position (SOP), Allowance for Credit Losses. The proposed SOP addresses the recognition and measurement by creditors of the allowance for credit losses related to all loans, as that term is defined in FASB Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, with certain exceptions. The proposed SOP would apply to all creditors other than state and local governmental entities and federal governmental entities. The provisions of the proposed SOP would be effective for financial statements for fiscal years beginning after December 15, 2003, with earlier application permitted. The effect of initially applying the provisions of the proposed SOP would be reported as a change in accounting estimate. Federal Financial Institutions Examination Council (FFIEC) James E. Gilleran, Director of the Office of Thrift Supervision, has been named Chairman of the FFIEC for a two-year term beginning April l, 2003. Director Gilleran succeeds Donald E. Powell, Chairman of the Federal Deposit Insurance Corporation. The Council also named NCUA Chairman Dennis Dollar, as its new Vice Chairman. The FFIEC announced several appointments to its State Liaison Committee. The Council has appointed Richard C. Houseworth, Superintendent of Banks, Arizona, to fill the vacancy created by the resignation of Elizabeth McCaul, former Superintendent of Banking, New York. The National Association of State Credit Union Supervisors appoints Jerrie J. Lattimore, Credit Union Division, North Carolina Commerce Department to the Committee to replace Iowa Superintendent of Credit Unions James E. Forney. The American Council of State
17
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
Q U A R T E R L Y
U P D A T E S
Savings Supervisors has appointed Jonathan Smith, Review Examiner, State Banking Department, Delaware, to replace Texas Savings & Loan Commissioner James L. Pledger.
(Sources: FASB, SEC, AICPA, and FFIEC Websites)
KPMGs Audit Committee Institute (ACI) has been serving audit committee members, interacting with thousands of directors and officers, since its inception two years ago. ACIs initiatives include semiannual roundtables, conference and board presentations, a tollfree hotline, the Audit Committee Quarterly Update, periodic distribution of time-sensitive information and its Web site. ACI has received positive feedback from directors and officers who have used the Web site, which is dedicated to providing tools to meet the needs of audit committee members. ACIs Web site address is http://www.us.kpmg.com/auditcommittee. ACI can be reached at 877KPMG-ACI (877-576-4224) or via e-mail at auditcommittee@kpmg.com.
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
18
M A R K E T
F O R C E S
Broker/Dealers
Thomson Financial announced on June 4th the introduction of a suite of brokerage solutions designed to add transparency to the research process and facilitate broker compliance with the recently announced Global Analyst Settlement. The solutions, which can be grouped together and customized to meet individual requirements, include the newly created Thomson proprietary In Context reports that are designed to educate individual investors and add context to brokerage and boutique research, broker infrastructure outsourcing opportunities and Thomsons independent analyst rankings and monitoring services. (Thomson press release, June 4, 2003) On May 13th, Charles Schwab & Co., Inc. announced public disclosure of performance reporting on all its stock ratings. The company launched its Schwab Equity Ratings on May 6, 2002, and with one year of performance data available the public can now have access to the performance of Schwabs equity ratings during rolling 52-week periods through the companys Web site. A survey sponsored by Schwab found that the majority of those polled want objective research combined with performance information. According to the results of the survey, research conducted by independent research firms is more valuable than research conducted by Wall Street firms that are financially tied to the companies they evaluate. Also, the majority surveyed said they would like to know how well stock analysts recommendations compare to subsequent stock performance. (Charles Schwab & Co., Inc. press release, May 13, 2003) Charles Schwabs newly launched Charles Schwab Bank has entered into the home mortgage loan area for clients and clients of independent investment advisors. Responding to consumers requests for greater transparency in mortgage rates and terms, the bank is offering three guarantees. First, Schwab will top any competitors price by $100 or will give homebuyers $500 ($750 in California) if they choose another lender.
Second, the bank will approve a loan decision within 24 hours or pay consumers $250. Third, if it does not meet the designated closing dates, Schwab will lower a consumers interest rate by 1/8 of one percent for the life of the loan. (Charles Schwab press release, April 28, 2003) With the launch of its Mortgage on the Move program, E*TRADE Mortgage will allow its consumers to lock into current low portable home mortgage rates that they may later transfer to the next home they buy in the future. Rather than paying off an existing loan and applying for a new loan, the program allows the borrower to transfer the terms of the loan to the new residence, thus potentially saving a considerable amount of money in interest. This program is available for a limited time to U.S. borrowers. (E*TRADE Financial press release, June 9, 2003)
C o n s o l i d a t i o n a n d C o nv e r g e n c e
While merger and acquisition deal value improved in the banking and thrift and securities and investments sectors during the first quarter of 2003 with a few major deal announcements, overall the number of new deals announced declined from the fourth quarter of 2002. The volume by total deal value for banks and thrifts increased by 240.5 percent to $5.4 billion from the fourth quarter 2002, however, the number of deal announcements fell by 6.3 percent to 45 from 48 in the prior quarter. Deal value for securities and investment increased considerably to $3.8 billion with the Bank of New York Co.s agreement to acquire Pershing from Credit Suisse, and Wachovia Corp.s and Prudential Financial Inc.s agreement to merge retail brokerage operations. The number of deal announcements declined 17 percent to 30 from the last quarter. In the insurance sector the number of deals announced declined by 33 percent to 55 from 82 in the fourth quarter 2002. Deal value was also down 68 percent to $647.7 million from $2.0 billion last quarter. (SNL Financial press release, April 9, 2003)
19
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
M A R K E T
F O R C E S
An agreement was announced on May 30, 2003 in which Bank One Corporation would acquire most of Zurich Life, a large U.S. life insurance group, from Zurich Financial Services Group. According to Bank One the acquisition will provide the opportunity to leverage Zurich Lifes distribution channel and its capability to manufacture high quality life insurance and annuity products. Pending regulatory approval, Bank One will pay Zurich approximately USD 500 million in cash. Zurich is retaining Kemper Investors Life Insurance Co. Bank One will provide administration and assume through reinsurance certain lines of business now underwritten by Kemper Investors Life Insurance Company. (Bank One and Zurich press releases, May 30, 2003) Swiss Re, Deutsche Bank and Sal. Oppenheim are jointly acquiring 90 percent of credit insurer Gerling NCM Credit and Finance AG in a transaction that is expected to close this summer. The deal, which includes a EUR 120 million cash payment from Deutsche Bank and EUR 60 million in cash from Swiss Re, will reduce Gerlings stake in the company from 55.9 percent to 3.04 percent. When the transaction is complete, Swiss Re will own 47.5 percent of Gerling NCM and Deutsche Bank, 35.2 percent. Sal. Oppenheim and Gerling NCM pension trust will own 7.0 percent and 7.1 percent respectively. (Swiss Re press release, May 7, 2003)
I N D U S T R Y
On June 23rd, John Manley, Canadas Deputy Prime Minister and Minister of Finance, tabled the Federal Governments response to the recommendations of the House of Commons Standing Committee on Finance and the Standing Senate Committee on Banking, Trade and Commerce on the public interest considerations in reviewing merger proposals among large financial institutions. According to Minister Manley the work done by the committees raised broader issues regarding the sectors future that need to be addressed. He indicated that a policy framework is needed, given the importance of financial services to Canadas competitive advantage, to allow the sector to play a significant role in the countrys economic growth. The Governments response has three elements: It sets out new public interest considerations for large bank mergers. The merging financial institutions need to demonstrate how the merger will support longterm growth and the creation of high quality jobs. Also, the institutions would be required to demonstrate that small and medium-sized businesses and individual Canadians would continue to have access to a wide range of financial products and services. It reviews broader issues such as the restriction on cross pillar mergers, the need for structural guidelines, the process for assessing multiple merger proposals in order to eliminate the first mover advantage, and measures to ensure robust competition in the sector. It sets out a clear timetable for future developments related to the financial sector. Comments will be accepted until December 31, 2003. The Government will release its policies on the issues and revised merger review guidelines by June 30, 2004, after which there will be a three-month transition period until September 30, 2004 to provide institutions with a reasonable period to position them in the new environment. Until these steps have been completed, the Government will not accept nor consider mergers involving large financial institutions (including
T H E
Thomson Financial announced the launch of its Thomson Deals, which is a component of Thomson ONE Banker. This web-based interface resource will initially provide in-depth, timely M&A data, and over the next year, will expand to provide deal data across five distinct asset classes including Capital Markets New Issues data, Project Finance and Venture Economics, according to Thomson Financial. The M&A component of Thomson Deals will offer access to more than 400,000 M&A deal records from the last 30 years of market activity worldwide and allows users to select the deal data, custom rankings and league tables from over 700 search criteria. (Thomson Financial press release, April 28, 2003
S T A T E
O F
T H E
B A N K I N G
20
M A R K E T
F O R C E S
commercial or investment banks, trust companies, brokerage houses, insurance companies or credit unions that participate in financial transactions involving cash or financial products, normally in the role of intermediary). (Department of Finance Canada press release, June 23, 2003) RBC Mortgage Company and Bank One Corporation announced an agreement for RBC Mortgage to acquire the banks wholesale first mortgage and broker homeequity origination capabilities. The transaction, for which terms have not been disclosed, is expected to be completed in summer 2003. Bank One has decided to exit the wholesale first mortgage and broker homeequity businesses to focus on direct consumer residential lending. With this acquisition, RBC anticipates more than doubling its wholesale loan volume at the same time that it hopes to grow a national home equity business. (RBC Financial Group and Bank One press releases, May 28, 2003) Royal Bank of Canadas RBC Insurance unit completed an acquisition of certain assets of Business Mens Assurance Co. of America, including its in-force block of about 135,000 traditional life insurance policies and annuities, from Italys Generali Group for approximately USD 210 million in May. BMA becomes a subsidiary of RBC Liberty Life Insurance, and will relocate its life and annuity operations from Kansas City to RBC Libertys headquarters in Greenville, South Carolina, where it will operate under the name of RBC Insurance. RBCs marketing functions will remain in Kansas City. (RBC Financial Group press release, May 1, 2003) As part of a strategy to focus on its three home markets the Netherlands, the Midwest U.S., and Brazil ABN AMRO announced that its Brazilian subsidiary, Banco ABN AMRO Real, would acquire Banca Intesas 94.57 percent stake in Banco Sudameris. Located in the southeast, a region that accounts for 58 percent of
Brazils GDP, Banco Sudameris will significantly enhance ABN AMRO Reals position in the region, according to the bank. The acquisition will be funded partly by a cash amount of BRL 527 (EUR 158.1 million) and by shares in Banco ABN AMRO Real to the value of BRL 1,766 million (EUR 529.8 min). (ABN AMRO press release, April 16, 2003) Barclays PLC has announced that Barclays Bank SA (Barclays Spain) will acquire all of the issued share capital of Banco Zaragozano for EUR 12.7 per share in cash, which represents a total consideration of EUR 1,143 million. The merger of the two banks will create Spains sixth largest banking group by assets. The deal, which is expected to be completed in July, 2003 must be approved by Spains central bank as well as by the Spanish Securities Market Commission. The transaction is also contingent on 75.01 percent of Zaragozanos shareholders accepting Barclays offer. (Barclays press release, May 8, 2003) UBS (France) S.A. announced that it will acquire Lloyds Bank S.A., the French wealth management business of the British bank Lloyds TSB, for an undisclosed price. Lloyds Bank S.A., which manages approximately EUR 1 billion in invested assets, serves high net worth clients in the French market. Subject to regulatory approvals, Lloyds Bank S.A. will be renamed UBS Wealth Management (France) S.A. (UBS press release, May 16, 2003) Credit Suisses Winterthur Insurance subsidiary has agreed to sell Churchill, its direct insurance business, to the Royal Bank of Scotland Group plc for approximately GBP 1.1 billion in cash. The Churchill transaction, which Winterthur Group CEO Leonhard Fischer has said will have no strategic implications or negative repercussions for Winterthurs U.K. life insurance business is expected to be completed in the third quarter of 2003. (Credit Suisse press release, June 11, 2003)
21
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
M A R K E T
F O R C E S
I n t e r n a t i o n a l Fo c u s a n d G l o b a l i z a t i o n
Effective June 9, 2003, UBS implemented its single brand strategy and will no longer market its services under the UBS Warburg and UBS PaineWebber brands. According to UBS, this move more accurately reflects the organizations integrated business model of delivering services to clients as one firm. (UBS press releases, June 9, 2003; November 12, 2002) Following a strategic review of its business initiatives, products and services the Nasdaq Stock Market, Inc. indicated that it will support the closing of the market operated by NASDAQ Europe located in Belgium in which NASDAQ has a majority stake. Additionally, NASDAQ plans to forgo its stake in NQLX, a joint venture with the London International Financial Futures Exchange, and transfer its ownership interest to LIFFE which will assume financial and management responsibility for the business. NQLX is a joint venture to create a market for single stock futures and other futures products. These and other steps are being taken by NASDAQ in line with its intent to concentrate on the U.S. equities market. (NASDAQ press release, June 26, 2003) In a move to restore investor confidence in Canadas capital markets in light of the financial reporting scandals in the U.S., the Ontario Securities Commission issued three proposed rules for comment on June 27th. These rules closely parallel the requirements of the U.S. Sarbanes-Oxley legislation, while specifically addressing Canadian issues. These deal with: CEO and CFO certification of annual and interim disclosures. The role and composition of audit committees. Support for the work of the Canadian Public Accountability Board in its oversight of auditors of public companies.
(Ontario Securities Commission press release, June 27, 2003) Canadas housing market remained strong in the first quarter of 2003, but according to RBCs Housing Affordability Index released by RBC Economics, affordability has slightly declined. The index, which measures the percentage of pre-tax household income needed to maintain the costs of home ownership, inched up to 32.5 percent from 32.1 percent in the first quarter of 2002. In dollar terms, this means that on average, CAD 1,264 in Canadian ownership costs this quarter ranging from CAD 923 in the Atlantic region to CAD 1,586 in British Columbia. A BMO Financial Group Economic report indicates that the real estate market will continue to be robust for the rest of the year despite recent higher interest rates and home prices. According to a TD Economics report, over the next decade the national average for resale home prices will outpace inflation and rise at a modest annual rate of 3.2 percent. Taking various tax benefits into consideration, this translates into a 5.8 percent return on investment. (RBC Financial Group press release, May 29, 2003; BMO Financial Group press release, May 8, 2003; TD Bank Financial Group press release, June 4, 2003) A new research report by TowerGroups Consumer Credit service finds that the revised Basel Capital Accord (Basel II) will have a wide-reaching impact on mortgage lending in the U.S. and Europe. The new regulations will increase transparency of credit risk information, as well as facilitate greater accuracy and equitable valuation of mortgage credit. Cross-border mortgage lending by global financial services institutions is expanding through mergers and joint ventures, thereby creating global risks for individual financial institutions and countries, and the international banking system. As a result, mortgage lenders will increasingly be subjected to international banking regulations that monitor cross-border risk. (TowerGroup press release, April 17, 2003)
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
22
M A R K E T
F O R C E S
After a decade of stalled economic growth, Japans banks may be impacted by new criteria for capital adequacy ratios, dividend payouts and performance that could potentially pave the way for the government to nationalize portions of the banking sector. The draft rules proposed by the countrys Financial Services Agency outlined the standards the banks now must meet. If they fail to meet the standards, the government could exercise its right to convert the preferred shares it bought by injecting JPY 7.45 trillion ($62.59 billion) in public funds in 1999 to recapitalize Japans top 15 banks. The 15 banks are now consolidated into seven groups, of which one, Mitsubishi Tokyo Financial Group, has repaid its debt to the government. Japans Economics and Financial Services Minister Heizo Takenaka also said that after a round of inspections, the FSA had identified the need for JPY 1.3 trillion ($10.85 billion) in loan loss charges at the seven banking groups. In anticipation of the FSAs findings, the groups had forecast bad loan charges for the year ended in March at about JPY 5 trillion, after a November forecast of JPY 3.1 trillion. In the previous financial year, bad loan charges reached JPY 7.8 trillion. Minister Heizo Takenaka indicated progress has been made in disposing non-performing loans. (Reuters April 3 and 25, 2003) As of May 2003, 33 percent of the U.K. public favors entering the EMU according to the results of the latest report by Credit Suisse First Bostons U.K. economic research team on the U.K. publics use of the euro and support for EMU entry. The CSFB report also notes that the current percentage of the public supporting EMU entry has declined from 42 percent in January 2002. (Credit Suisse Group press release, May 28, 2003) With the growing importance of euro-denominated trade flows, The Bank of New York has launched its Euro Reimbursement service that will provide clients with access to an extensive range of trade processing features. The service, which is directly linked to the inter-bank euro payment system through BNYs Frankfurt branch, will provide pre-debit notification to clients of reimbursement claims, value-added reporting on eurodenominated transactions, and transaction execution
through a central processing hub. (The Bank of New York, June 3, 2003) One June 2nd, Citibank announced the launch of its U.S. stock investment service in Taiwan in order to offer customers more choices with easy access to investing in the NYSE, Nasdaq, ASE, ETF, and ADR/GDR markets. Results of a survey of its wealth management banking customers in Taiwan showed that almost three-fourths of the respondents said they were interested in directly investing in the U.S. stock market. (Citigroup press release, June 2, 2003)
e - B u s i n e s s a n d Te ch n o l o g y
Despite prevalent cost-cutting measures throughout the global financial services industry, financial services companies are forecast to increase IT expenditures by 2.3 percent this year over last year to $333.7 billion. Even in the European Union, where IT spending is expected to decline just over one percent in 2003, TowerGroup predicts that technology spending by financial institutions will gradually increase over the next three years. It also estimates that about a third of all IT investments made by financial services companies worldwide are earmarked for new technologies. With this in mind, TowerGroup is launching its new consulting practice, IT Value Management, designed to help financial institutions align their business strategies more effectively with their IT investments while increasing return on investment. (TowerGroup press releases, May 12 and 21, 2003) During April 2003, Wachovia announced three new initiatives: CyberImport, released by Wachovias International Division, is the companys proprietary Web-based product designed to automate a customers access to the life cycle of Letters of Credit. CyberImport is designed to make the Letters of Credit transaction process more efficient from issuance/acceptance, discrepancy resolution, drawdown to final settlement.
23
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
M A R K E T
F O R C E S
Online FX, rolled out by Wachovia Bank N.A., is a proprietary online foreign exchange trading platform for executing spot, forward, and cross-currency transactions in more than 25 currencies. Dropbox ARC, introduced by Wachovias Treasury Services Division, and developed with San Francisco-based BankServ, the new electronic check conversion service is designed to help customers be more efficient in collecting, centralizing, tracking, and researching their accounts receivable transactions. (Wachovia press releases April 7, 21, and 24, 2003) Wells Fargo & Company, which announced the launch of its online banking services for blind and visually impaired consumers, became the first financial institution to have its Web site certified by the National Federation of the Blind. Other such certified organizations include the U.S. Social Security Administration and global technology provider HP. Enhancements to the Web site include screen readers capabilities that read the contents of the screen out loud, as well as magnifiers which enlarge the screens font size. (Wells Fargo press release, May 12, 2003) A report by Celent predicts a decline in IT spending by the U.S. securities industry in 2003, representing the first running two-year decline in the industrys history. According to Celent, even during the market crash of the late 1980s and the early 1990s recession, there has never been a year-on-year decline in securities industry IT spending levels. In the past, individual firms may have cut IT outlays but on an industry level spending had grown continuously since the 1970s. While outlining priorities and challenges facing U.S. securities firms, the Celent report notes that lower technology and operations budgets may be exposing some firms to serious risks in terms of processing trades correctly. In contrast with the U.S., banks in Japan, though coping with a stagnant economy and heavy bad debt portfolios, are maintaining a strategic focus on technology investments as a way to reduce costs, increase efficiency
and enable value-added and competitive products and services. In the current fiscal year, Japans banks, both large and small, spend USD 11.9 billion on technology. (Celent press releases, April 3 and 28, 2003) As banks endeavor to control costs in the current economic environment, outsourcing services for ATM (Automated Teller Machine) operations are becoming more popular, and have considerable room for growth, according to a new Celent report, ATM Outsourcing Services: A Global View, that estimates in 2003 financial institutions and ISOs worldwide spent $4.9 billion on these services. Celent estimates steady growth ATM outsourcing, reaching $6.5 billion by the end of 2007. The report analyzes ATM outsourcing trends in North America, Europe and Asia-Pacific. (Celent press release, June 4, 2003) The Bank of New York (Delaware), a subsidiary of The Bank of New York Company, Inc., became one of the first banks in the U.S. to convert from physical paper checks to electronic presentment for its corporate customers. The electronic image capability that has been enabled by the installation of an image archive at the banks mainframe data center and by the electronic capture of check images at the Federal Reserve Bank of Philadelphia, allows all of the steps in the Banks check processing procedures, while providing customers with immediate service enhancements such as same day online viewing of images of all checks and an online seven-year archive capability to retrieve and view all check images. (The Bank of New York, June 3, 2003)
B A N K I N G
I N D U S T R Y
Risk Management
According to Moodys KMV, a firm that tracks credit risk, credit risk models point to improvement across most industries. This can be attributed to fewer default or bankruptcy risks for the average U.S. company which is down 20 percent to 50 percent this year; and important to investors in high-grade corporate bonds, a smaller danger of falling bond prices. An equity-based model created by CreditSights Inc., a fixed-income
T H E
S T A T E
O F
T H E
24
M A R K E T
F O R C E S
research service, found that credit risk for U.S. companies has fallen by 40 percent to 50 percent on average since August 2002. Although models are providing early glimpses of improvement, some experts indicate that troubled times have not entirely passed. (Reuters, June 11, 2003) JPMorgan announced the launch of is Credit Navigator in April 2003. Responding to the increasing integration of the credit markets, with market makers and investors aggregating the trading of all formats of credit risk into a single risk management system, this new user-friendly analytical tool is designed to help investors identify relative value and opportunities in the credit markets. According to JPMorgan, Credit Navigator provides comprehensive data for more than 50 European and U.S. names, including, among other features, an asset universe and basis history chart for each name. Company executives say the product is a step forward toward greater transparency in the credit derivative and corporate bond markets. (JPMorganChase press release, April 23, 2003)
25
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
K P M G S w w w . k p m g i n s i d e r s . c o m
B A N K I N G
I N S I D E R
Overview
In response to the increasing demand for easily accessible industry information and value-added insights that financial services industry professionals can leverage to achieve a competitive market advantage, KPMG publishes the Banking Insider, an easy-to-use industry news and information service delivered directly to registered viewers by e-mail. A dedicated editorial staff oversees the content, providing the top stories of the day daily, weekly, and/or as breaking news occurs. The Banking Insider saves time by offering focused, industry-specific news and information on the industry with a simple mouse click and includes: Links to premium content from a wide range of news and information services. Exclusive KPMG-authored analysis and commentary that provide an in-depth perspective on the issues that have an impact on todays business. A searchable archive of KPMG-authored articles accessible from any KPMG-Analysis page. In todays merging world of business, KPMG also offers the following Insiders providing quick access to the latest news and information of other industries. Consumer Markets Insider Electronics Insider Health Care Insider
I N D U S T R Y
Analysis and Commentary
N e w O u t s o u r c i n g M a n t r a : Tr u s t , b u t Ve r i f y
By Christopher Westfall, Managing Editor, Banking Insider
As outsourcing grows, financial services executives are demanding greater oversight of technology vendors, establishing penalties for service failures and often hiring other firms to oversee the relationship. At the same time, management teams are anxious not to alienate vendors, fearing that damaging a relationship could come back to haunt them in additional back-office headaches. "You need to have a high-level person or team following outsourced activities--almost as customer service reps to the outsourcees," said Will Gibson, global chief operating officer for ING Investment Management, at a recent meeting of the National Investment Company Services Association (NICSA). "It's the cost you are going to have to pay to keep up a healthy outsourcing deal." Financial services companies have long outsourced internal functions, but now outsourcing seems to be hitting a fever pitch. The TowerGroup estimates that $120 billion of the $340 billion in IT spending in 2003 will be outsourced. How financial services companies outsource varies greatly. Some of the nation's largest broker/dealers and banks have announced huge IT outsourcing deals, including J.P. Morgan Chase's $5 billion contract with IBM, Bank of America's 10year, $4.5 billion agreement with Electronic Data Systems, and a $400 million outsourcing deal between Unisys and Washington Mutual. Meanwhile, mutual fund companies and mid-tier and small banks are outsourcing back office operations incrementally, says Eric Panepinto, president of Sanchez Data Systems in Malvern, Pa. "The large deals are about carving out entire IT departments," he says. "It is probably more of a piecemeal approach in the mid-tier banks."
Insurance Insider Pharmaceuticals Insider In the following section, we offer KPMG analysis and commentary reprinted from the Banking Insider. These articles provide information on recent issues and trends impacting the financial services industry. This complimentary service is available through the Internet at www.kpmginsiders.com. The information provided in the following articles is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. The views and opinions are those of the author and do not necessarily represent the views and opinions of KPMG LLP.
T H E
S T A T E
O F
T H E
B A N K I N G
26
K P M G S
B A N K I N G
I N S I D E R
But whether it's farming out check processing or moving the entire computer staff to a third party, banks are just now trying to determine how to measure the success of outsourcing deals, says David DiCristofaro, partner and financial services industry leader for KPMG's Information Risk Management practice in Charlotte. "Most of the time, companies will outsource because they want the economic benefit, and they want to improve operations," DiCristofaro says. "But how to determine [success] is still a challenge." DiCristofaro explains that many banks have a hard time "getting dollars into the business case" while trying to sign the deal. That makes performance measurement and monitoring important in justifying an outsourcing deal to upper management and the board of directors. Sanchez's Panepinto says that many banks have been relying on service level agreements (SLAs), which are contractual benchmarks that set predetermined measures that the vendor needs to meet. For example, an SLA allows a fund company to dock part of the payments to a custody vendor that allows too many failed trades. The fund company may even say the vendor defaulted on a contract if it violates too many SLAs. Banks and fund companies, which are becoming more adept at outsourcing, need to have a plan in place for those uncomfortable moments when vendors don't live up to the terms of the contract, ING's Gibson said. "Someone who has not outsourced should know how they can get extricated," he said. "For example, when we do an outsourcing agreement, it will always [look] like a prenup." As a result, many firms are hiring third parties to oversee outsourcing arrangements; they are also having non-technical staff monitor vendor performance, DiCristofaro says. "It is becoming increasingly common in the industry to have an outside firm oversee all vendors," he says.
Greater regulatory oversight has also put a spotlight on vendor performance, said Richard Hisey, treasurer and senior vice president for MFS Investment Management, at the NICSA meeting. Many common outsourced functions of mutual funds are coming under increased scrutiny from management. "There could be an argument that, given Sarbanes-Oxley, financial reporting could be considered a core competency [that fund executives will be held liable for]," Hisey said. Sanchez's Panepinto agrees, saying his clients are looking closely at benchmarks and third-party providers in light of regulatory issues. "The regulators have really come down on [oversight]," he says. "Just because you outsource, you can't turn a blind eye to what is going on." (KPMGs Insiders, May 20, 2003) Bankers Struggle to Comply With Te r r o r R e g u l a t i o n s
By Christopher Westfall, Managing Editor, Banking Insider
Zarate and other regulatory representatives spoke at the American Bankers Association Regulatory Compliance Conference in Washington, D.C. As part of the USA Patriot Act of 2001, Congress included a provision that allowed FinCEN to send banks the names of
27
T H E
S T A T E
O F
T H E
B A N K I N G
"The entire [request] process is being revamped and has come a long way since December [of 2002]," said Albert Zarate, senior regulatory counsel for the U.S. Department of the Treasury's Financial Crimes Enforcement Network (FinCEN) in Vienna, Va.
I N D U S T R Y
Regulators are promising that an overhauled system for requesting terror suspects' bank records will address financial industry criticisms that the system was confusing and unmanageable.
K P M G S
B A N K I N G
I N S I D E R
suspected terrorists and organizations to see if there was a match in bank records. The process, called "314(a) requests" for the corresponding section of the Patriot Act, compels banks to conduct a onetime search of their deposit accounts, funds transfer records, loan documentation and other material at the behest of FinCEN. But following implementation, bank compliance staff complained that requests arrived too fast, while they were unclear about how to conduct searches. They also didn't know when and how to report back to the government. From February until the end of May, FinCEN made 77 requests about 374 suspects to over 20,000 financial institutions, resulting in about 2,300 matches. Zarate said that FinCEN, a liaison between banks and the government, has made changes in the 314(a) request process in response to complaints. "The biggest improvement has been narrowing of the 314(a) records to be searched," he said. This includes narrowing the definition of what types of people qualify for a search, and limiting law enforcement to request information on terrorism and the most significant money laundering cases.
I N D U S T R Y
Laurie Bender, senior special anti-money laundering examiner for the Federal Reserve Board, said that the Office of Foreign Asset Control (OFAC) will give some time for banks to adjust to the new regulatory environment, but they will need to comply with all regulations. While both FinCEN and OFAC focus on money laundering, their approaches are different. OFAC keeps a list of institutions and banks that are known launderers that U.S. firms cannot work with, as part of an ongoing program. FinCEN, meanwhile, assists law enforcement in individual investigations. "OFAC is not the result of the Patriot Act, it has been around for a number of years," she said, noting that there are additional compliance requirements for OFAC under the Patriot Act. "There will be a modest grace period for compliance, but given the risk and what could happen, we are looking at [compliance] very seriously," she said. This means having bank examiners reviewing OFAC compliance "much like a program requirement" that could result in sanctions if banks are lacking, Bender said. Even smaller banks, which often complain that they do not have the resources to comply with myriad anti-money laundering regulations, are expected to keep up to speed. Terrorists like those involved in the September 11 attacks will often use smaller institutions in several different regions to escape detection. Bender said that the Sept. 11 hijackers moved several times within the U.S., changing addresses and banks, because law enforcement and financial institutions alike did not have systems to follow individuals' movements from region to region. "We have seen a lot of banks doing OFAC manually, which is virtually impossible with all the records that are involved," Bender said. "Some vendors are offering [compliance]
B A N K I N G
Regulators have also started sending batch requests every two weeks and giving the institutions two weeks to reply. FinCEN is also working to create a better system of reporting positive matches, which currently comprises sending a form reply to an e-mail address. Complaints have come from the whole spectrum of American banks, but often the 314(a) requests hit regional and small banks hardest. Many small banks lack experienced compliance professionals, putting them under a strain with the rise in anti-money laundering regulations. A recent ABA survey said that 90 percent of respondents found it "very difficult" to find qualified compliance officers.
T H E
S T A T E
O F
T H E
28
K P M G S
B A N K I N G
I N S I D E R
systems for as little as $700, so you need to look at the costbenefit [analysis] of that." Banks should also take advantage of the Patriot Act's provision that allows financial institutions to share information on suspect accounts, said Lisa Grigg, a manager in the anti-money laundering investigative service department of Wachovia Bank in Charlotte. Griggs said that banks can take advantage of the provision, called 314(b), if they meet four requirements: they give notice to FinCEN; re-file the notice annually; only share with financial institutions that have also filed notice to share; and ensure that they have procedures to safeguard the information. (KPMGs Insiders, June 19, 2003)
29
T H E
S T A T E
O F
T H E
B A N K I N G
I N D U S T R Y
Joseph Mauriello Vice Chairman, Financial Services New York, NY Phone: (212) 954-3727 e-mail: jmauriello@kpmg.com
Jerry Licari Partner and Banking Industry Sector Leader Charlotte, NC Phone: (704) 335-5311 e-mail: jrlicari@kpmg.com Robert F. Arning New York Office Managing Partner New York, NY Phone: (212) 872-3202 e-mail: rarning@kpmg.com Robert T. McCahill Partner, Tax Services New York, NY Phone: (212) 872-6776 e-mail: mccahill@kpmg.com Editor: Mary Ann Bramer Director, Special Projects - Markets Montvale, NJ Phone: (201) 505-3570 e-mail: mabramer@kpmg.com Contributing Authors: Taxation Washington National Tax Washington, D.C. Phone (202) 533-3800 e-mail: ldyor@kpmg.com Legislation and Regulation Steve Roberts Partner in Charge National Regulatory Advisory Services Group Washington, D.C. Phone: (202) 533-3018 e-mail: sroberts@kpmg.com Michael Flood National Regulatory Advisory Services Group Washington, D.C. Phone: (202) 533-3264 e-mail: mflood@kpmg.com Laura Haywood-Leigh Senior Financial Analyst Washington, DC Phone: (202) 533-5424 e-mail: lauraleight@kpmg.com Accounting T. J. Scallon Senior Manager Audit New York, NY Phone: (212) 954-7059 e-mail: tscallon@kpmg.com For additional information on KPMG, please visit our Web site at www.kpmg.com. To submit changes to our mailing list, please send an e-mail message to Kathy Wall at kwall@kpmg.com.

Banking, Investment Banking and Securities

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Banking, Investment Banking and Securities

Uploaded by

Copyright:

Available Formats

T H E

Bank of New York: The closing of Pershing

Bank One Corp.: Reported 2003 second-quarter

Earnings U.S. Bank Earnings Bank of America Corp.: With a strong

Citigroup: Helped by its strong consumer business,

FleetBoston Financial: Reported net income of

Goldman Sachs : Reported second-quarter 2003

First quarter ended May 31, 2003

Morgan Stanley : Reported second quarter 2003

National City Corp.: Helped by a strong core

Wells Fargo & Co.: With strong results in

Royal Bank of Canada announced second

Canadian Bank Earnings* Bank of Montreal announced a second quarter

Scotiabank announced second quarter net income

CIBC announced a second quarter net income of $320

(Source: Company financial reports)

Accounting Standards and Developments

Analysis and Commentary

You might also like