Bear Stearns Annual Report 2006

A N N U A L

R E P O R T

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C O M M I T M E N T

EIGHT Y-THREE YEARS OF PROFITABILITY

TWENT Y YEARS AS A PUBLIC COMPANY

A FIRM COMMITMENT to provide superior service to our clients, best-in-class returns to our stockholders and a superior workplace for our people. Our commitment is backed by our guiding principles. More than words on paper, they are the CORNERSTONES of our culture. Although Bear Stearns has grown and changed dramatically in the 83 years we have been in existence, these FUNDAMENTAL beliefs still serve as the foundation of our success: Respect, Integrity, Meritocracy, Innovation and Philanthropy. These core VALUES ring as true today as they did the day we first opened our doors on Wall Street and 20 years ago when we moved from a partnership to a public entity. In this day and age, treating others with RESPECT and operating with the highest degree of INTEGRITY may seem commonplace. For us, it is the code of conduct we live by. Bear Stearns was

created as a MERITOCRACY: a

place where individuals are

judged on the QUALITY of their

work and their contribution to on their socioeconomic class, that our people are the firm, most talented individuals. individuals have been with You will see a number of throughout this 20th anniversary

20 06

the whole, not pre-judged based race or religion. Understanding we seek to attract and keep the More than 800 of these the firm for 20 years or more. them pictured and highlighted annual report. We appreciate

their WISDOM, dedication and their tremendous contribution to the firm over time, just as we welcome the new TALENT who will grow and guide us through the next TWENTY YEARS. At a time when change and speed seem to be prized for their own sake, we contend that continuity and consistent INNOVATION create a balanced foundation for a lasting organization. Our stockholders have benefited from this approach year after PROFITABLE year. Hand-in-hand with our profitability is the desire to give back to our communities and to those in need. We believe our policies on PHILANTHROPY support both our employees’ wishes and our ability to nurture a well-rounded workforce. From these actions, we strive to foster an environment of CARING within the corporation. To our employees, to our stockholders, to our clients, Bear Stearns has – and always will have – A FIRM COMMITMENT.

Financial Highlights Fiscal years ended November 30,

2006

2005

2004

2003

2002

(in thousands, except common share data, financial ratios and other data)

RESULTS Revenues, net of interest expense Employee compensation and benefits Non-compensation expenses Total expenses Net income Net income applicable to common shares

FINANCIAL POSITION (1) Total assets Long-term borrowings Guaranteed Preferred Beneficial Interests in Company Subordinated (2) Debt Securities Stockholders’ equity

COMMON SHARE DATA Basic earnings per share Diluted earnings per share Cash dividends declared per common share Book value per common share Common shares outstanding(4)

$

7,410,794 3,553,216 1,650,519 5,203,735 $ 1,462,177 $ 1,437,856

$

$350,432,595 $ 54,569,916

$287,292,637 $ 43,489,616

$252,112,691 $ 36,843,277

$209,181,240 $ 29,430,465

$181,452,776 $ 23,681,399

$ — $ 12,129,384

$ — $ 10,791,432

$ $

— 8,990,872

$ $

562,500 7,470,088

$ $

$ 15.79 $ 14.27 $ 1.12 $ 86.39(3) 145,693,021

$ $ $ $

$ $ $ $

10.88 9.76 0.85 59.13 144,484,099

$ $ $ $

9.44 8.52 0.74 48.69 142,369,836

$ 7.00 $ 6.47 $ 0.62 $ 39.94 145,591,496

20.2% 29.6%

18.1% 25.6%

$ $

FINANCIAL RATIOS Return on average common equity (5) Profit margin

OTHER DATA Assets under management (in billions) Average value-at-risk (in millions) Employees

9,227,165 4,343,499 1,737,036 6,080,535 2,053,871 2,032,508

$

19.1% 34.1%

$ $

52.5 28.6 13,566

11.42 10.31 1.00 71.08 146,431,767

$ $

16.5% 29.8%

$ $

41.9 20.5 11,843

6,812,883 3,253,862 1,536,867 4,790,729 1,344,733 1,316,661

$

$ $

19.1% 29.7%

$ $

37.8 15.8 10,961

$ $

5,994,491 2,880,695 1,341,527 4,222,222 1,156,406 1,125,031

29.2 15.8 10,532

$

5,128,236 2,508,197 1,309,076 3,817,273 $ 878,345 $ 842,739

$ $

562,500 6,382,083

24.0 16.5 10,574

As of November 30, 2006, the Company elected, under FIN No. 39, “Offsetting Amounts Related to Certain Contracts,” to net cash collateral received or paid against its derivatives inventory, on a counterparty basis, provided that the legal right of offset exists. The Consolidated Statements of Financial Condition as of November 30, 2005, 2004, 2003, and 2002 have been adjusted to conform to the current year’s presentation. (1)

(2) In accordance with FIN No. 46 (R), the Company has deconsolidated Bear Stearns Capital Trust III effective beginning with the quarter ended February 29, 2004. As a result, the Debentures issued by the Company to Bear Stearns Capital Trust III are included within long-term borrowings. The $262.5 million of Preferred Securities issued by Capital Trust III is still outstanding, providing the funding for such Debentures. The Preferred Securities issued by Capital Trust III are no longer included in the Company’s Consolidated Statements of Financial Condition. As of November 30, 2003 and 2002, Guaranteed Preferred Beneficial Interests in Company Subordinated Debt Securities consists of $300 million of Preferred Securities issued by Bear Stearns Capital Trust II and $262.5 million of Preferred Securities issued by Bear Stearns Capital Trust III. (3) For book value purposes, at November 30, 2006, common stockholders’ equity was adjusted by $816 million and common stock outstanding was adjusted by 4.6 million units, which represents stock-based compensation associated with fiscal 2006 awards that was reflected in stockholders’ equity as of the grant date in December 2006, in accordance with SFAS No. 123 (R), “Share-based Payment.” In previous years, stock-based compensation granted in December was included in stockholders’ equity at November year-end. (4)

Common shares outstanding include units issued under certain stock compensation plans, which will be distributed as shares of common stock.

(5)

Represents the ratio of income before provision for income taxes to revenues, net of interest expense.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

Dear Fellow Stockholders, Celebrating twenty years as a public company has given us the opportunity to reflect on our past success and focus on the drivers of a profitable future. In the past twenty years, we have seen Bear Stearns thrive far beyond anything the founding partners could have imagined. In 2006 we reported our fifth consecutive year of record net income and earnings per share. Net income topped $2 billion for the first time, up 40% from $1.5 billion in 2005, and earnings per share (diluted) were $14.27, up nearly $4.00 from the prior year. We reported our fourth consecutive year of record net revenues. Net revenues rose 25% to $9.2 billion to beat the all-time high of $7.4 billion set in 2005. Each of our major business areas reported record revenues to contribute to this outstanding performance. Traditionally, I have pointed to book value as a measure that I believe reflects the underlying success of the company and a barometer of the health of the business. Last year alone, Bear Stearns’ book value increased 21.5% to close the fiscal year at $86.39 per share. Over the past five years, the compound annual growth rate of book value has been 21%. During the 2006 fiscal year, you saw your stock in Bear Stearns appreciate by 37%. This progress has been built on a firm foundation. Our balance sheet is now over $350 billion and the strong credit quality of Bear Stearns continues to be recognized by bondholders as well as rating agencies. In 2006 Standard & Poor’s upgraded Bear Stearns to A+ with a stable outlook—a rating that we believe reflects the dedication to risk evaluation and management that has given us the ability to expand carefully and conservatively. The strict risk discipline imposed on our trading desks is reinforced by the strong sense of ownership that permeates the culture of the corporation. With roughly one-third of Bear Stearns’ total stock in employees’ hands, our people are owners of the company. This ensures that the interests of stockholders and employees are very much aligned. You can expect us to continue to adhere to our core values, including this consistent and deliberate approach to risk and measured advancement of key businesses across the globe. Now is an exciting time in the development of Bear Stearns. The growth initiatives we have launched in the past few years continue to strengthen our company. In Fixed Income, the 27% year-over-year growth came from efforts to both further broaden the mortgage origination platform and expand the credit business. We believe the 36% year-over-year increase in the Institutional Equities area is a direct result of the focus we put on customer care and product bandwidth. With client service always in the forefront of our minds, we announced the integration of the cash, equity derivatives and clearing operations to create the Global Equities

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Our people are the greatest asset we have. Their hard work and dedication provide results for our clients and returns for our stockholders.

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JAMES E. CAYNE Chairman of the Board and Chief Executive Officer Executive Committee Chairman of the Management & Compensation Committee

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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FIRM

COMMITMENT competencies from the United States to other geographies

Division. Customers will enjoy

and the hiring of talented

a single point of access for all of the products and services

under management and

professionals will drive our

we offer. In particular, we

increase the underlying base

expansion in new markets.

believe this integration sets

of stable fee revenues. I also

Developing innovative product

the stage for deeper prime

continue to be impressed by

structures according to

brokerage and institutional

the caliber of investment

demand in local marketplaces

client relationships. Both

professionals who have been

has already led the expansion

domestically and internationally,

choosing Bear Stearns Private

in the United Kingdom, France

Global Clearing Services

Client Services Division as their

and Germany.

accounts can expect more

home. Whether in one of our

comprehensive service with

branch offices or one of the

Our record success is to the

increasingly advanced,

new satellite locations, these

credit of the 13,500

integrated technology as our

professionals are truly the best

employees who have made

platform moves to the next

of the best.

it possible. Although the size of our talent pool has more

level. Clients will also benefit from the significant progress

Another primary focus is

than tripled over the past 20

we have made in building our

continuing the successful

years, the camaraderie

energy trading platform, both

expansion of the international

among co-workers continues

in hiring people and developing

platform. We made great

to bind us together as one

technology. This capacity in

strides in 2006 as we saw

firm dedicated to serving

Bear Energy complements

international net revenues rise

clients with excellence and

our existing ability to purchase

above $1.2 billion, having

integrity. I thank each of my

and securitize physical power

grown 32% from the prior year.

colleagues and you, our

plant assets.

This success has fueled the

stockholders, for the

need and the desire for a

continued privilege of

Integrating our business to more

larger, more permanent

leading Bear Stearns.

comprehensively service clients

international home. Our

has supported the advancement

overseas headquarters is

of the investment banking

currently being built in London

franchise, particularly our work

at 5 Churchill Place in Canary

James E. Cayne

with financial sponsors. In

Wharf. Seeking to export

Chairman of the Board

total, banking revenues rose

and adapt key product

and Chief Executive Officer

19% for the year as the combined effort of advisory, debt and equity capital market capabilities proved to be of value to our clients. In Wealth Management, we are extremely pleased with Bear Stearns Asset Management’s ability to attract new assets

Debbie Deuel, Suzanne Fitzgerald, Suzette Fasano and Charlotte Dimitriyadi each have had a firm commitment to Bear Stearns for over 20 years.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

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Throughout these pages, we feature employees who have shared at least 20 years with us. As we celebrate our 20th anniversary annual report, we thank them and all of our Bear Stearns employees for their continued commitment.

1994 ‘‘

Annual Report

Our unique culture, based on integrity, performance, entrepreneurship and teamwork, has fostered a deep commitment to shareholders, clients and employees.

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Integrity BEAR

STEARNS

GUIDING

PRINCIPLE

We act in a manner that is based on, or characterized by, good judgment and sound thinking. As an organization, we aspire to achieve the highest standards of professional conduct and ethics; to raise the bar on individual accountability for our actions; to prevent and detect wrongdoing; and to govern ourselves in accordance with the relevant rules, regulations and laws.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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WARREN J. SPECTOR

ALAN D. SCHWARTZ

President and Co-Chief Operating Officer Executive Committee Management & Compensation Committee

President and Co-Chief Operating Officer Executive Committee Management & Compensation Committee

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The quality of our people and the originality of our thinking distinguish us in the marketplace.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

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We are constantly looking ahead and striving to move the firm forward. Our success is driven by innovation.

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COMMITMENT

SAMUEL L. MOLINARO JR.

ALAN C. GREENBERG

Executive Vice President and Chief Financial Officer Executive Committee Management & Compensation Committee

Chairman of the Executive Committee

Holding ourselves to the highest standards is at the forefront of all that we do, both as individuals and as an organization.

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All of our senior managing directors give 4% of their gross income to charities of their choosing. It sets us apart. As far as I know, we are the only company that has this type of policy.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

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O U R

P E O P L E

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R E F L E C T

O N

W H O

W E

A R E

We take responsibility for our actions at Bear Stearns and thereby we have earned a public trust through our integrity, both in our own lives as well as in our business. –Bill Hayden, 23 years, Public Finance

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So many of us have spent the majority of our careers at Bear Stearns. The firm breeds a sense of loyalty and dedication that would be hard to find elsewhere. –Suzanne Morrison, 23 years, Fixed Income Sales

Integrity

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Bear Stearns’ greatest accomplishment over the past 20 years has been to remain true to the principles and culture that have made the firm successful from the beginning. –Joe Buckley, 22 years, Equity Research

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

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A Mike Josephson’s commitment has been to delivering superior client service throughout his 24 years in Equity Sales.

FIRM

COMMITMENT

ter able to serve clients in an integrated and seamless, customer-friendly fashion.

In II’s Alpha survey of hedge

The new Global Equities

funds, Bear Stearns climbed

Division will leverage our

from third to second place.

prime brokerage business and increase our client touch

STRUCTURED EQUITY PRODUCTS

points. As we embark into

Structured Equity Products

2007, the Global Equities

achieved another record year

Division remains focused on

in 2006. With its key trading

expanding market share and

desks in New York, London,

deepening relationships with

Hong Kong and Tokyo,

both new and existing

our global Structured Equity

customers.

Products Group offers innovative structured investments on

INTERNATIONAL

equity and debt securities.

Our international business

The Adagio Strategy suite of

enjoyed a record year of net

indices, an innovative method-

nstitutional Equities is firmly

revenues and profitability.

ology for dynamic asset

INSTITUTIONAL EQUITIES

I 12 Equity Research analysts earned

No.1 positions in the 2006 Institutional Investor All-America Research Team survey.

committed to providing

In Europe, our equity activities

allocation across equities,

clients globally with the very

have seen significant revenue

bonds and real estate, was

best in service, product and

growth and market share

adapted for US and Japanese

innovation. The division’s ability

gains. We also continue to

investments. In 2006 our

to deliver a broad array of

focus on growth in Asia. As

Structured Equity Products

exceptional products and

we broaden our client base

Group also brought to market

services, combined with

and product offering, our

notes that provided US

favorable market conditions,

international business is

investors with broad market

benefited both clients and

well positioned for continued

exposure to Indian equities.

stockholders. For the fiscal

success and should become

As clients look for ways to

year ended 2006, Institutional

a greater revenue source in

Equities’ net revenues climbed

future years.

36% to a record $2 billion.

Bear Stearns Equity Research ranked

Equity derivatives and interna-

Being a source of valuable and

tional sales and trading deliv-

unique ideas is the firm com-

No.2

ered record results for the year.

mitment of Equity Research.

in the 2006 Alpha All-America Research Team survey of hedge funds. In all, 25 analysts were ranked, with 8 earning top honors in their respective categories.

From the Americas to Asia, As clients use multiple prod-

our global equity research

ucts and services that span

offering is based on independ-

the length and depth of our

ent thinking and grass-roots

firm, we are enhancing our

analysis. Clients continue to

ability to deliver the firm to them

recognize our research as an

globally. By uniting all of the

industry leader. In 2006

firm’s cash equities, structured

Institutional Investor named

equities and clearing activities

12 of our Equity Research

into one division, we are bet-

analysts as the best in their sectors, a new record for the department. Our Latin America research was also highly ranked.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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Overall, 30 Equity Research analysts were ranked in 31 positions in the 2006 Institutional Investor All-America Research Team survey.

BEAR

PLORER

BEARXPLORER Bear Stearns is committed to enter the world’s markets,

providing clients with cutting-

demand for a unique product

edge investment tools. In 2006

offering is growing and our

BearXplorer™ was introduced—

market share is broadening.

a set of four sophisticated,

across the firm have embraced

securities-based portfolio tools.

the ease and flexibility BearCast

RISK ARBITRAGE

BearXplorer is designed to

offers. In its first year, approxi-

Reflecting a significant

help chief investment officers,

mately 2,600 unique users

increase in announced global

portfolio managers, risk

accessed the site, downloading

mergers and acquisitions,

managers, traders and others

an average of 5,500 audio files

Risk Arbitrage had another

manage risk and optimize

and slides a month.

successful year. The Risk

stock portfolios. Covering

Arbitrage Department is

more than 14,000 securities in

TECHNOLOGY

regarded as one of the pre-

26 countries, the tools screen

Backed by advanced tech-

mier risk arbitrage operations

portfolios for exposure to over

nology, Bear XO, formerly

60 stock market drivers, such

Institutional Direct Inc.,

as commodity prices, interest

provides institutions, hedge

rates, exchange rates and eco-

funds, broker-dealers and

nomic indicators. Recognizing

other investors with unbundled

the value BearXplorer brings to

solutions for trading and

clients, the American Financial

execution. Our broad platform

in the world. It is also one of

Technology Awards named it

of services covers portfolio

the largest, with professionals

“Best Risk Analytics Initiative

and single stock trading, direct

working out of offices in New

of the Year.”

market access and algorithmic

BearXplorer, our securities-based portfolio tool, was named the “Best Risk Analytics Initiative of the Year” at the 2006 American Financial Technology Awards.

York and London. The depart-

trading programs, all of which

ment focuses on traditional

BEARCAST

risk arbitrage, event-driven

In 2006 Bear Stearns also

streamline the trading process.

and capital structure situations.

introduced BearCast , a

Through our global coverage

The department trades and

mobile platform that uses

and access to the New York

provides analysis of equity

podcasting technology to

Stock Exchange, Bear XO

and debt securities and

deliver Bear Stearns content

connects clients to all major

derivative instruments involved

on demand to clients.

markets around the world.

in speculative or definitive

BearCast captures Bear

have been designed to SM

mergers, stock repurchases, spin-offs or major restructurings. Our experts in Risk Arbitrage share their thoughts about the probability of success, the time to consummation, as well as

BearCast is a mobile platform that uses podcasting technology to deliver Bear Stearns conference calls, proprietary equity and fixed income research, and special events on demand for investors to listen to anywhere.

the risks surrounding these major corporate events that

Stearns conference calls,

are likely to drive significant

proprietary research and

changes in market valuation.

special events in downloadable audio files for investors to listen

Janet Pegg’s commitment has been to offering clients valuable insights throughout her 24 years as an accounting and tax policy analyst in Equity Research.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

to anywhere. Audio files on the BearCast site often include slides and printed research. Clients and departments

A Paul Friedman’s commitment has been to building and maintaining businesses throughout his 26 years in Fixed Income.

FIRM

C O MMI TM EN T

securities underwriting, secured the top spot in the securitization of adjustable-rate

Bear Res and Encore Credit,

mortgages, and ranked in the

through a team of 275 account

top five in the global collateral-

executives across the country,

ized debt obligation (CDO)

is expected to generate

market. The volume of securiti-

approximately $1 billion in

zation rose to $113 billion from

loans per month.

$95 billion in 2005, capturing 11% of the overall domestic

EMC MORTGAGE

mortgage securities market.

Another important part of Bear Stearns’ vertically integrated

Our vertically integrated

mortgage platform is EMC

mortgage franchise allows us

Mortgage Corporation, our

access to every step of the

loan acquisition and servicing

mortgage process, including

operation based in Lewisville,

origination, securitization,

Texas. Since 2000, the unpaid

distribution and servicing.

principal balance of its total

At a time when the overall

servicing portfolio grew from

housing market experienced

$4.2 billion to $69.5 billion and

or the sixth consecutive year,

a sharp decline in volume,

loan volume has grown more

Bear Stearns Fixed Income

FIXED INCOME

F

the significant expansion of

than sevenfold. EMC, at the

Division achieved record results.

our captive origination activity,

end of 2006, serviced over

Robust client activity across the

which in 2006 reached 21% of

475,000 performing and

firm’s diverse global platform

our total residential mortgage

non-performing loans, up

fueled this performance. Every

securitization volume, allowed

approximately 10% from the

part of the franchise made a

us to increase our market share.

prior year’s level.

year’s success; in particular, our

A key to our vertical integration

INTERNATIONAL

No.1

industry-leading and vertically

strategy has been the develop-

Mortgage origination volume in

integrated mortgage franchise

ment of Bear Stearns Residential

the United Kingdom through our

US Mortgage-Backed Securities-Residential

and our vast credit business

Mortgage Corporation (Bear

residential lender, Rooftop

once again performed at record

Res). Established in April 2005,

Mortgages Limited, increased

levels. Internationally, we

Bear Res has grown from 55

continue to expand and our

to 600 employees. Through its

business has experienced

state-of-the-art origination

double-digit growth for the third

platform, BearDirect.net, it

consecutive year. Net revenues

generated more than $5 billion

for the Fixed Income Division in

of mortgages since its inception.

2006 were up 27% over 2005

In 2006 we announced the

No.1

and reached $4.2 billion.

purchase of the subprime

US Adjustable Rate Mortgages

MORTGAGE FRANCHISE

of Encore Credit Corporation.

Thomson Financial

Bear Stearns’ mortgage

The acquisition, completed

franchise continues to lead the

in early 2007, will give us a

industry. We ranked number

valuable foothold in the sub-

one for the third consecutive

prime mortgage market and

year in US mortgage-backed

is a natural extension of the

No.1 US Mortgage-Backed Securities Thomson Financial

Thomson Financial

No.1 US Whole Loans Thomson Financial

significant contribution to the

mortgage origination platform

technology built by Bear Res. The combined platform of

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COMMITMENT leading underwriter of collateralized loan obligations, mezzanine

Bear Stearns Fixed Income Research ranked

No.3 in the 2006 Institutional Investor All-America Research Team survey.

asset-backed securitized debt

We also provided approximately

obligations, and a range of

$5.1 billion of acquisition

other types of CDOs, including

financing in conjunction with

those related to commercial

four other banks.

by approximately 25% in the

mortgage-backed securities,

2006 fiscal year. Rooftop

trust preferred securities and

CREDIT BUSINESS

recently launched a new

CDOs of CDOs.

The continued diversification

business unit to perform special

of the credit business resulted

servicing and loss mitigation for

COMMERCIAL MORTGAGES

in a banner year. Credit

all of its future securitization

Commercial Mortgages had a

derivatives, leveraged finance,

transactions. Rooftop also

record year, with originations

and the distressed debt areas

completed its acquisition and

exceeding $13.5 billion, marking

all enjoyed exceptional results,

integration of packager ISL.

a 14% increase over 2005.

reflecting the significant strides these businesses

In 2006 Bear Stearns was the lead underwriter for a $650 million bond sale for the New York City Department of Education. At a press conference held at Bear Stearns, Mayor Michael Bloomberg spoke about the firm’s ongoing commitment to New York City.

made in increasing market share and customer volume. Credit Derivatives’ revenues increased 52% year over year as credit spreads tightened, fueling robust client activity. Distressed

No.3 Global Mortgage-Backed Securities Thomson Financial

No.4 Municipal Long-Term Negotiated Deals Thomson Financial

No.5 Global Collateralized Debt Obligations Thomson Financial

Bearimmo, our residential

Nearly one-third of all new

debt net revenues increased by

mortgage origination business

business was originated outside

50% due to success in special

in France, completed its first

the United States, including

situations, bank and bond debt.

year of operation and its

transactions in the United

pipeline of pending loan appli-

Kingdom, continental Europe,

MAJOR DEALS

cations grew substantially

Japan and Latin America. We

In 2006 Bear Stearns played

over the course of the year.

expanded the scope of real

a major role in Verizon

Applications received in

estate financial products to

Communications’ $13 billion

November 2006 were four

include real estate equity and

times as great as the volume

distressed debt investments

received in November 2005

in the United States and interna-

as the unit broadened its

tionally. Bear Stearns continues

distribution channels by

to be a top strategic advisor on

adding four new broker

major real estate deals. In 2006

groups in the fall of 2006.

the firm was the financial advisor to The Blackstone Group

Bear Stearns’ global collateral-

and Brookfield Properties

ized debt obligations (CDO)

Corporation for its $8.9 billion

business grew by 50%, with

acquisition of Trizec Properties,

total issuance of $27.1 billion

one of the largest owners and

in 2006. Our success across all

operators of commercial office

sectors of the CDO market and

properties in the United States.

in both European and US issuance reflects our 10-year presence in this business, combined with strong overall market growth. We are a

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

Daniela Bar-Illan’s commitment has been to adding value for her clients in her 23 years in High Yield Sales.

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Innovation BEAR

STEARNS

GUIDING

PRINCIPLE

We foster the development of new ideas, products and improvements. We take pride in our willingness and ability to break from the crowd to pursue new or alternate paths. Our innovation can be seen in the nature and breadth of our products, the flexibility of our operating model and our focus on teamwork in our organizational processes.

Annual Report The Bear Stearns tradition of dynamism, innovation and commitment to growth began in 1923. We have solved our clients’ problems with creativity, breaking new ground wherever conventional solutions did not work. Rather than accepting ‘the way things have always been done,’ we develop new methods to achieve our clients’ goals.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

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COMMITMENT

JEFFREY MAYER

STEVEN L. BEGLEITER

ROBERT M. STEINBERG

Management & Compensation Committee Co-Head of Fixed Income

Management & Compensation Committee Head of Corporate Strategy

Management & Compensation Committee

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We are always open to new opportunities to further our growth. The best ideas for new products and businesses have come from our own people.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

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Our commitment to risk management is evident from the boardroom to every trading desk in the firm.

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Setting records is not what is most important to us. Setting the bar higher for ourselves to achieve more and to be a better firm is what really matters.

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BRUCE M. LISMAN

MICHAEL MINIKES

Management & Compensation Committee Co-Head of Global Equities Division

Treasurer The Bear Stearns Companies Inc. Co-President Bear, Stearns Securities Corp.

COMMITMENT

We believe our clients deserve more, which is why we have increased the level of service to our clients.

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We began Global Clearing Services over 30 years ago. Although much has changed over the years, our unwavering commitment to continue to grow the business has only gotten stronger.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

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I have seen firsthand how powerful philanthropy can be by working at Bear Stearns. I always thought philanthropy just meant writing a check. At Bear Stearns, you learn it is about getting involved and giving your time. Here you see philanthropy in action at all levels of our organization. –Bonnie Leff, 25 years, Human Resources

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Philanthropy

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

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Over the years, I’ve been impressed by how we’ve been able to anticipate our clients’ needs, developing new products and services that help them stay ahead of the game. –Greg Hanley, 22 years, High Yield and Distressed Debt

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After 20 years, it is the new ideas of our people and the development of new products and businesses that still make Bear Stearns an exciting place to work every day. –Pete Cherasia, 21 years, Information Technology

Innovation

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COMMITMENT

spin-off of Idearc. In addition to being the strategic M&A bond issue for Cap Cana, SA.

advisor, we were the joint-lead

The $250 million transaction

arranger, syndication agent and joint bookrunner for

served as sole lead arranger

was not only Cap Cana’s

Idearc’s $9.4 billion bank and

and joint bookrunner on a

debut in the international

high yield financing. These

$1.7 billion senior secured credit

capital markets, but also the

offerings rank among the

facility and served as joint

largest corporate debt issue

largest single-tranche debt

bookrunner on a $1 billion sen-

out of the Dominican Republic.

offerings undertaken in the

ior notes offering for MetroPCS

Located on the easternmost

leveraged finance markets.

Wireless. Proceeds from the

tip of the Dominican Republic,

Both financings were well

transactions were used to

Cap Cana will be one of the

received by the debt markets

purchase about $1.4 billion in

largest multi-use luxury resort

and were well oversubscribed,

additional wireless spectrum

developments in the Caribbean.

with the senior notes offering

licenses, repay existing debt,

Bear Stearns is a leading

executed as one of the largest

pay premiums, fees and

underwriter for Caribbean and

unsecured tranches ever com-

expenses and for general

Central American issuers,

pleted in the high yield market.

corporate purposes.

having recently underwritten sovereign and corporate

We also acted as principal in facilitating the transaction’s

Major deals in emerging

unprecedented $7 billion debt-

markets included the financing

for-debt exchange, swapping

for the first stage of The Blue

Verizon parent-company debt

City (Al Madina Al Zarqa) in the

securities for Idearc debt.

Sultanate of Oman. The first real estate bond financing of its

Over 100 children of Bear Stearns employees learned about giving back when they decorated quilts and pillows for hospitalized children in New York City as part of Bear Stearns’ Take Your Sons and Daughters to Work Day.

We also provided debt financing

size in the Gulf region, this

for MetroPCS Wireless Inc., one

landmark transaction of nearly

transactions in Jamaica,

of the fastest-growing wireless

$1 billion launched the largest

Trinidad and Tobago, Belize,

broadband providers in the

real estate project in Oman.

Grenada and Barbados.

United States. Bear Stearns

It is the first of 10 phases to be used in the initial construction

Bear Stearns’ customers

of nearly 5,000 apartments,

recognized our commitment

200 villas, four hotels and five

to providing them with the best

retail centers. Bear Stearns

service, analysis and decision-

used a broad variety of financing

making investment tools.

techniques in developing its

Our Fixed Income Research

funding structure, including

team ranked third in the 2006

whole business securitization,

Institutional Investor All-America

traditional secured real estate

Fixed Income Research survey,

lending, project finance and

up from fifth the previous year.

credit enhancement.

Since 2000, we are the only firm included in the survey’s top

Bear Stearns was sole

ten to rise through the ranks

bookrunner for the inaugural

each year.

BondStudio® is an advanced portfolio management tool that provides investors with access to Bear Stearns’ proprietary analytical models, which perform valuation, optimization and risk management analyses on a broad spectrum of fixed income and derivative structures across multiple stress scenarios and currencies.

FUTURES AND FOREIGN EXCHANGE We had a record year in Jeff Desind’s commitment has been to the Fixed Income Department for the 21 years he has been with the firm.

futures, capitalizing on continued record trading volumes on the exchanges. Higher commodity

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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COMMITMENT

prices and our ability to transact in a greater number of products led to these excellent results.

Mike Hyatt has had a commitment to the Investment Banking Division in the 26 years he has been with the firm.

resources to bear on a single client—whether involving equity capital markets, debt capital markets, structured products, risk management, or a

Interest rate derivatives and

combination of all of the above,”

financing activities remained

added Euromoney magazine.

steady in 2006. International business growth and the

Our ongoing work with Verizon

development of correlation and

Communications Inc. illustrates

mortgage derivatives business-

the strength of Bear Stearns’

es bolstered domestic results.

investment banking franchise. In advising Verizon on its tax-

Revenues in the foreign

free spin-off of Idearc Inc., its

exchange and metals area

US print and Internet yellow

remained stable, following

pages directories business, we

five years of record growth

surpassed another milestone in

despite the lowest level of volatility for major currencies

INVESTMENT BANKING

a long-standing investment banking relationship. Bear Stearns has assisted Verizon

in a decade. n 2006 Euromoney magazine

(and its predecessor companies)

named Bear Stearns the

with many of its major strategic

MUNICIPAL BUSINESS

I

Bear Stearns’ municipal

“Best Investment Bank in

and financing initiatives for over

business had an outstanding

North America,” saying,

a decade.

“Bear’s strategy may become

year—assisting states, cities,

Bear Stearns was named

the new investment banking

This particular transaction

Best Investment Bank

business model of the near

demonstrated again the benefits

future.” For Bear Stearns, the

of Bear Stearns’ cross-discipli-

cornerstone of that strategy

nary and holistic approach to

means fully understanding our

meeting clients’ needs. Our

clients’ needs, identifying

Technology/Media/Telecom

in North America by Euromoney magazine.

solutions and opportunities

Investment Banking coverage

for those clients and following

team and Strategic Finance

through with flawless execution.

and Liability Management

in 2006, with Bear Stearns

In 2006 we reported a record

Groups worked closely together

underwriting six transactions

$1.2 billion in net revenues—a

to design and execute the

totaling more than $3.5 billion.

19% increase from 2005.

transaction.

managed a total of $5.5 billion

Our unique approach to

For General Motors and its

in insurance assessment-

investment banking is evident

GMAC financing subsidiary, we

backed financings in Florida,

within the division’s Strategic

played a key advisory role in the

Louisiana and Mississippi.

Finance Group, where each

sale of 51% of GMAC to an

In the future, as states seek

client receives a tailored, holistic

investor group led by Cerberus

efficient financing mechanisms

solution to its needs. This

Capital Management. The deal,

for catastrophe relief, Bear

approach has drawn applause:

the latest in a history of

Stearns’ experience in pricing

“Bear has attempted to put into

significant transactions for the

and structuring has the

action what most other firms

potential to significantly

merely give lip service to:

benefit our clients in times

bringing the entire investment

of crisis.

banking division and all firmwide

public authorities and not-forprofit institutions in meeting their financing needs. Our clients continued to seek flexibility and cost savings through the derivatives and cash markets. Tobacco securitizations remained a mainstay of municipal finance

During 2006, Bear Stearns

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

A company, was recognized by

$1.3 billion IPO. Bear Stearns

Investment Dealers’ Digest

also served as a joint-book-

magazine (IDD) as the overall

running manager for the privatization of a public hospitality

and joint bookrunner on a

LONG-TERM RELATIONSHIPS

company, Extended Stay

$155 million IPO for athletic

These types of long-term client

America. As a result of an

footwear company Heely’s Inc.

relationships are the hallmark of

innovative approach to lever-

Bear Stearns Investment

aged buyouts in the real estate

As financial sponsors continue

Banking Division. The Walt

universe, Blackstone is one of

to play a larger role across the

Disney Company is another

the world’s largest owners of

investment banking landscape,

example. Bear Stearns’

hotel rooms and the most active

Bear Stearns is well positioned

relationship with Disney dates

buyer of office buildings in the

to capitalize on the trend.

back more than a decade. In

United States. Bear Stearns has

Several years ago the firm

1996 we advised on Disney’s

served as one of Blackstone’s

closely aligned its leveraged

acquisition of Capital Cities/ABC.

advisors and financing sources in

finance capabilities with its

In 2006 Bear Stearns advised

almost all of these transactions.

coverage of private equity firms, hedge funds and other financial

Disney on its sale of ABC Radio

The Blackstone Group’s Real

COMMITMENT

$432 million IPO for J. Crew

“Deal of the Year.”

and its acquisition of Pixar.

FIRM

Other notable advisory and

sponsors. This integrated

financing assignments in 2006

structure provides our clients

included guiding Pfizer on its

with a streamlined approach

Estate Opportunity Fund management team, Blackstone Real Estate Partners (BREP), continued to be a very active client of Bear Stearns in 2006. During the year, Bear Stearns

Bear Stearns employees were the highest corporate fundraising team in New York City for the Leukemia & Lymphoma Society’s annual Light the Night campaign. Funds raised by the team went to cancer research.

served as an advisor and provided financing as Blackstone

$17 billion sale of its consumer

to acquisition financing. For

acquired, or announced agree-

healthcare business to Johnson

instance, when Bain Capital

ments to acquire, La Quinta

& Johnson; advising Symbol

acquired Burlington Coat

Corporation for $3.4 billion,

Technologies on its $3.9 billion

Factory, Bear Stearns acted as

MeriStar Hospitality Corporation

acquisition by Motorola; and

M&A advisor to Bain and joint

for $2.6 billion, Trizec Office

serving as joint bookrunner on

bookrunner for $2.1 billion of

Properties for $8.9 billion (in

a $4.5 billion debt offering for

debt financing. When Gold Toe

partnership with Brookfield

Embarq, which was spun off

Investment Corp. and Moretz

Properties Corporation) and

by Sprint Nextel. This deal was

Inc. combined to form one of

Equity Office Properties Trust for

recognized by IDD magazine as

the largest global sock compa-

$39.0 billion. The Equity Office

the “Telecommunications Deal

nies, Bear Stearns played an

Properties transaction was one

of the Year.”

integral role. The deal was backed by The Blackstone

of the largest leveraged buyouts ever and was recognized by

EQUITIES

Group, which acquired Gold

IDD magazine as the “Real

In 2006 Bear Stearns was lead

Toe and simultaneously facilitat-

Estate Deal of the Year.”

manager of one of the largest

ed the merger between the two

IPOs of the year: defense and

companies. Bear Stearns

engineering company SAIC’s

advised Gold Toe on the sale

Blackstone’s trend-setting wave of transactions began in 2004 when it used the commercial mortgage-backed securitization market to finance its first

Jacqueline Taddei’s commitment to supporting Investment Banking is still strong after 21 years.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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COMMITMENT Matt Redshaw’s commitment to Derivative Operations at Bear Stearns has surpassed 22 years.

and was the sole manager on $380 million of senior credit facilities for Blackstone to fund the acquisition.

a $112.5 million IPO for China GrenTech Corp. Ltd. And, in

LEVERAGED FINANCE

Latin America, Bear Stearns

Bear Stearns’ leveraged

served as sole bookrunner on

finance unit participated in

a $250 million bond issue for

several landmark transactions

Cap Cana, SA, a transaction

during the year. The firm

recognized by Latin Finance

achieved record levels of lead-

magazine as the “Asset-

managed bond deals and

Backed Deal of the Year.”

lead-arranged bank deals. Bear Stearns was a joint

MERCHANT BANKING

bookrunner on the largest

Bear Stearns Merchant Banking

holding company bond deal,

(BSMB) continues to be an

$2.1 billion of senior notes for

integral part of our franchise.

R.H. Donnelley. Bear Stearns

In 2006 BSMB raised a new

was sole bookrunner and

$2.7 billion institutional private

joint-lead arranger on a

equity fund. The fund is dedi-

$2.1 billion bank financing for

cated to making middle-market

the amusement park company

investments, primarily in the

G

Cedar Fair, and Bear Stearns

$100 million to $200 million

commitment to providing

worked closely with Metro

range, with the ability to make

clients with personalized

PCS Wireless, serving as sole-

substantially larger investments.

lead arranger and joint

BSMB has particular expertise

bookrunner on a $1.7 billion

with retail and financial services

credit facility and a $1 billion

companies and makes both

senior notes offering, the largest

control and entrepreneur-driven

Caa2/CCC-rated bond deal

investments. BSMB 2006 high-

in the history of the high yield

lights include the sales of Aearo

market.

Technologies and Hand Innovations; follow-on offerings

INTERNATIONAL

for New York & Co. and Reddy

Internationally, Bear Stearns

Ice; and the IPO of ACA Capital.

continues to extend its reach.

In addition, BSMB made an

In Europe, the firm worked

investment in Churchill Capital,

closely with pharmaceutical

a senior lender to middle-market

leader Merck KGaA on various

companies.

strategic and financing initiatives. In the Middle East,

BSMB’s affiliate Bear Growth

Bear Stearns served as lead

Capital Partners was also

arranger on the vast Blue City

active in 2006. Since its

project in Oman. In China,

inception, the group has

Bear Stearns lead managed

committed $162.5 million of Bear Stearns’ capital to 11 companies, including Harlem Furniture, Inc., Dairyland Corp. and Clintrak Pharmaceutical Services.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

GLOBAL CLEARING SERVICES lobal Clearing Services (GCS) has an unwavering

Global Clearing Services offers clients superior technology through

service and access to Bear

BearAccess,

prime brokerage, broker-dealer

which makes portfolio data directly accessible to clients and

BearPrime, a comprehensive website providing secure, round-the-clock access to portfolios.

Stearns’ global resources. Whether through our premier or investment advisor services, Bear Stearns delivers the firm in a tailored fashion to each client. With more than 30 years of experience in the global

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COMMITMENT

Annual Report

Our structure, with teams of professionals rather than layers of management, has given us a significant advantage in the constant drive for innovation in the financial markets.

‘‘

Meritocracy BEAR

STEARNS

GUIDING

PRINCIPLE

We have a culture where individuals are rewarded for their contributions to the whole. We maintain an organizational philosophy in which all of the company’s employees are recognized, rewarded and advanced based on their results, the quality of their work and their ability to uphold and improve the standards we have set for ourselves.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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O U R

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When I joined Bear Stearns, almost 22 years ago, I was immediately impressed with the drive, energy, intelligence and honesty of the employees I met. These same words—drive, energy, intelligence and honesty—continue to describe Bear Stearns. It is a pleasure to work here. –Barbara Bishop, 21 years, Legal

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I am proud to have been part of the firm’s growth into a worldclass investment bank over the past 20 years. While we are larger today, Bear Stearns has maintained its entrepreneurial culture where each of us can still make a difference. I still feel like a member of a special club, just with a larger membership. –Jim Nish, 20 years, Investment Banking

‘‘

Meritocracy ‘‘

At Bear Stearns, those who display superior achievement are rewarded with positions of leadership. All of us have the opportunity to be recognized based on our abilities and accomplishments. My career at Bear Stearns has taken many different turns and I am now a senior managing director in the Global Equities Division. The culture of meritocracy has made that possible. –Caren Wigdor-Skutch, 20 years, Equity Sales and Trading

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

A Bear Stearns one of the largest borrowers of securities and one of the largest lenders of margin

to our award-winning research.

debt on Wall Street. In addition,

Clients are responding positively,

total client assets rose to

as demonstrated by our strong

$291.2 billion on November 30,

ranking in industry surveys. In

2006, up 10% from the same

the 2006 Lipper HedgeWorld

date the prior year.

Service Provider Directory &

FIRM

COMMITMENT

Global Clearing Services has been delivering the firm to clients for over

30 years.

Guide, Bear Stearns was In 2006 we announced the

recognized as the leading

integration of our clearing

provider to the largest global

services with Institutional

hedge funds. Our prime

Equities to create a more

brokerage business ranked

seamless experience for our

first for “Assets of US Hedge

clients. We also consolidated

Funds” and second for

our senior relationship and

“Non-US Funds in the Greater

trading management teams to provide clients with a single clearing business, we are a

touch point to the firm. The

market leader in custody,

integration of these businesses

clearance, finance, securities

will enable us to increase the

lending and risk management.

volume of business we transact

Our business has grown and

with our clients and more

evolved as our clients’ needs

effectively service hedge funds.

Bear Stearns was recognized as No. 1 for “Assets of US Hedge Funds” and No. 2 for “Non-US Funds in the Greater Than $1 Billion” class by Lipper HedgeWorld Service Provider Directory & Guide. Than $1 Billion” class. This record of achievement is the

have become more sophisticated and geographically

Current estimates show that

culmination of our years of

diverse. We enter 2007 with a

there are approximately 7,000

experience in providing clearing,

market-leading US franchise and

hedge funds managing a

financing and custody services.

a deeper focus on building best-

collective $1.5 trillion worldwide.

in-class European capabilities.

These funds are now more

PRIME BROKERAGE

seasoned and mature—nearly

Effectively managing investments

In 2006 GCS reported net

40% of hedge funds have

through advanced technology is

revenues of $1.08 billion—an

existed for more than five years

all-time record. Our clients were

and their strategies have

active, as measured by

become increasingly complex.

customer margin debt balances,

At Bear Stearns, our prime

which averaged $68.4 billion in

brokerage client base is large,

2006 and ended the year at a

diversified and well-positioned

record $78.6 billion. Another

to grow. To effectively serve this

gauge of steady client activity

increasingly sophisticated client

is the average balances of

base, we have created products

securities borrowed and loaned

and services that span a wide

to customers. During 2006,

variety of investment strategies

the average balance of securities

and styles. Services include

borrowed was $55 billion and

enhanced leverage, global

the average balance of securities

securities lending, and cash,

customers had borrowed to sell

liquidity and risk management.

short was $82.6 billion—making

Prime brokerage also provides

Nancy Sevilla and Michelle Tapper have shared in a commitment to the Operations Group for 34 years and 26 years, respectively.

clients with capital introductions, business consulting and access

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COMMITMENT a priority for our clients. Prime group in retaining their best

brokerage provides clients, regardless of size or strategy,

for operations, sales and

clients and helping them com-

with proprietary and advanced

support staff. Computer-based

pete for new business. Global

technology solutions. Our

training, online tutorials and

Clearing Services facilitates

BearAccess application makes

easy-to-use training materials

investment advisors’ success

portfolio data directly accessible

are available at any time. At

through innovative technology

via a Microsoft Excel® add-in,

Bear Stearns, flexibility means

and information systems. IAS

which can create or adapt

satisfying a broad variety of

delivers clients front- and back-

customized spreadsheets.

client needs. We have strong

office technology, featuring

BearAccess fluidly interacts with

relationships with the industry’s

portfolio access, specialized

all Excel functionality, other

leading service providers,

trading tools, data downloads,

add-ins, and third-party market

which enables our technology

performance and management

data feeds. BearPrime is a

to interface seamlessly with the

reporting. RIAs can also rely on

comprehensive and intuitive

best trading, execution and

the advanced risk measurement,

website that provides secure,

reporting systems available.

analytic, investment planning

Bear Stearns Broker-Dealer

and proposal tools we provide

Services’ clients have access

to them. As the trend of smaller

to one of the most compre-

broker-dealers transitioning into

hensive trading desks in the

the RIA space increases, the

world. This includes a team

dual capability of Bear Stearns

of experienced agency traders

in both the broker-dealer and

who are committed to meeting

investment advisor sectors

the needs of all our correspon-

uniquely positions us to help

round-the-clock access to

dent customers—from

this client group.

portfolios, including positions,

institutional brokerage houses

transactions and performance

to startups. Looking forward,

As we look to 2007, Global

information. The website is a

institutional broker-dealers,

Clearing Services will continue

portal to research information,

independent retail broker-

our commitment to delivering

market data and other Bear

dealers and hedge funds are

the firm to our clients, investing

Stearns applications.

all areas where we see great

in technology, and focusing on

potential for future growth.

growing our businesses.

®

At Bear Stearns, we believe that mentors help young people discover their potential to succeed. Through our mentoring programs, our greatest asset—our employees—helps young people to excel both in and out of the classroom.

BROKER-DEALER SERVICES Broker-Dealer Services (BDS)

INVESTMENT ADVISOR SERVICES

provides innovative solutions

The Investment Advisor

to this client group worldwide,

Services (IAS) Group has broad-

including processing, clearing

based knowledge and a wealth

and settling of securities

of experience working with

transactions. Our client-centric

large, sophisticated investment

approach means every broker-

advisors. IAS is a top provider

dealer, also known as a

of custody, trading, technology

correspondent client, is serviced

and service support to leading

by a relationship management

SEC-registered investment

team to ensure it receives

advisors (RIAs). By leveraging

service from all areas of the

the complete resources of Bear

firm—operations, technology

Stearns, we assist this premier

and business integration. Clients benefit from professionals dedicated to meeting correspondents’ training needs

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Brian Lafaman’s ongoing commitment to the Margin Debt Group continues after 26 years.

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The increase in fee-based

Barry Ganz’s commitment has been to offering the resources of the entire firm to his clients in his 22 years in Private Client Services.

business is a direct result of the type of top-tier investment professionals that continue to join the firm. In 2006 more than 40 successful investment professionals, many with significant fee-based business, chose to join Bear Stearns. Combined, these new professionals have assets under management of more than $5 billion. In addition to attracting new financial professionals to the firm, Bear Stearns’ platform

PRIVATE CLIENT SERVICES

has also proved to be a compelling offering for many of our long-serving brokers.

I

n 2006 gross revenues,

Complementing the transaction-

before commission

oriented business that Bear

allocations, for the Private

Stearns has traditionally been

Client Services (PCS) segment

known for, our established

were $620 million. Net revenues

In 2006 Bear Stearns hired over

were $522 million, up 15%

40

parable basis in 2005. This

successful investment professionals.

from $453 million on a comsuccess was driven by impressive growth in feebased assets, further additions

Bear Stearns is proud to be a part of Chris Gardner’s pursuit of happiness. Long before Chris had his life story told in the critically acclaimed movie, he was a success story in Bear Stearns Private Client Services Division.

to our talented sales force, and expansion of our client

sales force has also been

resources and tools designed to

offerings.

transitioning into managed

meet the sophisticated needs of

accounts, using the services

the high-net-worth client.

Private Client Services opened

PCS made great strides in

of our advisory team to further

Through Advisory Services,

building its revenue from

diversify their clients’

investment professionals can

new satellite

fee-based business. Three

investments. As a result, the

execute a wide range of strate-

years ago, we made a

typical Bear Stearns investment

gies tailored for their clients,

commitment to this area

professional now has more

including separately managed

with the inception of Bear

assets per broker in fee-based

accounts, mutual funds and

Stearns Advisory Services®,

programs than our competitors,

alternative investments. This

Private Client Services’

according to research by

open architecture offering,

comprehensive wealth and

Cerulli Associates.

which is subject to a rigorous

offices in Columbus, Ohio and Providence, Rhode Island.

due diligence process, provides

asset management platform. In 2006 revenue from fee-

ADVISORY SERVICES

investment opportunities from

based accounts rose 67%

These investment professionals

across the industry, along with

from the year prior, and now

are turning to our program

proprietary products created

represents 33% of all PCS

because the platform has the

and managed by Bear Stearns

revenues.

Asset Management.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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Respect BEAR

STEARNS

GUIDING

PRINCIPLE

We treat others with honor and esteem. We run our company in such a way that all of our constituencies are treated with respect, including our employees, clients, stockholders, vendors, regulators and the people in the communities in which we live and work.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

Annual Report

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1999 ‘‘

We have maintained a commitment to a high degree of professionalism and ethical responsibility.

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COMMITMENT

A R E

I’ve seen many changes in the firm and it’s still a privilege to come to work every day. The quality of people coming to Bear Stearns will drive our future success. We’ve made such progress, but true growth is still ahead of us. –Dan Keating, 32 years, Municipal Finance

‘‘

‘‘

Working for a firm committed to respecting diversified talent, individual creativity and innovative ideas has given me the opportunity to explore new challenges and contribute to Bear Stearns’ success. –Bettie Jones, 26 years, Human Resources

‘‘

A strong work ethic, loyalty and teamwork are highly valued at Bear Stearns. The firm recognizes achievement and dedication. –Bob Juliana, 23 years, Fixed Income Sales

‘‘

‘‘

Respect

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

27

A

FIRM

COMMITMENT

Investment professionals have access to our cutting-edge asset allocation platform,

allowing investment profes-

which creates a customized

sionals to integrate strategic

investment profile for each

financing alternatives into their

client’s needs, goals and risk

clients’ overall wealth objectives.

Ralph Cioffi’s commitment has been to the Credit and Fixed Income Departments, and now to Bear Stearns Asset Management, in the 21 years he has been with Bear Stearns.

tolerance. PCS has also increased its offering of

But what truly sets Bear Stearns

alternative investment choices.

Private Client Services apart is

Clients have access to

the firm’s unique culture. The

Advisory Services Alternative

investment professionals who

Investments, a fee-based

have chosen to join Bear

program of externally managed

Stearns this year, and those

hedge fund of funds, and an

who continue to have long and

open architecture platform

successful careers here, have

that customizes a portfolio

access to the expertise of

of alternative strategies.

individuals and resources throughout the entire firm. While

ASSET MANAGEMENT

NEW INITIATIVES

new products are launched and

In 2006 we introduced a

technology evolves, this level of

retirement services platform,

access remains the same.

I

institutions and high-net-worth

SATELLITE OFFICES

record net revenues of $335

individuals. Private Client

We continue to seek talented

million, up 47% from $228

Services also announced that

investment professionals with

it would be developing a credit

established businesses. If

and lending program, which

these investment professionals

will give clients broader and

are not located near one of our

more flexible financing options.

branch offices, the firm contin-

The new program will comple-

ues to consider opening satel-

ment Advisory Services,

lite offices. Over the past few

which offers strategies to both

years, Bear Stearns has opened satellite offices in Bellevue, Washington; St. Louis, Missouri; and in northern

Bear Stearns Asset Management

Repackages Risk by developing a better understanding of risk, the investor’s risk appetite, and the balance between risk and return.

n 2006 Bear Stearns Asset Management reported

million in the prior year. Assets under management grew to $52.5 billion, up 25% from $41.9 billion in 2005. This achievement was the result of the outstanding performance in many of our product areas and the continued growth and development of our platform. BSAM delivers sophisticated

New Jersey. In 2006 the firm

and comprehensive investment

opened satellite offices in

solutions in traditional,

Columbus, Ohio and Providence, Rhode Island.

BSAM

expanded As we look to 2007, Private Client Services remains focused on growing our sales force, expanding our client offerings, and further contributing to the success of the firm.

its capabilities with the addition of a Quantitative Equity Team and a Fundamental Small Cap Value Team.

alternative and private equity strategies. BSAM’s core capabilities, investment analytics and investment vehicles, serve a wide range of sophisticated clients around the world, including corporations, pension plans, foundations, endowments, Taft-Hartley funds, and

Jeff Sheresky’s commitment to Private Client Services has lasted over 20 years.

28

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

high-net-worth investors. A cornerstone of BSAM’s philosophy is “repackaging

A

COMMITMENT

Emerging Managers

analytic platform that launched in 2004. Bear Measurisk offers clients

Seeding Program currently has investments in eight strategies with strong growth potential.

independent, sophisticated risk management capabilities

FIRM

INTERNATIONAL

that span asset classes and

We made significant inroads

managers. Clients are able to

in 2006 to further build our

access the results of this risk

international presence. In

modeling and performance

Europe, we have expanded

tracking via a highly interactive

our distribution capabilities

online tool. As client confiden-

and added an International

tiality is of the utmost

Growth Equity Team based in

importance, we maintain

London. BSAM also continues

separate staff and secure data

to build its presence in the

center facilities. Currently, we

Middle East. In 2005 BSAM

have 45 clients and receive

purchased 50% of Migdal

risk”—developing a better

data from over 700 hedge

Capital Markets, formerly the

understanding of risk, the

funds, representing over one-

asset management and

investor’s risk appetite, and

third of the total assets in the

brokerage division of Israeli

the balance between risk and

hedge fund universe.

insurance company Migdal Insurance. In 2006 Migdal

return. We work with clients to evaluate and use risk to

BSAM made a number of key

continued on its path to

achieve targeted returns

hires to expand the breadth

becoming one of the leading

through innovative, customized

of our capabilities, including a

firms in Israel through the

strategies.

Quantitative Equity Team and

acquisitions of Afikim Mutual

a Fundamental Small Cap BEAR MEASURISK

Value Team. We continue to

At the core of our expertise

offer clients an array of

in risk management is Bear

absolute return strategies

Measurisk, our proprietary

in the alternative space. In addition to our own alternative

Bear Stearns partnered with Sesame Workshop, the non-profit educational organization behind Sesame Street, to develop a program to help young children prepare for the challenges of today’s world.

investment offerings, BSAM

Funds and Dikla Mutual

also has developed the

Funds. This investment in

Emerging Managers Seeding

Migdal continues to expand

Program, which currently has

distribution channels in the

investments in eight strategies

Israeli market and further

with strong growth potential.

build BSAM’s international

In the private equity area,

footprint.

BSAM offers Bear Stearns Private Equity Advisors, which

We had a year of record

focuses on developing and

revenues and tremendous

delivering innovative private

growth. We look forward to

equity solutions.

further enhancing and diversifying the capabilities

Joe Riccardo’s commitment has been to offering valuable insights in Equity Research and, most recently, Bear Stearns Asset Management, in the 27 years he has been with the firm.

we deliver for our clients, expanding our global presence and raising the bar for our own success.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

29

A

FIRM

COMMITMENT

1987 ‘‘

Annual Report While the people of Bear Stearns are committed to our business, we are equally committed to the community. Management strongly encourages participation at all levels in civic, charitable and educational organizations. All [senior] managing directors, as individuals, are required to give at least 4% of their annual incomes to charity. We believe that it is our duty to provide opportunities for others and help them grow as we continue to grow.

‘‘

Philanthropy BEAR

STEARNS

GUIDING

PRINCIPLE

We believe that a personal commitment to charity is a basic underpinning of good citizenship. We have a long-standing commitment to philanthropy. We believe that it fosters a more well-rounded individual, while providing substantial assistance to the communities in which we live and work.

30

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

FINANCIAL REPORT Table of Contents

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Consolidated Financial Statements Consolidated Statements of Income

74

Introduction

32

Consolidated Statements of Financial Condition

75

Certain Factors Affecting Results of Operations

32

Consolidated Statements of Cash Flows

76

Forward-Looking Statements

32

Consolidated Statements of Changes in

Executive Overview

33

Results of Operations

35

Liquidity and Capital Resources

44

Notes to Consolidated Financial Statements

Off-Balance-Sheet Arrangements

56

Note 1

Derivative Financial Instruments

56

Critical Accounting Policies

58

Accounting and Reporting Developments Effects of Inflation

Stockholders’ Equity

77

Summary of Significant Accounting Policies

79

Note 2

Fair Value of Financial Instruments

85

60

Note 3

Financial Instruments

86

61

Note 4

Derivatives and Hedging Activities

86

Note 5

Transfers of Financial Assets 88

and Liabilities

Risk Management Note 6 Overall

62

Market Risk

63

Credit Risk

67

Operational Risk

69

Legal Risk

70

Other Risks

70

Management’s Report on Internal Control over Financial Reporting Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm

Variable Interest Entities and Mortgage Loan Special Purpose Entities

90

Note 7

Collateralized Financing Arrangements

91

Note 8

Short-Term Borrowings

92

Note 9

Long-Term Borrowings

93

Note 10 Preferred Stock

94

Note 11 Earnings Per Share

96

Note 12 Employee Benefit Plan

96

Note 13 Stock Compensation Plans

96

71 72 73

Note 14 Customer Activities

100

Note 15 Income Taxes

101

Note 16 Regulatory Requirements

103

Note 17 Commitments and Contingencies

104

Note 18 Guarantees

105

Note 19 Segment and Geographic Area Data

107

Note 20 Quarterly Information (Unaudited)

110

Corporate Information Price Range of Common Stock and Dividends

111

and Related Stockholder Matters Performance Graph

112

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

31

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

OF

FINANCIAL CONDITION

AND

R E S U LT S

OF

O P E R AT I O N S

The Bear Stearns Companies Inc.

INTRODUCTION

These and other factors can affect the Company’s volume of new

The Bear Stearns Companies Inc. (the “Company”) is a holding

securities issuances, mergers and acquisitions and business

company that through its broker-dealer and international bank

restructurings; the stability and liquidity of securities and futures

subsidiaries, principally Bear, Stearns & Co. Inc. (“Bear Stearns”),

markets; and the ability of issuers, other securities firms and

Bear, Stearns Securities Corp. (“BSSC”), Bear, Stearns International

counterparties to perform on their obligations. A decrease in the

Limited (“BSIL”) and Bear Stearns Bank plc (“BSB”), is a leading

volume of new securities issuances, mergers and acquisitions or

investment banking, securities and derivatives trading, clearance

restructurings generally results in lower revenues from investment

and brokerage firm serving corporations, governments, and

banking and, to a lesser extent, reduced principal transactions. A

institutional and individual investors worldwide. BSSC, a subsidiary

reduced volume of securities and futures transactions and reduced

of Bear Stearns, provides professional and correspondent clearing

market liquidity generally results in lower revenues from principal

services in addition to clearing and settling customer transactions

transactions and commissions. Lower price levels for securities may

and certain proprietary transactions of the Company. The Company

result in a reduced volume of transactions, and may also result in

also conducts significant activities through other wholly owned

losses from declines in the market value of securities held in

subsidiaries, including: Bear Stearns Global Lending Limited;

proprietary trading and underwriting accounts. In periods of

Custodial Trust Company; Bear Stearns Financial Products Inc.

reduced sales and trading or investment banking activity, profitability

(“BSFP”); Bear Stearns Capital Markets Inc.; Bear Stearns Credit

may be adversely affected because certain expenses remain

Products Inc.; Bear Stearns Forex Inc.; EMC Mortgage Corporation;

relatively fixed. The Company’s securities trading, derivatives,

Bear Stearns Commercial Mortgage, Inc.; and through its majority

arbitrage, market-making, specialist, leveraged lending, leveraged

owned subsidiary Bear Hunter Holdings LLC. The Company is

buyout and underwriting activities are conducted on a principal

primarily engaged in business as a securities broker-dealer

basis and expose the Company to significant risk of loss. Such risks

operating in three principal segments: Capital Markets, Global

include market, counterparty credit and liquidity risks. For a discussion

Clearing Services and Wealth Management. As used in this report,

of how the Company manages risks, see the “Risk Management”

the “Company” refers (unless the context requires otherwise) to The

and “Liquidity and Capital Resources” sections in this report.

Bear Stearns Companies Inc. and its subsidiaries. Unless specifically noted otherwise, all references to fiscal 2006, 2005

Substantial legal liability or a significant regulatory action against the

and 2004 refer to the twelve months ended November 30, 2006,

Company could have a material adverse effect or cause significant

2005 and 2004, respectively.

reputational harm to the Company, which in turn could seriously harm the Company’s business prospects. Firms in the financial

CERTAIN FACTORS AFFECTING RESULTS OF OPERATIONS

services industry have been operating in a stringent regulatory

The Company’s principal business activities—investment banking,

environment. The Company faces significant legal risks in its

securities and derivatives sales and trading, clearance, brokerage

businesses, and the volume of claims and amount of damages and

and asset management—are, by their nature, highly competitive

penalties claimed in litigation and regulatory proceedings against

and subject to various risks, including volatile trading markets and

financial institutions have been increasing.

fluctuations in the volume of market activity. Consequently, the Company’s net income and revenues have been, and are likely to

FORWARD-LOOKING STATEMENTS

continue to be, subject to wide fluctuations, reflecting the effect of

Certain statements contained in this discussion are “forward-

many factors, including general economic conditions, securities

looking statements” within the meaning of the Private

market conditions, the level and volatility of interest rates and equity

Securities Litigation Reform Act of 1995. Such forward-looking

prices, competitive conditions, liquidity of global markets, international

statements concerning management’s expectations, strategic

and regional political conditions, regulatory and legislative

objectives,

developments, monetary and fiscal policy, investor sentiment,

performance and financial condition and other similar matters

availability and cost of capital, technological changes and events,

are subject to risks and uncertainties, including those

outcome of legal proceedings, changes in currency values, inflation,

described in the preceding paragraph, which could cause

credit ratings and the size, volume and timing of transactions.

actual results to differ materially from those discussed in the

32

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

business

prospects,

anticipated

economic

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

forward-looking statements. Forward-looking statements

increase in average customer margin balances, reflecting improved

speak only as of the date of the document in which they are

US equity markets, contributed to an increase in net interest revenues,

made. We disclaim any obligation or undertaking to provide

partially offset by a decline in commission and other revenues.

any updates or revisions to any forward-looking statement to reflect any change in our expectations or any change in events,

Wealth Management net revenues increased 26.0% to a record

conditions or circumstances on which the forward-looking

$857.7 million in fiscal 2006 from $680.5 million in fiscal 2005,

statement is based.

reflecting higher asset management revenues due to increased performance fees on proprietary hedge fund products and

EXECUTIVE OVERVIEW

increased management fees on higher levels of traditional assets

SUMMARY OF RESULTS

under management. Private Client Services (“PCS”) also had increased

A generally favorable operating environment characterized by an

net interest revenues and increased net revenues associated with

expanding US economy and active equity and fixed income markets

growth in fee-based assets.

provided a healthy climate for the Company’s businesses during fiscal 2006. Revenues, net of interest expense (“net revenues”), for the fiscal year ended November 30, 2006 increased 24.5% to a

BUSINESS ENVIRONMENT Fiscal 2006

record $9.23 billion from $7.41 billion for the fiscal year ended

The business environment during the Company’s fiscal year ended

November 30, 2005, while pre-tax earnings increased 42.6%

November 30, 2006 was generally favorable due to a combination of

during the same period to $3.15 billion. The pre-tax profit margin for

factors, including an expanding US economy, improved corporate

fiscal 2006 increased to 34.1%, compared with 29.8% for fiscal

profitability, low unemployment and moderate inflation. Favorable

2005. Return on average common equity was 19.1% for

labor reports provided ongoing support to economic activity in fiscal

fiscal 2006, compared with 16.5% for fiscal 2005.

2006. The unemployment rate dropped to 4.4% in October 2006, its lowest level since August 2001 and ended fiscal 2006 at 4.5%.

Capital Markets net revenues increased 27.9% to a record $7.32

However, rising energy prices continued to be a cause for concern

billion for fiscal 2006, compared with $5.72 billion for fiscal 2005.

throughout fiscal 2006, as the price of oil increased from

Within the Capital Markets segment, institutional equities net

approximately $57 a barrel in December 2005 to a high of

revenues increased 35.7% to a record $1.96 billion for fiscal 2006

approximately $77 a barrel in August 2006. A decline in oil prices

from $1.45 billion for fiscal 2005. The increase in institutional equities

during the fourth quarter of fiscal 2006 helped fuel a year-end rally in

was driven by increases in equity derivatives, international sales and

the equity markets. The Federal Reserve Board (the “Fed”) met eight

trading, risk arbitrage and energy activities. Fixed income net

times during fiscal 2006 and raised the federal funds rate during

revenues reached record levels, increasing 27.2% to $4.19 billion

each of its first five meetings, in 25 basis point increments, from

for fiscal 2006 from $3.29 billion for fiscal 2005. Mortgage-backed

4.00% to 5.25%, supported by gains in productivity, relatively low

securities net revenues increased during fiscal 2006 when

core inflation and expansion in economic activity. However, during its

compared with fiscal 2005 as mortgage-backed securities

last three meetings of fiscal 2006, the Fed kept the federal funds rate

origination volumes and secondary trading revenues increased.

unchanged at 5.25%, citing a cooling of the housing market and

Credit product net revenues reached record levels, reflecting record

moderating economic growth from its strong pace earlier in the year.

results from the leveraged finance and distressed trading areas and improved credit derivatives net revenues. Investment banking

Each of the major US equity indices increased during the fiscal year

revenues increased 19.0% to a record $1.17 billion for fiscal 2006

ended November 30, 2006. The Standard & Poor’s 500 Index (“S&P

from $983.0 million for fiscal 2005, primarily reflecting increases in

500”), the Dow Jones Industrial Average (“DJIA”) and the Nasdaq

advisory fee revenues and underwriting revenues, partially offset by a

Composite Index (“NASDAQ”) increased 12.1%, 13.1% and 8.9%,

decrease in merchant banking revenues.

respectively. Average daily trading volume on the New York Stock Exchange (“NYSE”) and the Nasdaq increased 5.5% and 10.3%,

Global Clearing Services net revenues increased 4.7% to a record

respectively, compared with fiscal 2005. Industry-wide US-announced

$1.08 billion for fiscal 2006 from $1.03 billion for fiscal 2005. An

M&A volumes increased 22.0% while industry-wide US-completed

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

33

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

M&A volumes increased 40.7%, compared with fiscal 2005. Total

increased 6.4%, 3.6% and 6.5%, respectively. Average daily trading

industry-wide equity issuance volumes increased 25.3%, while

volume on the NYSE and the NASDAQ increased 9.4% and 3.9%,

industry-wide initial public offering (“IPO”) volumes increased 3.4%,

respectively, compared with fiscal 2004. Industry-wide US-announced

compared with the levels reached during fiscal 2005.

M&A volumes increased 52% while industry-wide US-completed M&A volumes increased 8%, compared with fiscal 2004. Total

Fixed income markets remained strong in fiscal 2006 despite

equity issuances, including IPO volumes, declined 11% and 14%,

challenges associated with higher short-term interest rates and a flat

respectively, compared with the levels reached during fiscal 2004.

yield curve. Long-term rates, as measured by the 10-year Treasury bond, remained relatively stable during fiscal 2006. At the close of

Fixed income markets continued to be robust in fiscal 2005 despite

fiscal 2006, the 10-year Treasury bond yield was 4.46%, compared

a more challenging environment associated with higher short-term

with 4.50% on November 30, 2005. US mortgage-backed securities

interest rates and a flattening yield curve. Long-term rates, as measured

underwriting volumes increased 10.9% in fiscal 2006 compared with

by the 10-year Treasury bond, remained relatively stable during fiscal

fiscal 2005 and continued to benefit from favorable market conditions.

2005. At the close of fiscal 2005, the 10-year Treasury bond yield

Agency collateralized mortgage obligation (“CMO”) volumes

was 4.50%, compared with 4.36% on November 30, 2004. Mortgage-

declined 15.9% industry-wide from the levels reached during fiscal

backed securities underwriting volumes continued to benefit from

2005, reflecting declining refinancing activity. However, non-agency

favorable market conditions. Agency CMO volumes declined

mortgage-backed originations increased 27.3%. The Mortgage

industry-wide from the levels reached during fiscal 2004, but were

Bankers Association Purchase Index decreased approximately

offset by an increase in non-agency mortgage-backed originations.

12.9%, compared with fiscal 2005, as average 30-year fixed

The Mortgage Bankers Association Purchase Index increased

mortgage rates increased and the home purchasing market cooled

approximately 5%, compared with fiscal 2004, as continued low long-

in fiscal 2006 compared with fiscal 2005.

term interest rates fueled a strong home purchasing market.

Fiscal 2005 The business environment during the Company’s fiscal year ended November 30, 2005 was generally favorable due to a combination of factors, including an expanding US economy, improved corporate profitability and low inflation. Favorable labor reports and an active housing market provided ongoing support to economic activity in fiscal 2005. The unemployment rate dropped to 4.9% in August 2005, its lowest level since August 2001 and ended fiscal 2005 at 5.0%. However, rising energy prices continued to be a cause for concern throughout fiscal 2005, as the price of oil increased from a low of approximately $41 a barrel in December 2004 to a high of approximately $70 a barrel by the end of August 2005, affected by hurricane-related supply disruptions. Rising energy costs reinforced concerns by investors that the US economy would slow in the second half of fiscal 2005. However, the US economy remained resilient. A number of positive economic reports during the second half of fiscal 2005 and a pullback in oil prices to $57 a barrel in November fueled a year-end rally in the equity markets. The Fed met eight times during fiscal 2005 and raised the federal funds rate each time, in 25 basis point increments, from 2.00% to 4.00%, supported by gains in productivity, an increase in job growth and rising consumer confidence. Each of the major US equity indices increased during the fiscal year ended November 30, 2005. The S&P 500, the DJIA and the NASDAQ

34

•

T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

RESULTS OF OPERATIONS FIRMWIDE RESULTS The following table sets forth an overview of the Company’s financial results for the fiscal years ended November 30, 2006, 2005 and 2004: (in thousands, except per share amounts, pre-tax profit margin and return on average common equity)

% Increase 2006/2005 2005/2004

2006

2005

2004

Revenues, net of interest expense

$ 9,227,165

$ 7,410,794

$ 6,812,883

24.5%

8.8%

Income before provision for income taxes

$ 3,146,630

$ 2,207,059

$ 2,022,154

42.6%

9.1%

Net income

$ 2,053,871

$ 1,462,177

$ 1,344,733

40.5%

8.7%

Diluted earnings per share

$

$

$

38.4%

5.6%

14.27

10.31

9.76

Pre-tax profit margin

34.1%

29.8%

29.7%

Return on average common equity

19.1%

16.5%

19.1%

The Company reported net income of $2.05 billion, or $14.27 per

Fiscal 2006 versus Fiscal 2005 Net revenues increased 24.5% to

share (diluted), for fiscal 2006, which represented an increase of

$9.23 billion in fiscal 2006 from $7.41 billion in fiscal 2005 due to

40.5% from $1.46 billion, and 38.4% from $10.31 per share (diluted),

increases in principal transactions revenues, investment banking

respectively, for fiscal 2005. The Company reported net income of

revenues, net interest revenues and asset management and other

$1.34 billion for fiscal 2004, or $9.76 per share (diluted).

revenues, partially offset by a decrease in commission revenues.

The Company’s commission revenues by reporting category for the fiscal years ended November 30, 2006, 2005 and 2004 were as follows:

2006

(in thousands)

Institutional Clearance Retail Total commissions

$

786,359 233,805

2005 $

776,900 260,889

2004 $

% Increase (Decrease) 2006/2005 2005/2004

703,593

1.2%

10.4%

303,194

(10.4%)

(14.0%)

142,522

162,665

171,287

(12.4%)

(5.0%)

$ 1,162,686

$ 1,200,454

$ 1,178,074

(3.1%)

1.9%

Note: Certain prior period items have been reclassified to conform to the current period’s presentation.

Commission revenues in fiscal 2006 decreased 3.1% to $1.16 billion from $1.20 billion in fiscal 2005. Institutional commissions increased 1.2% to $786.4 million from $776.9 million in fiscal 2005 due to increased average daily trading volumes. Clearance commissions decreased 10.4% to $233.8 million in fiscal 2006 from $260.9 million in fiscal 2005, primarily reflecting lower average rates from prime brokerage and fully disclosed clients. Retail commissions decreased 12.4% to $142.5 million in fiscal 2006 from $162.7 million in fiscal 2005 due to the transition of certain accounts from a commissionbased to a fee-based platform.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

35

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

The Company’s principal transactions revenues by reporting category for the fiscal years ended November 30, 2006, 2005 and 2004 were as follows:

Fixed income

2005

2004

$ 3,617,359

$ 2,998,286

$ 3,071,960

20.6%

(2.4%)

1,377,653

837,731

523,635

64.5%

60.0%

$ 4,995,012

$ 3,836,017

$ 3,595,595

30.2%

6.7%

Equities Total principal transactions

% Increase (Decrease) 2006/2005 2005/2004

2006

(in thousands)

Note: Certain prior period items have been reclassified to conform to the current period’s presentation.

Revenues from principal transactions in fiscal 2006 increased

acquisition finance activity. Additionally, revenues from credit

30.2% to $5.00 billion from $3.84 billion in fiscal 2005. Fixed income

derivatives increased due to higher customer activities reflecting

revenues increased 20.6% to $3.62 billion for fiscal 2006 from

favorable market conditions. Revenues derived from the Company’s

$3.00 billion for fiscal 2005, primarily attributable to an increase in

equities activities increased 64.5% to $1.38 billion in fiscal 2006

net revenues in the mortgage-backed securities, distressed trading

from $837.7 million in fiscal 2005. Net revenues from equity

and credit derivatives areas. Mortgage-backed securities revenues

derivatives rose on favorable market conditions and increased

increased during fiscal 2006 when compared with fiscal 2005 on

customer activity. Equity revenues from the Company’s international

higher origination volumes from asset-backed securities, adjustable

equity sales and trading business also increased, which benefited

rate mortgage (“ARM”) securities and commercial mortgage-

from higher average daily trading volumes and increased market share

backed securities, as well as increased secondary trading revenues,

in both European and Asian equities. Revenues from the risk

particularly in non-agency mortgage-backed securities, asset-backed

arbitrage area increased due to higher global announced M&A

securities and ARMs. Revenues derived from distressed trading

volumes. In addition, fiscal 2006 included gains on the Company’s

increased as corporate credit spreads tightened and customer

sale of certain commodity assets as well as gains on the Company’s

activity increased during fiscal 2006. Revenues from the leveraged

investment in the NYSE Group Inc.

finance business increased significantly, associated with increased The Company’s investment banking revenues by reporting category for the fiscal years ended November 30, 2006, 2005 and 2004 were as follows:

2006

(in thousands)

Underwriting Advisory and other fees Merchant banking Total investment banking

$

514,698 707,093

2005 $

470,910 412,689

2004 $

% Increase (Decrease) 2006/2005 2005/2004

433,437

9.3%

8.6%

350,727

71.3%

17.7%

111,960

153,614

246,887

(27.1%)

(37.8%)

$ 1,333,751

$ 1,037,213

$ 1,031,051

28.6%

0.6%

Investment banking revenues increased 28.6% to $1.33 billion in fiscal

investment gains and performance fees on managed merchant

2006 from $1.04 billion in fiscal 2005. Underwriting revenues

banking funds. Merchant banking revenues decreased 27.1% to

increased 9.3% to $514.7 million in fiscal 2006 from $470.9 million

$112.0 million for fiscal 2006 from $153.6 million for fiscal 2005,

in fiscal 2005, primarily due to higher levels of high yield and high

reflecting lower net gains on the Company’s portfolio of investments

grade underwriting activity. Partially offsetting these increases was a

and lower performance fees on managed merchant banking funds.

decline in equity underwriting revenues reflecting lower levels of equity underwriting activity. Advisory and other fees for fiscal 2006

Net interest revenues (interest and dividends revenue less interest

increased 71.3% to $707.1 million from $412.7 million for fiscal 2005,

expense) increased 25.5% to $1.21 billion in fiscal 2006 from

reflecting a significant increase in completed M&A assignments during

$965.4 million in fiscal 2005. The increase in net interest revenues

fiscal 2006. Merchant banking revenues include realized and unrealized

was primarily attributable to higher levels of customer interest-bearing

36

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

balances and improved net interest margins. Average customer

related financing rose on increased M&A activities and distressed

margin debt balances increased 5.4% to $68.4 billion in fiscal 2006

debt revenues increased as credit spreads tightened and customer

from $64.9 billion in fiscal 2005. Average customer short balances

activity increased. In addition, revenues from credit and fixed

decreased 2.1% to $82.6 billion in fiscal 2006 from $84.4 billion in

income derivatives increased due to increased customer volume.

fiscal 2005 and average securities borrowed balances decreased

Revenues derived from the Company’s equities activities increased

7.4% to $55.0 billion in fiscal 2006 from $59.4 billion in fiscal 2005.

60.0% to $837.7 million in fiscal 2005 from $523.6 million in fiscal 2004, primarily due to increased revenues from the Company’s

Asset management and other revenues increased 40.9% to $523.9

equity derivatives as a result of increased customer volume and

million for fiscal 2006 from $371.7 million for fiscal 2005, primarily

principal gains of $75.6 million associated with the Company’s

reflecting increased performance fees on proprietary hedge fund

investment in the International Securities Exchange (“ISE”). In

products and increased management fees on higher levels of

addition, equity revenues from the Company’s international equity

traditional assets under management. PCS fees also increased due

sales and trading business increased, which benefited from higher

to higher levels of fee-based assets.

average daily trading volumes and increased market share.

Fiscal 2005 versus Fiscal 2004 Net revenues increased 8.8% to

Investment banking revenues increased slightly to $1.04 billion in

$7.41 billion in fiscal 2005 from $6.81 billion in fiscal 2004 due to

fiscal 2005 from $1.03 billion in fiscal 2004. Underwriting revenues

increases in all revenue categories, including net interest revenues,

increased 8.6% to $470.9 million in fiscal 2005 from $433.4 million

principal transactions revenues, commission revenues, investment

in fiscal 2004, primarily resulting from higher levels of equity

banking revenues and asset management and other revenues.

underwriting revenues that reflected strengthening market conditions and increased new issue activity. Partially offsetting these increases

Commission revenues in fiscal 2005 increased 1.9% to $1.20 billion

was a decline in high yield underwriting revenues on lower new issue

from $1.18 billion in fiscal 2004. Institutional commissions increased

volumes. Advisory and other fees for fiscal 2005 increased 17.7% to

10.4% to $776.9 million from $703.6 million in fiscal 2004 due to

$412.7 million from $350.7 million for fiscal 2004 as M&A fees rose

increased average daily trading volume on the NYSE and market

resulting from an increase in completed M&A assignments during

share improvement. Clearance commissions decreased 14.0% to

fiscal 2005. In addition, mortgage servicing revenues increased

$260.9 million in fiscal 2005 from $303.2 million in fiscal 2004,

during fiscal 2005, reflecting significant growth in loan servicing

primarily reflecting lower trading volumes and rates from prime

volumes. Merchant banking revenues decreased 37.8% to $153.6

brokerage clients. Retail commissions decreased 5.0% to $162.7

million for fiscal 2005 from $246.9 million for fiscal 2004. Merchant

million in fiscal 2005 from $171.3 million in fiscal 2004.

banking revenues include realized and unrealized investment gains and performance fees on managed merchant banking funds.

Revenues from principal transactions in fiscal 2005 increased 6.7%

Fiscal 2004 includes merchant banking gains of approximately $163

to $3.84 billion from $3.60 billion in fiscal 2004. Fixed income

million related to the Company’s investment in New York &

revenues decreased 2.4% to $3.00 billion for fiscal 2005 from $3.07

Company, Inc.

billion for fiscal 2004, primarily attributable to a decrease in net revenues in the mortgage-backed securities business, which was

Net interest revenues (interest and dividends revenue less interest

partially offset by an increase in net revenues in the Company’s

expense) increased 36.3% to $965.4 million in fiscal 2005 from

leveraged finance and distressed debt areas. Mortgage-backed

$708.3 million in fiscal 2004. The increase in net interest revenues

securities origination revenues declined from the robust levels of

was primarily attributable to higher levels of customer interest-bearing

fiscal 2004 due to a flattening yield curve, shifting market conditions

balances and improved net interest margins. Average customer

and changes in product mix. A decline in agency CMO volumes was

margin debt balances increased 25.8% to $64.9 billion in fiscal 2005

offset by an increase in non-agency mortgage originations.

from $51.6 billion in fiscal 2004. Average customer short balances

Secondary mortgage-backed securities revenues also declined

increased 10.6% to $84.4 billion in fiscal 2005 from $76.3 billion in

from fiscal 2004 as an increase in hedging costs, resulting from

fiscal 2004 and average securities borrowed balances decreased

more volatile market conditions, offset increased customer volumes.

3.3% to $59.4 billion in fiscal 2005 from $61.4 billion in fiscal 2004.

The net revenues from leveraged finance increased as acquisition-

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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37

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

Asset management and other revenues increased 24.0% to $371.7

products. Management fees also increased during fiscal 2005 on

million for fiscal 2005 from $299.9 million for fiscal 2004, primarily

higher levels of traditional assets under management. PCS fees

reflecting increased performance fees on proprietary hedge fund

increased as well due to higher levels of fee-based assets.

Non-Interest Expenses The Company’s non-interest expenses for the fiscal years ended November 30, 2006, 2005 and 2004 were as follows:

2006

2005

2004

$ 4,343,499

$ 3,553,216

$ 3,253,862

Floor brokerage, exchange and clearance fees

226,882

221,553

Communications and technology

478,780

401,673

Occupancy

197,756

167,825

Advertising and market development

147,262

Professional fees

279,942

(in thousands)

Employee compensation and benefits

Other expenses Total non-interest expenses

% Increase (Decrease) 2006/2005 2005/2004 22.2%

9.2%

230,652

2.4%

(3.9%)

369,176

19.2%

8.8%

141,916

17.8%

18.3%

126,678

113,800

16.2%

11.3%

229,198

197,086

22.1%

16.3%

406,414

503,592

484,237

(19.3%)

4.0%

$ 6,080,535

$ 5,203,735

$ 4,790,729

16.8%

8.6%

Fiscal 2006 versus Fiscal 2005 Employee compensation and

2006 from $167.8 million for fiscal 2005, reflecting additional office

benefits includes the cost of salaries, benefits and incentive

space requirements and higher leasing costs associated with the

compensation, including Capital Accumulation Plan (“CAP Plan”)

Company’s headquarters building at 383 Madison Avenue in New

units, restricted stock units and option awards. Employee

York City. Advertising and market development costs increased

compensation and benefits increased 22.2% to $4.34 billion for

16.2% to $147.3 million for fiscal 2006 from $126.7 million for fiscal

fiscal 2006 from $3.55 billion for fiscal 2005, primarily due to higher

2005 primarily due to higher levels of business promotion expenses.

discretionary compensation associated with the increase in net

Other expenses decreased 19.3% to $406.4 million in fiscal 2006

revenues and increased headcount. Employee compensation and

from $503.6 million in fiscal 2005, principally due to a reduction in

benefits as a percentage of net revenues was 47.1% for fiscal 2006,

legal and litigation-related costs. Partially offsetting this decrease

compared with 47.9% for fiscal 2005. Full-time employees

was an increase in costs related to the CAP Plan. CAP Plan-related

increased to 13,566 at November 30, 2006 from 11,843 at

costs increased to $154.0 million for fiscal 2006 from $144.0 million

November 30, 2005.

in fiscal 2005 due to a higher level of earnings. The Company achieved a pre-tax profit margin of 34.1% for fiscal 2006, up from

Non-compensation expenses increased 5.2% to $1.74 billion for

29.8% for fiscal 2005.

fiscal 2006 from $1.65 billion for fiscal 2005. Non-compensation expenses as a percentage of net revenues decreased to 18.8% for

The Company’s effective tax rate increased to 34.73% for fiscal 2006,

fiscal 2006, compared with 22.3% for fiscal 2005. The increase in

compared with 33.75% for fiscal 2005, primarily due to an increase

non-compensation-related costs compared with fiscal 2005 was

in the level of earnings in fiscal 2006, as related to preference items.

principally related to increased communications and technology costs, professional fees, occupancy costs and advertising and market

Fiscal 2005 versus Fiscal 2004 Employee compensation and

development costs. Communications and technology costs increased

benefits includes the cost of salaries, benefits and incentive

19.2% to $478.8 million in fiscal 2006 from $401.7 million in fiscal

compensation, including CAP Plan units, restricted stock units and

2005 as increased headcount resulted in higher voice and market

option awards. Employee compensation and benefits increased

data-related costs as well as information technology consulting

9.2% to $3.55 billion for fiscal 2005 from $3.25 billion for fiscal 2004,

costs. Professional fees increased 22.1% to $279.9 million in fiscal

primarily due to higher discretionary compensation associated with

2006 from $229.2 million in fiscal 2005 attributable to higher levels

the increase in net revenues and an increase in headcount.

of non-IT consulting fees, employment agency fees, and temporary

Employee compensation and benefits as a percentage of net

staff. Occupancy costs increased 17.8% to $197.8 million for fiscal

revenues was 47.9% for fiscal 2005, compared with 47.8% for fiscal

38

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S DISCUSSION

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A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

2004. Full-time employees increased to 11,843 at November 30, 2005 from 10,961 at November 30, 2004. Non-compensation expenses increased 7.4% to $1.65 billion for fiscal 2005 from $1.54 billion for fiscal 2004. Non-compensation expenses as a percentage of net revenues decreased to 22.3% for fiscal 2005, compared with 22.6% for fiscal 2004. The increase in non-compensation-related costs compared with fiscal 2004 was principally related to increased communications and technology costs, occupancy costs and professional fees. Communications and technology costs increased 8.8% as increased headcount resulted in higher voice and market data-related costs. Occupancy costs increased 18.3% to $167.8 million for fiscal 2005, reflecting additional office space requirements and higher leasing costs associated with the Company’s headquarters building at 383 Madison Avenue in New York City. Professional fees increased 16.3% to $229.2 million in fiscal 2005 from $197.1 million in fiscal 2004, attributable to higher levels of legal fees, temporary help and employment agency fees. Other expenses increased $19.4 million, or 4.0%, in fiscal 2005, principally due to an increase in litigation-related costs. Partially offsetting these increases was a decrease in costs related to the CAP Plan. CAP Plan-related costs decreased to $144.0 million for fiscal 2005 from $176.0 million in fiscal 2004 due to fewer CAP Plan units outstanding. The Company achieved a pre-tax profit margin of 29.8% for fiscal 2005, up slightly from 29.7% for fiscal 2004. The Company’s effective tax rate increased to 33.75% for fiscal 2005, compared with 33.50% for fiscal 2004.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

39

MANAGEMENT’S DISCUSSION

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A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

BUSINESS SEGMENTS

interest) as well as certain corporate administrative expenses from

The remainder of “Results of Operations” is presented on a business

“Other” to its three business segments. Certain legal and CAP Plan

segment basis. The Company’s three business segments—Capital

costs continue to be included in “Other.” Management believes that

Markets, Global Clearing Services and Wealth Management—are

these changes provide an improved representation of each segment’s

analyzed separately due to the distinct nature of the products they

contribution to net revenues and pre-tax income for which to

provide and the clients they serve. Certain Capital Markets products

evaluate performance. These reclassifications were also made to prior

are distributed by the Wealth Management and Global Clearing

year amounts to conform to the current year’s presentation and are

Services distribution networks, with the related revenues of such

reflected in the following business segment discussion and in

intersegment services allocated to the respective segments.

Note 19, “Segment and Geographic Area Data,” in Notes to Consolidated Financial Statements.

For the year ended November 30, 2006, the Company changed its presentation of segments to allocate certain revenues (predominantly Capital Markets

(in thousands)

% Increase (Decrease) 2006/2005 2005/2004

2006

2005

2004

$ 1,961,769

$ 1,445,907

$ 1,087,819

35.7%

32.9%

4,189,879

3,293,044

3,147,261

27.2%

4.6%

Net revenues Institutional equities Fixed income

1,169,505

983,044

1,070,048

19.0%

(8.1%)

Total net revenues

Investment banking

$ 7,321,153

$ 5,721,995

$ 5,305,128

27.9%

7.9%

Pre-tax income

$ 2,800,506

$ 2,020,484

$ 1,914,917

38.6%

5.5%

Note: Certain prior period items have been reclassified to conform to the current period’s presentation.

The Capital Markets segment is comprised of the institutional equities,

underwriting of equity, investment grade, municipal and high yield

fixed income and investment banking areas. The Capital Markets

debt products.

segment operates as a single integrated unit that provides the sales, trading and origination effort for various fixed income, equity and

Fiscal 2006 versus Fiscal 2005 Net revenues for Capital Markets

advisory products and services. Each of the three businesses work

increased 27.9% to $7.32 billion for fiscal 2006, compared with

in tandem to deliver these products and services to institutional and

$5.72 billion for fiscal 2005. Pre-tax income for Capital Markets

corporate clients.

increased to $2.80 billion for fiscal 2006 from $2.02 billion for fiscal 2005. Pre-tax profit margin was 38.3% for fiscal 2006, compared

Institutional equities consists of sales, trading and research, in areas

with 35.3% for fiscal 2005.

such as domestic and international equities, block trading, over-thecounter equities, equity derivatives, energy and commodity

Institutional equities net revenues for fiscal 2006 increased 35.7% to

activities, risk and convertible arbitrage and through a majority-owned

$1.96 billion from $1.45 billion for fiscal 2005. Revenues from the

joint venture, specialist activities on the NYSE, American Stock

Company’s energy and commodity activities increased, reflecting gains

Exchange (“AMEX”) and ISE. Fixed income includes sales, trading,

from the sale of certain commodity assets and increased revenues from

origination and research provided to institutional clients across a

the Company’s energy activities. Equity derivatives revenues increased

variety of products such as mortgage- and asset-backed securities,

during fiscal 2006 to record levels reflecting increased customer

corporate and government bonds, municipal bonds, high yield

activity and favorable market conditions. Net revenues from

products, including bank and bridge loans, foreign exchange and

international institutional equities activities increased, reflecting higher

interest rate and credit derivatives. Investment banking provides

customer trading volumes and increased market share in both the

services in capital raising, strategic advice, mergers and acquisitions

European and Asian equity markets. Risk arbitrage revenues also

and merchant banking. Capital raising encompasses the Company’s

increased during fiscal 2006 on higher announced M&A volumes and

40

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

market share gains. Fiscal 2006 also included gains on the

reflecting higher customer trading volumes. Market share gains in

Company’s investment in the NYSE Group Inc.

Europe and improved Asian equity markets contributed to an increase in net revenues from international equities activities in fiscal

Fixed income net revenues increased 27.2% to $4.19 billion for fiscal

2005. Risk arbitrage revenues increased during fiscal 2005 on higher

2006 from $3.29 billion for fiscal 2005, primarily reflecting strong

announced M&A volumes and market share gains. Equity derivatives

results from the Company’s mortgage-backed securities area as

revenues also increased significantly during fiscal 2005, benefiting

well as record net revenues from the credit businesses. Mortgage-

from improved market conditions and increased customer activity.

backed securities revenues increased during fiscal 2006 when

Fiscal 2005 also includes principal gains of $63.3 million associated

compared with fiscal 2005 on higher origination volumes from

with the Company’s investment in the ISE. Partially offsetting these

asset-backed securities, ARMs, and commercial mortgage-backed

increases was a decline in net revenues from NYSE specialist activities

securities, as well as increased secondary trading revenues. Credit

during fiscal 2005, reflecting lower market volatility.

products net revenues reached record levels, reflecting a significant increase in revenues from the Company’s leveraged finance,

Fixed income net revenues increased 4.6% to $3.29 billion for fiscal

distressed trading and credit derivatives areas. Leveraged finance

2005 from $3.15 billion for fiscal 2004, primarily reflecting strong

revenues achieved record levels, reflecting the surge in acquisition

results from the Company’s high yield business, particularly the

related financing activity associated with higher M&A volumes and

leveraged finance and distressed debt areas. Credit derivatives net

increased market share. Revenues from the Company’s interest rate

revenues increased during fiscal 2005 on improved customer volumes

product business declined during fiscal 2006 when compared with

together with market share gains. In addition, net revenues from the

fiscal 2005, primarily due to a decrease in interest rate derivatives

Company’s interest rate business increased significantly on record

and foreign exchange revenues.

foreign exchange net revenues. During fiscal 2005, the Company maintained its industry-leading position in underwriting adjustable-rate

Investment banking revenues increased 19.0% to $1.17 billion for fiscal

mortgages and non-conforming fixed-rate mortgages. Mortgage-

2006 from $983.0 million for fiscal 2005. Underwriting revenues

backed securities revenues declined from the robust levels of

increased 6.7% to $567.6 million for fiscal 2006 from $532.0 million

fiscal 2004 due to a flattening yield curve, shifting market conditions

for fiscal 2005. Higher levels of high yield and high grade underwriting

and changes in product mix. Secondary mortgage-backed

activity during fiscal 2006 were partially offset by lower levels of

securities revenues also declined from fiscal 2004 as an increase in

equity underwriting activity. Advisory and other fees for fiscal 2006

hedging costs resulting from volatile market conditions offset

increased 64.7% to $489.9 million from $297.4 million for fiscal

increased customer volumes.

2005, reflecting an increase in M&A fees resulting from a significant increase in completed M&A assignments. Merchant banking revenues

Investment banking revenues decreased 8.1% to $983.0 million for

include realized and unrealized investment gains and performance

fiscal 2005 from $1.07 billion for fiscal 2004. Underwriting revenues

fees on managed merchant banking funds. Merchant banking revenues

increased 2.4% to $532.0 million for fiscal 2005 from $519.7 million

decreased 27.1% to $112.0 million for fiscal 2006 from $153.6 million

for fiscal 2004. Higher levels of equity and municipal underwriting

for fiscal 2005.

revenues during fiscal 2005 were partially offset by lower levels of high yield underwriting revenues. Advisory and other fees for fiscal

Fiscal 2005 versus Fiscal 2004 Net revenues for Capital Markets

2005 decreased 2.0% to $297.4 million from $303.4 million for fiscal

increased 7.9% to $5.72 billion for fiscal 2005, compared with

2004. Merchant banking revenues decreased 37.8% to $153.6 million

$5.31 billion for fiscal 2004. Pre-tax income for Capital Markets

for fiscal 2005 from $246.9 million for fiscal 2004. Fiscal 2004

increased 5.5% to $2.02 billion for fiscal 2005 from $1.91 billion for

included merchant banking gains related to the Company’s investment

fiscal 2004. Pre-tax profit margin was 35.3% for fiscal 2005, compared

in New York & Company, Inc.

with 36.1% for fiscal 2004. Institutional equities net revenues for fiscal 2005 increased 32.9% to $1.45 billion from $1.09 billion for fiscal 2004. Net revenues from domestic and international institutional equities activities increased,

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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41

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A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

Global Clearing Services

% Increase (Decrease) 2006

2005

Net revenues

$ 1,076,997

$ 1,028,864

$

894,333

4.7%

15.0%

Pre-tax income

$

$

$

349,922

(1.5%)

34.8%

(in thousands)

464,519

471,796

2004

2006/2005

2005/2004

Note: Certain prior period items have been reclassified to conform to the current period’s presentation.

The Global Clearing Services segment provides execution, clearing,

Fiscal 2005 versus Fiscal 2004 Net revenues for Global Clearing

margin lending and securities borrowing to facilitate customer short

Services increased 15.0% to $1.03 billion for fiscal 2005 from $894.3

sales to clearing clients worldwide. Prime brokerage clients include

million for fiscal 2004. Net interest revenues increased 29.4% to $735.8

hedge funds and clients of money managers, short sellers, arbitrageurs

million for fiscal 2005 from $568.5 million for fiscal 2004, primarily

and other professional investors. Fully disclosed clients engage in

reflecting increased average customer margin and short sale balances

either the retail or institutional brokerage business. At November 30,

from prime brokerage and fully disclosed clearance clients due to

2006 and 2005, the Company held approximately $291.2 billion

improving US equity market conditions. These results were partially

and $264.1 billion, respectively, in equity in Global Clearing Services

offset by a decline in commission and other revenues of 10.0% to

client accounts.

$293.1 million for fiscal 2005 from $325.8 million for fiscal 2004, reflecting reduced trading volumes and rates from prime brokerage

Fiscal 2006 versus Fiscal 2005 Net revenues for Global Clearing

clients. Pre-tax income increased 34.8% to $471.8 million for fiscal

Services increased 4.7% to $1.08 billion for fiscal 2006 from $1.03

2005 from $349.9 million for fiscal 2004, reflecting higher net revenues

billion for fiscal 2005. Net interest revenues increased 9.1% to

and stable expenses. Pre-tax profit margin was 45.9% for fiscal

$802.6 million for fiscal 2006 from $735.8 million for fiscal 2005,

2005, compared with 39.1% for fiscal 2004.

primarily reflecting increased average customer margin balances from prime brokerage clients. These results were partially offset by a decline in commission and other revenues of 6.4% to $274.4 million for fiscal 2006 from $293.1 million for fiscal 2005, reflecting reduced rates from prime brokerage and fully disclosed clients. Pre-tax income decreased 1.5% to $464.5 million for fiscal 2006 from $471.8 million for fiscal 2005. Pre-tax profit margin was 43.1% for fiscal 2006, compared with 45.9% for fiscal 2005. The following table presents the Company’s interest-bearing balances for the fiscal years ended November 30, 2006 and 2005: (in billions)

Margin debt balances, average for period

2006

2005

$ 68.4

$ 64.9

Margin debt balances, at period end

78.6

66.6

Customer short balances, average for period

82.6

84.4

Customer short balances, at period end

95.8

79.9

Securities borrowed, average for period

55.0

59.4

Securities borrowed, at period end

57.6

49.9

Free credit balances, average for period

32.8

29.7

Free credit balances, at period end

32.6

31.0

291.2

264.1

Equity held in client accounts

42

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

Wealth Management

% Increase (Decrease) 2006

(in thousands)

2005

2004

2006/2005

2005/2004

Net revenues 527,127

13.5%

3.7%

(98,083)

(93,586)

(84,880)

4.8%

10.3%

Private client services net revenues

522,254

452,948

442,247

15.3%

2.4%

Asset management

335,474

227,572

185,768

47.4%

22.5%

Private client services revenues

$

Revenue transferred to Capital Markets segment

620,337

$

546,534

$

Total net revenues

$

857,728

$

680,520

$

628,015

26.0%

8.4%

Pre-tax income

$

69,160

$

36,770

$

62,344

88.1%

(41.0%)

Note: Certain prior period items have been reclassified to conform to the current period’s presentation.

The Wealth Management segment is comprised of the PCS and

Fiscal 2005 versus Fiscal 2004 Net revenues for Wealth

asset management areas. PCS provides high-net-worth individuals

Management increased 8.4% to $680.5 million for fiscal 2005 from

with an institutional level of investment service, including access to

$628.0 million for fiscal 2004. PCS revenues increased 2.4% to

the Company’s resources and professionals. At November 30, 2006,

$452.9 million for fiscal 2005 from $442.2 million for fiscal 2004,

PCS had approximately 500 account executives in its principal

reflecting increased net interest revenues associated with higher

office, six regional offices and two international offices. Asset

margin balances and increased fee income attributable to higher

management manages equity, fixed income and alternative assets for

levels of fee-based assets as well as an increase in broker productivity.

corporate pension plans, public systems, endowments, foundations,

Asset management revenues increased 22.5% to $227.6 million for

multi-employer plans, insurance companies, corporations, families

fiscal 2005 from $185.8 million for fiscal 2004, reflecting increased

and high-net-worth individuals in the United States and abroad.

performance fees on proprietary hedge fund products. Management fees also increased during fiscal 2005 on higher levels

Fiscal 2006 versus Fiscal 2005 Net revenues for Wealth

of traditional assets under management. Pre-tax income for Wealth

Management increased 26.0% to $857.7 million for fiscal 2006 from

Management decreased 41.0% to $36.8 million in fiscal 2005 from

$680.5 million for fiscal 2005. PCS revenues increased 15.3% to

$62.3 million for fiscal 2004. The pre-tax income decrease relates to

$522.3 million for fiscal 2006 from $452.9 million for fiscal 2005,

$22 million in non-recurring income received from the sale of assets

reflecting increased fee income attributable to the Company’s private

to Dreyfus in fiscal 2004 as well as increased operating costs

client advisory services products as well as an increase in broker

incurred during fiscal 2005.

productivity. Asset management revenues increased 47.4% to $335.5 million for fiscal 2006 from $227.6 million for fiscal 2005, reflecting

Assets under management were $41.9 billion at November 30, 2005,

increased performance fees on proprietary hedge fund products

reflecting a 10.8% increase from $37.8 billion in assets under

and increased management fees on higher levels of traditional assets

management at November 30, 2004. The increase in assets under

under management. Pre-tax income for Wealth Management increased

management reflects continued increases in traditional equity assets

88.1% to $69.2 million in fiscal 2006 from $36.8 million for fiscal 2005.

attributable to market appreciation and net inflows. Assets under management at November 30, 2005 include $6.3 billion of assets

Assets under management were $52.5 billion at November 30,

from alternative investment products, a slight increase from $6.2

2006, reflecting a 25.3% increase from $41.9 billion in assets under

billion at November 30, 2004.

management at November 30, 2005. The increase in assets under management primarily reflects an increase in traditional equity assets attributable to both market appreciation and net inflows. Assets under management at November 30, 2006 include $7.8 billion of assets from alternative investment products, a 23.8% increase from $6.3 billion at November 30, 2005.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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43

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A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

LIQUIDITY AND CAPITAL RESOURCES

a principal basis, together with its customer-related activities in its

FINANCIAL LEVERAGE Asset Composition

clearance business, results in significant levels of customer-related balances, including customer margin debt, securities borrowed and

The Company’s actual level of capital, capital requirements and

reverse repurchase activity. The Company’s total assets and financial

thereby the level of financial leverage, is a function of numerous

leverage can and do fluctuate, depending largely on economic and

variables, including asset composition, rating agency/creditor

market conditions, volume of activity and customer demand.

perception, business prospects, regulatory requirements, balance sheet liquidity, cost/availability of capital and risk of loss. The Company

The Company’s total assets at November 30, 2006 increased to

consistently maintains a highly liquid balance sheet, with the vast

$350.4 billion from $287.3 billion at November 30, 2005. The increase

majority of the Company’s assets consisting of cash, marketable

was primarily attributable to increases in financial instruments

securities inventories and collateralized receivables arising from

owned, assets of variable interest entities and mortgage loan special

customer-related and proprietary securities transactions.

purpose entities, securities received as collateral, and securities borrowed, partially offset by a decrease in securities purchased under

Collateralized receivables consist of resale agreements secured

agreements to resell. The Company’s total capital base, which consists

predominantly by US government and agency securities, customer

of long-term debt, preferred equity issued by subsidiaries and total

margin loans and securities borrowed, which are typically secured

stockholders’ equity, increased to $66.7 billion at November 30,

by marketable corporate debt and equity securities. The nature of

2006 from $54.3 billion at November 30, 2005. This change was

the Company’s business as a securities dealer requires it to carry

primarily due to a net increase in long-term debt and an increase in

significant levels of securities inventories to meet its customer

stockholders’ equity primarily due to fiscal 2006 earnings.

and proprietary trading needs. Additionally, the Company’s role as a financial intermediary for customer activities, which it conducts on

The Company’s total capital base as of November 30, 2006 and 2005 was as follows:

2006

2005

$ 53,307.4

$ 43,227.1

(in millions)

Long-term borrowings: Senior debt Subordinated debt

(1)

Total long-term borrowings

1,262.5

262.5

$ 54,569.9

$ 43,489.6

$

$

Stockholders’ equity: Preferred stockholders’ equity Common stockholders’ equity

359.2

372.3

11,770.2

10,419.1

Total stockholders’ equity

$ 12,129.4

$ 10,791.4

Total capital

$ 66,699.3

$ 54,281.0

(1) Includes $1.0 billion in subordinated debt issued by the Company and $262.5 million in junior subordinated deferrable interest debentures (“Debentures”) issued by the Company and held by Bear Stearns Capital Trust III (“Capital Trust III”) at November 30, 2006 and $262.5 million in Debentures issued by the Company and held by Capital Trust III at November 30, 2005. See Note 9, “Long-Term Borrowings,” and Note 10,“Preferred Stock,” in the Notes to Consolidated Financial Statements for further information.

44

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MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

The amount of long-term debt as well as total capital that the Company maintains is driven by a number of factors, with particular focus on asset composition. The Company’s ability to support increases in total assets is a function of its ability to obtain short-term secured and unsecured funding, as well as its access to longer-term sources of capital (i.e., long-term debt and equity). The Company regularly measures and monitors its total capital requirements, which are primarily a function of the self-funding ability of its assets. The equity portion of total capital is primarily a function of on- and off-balance-sheet risks (i.e., market, credit and liquidity) and regulatory capital requirements. As such, the liquidity and risk characteristics of assets being held are critical determinants of both total capital and the equity portion thereof, thus significantly influencing the amount of leverage that the Company can employ. Given the nature of the Company’s market-making and customerfinancing activity, the overall size of the balance sheet fluctuates from time to time. The Company’s total assets at each quarter end are typically lower than would be observed on an average basis. At the end of each quarter, the Company typically uses excess cash to finance high-quality, highly liquid securities inventory that otherwise would be funded via the repurchase agreement market. In addition, the Company reduces its matched book repurchase and reverse repurchase activities at quarter end. Finally, the Company may reduce the aggregate level of inventories through ordinary course, open market activities in the most liquid portions of the balance sheet, which are principally US government and agency securities and agency mortgage pass-through securities. At November 30, 2006, total assets of $350.4 billion were approximately 0.5% higher than the average of the month-end balances observed over the trailing 12-month period, while total assets at November 30, 2005 were approximately 5.9% lower than the average of the same time period in the prior year. Despite reduced total assets at each quarter end, the Company’s overall market, credit and liquidity risk profile does not change materially, since the reduction in asset balances is predominantly in highly liquid, short-term instruments that are financed on a secured basis. This periodic reduction verifies the inherently liquid nature of the balance sheet and provides consistency with respect to creditor constituents’ evaluation of the Company’s financial condition.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

45

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

Leverage Ratios

equity capital, which excludes goodwill and intangible assets from

Balance sheet leverage measures are one approach to assessing

both the numerator and denominator, as equity used to support

the capital adequacy of a securities firm, such as the Company.

goodwill and intangible assets is not available to support the

Gross leverage equals total assets divided by stockholders’ equity,

balance of the Company’s net assets. With respect to a comparative

inclusive of preferred and trust preferred equity. The Company views

measure of financial risk and capital adequacy, the Company

its trust preferred equity as a component of its equity capital base

believes that the low-risk nature of the items excluded in deriving net

given the equity-like characteristics of the securities. The Company

adjusted assets (see table) renders net adjusted leverage as the

also receives rating agency equity credit for these securities. Net

relevant measure.

adjusted leverage equals net adjusted assets divided by tangible The following table presents total assets and net adjusted assets with the resultant leverage ratios at November 30, 2006 and 2005:

2006

(in millions, except ratios)

Total assets

$

2005

350,433

$ 287,293

8,804

5,270

Securities purchased under agreements to resell

38,838

42,648

Securities received as collateral

19,648

12,426

Securities borrowed

80,523

62,915

Receivables from customers

29,482

31,273

Assets of variable interest entities and mortgage loan special purpose entities, net

29,080

14,321

Deduct: Cash and securities deposited with clearing organizations or segregated in compliance with federal regulations

Goodwill & intangible assets

383

355

143,675

118,085

42,256

33,022

11,865

10,975

$

174,066

$ 140,132

$

11,770

Subtotal Add: Financial instruments sold, but not yet purchased Deduct: Derivative financial instruments sold, but not yet purchased Net adjusted assets Stockholders’ equity Common equity

$

10,419

Stock-based compensation(1)

816

—

Preferred stock

359

372

12,945

10,791

Total adjusted stockholders’ equity Add: Trust preferred equity Subtotal — leverage equity

263

263

13,208

11,054

383

355

Deduct: Goodwill & intangible assets Tangible equity capital

$

12,825

$

10,699

Gross leverage

26.5x

26.0x

Net adjusted leverage

13.6x

13.1x

(1) Represents stock-based compensation associated with fiscal 2006 awards that was reflected in equity as of the grant date in December 2006, in accordance with SFAS No. 123(R), “Share-based Payment.” In previous years, stock-based compensation granted in December was included in stockholders’ equity at November year end. Excluding this adjustment for stock-based compensation, gross leverage and net adjusted leverage would be 28.3x and 14.5x, respectively.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

FUNDING STRATEGY AND LIQUIDITY RISK MANAGEMENT General Funding Strategy

Company is not reliant upon nor does it contemplate forced

Liquidity is extraordinarily important for financial services firms in

availability. This underlying approach is supported by maintenance

general and for securities firms such as the Company in particular,

of a formal contingency funding plan, which includes a detailed

given their reliance on market confidence. The Company’s overall

delegation of authority and precise action steps for managing an

objective and general funding strategy seeks to ensure liquidity and

event-driven liquidity crisis. The plan identifies the crisis management

diversity of funding sources to meet the Company’s financing needs

team, details an effective internal and external communication strategy,

at all times and under all market environments. In financing its balance

and facilitates the greater information flow required to effect a rapid

sheet, the Company attempts to maximize its use of secured funding

and efficient transition to a secured funding environment.

balance sheet reduction to endure a period of constrained funding

where economically competitive. Short-term sources of cash consist principally of collateralized borrowings, including repurchase

As it relates to the alternative funding strategy discussed above, the

transactions, sell/buy arrangements, securities lending arrangements

Company prepares an analysis that focuses on a 12-month time

and customer free credit balances. Short-term unsecured funding

period and assumes that the Company does not liquidate assets

sources expose the Company to rollover risk, as providers of credit

and cannot issue any new unsecured debt, including commercial

are not obligated to refinance the instruments at maturity. For this

paper. Under these assumptions, the Company monitors its cash

reason, the Company seeks to prudently manage its reliance on

position and the borrowing value of unencumbered, unhypothecated

short-term unsecured borrowings by maintaining an adequate total

financial instruments in relation to its unsecured debt maturing over

capital base and extensive use of secured funding. In addition to

the next 12 months, striving to maintain the ratio of liquidity sources

this strategy, the Company places emphasis on diversification by

to maturing debt at 110% or greater. Also within this strategy, the

product, geography, maturity and instrument in order to further

Company seeks to maintain cash capital in excess of that portion of

ensure prudent, moderate usage of more credit-sensitive, potentially

its assets that cannot be funded on a secured basis (i.e., positive

less stable, funding. Short-term unsecured funding sources include

net cash capital). These two measures, liquidity ratio and net cash

commercial paper, medium-term notes and bank borrowings, which

capital, are complementary and constitute the core elements of the

generally have maturities ranging from overnight to one year. The

Company’s alternative funding strategy and, consequently, its

Company views its secured funding as inherently less credit sensitive

approach to funding and liquidity risk management.

and therefore a more stable source of funding due to the collateralized nature of the borrowing.

The borrowing value advance rates used in the Company’s liquidity ratio calculation and the haircuts incorporated in the cash capital

In addition to short-term funding sources, the Company utilizes

model are symmetrical. These advance rates are considered readily

equity and long-term debt, including floating- and fixed-rate notes, as

available, even in a stress environment. In the vast majority of

longer-term sources of unsecured financing. The Company regularly

circumstances/asset classes, advance rates are derived from committed

monitors and analyzes the size, composition and liquidity

secured bank facilities, whereby a bank or group of banks are

characteristics of its asset base in the context of each asset’s ability

contractually obligated to lend to the Company at a pre-specified

to be used to obtain secured financing. This analysis helps the

advance rate on specific types of collateral regardless of “market

Company in determining its aggregate need for longer-term funding

environment.” As such, the advance rates/haircuts in the alternative

sources (i.e., long-term debt and equity). The Company views long-

liquidity models are typically worse than those the Company realizes

term debt as a stable source of funding, which effectively

in normalized repo and secured lending markets. The advance

strengthens its overall liquidity profile and mitigates liquidity risk.

rates in the liquidity ratio reflect what can be reliably realized in a stressed liquidity environment. The haircuts used in the cash capital

Alternative Funding Strategy

model are consistent with the advance rates used in the liquidity

The Company maintains an alternative funding strategy focused on

ratio in that the haircut is equal to one minus the advance rate.

the liquidity and self-funding ability of the underlying assets. The objective of this strategy is to maintain sufficient cash capital

As of November 30, 2006, the market value of unencumbered,

(i.e., equity plus long-term debt maturing in more than 12 months)

unhypothecated financial instruments owned by the Company was

and funding sources to enable the Company to refinance short-term,

approximately $47.7 billion with a borrowing value of $37.2 billion.

unsecured borrowings with fully secured borrowings. As such, the

The assets are primarily comprised of mortgage- and asset-backed

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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47

MANAGEMENT’S DISCUSSION

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A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

securities, investment grade municipal and corporate bonds, US

The cash capital framework is utilized to evaluate the Company’s

equities and residential and commercial mortgage whole loans. The

long-term funding sources and requirements in their entirety.

average advance rate on these different asset types ranges from

Cash capital required to support all of the Company’s assets is

51% to 95% and, as described above, is based predominantly on

determined on a regular basis. For purposes of broadly classifying

committed, secured facilities that the Company and its subsidiaries

the drivers of cash capital requirements, cash capital usage can be

maintain in different regions globally. The liquidity ratio, explained

delineated across two very broad categories as (1) firmwide haircuts

above, based solely on Company-owned securities, has averaged

and (2) illiquid assets/long-term investments. More precisely,

125% over the previous 12 months, including unused committed

the Company holds cash capital to support longer-term funding

unsecured bank credit and 119%, excluding the unsecured portion

requirements, including, but not limited to, the following:

of the Company’s $4.0 billion committed revolving credit facility. On this same basis, the liquidity ratio was 131% as of November 30, 2006 and 125% excluding committed unsecured bank credit.

• That portion of financial instruments owned that cannot be funded on a secured basis (i.e., the haircuts); • Margin loans and resale principal in excess of the borrowing

While The Bear Stearns Companies Inc. (“Parent Company”) is the primary issuer of unsecured debt in the marketplace, the collateral referred to in the preceding paragraph is held in various subsidiaries, both regulated and unregulated. A subsidiary’s legal entity status and the Company’s intercompany funding structure may constrain

value of collateral received; • Operational cash deposits required to support the regular activities of the Company (e.g., exchange initial margin); • Unfunded committed funding obligations, such as corporate loan commitments;

liquidity available to the Parent Company, as regulators may prevent

• Less liquid and illiquid assets, such as goodwill and fixed assets;

the flow of funds and/or securities from a regulated subsidiary to its

• Uncollateralized funded loans and funded loans secured by

parent company or other subsidiaries. In recognition of this potential

illiquid and/or non-rehypothecatable collateral;

for liquidity to be trapped in subsidiaries, the Company maintains a

• Merchant banking assets and other long-term investments; and

minimum of $5.0 billion of liquidity immediately accessible by the

• Regulatory capital in excess of a regulated entity’s cash capital

Parent Company at all times. This liquidity reserve takes the form of

based longer-term funding requirements.

cash deposits and money market instruments that are held at the Parent Company and high-quality collateral (corporate bonds,

At November 30, 2006, the Company’s net cash capital position

municipal bonds, equity securities) that is owned by subsidiaries

was $519.4 million. Fluctuations in net cash capital are common and

and explicitly pledged to and segregated for the benefit of the

are a function of variability in total assets, balance sheet composition

Parent Company and maintained at a third-party custodian. For

and total capital. The Company attempts to maintain cash capital

purposes of calculating the aggregate value of the liquidity reserve,

sources in excess of the aggregate longer-term funding requirements

the contractually obligated advance rates described herein are used

of the firm (i.e., positive net cash capital). Over the 12 months of fiscal

to determine the borrowing value of collateral pledged. In addition to

year 2006, the Company’s total cash capital requirement, cash capital

this immediately available liquidity, the Company monitors unrestricted

intensity ratio (average haircut), and net cash capital position have

liquidity available to the Parent Company via the ability to monetize

averaged $53.9 billion, 15.2% and $1.8 billion, respectively.

unencumbered assets held in unregulated and regulated entities. As of November 30, 2006, approximately $33.8 billion of the market

In addition to the alternative funding measures above, the Company

value identified in the liquidity ratio data above was held in

monitors the maturity profile of its unsecured debt to minimize

unregulated entities and thus likely to be available to the Parent

refinancing risk, maintains relationships with a broad global base of

Company, while an additional $4.0 billion market value had been

debt investors and bank creditors, establishes and adheres to strict

pledged to the Parent Company as collateral for inter-company

short-term debt investor concentration limits, and periodically tests

borrowings and was thus readily available. The remaining $9.9 billion

its secured and unsecured committed credit facilities. An important

market value of unencumbered securities was held in regulated

component of the Company’s funding and liquidity risk management

entities, a portion of which may not be available to provide liquidity

efforts involves ongoing dialogues with a large number of creditor

to the Parent Company.

constituents. Strong relationships with a diverse base of creditors

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MANAGEMENT’S DISCUSSION

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A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

and debt investors are crucial to the Company’s liquidity. The Company also maintains available sources of short-term funding that exceed actual utilization, thus allowing it to endure changes in investor appetite and credit capacity to hold the Company’s debt obligations. With respect to the management of refinancing risk, the maturity profile of the long-term debt portfolio of the Company is monitored on an ongoing basis and structured within the context of two diversification guidelines. The Company has a general guideline of no more than 20% of its long-term debt portfolio maturing in any one year, as well as no more than 10% maturing in any one quarter over the next five years. The Company continued to effectively meet these guidelines at the end of fiscal 2006 as evidenced by the bar graphs below. As of November 30, 2006, the weighted average maturity of the Company’s long-term debt was 4.4 years.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

49

MANAGEMENT’S DISCUSSION

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A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

Yearly Long-Term Debt Maturity Profile As of November 30, 2006 10,992

11,000 10,000

8,540

9,000 $ IN MILLIONS

8,000 7,000

6,812

6,584

6,484

6,000 5,000

5,171

4,000

3,215 2,851

2,540

3,000 2,000 1,000 0

1,381

One

Two

Three

Four

Five

Six

Seven

Eight

Nine

Ten & >

YEARS E

Five Year Quarterly Long-Term Debt Maturity Profile

5,500

5,257

5,000 4,500 $ IN MILLIONS

4,000 3,500

3,018

3,000 2,500 2,402 2,000 1,500 1,000

2,908

2,599 1,477 1,578

2,260

1,979 2,073

1,819 1,317

1,856 1,998

1,746

1,470

1,364

1,027

794 470

500 0

1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 QUARTERS E

NON-EXTENDIBLES

EXTENDIBLES(1)

(1) Extendibles are debt instruments with an extendible maturity date and are included in long-term debt at the earliest maturity date. Unless debt holders instruct the Company to redeem their debt, the earliest maturity date of these instruments is automatically extended. Based on past experience, the majority of the Company’s extendibles is expected to remain outstanding beyond their earliest maturity date.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

Committed Credit Facilities

require, among other things, maintenance of specified levels of

The Company has a committed revolving credit facility (“Facility”)

stockholders’ equity of the Company. The Tax Lien Facility terminates

totaling $4.0 billion, which permits borrowing on a secured basis by

in March 2007 with all loans outstanding at that date payable no later

the Parent Company, BSSC, BSIL and certain other subsidiaries.

than March 2008. There were no borrowings outstanding under the

The Facility also allows the Parent Company and BSIL to borrow up to

Tax Lien Facility at November 30, 2006.

$2.0 billion of the Facility on an unsecured basis. Secured borrowings can be collateralized by both investment-grade and non-investment-

The Company also maintains a series of committed credit facilities,

grade financial instruments as the Facility provides for defined

which permit borrowing on a secured basis, to support liquidity needs

advance rates on a wide range of financial instruments eligible to be

for the financing of investment-grade and non-investment-grade

pledged. The Facility contains financial covenants, the most significant

corporate loans, residential mortgages, commercial mortgages, listed

of which require maintenance of specified levels of stockholders’

options and whole loans. The facilities are expected to be drawn

equity of the Company and net capital of BSSC. In February 2007,

from time to time and expire at various dates, the longest of such

the Company renewed the Facility with similar terms. The Facility now

periods ending in fiscal 2007. All of these facilities contain a term-out

allows the Parent Company, BSIL, and Bear Stearns International

option of one year or more for borrowings outstanding at expiration.

Trading Limited (“BSIT”) to borrow up to $4.0 billion of the Facility on

The banks providing these facilities are committed to provide up to

an unsecured basis. The Facility terminates in February 2008, with

an aggregate of approximately $4.5 billion. At November 30, 2006,

all loans outstanding at that date payable no later than February

the borrowings outstanding under these committed credit facilities

2009. There were no borrowings outstanding under the Facility at

were $90.1 million.

November 30, 2006. Capital Resources The Company has a $1.50 billion committed revolving securities

The Parent Company, operating as the centralized unsecured funding

repo facility (“Repo Facility”), which permits borrowings secured by

arm of the Company, raises the vast majority of the Company’s

a broad range of collateral under a repurchase arrangement by the

unsecured debt, including both commercial paper and long-term

Parent Company, BSIL, BSIT and BSB. The Repo Facility contains

debt. The Parent Company is thus the “central bank” of the Company,

financial covenants that require, among other things, maintenance

where all capital is held and from which capital is deployed. The

of specified levels of stockholders’ equity of the Company. The

Parent Company advances funds in the form of debt or equity to

Repo Facility terminates in August 2007, with all repos outstanding at

subsidiaries to meet their operating funding needs and regulatory

that date payable no later than August 2008. There were no borrowings

capital requirements. In addition to the primary regulated subsidiaries,

outstanding under the Repo Facility at November 30, 2006.

the Company also conducts significant activities through other wholly owned subsidiaries, including: Bear Stearns Global Lending Limited,

The Company has a $350 million committed revolving credit facility

Custodial Trust Company, Bear Stearns Financial Products Inc.,

(“Pan Asian Facility”), which permits borrowing on a secured basis

Bear Stearns Capital Markets Inc., Bear Stearns Credit Products

by the Parent Company, BSSC, Bear Stearns Japan Limited (“BSJL”),

Inc., Bear Stearns Forex Inc., EMC Mortgage Corporation, Bear

and BSIL. The Pan Asian Facility contains financial covenants that require,

Stearns Commercial Mortgage, Inc. and Bear Hunter Holdings LLC.

among other things, maintenance of specified levels of stockholders’

In connection with all of the Company’s operating activities, a

equity of the Company and net capital of BSSC. In December 2006,

substantial portion of the Company’s long-term borrowings and

the Company renewed the Facility at a $350 million committed level

equity has been used to fund investments in, and advances to,

with substantially the same terms. The Pan Asian Facility terminates

these subsidiaries, including subordinated debt advances.

in December 2007 with all loans outstanding at that date payable no later than December 2008. There were no borrowings outstanding

Within this funding framework, the Company attempts to fund equity

under the Pan Asian Facility at November 30, 2006.

investments in subsidiaries with equity from the Parent Company (i.e., utilize no equity double leverage). At November 30, 2006, the

The Company has a $350 million committed revolving credit facility

Parent Company’s equity investment in subsidiaries was $7.9 billion

(“Tax Lien Facility”), which permits borrowing on a secured basis by

versus common stockholders’ equity and preferred equity of $11.8

the Parent Company, Plymouth Park Tax Services and Madison Tax

billion and $359.2 million, respectively. As such, at November 30,

Capital LLC. The Tax Lien Facility contains financial covenants that

2006, the ratio of the equity investment in subsidiaries to Parent

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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51

MANAGEMENT’S DISCUSSION

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A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

Company equity (equity double leverage) was approximately 0.67

At November 30, 2006, the Company’s long-term/short-term debt

based on common equity and 0.65 including preferred equity. At

ratings were as follows:

November 30, 2005, these measures were 0.69 based on common equity and 0.67 including preferred equity. Additionally, all

Long-Term Rating

Short-Term Rating

A (high)

R-1 (middle)

subordinated debt advances to regulated subsidiaries for use as regulatory capital, which totaled $10.0 billion at the end of fiscal

Dominion Bond Rating Service Limited

2006, are funded with long-term debt issued by the Company,

Fitch Ratings

A+

F1+

having a remaining maturity equal to or greater than the maturity of

Japan Credit Rating Agency, Ltd.

AA

NR

the subordinated debt advance. The Company regularly monitors

Moody’s Investors Service

A1

P-1

the nature and significance of assets or activities conducted in all

Rating and Investment Information, Inc.

AA-

NR

Standard & Poor’s Rating Services

A+

A-1

subsidiaries and attempts to fund such assets with both capital and/or borrowings having a maturity profile and relative mix

NR - does not assign a short-term rating

consistent with the nature and self-funding ability of the assets being financed. The funding mix also takes into account regulatory capital

In October 2006, Standard & Poor’s Ratings Services (“S&P”) upgraded

requirements for regulated subsidiaries.

The Bear Stearns Companies Inc. long-term rating to A+. In a press release, S&P stated that the rating change reflects the Company’s

Long-term debt totaling $48.1 billion and $37.0 billion had remaining

relatively low profit volatility, conservative management and cost

maturities beyond one year at November 30, 2006 and November 30,

flexibility, as well as long-term improvements in its liquidity and risk

2005, respectively. The Company accesses funding in a variety of

management. In addition, in June 2006, Japan Credit Rating

markets in the United States, Europe and Asia. The Company issues

Agency, Ltd. assigned a rating of AA with a “Stable” outlook to the

debt through syndicated US-registered offerings, US-registered and

Company, while in August 2006, Rating and Investment Information,

144A medium-term note programs, other US and non-US bond and

Inc. upgraded the Company to AA- from A+ with a “Stable” outlook.

note offerings and other methods. The Company’s access to external sources of financing, as well as the cost of that financing, is dependent

Stock Repurchase Program

on various factors and could be adversely affected by a deterioration

The Company has various employee stock compensation plans

of the Company’s long- and short-term debt ratings, which are influenced

designed to increase the emphasis on stock-based incentive

by a number of factors. These include, but are not limited to: material

compensation and align the compensation of its key employees

changes in operating margins; earnings trends and volatility; the

with the long-term interests of stockholders. Such plans provide for

prudence of funding and liquidity management practices; financial

annual grants of stock units and stock options. The Company

leverage on an absolute basis or relative to peers; the composition of

intends to offset the potentially dilutive impact of the annual grants by

the balance sheet and/or capital structure; geographic and business

purchasing common stock throughout the year in open market and

diversification; and the Company’s market share and competitive

private transactions. On December 12, 2005, the Board of Directors

position in the business segments in which it operates. Material

of the Company approved an amendment to the Stock Repurchase

deterioration in any one or a combination of these factors could result

Program (“Repurchase Program”) to replenish the previous

in a downgrade of the Company’s credit ratings, thus increasing the

authorizations to allow the Company to purchase up to $1.5 billion of

cost of and/or limiting the availability of unsecured financing. Additionally,

common stock in fiscal 2006 and beyond. During the fiscal year

a reduction in the Company’s credit ratings could also trigger

ended November 30, 2006, the Company purchased under the

incremental collateral requirements, predominantly in the over-the-

current and prior authorizations a total of 9,440,880 shares at a cost

counter derivatives market. As of November 30, 2006, a downgrade

of approximately $1.22 billion. Approximately $279.9 million was

by either Moody’s Investors Service or Standard & Poor’s in the

available to be purchased under the current authorization as of

Company’s long-term credit ratings to the level of A2 or A (i.e., one

November 30, 2006. On December 13, 2006, the Board of Directors

notch) would have resulted in the Company being required to post

of the Company approved an amendment to the Repurchase

$53.2 million in additional collateral pursuant to contractual

Program to replenish the previous authorization in order to allow the

arrangements for outstanding over-the-counter derivatives contracts.

Company to purchase up to $2.0 billion of common stock in fiscal

A downgrade to A3 or A- (i.e., two notches) would have resulted in the

2007 and beyond. The Company expects to utilize the repurchase

Company being required to post an additional $118.1 million in collateral.

authorization to offset the dilutive impact of annual share awards.

52

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A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

The Company may, depending on price and other factors, repurchase

borrowed, net of securities loaned, which occurred in the normal

additional shares in excess of that required for annual share awards.

course of business as a result of changes in customer needs, market conditions and trading strategies. Cash used in investing activities of

During the fiscal year ended November 30, 2006, the Company also

$202.9 million reflected purchases of property, equipment and

purchased a total of 1,141,334 shares of its common stock at a

leasehold improvements. Cash provided by financing activities of

total cost of $154.0 million pursuant to a $200 million CAP Plan

$16.33 billion reflected net proceeds from the issuance of long-term

Earnings Purchase Authorization, which was approved by the

borrowings of $16.00 billion and net proceeds relating to short-term

Compensation Committee of the Board of Directors of the Company

borrowings of $7.80 billion, primarily to fund normal operating activities.

on November 30, 2005. On December 12, 2006, the Compensation

This was partially offset by net payments for the retirement/repurchase

Committee of the Company approved an amendment to the CAP

of long-term borrowings of $7.27 billion. Treasury stock purchases of

Plan Earnings Purchase Authorization to replenish the previous

$869.6 million were made to provide for the annual grant of CAP

authorization in order to allow the Company to purchase up to $200

Plan units, restricted stock units and stock options.

million of common stock in fiscal 2007. Fiscal 2004 Cash and cash equivalents increased $335.8 million to Cash Flows

$4.17 billion at November 30, 2004 from $3.84 billion at November

Fiscal 2006 Cash and cash equivalents decreased $1.26 billion

30, 2003. Cash used in operating activities was $2.34 billion, primarily

to $4.60 billion at November 30, 2006 from $5.86 billion at

attributable to an increase in financial instruments owned, partially

November 30, 2005. Cash used in operating activities was

offset by a decrease in securities borrowed, net of securities loaned

$19.22 billion, primarily attributable to increases in financial instruments

and cash and securities deposited with clearing organizations or

owned and securities borrowed, net of securities loaned, partially

segregated in compliance with federal regulations, which occurred

offset by increases in financial instruments sold, but not yet

in the normal course of business as a result of changes in customer

purchased, securities sold under agreements to repurchase, net of

needs, market conditions and trading strategies. Cash used in

securities purchased under agreements to resell and net payable to

investing activities of $128.4 million reflected purchases of property,

customers, which occurred in the normal course of business as a

equipment and leasehold improvements. Cash provided by financing

result of changes in customer needs, market conditions and trading

activities of $2.81 billion reflected net proceeds of $11.25 billion

strategies. Cash used in investing activities of $180.7 million reflected

from issuances of long-term borrowings used primarily to fund normal

purchases of property, equipment and leasehold improvements. Cash

operating activities. This was partially offset by repayments of $6.65

provided by financing activities of $18.14 billion reflected net proceeds

billion in long-term borrowings, and net payments of $1.18 billion

from the issuance of long-term borrowings of $19.89 billion and net

relating to short-term borrowings and a $300 million redemption of

proceeds relating to short-term borrowings of $9.05 billion, primarily

trust-issued preferred stock. Treasury stock purchases of $780.8

to fund normal operating activities. This was partially offset by net

million were made to provide for the annual grant of CAP Plan units,

payments for the retirement/repurchase of long-term borrowings of

restricted stock units and stock options.

$10.25 billion. Treasury stock purchases of $1.37 billion were made to provide for the annual grant of CAP Plan units, restricted

Regulated Subsidiaries

stock units and stock options and other corporate purposes.

Effective December 1, 2005, the Company became regulated by the Securities and Exchange Commission (“SEC”) as a consolidated

Fiscal 2005 Cash and cash equivalents increased $1.69 billion

supervised entity (“CSE”). As a CSE, the Company is subject to

to $5.86 billion at November 30, 2005 from $4.17 billion at

group-wide supervision and examination by the SEC and is required

November 30, 2004. Cash used in operating activities was $14.44 billion,

to compute allowable capital and allowances for market, credit and

primarily attributable to an increase in financial instruments owned

operational risk on a consolidated basis. As of November 30, 2006,

and a decrease in net payables to customers, partially offset by

the Company was in compliance with the CSE capital requirements.

increases in securities sold under agreements to repurchase, net of securities purchased under agreements to resell and financial

As registered broker-dealers and futures commission merchants,

instruments sold, but not yet purchased, and a decrease in securities

Bear Stearns and BSSC are subject to the net capital requirements

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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53

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

of the Exchange Act and Rule 1.17 under the Commodity Futures

High Yield Positions

Trading Commission. Effective December 1, 2005, the SEC approved

As part of its fixed income activities, the Company participates in the

Bear Stearns’ use of Appendix E of the Net Capital Rule, which

underwriting and trading of non-investment-grade corporate debt

establishes alternative net capital requirements for broker-dealers

securities and non-investment-grade commercial and leveraged

that are part of consolidated supervised entities. Appendix E allows

loans. The Company also invests in, syndicates and trades in loans

Bear Stearns to calculate net capital charges for market risk and

to below-investment-grade-rated companies (collectively, “high yield

derivatives-related credit risk based on mathematical models, provided

positions”). Non-investment-grade debt securities have been defined

that Bear Stearns holds tentative net capital in excess of $1 billion

as non-investment-grade corporate debt and emerging market

and net capital in excess of $500 million. BSIL and BSIT, the

debt rated BB+ or lower, or equivalent ratings recognized by credit

Company’s London-based broker-dealer subsidiaries, are subject

rating agencies. At November 30, 2006 and November 30, 2005,

to the regulatory capital requirements of the United Kingdom’s

the Company held high yield positions approximating $10.73 billion

Financial Services Authority. Additionally, BSB is subject to the regulatory

and $6.71 billion, respectively, substantially all of which are in

capital requirements of the Financial Regulator. Custodial Trust

“Financial Instruments Owned” in the Consolidated Statements of

Company (“CTC”), a Federal Deposit Insurance Corporation (“FDIC”)

Financial Condition, and $605.4 million and $1.72 billion,

insured New Jersey state chartered bank, is subject to the regulatory

respectively, reflected in “Financial Instruments Sold, But Not Yet

capital requirements of the FDIC. At November 30, 2006, Bear

Purchased” in the Consolidated Statements of Financial Condition.

Stearns, BSSC, BSIL, BSIT, BSB and CTC were in compliance with

Included in the high yield positions are extensions of credit to highly

their respective regulatory capital requirements. Certain other

leveraged companies. At November 30, 2006 and 2005, the amount

subsidiaries are subject to various securities regulations and capital

outstanding to highly leveraged borrowers totaled $7.70 billion and

adequacy requirements promulgated by the regulatory and exchange

$4.24 billion, respectively. The largest industry concentration was

authorities of the countries in which they operate. At November 30,

the telecommunications industry, which approximated 22.8% and

2006, these other subsidiaries were in compliance with their applicable

17.2% of these highly leveraged borrowers’ positions at November

local capital adequacy requirements.

30, 2006 and 2005, respectively. Additionally, the Company has lending commitments with highly leveraged borrowers (see the

The Company’s broker-dealer subsidiaries and other regulated

summary table under “Commitments”).

subsidiaries are subject to minimum capital requirements and may also be subject to certain restrictions on the payment of dividends,

The Company’s Risk Management Department and senior trading

which could limit the Company’s ability to withdraw capital from

managers monitor exposure to market and credit risk for high yield

such regulated subsidiaries, which in turn could limit the Company’s

positions and establish limits and concentrations of risk by individual

ability to pay dividends. See Note 16, “Regulatory Requirements,” in

issuer. High yield positions generally involve greater risk than investment

the Notes to Consolidated Financial Statements.

grade debt securities due to credit considerations, liquidity of secondary trading markets and increased vulnerability to changes in

Merchant Banking and Private Equity Investments

general economic conditions. The level of the Company’s high yield

In connection with the Company’s merchant banking activities, the

positions, and the impact of such activities on the Company’s results

Company has investments in merchant banking and private equity-

of operations, can fluctuate from period to period as a result of

related investment funds as well as direct investments in private

customer demand, economic conditions and market considerations.

equity-related investments. At November 30, 2006, the Company held investments with an aggregate recorded value of approximately $822.4 million, reflected in the Consolidated Statements of Financial Condition in “Other Assets.” At November 30, 2005, the Company held investments with an aggregate recorded value of approximately $658.8 million. In addition to these various direct and indirect principal investments, the Company has made commitments to invest in private equity-related investments and partnerships (see the summary table under “Commitments”).

54

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

Contractual Obligations In connection with its operating activities, the Company enters into contractual obligations that require future cash payments. At November 30, 2006, the Company’s contractual obligations by maturity, excluding derivative financial instruments, were as follows: Payments Due by Period Fiscal 2007

(in millions)

Fiscal 2008-2009

Fiscal 2010-2011

Thereafter

Total

Long-term borrowings (1)(2)

$ 6,484

$19,532

$13,396

$ 15,158

$54,570

Future minimum operating lease payments (3)(4)

$

$

$

$

$ 1,103

98

204

204

597

(1) Amounts include fair value adjustments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as well as $262.5 million of junior subordinated deferrable interest debentures (“Debentures”). The Debentures will mature on May 15, 2031; however, the Company, at its option, may redeem the Debentures beginning May 15, 2006. The Debentures are reflected in the table at their contractual maturity dates. (2) Included in fiscal 2008-2009 are approximately $1.83 billion of floating-rate notes that are redeemable prior to maturity at the option of the noteholder. These notes contain certain provisions that effectively enable noteholders to put these notes back to the Company and, therefore, are reflected in the table at the date such notes first become redeemable. The final maturity dates of these notes are during fiscal 2010-2011. (3) Includes the Company’s Headquarters at 383 Madison Avenue in New York City. (4) See Note 17, “Commitments and Contingencies,” in the Notes to Consolidated Financial Statements.

Commitments The Company has commitments (1) under a variety of commercial arrangements. At November 30, 2006, the Company’s commitments associated with lending and financing, private equity-related investments and partnerships, underwriting, outstanding letters of credit and other commercial commitments summarized by period of expiration were as follows: Amount of Commitment Expiration Per Period

(in millions)

Fiscal 2007

Fiscal 2008-2009

Fiscal 2010-2011

Thereafter

$

$

Commitments with no stated maturity

Total

Lending-related commitments: Investment-grade(2) Non-investment-grade(2) Contingent commitments

$ 1,983

348

$ 1,464

—

$ 3,825

541

214

954

333

30

$

—

2,042

16,789

—

—

—

688

17,477

—

—

—

—

788

788

Commitments to invest in private equity-related investments and partnerships (3)

205

—

—

—

—

205

Commercial and residential loans

4,163

21

44

—

—

4,228

Letters of credit

4,500

15

35

—

—

4,550

49

47

—

—

—

96

Underwriting commitments

Other commercial commitments

(1) See Note 17, “Commitments and Contingencies,” in the Notes to Consolidated Financial Statements. (2) In order to mitigate the exposure to investment-grade and non-investment-grade borrowings, the Company entered into credit default swaps approximating $697.8 million and $88.8 million, respectively, in notional value, at November 30, 2006. (3) At November 30, 2006, commitments to invest in private equity-related investments and partnerships aggregated $788.3 million. These commitments will be funded, if called, through the end of the respective investment periods, the longest of such periods ending in 2017.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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55

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

OFF-BALANCE-SHEET ARRANGEMENTS

Variable Interest Entities,” for its variable interests in fiscal 2004. The

In the normal course of business, the Company enters into

Company consolidates those VIEs in which the Company is the primary

arrangements with special purpose entities (“SPEs”), also known as

beneficiary. See Note 6, “Variable Interest Entities and Mortgage

variable interest entities (“VIEs”). SPEs are corporations, trusts or

Loan Special Purpose Entities,” in the Notes to Consolidated Financial

partnerships that are established for a limited purpose. SPEs, by

Statements for a complete discussion of the consolidation of VIEs.

their nature, are generally not controlled by their equity owners, as the establishing documents govern all material decisions. The

The majority of the SPEs that the Company sponsors or transacts with

Company’s primary involvement with SPEs relates to securitization

are QSPEs, which the Company does not consolidate in accordance

transactions in which transferred assets, including commercial and

with this guidance. QSPEs are entities that have no discretionary

residential mortgages, consumer receivables, securities and other

activities and may only passively hold assets and distribute cash

financial assets are sold to an SPE and repackaged into securities

generated by the assets they hold. The Company reflects the fair

or similar beneficial interests. SPEs may also be used to create

value of its interests in QSPEs on its balance sheet but does not

securities with a unique risk profile desired by investors and as a

recognize the assets or liabilities of QSPEs. QSPEs are employed

means of intermediating financial risk. The Company, in the normal

extensively in the Company’s mortgage-backed and asset-backed

course of business, may establish SPEs, sell assets to SPEs,

securitization businesses.

underwrite, distribute and make a market in securities or other beneficial interests issued by SPEs, transact derivatives with SPEs,

Certain other SPEs do not meet the requirements of a QSPE,

own securities or other beneficial interests, including residuals, in

because their activities are not sufficiently limited or they have

SPEs, and provide liquidity or other guarantees for SPEs.

entered into certain non-qualifying transactions. The Company follows the criteria in FIN No. 46 (R) in determining whether it should consolidate

The Company follows Statement of Financial Accounting Standards

such entities. These SPEs are commonly employed in collateralized

(“SFAS”) No. 140, “Accounting for Transfers and Servicing of

debt obligation transactions where portfolio managers have the ability

Financial Assets and Extinguishments of Liabilities—a Replacement

to buy and sell assets or in synthetic credit transactions.

of FASB Statement No. 125,” to account for securitizations and other transfers of financial assets. In accordance with

In addition to the above, in the ordinary course of business the

SFAS No. 140, the Company accounts for transfers of financial

Company issues various guarantees to counterparties in connection

assets as sales provided that control has been relinquished. Control

with certain derivatives, leasing, securitization and other transactions.

is deemed to be relinquished only when all of the following

See Note 18, “Guarantees,” in the Notes to Consolidated Financial

conditions have been met: (1) the assets have been isolated from

Statements for a complete discussion on guarantees.

the transferor, even in bankruptcy or other receivership; (2) the transferee is a Qualifying Special Purpose Entity (“QSPE”) or has the

DERIVATIVE FINANCIAL INSTRUMENTS

right to pledge or exchange the assets received; and (3) the

Derivative financial instruments are contractual commitments

transferor has not maintained effective control over the transferred

between counterparties that derive their values from changes in an

assets. Therefore, the Company derecognizes financial assets

underlying interest rate, currency exchange rate, index (e.g., S&P 500),

transferred in securitizations, provided that such transfer meets all of

reference rate (e.g., LIBOR), or asset value referenced in the related

these criteria. See Note 5, “Transfers of Financial Assets and

contract. Some derivatives, such as futures contracts, certain options

Liabilities,” in the Notes to Consolidated Financial Statements for a

and index-referenced warrants, can be traded on an exchange.

more complete discussion of the Company’s securitization

Other derivatives, such as interest rate and currency swaps, caps,

activities.

floors, collars, swaptions, equity swaps and options, structured notes and forward contracts, are negotiated in the over-the-counter

The Company regularly creates or transacts with entities that may

markets. Derivatives generate both on- and off-balance-sheet risks

be VIEs. These entities are an essential part of its securitization,

depending on the nature of the contract. The Company is engaged

asset management and structured finance businesses. In addition,

as a dealer in over-the-counter derivatives and, accordingly, enters

the Company purchases and sells instruments that may be variable

into transactions involving derivative instruments as part of its

interests. The Company adopted Financial Accounting Standards

customer-related and proprietary trading activities.

Board (“FASB”) Interpretation (“FIN”) No. 46 (R), “Consolidation of

56

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

The Company’s dealer activities require it to make markets and

on their ability to meet their respective obligations without any additional

trade a variety of derivative instruments. In connection with these

capital from the Company. In the unlikely occurrence of a trigger

activities, the Company attempts to mitigate its exposure to market

event, the Company does not expect any significant incremental

risk by entering into hedging transactions that may include over-the-

impact on the liquidity or financial condition of the Company. At

counter derivative contracts or the purchase or sale of interest-bearing

November 30, 2006, there was no net potential cash settlement

securities, equity securities, financial futures and forward contracts.

payable by BSTRM on the occurrence of a trigger event.

The Company also utilizes derivative instruments to hedge proprietary market-making and trading activities. In this regard, the utilization of

To measure derivative activity, notional or contract amounts are

derivative instruments is designed to reduce or mitigate market risks

frequently used. Notional/contract amounts are used to calculate

associated with holding dealer inventories or in connection with

contractual cash flows to be exchanged and are generally not actually

arbitrage-related trading activities. The Company also utilizes interest

paid or received, with the exception of currency swaps, foreign

rate and currency swaps, futures contracts and US Treasury positions to

exchange forwards and mortgage-backed securities forwards. The

hedge its debt issuances as part of its asset and liability management.

notional/contract amounts of financial instruments that give rise to off-balance-sheet market risk are indicative only to the extent of

In connection with the Company’s dealer activities, the Company

involvement in the particular class of financial instruments and are

formed BSFP and its wholly owned subsidiary, Bear Stearns Trading

not necessarily an indication of overall market risk.

Risk Management Inc. (“BSTRM”). BSFP is a wholly owned subsidiary of the Company. BSFP and BSTRM were established to provide

As of November 30, 2006 and 2005, the Company had

clients with a AAA-rated counterparty that offers a wide range of

notional/contract amounts of approximately $8.74 trillion and $5.45

global derivative products. BSFP is structured so that if a specified

trillion, respectively, of derivative financial instruments, of which

trigger event (including certain credit rating downgrades of the

$1.25 trillion and $1.13 trillion, respectively, were listed futures and

Company, the failure of BSFP to maintain its credit rating and the

option contracts. The aggregate notional/contract value of derivative

occurrence of a bankruptcy event with respect to the Company)

contracts is a reflection of the level of activity and does not represent

occurs, BSFP will perform on all of its contracts to their original

the amounts that are recorded in the Consolidated Statements of

maturities with the assistance of an independent derivatives portfolio

Financial Condition. The Company’s derivative financial instruments

manager who would assume the active management of BSFP’s

outstanding, which are either used to hedge trading positions, modify

portfolio. BSTRM is structured so that, on the occurrence of a specified

the interest rate characteristics of its long- and short-term debt, or

trigger event, it will cash-settle all outstanding derivative contracts in

form part of its derivative dealer activities, are recorded in the

a predetermined manner. Clients can use either structure. The

Consolidated Statements of Financial Condition at fair value.

AAA/Aaa ratings that BSFP and BSTRM have received are based The Company’s derivatives had a notional weighted average maturity of approximately 4.1 years at November 30, 2006 and 2005. The maturities of notional/contract amounts outstanding for derivative financial instruments as of November 30, 2006 were as follows: Less Than One Year

One to Three Years

$ 2,076.7

$ 1,656.0

$ 1,549.9

$ 2,005.9

$ 7,288.5

457.5

290.3

24.6

0.2

772.6

Forward contracts

133.5

—

Options held

309.7

25.8

(in billions)

Swap agreements, including options, swaptions, caps, collars and floors Futures contracts

Options written Total Percent of total

Three to Five Greater Than Years Five Years

— 1.9

— 0.6

Total

133.5 338.0

177.2

24.5

2.4

0.7

204.8

$ 3,154.6

$ 1,996.6

$ 1,578.8

$ 2,007.4

$ 8,737.4

36.1%

22.9%

18.1%

22.9%

100.0%

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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57

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

CRITICAL ACCOUNTING POLICIES

has considerable insight into the trading level of financial

The consolidated financial statements of the Company are prepared

instruments held in inventory and/or related financial instruments

in conformity with accounting principles generally accepted in the

that it uses as a basis for its valuation.

United States of America. These principles require management to make certain estimates and assumptions that could materially affect

(2) Financial Instruments Whose Fair Value Is Determined Based on Internally

reported amounts in the financial statements (see Note 1, “Summary

Developed Models or Methodologies That Employ Data That Are Readily

of Significant Accounting Policies,” in the Notes to Consolidated

Observable from Objective Sources

Financial Statements). Critical accounting policies are those policies

The second broad category consists of financial instruments

that are the most important to the financial statements and/or those

for which the Company does not receive quoted prices; therefore,

that require significant management judgment related to matters

models or other methodologies are utilized to value these financial

that are uncertain.

instruments. Such models are primarily industry-standard models that consider various assumptions, including time value, yield curve,

VALUATION OF FINANCIAL INSTRUMENTS

volatility factors, prepayment speeds, default rates, loss severity,

The Company has identified the valuation of financial instruments as

current market and contractual prices for the underlying financial

a critical accounting policy due to the complex nature of certain of

instruments, as well as other relevant economic measures.

its products, the degree of judgment required to appropriately value

Substantially all of these assumptions are observable in the

these products and the pervasive impact of such valuation on the

marketplace, can be derived from observable data, or are

financial condition and earnings of the Company.

supported by observable levels at which transactions are executed in the marketplace. A degree of subjectivity is required to determine

The Company’s financial instruments can be aggregated in three

the appropriate models or methodologies as well as the appropriate

broad categories: (1) those whose fair value is based on quoted

underlying assumptions. This subjectivity makes these valuations

market prices or for which the Company has independent external

inherently less reliable than quoted market prices. Financial instruments

valuations, (2) those whose fair value is determined based on internally

in this category include non-exchange-traded derivatives such as

developed models or methodologies that employ data that are

interest rate swaps, certain mortgage-backed securities and certain

readily observable from objective sources and (3) those whose fair

other cash instruments. For an indication of the Company’s

value is estimated based on internally developed models or

involvement in derivatives, including maturity terms, see the table

methodologies utilizing significant assumptions or other data that

setting forth notional/contract amounts outstanding in the

are generally less readily observable from objective sources.

preceding “Derivative Financial Instruments” section.

(1) Financial Instruments Valued Based on Quoted Market Prices or for Which

(3) Financial Instruments Whose Fair Value Is Estimated Based on Internally

the Company Has Independent External Valuations

Developed Models or Methodologies Utilizing Significant Assumptions or Other

The Company’s valuation policy is to use quoted market prices from

Data That Are Generally Less Readily Observable from Objective Sources

securities and derivatives exchanges where they are available and

Certain complex financial instruments and other investments have

reliable. Financial instruments valued based on quoted market

significant data inputs that cannot be validated by reference to readily

prices are primarily exchange-traded derivatives and listed equities.

observable data. These instruments are typically illiquid, long dated

Financial instruments that are most typically valued using alternative

or unique in nature and therefore require considerable judgment by

approaches but for which the Company typically receives

traders and their management who, as dealers in many of these

independent external valuation information include US Treasuries,

instruments, have the appropriate knowledge to estimate data

most mortgage-backed securities and corporate, emerging market,

inputs that are less readily observable. For certain instruments,

high yield and municipal bonds. Unlike most equities, which tend to

extrapolation or other methods are applied to observed market or

be traded on exchanges, the vast majority of fixed income trading

other data to estimate assumptions that are not observable.

(including US Treasuries) occurs in over-the-counter markets, and, accordingly, the Company’s valuation policy is based on its best

The Company followed Emerging Issues Task Force (“EITF”)

estimate of the prices at which these financial instruments trade in

Statement No. 02-3, “Issues Involved in Accounting for Derivative

those markets. The Company is an active dealer in most of the over-

Contracts Held for Trading Purposes and Contracts Involved in

the-counter markets for these financial instruments, and typically

Energy Trading and Risk Management Activities,” through

58

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

November 30, 2006. This guidance generally eliminates the practice

Management Departments perform analysis of internal valuations,

of recognizing profit at the inception of a derivative contract unless

typically on a monthly basis but often on an intra-month basis as

the fair value of the derivative is obtained from a quoted market

well. These departments are independent of the trading areas

price in an active market or is otherwise evidenced by comparison

responsible for valuing the positions. Results of the monthly

to other observable current market transactions or based on a valuation

validation process are reported to the Mark-to-Market (“MTM”)

technique that incorporates observable market data. The Company

Committee, which is composed of senior management from the

intends to adopt SFAS No. 157, “Fair Value Measurements,” in

Risk Management and Controllers Departments. The MTM

the first quarter of 2007. SFAS No. 157 nullifies the consensus

Committee is responsible for ensuring that the approaches used to

reached in EITF No. 02-3, which prohibited recognition of day one

independently validate the Company’s valuations are robust,

gains or losses on certain derivative contracts. See Accounting

comprehensive and effective. Typical approaches include valuation

and Reporting Developments within Management’s Discussion and

comparisons with external sources, comparisons with observed

Analysis for a complete discussion of SFAS No. 157.

trading, independent comparisons of key model valuation inputs, independent trade modeling and a variety of other techniques.

The Company participates in the underwriting, securitization or trading of non-performing mortgage-related assets, real estate assets

MERCHANT BANKING

and certain residuals. In addition, the Company has a portfolio of

As part of its merchant banking activities, the Company participates

Chapter 13 and other credit card receivables from individuals.

from time to time in principal investments in leveraged transactions.

Certain of these high yield positions have limited price observability.

As part of these activities, the Company originates, structures and

In these instances, fair values are determined by statistical analysis of

invests in merger, acquisition, restructuring and leveraged capital

historical cash flows, default probabilities, recovery rates, time value

transactions, including leveraged buyouts. The Company’s principal

of money and discount rates considered appropriate given the level

investments in these transactions are generally made in the form of

of risk in the instrument and associated investor yield requirements.

equity investments, equity-related investments or subordinated loans and have not historically required significant levels of capital investment.

The Company is also engaged in structuring and acting as principal in complex derivative transactions. Complex derivatives include certain

Equity interests and securities acquired as a result of leveraged

long-dated equity derivatives, certain credit and municipal derivatives

acquisition transactions are reflected in the consolidated financial

and other exotic derivative structures. These non-exchange-traded

statements at their initial cost until significant transactions or

instruments may have immature or limited markets and, by their

developments indicate that a change in the carrying value of the

nature, involve complex valuation methodologies and models, which

securities is appropriate. Generally, the carrying values of these

are often refined to correlate with the market risk of these instruments.

securities will be increased only in those instances where market values are readily ascertainable by reference to substantial transactions

At November 30, 2006 and 2005, the total value of all financial

occurring in the marketplace or quoted market prices. If quoted

instruments whose fair value is estimated based on internally

market prices are not available, or if liquidating the Company’s

developed

significant

position is reasonably expected to affect market prices, fair value is

assumptions or other data that are generally less readily observable

determined based on other relevant factors. Reductions to the

from objective sources (primarily fixed income cash positions)

carrying value of these securities are made in the event that the

aggregated approximately $12.1 billion and $7.1 billion,

Company’s estimate of net realizable value has declined below the

respectively, in “Financial Instruments Owned” and $7.5 billion and

carrying value. See “Merchant Banking and Private Equity Investments”

$3.5 billion, respectively, in “Financial Instruments Sold, But Not Yet

in Management’s Discussion and Analysis for additional details.

models

or

methodologies

utilizing

Purchased” in the Consolidated Statements of Financial Condition.

LEGAL, REGULATORY AND TAX CONTINGENCIES Controls Over Valuation of Financial Instruments

In the normal course of business, the Company has been named as

In recognition of the importance the Company places on the accuracy

a defendant in various legal actions, including arbitrations, class

of its valuation of financial instruments as described in the three

actions and other litigation. Certain of the legal actions include

categories above, the Company engages in an ongoing internal

claims for substantial compensatory and/or punitive damages or

review of its valuations. Members of the Controllers and Risk

claims for indeterminate amounts of damages. The Company is also

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

59

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

involved in other reviews, investigations and proceedings by

a Group, Controls a Limited Partnership or Similar Entity When the

governmental

the

Limited Partners Have Certain Rights.” The EITF consensus requires

Company's business, certain of which may result in adverse judgments,

a general partner in a limited partnership to consolidate the limited

settlements, fines, penalties, injunctions or other relief.

partnership unless the presumption of control is overcome. The

and

self-regulatory

agencies

regarding

general partner may overcome this presumption of control and Reserves for litigation and regulatory proceedings are determined

not consolidate the entity if the limited partners have: (a) the

on a case-by-case basis and represent an estimate of probable

substantive ability to dissolve or liquidate the limited partnership

losses after considering, among other factors, the progress of each

or otherwise remove the general partner without having to show

case, prior experience and the experience of others in similar cases,

cause; or (b) substantive participating rights in managing the

and the opinions and views of internal and external legal counsel.

partnership. This guidance became effective upon ratification

Because litigation is inherently unpredictable, particularly in cases

by the FASB on June 29, 2005 for all newly formed limited

where claimants seek substantial or indeterminate damages or where

partnerships and for existing limited partnerships for which

investigations and proceedings are in the early stages, the Company

the partnership agreements have been modified. For all other

cannot predict with certainty the loss or range of loss related to

limited partnerships, the guidance is effective no later than the

such matters, the ultimate resolution, the timing of resolution or the

beginning of the first reporting period in fiscal years beginning

amount of eventual settlement, fine, penalty or relief, if any.

after December 15, 2005. As of December 1, 2006, the Company has fully adopted EITF No. 04-5 for both newly formed

The Company is subject to the income tax laws of the United

partnerships as well as partnerships entered into prior to June 29,

States, its states and municipalities and those of the foreign

2005. The adoption of EITF No. 04-5 did not have a material

jurisdictions in which the Company has significant business

impact on the consolidated financial statements of the Company.

operations. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant governmental taxing

In February 2006, the FASB issued SFAS No. 155, “Accounting

authorities.

and

for Certain Hybrid Financial Instruments—an amendment of

interpretations about the application of these inherently complex tax

FASB Statements No. 133 and 140.” SFAS No. 155 permits

laws when determining the provision for income taxes and must

companies to elect, on a transaction-by-transaction basis, to

also make estimates about when in the future certain items affect

apply a fair value measurement to hybrid financial instruments

taxable income in the various tax jurisdictions. Disputes over

that contain an embedded derivative that would otherwise require

interpretations of the tax laws may be settled with the taxing

bifurcation under SFAS No. 133. As permitted, the Company

authority upon examination or audit. The Company regularly

adopted SFAS No. 155 on December 1, 2006 and elected to

evaluates the likelihood of assessments in each of the taxing

apply a fair value measurement to all existing hybrid financial

jurisdictions resulting from current and subsequent years’

instruments that meet the SFAS No. 155 definition. The Company

examinations and tax reserves are established as appropriate.

has also elected the fair value measurement for all appropriate

The

Company

must

make

judgments

hybrid financial instruments issued on or after December 1, 2006. The Company establishes reserves for potential losses that may

The adoption of SFAS No. 155 did not have a material impact on

arise out of litigation, regulatory proceedings and tax audits to the

the consolidated financial statements of the Company.

extent that such losses are probable and can be estimated, in accordance with SFAS No. 5, “Accounting for Contingencies.”

In March 2006, the FASB issued SFAS No. 156, “Accounting for

Once established, reserves are adjusted as additional information

Servicing of Financial Assets—an amendment of FASB Statement

becomes available or when an event requiring a change to the

No. 140.” SFAS No. 156, consistent with SFAS No. 140, requires

reserves occurs. Significant judgment is required in making these

that all separately recognized servicing assets and liabilities be

estimates and the ultimate resolution may differ materially from the

initially measured at fair value. For subsequent measurements,

amounts reserved.

SFAS No. 156 permits companies to choose between using an amortization method or a fair value measurement method

ACCOUNTING AND REPORTING DEVELOPMENTS

for reporting purposes. SFAS No. 156 is effective as of the

In June 2005, the EITF reached a consensus on EITF Issue No. 04-5,

beginning of a company’s first fiscal year that begins after

“Determining Whether a General Partner, or the General Partners as

September 15, 2006. On December 1, 2006, the Company

60

•

T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S DISCUSSION

AND

A N A LY S I S

(continued)

The Bear Stearns Companies Inc.

adopted SFAS No. 156 and elected to measure servicing

The three levels of the fair value hierarchy are:

assets at fair value. The adoption of this standard did not have a material impact on the consolidated financial statements of the Company.

• Level 1: Quoted market prices for identical assets or liabilities in active markets. • Level 2: Observable market-based inputs or unobservable

In April 2006, the FASB issued FASB Staff Position (“FSP”) FIN No. 46 (R)-6, “Determining the Variability to Be Considered in Applying Interpretation No. 46 (R).” This FSP addresses how a

inputs that are corroborated by market data. • Level 3: Unobservable inputs that are not corroborated by market data.

reporting enterprise should determine the variability to be considered in applying FIN No. 46 (R). The variability that is

Additionally, companies are required to provide enhanced

considered in applying FIN No. 46 (R) affects the determination

disclosure information regarding the activities of those financial

of: (a) whether the entity is a variable interest entity, (b) which

instruments classified within the level 3 category, including a

interests are variable interests in the entity, and (c) which party, if

rollforward analysis of fair value balance sheet amounts for each

any, is the primary beneficiary of the VIE. FSP FIN No. 46 (R)-6

major category of assets and liabilities and disclosure of the

states that the design of the entity shall be considered in the

unrealized gains and losses for level 3 positions held at the

determination of variable interests. The Company adopted FSP

reporting date. SFAS No. 157 is effective for financial statements

FIN No. 46 (R)-6 on September 1, 2006. The adoption of this

issued for fiscal years beginning after November 15, 2007. Early

standard did not have a material impact on the consolidated

adoption is permitted if the entity has not yet issued financial

financial statements of the Company.

statements for that fiscal year (including any interim periods). The Company is planning to early adopt SFAS No. 157 in the first

In July 2006, the FASB issued Interpretation No. 48, “Accounting

quarter of fiscal 2007 as permitted, and does not expect that the

for Uncertainty in Income Taxes—an interpretation of FASB

adoption of SFAS No. 157 will have a material impact on the

Statement No. 109” (“FIN No. 48”). FIN No. 48 clarifies the

consolidated financial statements of the Company.

accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with

EFFECTS OF INFLATION

SFAS No. 109. FIN No. 48 prescribes a recognition threshold and

The Company’s assets are primarily recorded at their current

measurement attribute for the financial statement recognition and

market value and, to a large extent, are liquid in nature. The rate

measurement of a tax position taken or expected to be taken in

of inflation affects the Company’s expenses, such as employee

a tax return. FIN No. 48 also provides guidance on derecognition,

compensation, office leasing costs, information technology and

classification, interest and penalties, accounting in interim

communications charges, which may not be readily recoverable

periods, disclosure, and transition. The Company expects to

in the price of services offered by the Company. In addition, to the

adopt the provisions of FIN No. 48 beginning in the first quarter

extent that inflation causes interest rates to rise and has other

of 2008. The Company is currently evaluating the impact, if any,

adverse effects on the securities markets and on the value of

the adoption of FIN No. 48 may have on the consolidated

securities held in inventory, it may adversely affect the Company’s

financial statements of the Company.

financial position and results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS No. 157 requires companies to disclose the fair value of its financial instruments according to a fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets carried at fair value will be classified and disclosed in one of the three categories in accordance with the hierarchy.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

61

RISK MANAGEMENT The Bear Stearns Companies Inc.

OVERALL

The Credit Policy Committee is composed of senior risk, legal and

The Company’s principal business activities engender significant

business managers. The Credit Policy Committee delegates credit

market and credit risks. In addition, the Company is subject to

approval authority to the Global Credit Committee, approves exposure

operational, legal, funding and other risks. Effective identification,

measurement standards, reviews concentrations of credit risk, sets

assessment and management of these risks are critical to the

documentation and credit support standards, and considers new or

success and stability of the Company. As a result, comprehensive

unusual credit-related transactions.

risk management procedures have been established to identify, monitor and control each of these major risks. The risk

The Global Credit Committee, which includes several members of

management process encompasses many units independent of the

the Credit Policy Committee, implements policy through its review

trading desks, including the Risk Management, Global Credit,

and approval of counterparty credit limits.

Global Clearing Services, Controllers, Operations, Compliance, Legal and Financial Analytics & Structured Transactions (“F.A.S.T.”)

The Model Review Committee is composed of senior members of

Departments. The Company’s diverse securities industry activities

the Risk Management, Risk Analytics and F.A.S.T. Departments, as

help to reduce the impact that volatility in any particular market may

well as senior business unit managers who have experience

have on its net revenues. The Treasurer’s Department is

developing and using trading models. The Model Review

independent of trading units and is responsible for the Company’s

Committee works with staff of the Risk Management Department to

funding and liquidity risk management. Funding and liquidity risk

ensure that trading models are independently vetted and controlled.

management are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the

The Principal Activities Committee is composed of senior investment

“Liquidity and Capital Resources” section.

banking, capital markets, credit and risk management professionals.

The Company has established various management committees

underwriting proposals. Certain leveraged loan commitments, as

that have responsibilities for monitoring and oversight of its activities

well as large or unusual credit extensions, are referred by this

and risk exposures. Some of these committees are described below.

committee for approval to the Company’s Executive Committee.

The Executive Committee is the most senior management

The Mark-to-Market (MTM) Committee is composed of senior

committee of the Company. The ultimate approval of decisions

management from the Risk Management and Controllers

regarding the Company’s risk appetite and risk-taking capacity rests

Departments. The MTM Committee is responsible for ensuring that

with the Executive Committee.

the approaches used to independently validate the Company’s

The Principal Activities Committee reviews and approves loan

valuations are robust, comprehensive and effective. The Management & Compensation Committee has primary responsibility for hiring approvals and compensation-related issues.

The New Products and Special Structured Transactions Committee

In addition, a number of decisions regarding business risk and other

is composed of senior management from various departments. The

issues are delegated to the Management & Compensation

New Products and Special Structured Transactions Committee is

Committee from the Executive Committee.

responsible for ensuring that identified new businesses and products are reviewed in advance for legal, credit, operational, accounting,

The Operations Committee is composed of senior managing directors

market and reputation risk and related concerns. The New Products

from various departments, primarily representing key internal control

and Special Structured Transactions Committee meets on a regular

functions. The Operations Committee ensures the coordination of key

basis to review new business proposals and address related issues.

operational, control and regulatory issues across the Company. The Disclosure Committee is composed of senior members of The Risk Committee is composed of senior managing directors

management, including the chief financial officer, controller and general

from each trading department as well as the Risk Management

counsel. The Disclosure Committee has oversight responsibilities for

Department. The Risk Committee provides a high level of oversight

assisting in the review of disclosures to be made by the Company

to trading departments and their trading strategies.

to help ensure that they are complete and accurate, fairly represent

62

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

RISK MANAGEMENT

(continued)

The Bear Stearns Companies Inc.

the Company’s financial condition and are in compliance with the

customer and proprietary trading activities. In connection with these

requirements of applicable securities laws, rules and regulations of

activities, the Company attempts to mitigate its exposure to market

the NYSE.

risk by entering into hedging transactions, which may include listed and over-the-counter derivatives contracts or the purchase or sale

The Company’s Ethics Compliance Committee is composed of the

of securities, financial futures and options on futures or forward

Company’s ethics compliance officer and senior management from

contracts. Additionally, the Company has a controlling interest in a

various departments, including Administration, Legal and Compliance.

majority-owned joint venture that transacts in specialist activities on

The Ethics Compliance Committee is responsible for administering

the NYSE, AMEX and ISE. Stock exchange rules require that

and enforcing the Company’s Code of Business Conduct and

specialists maintain an orderly market, including purchasing shares

Ethics and ethics-related standards and procedures adopted by the

in a declining market, which may result in trading losses.

Corporate Governance Committee. The Ethics Compliance Committee also evaluates potential conflicts of interest between the Company

The Company’s arbitrage activities are designed to take advantage

and its officers.

of market price discrepancies in securities trading in different markets, between related products or derivative instruments.

MARKET RISK

Arbitrage activities involve maintaining offsetting positions in other

Market risk generally represents the risk of loss that may result from

financial instruments. In many instances, the Company may be

the potential change in the value of a financial instrument as a result

required to purchase or sell derivative financial instruments as part

of fluctuations in interest and currency exchange rates, equity,

of the arbitrage of a cash market security. These transactions may

futures and commodity prices, changes in the implied volatility of

involve forward-settling transactions such as forwards or futures,

interest rates, foreign exchange rates, equity, futures and commodity

where the objective may be to capture differences in the time

prices, and price deterioration or changes in value due to changes

value of money, or options transactions, which seek to capture

in market perception or actual credit quality of either the issuer or its

differences between the expected and actual volatility of the

country of origin. Market risk can be exacerbated in times of illiquidity

underlying instrument. The Company attempts to mitigate market

where market participants refrain from transacting in normal quantities

risk in these activities by entering into hedging transactions.

and/or at normal bid-offer spreads. Market risk is inherent to both cash and derivative financial instruments and, accordingly, the scope

Managing risk at the Company begins with the expertise and

of the Company’s market risk management procedures includes all

experience of trading department management. Senior managing

market risk-sensitive financial instruments. The Company’s exposure

directors in each department have extensive knowledge of the

to market risk is directly related to its role as a financial intermediary

specialized products, markets and activities in which they do business.

in customer trading transactions and to its proprietary trading,

Their experience and insight are supplemented by risk management

investment and arbitrage activities.

procedures that monitor and evaluate the Company’s risk profile. Those procedures begin with the Company marking

The Company makes dealer markets in investment grade, corporate

its financial instruments owned to fair value on a daily basis and

debt, non-investment-grade corporate (“high yield”) debt, US

producing daily profit and loss statements for senior management

government securities, sovereign debt, emerging markets debt

covering all trading departments.

obligations, mortgages and mortgage-backed securities, other collateralized securities and municipal bonds. The Company is also

The cornerstone of these procedures is constant communication

an active market maker and conducts block trading activities in

between trading department management and senior management

both listed and over-the-counter equity markets. In connection with

concerning inventory positions and market risk profile. This process

these activities, the Company may be required to maintain

culminates each week with the trading departments making formal

significant inventories to ensure availability and to facilitate customer

reports of positions, profits and losses and certain trading strategies

order flow. The Company is also engaged as a dealer in both listed

to the Risk Committee.

and over-the-counter derivatives and, accordingly, enters into transactions such as interest rate and cross-currency swaps, over-

The Company believes that a clear understanding of how its positions

the-counter options on interest rates and foreign currencies, various

generate profit or loss on a daily basis is crucial to managing risk.

credit default swaps and equity swaps and options, all as part of its

Many of the independent units are actively involved in ensuring the

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

63

RISK MANAGEMENT

(continued)

The Bear Stearns Companies Inc.

integrity and clarity of the daily profit and loss statements. Activities

emphasize the importance of two-way trading in financial instruments

include daily and monthly price verification procedures, position

valued using models in order to verify the accuracy of the models.

reconciliation, review of pricing models and review of recording of

While the Company believes these controls to be effective, it is also

complex transactions. Furthermore, the Company uses market-based

important to note that the risk of model-based valuations is inherent

credit pricing to estimate the appropriate credit reserves associated

in a number of the Company’s activities.

with certain counterparty credit exposures. Following is a discussion of the Company’s primary market risk In addition, trading desk management, senior management and

exposures as of November 30, 2006 and November 30, 2005,

independent units also review the age and composition of proprietary

including a discussion of how those exposures are currently

accounts and review risk reports appropriate to the risk profile of each

managed. The following discussion of the Company’s risk

trading activity. Risk limits are established and monitored, market

management procedures for its principal risks and the estimated

conditions are evaluated, certain transactions are reviewed in detail,

amounts of the Company’s market risk exposure generated by the

and quantitative methods such as value-at-risk and stress testing are

Company’s statistical analyses contains forward-looking statements.

employed (see “Value-at-Risk”). These procedures better ensure that

The analyses used to assess such risks are not predictions of future

trading strategies are followed within acceptable risk parameters.

events, and actual results may vary significantly from such analyses due to events in the markets in which the Company operates and

The Risk Management Department is independent of all trading

certain other factors as described herein.

areas and reports to the chief risk officer. The goals of the department are to understand the market risk profile of each trading area, to

INTEREST RATE RISK

consolidate common risks on a firmwide basis, to articulate large

Interest rate risk is a consequence of maintaining market-making and

trading or position risks to senior management, to provide traders

proprietary inventory positions and trading in interest rate-sensitive

with perspectives on their positions and to better ensure accurate

financial instruments. In connection with the Company’s dealer and

mark-to-market pricing. The department supplements the

arbitrage activities, including market-making in over-the-counter

communication

senior

derivatives contracts, the Company exposes itself to interest rate risk

management by providing its independent perspective on the

arising from changes in the level or volatility of interest rates,

Company’s market risk profile via a daily risk highlights report that is

mortgage prepayment speeds or the level and shape of the yield

distributed to a number of senior managers in the Company.

curve. The Company’s fixed income activities also expose it to the

between

trading

managers

and

risk of loss related to changes in credit spreads on debt instruments. The Company is an active participant in over-the-counter markets,

Credit spread risk arises from the potential that changes in an

including derivatives, commercial and residential mortgage loans,

issuer’s credit rating or credit perception could affect the value of

leveraged loans and Chapter 13 and other credit card receivables.

financial instruments. Credit risk resulting from default on counterparty

The nature of many of these financial instruments is such that they

obligations is discussed in the “Credit Risk” section. The Company

are valued through the use of models. The complexities and reduced

attempts to hedge its exposure to interest rate risk primarily

transparency inherent in financial instruments that are valued using

through the use of interest rate swaps, options, eurodollar and US

models, as compared with exchange-traded prices or other quoted

government securities, and futures and forward contracts designed

market valuations, introduce a particular element of operational risk

to reduce the Company’s risk profile. Credit spread risk is hedged

into the Company’s business. In most cases, internal valuation

through the use of credit derivatives such as credit default swaps,

models are developed by staff within the F.A.S.T. Department.

and by offsetting long or short positions in various related securities.

Traders and trading management supplement and review the development efforts. A further level of review is performed by the

FOREIGN EXCHANGE RATE RISK

independent model review team within the Risk Management

Foreign exchange rate risk arises from the possibility that changes in

Department. Results of the independent model review process are

foreign exchange rates will affect the value of financial instruments.

presented to the Model Review Committee. In certain cases, the

When the Company buys or sells a foreign currency or a financial

Company is also able to compare its model-based valuations with

instrument denominated in a currency other than US dollars,

counterparties in conjunction with collateral exchange agreements.

exposure exists from a net open currency position. Until the position

Senior trading managers and independent Risk Management also

is covered by selling or buying the equivalent amount of the same

64

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

RISK MANAGEMENT

(continued)

The Bear Stearns Companies Inc.

currency or by entering into a financing arrangement denominated

instruments owned and sold, repurchase and resale agreements

in the same currency, the Company is exposed to the risk that the

and funding assets and liabilities. The Company regularly evaluates

exchange rate may move against it. The Company attempts to hedge

and enhances such VaR models in an effort to more accurately

the risk arising from its foreign exchange activities primarily through

measure risk of loss. Certain equity-method investments and

the use of currency borrowing, swaps, options, forwards and futures.

non-publicly traded investments are not reflected in the VaR results. The VaR related to certain non-trading financial instruments has

EQUITY PRICE RISK

been included in this analysis and is not reported separately

The Company is exposed to equity price risk through making

because the amounts are not material. The calculation is based on

markets in equity securities, distressed debt, equity derivatives as

a methodology that uses a one-day interval and a 95% confidence

well as specialist activities. Equity price risk results from changes in

level. The Company uses a historical simulation approach for VaR,

the level or volatility of equity prices, which affect the value of equity

which is supplemented by statistical risk add-ons for risk factors

securities or instruments that derive their value from a particular

that do not lend themselves readily to historical simulation. Historical

stock, a basket of stocks or a stock index. The Company attempts

simulation involves the generation of price movements in a portfolio

to reduce the risk of loss inherent in its inventory of equity securities

using price sensitivities, and actual historical movements of the

by entering into hedging transactions, including equity options and

underlying risk factors to which the securities are sensitive. Risk

futures, designed to mitigate the Company’s market risk profile.

factors incorporated via historical simulation include interest rate movements, yield curve shape, general market credit spreads, equity

COMMODITY PRICE RISK

price movement, option volatility movement (for certain option

Beginning in fiscal 2006, the Company is exposed to commodity

types) and foreign exchange movement, among others. Risk factors

price risk. Commodity price risk refers to the potential loss the

incorporated via add-on factors include the risk of specific bond

Company could suffer from adverse moves in the levels of commodity

issuers, among others. The Company believes that its VaR

prices and derivatives linked to them. The Company is exposed to

methodologies are consistent with industry practices for these

such moves through its energy trading business, which transacts in

calculations.

both listed and over-the-counter energy derivatives as well as the underlying physical commodities themselves, and through various

VaR has inherent limitations, including reliance on historical data,

trading activities which make use of listed commodity futures and

which may not accurately predict future market risk, and the

options on futures. The Company attempts to mitigate the risk of

quantitative risk information generated is limited by the parameters

loss in these activities by using commodity derivatives to limit its

established in creating the models. There can be no assurance that

exposure to changes in the overall level of any given commodity

actual losses occurring on any one day arising from changes in

price, to changes in the volatility of that price, and to changes in the

market conditions will not exceed the VaR amounts shown below or

relative levels of future prices for that commodity.

that such losses will not occur more than once in 20 trading days. VaR is not likely to accurately predict exposures in markets that

VALUE-AT-RISK

exhibit sudden fundamental changes or shifts in market conditions

An estimation of potential losses that could arise from changes

or established trading relationships. Many of the Company’s

in market conditions is typically accomplished through the use of

hedging strategies are structured around likely established trading

statistical models known as value-at-risk (“VaR”) that seek to predict

relationships and, consequently, those hedges may not be effective

risk of loss based on historical and/or market-implied price and

and VaR models may not accurately predict actual results.

volatility patterns. VaR estimates the probability of the value of a

Furthermore, VaR calculated for a one-day horizon does not fully

financial instrument rising above or falling below a specified amount.

capture the market risk of positions that cannot be liquidated in a

The calculation uses the simulated changes in value of the market

one-day period. However, the Company believes VaR models are

risk-sensitive financial instruments to estimate the amount of change

an established methodology for the quantification of risk in the

in the current value that could occur at a specified probability level.

financial services industry despite these limitations. VaR is best used in conjunction with other financial disclosures in order to assess the

The Company has performed an entity-wide VaR analysis of

Company’s risk profile.

the Company’s financial assets and liabilities, including financial

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

65

RISK MANAGEMENT

(continued)

The Bear Stearns Companies Inc.

The aggregate VaR presented here is less than the sum of the individual

The following table illustrates the VaR for each component of

components (i.e., interest rate risk, foreign exchange rate risk, equity

market risk as of November 30, 2006 and 2005.

risk and commodity price risk), due to the benefit of diversification (in millions)

among the risks. Diversification benefit equals the difference between

2006

2005

$ 29.9

$ 22.1

aggregate VaR and the sum of the VaRs for the four risk categories.

Market Risk

This benefit arises because the simulated one-day losses for each of

Interest rate

the four primary market risk categories occur on different days and

Currency

0.8

0.3

because of general diversification benefits introduced when risk is

Equity

3.0

3.6

measured across a larger set of specific risk factors than exist in the

Commodity

0.0

0.0

respective categories; similar diversification benefits also are taken

Diversification benefit

(4.9)

(4.6)

into account across risk factors within each category.

Aggregate VaR

$ 28.8

$ 21.4

The table below illustrates the high, low and average VaR for each component of market risk and aggregate market risk during fiscal 2006 and fiscal 2005 (calculated on a daily basis):

(in millions)

High

Fiscal 2006 Low

Average

High

Fiscal 2005 Low

Average

$ 41.3

$ 20.3

$ 30.8

$ 30.6

$ 11.9

$ 22.1

3.2

0.0

0.8

3.4

0.0

1.2

Market Risk

Interest rate Currency Equity Commodity Aggregate VaR

11.3

1.3

4.3

5.3

0.7

2.9

1.2

0.0

0.2

0.0

0.0

0.0

44.4

19.0

28.6

31.4

11.9

20.5

Aggregate average VaR increased to $28.6 million in 2006 from

Stress tests are performed on a regular basis as well as on an ad

$20.5 million in 2005. The increase was primarily due to higher levels

hoc basis, as deemed appropriate. The ongoing evaluation process

of exposure to interest rates and equity prices.

of trading risks as well as the consideration of new trading positions commonly incorporates an ad hoc discussion of “what-if” stressed

As previously discussed, the Company utilizes a wide variety of market

market conditions and their impact on profitability. This analysis

risk management methods, including trading limits; marking all

varies in its degree of formality based on the judgment of trading

positions to market on a daily basis; daily profit and loss statements;

department management, risk management and senior managers.

position reports; daily risk highlight reports; aged inventory position

While the Company recognizes that no methodology can perfectly

reports; and independent verification of inventory pricing. Additionally,

predict future market conditions, it believes that these tools are an

management of each trading department reports positions, profits

important supplement to the Company’s risk management process.

and losses and notable trading strategies to the Risk Committee on

The Company expects to continue to develop and refine its formal

a weekly basis. The Company believes that these procedures, which

stress testing methodologies.

stress timely communication between traders, trading department management and senior management, are the most important elements of the risk management process. Stress testing (also referred to as scenario analysis) measures the risk of loss over a variety of extreme market conditions that are defined in advance. Stress testing is a key methodology used in the management of market risk as well as counterparty credit risk (see “Credit Risk”). Stress tests are calculated at the firmwide level for particular trading books, customer accounts and individual positions.

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RISK MANAGEMENT

(continued)

The Bear Stearns Companies Inc.

The following chart represents a summary of the daily principal

amounts during the fiscal years ended November 30, 2006 and 2005.

transactions revenues and reflects a combination of trading revenues,

The frequency distribution of the Company’s daily net trading revenues

net interest revenues for certain trading areas and other revenues

reflects the Company’s historical ability to manage its exposure to

for the fiscal years ended November 30, 2006 and 2005. The chart

market risk and the diversified nature of its trading activities. Market

represents a historical summary of the results generated by the

conditions were favorable for the Company’s trading activity in both

Company’s trading activities as opposed to the probability

its fiscal years ending November 30, 2006 and 2005. Hedging

approach used by the VaR model. The average daily trading profit

strategies were generally effective as established trading

was $19.8 million and $15.2 million for the fiscal years ended

relationships remained substantially intact and volatility tended to be

November 30, 2006 and 2005, respectively. There were 13 daily

lower than historical norms. No guarantee can be given regarding

trading losses for the fiscal year ended November 30, 2006 and 9

future net trading revenues or future earnings volatility. However, the

daily trading losses for the fiscal year ended November 30, 2005.

Company believes that these results are indicative of its

Daily trading losses never exceeded the reported average VaR

commitment to the management of market trading risk.

Distribution of Daily Net Trading Revenues Fiscal Years Ended November 30, 2006 and November 30, 2005

NUMBER OF TRADING DAYS

70 60 50 40 30 20 10 0 (10)+

(10)-(5)

(5)-0

0-5

5-10

10-15

15-20

20-25

25-30

30+

DAILY NET TRADING REVENUES ($ IN MILLIONS)

NOVEMBER 30, 2006

NOVEMBER 30, 2005

CREDIT RISK

with the Credit Policy Committee and its subcommittee, the Global

Credit risk arises from potential non-performance by counterparties,

Credit Committee, establishes and reviews appropriate credit limits

customers, borrowers or debt security issuers. The Company is

and collateral requirements for customers and dealer counterparties.

exposed to credit risk as trading counterparty to dealers and

Credit limits are set to control potential exposure arising from

customers, as direct lender, as holder of securities and as member

repurchase and resale agreements, stock borrowing or loan

of exchanges and clearing organizations. The Company has

facilities, derivative financial instruments and other products that

established policies and procedures to manage credit risk.

may give rise to secured and unsecured credit exposure.

Dedicated professionals in several departments contribute to the

Global Credit Department professionals assess the creditworthiness

administration of the Company’s credit policies and procedures.

of the Company’s counterparties, assign an internal credit rating that

The responsible groups include Global Credit, Operations and

reflects the Global Credit Department’s quantitative and qualitative

Administration (Margin), Risk Management, Global Clearing Services

assessment of each counterparty’s relative probability of default,

(Prime Brokerage) and Investment Banking.

and assign or recommend credit limits and requirements. In addition, credit and quantitative analysts assess the quality and acceptability

The Global Credit Department monitors and controls extensions of

of collateral, measure potential credit exposure associated with certain

credit to customers and dealer counterparties and, in conjunction

transactions, monitor compliance with credit limits, obtain appropriate

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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67

RISK MANAGEMENT

(continued)

The Bear Stearns Companies Inc.

legal documentation and provide comprehensive credit risk reporting

reducing features to the extent they are legally enforceable. The

for senior management.

Company’s net replacement cost of derivatives contracts in a gain position at November 30, 2006 and 2005 approximated $4.99 billion

The Company measures its actual credit exposure (the replacement

and $4.41 billion, respectively. Exchange-traded financial instruments,

cost of counterparty contracts) on a daily basis. Master netting

which typically are guaranteed by a highly rated clearing organization,

agreements, collateral and credit insurance are used to mitigate

have margin requirements that substantially mitigate risk of credit loss.

counterparty credit risk. The credit exposures reflect these riskThe following table summarizes the counterparty credit quality of the Company’s exposure with respect to over-the-counter derivatives (including foreign exchange and forward-settling mortgage transactions) as of November 30, 2006: Over-the-Counter Derivatives Credit Exposure (1)

Rating (2)

Exposure

Collateral (3)

Exposure, Net of Collateral (4)

Percentage of Exposure, Net of Collateral

(in millions)

AAA

$ 1,391

$ 104

$ 1,359

27%

AA

5,829

4,053

1,949

39%

A

2,794

1,764

1,085

22%

BBB BB and lower Non-rated

455

455

200

4%

1,379

2,574

316

6%

88

15

83

2%

(1) Excluded are covered transactions structured to ensure that the market values of collateral will at all times equal or exceed the related exposures. The net exposure for these transactions will, under all circumstances, be zero. (2) Internal counterparty credit ratings, as assigned by the Company’s Credit Department, converted to rating agency equivalents. (3) For lower-rated counterparties, the Company generally receives collateral in excess of the current market value of derivatives contracts. (4) In calculating exposure net of collateral, collateral amounts are limited to the amount of current exposure for each counterparty. Excess collateral is not applied to reduce exposure because such excess in one counterparty portfolio cannot be applied to deficient collateral in a different counterparty portfolio.

The Company establishes potential exposure limits across a variety

monitors its exposure to sovereign default, devaluation and

of financing and trading products for all counterparties on a group

inconvertibility of local currencies.

and individual entity basis. Potential exposure is the statistically estimated net credit exposure associated with adverse market

The Margin Department is responsible for evaluating the risk of

moves over the life of transactions at a 97.7% confidence interval.

extending loans to the Company’s customers secured by certain

The potential exposure is estimated daily, using sophisticated,

marketable securities. The department evaluates the acceptability

internally developed risk models that employ Monte Carlo

of collateral and actively monitors to ensure that collateral received

simulations. Potential exposure estimates consider the size and

meets regulatory and internal requirements. Internal (or “house”)

maturity of contracts; the volatility of, and correlations among, the

margin requirements generally exceed minimum regulatory

underlying assets, indices and currencies; settlement mechanisms;

requirements and may be adjusted for specific securities based on

rights to demand additional collateral; and other legally enforceable

volatility or liquidity. The Special Credit Services unit of the Global

credit mitigants such as third-party guarantees or insurance.

Credit Department evaluates and sets terms for loans secured by restricted or control stock, emerging markets securities and

The Company establishes country concentration limits and

concentrated or less liquid securities.

monitors actual and potential exposures, including both position and counterparty exposures, in emerging markets. Sovereign risk

The Risk Management Department is responsible for monitoring the

analysts evaluate international macroeconomic conditions and

market risk of the Company’s proprietary positions. As part of its

recommend country concentration limits. The Company limits and

duties, the group evaluates the credit quality of securities positions

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

RISK MANAGEMENT

(continued)

The Bear Stearns Companies Inc.

held in inventory to quantify and limit the risk to the Company of

Client portfolios are analyzed and evaluated daily through extensive

issuer default or changes in credit spreads. In a similar manner,

stress testing simulations designed to estimate market-related risk

the department also evaluates the credit quality of reference issuer

under different scenarios. Using its internally developed risk

obligations associated with derivatives contracts whose values are

management system, known as RACS (Risk Analytic Control

linked to the credit quality or credit spread trading level of reference

System), the Risk Department is able to analyze every professional

issuers. The department monitors issuer credit exposures across

client’s portfolio prior to each market opening and track that

the various cash and derivatives trading desks that trade in securities

portfolio on an intra-day basis. Client positions are simulated across

or derivatives of the same or related issuers to monitor aggregate

more than 200 different scenarios, resulting in a wide variety of

exposures. This process also aggregates counterparty credit exposures

potential profit and loss possibilities. Some basic assumptions used

with issuer exposures to produce a more comprehensive perspective

in the analysis are minimum portfolio moves of 20% as well as

on the Company’s exposure to credit risks.

minimum moves in individual securities of 25% or more. Other scenarios include price movement tests of 1 and 2 standard

The Company is subject to concentration risk by holding large

deviations, fixed percentage moves, beta-weighted and market

positions or committing to hold large positions in certain types of

capitalization-driven extreme price moves. Scenarios are

securities, securities of a single issuer, including governments,

constructed in such a way as to assess position and portfolio

issuers located in a particular country or geographic area, or issuers

sensitivities to changes in underlying prices, volatilities, interest

engaged in a particular industry. Positions taken and commitments

rates, credit spreads, cross-currency rates and forward time

made by the Company, including underwriting, often involve

horizons. Experienced managers review the results of the stress

substantial amounts and significant exposure to individual issuers

testing to determine whether additional margin is necessary. In

and businesses, including non-investment-grade issuers. At

addition to client-level security and portfolio analysis, the system

November 30, 2006, the Company’s most significant concentrations

produces over 40 various reports that provide multi-dimensional

are related to US government and agency inventory positions,

views, which include industry exposures, country/region exposures

including those of the Federal National Mortgage Association

and security concentration and liquidity risk.

(“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). In addition, a substantial portion of the collateral

The Loan Portfolio Management Group is responsible for managing

held by the Company for reverse repurchase agreements consists

the credit risk in the Company’s loan portfolio. The group is

of securities issued by the US government and agencies. The

responsible for evaluating transactions originated by investment

Company seeks to limit concentration risk through the use of the

bankers and advising on pricing or other considerations during

systems and procedures described in the preceding discussions of

the due diligence process. Specific portfolio limits have been

market and credit risk.

established for the various types of lending, and there are formally approved guidelines for hedging the loan portfolio.

Global Clearing Services carries the accounts of professional clients, including floor traders and specialists, arbitrageurs, broker-dealers,

OPERATIONAL RISK

hedge funds and fund of funds groups. These clients employ a wide

Operational risk is the potential for loss arising from inadequate or

variety of trading styles, including option hedging, market-neutral

failed internal processes, people or systems, or from external

statistical arbitrage, risk arbitrage, hedged convertible strategies and

events. This includes, but is not limited to, limitations in the

multiple fixed income strategies. Trading strategies are employed in

Company’s financial systems and controls, deficiencies in legal

both domestic and international markets. The extension of credit,

documentation, non-compliance with the execution of legal,

via secured margin debt for a given customer, is determined by the

regulatory and fiduciary responsibilities, deficiencies in technology

Risk Department of Global Clearing Services using a systematic

and the risk of loss attributable to operational problems. These risks

analysis of the securities held and trading strategy that such customer

are less direct than credit and market risk, but managing them is

employs. Global Clearing Services has established a risk-based margin

critical, particularly in a rapidly changing environment with increasing

lending policy under which the minimum capital requirement for a

regulation and transaction volumes. In an effort to reduce or mitigate

portfolio may be greater than the applicable regulatory capital

these risks, the Company has established and maintains an internal

requirement for the sum of the underlying constituents of that

control environment that incorporates various control mechanisms

portfolio.

at different levels throughout the organization and within such

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

69

RISK MANAGEMENT

(continued)

The Bear Stearns Companies Inc.

departments as Controllers, Operations, Legal, Risk Management,

perform on its obligations due to non-credit-related conditions,

Global Credit, Compliance and Internal Audit. These control

including counterparty legal authority and capacity. The Company is

mechanisms are designed to better ensure that operational policies

generally subject to extensive regulation in the various jurisdictions

and procedures are being followed and that the Company’s various

in which it conducts its business. The Company has established

businesses are operating within established corporate policies and

procedures based on legal and regulatory requirements on a

limits.

worldwide basis that are designed to ensure compliance with applicable statutory and regulatory requirements. The Company has

In addition to these existing control mechanisms, the Company

established policies and procedures in an effort to mitigate the risk

has an Operational Risk Management function, which focuses on

that counterparty performance obligations will be unenforceable.

facilitating internal communication, disclosure, and supervisory review of operational risk management practices. The Operational Risk

OTHER RISKS

Management function has responsibilities related to the development,

Other risks encountered by the Company include political, regulatory

consistent application and oversight of operational risk policies,

and tax risks. These risks reflect the potential impact that changes

processes and procedures firmwide. The function is independent of

in local and international laws, regulatory requirements or tax

all business units and formally reports to the chief risk officer.

statutes have on the economics and viability of current or future transactions. In an effort to mitigate these risks, the Company seeks

Management of the Company has established and maintains

to continuously review new and pending regulations and legislation

effective internal control over financial reporting. Internal control over

and participates in various industry interest groups.

financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. The Company has invested heavily in technology over the years to have the ability to gather and process information efficiently and to handle the wide variety of products and services the Company offers. In addition, the Company’s investment in technology allows the Company to communicate information efficiently and securely to customers and to groups within the Company.

LEGAL RISK Legal risk includes the risk of non-compliance with applicable legal and regulatory requirements and the risk that a counterparty will not

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

MANAGEMENT’S REPORT

ON

INTERNAL CONTROL OVER FINANCIAL REPORTING The Bear Stearns Companies Inc.

Management of The Bear Stearns Companies Inc. and subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed under the supervision of the Company’s principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of November 30, 2006. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on its assessment, management believes that, as of November 30, 2006, the Company’s internal control over financial reporting is effective based on those criteria. The Company’s independent registered public accounting firm has audited management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of November 30, 2006, as stated in their report, appearing on page 72.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

71

REPORT

OF

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Bear Stearns Companies Inc.

To the Board of Directors and Stockholders of The Bear Stearns Companies Inc. We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that The Bear Stearns Companies Inc. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of November 30, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of November 30, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of November 30, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition as of November 30, 2006 and the related consolidated statements of income, cash flows and changes in stockholders’ equity for the year ended November 30, 2006 of the Company and our report dated February 12, 2007 expressed an unqualified opinion on those financial statements.

New York, New York February 12, 2007

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

REPORT

OF

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Bear Stearns Companies Inc.

To the Board of Directors and Stockholders of The Bear Stearns Companies Inc. We have audited the accompanying consolidated statements of financial condition of The Bear Stearns Companies Inc. and subsidiaries (the “Company”) as of November 30, 2006 and 2005, and the related consolidated statements of income, cash flows and changes in stockholders’ equity for each of the three years in the period ended November 30, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Bear Stearns Companies Inc. and subsidiaries as of November 30, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended November 30, 2006, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of November 30, 2006, based on the criteria established in Internal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 12, 2007 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

New York, New York New York, New York February 12, 2007

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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73

C O N S O L I DAT E D S TAT E M E N T S

OF

INCOME

The Bear Stearns Companies Inc.

Fiscal Years Ended November 30,

2006

2005

2004

$ 1,162,686

$ 1,200,454

$ 1,178,074

Principal transactions

4,995,012

3,836,017

3,595,595

Investment banking

1,333,751

1,037,213

1,031,051

Interest and dividends

8,536,029

5,107,019

2,317,315

523,941

371,744

299,867

Total revenues

16,551,419

11,552,447

8,421,902

Interest expense

7,324,254

4,141,653

1,609,019

9,227,165

7,410,794

6,812,883

(in thousands, except share and per share data)

Revenues Commissions

Asset management and other income

Revenues, net of interest expense Non-Interest Expenses Employee compensation and benefits

4,343,499

3,553,216

3,253,862

Floor brokerage, exchange and clearance fees

226,882

221,553

230,652

Communications and technology

478,780

401,673

369,176

Occupancy

197,756

167,825

141,916

Advertising and market development

147,262

126,678

113,800

Professional fees

279,942

229,198

197,086

Other expenses

406,414

503,592

484,237

6,080,535

5,203,735

4,790,729

3,146,630

2,207,059

2,022,154

Total non-interest expenses Income before provision for income taxes Provision for income taxes

1,092,759

744,882

677,421

$ 2,053,871

$ 1,462,177

$ 1,344,733

(21,363)

(24,321)

(28,072)

Net income applicable to common shares

$ 2,032,508

$ 1,437,856

$ 1,316,661

Basic earnings per share

$

15.79

$

11.42

$

10.88

Diluted earnings per share

$

14.27

$

10.31

$

9.76

Net income Preferred stock dividends

Weighted average common shares outstanding: Basic

131,711,382

130,326,947

127,468,061

Diluted

148,575,469

147,467,992

145,284,589

See Notes to Consolidated Financial Statements.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

C O N S O L I DAT E D S TAT E M E N T S

OF

FINANCIAL CONDITION

The Bear Stearns Companies Inc.

As of November 30,

2006

2005

(in thousands, except share data)

Assets Cash and cash equivalents Cash and securities deposited with clearing organizations or segregated in compliance with federal regulations Securities purchased under agreements to resell Securities received as collateral Securities borrowed Receivables: Customers Brokers, dealers and others Interest and dividends Financial instruments owned, at fair value Financial instruments owned and pledged as collateral, at fair value Total financial instruments owned, at fair value Assets of variable interest entities and mortgage loan special purpose entities Property, equipment and leasehold improvements, net of accumulated depreciation and amortization of $1,152,279 and $1,011,036 in 2006 and 2005, respectively Other assets Total Assets Liabilities & Stockholders’ Equity Short-term borrowings Securities sold under agreements to repurchase Obligation to return securities received as collateral Securities loaned Payables: Customers Brokers, dealers and others Interest and dividends Financial instruments sold, but not yet purchased, at fair value Liabilities of variable interest entities and mortgage loan special purpose entities Accrued employee compensation and benefits Other liabilities and accrued expenses Long-term borrowings Total Liabilities Commitments and contingencies (Note 17) Stockholders’ Equity Preferred stock Common stock, $1.00 par value; 500,000,000 shares authorized as of November 30, 2006 and 2005; 184,805,847 shares issued as of November 30, 2006 and 2005 Paid-in capital Retained earnings Employee stock compensation plans Unearned compensation Treasury stock, at cost: Common stock: 67,396,876 and 70,937,640 shares as of November 30, 2006 and 2005, respectively Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity

$

4,595,184

$

5,859,133

8,803,684 38,838,279 19,648,241 80,523,355

5,269,676 42,647,603 12,426,383 62,915,010

29,481,799 6,119,348 744,542

31,272,881 3,544,806 433,305

109,200,487 15,967,964 125,168,451

90,003,591 12,880,333 102,883,924

30,303,275

15,151,699

479,637 5,726,800 $ 350,432,595

451,247 4,436,970 $ 287,292,637

$ 29,062,714 69,749,675 19,648,241 11,451,324

$ 20,015,727 66,131,617 12,426,383 10,104,325

72,988,661 3,396,835 1,123,348 42,256,544 29,079,552 2,895,047 2,081,354 54,569,916 338,303,211

69,870,570 2,657,178 796,956 33,022,234 14,321,285 1,853,416 1,811,898 43,489,616 276,501,205

359,156

372,326

184,806 4,578,972 9,384,595 2,221,997 (155,596)

184,806 4,109,166 7,492,951 2,600,186 (143,302)

(4,444,546) 12,129,384 $ 350,432,595

(3,824,701) 10,791,432 $ 287,292,637

See Notes to Consolidated Financial Statements. Note: Certain prior year items have been reclassified to conform to the current year’s presentation. T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

75

C O N S O L I DAT E D S TAT E M E N T S

OF

CASH FLOWS

The Bear Stearns Companies Inc.

Fiscal Years Ended November 30,

2006

2005

2004

$ 2,053,871

$ 1,462,177

$ 1,344,733

Depreciation and amortization

350,367

276,658

221,173

Deferred income taxes

(85,325)

112,937

(82,575)

1,009,519

801,216

763,162

(3,534,008)

(846,978)

4,234,367

(16,261,346)

6,263,989

7,595,123

(1,834,885)

(552,783)

2,996,454

(21,415,324)

(26,938,437)

(18,710,277)

(831,155)

(672,940)

(in thousands)

Cash Flows from Operating Activities Net income Adjustments to reconcile net income to cash used in operating activities: Non-cash items included in net income:

Employee stock compensation plans Changes in operating assets and liabilities: Cash and securities deposited with clearing organizations or segregated in compliance with federal regulations Securities borrowed, net of securities loaned Net receivables from brokers, dealers and others Financial instruments owned Other assets

(1,538,505)

Securities sold under agreements to repurchase, net of securities purchased under agreements to resell

7,427,382

10,274,913

(432,360)

Net payables to customers

4,909,173

(8,671,958)

(3,329,522)

Financial instruments sold, but not yet purchased

8,895,281

3,546,354

1,237,709

207,082

170,966

302,727

Accrued employee compensation and benefits Other liabilities and accrued expenses Cash used in operating activities

595,848

494,099

2,191,135

(19,220,870)

(14,438,002)

(2,341,091)

Purchases of property, equipment and leasehold improvements

(180,669)

(202,911)

(128,433)

Cash used in investing activities

(180,669)

(202,911)

(128,433)

Cash Flows From Investing Activities

Cash Flows From Financing Activities Net proceeds from (payments for) short-term borrowings

9,046,987

7,804,896

(1,176,830)

Proceeds from issuances of long-term borrowings

19,891,429

15,996,998

11,248,786

Payments for retirement/repurchase of long-term borrowings

(10,249,865)

(7,273,206)

(6,653,510)

254,771

273,849

Proceeds from issuances of derivatives with a financing element, net

339,029 —

—

(300,000)

Issuance of common stock

289,402

201,851

235,812

Cash retained resulting from tax deductibility under share-based payment arrangements

363,044

426,055

163,887

Redemption of preferred stock

(13,115)

(75,822)

(89,037)

(1,374,064)

(869,629)

(780,827)

(155,257)

(139,253)

(116,791)

Cash provided by financing activities

18,137,590

16,326,661

2,805,339

Net (decrease) increase in cash and cash equivalents

(1,263,949)

1,685,748

335,815

Cash and cash equivalents, beginning of year

5,859,133

4,173,385

3,837,570

$ 4,595,184

$ 5,859,133

$ 4,173,385

Redemption of preferred stock issued by a subsidiary

Treasury stock purchases—common stock Cash dividends paid

Cash and cash equivalents, end of year Supplemental Disclosure of Cash Flow Information:

Cash payments for interest were $7.93 billion, $4.30 billion and $1.66 billion during the fiscal years ended November 30, 2006, 2005 and 2004, respectively. Cash payments for income taxes, net of refunds, were $708.9 million, $146.3 million and $524.5 million for the fiscal years ended November 30, 2006, 2005 and 2004, respectively. Cash payments for income taxes, net of refunds, would have been $1.07 billion, $572.4 million and $688.4 million for the fiscal years ended November 30, 2006, 2005 and 2004, respectively, if increases in the value of equity instruments issued under share-based payment arrangements had not been deductible in determining taxable income. See Notes to Consolidated Financial Statements. Note: Certain prior year items have been reclassified to conform to the current year’s presentation.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

C O N S O L I DAT E D S TAT E M E N T S

OF

CHANGES

IN

STOCKHOLDERS’ EQUITY

The Bear Stearns Companies Inc.

Common Preferred Stock Stock $1 Par Value

Paid-in Capital

Retained Earnings

Employee Stock Compensation Unearned Plans Compensation

$ 4,954,508

$ 2,299,170 $ (188,952)

Treasury Stock— Common Stock

Total

(in thousands, except share and per share data)

Balance, November 30, 2003

$ 538,415 $ 184,806 $ 3,245,380

Net income Dividends declared— Common ($0.85 per share) Preferred

(94,888) (28,712)

7,199

Treasury stock— Common stock purchased (9,236,141 shares)

(780,827)

Common stock issued out of treasury (10,454,157 shares) Redemption of preferred stock

41,631 (90,267)

Income tax benefit related to distributions from employee stock compensation plans

(272,293)

468,517

1,230

163,887

Unearned employee stock compensation, net

30,290

Employee stock compensation awards, net

98,940

Amortization of preferred stock issue costs Balance, November 30, 2004

632,803

(1,459) $ 448,148 $ 184,806 $ 3,548,379

Net income

$ 6,176,871

$ 2,666,879 $ (158,662)

(121,245) (24,852)

7,181

Treasury stock— Common stock purchased (8,483,483 shares)

(869,629)

Common stock issued out of treasury (18,565,624 shares) Income tax benefit related to distributions from employee stock compensation plans

12,776

(729,226)

Amortization of preferred stock issue costs Balance, November 30, 2005

920,477

(75,822)

426,055

Unearned employee stock compensation, net Employee stock compensation awards, net

$(3,875,549) $ 8,990,872

1,462,177

Dividends declared— Common ($1.00 per share) Preferred

Redemption of preferred stock

$ (3,563,239) $ 7,470,088

1,344,733

15,360 655,352

123,198 (1,242) $ 372,326 $ 184,806 $ 4,109,166

$ 7,492,951

$ 2,600,186 $ (143,302)

$ (3,824,701) $10,791,432

T H E B E A R S T E A R N S C O M PA N I E S I N C .

•

77

C O N S O L I DAT E D S TAT E M E N T S

OF

CHANGES

IN

STOCKHOLDERS’ EQUITY

(continued)

The Bear Stearns Companies Inc.

Common Preferred Stock Stock $1 Par Value

Paid-in Capital

Retained Earnings

Employee Stock Compensation Unearned Plans Compensation

Treasury Stock— Common Stock

Total

(in thousands, except share and per share data)

Balance, November 30, 2005

$ 372,326 $184,806 $ 4,109,166

$ 7,492,951

$ 2,600,186 $ (143,302) $ (3,824,701)

Dividends declared— Common ($1.12 per share) Preferred

(140,821) (21,461)

7,417

Treasury stock— Common stock purchased (10,582,214 shares)

(1,374,064)

Common stock issued out of treasury (14,122,978 shares) Redemption of preferred stock Income tax benefit related to distributions from employee stock compensation plans

91,053 (13,170)

(551,441)

Amortization of preferred stock issue costs Balance, November 30, 2006 See Notes to Consolidated Financial Statements.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

754,219

55

363,044

Unearned employee stock compensation, net Employee stock compensation awards, net

$10,791,432

2,053,871

Net income

(12,294) 16,609

165,835

(900) $ 359,156 $184,806 $ 4,578,972

$ 9,384,595

$ 2,221,997 $(155,596) $(4,444,546)

$12,129,384

NOTES

TO

C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S The Bear Stearns Companies Inc.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Interest Entities and Mortgage Loan Special Purpose Entities,” in the

DESCRIPTION OF BUSINESS

Notes to Consolidated Financial Statements.

The Bear Stearns Companies Inc. (the “Company”) is a holding company that, through its broker-dealer and international bank

When the Company does not have a controlling interest in an entity,

subsidiaries, principally Bear, Stearns & Co. Inc. (“Bear Stearns”),

but exerts significant influence over the entity’s operating and

Bear, Stearns Securities Corp. (“BSSC”), Bear, Stearns International

financial decisions (generally defined as owning a voting or

Limited (“BSIL”) and Bear Stearns Bank plc (“BSB”), is primarily

economic interest of 20% to 50%), the Company applies the equity

engaged in business as a securities broker-dealer and operates in

method of accounting.

three principal segments: Capital Markets, Global Clearing Services and Wealth Management. Capital Markets is comprised of the

The consolidated financial statements are prepared in conformity

institutional equities, fixed income and investment banking areas.

with accounting principles generally accepted in the United States

Global Clearing Services provides clearance-related services for

of America. These principles require management to make certain

prime brokerage clients and clearance on a fully disclosed basis for

estimates and assumptions, including those regarding inventory

introducing broker-dealers. Wealth Management is comprised of

valuations, stock-based compensation, certain accrued liabilities

the private client services (“PCS”) and asset management areas.

and the potential outcome of litigation and tax matters, which may

See Note 19, “Segment and Geographic Area Data,” in the Notes

affect the amounts reported in the consolidated financial statements

to Consolidated Financial Statements for a complete description of

and accompanying notes. Actual results could differ materially from

the Company’s principal segments. The Company also conducts

these estimates.

significant activities through other wholly owned subsidiaries, including: Bear Stearns Global Lending Limited; Custodial Trust

As of November 30, 2006, the Company elected, under FASB

Company; Bear Stearns Financial Products Inc. (“BSFP”); Bear

Interpretation No. 39, "Offsetting Amounts Related to Certain

Stearns Capital Markets Inc.; Bear Stearns Credit Products Inc.;

Contracts," to net the payable or receivable relating to the fair value of

Bear Stearns Forex Inc.; EMC Mortgage Corporation; Bear Stearns

cash collateral received or paid associated with its derivatives

Commercial Mortgage, Inc.; and through its majority-owned

inventory, on a counterparty basis, provided that the legal right of

subsidiary Bear Hunter Holdings LLC. The Company participates,

offset exists under a master netting agreement. The Company

through Bear Hunter Holdings LLC, in specialist activities on the

believes this presentation is preferable as compared to a gross

New York Stock Exchange (“NYSE”), American Stock Exchange

presentation as it is a better representation of the Company’s credit

(“AMEX”) and International Securities Exchange (“ISE”).

exposure related to these derivative contracts. The Consolidated Statement of Financial Condition as of November 30, 2005 and the

BASIS OF PRESENTATION

Consolidated Statements of Cash Flows for the years ended

The consolidated financial statements include the accounts of the

November 30, 2005 and 2004 have been retrospectively adjusted to

Company, its wholly owned subsidiaries and other entities in which

conform to the current year’s presentation. The amounts netted

the Company has a controlling interest. All material intercompany

reduced Financial Instruments Owned and Payable to Customers, by

transactions and balances have been eliminated in consolidation.

$6.3 billion as of November 30, 2006 and $3.4 billion as of November

Certain prior year amounts have been reclassified to conform to the

30, 2005, and reduced Financial Instruments Sold, But Not Yet

current year’s presentation. In accordance with Financial

Purchased and Receivable From Customers, by $3.2 billion as of

Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 46

November 30, 2006 and $2.0 billion as of November 30, 2005.

(R), “Consolidation of Variable Interest Entities (revised December 2003)—an interpretation of ARB No. 51” (“FIN No. 46 (R)”), the

For the year ended November 30, 2006, the Company changed its

Company also consolidates any variable interest entities (“VIEs”) for

presentation of segments to allocate certain revenues (predominantly

which it is the primary beneficiary. The assets and related liabilities

interest) as well as certain corporate administrative expenses from

of such variable interest entities have been shown in the

“Other” to its three business segments. Certain legal and CAP Plan

Consolidated Statements of Financial Condition in the captions

costs continue to be included in “Other.” Management believes that

“Assets of variable interest entities and mortgage loan special

these changes provide an improved representation of each segment’s

purpose entities” and “Liabilities of variable interest entities and

contribution to net revenues and pre-tax income for which to evaluate

mortgage loan special purpose entities.” See Note 6, “Variable

performance. These reclassifications were also made to prior year

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S

(continued)

The Bear Stearns Companies Inc.

amounts to conform to the current year’s presentation and are

securities is appropriate. Generally, the carrying values of these

reflected in Note 19, “Segment and Geographic Area Data” in Notes

securities will be increased only in those instances where market

to Consolidated Financial Statements.

values are readily ascertainable by reference to substantial transactions occurring in the marketplace or quoted market prices.

FINANCIAL INSTRUMENTS

Reductions to the carrying value of these securities are made when

Proprietary securities, futures and other derivatives transactions are

the Company’s estimate of net realizable value has declined below

recorded on a trade-date basis. Financial instruments owned and

the carrying value.

financial instruments sold, but not yet purchased, including contractual commitments arising pursuant to futures, forward and option

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

contracts, interest rate swaps and other derivative contracts, are

The Company follows SFAS No. 133, “Accounting for Derivative

recorded at fair value with the resulting net unrealized gains and losses

Instruments and Hedging Activities,” as amended by SFAS No. 138,

reflected in “Principal Transactions” revenues in the Consolidated

“Accounting for Certain Derivative Instruments and Certain Hedging

Statements of Income.

Activities,” and SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which establishes

Fair value is generally based on quoted market prices. If quoted market

accounting and reporting standards for stand-alone derivative

prices are not available, or if liquidating the Company’s position is

instruments, derivatives embedded within other contracts or

reasonably expected to affect market prices, fair value is determined

securities, and hedging activities. Accordingly, all derivatives, whether

based on other relevant factors, including dealer price quotations,

stand-alone or embedded within other contracts or securities (except

price activity for equivalent instruments and valuation pricing models.

in narrowly defined circumstances), are carried in the Company’s

Valuation pricing models consider time value, yield curve and volatility

Consolidated Statements of Financial Condition at fair value, with

factors, prepayment speeds, default rates, loss severity, current

changes in fair value recorded in current earnings in “Principal

market and contractual prices for the underlying financial instruments,

Transactions” revenues. Designated hedged items in fair value hedging

as well as other measurements.

relationships are marked for the risk being hedged, with such changes recorded in current earnings.

The Company followed Emerging Issues Task Force (“EITF”) Statement No. 02-3, “Issues Involved in Accounting for Derivative

CUSTOMER TRANSACTIONS

Contracts Held for Trading Purposes and Contracts Involved in

Customer securities transactions are recorded on the Consolidated

Energy Trading and Risk Management Activities,” through November

Statements of Financial Condition on a settlement date basis, which is

30, 2006. This guidance generally eliminates the practice of

generally three business days after trade date, while the related

recognizing profit at the inception of a derivative contract unless the

commission revenues and expenses are recorded on a trade-date

fair value of the derivative is obtained from a quoted market price in

basis. Receivables from and payables to customers include amounts

an active market or is otherwise evidenced by comparison to other

related to both cash and margin transactions. Securities owned by

observable current market transactions or based on a valuation

customers, including those that collateralize margin or other similar

technique that incorporates observable market data. The Company

transactions, are generally not reflected in the Consolidated

intends to adopt Statement of Financial Accounting Standards

Statements of Financial Condition.

(“SFAS”) No. 157, “Fair Value Measurements,” in the first quarter of 2007. SFAS No. 157 nullifies the consensus reached in

MORTGAGE SERVICING ASSETS, FEES AND ADVANCES

EITF No. 02-3, which prohibited recognition of day one gains or

Mortgage servicing rights (“MSRs”), which are included in “Other

losses on certain derivative contracts. See “Accounting and

Assets” on the Consolidated Statements of Financial Condition, are

Reporting Developments” in Note 1 of Notes to Consolidated

reported at the lower of amortized cost or market. MSRs are amortized

Financial Statements for a complete discussion of SFAS No. 157.

in proportion to and over the period of estimated net servicing income. MSRs are periodically evaluated for impairment based on the fair value

Equity interests and securities acquired as a result of private equity

of those rights determined by using market-based models that

and merchant banking activities are reflected in the consolidated

discount anticipated future net cash flows considering loan

financial statements at their initial cost until significant transactions or

prepayment predictions, interest rates, default rates, servicing costs

developments indicate that a change in the carrying value of the

and other economic factors. For purposes of impairment evaluation

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

NOTES

TO

C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S

(continued)

The Bear Stearns Companies Inc.

and measurement, the Company stratifies MSRs by securitizations,

resell (“reverse repurchase agreements”) or sales of securities under

which are collateralized by loans with similar predominant risk

agreements to repurchase (“repurchase agreements”) are treated as

characteristics. The excess of amortized cost over market value, if any,

collateralized financing transactions and are recorded at their

is reflected as a valuation allowance as of balance sheet dates.

contracted resale or repurchase amounts plus accrued interest. Resulting interest income and expense is generally included in

Contractual servicing fees, late fees and other ancillary servicing fees

“Principal Transactions” revenues in the Consolidated Statements of

earned for servicing mortgage loans are reflected net of MSRs

Income.

amortization and impairment in “Investment Banking” revenues in the

agreements are presented in the Consolidated Statements of

Consolidated Statements of Income. Contractual servicing fees are

Financial Condition on a net-by-counterparty basis, where permitted

recognized when earned based on the terms of the servicing

by generally accepted accounting principles. It is the Company’s

agreement. All other fees are recognized when received. In the

general policy to take possession of securities with a market value in

normal course of its business, the Company makes principal, interest

excess of the principal amount loaned plus the accrued interest

and other servicing advances to external investors on mortgage

thereon, in order to collateralize reverse repurchase agreements.

loans serviced for these investors. Such advances are generally

Similarly, the Company is generally required to provide securities to

recoverable from the mortgagors, related securitization trusts or from

counterparties to collateralize repurchase agreements. The

the proceeds received from the sales of the underlying properties. A

Company’s agreements with counterparties generally contain

charge to expense is recognized to the extent that servicing

contractual provisions allowing for additional collateral to be obtained,

advances are estimated to be uncollectible under the provisions of

or excess collateral returned. It is the Company’s policy to value

the servicing contracts.

collateral and to obtain additional collateral, or to retrieve excess

Reverse

repurchase

agreements

and

repurchase

collateral from counterparties, when deemed appropriate.

TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES

Securities borrowed and securities loaned are recorded based upon

The Company follows SFAS No. 140, “Accounting for Transfers and

the amount of cash collateral advanced or received. Securities

Servicing of Financial Assets and Extinguishments of Liabilities—a

borrowed transactions facilitate the settlement process and require the

replacement of FASB Statement No. 125,” to account for

Company to deposit cash, letters of credit or other collateral with the

securitizations and other transfers of financial assets and collateral.

lender. With respect to securities loaned, the Company receives

SFAS No. 140 establishes accounting and reporting standards with a

collateral in the form of cash or other collateral. The amount of

financial-components approach that focuses on control. Under this

collateral required to be deposited for securities borrowed, or received

approach, financial assets or liabilities are recognized when control is

for securities loaned, is an amount generally in excess of the market

established and derecognized when control has been surrendered or

value of the applicable securities borrowed or loaned. The Company

the liability has been extinguished. Control is deemed to be

monitors the market value of securities borrowed and loaned, with

relinquished only when all of the following conditions have been met:

excess collateral retrieved or additional collateral obtained, when

(1) the assets have been isolated from the transferor, even in

deemed appropriate.

bankruptcy or other receivership; (2) the transferee is a Qualifying Special Purpose Entity (“QSPE”) or has the right to pledge or exchange

INVESTMENT BANKING AND ADVISORY SERVICES

the assets received; and (3) the transferor has not maintained effective

Underwriting revenues and fees for mergers and acquisitions

control over the transferred assets. The Company derecognizes

advisory services are accrued when services for the transactions are

financial assets transferred in securitizations provided that such

substantially completed. Transaction expenses are deferred until

transfer meets all of these criteria.

the related revenue is recognized. Investment banking and advisory services revenues are presented net of transaction-

Mortgage related transactions, net of certain direct costs, are

related expenses.

recorded in “Principal Transactions” revenues in the Consolidated Statements of Income.

COMMISSIONS Commission revenues primarily include fees from executing and

COLLATERALIZED SECURITIES TRANSACTIONS

clearing client transactions on stock, options and futures markets

Transactions involving purchases of securities under agreements to

worldwide. These fees are recognized on a trade-date basis. The

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S

(continued)

The Bear Stearns Companies Inc.

Company records its share of the commission under certain

determinants of basic EPS and, in addition, gives effect to dilutive

commission sharing arrangements where the Company is acting as

potential common shares related to stock compensation plans.

agent for another broker, in accordance with EITF Statement No. 9919, “Reporting Revenue Gross as a Principal versus Net as an Agent.”

STOCK-BASED COMPENSATION Effective December 1, 2005, the Company adopted the provisions of

ASSET MANAGEMENT AND OTHER INCOME

SFAS No. 123 (R), “Share-Based Payment.” SFAS No. 123 (R) is a

The Company receives advisory fees for investment management. In

revision of SFAS No. 123, “Accounting for Stock-Based

addition, the Company receives performance incentive fees for

Compensation,” and supersedes Accounting Principles Board (“APB”)

managing certain funds. Advisory fees are recognized over the period

Opinion No. 25, “Accounting for Stock Issued to Employees,” and

of advisory service. Unearned advisory fees are treated as deferred

amends SFAS No. 95, “Statement of Cash Flows.” SFAS No. 123 (R)

revenues and are included in “Other Liabilities” in the accompanying

eliminates the ability to account for share-based compensation

Consolidated Statements of Financial Condition. Performance

transactions using APB No. 25 and requires all share-based payments

incentive fees are recognized throughout the year as they become

to employees, including grants of employee stock options, to be

realizable based on achievement of specified performance targets.

recognized in the financial statements using a fair value-based method. The Company adopted SFAS No. 123 (R) using the modified

FIXED ASSETS

prospective method. Because the fair value recognition provisions of

Depreciation of property and equipment is provided by the Company

SFAS No. 123 and SFAS No. 123 (R) were materially consistent under

on a straight-line basis over the estimated useful life of the asset.

the Company’s equity plans, the adoption of SFAS No. 123 (R) did not

Amortization of leasehold improvements is provided on a straight-line

have a material impact on the Company’s financial position or results

basis over the lesser of the estimated useful life of the asset or the

of operations.

remaining life of the lease. Prior to the Company’s adoption of SFAS No. 123 (R), tax benefits in

GOODWILL AND IDENTIFIABLE INTANGIBLE ASSETS

excess of recognized compensation costs were reported as operating

The Company accounts for goodwill and identifiable intangible assets

cash flows. SFAS No. 123 (R) requires excess tax benefits to be

under the provisions of SFAS No. 142, “Goodwill and Other Intangible

reported as a financing cash inflow.

Assets.” In accordance with this guidance, the Company does not amortize goodwill, but amortizes identifiable intangible assets over their

The Company previously elected to adopt fair value accounting for

useful lives. Goodwill is tested at least annually for impairment and

stock-based compensation consistent with SFAS No. 123, using the

identifiable intangible assets are tested for potential impairment

prospective method with guidance provided by SFAS No. 148,

whenever events or changes in circumstances suggest that the

“Accounting for Stock-Based Compensation—Transition and

carrying value of an asset or asset group may not be fully recoverable

Disclosure,” effective December 1, 2002. As a result, commencing

in accordance with SFAS No. 144, “Accounting for the Impairment or

with options granted after November 30, 2002, the Company

Disposal of Long-Lived Assets.”

expenses the fair value of stock options issued to employees over the related vesting period. Prior to December 1, 2002, the Company had

EARNINGS PER SHARE

elected to account for its stock-based compensation plans using the

Earnings per share (“EPS”) is computed in accordance with SFAS No.

intrinsic value method prescribed by APB No. 25, as permitted by

128, “Earnings Per Share.” Basic EPS is computed by dividing net

SFAS No. 123. Under the provisions of APB No. 25, compensation

income applicable to common shares, adjusted for costs related to

cost for stock options was measured as the excess, if any, of the

vested shares under the Capital Accumulation Plan for Senior

quoted market price of the Company’s common stock at the date of

Managing Directors, as amended (“CAP Plan”), as well as the effect of

grant over the amount an employee must pay to acquire the stock.

the redemption of preferred stock, by the weighted average number of

Accordingly, no compensation expense was recognized for stock

common shares outstanding. Common shares outstanding includes

option awards granted prior to December 1, 2002 because the

vested units issued under certain stock compensation plans, which will

exercise price was at the fair market value of the Company’s common

be distributed as shares of common stock. Diluted EPS includes the

stock on the grant date.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

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C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S

(continued)

The Bear Stearns Companies Inc.

The cost related to stock-based compensation included in net income for the fiscal year ended November 30, 2006 has been fully determined under the fair value-based method, and for the fiscal years ended November 30, 2005 and 2004 is less than that which would have been recognized if the fair value-based method had been applied to stock option awards since the original effective date of SFAS No. 123. The following table illustrates the effect on net income and earnings per share if the fair value-based method had been applied to all outstanding awards in each fiscal year.

Fiscal Years Ended November 30,

2005

2004

$ 1,462.2

$ 1,344.7

375.4

335.4

(in millions, except per share amounts)

Net income, as reported Add: Stock-based employee compensation plans expense included in reported net income, net of related tax effect Deduct: Total stock-based employee compensation plans expense determined under the fair value-based method, net of related tax effect

(387.3)

(367.6)

$ 1,450.3

$ 1,312.5

Basic—as reported

$ 11.42

$ 10.88

Basic—pro forma

$ 11.33

$ 10.63

Diluted—as reported

$ 10.31

$

9.76

Diluted—pro forma

$ 10.23

$

9.54

Pro forma net income Earnings per share:

CASH EQUIVALENTS

reserves are adjusted as information becomes available or when an

The Company has defined cash equivalents as liquid investments

event requiring a change to the reserve occurs.

not held for sale in the ordinary course of business with original maturities of three months or less that are not part of the Company’s

TRANSLATION OF FOREIGN CURRENCIES

trading inventory.

Assets and liabilities denominated in foreign currencies are translated at fiscal year-end rates of exchange, while income

INCOME TAXES

statement items are translated at daily average rates of exchange

The Company and certain of its subsidiaries file a US consolidated

during the fiscal year. Comprehensive income was materially the

federal income tax return. The Company accounts for income taxes

same as net income for the Company for the years ended

under the provisions of SFAS No. 109, “Accounting for Income

November 30, 2006, 2005, and 2004. Gains or losses resulting

Taxes.” Under SFAS No. 109, deferred income taxes are based on

from foreign currency transactions are included in current earnings.

the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities. In addition, deferred

ACCOUNTING AND REPORTING DEVELOPMENTS

income taxes are determined by the enacted tax rates and laws

In June 2005, the EITF reached a consensus on EITF Issue No. 04-5,

expected to be in effect when the related temporary differences are

“Determining Whether a General Partner, or the General Partners as

expected to be reversed.

a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights.” The EITF consensus requires

The Company is under continuous examination by various tax

a general partner in a limited partnership to consolidate the limited

authorities in jurisdictions in which the Company has significant

partnership unless the presumption of control is overcome. The

business operations. The Company regularly evaluates the

general partner may overcome this presumption of control and

likelihood of additional assessments in each of the tax jurisdictions

not consolidate the entity if the limited partners have: (a) the

resulting from these examinations. Tax reserves have been

substantive ability to dissolve or liquidate the limited partnership or

established, which the Company believes to be adequate in relation

otherwise remove the general partner without having to show cause;

to the probability for additional assessments. Once established,

or (b) substantive participating rights in managing the partnership.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S

(continued)

The Bear Stearns Companies Inc.

This guidance became effective upon ratification by the FASB on

variable interest entity, (b) which interests are variable interests in the

June 29, 2005 for all newly formed limited partnerships and for

entity, and (c) which party, if any, is the primary beneficiary of the VIE.

existing limited partnerships for which the partnership agreements

FSP FIN No. 46 (R)-6 states that the design of the entity shall be

have been modified. For all other limited partnerships, the guidance is

considered in the determination of variable interests. The Company

effective no later than the beginning of the first reporting period in

adopted FSP FIN No. 46 (R)-6 on September 1, 2006. The adoption

fiscal years beginning after December 15, 2005. As of December 1,

of this standard did not have a material impact on the consolidated

2006, the Company has fully adopted EITF No. 04-5 for both newly

financial statements of the Company.

formed partnerships as well as partnerships entered into prior to June 29, 2005. The adoption of EITF No. 04-5 did not have a material

In July 2006, the FASB issued Interpretation No. 48, “Accounting for

impact on the consolidated financial statements of the Company.

Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN No. 48”). FIN No. 48 clarifies the accounting for

In February 2006, the FASB issued SFAS No. 155, “Accounting for

uncertainty in income taxes recognized in an enterprise’s financial

Certain Hybrid Financial Instruments—an amendment of FASB

statements in accordance with SFAS No. 109. FIN No. 48

Statements No. 133 and 140.” SFAS No. 155 permits companies

prescribes a recognition threshold and measurement attribute for

to elect, on a transaction-by-transaction basis, to apply a fair value

the financial statement recognition and measurement of a tax

measurement to hybrid financial instruments that contain an

position taken or expected to be taken in a tax return. FIN No. 48

embedded derivative that would otherwise require bifurcation under

also provides guidance on derecognition, classification, interest and

SFAS No. 133. As permitted, the Company adopted SFAS No. 155

penalties, accounting in interim periods, disclosure, and transition.

on December 1, 2006 and elected to apply a fair value

The Company expects to adopt the provisions of FIN No. 48

measurement to all existing hybrid financial instruments that meet

beginning in the first quarter of 2008. The Company is currently

the SFAS No. 155 definition. The Company has also elected the fair

evaluating the impact, if any, the adoption of FIN No. 48

value measurement for all appropriate hybrid financial instruments

may have on the consolidated financial statements of the Company.

issued on or after December 1, 2006. The adoption of SFAS No. 155 did not have a material impact on the consolidated financial

In September 2006, the FASB issued SFAS No. 157, “Fair Value

statements of the Company.

Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and requires enhanced

In March 2006, the FASB issued SFAS No. 156, “Accounting for

disclosures about fair value measurements. SFAS No. 157 requires

Servicing of Financial Assets—an amendment of FASB Statement

companies to disclose the fair value of its financial instruments

No. 140.” SFAS No. 156, consistent with SFAS No. 140, requires

according to a fair value hierarchy. The fair value hierarchy ranks the

that all separately recognized servicing assets and liabilities be initially

quality and reliability of the information used to determine fair values.

measured at fair value. For subsequent measurements, SFAS No.

Financial assets carried at fair value will be classified and disclosed

156 permits companies to choose between using an amortization

in one of the three categories in accordance with the hierarchy. The

method or a fair value measurement method for reporting purposes.

three levels of the fair value hierarchy are:

SFAS No. 156 is effective as of the beginning of a company’s first fiscal year that begins after September 15, 2006. On December 1, 2006, the Company adopted SFAS No. 156 and elected to measure servicing assets at fair value. The adoption of this standard did not have a material impact on the consolidated financial statements of the Company.

• Level 1: Quoted market prices for identical assets or liabilities in active markets. • Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data. • Level 3: Unobservable inputs that are not corroborated by market data.

In April 2006, the FASB issued FASB Staff Position (“FSP”) FIN No. 46 (R)-6, “Determining the Variability to Be Considered in Applying

Additionally, companies are required to provide enhanced

Interpretation No. 46 (R).” This FSP addresses how a reporting

disclosure information regarding the activities of those financial

enterprise should determine the variability to be considered in

instruments classified within the level 3 category, including a

applying FIN No. 46 (R). The variability that is considered in applying

rollforward analysis of fair value balance sheet amounts for each

FIN No. 46 (R) affects the determination of: (a) whether the entity is a

major category of assets and liabilities and disclosure of the

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The Bear Stearns Companies Inc.

unrealized gains and losses for level 3 positions held at the reporting date. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Early adoption is permitted if the entity has not yet issued financial statements for that fiscal year (including any interim periods). The Company is planning to early adopt SFAS No. 157 in the first quarter of fiscal 2007 as permitted, and does not expect that the adoption of SFAS No. 157 will have a material impact on the consolidated financial statements of the Company.

2. FAIR VALUE OF FINANCIAL INSTRUMENTS Substantially all of the Company’s assets and liabilities are carried at contracted amounts that approximate fair value. Assets that are recorded at contracted amounts approximating fair value consist largely of short-term secured receivables, including reverse repurchase agreements, securities borrowed, customer receivables and certain other receivables. Similarly, the Company’s short-term liabilities, such as bank loans, commercial paper, medium-term notes, repurchase agreements, securities loaned, customer payables and certain other payables, are recorded at contracted amounts approximating fair value. These instruments generally have variable interest rates and/or short-term maturities, in many cases overnight, and accordingly, their fair values are not materially affected by changes in interest rates. The estimated fair value of the Company’s long-term borrowings, based on market rates of interest and current foreign exchange rates available to the Company at November 30, 2006 for debt obligations of similar maturity, approximates carrying value as a result of applying SFAS No. 133. The Company uses derivatives to modify the interest rate characteristics of its long- and short-term debt. The Company generally enters into interest rate swaps and other transactions designed to either convert its fixed-rate debt into floating-rate debt or otherwise hedge its exposure to changes in interest rates.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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The Bear Stearns Companies Inc.

3. FINANCIAL INSTRUMENTS Financial instruments owned and financial instruments sold, but not yet purchased, consisting of the Company’s proprietary trading inventories, at fair value, as of November 30, 2006 and 2005, were as follows:

2006

(in thousands)

2005

Financial Instruments Owned: US government and agency

$

Other sovereign governments

7,151,703

$

9,914,866

356,201

1,159,265

Corporate equity and convertible debt

28,892,588

18,601,132

Corporate debt and other

33,924,116

21,571,914

Mortgages, mortgage- and asset-backed

43,226,699

40,297,016

Derivative financial instruments

11,617,144

11,339,731

$ 125,168,451

$ 102,883,924

$ 12,322,838

$ 10,115,133

676,402

1,617,998

12,623,291

6,900,004

4,714,019

3,274,034

Financial Instruments Sold, But Not Yet Purchased: US government and agency Other sovereign governments Corporate equity and convertible debt Corporate debt and other Mortgages, mortgage- and asset-backed Derivative financial instruments

54,802

139,988

11,865,192

10,975,077

$ 42,256,544

$ 33,022,234

As of November 30, 2006 and 2005, all financial instruments

November

owned that were pledged to counterparties where the

concentrations are related to US government and agency inventory

counterparty has the right, by contract or custom, to

positions, including those of the Federal National Mortgage

rehypothecate those securities are classified as “Financial

Association and the Federal Home Loan Mortgage Corporation. In

Instruments Owned and Pledged as Collateral, at Fair Value” in

addition, a substantial portion of the collateral held by the Company

the Consolidated Statements of Financial Condition.

for reverse repurchase agreements consists of securities issued by

30,

2006,

the

Company’s

most

significant

the US government and agencies. Financial instruments sold, but not yet purchased, represent obligations of the Company to purchase the specified financial

4. DERIVATIVES AND HEDGING ACTIVITIES

instrument at the then-current market price. Accordingly, these

The Company, in its capacity as a dealer in over-the-counter

transactions result in off-balance-sheet risk as the Company’s ultimate

derivative financial instruments and its proprietary market-making

obligation to repurchase such securities may exceed the amount

and trading activities, enters into transactions in a variety of cash

recognized in the Consolidated Statements of Financial Condition.

and derivative financial instruments for proprietary trading and to manage its exposure to market and credit risk. These risks include

CONCENTRATION RISK

interest rate, exchange rate and equity price risk. Derivative financial

The Company is subject to concentration risk by holding large

instruments

positions or committing to hold large positions in certain types of

counterparties that derive their value from changes in an underlying

securities, securities of a single issuer (including governments),

interest rate, currency exchange rate, index (e.g., Standard & Poor’s

issuers located in a particular country or geographic area, or issuers

500 Index), reference rate (e.g., London Interbank Offered Rate, or

engaged in a particular industry. Positions taken and commitments

LIBOR), or asset value referenced in the related contract. Some

made by the Company, including underwritings, often involve

derivatives, such as futures contracts, certain options and index-

substantial amounts and significant exposure to individual issuers

referenced warrants, are traded on an exchange. Other derivatives,

and businesses, including non-investment-grade issuers. At

such as interest rate and currency swaps, caps, floors, collars,

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represent

contractual

commitments

between

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(continued)

The Bear Stearns Companies Inc.

swaptions, equity swaps and options, credit derivatives, structured

derivatives inventory in financial instruments owned and financial

notes and forward contracts, are negotiated in the over-the-counter

instruments sold, but not yet purchased. See Note 1 of Notes to the

markets. Derivatives generate both on- and off-balance-sheet risks,

Consolidated Financial Statements for a complete discussion of

depending on the nature of the contract. Generally, these financial

cash collateral netting. Exchange-traded financial instruments, such

instruments represent commitments or rights to exchange interest

as futures and options, generally do not give rise to significant

payment streams or currencies or to purchase or sell other

unsecured counterparty exposure due to the Company’s margin

securities at specific terms at specified future dates. Option

requirements, which may be greater than those prescribed by the

contracts generally provide the holder with the right, but not the

individual exchanges. Options written generally do not give rise to

obligation, to purchase or sell a financial instrument at a specific

counterparty credit risk since they obligate the Company (not its

price on or before an established date or dates. Financial

counterparty) to perform.

instruments sold, but not yet purchased may result in market and/or credit risk in excess of amounts recorded in the Consolidated

The Company has controls in place to monitor credit exposures by

Statements of Financial Condition.

assessing the future creditworthiness of counterparties and limiting transactions with specific counterparties. The Company

MARKET RISK

also seeks to control credit risk by following an established credit

Derivative financial instruments involve varying degrees of off-

approval process, monitoring credit limits and requiring collateral

balance-sheet market risk, whereby changes in the level or volatility

where appropriate.

of interest rates, foreign currency exchange rates or market values of the underlying financial instruments may result in changes in the

NON-TRADING DERIVATIVES ACTIVITY

value of a particular financial instrument in excess of the amounts

To modify the interest rate characteristics of its long- and short-term

currently reflected in the Consolidated Statements of Financial

debt, the Company also engages in non-trading derivatives

Condition. The Company’s exposure to market risk is influenced by

activities. The Company has issued US dollar- and foreign

a number of factors, including the relationships among and

currency-denominated debt with both variable- and fixed-rate

between financial instruments with off-balance-sheet risk, the

interest payment obligations. The Company has entered into

Company’s proprietary securities, futures and derivatives

interest rate swaps, primarily based on LIBOR, to convert fixed-rate

inventories as well as the volatility and liquidity in the markets in

interest payments on its debt obligations into variable-rate interest

which the financial instruments are traded. The Company mitigates

payments. In addition, for foreign currency debt obligations that are

its exposure to market risk by entering into hedging transactions,

not used to fund assets in the same currency, the Company has

which may include over-the-counter derivative contracts or the

entered into currency swap agreements that effectively convert the

purchase or sale of interest-bearing securities, equity securities,

debt into US dollar obligations. Such transactions are accounted for

financial futures and forward contracts. In this regard, the utilization

as fair value hedges.

of derivative instruments is designed to reduce or mitigate market risks associated with holding dealer inventories or in connection

These financial instruments are subject to the same market and

with arbitrage-related trading activities.

credit risks as those that are traded in connection with the Company’s market-making and trading activities. The Company has

DERIVATIVES CREDIT RISK

similar controls in place to monitor these risks. Interest rate swap

Credit risk arises from the potential inability of counterparties to

agreements increased interest expense on the Company’s

perform in accordance with the terms of the contract. At any point

long- and short-term debt obligations by $376.1 million during the

in time, the Company’s exposure to credit risk associated with

fiscal year ended November 30, 2006 and reduced interest expense

counterparty non-performance is generally limited to the net

on the Company’s long- and short-term debt obligations by

replacement cost of over-the-counter contracts, net of the value of

$115.4 million and $589.3 million during the fiscal years ended

collateral held. Such financial instruments are reported at fair value

November 30, 2005 and 2004, respectively.

on a net-by-counterparty basis pursuant to enforceable netting agreements. As of November 30, 2006, the Company elected

SFAS No. 133, as amended by SFAS No. 138 and SFAS No. 149,

under FIN No. 39 to net the payable or receivable relating to the fair

establishes accounting and reporting standards for stand-alone

value of cash collateral received or paid associated with its

derivative instruments, derivatives embedded within other

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The Bear Stearns Companies Inc.

contracts or securities and for hedging activities. It requires that all

“Financial Instruments Owned” in the Consolidated Statements of

derivatives, whether stand-alone or embedded within other

Financial Condition and are carried at fair value. Consistent with

contracts or securities (except in very defined circumstances) be

the valuation of similar inventory, fair value is determined by

carried on the Company’s Statement of Financial Condition at fair

broker-dealer price quotations and internal valuation pricing

value. SFAS No. 133 also requires items designated as being fair

models that utilize variables such as yield curves, prepayment

value hedged to be recorded at fair value, as defined in SFAS No.

speeds, default rates, loss severity, interest rate volatilities and

133, provided that the intent to hedge is fully documented. Any

spreads. The assumptions used for pricing variables are based on

resultant net change in value for both the hedging derivative and

observable transactions in similar securities and are further verified

the hedged item is recognized in earnings immediately, such net

by external pricing sources, when available.

effect being deemed the “ineffective” portion of the hedge. The gains and losses associated with the ineffective portion of the fair

The Company’s securitization activities are detailed below:

value hedges are included in “Principal Transactions” revenues in the Consolidated Statements of Income. These amounts were immaterial for fiscal 2006, 2005 and 2004.

(in billions)

Agency Other MortgageMortgageand AssetBacked Backed

Total

Total securitizations

5. TRANSFERS OF FINANCIAL ASSETS AND LIABILITIES SECURITIZATIONS The Company is a market leader in mortgage-backed securitization and other structured financing arrangements. In the normal course of business, the Company regularly securitizes commercial and residential mortgages, consumer receivables and other financial assets. Securitization transactions are generally treated as sales, provided that control has been relinquished. In connection with securitization transactions, the Company establishes special-

Fiscal 2006 Fiscal 2005

$ 21.8 $ 26.2

$ 99.3 $ 89.8

$ 121.1 $ 116.0

As of November 30, 2006

$

1.5

$

4.1

$

5.6(1)

As of November 30, 2005

$

1.8

$

3.7

$

5.5(2)

Retained interests

(1) Includes approximately $4.3 billion in investment-grade retained interests, of which $3.0 billion is AAA rated. (2) Includes approximately $4.7 billion in investment-grade retained interests, of which $3.9 billion is AAA rated.

purpose entities (“SPEs”), in which transferred assets, including commercial and residential mortgages, consumer receivables and

The following table summarizes cash flows from securitization trusts

other financial assets are sold to an SPE and repackaged into

related to securitization transactions during the fiscal years ended

securities or similar beneficial interests. Transferred assets are

November 30, 2006 and 2005:

accounted for at fair value prior to securitization. The majority of the Company’s involvement with SPEs relates to securitization

Agency Other MortgageMortgageand AssetBacked Backed

transactions meeting the definition of a QSPE under the provisions

(in millions)

of SFAS No. 140. Provided it has relinquished control over such

Cash flows received from retained interests

assets, the Company derecognizes financial assets transferred in securitizations and does not consolidate the financial statements of QSPEs. For SPEs that do not meet the QSPE criteria, the Company uses the guidance in FIN No. 46 (R) to determine whether the SPE should be consolidated.

Total

Fiscal 2006

$ 295.8

$ 760.3

$1,056.1

Fiscal 2005

$ 452.9

$ 498.0

$ 950.9

Fiscal 2006

$

0.1

$ 89.5

$

89.6

Fiscal 2005

$

1.7

$ 68.8

$

70.5

Cash flows from servicing

In connection with these securitization activities, the Company may retain interests in securitized assets in the form of senior or

The Company is an active market maker in these securities and

subordinated securities or as residual interests. Retained interests in

therefore may retain interests in assets it securitizes, predominantly

securitizations are generally not held to maturity and typically are

highly rated or government agency-backed securities. The models

sold shortly after the settlement of a securitization. The weighted

employed in the valuation of retained interests use discount rates

average holding period for retained interest positions in inventory at

that are based on the Treasury yield curve plus a spread. Key points

November 30, 2006 and 2005 was approximately 150 days and

on the constant maturity Treasury curve at November 30, 2006

90 days, respectively. These retained interests are included in

were 4.59% for 2-year Treasuries and 4.52% for 10-year Treasuries,

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The Bear Stearns Companies Inc.

and ranged from 4.41% to 5.01%. These models also consider

In the normal course of business, the Company originates and

prepayment speeds and credit losses. Credit losses are calculated

purchases conforming and non-conforming, conventional fixed-

using option-adjusted spreads that also incorporate additional

rate and adjustable-rate residential mortgage loans and sells such

factors such as liquidity and optionality.

loans to investors. In connection with these activities, the Company may retain MSRs that entitle the Company to a future stream of in

cash flows based on the contractual servicing fee. In addition, the

measuring the fair value of retained interests in assets the Company

Company may purchase and sell MSRs. At November 30, 2006,

securitized at November 30, 2006 were as follows:

the key economic assumptions and the sensitivity of the current fair

Weighted

average

key

economic

assumptions

used

Agency MortgageBacked

Other Mortgageand AssetBacked

Weighted average life (years)

6.7

4.7

Average prepayment speeds (annual rate)

8%-45%

8%-65%

—

0%-9%

value of MSRs to immediate changes in those assumptions were as follows:

SubPrime Loans

FixedRate Prime & Alt-A Loans

AdjustableRate Prime & Alt-A Loans

Fair value of MSRs

$ 153.0

$ 101.8

$ 250.1

Constant prepayment rate (in CPR) Impact on fair value of:

19%-38%

13%-42%

32%-52%

2006 illustrates the potential adverse change in fair value of these

5 CPR adverse change

$ (11.1)

$ (9.8)

$ (19.7)

retained interests due to a specified change in the key valuation

10 CPR adverse change

(20.4)

(14.5)

(30.7)

Credit losses

The following hypothetical sensitivity analysis as of November 30,

assumptions. The interest rate changes represent a parallel shift in

(in millions)

the Treasury curve. This shift considers the effect of other variables,

Discount rate Impact on fair value of:

including prepayments. The remaining valuation assumptions are

5% adverse change

changed independently. Retained interests in securitizations are

10% adverse change

15%

12%

13%

$ (14.1)

$ (8.7)

$ (14.8)

(23.1)

(15.3)

(25.6)

generally not held to maturity and are typically sold shortly after the settlement of a securitization. The Company considers the current and expected credit profile of the underlying collateral in

The previous tables should be viewed with caution since the

determining the fair value and periodically updates the fair value for

changes in a single variable generally cannot occur without changes

changes in credit, interest rate, prepayment speeds and other

in other variables or conditions that may counteract or amplify the

pertinent market factors. Actual credit losses on retained interests

effect of the changes outlined in the tables. Changes in fair value

have not been significant.

based on adverse variations in assumptions generally cannot be extrapolated because the relationship of the change in assumptions

(in millions)

Agency MortgageBacked

Other Mortgageand AssetBacked

Interest rates Impact of 50 basis point adverse change

do not consider the change in fair value of hedging positions, which would generally offset the changes detailed in the tables, nor do they consider any corrective action that the Company may take in response to changes in these conditions. The impact of hedges is

$ (35.9)

$ (111.0)

(74.4)

(227.2)

Impact of 10% adverse change

(7.1)

(66.4)

Impact of 20% adverse change

(12.9)

(90.8)

Impact of 100 basis point adverse change

to the change in fair value is not usually linear. In addition, the tables

not presented because hedging positions are established on a portfolio level and allocating the impact would not be practicable.

Prepayment speeds

Credit losses Impact of 10% adverse change

(3.8)

(106.1)

Impact of 20% adverse change

(7.6)

(188.4)

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The Bear Stearns Companies Inc.

MSRs are included in “Other Assets” on the Consolidated

The Company has a limited number of mortgage securitizations that

Statements of Financial Condition. The Company’s MSR activities

did not meet the criteria for sale treatment under SFAS No. 140. As

for the fiscal years ended November 30, 2006 and 2005 were as

such, the Company continues to carry the assets and liabilities from

follows:

these transactions on its Consolidated Statements of Financial

2006

(in millions)

Balance, beginning of year

2005

Condition. Additionally, the Company retains call options on a limited number of securitization transactions that require the

$ 431.1

$ 230.2

Additions

366.0

384.1

Sales, net

(109.3)

(47.1)

Amortization

(187.5)

(159.2)

The Company also acts as portfolio manager and/or underwriter in

1.7

23.1

several collateralized debt obligation transactions. In these

$ 502.0

$ 431.1

transactions, the Company establishes a trust that purchases a

Recovery Balance, end of year

Company to continue recognizing the assets subject to the call options.

portfolio of assets and issues trust certificates that represent Changes in the MSR valuation allowance for the fiscal years ended

interests in the portfolio of assets. In addition, the Company may

November 30, 2006 and 2005 were as follows:

receive variable compensation for managing the portfolio and may

2006

(in millions)

Balance, beginning of year

also retain certain trust certificates. In certain of these transactions, these interests result in the Company becoming the primary

$ (10.6)

$ (33.7)

beneficiary of these entities. The holders of the trust certificates

1.7

23.1

have recourse only to the underlying assets of the trusts and not to

(8.9)

$ (10.6)

Recovery Balance, end of year

2005

$

other assets of the Company. The Company establishes and operates funds for the benefit of its

6. VARIABLE INTEREST ENTITIES AND MORTGAGE LOAN SPECIAL PURPOSE ENTITIES

employees. These funds are considered to be VIEs of which the Company is the primary beneficiary.

The Company regularly creates or transacts with entities that may be VIEs. These entities are an essential part of its securitization,

Additionally, the Company invests in certain distressed debt

asset management and structured finance businesses. In addition,

instruments in which the issuer is a VIE. The Company has

the Company purchases and sells financial instruments that may be

determined that it is the primary beneficiary of the VIE.

variable interests. The Company adopted FIN No. 46 (R) for its variable interests in fiscal 2004. The Company consolidates those VIEs in which the Company is the primary beneficiary. The Company may perform various functions, including acting as the seller, servicer, investor, structurer or underwriter in securitization transactions. These transactions typically involve entities that are considered to be QSPEs as defined in SFAS No. 140. QSPEs are exempt from the requirements of FIN No. 46 (R). For securitization vehicles that do not qualify as QSPEs, the holders of the beneficial interests have no recourse to the Company, only to the assets held by the related VIE. In certain of these VIEs, the Company could be determined to be the primary beneficiary through its ownership of certain beneficial interests, and would, therefore, be required to consolidate the assets and liabilities of the VIE.

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The Bear Stearns Companies Inc.

The following table sets forth the Company’s total assets and maximum exposure to loss associated with its significant variable interests in consolidated VIEs and securitizations that did not qualify for sale treatment. This information is presented based on principal business activity, as reflected in the first column.

As of November 30, 2006

(in millions)

VIE Assets

Maximum Exposure to Loss(1)

Mortgage Securitizations

$ 16,798.1

$

Call Options on Securitizations

12,186.2

762.0 —

As of November 30, 2005

VIE Assets

Maximum Exposure to Loss(1)

$ 5,296.1

$ 299.4

8,697.4

—

Collateralized Debt Obligations

685.0

47.9

409.7

4.1

Employee Funds

575.1

355.0

748.5

526.9

Distressed Debt

58.9

58.8

—

—

$ 30,303.3

$ 1,223.7

Total

$ 15,151.7

$ 830.4

(1) Represents the fair value of the Company’s interest in these entities and is reflected on the Consolidated Statements of Financial Condition.

The Company also owns significant variable interests in several VIEs

collateral. These securities may be used to secure repurchase

related to collateralized debt obligations for which the Company is

agreements, enter into securities lending or derivative transactions

not the primary beneficiary and therefore does not consolidate

or cover short positions.

these entities. In aggregate, these VIEs have assets approximating $14.8 billion and $4.7 billion at November 30, 2006 and 2005,

At November 30, 2006 and 2005, the fair value of securities

respectively. At November 30, 2006 and 2005, the Company’s

received as collateral by the Company that can be repledged,

maximum exposure to loss from these entities approximates $163.2

delivered or otherwise used was approximately $286.06 billion

million and $29.6 million, respectively, which represents the fair

and $254.62 billion, respectively. Of these securities received

value of its interests and is reflected in the Consolidated Statements

as collateral, those with a fair value of approximately

of Financial Condition.

$189.54 billion and $184.25 billion were delivered or repledged at November 30, 2006 and 2005, respectively.

The Company purchases and sells interests in entities that may be deemed to be VIEs in its market-making capacity in the ordinary

The Company also pledges financial instruments owned to

course of business. As a result of these activities, it is reasonably

collateralize certain financing arrangements and permits the

possible that such entities may be consolidated or deconsolidated

counterparty to pledge or rehypothecate the securities. These

at various points in time. Therefore, the Company’s variable interests

securities are recorded as “Financial Instruments Owned and

included above may not be held by the Company in future periods.

Pledged As Collateral, at Fair Value” in the Consolidated Statements of Financial Condition. The carrying value of securities and other

7. COLLATERALIZED FINANCING ARRANGEMENTS

inventory positions owned that have been pledged or otherwise

The Company enters into secured borrowing and lending

encumbered to counterparties where those counterparties do not

agreements to obtain collateral necessary to effect settlements,

have the right to sell or repledge was approximately $41.58 billion

finance inventory positions, meet customer needs or re-lend as part

and $20.83 billion at November 30, 2006 and 2005, respectively.

of its dealer operations. The Company receives collateral under reverse repurchase agreements,

securities

borrowing

transactions,

derivative

transactions, customer margin loans and other secured moneylending activities. In many instances, the Company is also permitted by contract or custom to rehypothecate securities received as

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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The Bear Stearns Companies Inc.

8. SHORT-TERM BORROWINGS The Company obtains short-term borrowings through the issuance of commercial paper and bank loans and other borrowings. The interest rates on such short-term borrowings reflect market rates of interest at the time of the transactions. The Company’s short-term borrowings at November 30, 2006 and 2005 consisted of the following:

2006

2005

$ 20,713,958

$ 9,675,903

(in thousands)

Commercial paper (1)

Bank loans and other borrowings Total short-term borrowings

8,348,756

10,339,824

$ 29,062,714

$ 20,015,727

(1) Included in bank loans and other borrowings at November 30, 2006 and 2005 were secured borrowings of $3.28 billion and $258.9 million, respectively.

The effective weighted average interest rates for short-term borrowings were as follows:

Fiscal Years Ended November 30, 2005

As of November 30, 2006 2005

2006

Commercial paper

5.25%

4.11%

4.92%

3.28%

1.32%

Bank loans and other borrowings

5.23%

4.16%

4.74%

3.33%

1.63%

2004

COMMITTED CREDIT FACILITIES

maintenance of specified levels of stockholders’ equity of the

The Company has a committed revolving credit facility (“Facility”)

Company. The Repo Facility terminates in August 2007, with all

totaling $4.0 billion, which permits borrowing on a secured basis by

repos outstanding at that date payable no later than August 2008.

the Parent Company, BSSC, BSIL and certain other subsidiaries.

There were no borrowings outstanding under the Repo Facility at

The Facility also allows the Parent Company and BSIL to borrow up

November 30, 2006.

to $2.0 billion of the Facility on an unsecured basis. Secured borrowings can be collateralized by both investment-grade and

The Company has a $350 million committed revolving credit facility

non-investment-grade financial instruments as the Facility provides

(“Pan Asian Facility”), which permits borrowing on a secured basis

for defined advance rates on a wide range of financial instruments

by the Parent Company, BSSC, Bear Stearns Japan Limited

eligible to be pledged. The Facility contains financial covenants, the

(“BSJL”), and BSIL. The Pan Asian Facility contains financial

most significant of which require maintenance of specified levels of

covenants that require, among other things, maintenance of

stockholders’ equity of the Company and net capital of BSSC. In

specified levels of stockholders’ equity of the Company and net

February 2007, the Company renewed the Facility with similar

capital of BSSC. In December 2006, the Company renewed the

terms. The Facility now allows the Parent Company, BSIL, and Bear

Facility at a $350 million committed level with substantially the same

Stearns International Trading Limited (“BSIT”) to borrow up to $4.0

terms. The Pan Asian Facility terminates in December 2007 with all

billion of the Facility on an unsecured basis. The Facility terminates

loans outstanding at that date payable no later than December

in February 2008, with all loans outstanding at that date payable no

2008. There were no borrowings outstanding under the Pan Asian

later than February 2009. There were no borrowings outstanding

Facility at November 30, 2006.

under the Facility at November 30, 2006. The Company has a $350 million committed revolving credit The Company has a $1.50 billion committed revolving securities

facility (“Tax Lien Facility”), which permits borrowing on a secured

repo facility (“Repo Facility”), which permits borrowings secured

basis by the Parent Company, Plymouth Park Tax Services and

by a broad range of collateral under a repurchase arrangement by

Madison Tax Capital LLC. The Tax Lien Facility contains financial

the Parent Company, BSIL, BSIT and BSB. The Repo Facility

covenants that require, among other things, maintenance of

contains financial covenants that require, among other things,

specified levels of stockholders’ equity of the Company. The Tax Lien

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(continued)

The Bear Stearns Companies Inc.

Facility terminates in March 2007 with all loans outstanding at that

mortgages, listed options and whole loans. The facilities are

date payable no later than March 2008. There were no borrowings

expected to be drawn from time to time and expire at various dates,

outstanding under the Tax Lien Facility at November 30, 2006.

the longest of such periods ending in fiscal 2007. All of these facilities contain a term-out option of one year or more for borrowings

The Company also maintains a series of committed credit facilities,

outstanding at expiration. The banks providing these facilities are

which permit borrowing on a secured basis, to support liquidity

committed to provide up to an aggregate of approximately $4.5

needs for the financing of investment-grade and non-investment-

billion. At November 30, 2006, the borrowings outstanding under

grade corporate loans, residential mortgages, commercial

these committed credit facilities were $90.1 million.

9. LONG-TERM BORROWINGS The Company’s long-term borrowings (which have original maturities of at least 12 months) at November 30, 2006 and 2005 consisted of the following:

2006

2005

$ 15,243,336

$ 16,641,197

7,273,409

5,331,974

16,530,680

10,317,812

6,697,114

3,890,974

US dollar-denominated

2,812,759

1,999,226

Non-US dollar-denominated

6,012,618

5,308,433

$ 54,569,916

$ 43,489,616

(in thousands)

Fixed-rate notes due 2007 to 2036: US dollar-denominated(1)(2) Non-US dollar-denominated Floating-rate notes due 2007 to 2046: US dollar-denominated Non-US dollar-denominated Index/equity/credit-linked notes:

Total long-term borrowings Amounts include fair value adjustments in accordance with SFAS No. 133. (1) At November 30, 2006, US dollar-denominated fixed-rate notes were at interest rates ranging from 1.0% to 7.5%.

(2) Included in US dollar-denominated fixed-rate notes at November 30, 2006 were $1.0 billion of Subordinated Global Notes due January 22, 2017 that have an annual interest rate of 5.5%, which rank junior in right of payment to all of the Company's senior indebtedness.

The Company has entered into interest rate swaps and other

To minimize the exposure resulting from movements in the

transactions to convert its fixed-rate notes into floating rates

underlying equity position or index, the Company has entered into

based on LIBOR. For floating-rate notes that are not based on

various equity swap contracts. Credit-linked notes include various

LIBOR, the Company has generally entered into interest rate

structured instruments whose payments and redemption values

swaps and other transactions to convert them into floating rates

are linked to the performance of a basket of credit products, an

based on LIBOR. Index/equity-linked borrowings include various

index or an individual security. To minimize exposure to these

structured instruments whose payments and redemption values

instruments, the Company has entered into swaps that pay the

are linked to the performance of a specific index (e.g., Dow Jones

performance of the underlying security or index.

Industrial Average), a basket of stocks or a specific equity security.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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(continued)

The Bear Stearns Companies Inc.

The effective weighted average interest rates for long-term borrowings, after giving effect to the swaps, were as follows:

As of November 30, 2006 2005

Fiscal Year Ended November 30, 2006 2005

Fixed-rate notes

5.77%

4.61%

5.47%

3.59%

Floating-rate notes

5.50%

4.44%

5.19%

3.56%

The Company’s long-term borrowings at November 30, 2006 mature as follows:

US Dollar

Non-US Dollar Index/ Equity/Credit Linked

Floating Rate

2007

$ 2,987

$ 2,192

2008

2,380

6,283

991

351

2009

916

3,216

316

941

2010

2,320

1,238

325

1,531

340

830

6,584

2011

901

2,514

444

1,205

235

1,513

6,812

(in millions)

Fixed Rate

Floating Rate

Index/ Equity/Credit Linked

Fixed Rate

Total

Fiscal Year

Thereafter Total

$

565

$

225

$

1

$

514

$ 6,484

232

755

10,992

1,986

1,165

8,540

5,739

1,088

172

3,020

3,903

1,236

15,158

$15,243

$16,531

$ 2,813

$ 7,273

$ 6,697

$ 6,013

$54,570

Amounts include fair value adjustments in accordance with SFAS No. 133 as well as $262.5 million of junior subordinated deferrable interest debentures (“Debentures”). The Debentures will mature on May 15, 2031; however, effective May 15, 2006, the Company, at its option, may redeem the Debentures. The Debentures are reflected in the table at their contractual maturity date. Included in fiscal 2008 are approximately $3.30 billion of floating-rate notes that are redeemable prior to maturity at the option of the noteholder. These notes contain certain provisions that effectively enable noteholders to put these notes back to the Company and, therefore, are reflected in the table under fiscal 2008 at the date such notes first become redeemable. The final maturity dates of these notes are during fiscal 2009, 2010 and 2011.

Instruments governing certain indebtedness of the Company

depositary share represents a one-fourth interest in a share of

contain various financial covenants, including maintenance of

Series E Preferred Stock. Dividends on the Series E Preferred Stock

minimum levels of stockholders’ equity of the Company. At

are payable at an annual rate of 6.15%. Series E Preferred Stock is

November 30, 2006, the Company was in compliance with all

redeemable at the option of the Company at any time on or after

covenants contained in these debt agreements.

January 15, 2008, in whole or in part, at a redemption price of $200 per share (equivalent to $50 per depositary share), plus accrued but

10. PREFERRED STOCK

unpaid dividends to the redemption date. During the fiscal year

PREFERRED STOCK ISSUED BY THE BEAR STEARNS COMPANIES INC.

ended November 30, 2006, the Company redeemed and retired

The Company is authorized to issue a total of 10 million shares of

145,000 depositary shares.

preferred stock at par value of $1.00 per share. At November 30, 2006, the Company has 1,795,782 shares issued and outstanding

The Company has outstanding 1,790,200 depositary shares

under various series as described below. All preferred stock has a

representing 447,550 shares of Cumulative Preferred Stock, Series

dividend preference over the Company’s common stock in the

F (“Series F Preferred Stock”), having an aggregate liquidation

paying of dividends and a preference in the liquidation of assets.

preference of $89.5 million as of November 30, 2006. Each depositary share represents a one-fourth interest in a share of

The Company has outstanding 3,348,252 depositary shares

Series F Preferred Stock. Dividends on the Series F Preferred Stock

representing 837,063 shares of Cumulative Preferred Stock, Series

are payable at an annual rate of 5.72%. Series F Preferred Stock is

E (“Series E Preferred Stock”), having an aggregate liquidation

redeemable at the option of the Company at any time on or after

preference of $167.4 million as of November 30, 2006. Each

April 15, 2008, in whole or in part, at a redemption price of $200 per

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(continued)

The Bear Stearns Companies Inc.

share (equivalent to $50 per depositary share), plus accrued but unpaid dividends to the redemption date. During the fiscal year ended November 30, 2006, the Company redeemed and retired 91,500 depositary shares. The Company has outstanding 2,044,675 depositary shares representing 511,169 shares of Cumulative Preferred Stock, Series G (“Series G Preferred Stock”), having an aggregate liquidation preference of $102.2 million as of November 30, 2006. Each depositary share represents a one-fourth interest in a share of Series G Preferred Stock. Dividends on the Series G Preferred Stock are payable at an annual rate of 5.49%. Series G Preferred Stock is redeemable at the option of the Company at any time on or after July 15, 2008, in whole or in part, at a redemption price of $200 per share (equivalent to $50 per depositary share), plus accrued but unpaid dividends to the redemption date. During the fiscal year ended November 30, 2006, the Company redeemed and retired 26,900 depositary shares.

PREFERRED STOCK ISSUED BY SUBSIDIARIES Bear Stearns Capital Trust III (“Capital Trust III”), a wholly owned subsidiary of the Company, has issued $262.5 million (10,500,000 shares) of Guaranteed Preferred Beneficial Interests in Company Subordinated Debt Securities (“Preferred Securities”). The Preferred Securities are fixed-rate securities, which have a liquidation value of $25 per security. Holders of the Preferred Securities are entitled to receive quarterly preferential cash distributions at an annual rate of 7.8% through May 15, 2031. The proceeds of the issuance of the Preferred Securities were used to acquire junior subordinated deferrable interest debentures (“Debentures”) issued by the Company. The Debentures have terms that correspond to the terms of the Preferred Securities and are the sole assets of Capital Trust III. The Preferred Securities will mature on May 15, 2031. Effective May 15, 2006, the Company, at its option, may redeem the Preferred Securities at their principal amounts plus accrued distributions. In accordance with FIN No. 46 (R), the Company has deconsolidated Capital Trust III. As a result, the Debentures issued by the Company to Capital Trust III are included within long-term borrowings at November 30, 2006 and 2005. The $262.5 million of Preferred Securities issued by Capital Trust III are still outstanding, providing the funding for such Debentures. The Preferred Securities issued by Capital Trust III are no longer included in the Company’s Consolidated Statements of Financial Condition.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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The Bear Stearns Companies Inc.

11. EARNINGS PER SHARE Basic EPS is computed by dividing net income applicable to common shares, adjusted for costs related to vested shares under the CAP Plan, as well as the effect of the redemption of preferred stock, by the weighted average number of common shares outstanding. Common shares outstanding includes vested units issued under certain stock compensation plans, which will be distributed as shares of common stock. Diluted EPS includes the determinants of Basic EPS and, in addition, gives effect to dilutive potential common shares related to stock compensation plans. The computations of Basic and Diluted EPS for the fiscal years ended November 30, 2006, 2005 and 2004 are set forth below:

2006

2005

2004

$ 2,053,871

$ 1,462,177

$ 1,344,733

(21,363)

(24,321)

(28,072)

55

—

1,230

46,947

50,630

69,518

2,079,510

1,488,486

1,387,409

41,017

31,622

31,011

$ 2,120,527

$ 1,520,108

$ 1,418,420

131,711

130,327

127,468

Employee stock options

5,948

4,064

3,604

CAP and restricted units

10,916

13,077

14,213

16,864

17,141

17,817

148,575

147,468

145,285

(in thousands, except per share amounts)

Net income Preferred stock dividends Redemption of preferred stock Income adjustment (net of tax) applicable to deferred compensation arrangements—vested shares Net earnings used for Basic EPS Income adjustment (net of tax) applicable to deferred compensation arrangements—non-vested shares Net earnings used for Diluted EPS Total basic weighted average common shares outstanding(1) Effect of dilutive securities:

Dilutive potential common shares Weighted average number of common shares outstanding and dilutive potential common shares Basic EPS

$

15.79

$

11.42

$

10.88

Diluted EPS

$

14.27

$

10.31

$

9.76

(1) Includes 12.7 million, 18.1 million and 24.6 million vested units for the fiscal years ended November 30, 2006, 2005 and 2004, respectively, issued under certain employee stock compensation plans, which will be distributed as shares of common stock.

12. EMPLOYEE BENEFIT PLAN

of Significant Accounting Policies,” effective December 1, 2005,

The Company has a qualified non-contributory profit sharing plan

the Company adopted SFAS No. 123 (R) using the modified

covering substantially all employees. Contributions are made at the

prospective application method. Stock-based compensation cost

discretion of management in amounts that relate to the Company’s

is measured at grant date, based on the fair value of the award

level of income before provision for income taxes. The Company’s

and is recognized as expense over the requisite service period.

expense related to the profit sharing plan for the fiscal years ended

The compensation cost that has been charged against income for

November 30, 2006, 2005 and 2004 was $45.0 million, $37.0

the Company’s stock compensation plans was $847.9 million,

million and $26.0 million, respectively.

$649.7 million and $588.2 million for the fiscal years ended November 30, 2006, 2005 and 2004, respectively. The total

13. STOCK COMPENSATION PLANS

income tax benefit recognized in the income statement for stock-

The Company has various stock compensation plans designed to

based compensation arrangements was $356.7 million, $273.3

increase the emphasis on stock-based incentive compensation

million and $247.4 million for fiscal years ended November 30,

and align the compensation of its key employees with the long-

2006, 2005 and 2004, respectively.

term interests of stockholders. As discussed in Note 1, “Summary

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(continued)

The Bear Stearns Companies Inc.

The Company concluded that under SFAS No. 123 (R), the grant

per share, as defined by the CAP Plan, less net income per share, as

date for stock-based compensation awards is the date the

defined by the CAP Plan, plus dividends per share (“earnings

awards are approved by the Company’s Compensation Committee.

adjustment”), subject to certain limitations. The earnings adjustment

The Compensation Committee approved the 2006 stock-based

will be credited to each participant’s deferred compensation account

compensation awards in December 2006. In prior years,

in the form of additional CAP units, based on the number of CAP

stock-based compensation granted in December was included in

units in such account at the end of each fiscal year. The number of

stockholders’ equity at November year end. The Company’s stock-

CAP units credited depends on the amount awarded to each

based compensation plans are summarized below.

participant and the average per share cost of common stock acquired by the Company. On completion of the five-year deferral

STOCK REPURCHASE PROGRAM

period, participants are entitled to receive shares of common stock

The Company intends to offset the potentially dilutive impact of the

equal to the number of CAP units then credited to their respective

annual grants by purchasing common stock throughout the year in

deferred compensation accounts. Amounts recognized attributable

open market and private transactions. On December 13, 2006, the

to CAP units with respect to the earnings adjustment are recorded in

Board of Directors of the Company approved an amendment to the

“Other Expenses” in the Consolidated Statements of Income.

Stock

Repurchase

Program

to

replenish

the

previous

authorization in order to allow the Company to purchase up to

The majority of stock-based compensation expense for the years

$2.0 billion of common stock in fiscal 2007 and beyond. The

ended November 30, 2006, 2005 and 2004 was generated from

Company expects to utilize the repurchase authorization to offset

the grant of CAP units. During the fiscal years ended November

the dilutive impact of annual share awards. The Company may,

30, 2006, 2005 and 2004, the Company expensed $544.9 million,

depending upon price and other factors, repurchase additional

$363.4 million and $330.9 million, respectively, attributable to

shares in excess of that required for annual share awards. In

CAP units granted to participants for each of those years. In

addition, on December 12, 2006, the Compensation Committee

addition, during the fiscal years ended November 30, 2006, 2005

of the Board of Directors of the Company approved an

and 2004, the Company recognized expense of $154.0 million,

amendment to the CAP Plan Earnings Purchase Authorization to

$144.0 million and $176.0 million, respectively, attributable to

replenish the previous authorization in order to allow the Company

CAP units with respect to the earnings adjustment. Awards

to purchase up to $200 million of common stock in fiscal 2007.

allocated pursuant to the CAP Plan are credited to participants’

The Company’s policy is to issue shares out of treasury upon

deferred compensation accounts in the form of CAP units and

share option exercise or share unit conversion.

are included in stockholders’ equity. At November 30, 2006, $544.9 million accrued for CAP units was included in Accrued

CAPITAL ACCUMULATION PLAN

Employee Compensation and Benefits on the Consolidated

Pursuant to the CAP Plan, certain key executives receive a portion

Statement of Financial Condition and not in stockholders’ equity.

of their total annual compensation in the form of CAP units. The

During the fiscal years ended November 30, 2006, 2005 and

number of CAP units credited is a function of the dollar amount

2004, the Company recognized total compensation expense, net

awarded to each participant and the closing fair market value of the

of forfeitures, related to the CAP plan, of $527.6 million,

Company’s common stock on the date of the award. The CAP units

$353.2 million and $322.2 million, respectively.

awarded under the CAP Plan are generally subject to vesting and convert to common stock after five years. Holders of CAP units

RESTRICTED STOCK UNIT PLAN

generally may forfeit ownership of a portion of their award if

The Restricted Stock Unit Plan (“RSU Plan”) provides for a portion

employment is terminated before the end of the vesting period. The

of certain key employees’ compensation to be granted in the form

total number of CAP units that may be issued under the CAP Plan

of restricted stock units (“RSUs”), with allocations made to

during any fiscal year may not exceed 15% of the sum of issued and

participants’ deferred compensation accounts. Under the RSU

outstanding shares of common stock and CAP units outstanding

Plan, RSUs granted to employees have various vesting provisions

determined as of the last day of the current fiscal year.

and generally convert to common stock within four years. Such units are restricted from sale, transfer or assignment until the end of

Each CAP unit gives the participant an unsecured right to receive, on

the restriction period. Holders of RSUs generally may forfeit

an annual basis, an amount equal to the Company’s pre-tax income

ownership of a portion of their award if employment is terminated

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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The Bear Stearns Companies Inc.

before the end of the vesting period. Holders of RSUs are entitled

and $90 million were expensed in fiscal 2006, 2005 and 2004,

to receive a dividend in the form of additional RSUs, based on

respectively. The $89 million expensed in fiscal 2006 includes grants

dividends declared on the Company’s common stock. The total

with a vesting period that under SFAS No. 123 (R) are required to

number of RSUs that may be granted under the RSU Plan may not

be expensed for employees who are retirement eligible. Unvested

exceed 15,000,000. As of November 30, 2006, the total number of

awards granted in prior years are expensed over the future vesting

RSUs outstanding was 6,953,340.

periods, generally over three years. As of November 30, 2006, $87 million accrued for stock option awards was included in Accrued

The Company measures compensation cost for RSUs based on the

Employee Compensation and Benefits in the Consolidated

fair market value of its common stock at the award date. A portion

Statement of Financial Condition and not in stockholders’ equity. In

related to current service is expensed in the year of the award and

fiscal 2006, 2005 and 2004, the Company recognized total

that portion relating to future service is amortized over the vesting

compensation expense related to stock options of $102.3 million,

period. Amounts awarded and deferred pursuant to the RSU Plan

$122.6 million and $98.6 million, respectively.

and the unamortized portion of these amounts are shown as separate components of stockholders’ equity. During the fiscal

Fair value was estimated at grant date based on a modified Black-

years ended November 30, 2006, 2005 and 2004, the Company

Scholes option-pricing model. The weighted average fair value of

recognized compensation expense of $201.2 million, $135.4

options granted relating to the fiscal years ended November 30,

million and $119.1 million, respectively, related to awards granted

2006, 2005 and 2004 was $45.83, $26.50 and $26.00 per option,

to participants in each of those years. At November 30, 2006,

respectively. These amounts reflect adjustments for vesting

$190.4 million accrued for RSUs was included in Accrued

requirements and potential maturity shortening. Estimates of fair

Employee Compensation and Benefits and not in stockholders’

value are not intended to predict the value ultimately realized by

equity. During the fiscal years ended November 30, 2006, 2005

employees who receive equity awards and subsequent events are

and 2004, the Company recognized total compensation expense

not indicative of the reasonableness of the original estimates of fair

related to the RSU Plan of $218.0 million, $173.9 million and

value made by the Company.

$167.4 million, respectively. The total intrinsic value of options exercised during the years ended As of November 30, 2006, there was $155.6 million of total

November 30, 2006, 2005 and 2004 was $246.8 million, $148.9

unrecognized compensation cost related to stock-based

million and $138.2 million, respectively. The total cash received from

compensation granted under the RSU Plan which is expected to

employees as a result of stock option exercises for the years ended

be recognized over a weighted average period of approximately

November 30, 2006, 2005 and 2004 was approximately $289.6

three years. In addition, $46.6 million in unearned compensation

million, $201.9 million and $235.8 million, respectively. In

granted in December 2006 in connection with fiscal 2006 awards

connection with these exercises, the tax benefits realized by the

was not reflected in stockholders’ equity as of November 30,

Company for the years ended November 30, 2006, 2005 and 2004

2006, and is expected to be recognized over a weighted average

were $89.8 million, $59.4 million and $47.4 million, respectively.

period of four years. The following table highlights the assumptions used for the fiscal

STOCK AWARD PLAN

years ended November 30:

Pursuant to the Stock Award Plan, certain key employees are given

2006

the opportunity to acquire common stock through the grant of (1)

2005

2004

options. Stock options generally have a 10-year expiration. The total

Risk-free interest rate

4.57%

4.46%

4.24%

number of stock options that may be issued under the Stock Award

Expected option life(2)

5 years

5 years

5 years

Plan may not exceed 40,000,000. As of November 30, 2006, the

Expected stock price volatility(3)

total number of stock options outstanding was 19,721,603.

Dividend yield

26%

21%

24%

0.68%

0.90%

1.45%

(1) Represents the interest rate of the five-year US Treasury note.

The Company awarded approximately $89 million, $108 million and $110 million of employee stock options in fiscal 2006, 2005 and 2004, respectively, of which approximately $89 million, $99 million

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(2) The expected option life is the number of years that the Company estimates, based on history, that options will be outstanding prior to exercise or forfeiture. (3) The Company’s estimates of expected volatility are principally based on implied volatility of the Company’s common stock and other relevant factors.

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(continued)

The Bear Stearns Companies Inc.

NON-EMPLOYEE DIRECTORS’ STOCK OPTION AND STOCK UNIT PLAN

under the plan generally vest six months after the date of issuance

Pursuant to the Non-Employee Directors’ Stock Option and Stock

and stock options have a 10-year expiration. The total number of

Unit Plan (“Directors’ Plan”), members of the Board of Directors of

stock options and RSUs combined that may be issued under the

the Company who are not employees of the Company or any of its

Directors’ Plan may not exceed 300,000. As of November 30,

subsidiaries (“Non-Employee Directors”) may be offered the

2006, the total number of stock options and RSUs outstanding was

opportunity to acquire common stock through the grant of options

118,778 and 23,248, respectively. During the fiscal years ended

and will receive common stock on the vesting of RSUs. Non-

November 30, 2006, 2005 and 2004, the Company recognized

Employee Directors may elect to exchange a portion of their annual

expense of $2.3 million, $1.2 million and $0.7 million, respectively,

cash retainer paid by the Company for services rendered as a

related to these awards.

director, for stock options or RSUs. Stock options and RSUs issued

SUMMARY OF ALL STOCK UNIT AND OPTION ACTIVITY The following is a summary of CAP units and RSUs outstanding:

Balance, November 30, 2005 Granted(1) Forfeited Distributed Balance, November 30, 2006

CAP Units 25,823,714 1,141,332 (291,051) (8,148,340) 18,525,655

Weighted Average Fair Value $ 74.25 $ 134.93 $ 110.60 $ 53.58 $ 86.49

RSUs 8,676,609(2) 707,400 (541,448) (1,865,973) 6,976,588

Weighted Average Fair Value $ 80.07 $ 125.07 $ 102.25 $ 61.50 $ 87.63

(1) The weighted average grant-date fair value for CAP units and RSUs combined was $132.01, $112.01 and $96.06 for fiscal years ended November 30, 2006, 2005 and 2004, respectively. (2) Includes 208,907 RSUs outstanding as of November 30, 2005, which were granted under a one-time award in fiscal 2000. Note: In December 2006, the Company granted 3,295,999 and 1,151,572 CAP units and RSUs, respectively, at an average market price of $165.32. In addition, in December 2006, 2,672,408 and 1,482,189 CAP units and RSUs, respectively, were converted into common shares and distributed to participants. The award grants and distributions made in December 2006 are not reflected in the table above.

Activity with respect to stock options for the fiscal year ended November 30, 2006 is presented below:

2006

Number of Shares

Weighted Average Exercise Price

Beginning balance Granted Exercised Forfeited

23,979,179 58,410 (1) (4,001,211) (195,997)

$ 77.31 $ 128.17 $ 72.33 $ 84.22

Ending balance

19,840,381 (2)

$ 78.39

(1) In December 2006, the Company granted 1,873,543 options to employees with an exercise price of $165.32 and a fair value of $46.66. These option grants are not reflected in the table above. (2) At November 30, 2006, 17,727,439 stock options were exercisable with a weighted average exercise price of $77.02 and had an average remaining contractual life of 6.5 years. The aggregate intrinsic value for options outstanding and options exercisable as of November 30, 2006 was $1.47 billion and $1.34 billion, respectively.

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The Bear Stearns Companies Inc.

Information for the Company’s stock options as of November 30, 2006 is presented in the following table:

Options Outstanding

Range of Exercise Prices $35.00-$49.99 $50.00-$64.99 $65.00-$79.99 $80.00-$94.99 $95.00-$109.99 $110.00-$124.99 $125.00-$139.99 $140.00-$201.99 Total

Number Outstanding

Weighted Average Exercise Price

Average Remaining Contractual Life (Years)

3,717,859 5,096,175 3,740,292 27,348 3,792,289 3,410,758 25,029 30,631 19,840,381

$ 47.01 $ 60.36 $ 73.72 $ 87.93 $ 102.62 $ 116.50 $ 135.73 $ 159.15 $ 78.39

3.8 5.5 7.0 6.1 8.1 9.1 9.0 7.8 6.6

14. CUSTOMER ACTIVITIES

pursuant to such guidelines, may require customers to deposit

CUSTOMER CREDIT RISKS

additional cash or collateral, or to reduce positions, when deemed

The Company’s clearance activities for both clearing clients and

necessary. The Company also establishes credit limits for

customers (collectively, “customers”), involve the execution,

customers engaged in futures activities and monitors credit

settlement and financing of customers’ securities and futures

compliance. Additionally, with respect to the Company’s

transactions. Customers’ securities activities are transacted on

correspondent clearing activities, introducing correspondent firms

either a cash or margin basis, while customers’ futures

generally guarantee the contractual obligations of their customers.

transactions are generally transacted on a margin basis subject to

Further, the Company seeks to reduce credit risk by entering into

exchange regulations.

netting agreements with customers, which permit receivables and payables with such customers to be offset in the event of a

In connection with the customer clearance activities, the Company

customer default.

executes and clears customer transactions involving the sale of securities short (“short sales”), entering into futures transactions and

In connection with the Company’s customer financing and

the writing of option contracts. Short sales require the Company to

securities settlement activities, the Company may pledge

borrow securities to settle customer short sale transactions and, as

customers’ securities as collateral to satisfy the Company’s

such, these transactions may expose the Company to loss if

exchange margin deposit requirements or to support its various

customers are unable to fulfill their contractual obligations and

secured financing sources such as bank loans, securities loaned

customers’ collateral balances are insufficient to fully cover their

and repurchase agreements. In the event counterparties are unable

losses. In the event customers fail to satisfy their obligations, the

to meet their contractual obligations to return customers’ securities

Company may be required to purchase financial instruments at

pledged as collateral, the Company may be exposed to the risk of

prevailing market prices in order to fulfill the customers’ obligations.

acquiring the securities at prevailing market prices to satisfy its obligations to such customers. The Company seeks to control this

The Company seeks to control the risks associated with its

risk by monitoring the market value of securities pledged and by

customers’ activities by requiring customers to maintain margin

requiring adjustments of collateral levels in the event of excess

collateral in compliance with various regulatory and internal

exposure. Moreover, the Company establishes credit limits for such

guidelines. The Company monitors required margin levels and,

activities and monitors credit compliance.

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CONCENTRATIONS OF CREDIT RISKS

exposure should these customers be unable to meet their

The Company is engaged in providing securities processing

commitments. In addition, the Company may be subject to

services to a diverse group of individuals and institutional investors,

concentration risk through providing margin to those customers

including affiliates. A substantial portion of the Company’s

holding large positions in certain types of securities, securities of a

transactions is collateralized and is executed with, or made on

single issuer, including sovereign governments, issuers located in a

behalf of, institutional investors, including other brokers and

particular country or geographic area or issuers engaged in a

dealers, commercial banks, insurance companies, pension plans,

particular industry, where the Company receives such large

mutual funds, hedge funds and other financial institutions. The

positions as collateral. The Company seeks to control these risks

Company’s exposure to credit risk, associated with the non-

by monitoring margin collateral levels for compliance with both

performance of customers in fulfilling their contractual obligations

regulatory and internal guidelines. Additional collateral is obtained

pursuant to securities and futures transactions, can be directly

when necessary. To further control these risks, the Company has

affected by volatile or illiquid trading markets, which may impair

developed automated risk control systems that analyze the

customers’ ability to satisfy their obligations to the Company. The

customers’ sensitivity to major market movements. The Company

Company attempts to minimize credit risk associated with these

will require customers to deposit additional margin collateral, or to

activities by monitoring customers’ credit exposure and collateral

reduce positions if it is determined that customers’ activities may

values and requiring, when deemed necessary, additional collateral

be subject to above-normal market risk.

to be deposited with the Company. The Company acts as a clearing broker for substantially all of the A significant portion of the Company’s securities processing

customer and proprietary securities and futures activities of its

activities includes clearing transactions for hedge funds, brokers

affiliates on either a fully disclosed or omnibus basis. Such activities

and dealers and other professional traders, including affiliates. Due

are conducted on either a cash or margin basis. The Company

to the nature of these operations, which may include significant

requires its affiliates to maintain margin collateral in compliance with

levels of credit extension such as leveraged purchases, short

various regulatory guidelines. The Company monitors required margin

selling and option writing, the Company may have significant credit

levels and requests additional collateral when deemed appropriate.

15. INCOME TAXES The Company and certain of its subsidiaries file a US consolidated federal income tax return. The provision for income taxes for the fiscal years ended November 30, 2006, 2005 and 2004 consisted of the following: (in thousands)

2006

2005

2004

$ 806,111

$ 448,843

$ 568,972

CURRENT: Federal State and local

181,876

59,032

125,332

Foreign

190,097

124,070

65,692

1,178,084

631,945

759,996

(47,153)

93,860

(28,519)

(966)

35,247

(34,485) (19,571)

Total current DEFERRED: Federal State and local Foreign

(37,206)

(16,170)

Total deferred

(85,325)

112,937

(82,575)

$ 1,092,759

$ 744,882

$ 677,421

Total provision for income taxes

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As of November 30, 2006, the Company had approximately $1.28 billion in accumulated earnings permanently reinvested overseas. If such income were repatriated, additional federal income tax (net of available tax credits) at current tax rates would be approximately $249 million. Significant components of the Company’s deferred tax assets (liabilities) as of November 30, 2006 and 2005 were as follows:

2006

2005

$ 1,213,138

$ 1,233,847

108,380

168,274

19,501

18,869

(in thousands)

DEFERRED TAX ASSETS: Deferred compensation Liability reserves and valuation adjustments Unrealized loss Other Total deferred tax assets

247,015

126,559

1,588,034

1,547,549

DEFERRED TAX LIABILITIES: Unrealized appreciation

(42,567)

(123,341)

Depreciation/amortization

(67,439)

(45,893)

Other

(47,076)

(32,687)

(157,082)

(201,921)

$ 1,430,952

$ 1,345,628

Total deferred tax liabilities Net deferred tax assets

At November 30, 2006 and 2005, no valuation allowance has been

A reconciliation of the statutory federal income tax rates to

established against deferred tax assets since it is more likely than

the Company’s effective tax rates for the fiscal years ended

not that the deferred tax assets will be realized. Net deferred tax

November 30, 2006, 2005 and 2004 was as follows:

assets are included in “Other Assets” in the Consolidated Statements of Financial Condition.

Statutory rate The Company is under continuous examination by various tax authorities in jurisdictions in which the Company has significant business operations. The Company regularly assesses the likelihood of additional assessments in each of the tax jurisdictions resulting

2006

2005

2004

35.0%

35.0%

35.0%

3.7

2.7

2.9

State and local income taxes, net of federal benefit Tax-exempt interest income and dividend exclusion

(1.1)

(2.1)

(2.3)

(0.4)

(0.5)

(0.5)

from these examinations. Tax reserves have been established,

Domestic tax credits

which the Company believes to be adequate in relation to the

Other, net

(2.5)

(1.3)

(1.6)

potential for additional assessments. Once established, reserves

Effective tax rate

34.7%

33.8%

33.5%

are adjusted as information becomes available or when an event requiring a change to the reserve occurs. The resolution of tax matters

Not included in the effective tax rate is the effect of approximately

could have a material impact on the Company’s effective tax rate.

$363.0 million, $426.1 million and $163.9 million in income tax benefits attributable to the distribution of common stock under the CAP Plan and other deferred compensation plans as well as the exercise of options, credited directly to paid-in capital, for fiscal 2006, 2005 and 2004, respectively.

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16. REGULATORY REQUIREMENTS

At November 30, 2006, Bear Stearns, BSSC, BSIL, BSIT, BSB and

Effective December 1, 2005, the Company became regulated by

CTC were in compliance with their respective regulatory capital

the Securities and Exchange Commission (“SEC”) as a consolidated

requirements. Certain other subsidiaries are subject to various

supervised entity (“CSE”). As a CSE, the Company is subject to

securities regulations and capital adequacy requirements

group-wide supervision and examination by the SEC and is required

promulgated by the regulatory and exchange authorities of the

to compute allowable capital and allowances for market, credit and

countries in which they operate. At November 30, 2006, these

operational risk on a consolidated basis. As of November 30, 2006,

other subsidiaries were in compliance with their applicable local

the Company was in compliance with the CSE capital requirements.

capital adequacy requirements.

Bear Stearns and BSSC are registered broker-dealers and futures

Regulatory rules, as well as certain covenants contained in various

commission merchants and, accordingly, are subject to Rule 15c3-1

instruments governing indebtedness of the Company, Bear

under the Securities Exchange Act of 1934 (“Net Capital Rule”) and

Stearns and other regulated subsidiaries, may restrict the

Rule 1.17 under the Commodity Futures Trading Commission.

Company’s ability to withdraw capital from its regulated

Effective December 1, 2005, the SEC approved Bear Stearns’ use

subsidiaries, which in turn could limit the Company’s ability to pay

of Appendix E of the Net Capital Rule, which establishes alternative

dividends. Also, the Company’s broker-dealer subsidiaries and

net capital requirements for broker-dealers that are part of

other regulated subsidiaries are subject to minimum capital

consolidated supervised entities. Appendix E allows Bear Stearns to

requirements that may restrict the Company’s ability to withdraw

calculate net capital charges for market risk and derivatives-related

capital from its regulated subsidiaries, which in turn could limit the

credit risk based on mathematical models, provided that Bear

Company’s ability to pay dividends. At November 30, 2006,

Stearns holds tentative net capital in excess of $1 billion and net

approximately $4.10 billion in equity capital of Bear Stearns, BSSC,

capital in excess of $500 million. At November 30, 2006, Bear

BSIL, BSIT and BSB was restricted as to the payment of cash

Stearns’ net capital of $4.03 billion exceeded the minimum

dividends and advances to the Company.

requirement by $3.48 billion. Bear Stearns’ net capital computation, as defined, includes $768.7 million, which represents net capital of BSSC in excess of 5.5% of aggregate debit items arising from customer transactions. BSIL and BSIT, London-based broker-dealer subsidiaries, are subject to the regulatory capital requirements of the United Kingdom’s Financial Services Authority. BSB, an Ireland-based bank principally involved in the trading and sales of fixed income products, is registered in Ireland and is subject to the regulatory capital requirements of the Financial Regulator. Custodial Trust Company (“CTC”), a Federal Deposit Insurance Corporation (“FDIC”) insured New Jersey state chartered bank, offers a range of trust, lending and securities-clearance services. CTC provides the Company with banking powers, including access to the securities and funds-wire services of the Federal Reserve System. CTC is subject to the regulatory capital requirements of the FDIC.

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17. COMMITMENTS AND CONTINGENCIES

The Company also had contingent commitments to investment-

In the ordinary course of business, the Company has commitments

grade and non-investment-grade companies of approximately

in connection with various activities, the most significant of which

$17.48 billion and $3.89 billion as of November 30, 2006 and

are as follows:

2005, respectively. Generally, these commitments are provided in connection with leveraged acquisitions. These commitments are

LEASES

not indicative of the Company's actual risk because the borrower

The Company occupies office space under leases that expire at

may never draw upon the commitment. In fact, the borrower may

various dates through 2024. At November 30, 2006, future

not be successful in the acquisition, the borrower may access the

minimum aggregate annual rentals payable under non-cancelable

capital markets instead of drawing on the commitment, or the

leases (net of subleases), including 383 Madison Avenue in New

Company’s portion of the commitment may be reduced through

York City, for fiscal years ended November 30, 2007 through 2011

the syndication process. Additionally, the borrower’s ability to

and the aggregate amount thereafter, are as follows:

draw may be subject to there being no material adverse change in either market conditions or the borrower’s financial condition,

(in thousands)

among other factors. These commitments generally contain

FISCAL YEAR

certain flexible pricing features to adjust for changing market

2007

$ 97,791

2008

104,642

conditions prior to closing.

2009

98,887

2010

101,034

In connection with the Company’s merchant banking activities, the

2011

103,202

Company has commitments to invest in merchant banking and

Thereafter

597,356

private equity-related investment funds as well as commitments to

PRIVATE EQUITY-RELATED INVESTMENTS AND PARTNERSHIPS

invest directly in private equity-related investments. At November The various leases contain provisions for periodic escalations

30, 2006 and 2005, such commitments aggregated $788.3 million

resulting from increased operating and other costs. Rental

and $222.1 million, respectively. These commitments will be

expense, including escalations and net of sublease rental income,

funded, if called, through the end of the respective investment

under these leases was $164.1 million, $134.2 million and $111.4

periods, with the longest of such periods ending in 2017.

million for the fiscal years ended November 30, 2006, 2005 and 2004, respectively.

UNDERWRITING In connection with the Company’s mortgage-backed securitizations

LENDING-RELATED COMMITMENTS

and fixed income underwriting, the Company had commitments to

In connection with certain of the Company’s business activities,

purchase new issues of securities aggregating $205.0 million and

the Company provides financing or financing commitments to

$943.1 million, respectively, at November 30, 2006 and 2005.

investment-grade and non-investment-grade companies in the form of senior and subordinated debt, including bridge financing.

COMMERCIAL AND RESIDENTIAL LOANS

Commitments have varying maturity dates and are generally

The Company participates in the origination, acquisition,

contingent on the accuracy and validity of certain representations,

securitization, servicing, financing and disposition of commercial and

warranties and contractual conditions applicable to the borrower.

residential loans. At November 30, 2006 and 2005, the Company

Lending-related commitments to investment-grade borrowers

had entered into commitments to purchase or finance commercial

aggregated approximately $3.83 billion and $2.37 billion at

and residential loans of $4.23 billion and $5.10 billion, respectively.

November 30, 2006 and 2005, respectively. Of this amount, approximately $697.8 million and $639.5 million was hedged at

LETTERS OF CREDIT

November 30, 2006 and 2005, respectively. Lending-related

At November 30, 2006 and 2005, the Company was contingently

commitments to non-investment-grade borrowers approximated

liable for unsecured letters of credit of approximately $3.30 billion

$2.04 billion and $1.44 billion at November 30, 2006 and 2005,

and $2.50 billion, respectively, and secured (by financial

respectively. Of this amount, approximately $88.8 million and $13.0

instruments) letters of credit of $1.25 billion and $985.6 million,

million was hedged at November 30, 2006 and 2005, respectively.

respectively. These letters of credit are primarily used to provide

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collateral for securities borrowed and to satisfy margin requirements

is only a reasonable possibility that a loss may have been incurred.

at option and commodity exchanges.

Although the ultimate outcome of these matters cannot be ascertained at this time, it is the opinion of management, after

OTHER

consultation with counsel, that the resolution of the foregoing

The Company had commitments to purchase Chapter 13 and other

matters will not have a material adverse effect on the financial

credit card receivables of $95.7 million and $159.8 million

condition of the Company, taken as a whole; such resolution may,

respectively, at November 30, 2006 and 2005.

however, have a material effect on the operating results in any future period, depending on the level of income for such period.

With respect to certain of the commitments outlined above, the Company utilizes various hedging strategies to actively manage its

The Company has provided reserves for such matters in

market, credit and liquidity exposures. Additionally, since these

accordance with SFAS No. 5, “Accounting for Contingencies.” The

commitments may expire unused, the total commitment amount may

ultimate resolution may differ materially from the amounts reserved.

not necessarily reflect the actual future cash funding requirements.

18. GUARANTEES LITIGATION

In the ordinary course of business, the Company issues various

The Company is the sole defendant in an action commenced in the

guarantees to counterparties in connection with certain derivative,

United States Bankruptcy court for the Southern District of New

leasing, securitization and other transactions. FIN No. 45,

York by the Chapter 11 Trustee for Manhattan Investment Fund

“Guarantor’s Accounting and Disclosure Requirements for

Limited (“MIFL”). The complaint seeks to recover from the

Guarantees, Including Indirect Guarantees of Indebtedness of

Company, among other things, certain allegedly fraudulent transfers

Others” requires the Company to recognize a liability at the

made by MIFL in the amount of $141.4 million plus pre-judgment

inception of certain guarantees and to disclose information about its

interest. The Company provided prime brokerage services to MIFL

obligations under certain guarantee arrangements.

prior to its bankruptcy. In January 2007, the Bankruptcy Court granted the Trustee’s motion for summary judgment on the

The guarantees covered by FIN No. 45 include contracts that

fraudulent transfer claims against the Company. The Company

contingently require the guarantor to make payments to the

believes it has substantial defenses to the Trustee’s claims and

guaranteed party based on changes related to an asset, a liability

intends to appeal the decision of the Bankruptcy Court.

or an equity security of the guaranteed party, contracts that contingently require the guarantor to make payments to the

In the normal course of business, the Company has been named as

guaranteed party based on another entity’s failure to perform

a defendant in various legal actions, including arbitrations, class

under an agreement and indirect guarantees of the indebtedness

actions and other litigation. Certain of the legal actions include

of others, even though the payment to the guaranteed party may

claims for substantial compensatory and/or punitive damages or

not be based on changes to an asset, liability or equity security of

claims for indeterminate amounts of damages. The Company is also

the guaranteed party. In addition, FIN No. 45 covers certain

involved in other reviews, investigations and proceedings by

indemnification agreements that contingently require the

governmental

the

guarantor to make payments to the indemnified party, such as an

Company's business, certain of which may result in adverse

adverse judgment in a lawsuit or the imposition of additional taxes

judgments, settlements, fines, penalties, injunctions or other relief.

due to either a change in the tax law or an adverse interpretation

and

self-regulatory

agencies

regarding

of the tax law. Because litigation is inherently unpredictable, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early stages, the Company cannot predict with certainty the loss or range of loss related to such matters, how such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, fine, penalty or other relief might be. Consequently, the Company cannot estimate losses or ranges of losses for matters where there

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The following table sets forth the maximum payout/notional amounts associated with the Company’s guarantees as of November 30, 2006: Amount of Guarantee Per Expiration Period Less Than One Year

One to Three Years

Three to Five Years

Greater Than Five Years

Total

$ 481,172

$ 405,969

$ 583,718

$ 475,159

$ 1,946,018

2,570

409

—

—

2,979

—

—

570

—

570

(in millions) (1)

Certain derivative contracts (notional) Municipal securities Residual value guarantee

(1) The carrying value of these derivatives approximated $4.66 billion as of November 30, 2006.

DERIVATIVE CONTRACTS

certificates. Certain of the trust certificates entitle the holder to

The Company’s dealer activities cause it to make markets and trade

receive future payments of principal and variable interest and to

a variety of derivative instruments. Certain derivative contracts that

tender such certificates at the option of the holder on a periodic

the Company has entered into meet the accounting definition of a

basis. The Company acts as placement agent and as liquidity

guarantee under FIN No. 45. Derivatives that meet the FIN No. 45

provider. The purpose of the program is to allow the Company’s

definition of guarantees include credit default swaps (whereby a

clients to purchase synthetic short-term, floating-rate municipal

default or significant change in the credit quality of the underlying

debt that does not otherwise exist in the marketplace. In the

financial instrument may obligate the Company to make a payment),

Company’s capacity as liquidity provider to the trusts, the maximum

put options, as well as floors, caps and collars. Since the Company

exposure to loss at November 30, 2006 was approximately $2.98

does not track the counterparties’ purpose for entering into a

billion, which represents the outstanding amount of all trust

derivative contract, it has disclosed derivative contracts that are

certificates. This exposure to loss is mitigated by the underlying

likely to be used to protect against a change in an underlying

municipal bonds. The underlying municipal bonds in the trusts are

financial instrument, regardless of their actual use.

either AAA- or AA-rated, insured or escrowed to maturity. Such bonds had a market value, net of related hedges, approximating

On certain of these contracts, such as written interest rate caps and

$3.05 billion at November 30, 2006.

foreign currency options, the maximum payout cannot be quantified since the increase in interest rates and foreign exchange rates is not

RESIDUAL VALUE GUARANTEE

contractually limited by the terms of the contracts. As such, the

The Company has entered into an operating lease arrangement for

Company has disclosed notional amounts as a measure of the

its world headquarters at 383 Madison Avenue in New York City (the

extent of its involvement in these classes of derivatives rather than

“Synthetic Lease”). Under the terms of the Synthetic Lease, the

maximum payout. Notional amounts do not represent the maximum

Company is obligated to make monthly payments based on the

payout and generally overstate the Company’s exposure to these

lessor's underlying interest costs. The Synthetic Lease expires on

contracts. These derivative contracts are recorded at fair value,

August 12, 2011 unless both parties agree to a renewal prior to

which approximated $4.66 billion at November 30, 2006.

expiration. At the expiration date of the Synthetic Lease, the Company has the right to purchase the building for the amount of

In connection with these activities, the Company attempts to

the then outstanding indebtedness of the lessor or to arrange for

mitigate its exposure to market risk by entering into a variety of

the sale of the property with the proceeds of the sale to be used to

offsetting derivative contracts and security positions.

satisfy the lessor's debt obligation. If the sale of the property does not generate sufficient proceeds to satisfy the lessor's debt

MUNICIPAL SECURITIES

obligation, the Company is required to fund the shortfall up to a

In 1997, the Company established a program whereby it created a

maximum residual value guarantee. As of November 30, 2006,

series of municipal securities trusts in which it has retained interests.

there was no expected shortfall and the maximum residual value

These trusts purchase fixed-rate, long-term, highly rated, insured or

guarantee approximated $570 million.

escrowed municipal bonds financed by the issuance of trust

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INDEMNIFICATIONS

separately as different levels and types of expertise are required to

The Company provides representations and warranties to

effectively manage the segments’ transactions.

counterparties in connection with a variety of commercial transactions, including certain asset sales and securitizations and

The Capital Markets segment is comprised of the institutional

occasionally indemnifies them against potential losses caused by

equities, fixed income and investment banking areas. The Capital

the breach of those representations and warranties. To mitigate

Markets segment operates as a single integrated unit that

these risks with respect to assets being securitized that have been

provides the sales, trading and origination effort for various fixed

originated by third parties, the Company seeks to obtain

income, equity and advisory products and services. Each of the

appropriate representations and warranties from such third-party

three businesses work in tandem to deliver these product services

originators upon acquisition of such assets. The Company generally

to institutional and corporate clients.

performs due diligence on assets purchased and maintains underwriting standards for assets originated. The Company may

Institutional equities consists of sales, trading and research,

also provide indemnifications to certain counterparties to protect

in areas such as domestic and international equities, block trading,

them in the event additional taxes are owed or payments are

over-the-counter equities, equity derivatives, energy and

withheld, due either to a rule change or an adverse application of

commodity activities, risk and convertible arbitrage and through

certain tax laws. These indemnifications generally are standard

a majority-owned joint venture, specialist activities on the NYSE,

contractual terms and are entered into in the normal course of

AMEX and ISE. Fixed income includes sales, trading, origination

business. Generally, there are no stated or notional amounts

and research provided to institutional clients across a variety of

included in these indemnifications, and the contingencies triggering

products such as mortgage- and asset-backed securities,

the obligation to indemnify are not expected to occur.

corporate and government bonds, municipal bonds, high yield products, including bank and bridge loans, foreign exchange and

Maximum payout information under these indemnifications is not

interest rate and credit derivatives. Investment banking provides

readily available because of the number, size and maturities of these

services in capital raising, strategic advice, mergers and

transactions. In implementing this accounting interpretation, the

acquisitions and merchant banking. Capital raising encompasses

Company reviewed its experience with the indemnifications on these

the Company’s underwriting of equity, investment grade, municipal

structures. Based on such experience, it is unlikely that the Company

and high yield debt products.

will have to make significant payments under these arrangements. The Global Clearing Services segment provides execution, clearing,

OTHER GUARANTEES

margin lending and securities borrowing to facilitate customer short

The Company is a member of numerous exchanges and

sales to clearing clients worldwide. Prime brokerage clients include

clearinghouses. Under the membership agreements, members are

hedge funds and clients of money managers, short sellers and other

generally required to guarantee the performance of other members.

professional investors. Fully disclosed clients engage in either the

Additionally, if a member becomes unable to satisfy its obligations to

retail or institutional brokerage business.

the clearinghouse, other members would be required to meet the associated shortfalls. To mitigate these performance risks, the

The Wealth Management segment is composed of the PCS and

exchanges and clearinghouses often require members to post

asset management areas. PCS provides high-net-worth individuals

collateral. The Company’s maximum potential liability under these

with an institutional level of investment service, including access to

arrangements cannot be quantified. However, the potential for the

the Company’s resources and professionals. Asset management

Company to be required to make payments under these

manages equity, fixed income and alternative assets for leading

arrangements is remote. Accordingly, no contingent liability is recorded

corporate pension plans, public systems, endowments, foundations,

in the consolidated financial statements for these arrangements.

multi-employer plans, insurance companies, corporations, families and high-net-worth individuals in the US and abroad.

19. SEGMENT AND GEOGRAPHIC AREA DATA The Company operates in three principal segments—Capital

The three business segments comprise many business areas, with

Markets, Global Clearing Services and Wealth Management. These

interactions among each. Revenues and expenses include those

segments offer different products and services and are managed

that are directly related to each segment. Revenues from

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S

(continued)

The Bear Stearns Companies Inc.

intersegment transactions are allocated based upon specific criteria

and interest, which are internally allocated by the Company primarily

or agreed-upon rates with such amounts eliminated in

based on balance sheet usage or expense levels. The Company

consolidation. Individual segments also include revenues and

generally evaluates performance of the segments based on net

expenses relating to various items, including corporate overhead

revenues and profit or loss before provision for income taxes.

Fiscal Years Ended November 30,

2006

2005

2004

(in thousands)

NET REVENUES Capital Markets Institutional equities

$ 1,961,769

$ 1,445,907

$ 1,087,819

Fixed income

4,189,879

3,293,044

3,147,261

Investment banking

1,169,505

983,044

1,070,048

Total Capital Markets

7,321,153

5,721,995

5,305,128

Global Clearing Services

1,076,997

1,028,864

894,333

522,254 335,474 857,728 (28,713)

452,948 227,572 680,520 (20,585)

442,247 185,768 628,015 (14,593)

Total net revenues

$ 9,227,165

$ 7,410,794

$ 6,812,883

PRE-TAX INCOME Capital Markets

$ 2,800,506

$ 2,020,484

$ 1,914,917

464,519

471,796

349,922

69,160

36,770

62,344

(187,555)

(321,991)

(305,029)

$ 3,146,630

$ 2,207,059

$ 2,022,154

$ 350,256

$ 172,056

$

802,554

735,772

58,965

57,538

58,151

$ 1,211,775

$ 965,366

$ 708,296

Wealth Management Private client services(1) Asset management Total Wealth Management Other(2)

Global Clearing Services Wealth Management Other (3) Total pre-tax income NET INTEREST REVENUES Capital Markets Global Clearing Services Wealth Management Total net interest revenues

81,604 568,541

Note: Certain prior period items have been reclassified to conform to the current period’s presentation. (1) Private client services detail: Gross revenues, before transfer to Capital Markets segment $ 620,337 $ 546,534 $ 527,127 (93,586) (84,880) Revenue transferred to Capital Markets segment (98,083) $ 522,254 $ 452,948 $ 442,247 Private client services net revenues (2) Includes consolidation and elimination entries. (3) Includes certain legal costs and costs related to the CAP Plan, which approximate $154.0 million, $144.0 million and $176.0 million for the fiscal years ended November 30, 2006, 2005 and 2004, respectively.

As of November 30,

2006

2005

2004

(in thousands)

SEGMENT ASSETS Capital Markets Global Clearing Services

$ 240,448,857

$ 191,932,128

$ 154,433,465

98,532,526

83,643,297

86,664,127

Wealth Management

3,138,239

2,751,749

2,679,697

Other

8,312,973

8,965,463

8,335,402

$ 350,432,595

$ 287,292,637

$ 252,112,691

Total segment assets Note: Certain prior period items have been reclassified to conform to the current period’s presentation.

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C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S

(continued)

The Bear Stearns Companies Inc.

The operations of the Company are conducted primarily in the United States of America. The Company also maintains offices in Europe, Asia and Latin America. The following are net revenues, income before provision for income taxes and assets by geographic region for the fiscal years ended November 30, 2006, 2005 and 2004:

2006

(in thousands)

Net revenues-US

$

Non-US

8,006,413

2005 $

1,220,752

6,487,321

2004 $

923,473

6,172,286 640,597

Total net revenues

$

9,227,165

$

7,410,794

$

6,812,883

Income before provision for income taxes-US

$

2,668,463

$

1,867,781

$

1,875,070

Total income before provision for income taxes

$

3,146,630

$

2,207,059

$

2,022,154

Total assets-US

$ 437,418,643

$ 344,757,169

92,836,337

70,436,123

54,517,734

Eliminations

(179,822,385)

(127,900,655)

(131,712,849)

Total assets

$ 350,432,595

$ 287,292,637

$ 252,112,691

Non-US

Non-US

478,167

339,278

147,084 $ 329,307,806

Note: Certain prior period items have been reclassified to conform to the current period’s presentation.

Because of the international nature of the financial markets and the resultant integration of US and non-US services, it is difficult to precisely separate foreign operations. The Company conducts and manages these activities with a view toward the profitability of the Company as a whole. Accordingly, the foreign operations information is, of necessity, based on management judgments and internal allocations. Included within the Company’s US net revenues during fiscal 2006 and fiscal 2005 are the revenues of Bear Wagner Specialists LLC.

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S

(continued)

The Bear Stearns Companies Inc.

20. QUARTERLY INFORMATION (UNAUDITED) The unaudited quarterly results of operations of the Company for the fiscal years ended November 30, 2006 and 2005 are prepared in conformity with accounting principles generally accepted in the United States of America, which include industry practices, and reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results of operations for the periods presented. Results of any interim period are not necessarily indicative of results for a full year.

(in thousands, except per share data)

Quarters Ended, May 31, August 31, 2006 2006

February 28, 2006

November 30, 2006

Total

$ 3,638,418

$ 4,303,749

$ 4,135,687

$ 4,473,565

$16,551,419

Interest expense

1,453,215

1,804,307

2,006,552

2,060,180

7,324,254

Revenues, net of interest expense

2,185,203

2,499,442

2,129,135

2,413,385

9,227,165

1,046,850

1,220,216

1,024,748

1,051,685

4,343,499

386,000

445,027

437,149

468,860

1,737,036

1,432,850

1,665,243

1,461,897

1,520,545

6,080,535

752,353

834,199

667,238

892,840

3,146,630

Revenues

Non-interest expenses Employee compensation and benefits Other Total non-interest expenses Income before provision for income taxes Provision for income taxes

229,682

330,014

1,092,759

$

514,156

238,197 $

539,333

$

437,556

$ 562,826

$ 2,053,871

$

3.92

$

4.12

$

3.34

$

4.42

$

15.79

Diluted earnings per share

$

3.54

$

3.72

$

3.02

$

4.00

$

14.27

Cash dividends declared per common share

$

0.28

$

0.28

$

0.28

$

0.28

$

1.12

Net income Basic earnings per share(1) (1)

(in thousands, except per share data)

Revenues

294,866

Quarters Ended, May 31, August 31, 2005 2005

February 28, 2005

November 30, 2005

Total

$ 2,622,369

$ 2,823,580

$ 2,925,394

$ 3,181,104

$11,552,447

784,709

950,028

1,113,114

1,293,802

4,141,653

1,837,660

1,873,552

1,812,280

1,887,302

7,410,794

Interest expense Revenues, net of interest expense Non-interest expenses Employee compensation and benefits

906,775

922,908

850,985

872,548

3,553,216

Other

352,557

488,205

381,140

428,617

1,650,519

Total non-interest expenses

1,259,332

1,411,113

1,232,125

1,301,165

5,203,735

Income before provision for income taxes

578,328

462,439

580,155

586,137

2,207,059

Provision for income taxes

199,523

164,329

201,850

179,180

744,882

$ 406,957

$ 1,462,177

$

3.21

$

11.42

Net income

$

378,805

$

298,110

$

378,305

Basic earnings per share(1)

$

2.94

$

2.32

$

2.96

Diluted earnings per share

$

2.64

$

2.09

$

2.69

$

2.90

$

10.31

Cash dividends declared per common share

$

0.25

$

0.25

$

0.25

$

0.25

$

1.00

(1)

(1) Due to rounding and/or the effect of averaging the number of shares of common stock and common stock equivalents throughout the year, the sum of the quarters’ earnings per share amounts does not equal the full fiscal year amount.

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T H E B E A R S T E A R N S C O M PA N I E S I N C .

C O R P O R AT E I N F O R M AT I O N The Bear Stearns Companies Inc.

PRICE RANGE OF COMMON STOCK AND DIVIDENDS AND RELATED STOCKHOLDER MATTERS

in each year on the Company’s outstanding Cumulative Preferred

The common stock of the Company is traded on the NYSE under

Cumulative Preferred Stock, Series G (collectively, the “Preferred

the symbol BSC. The table below sets forth for the periods indicated

Stock”). The terms of the Preferred Stock require that all accrued

the closing high and low prices for the common stock and the cash

dividends in arrears be paid prior to the payment of any dividends

dividends declared on the common stock.

on the common stock.

As of February 5, 2007, there were 1,509 holders of record of the

Since the Company is a holding company, its ability to pay

Company’s common stock. On February 5, 2007, the last reported

dividends is limited by the ability of its subsidiaries to pay dividends

sales price of the Company’s common stock was $165.06.

and to make advances to the Company. See Note 16, “Regulatory

Stock, Series E; Cumulative Preferred Stock, Series F; and

Requirements,” in the Notes to Consolidated Financial Statements Dividends are payable on January 15, April 15, July 15 and October 15

for a further description of the restrictions on dividends.

High

Low

Cash Dividends Declared Per Common Share

Fiscal Year Ended November 30, 2006 First Quarter (through February 28, 2006)

$ 136.40

$ 110.50

$ 0.28

Second Quarter (through May 31, 2006)

147.07

127.28

0.28

Third Quarter (through August 31, 2006)

145.49

123.43

0.28

Fourth Quarter (through November 30, 2006)

158.60

128.07

0.28

$ 106.68

$ 96.65

$ 0.25

106.03

93.09

0.25

Fiscal Year Ended November 30, 2005 First Quarter (through February 28, 2005) Second Quarter (through May 31, 2005) Third Quarter (through August 31, 2005)

107.21

97.96

0.25

Fourth Quarter (through November 30, 2005)

114.47

101.46

0.25

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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C O R P O R AT E I N F O R M AT I O N

(continued)

The Bear Stearns Companies Inc.

PERFORMANCE GRAPH

Goldman Sachs Group, Inc. and Lehman Brothers Holdings Inc.

The following graph compares the performance of an investment in

The performance graph assumes the value of the investment in the

the Company’s Common Stock over the last five fiscal years with its

Company’s Common Stock and each index was $100 on

Peer Group, the S&P 500 Investment Banking & Brokerage Index

November 30, 2001, and that all dividends have been reinvested.

and the S&P 500 Index. The entities included in the Company’s

The performance shown in the graph represents past performance

Peer Group consist of Merrill Lynch & Co., Inc., Morgan Stanley, The

and should not be considered an indication of future performance.

Comparison of Five-Year Cumulative Total Return

$300

$250

$200

$150

$100

$50

$0 2001

2002

The Bear Stearns Companies Inc.

2003

Peer Group

2004

2005

S&P 500 Investment Banking & Brokerage Index

2006

S&P 500 Index

2001

2002

2003

2004

2005

2006

$ 100.00

$ 112.45

$ 128.71

$ 175.06

$ 201.11

$ 278.52

Peer Group

100.00

87.08

109.57

112.25

140.53

194.96

S&P 500 Investment Banking & Brokerage Index

100.00

83.99

103.26

106.25

129.48

179.02

S&P 500 Index

100.00

83.49

96.08

108.44

117.59

134.33

The Bear Stearns Companies Inc.

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C O R P O R AT E I N F O R M AT I O N

(continued)

The Bear Stearns Companies Inc.

REQUESTS FOR FINANCIAL INFORMATION SEC FILINGS A copy of The Bear Stearns Companies Inc. Annual Report, Forms 10-K, 10-Q and 8-K along with other Securities and Exchange Commission filings are available through www.bearstearns.com, or by writing:

TRANSFER AGENT AND REGISTRAR Mellon Investor Services L.L.C. Overpeck Centre Ridgefield Park, NJ 07660 800-279-1229

Investor Relations Department The Bear Stearns Companies Inc.

LEGAL COUNSEL

383 Madison Avenue

Cadwalader, Wickersham & Taft LLP

New York, NY 10179

One World Financial Center

[email protected]

New York, NY 10281 212-504-6000

or by calling our automated service for financial information requests: 866-299-9331.

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

CEO AND CFO CERTIFICATIONS

Deloitte & Touche LLP

The certifications by the Chief Executive Officer and the Chief

Two World Financial Center

Financial Officer of The Bear Stearns Companies Inc., required

New York, NY 10281

under Section 302 of the Sarbanes-Oxley Act of 2002, have

212-436-2000

been filed as exhibits to the firm’s 2006 Annual Report on Form 10-K. The 2005 Annual CEO Certification of The Bear Stearns Companies Inc., required pursuant to NYSE Corporate Governance Standards Section 303A.12(a) that the CEO was

INVESTOR RELATIONS Elizabeth Ventura 212-272-9251

not aware of any violation by the firm of NYSE’s Corporate

John Quinn

Governance listing standards, was submitted to the NYSE on

212-272-5934

May 2, 2006. MEDIA RELATIONS Elizabeth Ventura 212-272-9251 Russell Sherman 212-272-5219 INFORMATION CENTER 212-272-3939

T H E B E A R S T E A R N S C O M PA N I E S I N C .

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113

DIRECTORS

AND

OFFICERS

The Bear Stearns Companies Inc.

THE BEAR STEARNS COMPANIES INC. BOARD OF DIRECTORS Donald J. Harrington(3) President, St. John’s University

James E. Cayne(1)*(2) Chairman of the Board and Chief Executive Officer

Other Officers Samuel L. Molinaro Jr.(1)(2) Executive Vice President and Chief Financial Officer

Frank T. Nickell President and Chief Executive Officer Kelso & Company (3)(6)(7)

Alan C. Greenberg(2)* Chairman of the Executive Committee Alan D. Schwartz(1)(2) President and Co-Chief Operating Officer Warren J. Spector(1)(2) President and Co-Chief Operating Officer Henry S. Bienen(4)(5) President, Northwestern University Carl D. Glickman(3)*(4)(5) Private Investor

Kenneth L. Edlow Secretary

Paul A. Novelly(4)(5)(6)(7)* Chairman and Chief Executive Officer Apex Oil Company, Inc.

Jeffrey M. Farber Senior Vice President—Finance and Controller

Frederic V. Salerno(4)(5)(6)*(7) Former Vice Chairman and Chief Financial Officer Verizon Communications Inc.

Michael Minikes Treasurer Michael S. Solender General Counsel

Vincent Tese(3)(4)*(5)*(6)(7) Chairman, Wireless Cable International Inc.

Michael Goldstein (4) Former Chairman and CEO Toys “R” Us, Inc.

Wesley S. Williams Jr.(4)(5) President and Co-Chairman Lockhart Companies Inc.

BEAR, STEARNS & CO. INC. BOARD OF DIRECTORS Thomas M. Flexner Vice Chairman

Michael Alix

Fares D. Noujaim Vice Chairman

Kathryn R. Booth

Michael Minikes

Denis A. Bovin

Michael Nierenberg

Peter D. Cherasia

Craig M. Overlander

Steven M. Dantus

Michel Péretié

Wendy L. de Monchaux

Robert M. Steinberg (1)

James F. Egan

Michael J. Urfirer

Robert E. Foran

Jeffrey H. Urwin

Bruce E. Geismar

Jeffrey L. Verschleiser

Warren J. Spector President and Co-Chief Operating Officer

David H. Glaser

Eli Wachtel

Alan D. Schwartz President and Co-Chief Operating Officer

Bruce M. Lisman (1)

Other Officer

Roland N. Livney

Robert N. M. Upton Treasurer

Alan C. Greenberg Chairman of the Executive Committee Samuel L. Molinaro Jr. Executive Vice President and Chief Financial Officer

E. John Rosenwald Jr. Vice Chairman Donald W. Tang Vice Chairman

Steven L. Begleiter

Jeffrey Mayer (1) (1)

Steven D. Meyer

Gregory A. Hanley Daniel L. Keating

Thomas Marano

(1) Management & Compensation Committee (2) Executive Committee (3) Compensation Committee (4) Audit Committee (5) Qualified Legal Compliance Committee (6) Corporate Governance and Nominating Committee (7) Finance and Risk Committee *Committee Chairman All members of the Board of Directors of Bear, Stearns & Co. Inc. hold the title senior managing director.

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Design by Bear Stearns Corporate Marketing/www.bearstearns.com Photography by James Irvine, Larry Lettera/Camera 1, Michelle Generous, Ann Kim and Nell Freeman

James E. Cayne Chairman of the Board and Chief Executive Officer

W O R L D W I D E L O CAT I O N S The Bear Stearns Companies Inc.

WORLD HEADQUARTERS 383 Madison Avenue New York, NY 10179 212-272-2000

GLOBAL OFFICES BRAZIL São Paulo, Brazil Bear Stearns do Brasil Ltda. Rua Joaquim Floriano 72-8° andar-cj 83 04534-000 São Paulo, Brazil 55-11-3457-3200 CHINA Beijing, China Bear, Stearns & Co. Inc. Representative Office Room 1608 China World Trade Center Building 1 Jian Guo Men Wai Avenue Beijing 100004 People’s Republic of China 86-10-6505-5101 Shanghai, China Bear, Stearns & Co. Inc. Representative Office Unit 09, 20th Floor Building One Corporate Avenue No. 222 Hubin Road Luwan District Shanghai 200120 People’s Republic of China 86-21-6340-6600 HONG KONG Bear Stearns Asia Limited 26th Floor, Citibank Tower Citibank Plaza 3 Garden Road, Hong Kong 852-2593-2700 IRELAND Dublin, Ireland Bear Stearns Bank plc Block 8 Harcourt Centre—Floor 3 Charlotte Way Dublin 2, Ireland 353-1-402-6200

ITALY Milan, Italy Bear, Stearns International Limited Via Pietro Verri 6 20121 Milano, Italy 39-02-3030-1700 JAPAN Tokyo, Japan Bear Stearns (Japan), Ltd. Shiroyama JT Trust Tower 3-1 Toranomon, 4-chome Minato-ku, Tokyo 105-6022 Japan 813-3437-7800 SINGAPORE Bear Stearns Singapore Pte. Ltd. 30 Raffles Place #21-00 Caltex House Singapore 048622 65-6437-3300 SWITZERLAND Lugano, Switzerland Bear, Stearns & Co. Inc. Corso Elvezia 14 PO Box 5155 6901 Lugano, Switzerland 41-91-911-7333 UNITED KINGDOM London, England Bear, Stearns International Limited One Canada Square London E14 5AD, England 44-20-7516-6000 UNITED STATES Atlanta, Georgia 3424 Peachtree Road, NE Suite 1700 Atlanta, GA 30326 404-842-4000 Boston, Massachusetts One Federal Street 29th Floor Boston, MA 02110 617-654-2800

Chicago, Illinois Three First National Plaza 70 West Madison Street Chicago, IL 60602 312-580-4000

Los Angeles, California 1999 Avenue of the Stars 25th Floor Los Angeles, CA 90067 310-201-3900

Dallas, Texas 100 Crescent Court Suite 1300 Dallas, TX 75201 214-979-7900

New York, New York One MetroTech Center North Brooklyn, NY 11201 347-643-1000

Los Angeles, California 1999 Avenue of the Stars Floors 31-33 Los Angeles, CA 90067 310-201-2600 San Francisco, California Citicorp Center One Sansome Street 41st Floor San Francisco, CA 94104 415-772-2900

San Francisco, California Citicorp Center One Sansome Street 39th Floor San Francisco, CA 94104 415-288-2300

CUSTODIAL TRUST COMPANY

Tampa, Florida Hidden River Corporate Center Three 14055 Riveredge Drive Suite 350 Tampa, FL 33637 813-558-3400

101 Carnegie Center Princeton, NJ 08540 609-951-2300

SUBSIDIARIES OF THE BEAR STEARNS COMPANIES INC.

BEAR, STEARNS SECURITIES CORP. Boston, Massachusetts One Federal Street 18th Floor Boston, MA 02110 617-654-2800 Chicago, Illinois 200 West Madison Street Chicago, IL 60606 312-663-3300 London, England Bear, Stearns International Limited One Canada Square London E14 5AD, England 44-20-7516-6000

Arroyo Energy Investors LP 16945 Northchase Drive Suite 1560 Houston, TX 77060 832-601-2600 Bear Energy LP 717 Texas Avenue Houston, TX 77702 713-236-3000 EMC Residential Mortgage Corporation 2780 Lake Vista Drive Lewisville, TX 75067 214-626-2735 Bear Stearns Residential Mortgage Corporation 9201 E. Mountainview Road Scottsdale, AZ 85258 480-358-2000

© 2007 The Bear Stearns Companies Inc. Bear Stearns, BSAM, EMC Mortgage, Bear Measurisk, Bear Direct, BondStudio, BearPrime and Bear Stearns Advisory Services are registered trademarks or service marks of The Bear Stearns Companies Inc. BearXplorer is a trademark and BearCast and Bearimmo are service marks of The Bear Stearns Companies Inc. Bear, Stearns & Co. Inc. is a registered broker-dealer subsidiary of The Bear Stearns Companies Inc. and a member of NYSE, NASD and SIPC.

383 Madison Avenue New York, New York 10179 212-272-2000 www.bearstearns.com