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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended August 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-11758
Morgan Stanley Dean Witter & Co.
(Exact Name of Registrant as Specified in its Charter)
----------------
Delaware 36-3145972
(State of Incorporation) (I.R.S. Employer Identification No.)
1585 Broadway 10036
New York, NY (Zip Code)
(Address of Principal
Executive Offices)
Registrant's telephone number, including area code: (212) 761-4000
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
As of September 30, 2000 there were 1,120,713,349 shares of Registrant's
Common Stock, par value $.01 per share, outstanding.
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MORGAN STANLEY DEAN WITTER & CO.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
Quarter Ended August 31, 2000
Page
----
Part I--Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Financial Condition--August 31,
2000 (unaudited) and November 30, 1999............................... 1
Condensed Consolidated Statements of Income (unaudited)--Three and
Nine Months Ended August 31, 2000 and August 31, 1999................ 2
Condensed Consolidated Statements of Comprehensive Income
(unaudited)--Three and Nine Months Ended August 31, 2000 and August
31, 1999............................................................. 3
Condensed Consolidated Statements of Cash Flows (unaudited)--Nine
Months Ended August 31, 2000 and August 31, 1999..................... 4
Notes to Condensed Consolidated Financial Statements (unaudited)...... 5
Independent Accountants' Report....................................... 15
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................. 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk...... 38
Part II--Other Information
Item 1. Legal Proceedings............................................... 39
Item 2. Changes in Securities and Use of Proceeds....................... 39
Item 5. Other Information............................................... 39
Item 6. Exhibits and Reports on Form 8-K................................ 39
i
MORGAN STANLEY DEAN WITTER & CO.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in millions, except share and per share data)
August 31, November 30,
2000 1999
----------- ------------
ASSETS (unaudited)
Cash and cash equivalents............................. $ 17,255 $ 12,325
Cash and securities deposited with clearing
organizations or segregated under federal and other
regulations (including securities at fair value of
$21,897 at August 31, 2000 and $6,925 at November 30,
1999) 25,756 9,713
Financial instruments owned:
U.S. government and agency securities................ 24,474 25,646
Other sovereign government obligations............... 21,874 17,522
Corporate and other debt............................. 27,314 30,443
Corporate equities................................... 20,947 14,843
Derivative contracts................................. 27,633 22,769
Physical commodities................................. 529 819
Securities purchased under agreements to resell....... 55,063 70,366
Receivable for securities provided as collateral...... 2,971 9,007
Securities borrowed................................... 107,354 85,064
Receivables:
Consumer loans (net of allowances of $776 at August
31, 2000 and $769 at November 30, 1999)............. 19,041 20,229
Customers, net....................................... 27,866 29,299
Brokers, dealers and clearing organizations.......... 5,879 2,252
Fees, interest and other............................. 5,739 5,371
Office facilities, at cost (less accumulated
depreciation and amortization of $1,865 at August 31,
2000 and $1,667 at November 30, 1999)................ 2,296 2,204
Aircraft under operating leases (less accumulated
depreciation of $209 at August 31, 2000 and $101 at
November 30, 1999)................................... 3,949 1,884
Other assets.......................................... 8,183 7,211
-------- --------
Total assets.......................................... $404,123 $366,967
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Commercial paper and other short-term borrowings...... $ 22,783 $ 38,242
Deposits.............................................. 11,454 10,397
Financial instruments sold, not yet purchased:
U.S. government and agency securities................ 11,597 12,285
Other sovereign government obligations............... 7,890 7,812
Corporate and other debt............................. 5,711 2,322
Corporate equities................................... 14,836 15,402
Derivative contracts................................. 28,310 23,228
Physical commodities................................. 1,390 919
Securities sold under agreements to repurchase........ 97,368 104,450
Obligation to return securities received as
collateral........................................... 12,015 14,729
Securities loaned..................................... 35,237 30,080
Payables:
Customers............................................ 73,601 45,775
Brokers, dealers and clearing organizations.......... 3,129 1,335
Interest and dividends............................... 2,073 2,951
Other liabilities and accrued expenses................ 14,403 10,439
Long-term borrowings.................................. 42,833 28,604
-------- --------
Total liabilities.................................... 384,630 348,970
-------- --------
Capital Units......................................... 439 583
-------- --------
Preferred Securities Issued by Subsidiaries........... 400 400
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock...................................... 545 670
Common stock(1) ($0.01 par value, 3,500,000,000
shares authorized, 1,211,685,904 and 1,211,685,904
shares issued, 1,121,597,725 and 1,104,630,098
shares outstanding at August 31, 2000 and November
30, 1999)........................................... 12 12
Paid-in capital(1)................................... 3,296 3,836
Retained earnings.................................... 19,826 16,285
Employee stock trust................................. 2,384 2,426
Cumulative translation adjustments................... (107) (27)
-------- --------
Subtotal........................................... 25,956 23,202
Note receivable related to ESOP...................... (55) (55)
Common stock held in treasury, at cost(1) ($0.01 par
value, 90,088,179 and 107,055,806 shares at August
31, 2000 and November 30, 1999)..................... (4,863) (4,355)
Common stock issued to employee trust................ (2,384) (1,778)
-------- --------
Total shareholders' equity......................... 18,654 17,014
-------- --------
Total liabilities and shareholders' equity............ $404,123 $366,967
======== ========
- -------
(1) Fiscal 1999 amounts have been retroactively adjusted to give effect for a
two-for-one common stock split, effected in the form of a 100% stock
dividend, which became effective on January 26, 2000.
See Notes to Condensed Consolidated Financial Statements.
1
MORGAN STANLEY DEAN WITTER & CO.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(dollars in millions, except share and per share data)
Three Months Nine Months
Ended August 31, Ended August 31,
--------------------------- ---------------------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
(unaudited) (unaudited)
Revenues:
Investment banking...... $ 1,172 $ 1,207 $ 3,877 $ 3,185
Principal transactions:
Trading............... 1,630 1,143 6,408 4,692
Investments........... 68 78 263 493
Commissions............. 831 681 2,787 2,033
Fees:
Asset management,
distribution and
administration....... 1,092 857 3,133 2,450
Merchant and
cardmember........... 447 392 1,337 1,090
Servicing............. 424 313 1,060 876
Interest and dividends.. 5,897 3,899 15,769 11,070
Other................... 150 56 335 174
------------- ------------- ------------- -------------
Total revenues........ 11,711 8,626 34,969 26,063
Interest expense........ 5,242 3,184 13,594 9,341
Provision for consumer
loan losses............ 175 113 602 409
------------- ------------- ------------- -------------
Net revenues.......... 6,294 5,329 20,773 16,313
------------- ------------- ------------- -------------
Non-interest expenses:
Compensation and
benefits............. 2,656 2,302 9,161 7,078
Occupancy and
equipment............ 202 166 551 465
Brokerage, clearing
and exchange fees.... 132 128 383 369
Information processing
and communications... 392 325 1,119 949
Marketing and business
development.......... 507 408 1,480 1,184
Professional
services............. 275 214 675 567
Other................. 255 223 802 608
------------- ------------- ------------- -------------
Total non-interest
expenses........... 4,419 3,766 14,171 11,220
------------- ------------- ------------- -------------
Gain on sale of
business............... 35 -- 35 --
------------- ------------- ------------- -------------
Income before income
taxes.................. 1,910 1,563 6,637 5,093
Provision for income
taxes.................. 664 593 2,389 1,935
------------- ------------- ------------- -------------
Net income.............. $ 1,246 $ 970 $ 4,248 $ 3,158
============= ============= ============= =============
Preferred stock dividend
requirements........... $ 9 $ 11 $ 27 $ 33
============= ============= ============= =============
Earnings applicable to
common shares(1)....... $ 1,237 $ 959 $ 4,221 $ 3,125
============= ============= ============= =============
Earnings per share(2):
Basic................. $ 1.14 $ 0.87 $ 3.87 $ 2.82
============= ============= ============= =============
Diluted............... $ 1.09 $ 0.83 $ 3.70 $ 2.68
============= ============= ============= =============
Average common shares
outstanding(2):
Basic................. 1,088,218,669 1,100,113,462 1,090,967,941 1,106,725,932
============= ============= ============= =============
Diluted............... 1,137,304,026 1,161,401,646 1,141,272,402 1,169,434,812
============= ============= ============= =============
- -------
(1) Amounts shown are used to calculate basic earnings per common share.
(2) Fiscal 1999 amounts have been retroactively adjusted to give effect for a
two-for-one common stock split, effected in the form of a 100% stock
dividend, which became effective on January 26, 2000.
See Notes to Condensed Consolidated Financial Statements.
2
MORGAN STANLEY DEAN WITTER & CO.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in millions)
Three Months Nine Months
Ended August 31, Ended August 31,
-------------------------------------
2000 1999 2000 1999
--------- ---------------- --------
(unaudited) (unaudited)
Net income............................... $ 1,246 $ 970 $ 4,248 $ 3,158
Other comprehensive income, net of tax:
Foreign currency translation
adjustment............................. (17) 8 (80) (16)
--------- ------- -------- --------
Comprehensive income..................... $ 1,229 $ 978 $ 4,168 $ 3,142
========= ======= ======== ========
See Notes to Condensed Consolidated Financial Statements.
3
MORGAN STANLEY DEAN WITTER & CO.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in millions)
Nine Months
Ended August 31,
-----------------
2000 1999
-------- -------
(unaudited)
Cash flows from operating activities
Net income.................................................. $ 4,248 $ 3,158
Adjustments to reconcile net income to net cash provided
by (used for) operating activities:
Non-cash charges included in net income................. 1,186 860
Changes in assets and liabilities:
Cash and securities deposited with clearing
organizations or segregated under federal and other
regulations............................................ (16,043) 134
Financial instruments owned, net of financial
instruments sold, not yet purchased.................... 107 (4,972)
Securities borrowed, net of securities loaned........... (17,133) (4,662)
Receivables and other assets............................ (1,785) (7,315)
Payables and other liabilities.......................... 32,215 6,076
-------- -------
Net cash provided by (used for) operating activities........ 2,795 (6,721)
-------- -------
Cash flows from investing activities
Net (payments for) proceeds from:
Office facilities....................................... (352) (560)
Purchase of Morgan Stanley Dean Witter, S.V., S.A., net
of cash acquired....................................... -- (223)
Purchase of Ansett Worldwide, net of cash acquired...... (199) --
Net principal disbursed on consumer loans............... (8,106) (4,154)
Sales of consumer loans................................. 8,707 2,997
-------- -------
Net cash provided by (used for) investing activities........ 50 (1,940)
-------- -------
Cash flows from financing activities
Net payments for short-term borrowings.................... (15,534) (5,983)
Securities sold under agreements to repurchase, net of
securities purchased under agreements to resell.......... 8,221 10,723
Net proceeds from:
Deposits................................................ 1,057 1,089
Issuance of common stock................................ 427 245
Issuance of put options................................. 27 7
Issuance of long-term borrowings........................ 21,192 7,227
Payments for:
Repurchases of common stock............................. (2,443) (1,732)
Repayments of long-term borrowings...................... (10,024) (5,562)
Redemption of Capital Units............................. (144) (416)
Cash dividends.......................................... (694) (433)
-------- -------
Net cash provided by financing activities................... 2,085 5,165
-------- -------
Net increase (decrease) in cash and cash equivalents........ 4,930 (3,496)
Cash and cash equivalents, at beginning of period........... 12,325 16,878
-------- -------
Cash and cash equivalents, at end of period................. $ 17,255 $13,382
======== =======
See Notes to Condensed Consolidated Financial Statements.
4
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Introduction and Basis of Presentation
The Company
Morgan Stanley Dean Witter & Co. (the "Company") is a global financial
services firm that maintains leading market positions in each of its three
business segments--Securities, Asset Management and Credit Services. Its
Securities business includes securities underwriting, distribution and
trading; merger, acquisition, restructuring, real estate, project finance and
other corporate finance advisory activities; full-service and online brokerage
services; research services; the trading of foreign exchange and commodities,
as well as derivatives on a broad range of asset categories, rates and
indices; securities lending; and private equity activities. The Company's
Asset Management business provides global asset management advice and services
to investors through a variety of product lines and brand names, including
Morgan Stanley Dean Witter Advisors, Van Kampen Investments, Morgan Stanley
Dean Witter Investment Management and Miller Anderson & Sherrerd. The
Company's Credit Services business includes the issuance of the Discover(R)
Card and the Morgan Stanley Dean Witter SM Card and the operation of Discover
Business Services (formerly the Discover/NOVUS(R) Network), a proprietary
network of merchant and cash access locations.
The condensed consolidated financial statements include the accounts of the
Company and its U.S. and international subsidiaries, including Morgan Stanley
& Co. Incorporated ("MS&Co."), Morgan Stanley & Co. International Limited
("MSIL"), Morgan Stanley Dean Witter Japan Limited ("MSDWJL"), Dean Witter
Reynolds Inc. ("DWR"), Morgan Stanley Dean Witter Advisors Inc. and NOVUS
Credit Services Inc.
Basis of Financial Information
The condensed consolidated financial statements are prepared in accordance
with generally accepted accounting principles, which require management to
make estimates and assumptions regarding certain trading inventory valuations,
consumer loan loss levels, the potential outcome of litigation and other
matters that affect the financial statements and related disclosures.
Management believes that the estimates utilized in the preparation of the
condensed consolidated financial statements are prudent and reasonable. Actual
results could differ materially from these estimates.
Certain reclassifications have been made to prior year amounts to conform to
the current presentation. All material intercompany balances and transactions
have been eliminated.
The condensed consolidated financial statements should be read in
conjunction with the Company's consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the fiscal
year ended November 30, 1999 (the "Form 10-K"). The condensed consolidated
financial statements reflect all adjustments (consisting only of normal
recurring adjustments) which are, in the opinion of management, necessary for
the fair statement of the results for the interim period. The results of
operations for interim periods are not necessarily indicative of results for
the entire year.
Financial instruments, including derivatives, used in the Company's trading
activities are recorded at fair value, and unrealized gains and losses are
reflected in trading revenues. Interest and dividend revenue and interest
expense arising from financial instruments used in trading activities are
reflected in the condensed consolidated statements of income as interest and
dividend revenue or interest expense. The fair values of trading positions
generally are based on listed market prices. If listed market prices are not
available or if liquidating the Company's positions would reasonably be
expected to impact market prices, fair value is determined based on other
relevant factors, including dealer price quotations and price quotations for
similar instruments traded in different markets, including markets located in
different geographic areas. Fair values for certain derivative contracts are
derived from pricing models which consider current market and contractual
prices for the underlying financial instruments or commodities, as well as
time value and yield curve or volatility factors underlying the positions.
Purchases and sales of financial instruments are recorded in the accounts on
trade date.
5
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Unrealized gains and losses arising from the Company's dealings in over-the-
counter ("OTC") financial instruments, including derivative contracts related
to financial instruments and commodities, are presented in the accompanying
condensed consolidated statements of financial condition on a net-by-
counterparty basis, when appropriate.
Equity securities purchased in connection with private equity and other
principal investment activities are initially carried in the condensed
consolidated financial statements at their original costs. The carrying value
of such equity securities is adjusted when changes in the underlying fair
values are readily ascertainable, generally as evidenced by listed market
prices or transactions which directly affect the value of such equity
securities. Downward adjustments relating to such equity securities are made
in the event that the Company determines that the eventual realizable value is
less than the carrying value. The carrying value of investments made in
connection with principal real estate activities which do not involve equity
securities are adjusted periodically based on independent appraisals,
estimates prepared by the Company of discounted future cash flows of the
underlying real estate assets or other indicators of fair value.
Loans made in connection with private equity and investment banking
activities are carried at cost plus accrued interest less reserves, if deemed
necessary, for estimated losses.
The Company has entered into various contracts as hedges against specific
assets, liabilities or anticipated transactions. These contracts include
interest rate swaps, foreign exchange forwards and foreign currency swaps. The
Company uses interest rate and currency swaps to manage the interest rate and
currency exposure arising from certain borrowings. The Company also uses
interest rate swaps to match the repricing characteristics of consumer loans
with those of the borrowings that fund these loans. For contracts that are
designated as hedges of the Company's assets and liabilities, gains and losses
are deferred and recognized as adjustments to interest revenue or expense over
the remaining life of the underlying assets or liabilities. For contracts that
are hedges of asset securitizations, gains and losses are recognized as
adjustments to servicing fees. Gains and losses resulting from the termination
of hedge contracts prior to their stated maturity are recognized ratably over
the remaining life of the instrument being hedged. The Company also uses
foreign exchange forward contracts to manage the currency exposure relating to
its net monetary investment in non-U.S. dollar functional currency operations.
The gain or loss from revaluing these contracts is deferred and reported
within cumulative translation adjustments in shareholders' equity, net of tax
effects, with the related unrealized amounts due from or to counterparties
included in receivables from or payables to brokers, dealers and clearing
organizations.
On December 20, 1999, the Company's Board of Directors declared a two-for-
one common stock split, effected in the form of a 100% stock dividend, payable
to shareholders of record on January 12, 2000 and distributable on January 26,
2000. All share, per share and shareholders' equity data have been
retroactively restated to reflect this split.
On April 6, 2000, shareholders of the Company approved an increase in the
number of authorized common stock shares to 3.5 billion.
As of August 31, 2000, approximately $1.9 billion of the Company's aircraft
assets were owned by Morgan Stanley Aircraft Finance, a bankruptcy-remote
special purpose business trust. Such aircraft assets are not available to
satisfy claims of potential creditors of the Company.
Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which establishes accounting
and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities. As issued, SFAS No. 133 was effective for fiscal years beginning
after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting
for
6
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Derivative Instruments and Hedging Activities--Deferral of the Effective Date
of FASB Statement No. 133". SFAS No. 137 deferred the effective date of SFAS
No. 133 for one year to fiscal years beginning after June 15, 2000. In June
2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities--an amendment of FASB Statement No.
133". The Company is in the process of evaluating the impact of adopting SFAS
No. 133, as amended by SFAS No. 138. However, it is not expected to be
material to the Company's consolidated financial statements since the majority
of the Company's derivative financial instruments are currently carried at
fair value. SFAS No. 133 will affect the accounting for, among other things,
the Company's hedging strategies, including those associated with certain
financing activities.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities--a
replacement of FASB Statement No. 125". SFAS No. 140 is effective for
transfers and servicing of financial assets occurring after March 31, 2001.
This Statement is also effective for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. The Company is in
the process of evaluating the impact of adopting SFAS No. 140.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." SOP 98-1 is effective for
financial statements for fiscal years beginning after December 15, 1998 and
provides specific guidance as to when certain costs incurred in connection
with an internal-use software project should be capitalized and when they
should be expensed. The Company adopted SOP 98-1 effective December 1, 1999.
The adoption of SOP 98-1 did not have a material impact on the Company's
condensed consolidated financial statements.
2. Consumer Loans
Activity in the allowance for consumer loan losses was as follows (dollars
in millions):
Three Months Nine Months
Ended August 31, Ended August 31,
---------------- ------------------
2000 1999 2000 1999
-------- -------- -------- --------
Balance, beginning of period............ $ 773 $ 768 $ 769 $ 787
Provision for loan losses............... 175 113 602 409
Less deductions:
Charge-offs........................... 192 201 677 683
Recoveries............................ (20) (27) (82) (89)
-------- -------- -------- --------
Net charge-offs....................... 172 174 595 594
-------- -------- -------- --------
Other(1)................................ -- 59 -- 164
-------- -------- -------- --------
Balance, end of period.................. $ 776 $ 766 $ 776 $ 766
======== ======== ======== ========
- --------
(1) Primarily reflects transfers related to asset securitizations.
Interest accrued on loans subsequently charged off, recorded as a reduction
of interest revenue, was $29 million and $92 million in the quarter and nine
month period ended August 31, 2000 and $26 million and $89 million in the
quarter and nine month period ended August 31, 1999.
The Company received net proceeds from asset securitizations of $4,394
million and $8,707 million in the quarter and nine month period ended August
31, 2000 and $526 million and $2,997 million in the quarter and nine month
period ended August 31, 1999. The uncollected balances of consumer loans sold
through asset securitizations were $25,024 million at August 31, 2000 and
$16,977 million at November 30, 1999.
7
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Long-Term Borrowings
Long-term borrowings at August 31, 2000 scheduled to mature within one year
aggregated $12,015 million.
During the nine month period ended August 31, 2000 the Company issued senior
notes aggregating $21,150 million, including non-U.S. dollar currency notes
aggregating $2,517 million, primarily pursuant to its public debt shelf
registration statements. The weighted average coupon interest rate of these
notes was 6.65% at August 31, 2000. The Company has entered into certain
transactions to obtain floating interest rates based primarily on short-term
LIBOR trading levels. Maturities in the aggregate of these notes by fiscal
year are as follows: 2001, $3,339 million; 2002, $2,677 million; 2003, $5,840
million; 2004, $25 million; 2005, $6,486 million and thereafter, $2,783
million. In the nine month period ended August 31, 2000, $10,024 million of
senior notes were repaid.
4. Preferred Stock, Capital Units and Preferred Securities Issued by
Subsidiaries
Preferred stock is composed of the following issues:
Shares Outstanding at Balance at
----------------------- -----------------------
August 31, November 30, August 31, November 30,
2000 1999 2000 1999
---------- ------------ ---------- ------------
(dollars in millions)
ESOP Convertible Preferred
Stock, liquidation
preference $35.88............. -- 3,493,477 $-- $125
Series A Fixed/Adjustable Rate
Cumulative Preferred Stock,
stated value $200............. 1,725,000 1,725,000 345 345
7 -3/4% Cumulative Preferred
Stock, stated value $200...... 1,000,000 1,000,000 200 200
---- ----
Total........................ $545 $670
==== ====
Each issue of outstanding preferred stock ranks in parity with all other
outstanding preferred stock of the Company.
In fiscal 1998, MSDW Capital Trust I, a Delaware statutory business trust
(the "Capital Trust"), all of the common securities of which are owned by the
Company, issued $400 million of 7.10% Capital Securities (the "Capital
Securities") that are guaranteed by the Company. The Capital Trust issued the
Capital Securities and invested the proceeds in 7.10% Junior Subordinated
Deferrable Interest Debentures issued by the Company, which are due February
28, 2038.
The Company has Capital Units outstanding that were issued by the Company
and Morgan Stanley Finance plc ("MS plc"), a U.K. subsidiary. A Capital Unit
consists of (a) a Subordinated Debenture of MS plc guaranteed by the Company
and having maturities from 2015 to 2017 and (b) a related Purchase Contract
issued by the Company, which may be accelerated by the Company beginning
approximately one year after the issuance of each Capital Unit, requiring the
holder to purchase one Depositary Share representing shares (or fractional
shares) of the Company's Cumulative Preferred Stock.
In January 2000, the Company and MS plc called for the redemption of all of
the outstanding 9.00% Capital Units on February 28, 2000. The aggregate
principal amount of the Capital Units redeemed was $144 million.
In January 2000, all shares of the ESOP Convertible Preferred Stock were
converted into shares of common stock of the Company.
8
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. Common Stock and Shareholders' Equity
MS&Co. and DWR are registered broker-dealers and registered futures
commission merchants and, accordingly, are subject to the minimum net capital
requirements of the Securities and Exchange Commission, the New York Stock
Exchange and the Commodity Futures Trading Commission. MS&Co. and DWR have
consistently operated in excess of these net capital requirements. MS&Co.'s
net capital totaled $4,423 million at August 31, 2000, which exceeded the
amount required by $3,685 million. DWR's net capital totaled $1,359 million at
August 31, 2000, which exceeded the amount required by $1,157 million. MSIL, a
London-based broker-dealer subsidiary, is subject to the capital requirements
of the Securities and Futures Authority, and MSDWJL, a Tokyo-based broker-
dealer subsidiary, is subject to the capital requirements of the Financial
Services Agency. MSIL and MSDWJL have consistently operated in excess of their
respective regulatory capital requirements.
Under regulatory capital requirements adopted by the Federal Deposit
Insurance Corporation ("FDIC") and other bank regulatory agencies, FDIC-
insured financial institutions must maintain (a) 3% to 5% of Tier 1 capital,
as defined, to average assets ("leverage ratio"), (b) 4% of Tier 1 capital, as
defined, to risk-weighted assets ("Tier 1 risk-weighted capital ratio") and
(c) 8% of total capital, as defined, to risk-weighted assets ("total risk-
weighted capital ratio"). At August 31, 2000, the leverage ratio, Tier 1 risk-
weighted capital ratio and total risk-weighted capital ratio of each of the
Company's FDIC-insured financial institutions exceeded these regulatory
minimums.
Certain other U.S. and non-U.S. subsidiaries are subject to various
securities, commodities and banking regulations, and capital adequacy
requirements promulgated by the regulatory and exchange authorities of the
countries in which they operate. These subsidiaries have consistently operated
in excess of their local capital adequacy requirements.
In an effort to enhance its ongoing stock repurchase program, the Company
may sell put options on shares of its common stock to third parties. These put
options entitle the holder to sell shares of the Company's common stock to the
Company on certain dates at specified prices. As of August 31, 2000, put
options were outstanding on an aggregate of 2.0 million shares of the
Company's common stock. These put options have various expiration dates that
range from September 2000 through November 2000. The Company may elect cash
settlement of the put options instead of purchasing the stock.
9
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Earnings per Share
Basic EPS reflects no dilution from common stock equivalents. Diluted EPS
reflects dilution from common stock equivalents and other dilutive securities
based on the average price per share of the Company's common stock during the
period. The following table presents the calculation of basic and diluted EPS
(in millions, except for per share data):
Nine Months
Three Months Ended August
Ended August 31, 31,
------------------ --------------
2000 1999 2000 1999
-------- -------- ------ ------
Basic EPS:
Net income............................... $ 1,246 $ 970 $4,248 $3,158
Preferred stock dividend requirements.... (9) (11) (27) (33)
-------- -------- ------ ------
Net income available to common
shareholders............................ $ 1,237 $ 959 $4,221 $3,125
======== ======== ====== ======
Weighted-average common shares
outstanding............................. 1,088 1,100 1,091 1,107
======== ======== ====== ======
Basic EPS................................ $ 1.14 $ 0.87 $ 3.87 $ 2.82
======== ======== ====== ======
Diluted EPS:
Net income............................... $ 1,246 $ 970 $4,248 $3,158
Preferred stock dividend requirements.... (9) (9) (27) (27)
-------- -------- ------ ------
Net income available to common
shareholders............................ $ 1,237 $ 961 $4,221 $3,131
======== ======== ====== ======
Weighted-average common shares
outstanding............................. 1,088 1,100 1,091 1,107
Effect of dilutive securities:
Stock options.......................... 49 38 48 39
ESOP convertible preferred stock....... -- 23 2 23
-------- -------- ------ ------
Weighted-average common shares
outstanding and common stock
equivalents............................. 1,137 1,161 1,141 1,169
======== ======== ====== ======
Diluted EPS.............................. $ 1.09 $ 0.83 $ 3.70 $ 2.68
======== ======== ====== ======
7. Commitments and Contingencies
In the normal course of business, the Company has been named as a defendant
in various lawsuits and has been involved in certain investigations and
proceedings. Some of these matters involve claims for substantial amounts.
Although the ultimate outcome of these matters cannot be ascertained at this
time, it is the opinion of management, after consultation with counsel, that
the resolution of such matters will not have a material adverse effect on the
consolidated financial condition of the Company, but may be material to the
Company's operating results for any particular period, depending upon the
level of the Company's net income for such period.
The Company had approximately $5.7 billion and $6.3 billion of letters of
credit outstanding at August 31, 2000 and at November 30, 1999, respectively,
to satisfy various collateral requirements.
8. Derivative Contracts
In the normal course of business, the Company enters into a variety of
derivative contracts related to financial instruments and commodities. The
Company uses swap agreements in managing its interest rate exposure. The
Company also uses forward and option contracts, futures and swaps in its
trading activities; these
10
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
derivative instruments also are used to hedge the U.S. dollar cost of certain
foreign currency exposures. In addition, financial futures and forward
contracts are actively traded by the Company and are used to hedge proprietary
inventory. The Company also enters into delayed delivery, when-issued, and
warrant and option contracts involving securities. These instruments generally
represent future commitments to swap interest payment streams, exchange
currencies or purchase or sell other financial instruments on specific terms
at specified future dates. Many of these products have maturities that do not
extend beyond one year, although swaps and options and warrants on equities
typically have longer maturities. For further discussion of these matters,
refer to "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Derivative Financial Instruments" and Note 9 to the
consolidated financial statements for the fiscal year ended November 30, 1999,
included in the Form 10-K.
These derivative instruments involve varying degrees of off-balance sheet
market risk. Future changes in interest rates, foreign currency exchange rates
or the fair values of the financial instruments, commodities or indices
underlying these contracts ultimately may result in cash settlements less than
or exceeding fair value amounts recognized in the condensed consolidated
statements of financial condition, which, as described in Note 1, are recorded
at fair value, representing the cost of replacing those instruments.
The Company's exposure to credit risk with respect to these derivative
instruments at any point in time is represented by the fair value of the
contracts reported as assets. These amounts are presented on a
net-by-counterparty basis (when appropriate), but are not reported net of
collateral, which the Company obtains with respect to certain of these
transactions to reduce its exposure to credit losses.
11
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The credit quality of the Company's trading-related derivatives at August
31, 2000 and November 30, 1999 is summarized in the tables below, showing the
fair value of the related assets by counterparty credit rating. The credit
ratings are determined by external rating agencies or by comparable ratings
used by the Company's Credit Department:
Collateralized Other
Non-Investment Non-Investment
AAA AA A BBB Grade Grade Total
------ ------ ------ ------ -------------- -------------- -------
(dollars in millions)
At August 31, 2000
Interest rate and
currency swaps and
options (including
caps, floors and swap
options) and other
fixed income securities
contracts.............. $2,357 $3,985 $2,836 $ 731 $ 229 $ 214 $10,352
Foreign exchange forward
contracts and options.. 264 1,051 1,084 125 -- 245 2,769
Equity securities
contracts (including
equity swaps, warrants
and options)........... 1,880 2,745 1,297 78 2,158 504 8,662
Commodity forwards,
options and swaps...... 284 1,366 1,008 1,895 191 1,031 5,775
Mortgage-backed
securities forward
contracts, swaps and
options................ 26 23 21 3 1 1 75
------ ------ ------ ------ ------ ------ -------
Total.................. $4,811 $9,170 $6,246 $2,832 $2,579 $1,995 $27,633
====== ====== ====== ====== ====== ====== =======
Percent of total ....... 18% 33% 23% 10% 9% 7% 100%
====== ====== ====== ====== ====== ====== =======
At November 30, 1999
Interest rate and
currency swaps and
options (including
caps, floors and swap
options) and other
fixed income securities
contracts.............. $1,569 $3,842 $2,896 $ 884 $ 117 $ 174 $ 9,482
Foreign exchange forward
contracts and options.. 556 1,551 1,285 170 -- 140 3,702
Equity securities
contracts (including
equity swaps, warrants
and options)........... 1,742 2,310 1,109 260 1,308 320 7,049
Commodity forwards,
options and swaps...... 164 571 660 469 52 508 2,424
Mortgage-backed
securities forward
contracts, swaps and
options................ 41 33 35 1 1 1 112
------ ------ ------ ------ ------ ------ -------
Total.................. $4,072 $8,307 $5,985 $1,784 $1,478 $1,143 $22,769
====== ====== ====== ====== ====== ====== =======
Percent of total........ 18% 37% 26% 8% 6% 5% 100%
====== ====== ====== ====== ====== ====== =======
A substantial portion of the Company's securities and commodities
transactions are collateralized and are executed with and on behalf of
commercial banks and other institutional investors, including other brokers
and dealers. Positions taken and commitments made by the Company, including
positions taken and underwriting and financing commitments made in connection
with its private equity and other principal investment activities, often
involve substantial amounts and significant exposure to individual issuers and
businesses, including non-investment grade issuers. The Company seeks to limit
concentration risk created in its businesses through a variety of separate but
complementary financial, position and credit exposure reporting systems,
including the use of trading limits based in part upon the Company's review of
the financial condition and credit ratings of its counterparties.
See also "Risk Management" included in the Company's Annual Report on Form
10-K for discussions of the Company's risk management policies and control
structure for its Securities businesses.
12
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Segment Information
The Company structures its segments primarily based upon the nature of the
financial products and services provided to customers and the Company's
management organization. The Company operates in three business segments:
Securities, Asset Management and Credit Services, through which it provides a
wide range of financial products and services to its customers. Revenues and
expenses directly associated with each respective segment are included in
determining their operating results. Other revenues and expenses that are not
directly attributable to a particular segment are allocated based upon the
Company's allocation methodologies, generally based on each segment's
respective revenues or other relevant measures. Selected financial information
for the Company's segments is presented in the tables below.
Three Months Ended August
31, 2000 Securities Asset Management Credit Services Total
- ------------------------- ---------- ---------------- --------------- ------
(dollars in millions)
All other net revenues..... $4,320 $623 $ 696 $5,639
Net interest............... 282 16 357 655
------ ---- ------ ------
Net revenues............... $4,602 $639 $1,053 $6,294
====== ==== ====== ======
Income before taxes........ $1,234 $329 $ 347 $1,910
Provision for income
taxes..................... 409 130 125 664
------ ---- ------ ------
Net income................. $ 825 $199 $ 222 $1,246
====== ==== ====== ======
Three Months Ended August
31, 1999 Securities Asset Management Credit Services Total
- ------------------------- ---------- ---------------- --------------- ------
(dollars in millions)
All other net revenues..... $3,485 $537 $ 592 $4,614
Net interest............... 364 8 343 715
------ ---- ------ ------
Net revenues............... $3,849 $545 $ 935 $5,329
====== ==== ====== ======
Income before taxes........ $1,021 $209 $ 333 $1,563
Provision for income
taxes..................... 376 86 131 593
------ ---- ------ ------
Net income................. $ 645 $123 $ 202 $ 970
====== ==== ====== ======
Nine Months Ended August
31, 2000 Securities Asset Management Credit Services Total
- ------------------------ ---------- ---------------- --------------- -------
(dollars in millions)
All other net revenues.... $14,980 $1,823 $1,795 $18,598
Net interest.............. 994 45 1,136 2,175
------- ------ ------ -------
Net revenues.............. $15,974 $1,868 $2,931 $20,773
======= ====== ====== =======
Income before taxes....... $ 4,853 $ 860 $ 924 $ 6,637
Provision for income
taxes.................... 1,694 347 348 2,389
------- ------ ------ -------
Net income................ $ 3,159 $ 513 $ 576 $ 4,248
======= ====== ====== =======
13
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Nine Months Ended August
31, 1999 Securities Asset Management Credit Services Total
- ------------------------ ---------- ---------------- --------------- --------
(dollars in millions)
All other net revenues... $ 11,497 $1,530 $ 1,557 $ 14,584
Net interest............. 690 37 1,002 1,729
-------- ------ ------- --------
Net revenues............. $ 12,187 $1,567 $ 2,559 $ 16,313
======== ====== ======= ========
Income before taxes...... $ 3,660 $ 574 $ 859 $ 5,093
Provision for income
taxes................... 1,374 239 322 1,935
-------- ------ ------- --------
Net income............... $ 2,286 $ 335 $ 537 $ 3,158
======== ====== ======= ========
Total Assets(1) Securities Asset Management Credit Services Total
- --------------- ---------- ---------------- --------------- --------
(dollars in millions)
August 31, 2000.......... $374,307 $5,264 $24,552 $404,123
======== ====== ======= ========
November 30, 1999........ $336,890 $4,927 $25,150 $366,967
======== ====== ======= ========
- --------
(1) Corporate assets have been fully allocated to the Company's business
segments.
10. Business Acquisition and Disposition
During the second quarter of fiscal 2000, the Company completed its
acquisition of Ansett Worldwide Aviation Services ("Ansett Worldwide"). Ansett
Worldwide is one of the world's leading aircraft leasing groups, supplying new
and used commercial jet aircraft to airlines around the world. The Company's
fiscal 2000 results include the operations of Ansett Worldwide since April 27,
2000, the date of acquisition.
In the fourth quarter of fiscal 1998, the Company completed the sale of its
Global Custody business to The Chase Manhattan Corporation ("Chase"). At that
time, the Company recorded a pre-tax gain of $323 million from the sale. Such
gain included estimates for certain payments and purchase price adjustments
which, under certain circumstances pursuant to the sales agreement, were
payable by the Company to Chase. As a result of the resolution of these
payments and purchase price adjustments during the quarter ended August 31,
2000, the Company recorded an additional pre-tax gain of $35 million related
to the sale of its Global Custody business.
14
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Shareholders of Morgan Stanley Dean Witter & Co.
We have reviewed the accompanying condensed consolidated statement of
financial condition of Morgan Stanley Dean Witter & Co. and subsidiaries as of
August 31, 2000, and the related condensed consolidated statements of income
and of comprehensive income for the three and nine month periods ended August
31, 2000 and 1999, and the condensed consolidated statements of cash flows for
the nine month periods ended August 31, 2000 and 1999. These condensed
consolidated financial statements are the responsibility of the management of
Morgan Stanley Dean Witter & Co.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data and of making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with auditing standards generally accepted in the
United States of America, the objective of which is the expression of an
opinion regarding the financial statements taken as a whole. Accordingly, we
do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to such condensed consolidated financial statements for them to
be in conformity with accounting principles generally accepted in the United
States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated statement of
financial condition of Morgan Stanley Dean Witter & Co. and subsidiaries as of
November 30, 1999, and the related consolidated statements of income,
comprehensive income, cash flows and changes in shareholders' equity for the
fiscal year then ended (not presented herein) included in Morgan Stanley Dean
Witter & Co.'s Annual Report on Form 10-K for the fiscal year ended November
30, 1999; and, in our report dated January 21, 2000, we expressed an
unqualified opinion on those consolidated financial statements (which report
includes an explanatory paragraph for a change in the method of accounting for
certain offering costs of closed-end funds). In our opinion, the information
set forth in the accompanying condensed consolidated statement of financial
condition as of November 30, 1999 is fairly stated, in all material respects,
in relation to the consolidated statement of financial condition from which it
has been derived.
/s/ Deloitte & Touche LLP
New York, New York
October 9, 2000
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Introduction
Morgan Stanley Dean Witter & Co. (the "Company") is a global financial
services firm that maintains leading market positions in each of its three
business segments--Securities, Asset Management and Credit Services. The
Company combines global strength in investment banking and institutional sales
and trading with strength in providing full-service and online brokerage
services, investment and global asset management services and, primarily
through its Discover(R) Card brand, quality consumer credit products. The
Company provides its products and services to a large and diversified group of
clients and customers, including corporations, governments, financial
institutions and individuals.
Results of Operations*
Certain Factors Affecting Results of Operations
The Company's results of operations may be materially affected by market
fluctuations and by economic factors. In addition, results of operations in
the past have been, and in the future may continue to be, materially affected
by many factors of a global nature, including economic and market conditions;
the availability and cost of capital; the level and volatility of equity
prices and interest rates; currency values and other market indices;
technological changes and events (such as the increased use of the Internet to
conduct electronic commerce and the emergence of electronic communication
trading networks); the availability and cost of credit; inflation; investor
sentiment; and legislative, legal and regulatory developments. Such factors
also may have an impact on the Company's ability to achieve its strategic
objectives on a global basis, including (without limitation) continued
increased market share in its securities activities, growth in assets under
management and expansion of its Credit Services business.
The results of the Company's Securities business, particularly its
involvement in primary and secondary markets for all types of financial
products, including derivatives, is subject to substantial positive and
negative fluctuations due to a variety of factors that cannot be predicted
with great certainty, including variations in the fair value of securities and
other financial products and the volatility and liquidity of global trading
markets. Fluctuations also occur due to the level of global market activity,
which, among other things, affects the size, number and timing of investment
banking client assignments and transactions and the realization of returns
from the Company's private equity and other principal investments. The level
of global market activity also could impact the flow of investment capital
into mutual funds and the way in which such capital is allocated among money
market, equity, fixed income or other investment alternatives, which could
impact the results of the Company's Asset Management business. In the
Company's Credit Services business, changes in economic variables, such as the
number and size of personal bankruptcy filings, the rate of unemployment and
the level of consumer debt, may substantially affect consumer loan levels and
credit quality, which, in turn, could impact overall Credit Services results.
The Company's results of operations also may be materially affected by
competitive factors. Among the principal competitive factors affecting the
Securities business are the Company's reputation, the quality of its
professionals and other personnel, its products and services, relative pricing
and innovation. Competition in the Company's Asset Management business is
affected by a number of factors, including investment objectives and
performance; advertising and sales promotion efforts; and the level of fees,
distribution channels and types and quality of services offered. In the Credit
Services business, competition centers on merchant acceptance of credit cards,
credit card acquisition and customer utilization of credit cards, all of which
are impacted by the type of fees, interest rates and other features offered.
- --------
* This Management's Discussion and Analysis of Financial Condition and Results
of Operations contains forward-looking statements as well as a discussion of
some of the risks and uncertainties involved in the Company's business that
could affect the matters referred to in such statements.
16
In addition to competition from firms traditionally engaged in the financial
services business, competition has increased in recent years from other
sources, such as commercial banks, insurance companies, online service
providers, sponsors of mutual funds and other companies offering financial
services both in the U.S. and globally. The financial services industry has
continued to experience consolidation and convergence, as financial
institutions involved in a broad range of financial services industries have
merged. This convergence trend is expected to continue and could result in the
Company's competitors gaining greater capital and other resources, such as a
broader range of products and services and geographic diversity. In November
1999, the Gramm-Leach-Bliley Act was passed in the U.S., effectively repealing
certain sections of the 1933 Glass-Steagall Act. Its passage allows commercial
banks, securities firms and insurance firms to affiliate, which may accelerate
consolidation and lead to increasing competition in markets which
traditionally have been dominated by investment banks and retail securities
firms.
The Company also has experienced increased competition for qualified
employees in recent years, including from companies engaged in Internet-
related businesses and private equity funds, in addition to the traditional
competition for employees from the financial services, insurance and
management consulting industries. The Company's ability to sustain or improve
its competitive position will substantially depend on its ability to continue
to attract and retain qualified employees.
For a detailed discussion of the competitive factors in the Company's
Securities, Asset Management and Credit Services businesses, see the Company's
Annual Report on Form 10-K for the fiscal year ended November 30, 1999.
As a result of the above economic and competitive factors, net income and
revenues in any particular period may not be representative of full-year
results and may vary significantly from year to year and from quarter to
quarter. The Company intends to manage its business for the long term and to
mitigate the potential effects of market downturns by strengthening its
competitive position in the global financial services industry through
diversification of its revenue sources and enhancement of its global
franchise. The Company's overall financial results will continue to be
affected by its ability and success in maintaining high levels of profitable
business activities, emphasizing fee-based assets that are designed to
generate a continuing stream of revenues, evaluating credit product pricing,
managing risks in the Securities, Asset Management and Credit Services
businesses, and monitoring costs. In addition, the complementary trends in the
financial services industry of consolidation and globalization present, among
other things, technological, risk management and other infrastructure
challenges that will require effective resource allocation in order for the
Company to remain competitive.
The Company believes that technological advancements in the Internet and the
growth of electronic commerce will continue to present both challenges and
opportunities to the Company and could lead to significant changes and
innovations in financial markets and the financial services industry as a
whole. The Company's initiatives in this area have included Web-enabling
existing businesses, enhancing client communication and services and access to
information and making investments, or otherwise participating, in alternative
trading systems, electronic communication networks and related businesses or
technologies. The Company expects to continue to augment these initiatives in
the future.
Global Market and Economic Conditions in the Quarter Ended August 31, 2000
Global market and economic conditions in the quarter ended August 31, 2000
were characterized by continued uncertainty regarding inflation and interest
rates, particularly in the U.S. and Europe. In addition, lower levels of
volatility and trading volumes as compared to the second quarter of fiscal
2000 affected the equity markets.
In the U.S., despite rising energy costs, the economy continued to exhibit
strong productivity gains with low levels of inflation. In addition, favorable
economic trends, such as historically low levels of unemployment, high levels
of consumer spending, and a high demand for imports, continued to persist.
However, several leading
17
economic indicators signaled a potential slowing of the economy, which
contributed to the Federal Reserve Board's (the "Fed") decision to leave
interest rates unchanged during the quarter ended August 31, 2000. During the
first half of fiscal 2000, inflationary concerns had prompted the Fed to
increase the overnight lending rate on two occasions by an aggregate of 0.75%.
The Fed has raised the overnight lending rate six times since June 1999
aggregating 1.75%.
In Europe, the euro fell to a record low against the U.S. dollar during the
quarter, as the growth rate of the U.S. economy continued to outpace the
growth rate in the European Union ("EU"). The region's economic performance,
coupled with the sharp rise in global energy and commodity prices and the
continued weakness of the euro, gave rise to fears of increasing inflationary
pressures within the EU and the UK. In an effort to mitigate such conditions,
during the third quarter of fiscal 2000 the European Central Bank raised
interest rates by 0.50% in June 2000 and by an additional 0.25% in August
2000. The Bank of England decided to leave interest rates unchanged.
Economic activity in the Far East region continued to recover from a period
of prolonged weakness. In Japan, there have been indications that the steps
taken by the nation's government to stimulate economic activity, such as bank
bailouts, emergency loans, stimulus packages and tax cuts for both individuals
and corporations, were beginning to have a favorable impact. As a result,
during the month of August 2000, the Bank of Japan raised interest rates by
0.25% amid indications of growing business confidence and industrial
production. However, Japan's budget deficit continues to grow and there have
been concerns that rising energy prices and the relative strength of the yen
could adversely effect economic growth in the future.
Results of the Company for the Quarter and Nine Month Period ended August 31,
2000
The Company's net income in the quarter and nine month period ended August
31, 2000 was $1,246 million and $4,248 million, an increase of 28% and 35%
from the comparable periods of fiscal 1999. Diluted earnings per common share
were $1.09 and $3.70 in the quarter and nine month period ended August 31,
2000, as compared to $0.83 and $2.68 in the comparable periods of fiscal 1999.
The Company's annualized return on common equity for the quarter and nine
month period ended August 31, 2000 were 27.6% and 32.2%, as compared to 25.9%
and 28.9% in the comparable periods of fiscal 1999.
The increase in net income in the quarter ended August 31, 2000 was
primarily attributable to the Company's Securities business, reflecting higher
principal trading revenues, commission revenues and asset management,
distribution and administration fees, partially offset by a decline in
investment banking and principal investment revenues. The increase in net
income for the nine month period ended August 31, 2000 was also primarily
attributable to the Company's Securities business, reflecting higher
investment banking, principal trading and commission revenues, partially
offset by lower principal investment revenues. Improved results from the
Company's Asset Management business also contributed to the increases in both
periods. The Company's net income for the quarter and nine month period ended
August 31, 2000 also included higher levels of incentive-based compensation
and other non-interest expenses.
Business Acquisition and Disposition
During the second quarter of fiscal 2000, the Company completed its
acquisition of Ansett Worldwide Aviation Services ("Ansett Worldwide"). Ansett
Worldwide is one of the world's leading aircraft leasing groups, supplying new
and used commercial jet aircraft to airlines around the world. The Company's
fiscal 2000 results include the operations of Ansett Worldwide since April 27,
2000, the date of acquisition.
In the fourth quarter of fiscal 1998, the Company completed the sale of its
Global Custody business to The Chase Manhattan Corporation ("Chase"). At that
time, the Company recorded a pre-tax gain of $323 million from the sale. Such
gain included estimates for certain payments and purchase price adjustments
which, under certain circumstances pursuant to the sales agreement, were
payable by the Company to Chase. As a result of the resolution of these
payments and purchase price adjustments during the quarter ended August 31,
2000, the Company recorded an additional pre-tax gain of $35 million related
to the sale of its Global Custody business.
18
Business Segments
The remainder of Results of Operations is presented on a business segment
basis. Substantially all of the operating revenues and operating expenses of
the Company can be directly attributed to its three business segments:
Securities; Asset Management; and Credit Services. Certain revenues and
expenses have been allocated to each business segment, generally in proportion
to their respective revenues or other relevant measures. The accompanying
business segment information includes the operating results of Morgan Stanley
Dean Witter Online ("MSDW Online"), the Company's provider of electronic
brokerage services, within the Securities segment. Prior to the second quarter
of fiscal 1999, the Company had included MSDW Online's results within its
Credit Services segment. In addition, the following segment data reflects the
Company's fiscal 1999 adoption of Statement of Financial Accounting Standards
("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related
Information." Prior to the adoption of SFAS No. 131, the Company had presented
the results of its Securities and Asset Management segments on a combined
basis. The segment data of all periods presented have been restated to reflect
these changes. Certain reclassifications have been made to prior-period
amounts to conform to the current year's presentation.
19
Securities
Statements of Income (dollars in millions)
Three Months Nine Months
Ended August Ended August
31, 31,
------------- ---------------
2000 1999 2000 1999
------ ------ ------- -------
(unaudited) (unaudited)
Revenues:
Investment banking............................. $1,145 $1,187 $ 3,773 $ 3,115
Principal transactions:
Trading...................................... 1,630 1,143 6,408 4,692
Investments.................................. 55 79 236 485
Commissions.................................... 828 679 2,775 2,031
Asset management, distribution and
administration fees........................... 512 341 1,453 1,000
Interest and dividends......................... 5,206 3,341 13,563 9,400
Other.......................................... 150 56 335 174
------ ------ ------- -------
Total revenues............................... 9,526 6,826 28,543 20,897
Interest expense............................... 4,924 2,977 12,569 8,710
------ ------ ------- -------
Net revenues................................. 4,602 3,849 15,974 12,187
------ ------ ------- -------
Non-interest expenses:
Compensation and benefits...................... 2,305 2,005 8,136 6,225
Occupancy and equipment........................ 163 126 440 354
Brokerage, clearing and exchange fees.......... 109 98 321 279
Information processing and communications...... 245 180 703 536
Marketing and business development............. 176 124 517 374
Professional services.......................... 223 155 525 396
Other.......................................... 147 140 479 363
------ ------ ------- -------
Total non-interest expenses.................. 3,368 2,828 11,121 8,527
------ ------ ------- -------
Income before income taxes....................... 1,234 1,021 4,853 3,660
Provision for income taxes....................... 409 376 1,694 1,374
------ ------ ------- -------
Net income..................................... $ 825 $ 645 $ 3,159 $ 2,286
====== ====== ======= =======
Securities achieved net revenues of $4,602 million and $15,974 million in
the quarter and nine month period ended August 31, 2000, an increase of 20%
and 31% from the comparable periods of fiscal 1999. Securities net income for
the quarter and nine month period ended August 31, 2000 was $825 million and
$3,159 million, an increase of 28% and 38% from the comparable periods of
fiscal 1999. The increases in net revenues and net income in both periods were
primarily attributable to higher revenues from sales and trading and asset
management activities, partially offset by lower principal investment revenues
and higher levels of incentive-based compensation and other non-interest
expenses. Higher investment banking revenues also contributed to the increases
in net revenues and net income for the nine month period ended August 31,
2000.
Investment Banking
Investment banking revenues are derived from the underwriting of securities
offerings and fees from advisory services. Investment banking revenues in the
quarter ended August 31, 2000 decreased 4% from the comparable period of
fiscal 1999, reflecting lower revenues from fixed income underwriting
transactions, partially offset by higher revenues from equity underwriting
transactions.
Fixed income underwriting revenues in the quarter ended August 31, 2000 were
lower than those recorded during the quarter ended August 31, 1999. The volume
of fixed income underwriting transactions was adversely affected by a higher
interest rate environment in both the U.S. and Europe as compared to the prior
year, resulting
20
in higher borrowing costs. The market for global high-yield issues was
particularly slow during the quarter. However, fixed income underwriting
revenues continued to benefit from the need for strategic financing in light
of the robust global market for merger and acquisition transactions, and from
the ongoing development of the euro-denominated credit market.
Equity underwriting revenues increased in the quarter ended August 31, 2000
as compared to the prior year period, benefiting from a high volume of equity
offerings, particularly during the first half of the quarter. New issue volume
in the media and telecommunications sectors were particularly strong. The
Company's strong global market share also continued to have a favorable impact
on equity underwriting revenues.
Revenues from merger, acquisition and restructuring activities in the
quarter ended August 31, 2000 were comparable to the prior year period, as the
global market for such transactions continued to be robust, particularly in
the U.S. and Europe. The high level of transaction activity reflected the
continuing trends of convergence, consolidation and globalization, as
companies continued to expand into new markets and businesses in order to
increase earnings growth. Transaction activity was strong across many
industries, particularly in the media, technology, financial services, public
utility and consumer sectors. The Company's strong global market share in many
industry sectors also contributed to the high level of revenues from merger
and acquisition transactions.
Investment banking revenues in the nine month period ended August 31, 2000,
increased 21% from the comparable period of fiscal 1999. The increase was
primarily attributable to record levels of revenues from merger, acquisition
and restructuring activities and equity underwritings, reflecting continued
strong levels of transaction volumes. These increases were partially offset by
a decline in revenues from fixed income underwriting transactions.
Principal Transactions
Principal transaction trading revenues, which include revenues from customer
purchases and sales of securities, including derivatives, in which the Company
acts as principal and gains and losses on securities held for resale,
increased 43% in the quarter ended August 31, 2000 from the comparable period
of fiscal 1999. The increase reflected higher levels of equity and fixed
income trading revenues, partially offset by declines in commodities and
foreign exchange trading revenues.
Equity trading revenues increased during the quarter ended August 31, 2000
from the comparable period of fiscal 1999, reflecting higher trading revenues
from cash and derivative equity products. Higher revenues from trading in
equity cash products were primarily driven by significantly increased levels
of customer trading volumes in both listed and over-the-counter securities,
particularly in the U.S. and in Europe. Revenues from equity derivative
products benefited from increased customer flows and strong trading volumes.
Higher revenues from certain proprietary trading activities also contributed
to the increase in equity trading revenues.
Fixed income trading revenues increased in the quarter ended August 31, 2000
from the comparable period of fiscal 1999, primarily due to higher revenues
from trading derivative and government fixed income securities, partially
offset by a decline in revenues from global high-yield fixed income
securities. Trading revenues from derivative products benefited from strong
customer flows and increased liquidity in the swap markets. Trading revenues
from government and agency products were strong, particularly in Europe and
Japan, due to increased interest rate volatility in these regions. Trading
revenues from global high-yield fixed income securities decreased due to
lighter trading activity and decreased levels of market liquidity, as
investors remained concerned about rising interest rates and credit quality
throughout the quarter.
Commodity trading revenues decreased in the quarter ended August 31, 2000
from the comparable period of fiscal 1999, primarily driven by lower revenues
from trading energy related products, including natural gas. The quarter's
trading revenues from these products were affected by mixed economic factors
and market sentiment caused by volatile prices in the energy sector. The
volatility in prices was primarily a result of historically low inventory
levels, strong demand, and concerns regarding the adequacy of production
levels.
21
Foreign exchange trading revenues decreased in the quarter ended August 31,
2000 as compared to the prior year period. Trading volumes were negatively
affected by the exit of certain hedge funds from the foreign
exchange market and by reduced liquidity in the Japanese yen and euro markets.
During the quarter, volatility levels between the U.S. dollar and Japanese yen
decreased to a ten-year low, creating reduced market liquidity. The euro
continued to depreciate relative to the U.S. dollar and also reached an all-
time low during the quarter, reflecting the strong economic performance of the
U.S. economy.
Principal transaction investment gains aggregating $55 million were recorded
in the quarter ended August 31, 2000, as compared to gains of $79 million in
the quarter ended August 31, 1999. Both period's results reflect net gains
from certain of the Company's principal investments.
Principal transaction trading revenues increased 37% in the nine month
period ended August 31, 2000 from the comparable period of fiscal 1999,
primarily reflecting higher equity and commodity trading revenues, partially
offset by a decline in fixed income and foreign exchange trading revenues. The
increase in equity trading revenues reflected higher revenues from both cash
and derivative equity products, due to higher levels of customer trading
volumes and market volatility. Commodity trading revenues benefited from the
sharp rise in global energy prices in fiscal 2000. Fixed income trading
revenues decreased, reflecting a rising global interest rate environment and
lower revenues from global high yield fixed income securities. Foreign
exchange trading revenues decreased moderately due to industry-wide decreases
in market activity.
Principal transaction investment gains aggregating $236 million were
recognized in the nine month period ended August 31, 2000 as compared to $485
million in the nine month period ended August 31, 1999. Fiscal 2000's results
primarily reflect net gains from certain of the Company's private equity and
venture capital investments, including Commerce One, Inc. Fiscal 1999's
results primarily reflect gains relating to the Company's investments in
Equant N.V. and Knight/Trimark Group, Inc.
Commissions
Commission revenues primarily arise from agency transactions in listed and
over-the-counter equity securities, sales of mutual funds, futures, insurance
products and options. Commission revenues increased 22% in the quarter ended
August 31, 2000 from the comparable period of fiscal 1999. In the U.S.,
commission revenues benefited from significantly increased levels of customer
securities transactions, including listed agency and over-the-counter equity
products, as volumes on the New York Stock Exchange and the NASDAQ increased
significantly from the comparable prior year period. Revenues from markets in
Europe also benefited from higher trading volumes, including strong activity
levels in the technology sector. Commission revenues from securities markets
in Japan and the Far East region also increased, particularly in Hong Kong,
Korea and Taiwan. Commission revenues also benefited from higher sales of
mutual funds and the continued growth in the number of the Company's financial
advisors.
Commission revenues increased 37% in the nine month period ended August 31,
2000 from the comparable period of fiscal 1999. The increase primarily
reflected higher levels of customer trading activity in the global equity
markets, as trading volumes on the New York Stock Exchange and the NASDAQ
increased to record levels, and trading volumes increased on major European
exchanges.
In October 1999, the Company launched ichoiceSM, a new service and
technology platform available to individual investors. ichoice provides each
of the Company's individual investor clients with the choice of self-directed
investing online; a traditional full-service brokerage relationship through a
financial advisor; or some combination of both. ichoice provides a range of
pricing options, including fee-based pricing. In future periods, the amount of
revenues recorded within the "Commissions" and "Asset management, distribution
and administration fees" income statement categories will be affected by the
number of the Company's clients electing a fee-based pricing arrangement.
22
Net Interest
Interest and dividend revenues and expense are a function of the level and
mix of total assets and liabilities, including financial instruments owned,
reverse repurchase and repurchase agreements, trading strategies associated
with the Company's institutional securities business, customer margin loans,
and the prevailing level, term structure and volatility of interest rates.
Interest and dividend revenues and expense are integral components of trading
activity. In assessing the profitability of trading activities, the Company
views net interest and principal trading revenues in the aggregate. In
addition, decisions relating to principal transactions in securities are based
on an overall review of aggregate revenues and costs associated with each
transaction or series of transactions. This review includes an assessment of
the potential gain or loss associated with a trade and the interest income or
expense associated with financing or hedging the Company's positions. Net
interest revenues decreased 23% in the quarter and increased 44% in the nine
month period ended August 31, 2000 from the comparable periods of fiscal 1999,
partially reflecting the level and mix of interest bearing assets and
liabilities (including liabilities associated with the Company's aircraft
financing activities) during the respective periods, as well as certain
trading strategies utilized in the Company's institutional securities
business. The increase in the nine month period ended August 31, 2000 includes
higher net interest revenues from brokerage services provided to institutional
and individual customers, including an increase in the level of customer
margin loans.
Asset Management, Distribution and Administration Fees
Asset management, distribution and administration revenues include fees for
asset management services, including fees for promoting and distributing
mutual funds ("12b-1 fees") and fees for investment management services
provided to segregated customer accounts pursuant to various contractual
arrangements in connection with the Company's Investment Consulting Services
("ICS") business. The Company receives 12b-1 fees for services it provides in
promoting and distributing certain open-ended mutual funds. These fees are
based on either the average daily fund net asset balances or average daily
aggregate net fund sales and are affected by changes in the overall level and
mix of assets under management or supervision. Asset management, distribution
and administration fees also include revenues from individual investors
electing a fee-based pricing arrangement under the Company's ichoice service
and technology platform.
Asset management, distribution and administration revenues increased 50% and
45% in the quarter and nine month period ended August 31, 2000 from the
comparable periods of fiscal 1999. The increase reflects higher revenues from
individual investors electing fee-based pricing, 12b-1 fees from promoting and
distributing mutual funds to individual investors through the Company's
financial advisors and higher revenues from investment management services
associated with the ICS business.
Non-Interest Expenses
Total non-interest expenses increased 19% and 30% in the quarter and nine
month period ended August 31, 2000 from the comparable periods of fiscal 1999.
Within the non-interest expense category, compensation and benefits expense
increased 15% and 31% in the quarter and nine month period ended August 31,
2000 from the comparable periods of fiscal 1999, principally reflecting higher
incentive-based compensation due to higher levels of revenues and earnings, as
well as costs related to the Company's strategic initiative to continue to
increase the number of its financial advisors. Excluding compensation and
benefits expense, non-interest expense increased 29% and 30% in the quarter
and nine month period ended August 31, 2000 from the comparable periods of
fiscal 1999. Occupancy and equipment expense increased 29% and 24% in the
quarter and nine month period ended August 31, 2000 from the comparable
periods of fiscal 1999, primarily due to additional rent associated with new
U.S. branch locations, as well as increased office space in New York and
certain other locations. Brokerage, clearing and exchange fees increased 11%
and 15% in the quarter and nine month period ended August 31, 2000 from the
comparable periods of fiscal 1999, primarily reflecting higher brokerage
expenses due to increased global trading volume, particularly in North America
and Europe. Brokerage costs associated with the business activities of Morgan
Stanley Dean Witter, S.V., S.A. (formerly AB Asesores), which
23
the Company acquired in March 1999, also contributed to the increase for the
nine month period ended August 31, 2000. Information processing and
communications expense increased 36% and 31% in the quarter and nine month
period ended August 31, 2000 from the comparable periods of fiscal 1999,
primarily due to increased costs associated with the Company's information
processing infrastructure, including data processing, market data services,
and telecommunications. A higher number of employees utilizing communications
systems and certain data services also contributed to the increase. Marketing
and business development expense increased 42% and 38% in the quarter and nine
month period ended August 31, 2000 from the comparable periods of fiscal 1999,
primarily reflecting increased travel and entertainment costs associated with
the high levels of business activity in the global financial markets. Higher
advertising costs, including new advertising campaigns for both the
institutional and individual securities businesses, also contributed to the
increase. Professional services expense increased 44% and 33% in the quarter
and nine month period ended August 31, 2000 from the comparable periods of
fiscal 1999, primarily reflecting higher consulting costs associated with
certain strategic initiatives in the Company's securities business, including
e-commerce. The increase also reflected higher costs for employment fees and
temporary staffing due to the increased level of overall business activity.
Other expense increased 5% and 32% in the quarter and nine month period ended
August 31, 2000 from the comparable periods of fiscal 1999, reflecting the
impact of a higher level of business activity on various operating expenses.
The amortization of goodwill associated with the Company's acquisition of
Morgan Stanley Dean Witter, S.V., S.A. and certain costs associated with the
Company's aircraft leasing business also contributed to the increase.
24
Asset Management
Statements of Income (dollars in millions)
Three Months Nine Months
Ended August 31, Ended August 31,
----------------- -----------------
2000 1999 2000 1999
-------- -------- -------- --------
(unaudited) (unaudited)
Revenues:
Investment banking...................... $ 27 $ 20 $ 104 $ 70
Principal transactions:
Investments........................... 13 (1) 27 8
Commissions............................. 3 2 12 2
Asset management, distribution and
administration fees.................... 580 516 1,680 1,450
Interest and dividends.................. 18 12 50 46
-------- -------- -------- --------
Total revenues........................ 641 549 1,873 1,576
Interest expense........................ 2 4 5 9
-------- -------- -------- --------
Net revenues.......................... 639 545 1,868 1,567
-------- -------- -------- --------
Non-interest expenses:
Compensation and benefits............... 187 165 571 479
Occupancy and equipment................. 23 24 66 71
Brokerage, clearing and exchange fees... 23 30 62 90
Information processing and
communications......................... 19 22 56 64
Marketing and business development...... 38 31 112 97
Professional services................... 22 29 67 89
Other................................... 33 35 109 103
-------- -------- -------- --------
Total non-interest expenses........... 345 336 1,043 993
-------- -------- -------- --------
Gain on sale of business.................. 35 -- 35 --
-------- -------- -------- --------
Income before income taxes................ 329 209 860 574
Provision for income taxes................ 130 86 347 239
-------- -------- -------- --------
Net income............................ $ 199 $ 123 $ 513 $ 335
======== ======== ======== ========
Asset Management achieved record net revenues of $639 million and $1,868
million in the quarter and nine month period ended August 31, 2000, an
increase of 17% and 19% from the comparable periods of fiscal 1999. Asset
Management's net income for the quarter and nine month period ended August 31,
2000 was $199 million and $513 million, an increase of 62% and 53% from the
comparable periods of fiscal 1999. Net income for the fiscal 2000 periods
included a net gain of $21 million from the sale of the Company's Global
Custody business (see "Results of Operations--Business Acquisition and
Disposition"). The increases primarily reflect higher asset management,
distribution and administration fees resulting from the continued accumulation
and management of customer assets and a more favorable asset mix, partially
offset by higher incentive-based compensation expenses.
Investment Banking
Asset Management primarily generates investment banking revenues from the
underwriting of Unit Investment Trust products. Investment banking revenues
increased 35% and 49% in the quarter and nine month period ended August 31,
2000 from the comparable periods of fiscal 1999, primarily reflecting a higher
volume of Unit Investment Trust underwriting transactions. Unit Investment
Trust sales volumes rose to $2.9 billion and $13.5 billion in the quarter and
nine month period ended August 31, 2000, an increase of 14% and 50% from the
comparable periods of fiscal 1999.
25
Principal Transactions
Asset Management primarily generates principal transaction revenues from net
gains (losses) resulting from the Company's capital investments in certain of
its funds and other investments.
In both the quarter and nine month period ended August 31, 2000 and the
comparable periods of fiscal 1999, principal transaction investment revenues
primarily consisted of net gains (losses) from the Company's capital
investments in certain of its funds.
Commissions
Asset Management primarily generates commission revenues from dealer and
distribution concessions on sales of certain funds, as well as certain
allocated commission revenues.
Commission revenues increased in both the quarter and nine month period
ended August 31, 2000 from the comparable periods of fiscal 1999, primarily
reflecting higher levels of transaction volume and allocated commission
revenues.
Net Interest
Asset Management generates net interest revenues from certain investment
positions, as well as from certain allocated interest revenues and expenses.
Net interest revenues increased in both the quarter and nine month period
ended August 31, 2000 from the comparable periods of fiscal 1999, primarily
reflecting higher net revenues from certain investment positions and
allocations.
Asset Management, Distribution and Administration Fees
Asset management, distribution and administration fees primarily include
revenues from the management and administration of assets. These fees arise
from investment management services the Company provides to investment
vehicles (the "Funds") pursuant to various contractual arrangements.
Generally, the Company receives fees based upon the Fund's average net assets.
In the quarter and nine month period ended August 31, 2000, asset
management, distribution and administration fees increased 12% and 16% from
the comparable periods of fiscal 1999. The increases in revenues primarily
reflected higher fund management fees as well as other revenues resulting from
a higher level of assets under management or supervision. The increases also
reflected a more favorable asset mix, primarily due to a shift in asset mix to
a greater percentage of equity products, which typically generate higher
management fees.
Customer assets under management or supervision increased to $548 billion at
August 31, 2000 from $458 billion at August 31, 1999. The increase in assets
under management or supervision primarily reflected appreciation in the value
of customer portfolios as well as net inflows of new customer assets. Customer
assets under management or supervision included products offered primarily to
individual investors of $354 billion at August 31, 2000 and $278 billion at
August 31, 1999. Products offered primarily to institutional investors were
$194 billion at August 31, 2000 and $180 billion at August 31, 1999.
Non-Interest Expenses
Asset Management's non-interest expenses increased 3% and 5% in the quarter
and nine month period ended August 31, 2000 from the comparable periods of
fiscal 1999. Within the non-interest expense category, compensation and
benefits expense increased 13% and 19% in the quarter and nine month period
ended August 31, 2000 from the comparable periods of fiscal 1999, primarily
reflecting higher incentive-based
26
compensation costs due to Asset Management's higher level of net revenues.
Excluding compensation and benefits expense, non-interest expenses decreased
8% in both the quarter and nine month period ended August 31, 2000 from the
comparable periods of fiscal 1999. Occupancy and equipment expense decreased
4% and 7% in the quarter and nine month period ended August 31, 2000 from the
comparable periods of fiscal 1999, due to lower levels of depreciation expense
on certain data processing equipment. These decreases were partially offset by
higher occupancy costs at certain office locations. Brokerage, clearing and
exchange fees decreased 23% and 31% in the quarter and nine month period ended
August 31, 2000 from the comparable periods of fiscal 1999, primarily
attributable to lower sales of closed-end funds through the non-proprietary
distribution channel. Information processing and communications costs
decreased 14% and 13% in the quarter and nine month period ended August 31,
2000 from the comparable periods of fiscal 1999, primarily reflecting lower
data processing servicing costs and computer software costs. Marketing and
business development expense increased 23% and 15% in the quarter and nine
month period ended August 31, 2000 from the comparable periods of fiscal 1999,
primarily related to higher promotional and distribution costs for certain
mutual funds. Professional services expense decreased 24% and 25% in the
quarter and nine month period ended August 31, 2000 from the comparable
periods of fiscal 1999, reflecting the inclusion of consulting costs related
to the Company's preparations for the Year 2000 within fiscal 1999's results,
as well as lower legal costs. Other expenses decreased 6% in the quarter and
increased 6% in the nine month period ended August 31, 2000 from the
comparable periods of fiscal 1999. The decrease in the quarter ended August
31, 2000 was primarily due to lower relocation expenses incurred during the
fiscal 2000 period from the comparable period of fiscal 1999. The increase in
the nine month period ended August 31, 2000 was primarily associated with new
and increased business activity, including the Company's new strategic
business venture, Morgan Stanley Dean Witter Alternative Investment Partners
that was announced in March 2000.
27
Credit Services
Statements of Income (dollars in millions)
Three Months Nine Months
Ended August 31, Ended August 31,
---------------- ----------------
2000 1999 2000 1999
------ ---- ------ ------
(unaudited) (unaudited)
Fees:
Merchant and cardmember...................... $ 447 $392 $1,337 $1,090
Servicing.................................... 424 313 1,060 876
------ ---- ------ ------
Total non-interest revenues................ 871 705 2,397 1,966
------ ---- ------ ------
Interest revenue............................... 673 546 2,156 1,624
Interest expense............................... 316 203 1,020 622
------ ---- ------ ------
Net interest income.......................... 357 343 1,136 1,002
Provision for consumer loan losses............. 175 113 602 409
------ ---- ------ ------
Net credit income............................ 182 230 534 593
------ ---- ------ ------
Net revenues................................. 1,053 935 2,931 2,559
------ ---- ------ ------
Non-interest expenses:
Compensation and benefits.................... 164 132 454 374
Occupancy and equipment...................... 16 16 45 40
Information processing and communications.... 128 123 360 349
Marketing and business development........... 293 253 851 713
Professional services........................ 30 30 83 82
Other........................................ 75 48 214 142
------ ---- ------ ------
Total non-interest expenses................ 706 602 2,007 1,700
------ ---- ------ ------
Income before income taxes..................... 347 333 924 859
Provision for income taxes..................... 125 131 348 322
------ ---- ------ ------
Net income................................. $ 222 $202 $ 576 $ 537
====== ==== ====== ======
Credit Services achieved net income of $222 million and $576 million in the
quarter and nine month period ended August 31, 2000, an increase of 10% and 7%
from the comparable periods of fiscal 1999. The increases in net income for
both periods were due to record operating results attributable to increased
merchant and cardmember fees, servicing fees and net interest income,
partially offset by a higher provision for loan losses and non-interest
expenses. Credit Services' results for the quarter and nine month period ended
August 31, 2000 also reflected higher levels of transaction volume from the
comparable periods of fiscal 1999, as well as a record level of period-end
managed consumer loans.
Non-Interest Revenues
Total non-interest revenues increased 24% and 22% in the quarter and nine
month period ended August 31, 2000 from the comparable periods of fiscal 1999.
Merchant and cardmember fees include revenues from fees charged to merchants
on credit card sales, late payment fees, overlimit fees, insurance fees and
cash advance fees. Merchant and cardmember fees increased 14% and 23% in the
quarter and nine month period ended August 31, 2000 from the comparable
periods of fiscal 1999. The increase in both periods was primarily due to
higher merchant discount revenue associated with the use of the Discover Card.
The increase in the nine month period ended August 31, 2000 also reflected
higher late payment fees associated with the use of the Discover Card. The
increases in Discover Card merchant discount revenues in both periods were
primarily due to a higher level of sales volume, coupled with an increase in
the average merchant discount rate. Late payment fees increased in the nine
month period ended August 31, 2000 over the comparable period of fiscal 1999
primarily due to a fee increase introduced during April 1999,
28
coupled with an increase in the number of late fee occurrences, reflecting
higher levels of transaction volume and consumer loans.
Servicing fees are revenues derived from consumer loans which have been sold
to investors through asset securitizations. Cash flows from the interest yield
and cardmember fees generated by securitized loans are used to pay investors
in these loans a predetermined fixed or floating rate of return on their
investment, to reimburse investors for losses of principal resulting from
charged-off loans and to pay the Company a fee for servicing the loans. Any
excess cash flows remaining are paid to the Company. The servicing fees and
excess net cash flows paid to the Company are reported as servicing fees in
the condensed consolidated statements of income. The sale of consumer loans
through asset securitizations, therefore, has the effect of converting
portions of net credit income and fee income to servicing fees. The Company
completed asset securitizations of $4.4 billion and $8.7 billion in the
quarter and nine month period ended August 31, 2000. During the comparable
periods of fiscal 1999, the Company completed asset securitizations of $0.5
billion and $3.0 billion. The asset securitization transactions completed in
the third quarter of fiscal 2000 have an expected maturity of approximately 5
to 7 years from the date of issuance.
The table below presents the components of servicing fees (dollars in
millions):
Three Months Nine Months
Ended August 31, Ended August 31,
------------------ ----------------
2000 1999 2000 1999
-------- -------- ------- ------
Merchant and cardmember fees............... $ 187 $ 149 $ 473 $ 418
Interest revenue........................... 944 705 2,459 2,028
Interest expense........................... (412) (264) (1,042) (744)
Provision for consumer loan losses......... (295) (277) (830) (826)
-------- -------- ------- ------
Servicing fees............................. $ 424 $ 313 $ 1,060 $ 876
======== ======== ======= ======
Servicing fees increased 35% and 21% in the quarter and nine month period
ended August 31, 2000 from the comparable periods of fiscal 1999. The
increases in both periods were due to higher levels of net interest cash flows
and increased merchant and cardmember fee revenue, partially offset by higher
credit losses associated with a higher level of average securitized consumer
loans. The increases in net interest and merchant and cardmember fee revenue
were primarily due to higher levels of average securitized consumer loans. The
increase in the provision for consumer loan losses was due to an increase in
the level of average securitized consumer loans, partially offset by a
decrease in credit losses resulting from a lower net charge-off rate related
to the securitized portfolio.
Net Interest Income
Net interest income represents the difference between interest revenue
derived from Credit Services consumer loans and short-term investment assets
and interest expense incurred to finance those assets. Credit Services assets,
consisting primarily of consumer loans, earn interest revenue at both fixed
rates and market-indexed variable rates. The Company incurs interest expense
at fixed and floating rates. Interest expense also includes the effects of
interest rate contracts entered into by the Company as part of its interest
rate risk management program. This program is designed to reduce the
volatility of earnings resulting from changes in interest rates and is
accomplished primarily through matched financing, which entails matching the
repricing schedules of consumer loans and related financing. Net interest
income increased 4% and 13% in the quarter and nine month period ended August
31, 2000 from the comparable periods of fiscal 1999. In both periods, the
increase was primarily due to higher average levels of consumer loans,
partially offset by a lower yield on these loans and increased financing costs
incurred by the Company. The increase in average consumer loans was due to
higher levels of sales and balance transfer volume. The lower yield on
Discover Card loans was primarily due to lower interest rates offered to new
cardmembers and certain existing cardmembers, partially offset by the
Company's repricing of certain credit card receivables discussed below. The
lower yield also reflected an increase in consumer loans from balance
transfers, which are generally offered at lower interest rates for an
introductory period. The increase in interest expense was due to a higher
level of interest bearing liabilities coupled with an increase in the
Company's average cost of borrowings, reflecting interest rate increases made
by the Fed in fiscal 1999 and the first half of fiscal 2000.
29
In response to the rising interest rate environment in the U.S., the Company
repriced a substantial portion of its existing credit card receivables to a
market-indexed variable interest rate during the second and third quarters of
fiscal 2000. The Company believes that its repricing actions will continue to
have a positive impact on net interest income.
The following tables present analyses of Credit Services average balance
sheets and interest rates for the quarters and nine month periods ended August
31, 2000 and 1999 and changes in net interest income during those periods:
Average Balance Sheet Analysis (dollars in millions)
Three Months Ended August 31,
-------------------------------------------------
2000 1999(3)
------------------------ ------------------------
Average Average
Balance Rate Interest Balance Rate Interest
------- ----- -------- ------- ----- --------
ASSETS
Interest earning assets:
General purpose credit card
and other consumer loans... $20,091 12.30% $621 $15,311 13.37% $516
Investment securities....... 560 6.65 10 551 5.04 7
Other....................... 2,430 6.91 42 1,607 5.78 23
------- ---- ------- ----
Total interest earning
assets................. 23,081 11.60 673 17,469 12.40 546
Allowance for loan losses... (779) (771)
Non-interest earning
assets..................... 1,598 1,720
------- -------
Total assets............ $23,900 $18,418
======= =======
LIABILITIES AND
SHAREHOLDER'S EQUITY
Interest bearing
liabilities:
Interest bearing deposits
Savings................... $ 1,470 5.97% $ 22 $ 1,447 4.42% $ 16
Brokered.................. 7,886 6.68 132 5,607 6.21 88
Other time................ 3,046 6.24 48 1,848 5.77 27
------- ---- ------- ----
Total interest bearing
deposits............... 12,402 6.49 202 8,902 5.83 131
Other borrowings............ 6,602 6.86 114 5,235 5.50 72
------- ---- ------- ----
Total interest bearing
liabilities............ 19,004 6.62 316 14,137 5.71 203
Shareholder's equity/other
liabilities................ 4,896 4,281
------- -------
Total liabilities and
shareholder's equity... $23,900 $18,418
======= =======
Net interest income......... $357 $343
==== ====
Net interest margin(1)...... 6.15% 7.79%
Interest rate spread(2)..... 4.98% 6.69%
- --------
(1) Net interest margin represents net interest income annualized as a
percentage of total interest earning assets.
(2) Interest rate spread represents the difference between the rate on total
interest earning assets and the rate on total interest bearing
liabilities.
(3) Certain prior-year information has been reclassified to conform to the
current year's presentation.
30
Average Balance Sheet Analysis (dollars in millions)
Nine Months Ended August 31,
-------------------------------------------------
2000 1999(3)
------------------------ ------------------------
Average Average
Balance Rate Interest Balance Rate Interest
------- ----- -------- ------- ----- --------
ASSETS
Interest earning assets:
General purpose credit card
and other
consumer loans.............. $22,244 12.12% $2,025 $15,458 13.18% $1,530
Investment securities........ 605 6.29 29 712 5.09 27
Other........................ 2,041 6.69 102 1,622 5.50 67
------- ------ ------- ------
Total interest earning
assets.................. 24,890 11.53 2,156 17,792 12.16 1,624
Allowance for loan losses.... (776) (775)
Non-interest earning assets.. 1,603 1,676
------- -------
Total assets............. $25,717 $18,693
======= =======
LIABILITIES AND SHAREHOLDER'S
EQUITY
Interest bearing liabilities:
Interest bearing deposits
Savings.................... $ 1,510 5.48% $ 62 $ 1,456 4.38% $ 48
Brokered................... 7,594 6.58 375 5,238 6.37 250
Other time................. 3,036 6.13 140 1,949 5.54 81
------- ------ ------- ------
Total interest bearing
deposits................ 12,140 6.33 577 8,643 5.85 379
Other borrowings............. 8,991 6.55 443 5,853 5.52 243
------- ------ ------- ------
Total interest bearing
liabilities............. 21,131 6.42 1,020 14,496 5.72 622
Shareholder's equity/other
liabilities................. 4,586 4,197
------- -------
Total liabilities and
shareholder's equity.... $25,717 $18,693
======= =======
Net interest income.......... $1,136 $1,002
====== ======
Net interest margin(1)....... 6.08% 7.50%
Interest rate spread(2)...... 5.11% 6.44%
- --------
(1) Net interest margin represents net interest income annualized as a
percentage of total interest earning assets.
(2) Interest rate spread represents the difference between the rate on total
interest earning assets and the rate on total interest bearing
liabilities.
(3) Certain prior-year information has been reclassified to conform to the
current year's presentation.
31
Rate/Volume Analysis (dollars in millions)
Nine Months Ended
Three Months Ended August 31, 2000 vs.
August 31, 2000 vs. 1999 1999
---------------------------- ------------------------
Increase/(Decrease) Increase/(Decrease)
Due to Changes in Due to Changes in
---------------------------- ------------------------
Volume Rate Total Volume Rate Total
--------- -------- -------- ------- ------- ------
INTEREST REVENUE
General purpose credit
card and other consumer
loans.................. $ 160 $ (55) $ 105 $ 672 $ (177) $ 495
Investment securities... -- 3 3 (4) 6 2
Other................... 12 7 19 17 18 35
-------- ------
Total interest
revenue............ 176 (49) 127 650 (118) 532
-------- ------
INTEREST EXPENSE
Interest bearing
deposits...............
Savings............... -- 6 6 2 12 14
Brokered.............. 41 (10) 31 119 (8) 111
Other time............ 17 4 21 45 14 59
-------- ------
Total interest
bearing deposits... 57 1 58 159 25 184
Other borrowings........ 15 40 55 123 91 214
-------- ------
Total interest
expense............ 70 43 113 286 112 398
-------- ------
Net interest income..... $ 106 $ (92) $ 14 $ 364 $ (230) $ 134
======== ======== ======== ====== ======= ======
The supplemental table below provides average managed loan balance and rate
information which takes into account both owned and securitized loans:
Supplemental Average Managed Loan Balance Sheet Information (dollars in
millions)
Three Months Ended August 31,
---------------------------------------------------------
2000 1999
---------------------------- ---------------------------
Avg. Bal. Rate % Interest Avg. Bal Rate % Interest
--------- ------ -------- -------- ------ --------
General purpose credit
card and other consumer
loans.................. $44,345 14.05% $1,566 $33,379 14.30% $1,204
Total interest earning
assets................. 47,335 13.59 1,618 35,537 13.78 1,250
Total interest bearing
liabilities............ 43,258 6.70 728 32,205 5.69 466
Consumer loan interest
rate spread............ 7.35 8.61
Interest rate spread.... 6.89 8.09
Net interest margin..... 7.47 8.62
Nine Months Ended August 31,
---------------------------------------------------------
2000 1999
---------------------------- ---------------------------
Avg. Bal. Rate % Interest Avg. Bal Rate % Interest
--------- ------ -------- -------- ------ --------
General purpose credit
card and other consumer
loans.................. $42,783 13.70% $4,406 $32,845 14.25% $3,515
Total interest earning
assets................. 45,428 13.29 4,616 35,179 13.67 3,652
Total interest bearing
liabilities............ 41,670 6.47 2,062 31,883 5.64 1,366
Consumer loan interest
rate spread............ 7.23 8.61
Interest rate spread.... 6.82 8.03
Net interest margin..... 7.35 8.55
32
Provision for Consumer Loan Losses
The provision for consumer loan losses is the amount necessary to establish
the allowance for loan losses at a level the Company believes is adequate to
absorb estimated losses in its consumer loan portfolio at the balance sheet
date. The Company's allowance for loan losses is regularly evaluated by
management for adequacy and was $776 million at August 31, 2000. At November
30, 1999, the Company's allowance for loan losses was $769 million.
The provision for consumer loan losses, which is affected by net charge-
offs, loan volume and changes in the amount of consumer loans estimated to be
uncollectable, increased 55% and 47% in the quarter and nine month period
ended August 31, 2000 from the comparable periods of fiscal 1999. The
increases were primarily due to higher levels of average consumer loans in the
Discover Card portfolio, partially offset by a lower net charge-off rate. In
addition, the provision for consumer loan losses in fiscal 1999 benefited from
a decline in the loan loss allowance in connection with securitization
transactions entered into prior to the third quarter of 1996. This loan loss
allowance was fully amortized by the end of fiscal 1999.
The Company's future charge-off rates and credit quality are subject to
uncertainties that could cause actual results to differ materially from what
has been discussed above. Factors that influence the provision for consumer
loan losses include the level and direction of consumer loan delinquencies and
charge-offs, changes in consumer spending and payment behaviors, bankruptcy
trends, the seasoning of the Company's loan portfolio, interest rate movements
and their impact on consumer behavior, and the rate and magnitude of changes
in the Company's consumer loan portfolio, including the overall mix of
accounts, products and loan balances within the portfolio.
Consumer loans are considered delinquent when interest or principal payments
become 30 days past due. Consumer loans are charged-off on the last day of the
month in which they become 180 days delinquent, except in the case of
bankruptcies and fraudulent transactions, where loans are charged-off earlier.
Loan delinquencies and charge-offs are primarily affected by changes in
economic conditions and may vary throughout the year due to seasonal consumer
spending and payment behaviors.
The following table presents delinquency and net charge-off rates with
supplemental managed loan information:
Asset Quality (dollars in millions)
August 31, November 30,
---------------------------------- ----------------
2000 1999 1999
---------------- ---------------- ----------------
Owned Managed Owned Managed Owned Managed
------- ------- ------- ------- ------- -------
Consumer loans at
period-end............. $19,817 $44,841 $16,557 $34,381 $20,998 $37,975
Consumer loans
contractually past due
as a percentage of
period-end consumer
loans:
30 to 89 days......... 2.80% 3.26% 3.62% 4.04% 3.35% 3.79%
90 to 179 days........ 1.91% 2.21% 2.04% 2.30% 2.20% 2.53%
Net charge-offs as a
percentage of average
consumer loans (year-
to-date)............... 3.54% 4.34% 5.12% 5.70% 4.78% 5.42%
Non-Interest Expenses
Non-interest expenses increased 17% and 18% in the quarter and nine month
period ended August 31, 2000 from the comparable periods of fiscal 1999.
Compensation and benefits expense increased 24% and 21% in the quarter and
nine month period ended August 31, 2000 from the comparable periods of fiscal
1999, primarily reflecting higher domestic and international employment costs
associated with increased employment levels resulting from higher levels of
transaction volume. Occupancy and equipment expense increased 13% in the nine
month period ended August 31, 2000 from the comparable period of fiscal 1999,
primarily due to higher
33
occupancy costs associated with increased office space at certain domestic
facilities. Information processing and communications expense increased 4% and
3% in the quarter and nine month period ended August 31, 2000 from the
comparable periods of fiscal 1999, primarily due to an increase in volume-
related external data processing costs at both domestic and international
operations. The increase in the nine month period was partially offset by the
termination of an external transaction processing contract in the fiscal 1999
period. Marketing and business development expense increased 16% and 19% in
the quarter and nine month period ended August 31, 2000 from the comparable
periods of fiscal 1999, primarily due to higher cardmember rewards expense
associated with increased sales volume, as well as increased advertising and
direct mailing costs at both domestic and international operations.
Professional services expense increased 1% in the nine month period ended
August 31, 2000 from the comparable period of fiscal 1999, reflecting higher
costs associated with account collections and consumer credit counseling and
the outsourcing of certain call center operations, partially offset by the
exclusion of Year 2000 costs in fiscal 2000's results. Other expenses
increased 56% and 51% in the quarter and nine month period ended August 31,
2000 from the comparable periods of fiscal 1999. These increases were
primarily due to increases in certain domestic and international operating
expenses due to higher levels of transaction volume and business activity,
including higher fraud losses associated with increased levels of transaction
volume and customer accounts.
Liquidity and Capital Resources
The Company's total assets increased to $404.1 billion at August 31, 2000
from $367.0 billion at November 30, 1999, primarily attributable to increases
in securities borrowed, financial instruments owned and cash and securities
deposited with clearing organizations associated with increased levels of
customer activity. Aircraft under operating leases increased due to the
purchase of Ansett Worldwide. These increases were partially offset by a
decrease in securities purchased under agreements to resell. A substantial
portion of the Company's total assets consists of highly liquid marketable
securities and short-term receivables arising principally from securities
transactions. The highly liquid nature of these assets provides the Company
with flexibility in financing and managing its business.
The Company's senior management establishes the overall funding and capital
policies of the Company, reviews the Company's performance relative to these
policies, monitors the availability of sources of financing, reviews the
foreign exchange risk of the Company and oversees the liquidity and interest
rate sensitivity of the Company's asset and liability position. The primary
goal of the Company's funding and liquidity activities is to ensure adequate
financing over a wide range of potential credit ratings and market
environments.
The Company views return on equity to be an important measure of its
performance, in the context of both the particular business environment in
which the Company is operating and its peer group's results. In this regard,
the Company actively manages its consolidated capital position based upon,
among other things, business opportunities, capital availability and rates of
return together with internal capital policies, regulatory requirements and
rating agency guidelines and therefore may, in the future, expand or contract
its capital base to address the changing needs of its businesses. The Company
returns internally generated equity capital which is in excess of the needs of
its businesses to its shareholders through common stock repurchases and
dividends.
The Company funds its balance sheet on a global basis. The Company's funding
for its Securities and Asset Management businesses is raised through diverse
sources. These sources include the Company's capital, including equity and
long-term debt; repurchase agreements; U.S., Canadian, Euro and Japanese
commercial paper; letters of credit; unsecured bond borrows; securities
lending; buy/sell agreements; municipal reinvestments; master notes; and
committed and uncommitted lines of credit. Repurchase agreement transactions,
securities lending and a portion of the Company's bank borrowings are made on
a collateralized basis and therefore provide a more stable source of funding
than short-term unsecured borrowings.
34
The funding sources utilized for the Company's Credit Services business
include the Company's capital, including equity and long-term debt; asset-
backed securitizations; commercial paper; deposits; Federal Funds; and short-
term bank notes. The Company sells consumer loans through asset
securitizations using several transaction structures. During the second
quarter of fiscal 2000, an extendible asset-backed certificate program was
launched.
The Company's bank subsidiaries solicit deposits from consumers, purchase
Federal Funds and issue short-term bank notes. Interest bearing deposits are
classified by type as savings, brokered and other time deposits. Savings
deposits consist primarily of money market deposits and certificates of
deposit, including savings deposits from individual securities clients.
Brokered deposits consist primarily of certificates of deposits issued by the
Company's bank subsidiaries. Other time deposits include institutional
certificates of deposits. The Company, through Discover Bank (formerly
Greenwood Trust Company), a wholly-owned indirect subsidiary of the Company,
sells notes under a short-term bank note program.
The Company maintains borrowing relationships with a broad range of banks,
financial institutions, counterparties and others from which it draws funds in
a variety of currencies. The volume of the Company's borrowings generally
fluctuates in response to changes in the amount of repurchase transactions
outstanding, the level of the Company's securities inventories and consumer
loans receivable, and overall market conditions. Availability and cost of
financing to the Company can vary depending upon market conditions, the volume
of certain trading activities, the Company's credit ratings and the overall
availability of credit.
The Company's reliance on external sources to finance a significant portion
of its day-to-day operations makes access to global sources of financing
important. The cost and availability of unsecured financing generally are
dependent on the Company's short-term and long-term debt ratings. In addition,
the Company's debt ratings can have a significant impact on certain trading
revenues, particularly in those businesses where longer term counterparty
performance is critical, such as over-the-counter derivative transactions.
As of September 30, 2000, the Company's credit ratings were as follows:
Commercial Senior
Paper Debt
------------ --------
Dominion Bond Rating Service Limited................... R-1 (middle) AA (low)
Fitch (1).............................................. F1+ AA
Rating and Investment Information, Inc. (2)............ a-1+ AA
Moody's Investors Service.............................. P-1 Aa3
Standard & Poor's (3).................................. A-1+ AA-
Thomson Financial BankWatch............................ TBW-1 AA+
- --------
(1) Fitch IBCA, Inc. and Duff & Phelps Credit Rating Co. merged on June 1,
2000. The merged company will use the former Fitch IBCA, Inc. rating
scale.
(2) On August 1, 2000, Japan Rating and Investment Information, Inc. changed
its name to Rating and Investment Information, Inc.
(3) On May 17, 2000, Standard & Poor's upgraded the Company's commercial paper
rating from A-1 to A-1+ and upgraded the Company's senior debt rating from
A+ to AA-.
As the Company continues to expand globally and derives revenues
increasingly in various currencies, foreign currency management is a key
element of the Company's financial policies. The Company benefits from
operating in several different currencies because weakness in any particular
currency is often offset by strength in another currency. The Company closely
monitors its exposure to fluctuations in currencies and, where cost-justified,
adopts strategies to reduce the impact of these fluctuations on the Company's
financial performance. These strategies include engaging in various hedging
activities to manage income and cash flows denominated in foreign currencies
and using foreign currency borrowings, when appropriate, to finance
investments outside the U.S.
35
During the nine month period ended August 31, 2000, the Company issued
senior notes aggregating $21,150 million, including non-U.S. dollar currency
notes aggregating $2,517 million, primarily pursuant to its public debt shelf
registration statements. These notes have maturities from 2001 to 2030 and a
weighted average coupon interest rate of 6.65% at August 31, 2000. The Company
has entered into certain transactions to obtain floating interest rates based
primarily on short-term LIBOR trading levels. At August 31, 2000 the aggregate
outstanding principal amount of the Company's Senior Indebtedness (as defined
in the Company's public debt shelf registration statements) was approximately
$56 billion (not including approximately $7.1 billion of additional senior
indebtedness consisting of guaranteed obligations of the indebtedness of
subsidiaries).
In January 2000, the Company and Morgan Stanley Finance, plc, a U.K.
subsidiary, called for the redemption of all of the outstanding 9.00% Capital
Units on February 28, 2000. The aggregate principal amount of the Capital
Units redeemed was $144 million.
During the nine month period ended August 31, 2000, the Company purchased
$2,443 million of its common stock. Subsequent to August 31, 2000 and through
September 30, 2000, the Company purchased an additional $209 million of its
common stock.
Effective June 22, 2000, the Company's Board of Directors authorized the
repurchase, subject to market conditions and certain other factors, of an
additional $1.5 billion of the Company's common stock for capital management
purposes.
In an effort to enhance its ongoing stock repurchase program, the Company
may sell put options on shares of its common stock to third parties. These put
options entitle the holder to sell shares of the Company's common stock to the
Company on certain dates at specified prices. As of August 31, 2000, put
options were outstanding on an aggregate of 2.0 million shares of the
Company's common stock. These put options have various expiration dates that
range from September 2000 through November 2000. The Company may elect cash
settlement of the put options instead of purchasing the stock.
The Company maintains a senior revolving credit agreement with a group of
banks to support general liquidity needs, including the issuance of commercial
paper (the "MSDW Facility"). Under the terms of the MSDW Facility, the banks
are committed to provide up to $5.5 billion. The MSDW Facility contains
restrictive covenants which require, among other things, that the Company
maintain shareholders' equity of at least $11.0 billion at all times. The
Company believes that the covenant restrictions will not impair the Company's
ability to pay its current level of dividends. At August 31, 2000, no
borrowings were outstanding under the MSDW Facility.
The Company maintains a master collateral facility that enables Morgan
Stanley & Co. Incorporated ("MS&Co."), one of the Company's U.S. broker-dealer
subsidiaries, to pledge certain collateral to secure loan arrangements,
letters of credit and other financial accommodations (the "MS&Co. Facility").
As part of the MS&Co. Facility, MS&Co. also maintains a secured committed
credit agreement with a group of banks that are parties to the master
collateral facility under which such banks are committed to provide up to
$1.875 billion. The credit agreement contains restrictive covenants, which
require among other things, that MS&Co. maintain specified levels of
consolidated shareholder's equity and Net Capital, as defined in the credit
agreement. At August 31, 2000, no borrowings were outstanding under the MS&Co.
Facility.
Morgan Stanley & Co. International Limited ("MSIL"), the Company's London-
based broker-dealer subsidiary, maintains a revolving committed financing
facility to secure committed funding from a syndicate of banks by providing a
broad range of collateral under repurchase agreements (the "MSIL Facility").
Such banks are committed to provide up to an aggregate of $1.785 billion
available in nine major currencies. The facility agreement contains
restrictive covenants which require, among other things, that MSIL maintain
specified levels of Shareholder's Equity and Financial Resources, each as
defined in the credit agreement. At August 31, 2000, no borrowings were
outstanding under the MSIL Facility.
36
Morgan Stanley Dean Witter Japan Limited ("MSDWJL"), the Company's Tokyo-
based broker-dealer subsidiary, maintains a committed revolving credit
facility guaranteed by the Company that provides funding to support general
liquidity needs, including support of MSDWJL's unsecured borrowings (the
"MSDWJL Facility"). Under the terms of the MSDWJL Facility, a syndicate of
banks is committed to provide up to 70 billion Japanese yen. At August 31,
2000, no borrowings were outstanding under the MSDWJL Facility.
The Company anticipates that it will utilize the MSDW Facility, the MS&Co.
Facility, the MSIL Facility or the MSDWJL Facility for short-term funding from
time to time.
At August 31, 2000, certain assets of the Company, such as real property,
equipment and leasehold improvements of $2.3 billion, aircraft assets of $3.9
billion, and goodwill and other intangible assets of $1.4 billion, were
illiquid. Certain equity investments made in connection with the Company's
private equity and other principal investment activities, high-yield debt
securities, emerging market debt, certain collateralized mortgage obligations
and mortgage-related loan products, bridge financing, and certain senior
secured loans and positions are not highly liquid. The Company also has
commitments of approximately $600 million at August 31, 2000 in connection
with its private equity and certain other principal investment activities.
At August 31, 2000, the aggregate value of high-yield and emerging market
debt securities held in inventory was $2.5 billion, as compared to $2.3
billion at May 31, 2000 (a substantial portion of which was subordinated
debt). These securities were not attributable to more than 6% to any one
issuer, 38% to any one industry or 17% to any one geographic region. High-
yield and emerging market debt securities generally involve greater risk than
investment grade securities due to the lower credit ratings of the issuers,
which typically have relatively high levels of indebtedness and are,
therefore, more sensitive to adverse economic conditions. In addition, the
market for high-yield and emerging market debt securities is, and may continue
to be, characterized by periods of volatility and illiquidity. The Company has
in place credit and other risk policies and procedures to control total
inventory positions and risk concentrations for high-yield and emerging market
debt securities that are administered in a manner consistent with the
Company's overall risk management policies and control structure (see "Risk
Management" and Note 9 to the consolidated financial statements for the fiscal
year ended November 30, 1999, included in the Company's Annual Report on Form
10-K).
In connection with certain of its business activities, the Company provides
financing or financing commitments (on a secured and unsecured basis) to
companies in the form of senior and subordinated debt, including bridge
financing, on a selective basis. The borrowers may be rated investment grade
or non-investment grade and the loans may have varying maturities. As part of
these activities, the Company may syndicate and trade certain positions of
these loans. At August 31, 2000, the aggregate value of such loans and
positions was $3.8 billion. The Company has also provided additional
commitments associated with these activities aggregating $9.2 billion at
August 31, 2000.
The Company has contracted to develop a one million-square-foot office tower
in New York City. Pursuant to this agreement, the Company will own the
building and has entered into a 99-year lease for the land at the development
site. Construction began in 1999 and the Company intends to occupy the
building upon project completion, which is anticipated in 2002. The total
investment in this project (which will be incurred over the next several
years) is estimated to be approximately $650 million.
At August 31, 2000, financial instruments owned by the Company included
derivative products (generally in the form of futures, forwards, swaps, caps,
collars, floors, swap options and similar instruments which derive their value
from underlying interest rates, foreign exchange rates or commodity or equity
instruments and indices) related to financial instruments and commodities with
an aggregate net replacement cost of $27.6 billion. The net replacement cost
of all derivative products in a gain position represents the Company's maximum
37
exposure to derivatives related credit risk. Derivative products may have both
on- and off-balance sheet risk implications, depending on the nature of the
contract. However, in many cases derivatives serve to reduce, rather than
increase, the Company's exposure to losses from market, credit and other
risks. The risks associated with the Company's derivative activities,
including market and credit risks, are managed on an integrated basis with
associated cash instruments in a manner consistent with the Company's overall
risk management policies and control structure. The Company manages its credit
exposure to derivative products through various means, which include reviewing
counterparty financial soundness periodically; entering into master netting
agreements and collateral arrangements with counterparties in appropriate
circumstances; and limiting the duration of exposure.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As of August 31, 2000, Aggregate Value-at-Risk ("VaR") for the Company's
trading and related activities, measured at a 99% confidence level with a one-
day time horizon, was $54 million. Aggregate VaR increased from $51 million as
of November 30, 1999, primarily as the result of an increase in the VaR
associated with various equity and commodity risk positions, partially offset
by a decrease in VaR associated with interest rate risk positions. Aggregate
VaR increased from $39 million as of May 31, 2000, primarily resulting from
increased VaR associated with equity, interest rate and commodity risk
positions, partially offset by a decline in VaR associated with foreign
exchange risk positions.
The Company uses VaR as one of various risk management tools and notes that
VaR values should be interpreted in light of the method's strengths and
limitations. For a further discussion of the Company's risk management policy
and control structure, refer to the "Risk Management" section of the Company's
Annual Report on Form 10-K for the fiscal year ended November 30, 1999.
38
PART II OTHER INFORMATION
Item 1. Legal Proceedings
The following developments have occurred with respect to certain matters
previously reported in the Company's Annual Report on Form 10-K for the fiscal
year ended November 30, 1999 and in the Company's Quarterly Reports on Form
10-Q for the fiscal quarters ended February 29, 2000 and May 31, 2000.
Term Trust Class Actions. The dismissals of the New York and New Jersey
actions were not appealed. The Florida action was remanded to state court from
federal court by order dated October 2, 2000.
IPO Fee Litigation. On July 21, 2000, plaintiffs in the consolidated class
action captioned In re Public Offering Fee Antitrust Litigation in the U.S.
District Court for the Southern District of New York filed a motion to amend
the complaint to add an issuer plaintiff. On September 7, 2000, defendants
filed their opposition to plaintiffs' motion.
On or about August 3, 2000, another purported class action complaint, CHS
Electronics, Inc. v. Credit Suisse First Boston Corporation, et al., was filed
in the U.S. District Court for the Southern District of Florida against the
Company and 17 other underwriters of IPO securities. The complaint alleges
that defendants conspired to fix at 7% the underwriting fee that issuers paid
for underwriting services in connection with IPOs in the $20 million to $80
million range. This action was brought by an issuer plaintiff who purports to
represent a class comprised of corporations and other entities that paid
underwriting fees on IPOs in that range. The complaint alleges violations of
Section 1 of the Sherman Act and seeks treble damages and injunctive relief,
as well as reasonable attorneys' fees and costs. On October 2, 2000,
defendants moved to transfer venue to the U.S. District Court for the Southern
District of New York where the other IPO fee actions have been consolidated.
Nenni, et al. v. Dean Witter Reynolds Inc. The U.S. Court of Appeals for the
First Circuit remanded the case to the district court on June 2, 2000 to
consider a resolution proposed by the parties. An order was entered in the
district court approving the resolution on October 10, 2000.
Item 2. Changes in Securities and Use of Proceeds
(c) To enhance its ongoing stock repurchase program, during the quarter
ended August 31, 2000, the Company sold European-style put options on an
aggregate of 2.5 million shares of its common stock, of which put options on
1.0 million shares remained outstanding at August 31, 2000. The outstanding
put options have various expiration dates that range from September 2000
through November 2000. They entitle the holders to sell common stock to the
Company at prices ranging from $80.98 to $84.79 per share. The sale of these
put options, which were made as private placements to third parties, generated
proceeds to the Company of approximately $9 million.
Item 5. Other Information
The Company holds an analyst conference call subsequent to the distribution
of its earnings press release each fiscal quarter. The Company provides public
access to an audio listen-only web simulcast of its conference call through
the Company's website www.msdw.com. Notice of the date and time of each
quarterly earnings conference call is posted on the Company's website
www.msdw.com at least five business days prior to the call.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
An exhibit index has been filed as part of this Report on Page E-1.
(b) Reports on Form 8-K
Form 8-K dated June 6, 2000 reporting Item 5 and Item 7.
Form 8-K dated June 22, 2000 reporting Item 5 and Item 7.
Form 8-K dated July 27, 2000 reporting Item 7.
39
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Morgan Stanley Dean Witter & Co.
(Registrant)
/s/ Joanne Pace
By: _________________________________
Joanne Pace, Controller and
Principal Accounting Officer
Date: October 16, 2000
40
EXHIBIT INDEX
MORGAN STANLEY DEAN WITTER & CO.
Quarter Ended August 31, 2000
Exhibit
No. Description
------- -----------
10 Change in Employment Status Agreement by and between the Company and
Peter F. Karches dated as of September 1, 2000 (portions of this
Exhibit have been omitted pursuant to a request for confidential
treatment under Rule 24b-2).
11 Computation of earnings per share.
12 Computation of ratio of earnings to fixed charges.
15 Letter of awareness from Deloitte & Touche LLP, dated October 13,
2000, concerning unaudited interim financial information.
27 Financial Data Schedule.
E-1