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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 May 31, 2001
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)
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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 June 30, 2001 there were 1,108,723,011 shares of the 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 May 31, 2001
Page
----
Part I--Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Financial Condition--May 31, 2001 (unaudited) and
November 30, 2000........................................................................ 1
Condensed Consolidated Statements of Income (unaudited)--Three and Six Months Ended
May 31, 2001 and May 31, 2000............................................................ 2
Condensed Consolidated Statements of Comprehensive Income (unaudited)--Three and Six
Months Ended May 31, 2001 and May 31, 2000............................................... 3
Condensed Consolidated Statements of Cash Flows (unaudited)--Six Months Ended May 31,
2001 and May 31, 2000.................................................................... 4
Notes to Condensed Consolidated Financial Statements (unaudited)........................... 5
Independent Accountants' Report............................................................ 18
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk............................. 41
Part II--Other Information
Item 1. Legal Proceedings...................................................................... 44
Item 4. Submission of Matters to a Vote of Security Holders.................................... 44
Item 5. Other Information...................................................................... 45
Item 6. Exhibits and Reports on Form 8-K....................................................... 45
i
MORGAN STANLEY DEAN WITTER & CO.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in millions, except share and per share data)
May 31, November 30,
2001 2000
----------- ------------
(unaudited)
ASSETS
Cash and cash equivalents.............................................. $ 27,096 $ 18,819
Cash and securities deposited with clearing organizations or
segregated under federal and other regulations (including securities
at fair value of $36,843 at May 31, 2001 and $41,312 at November 30,
2000)................................................................. 45,670 48,637
Financial instruments owned:
U.S. government and agency securities............................... 41,024 28,841
Other sovereign government obligations.............................. 25,372 24,119
Corporate and other debt............................................ 44,100 33,419
Corporate equities.................................................. 21,997 16,889
Derivative contracts................................................ 29,793 27,333
Physical commodities................................................ 342 217
Securities purchased under agreements to resell........................ 44,545 50,992
Securities provided as collateral...................................... 18,668 3,563
Securities borrowed.................................................... 128,328 105,231
Receivables:
Consumer loans (net of allowances of $787 at May 31, 2001 and $783
at November 30, 2000).............................................. 20,974 21,745
Customers, net...................................................... 22,298 26,015
Brokers, dealers and clearing organizations......................... 4,363 1,257
Fees, interest and other............................................ 6,826 5,447
Office facilities, at cost (less accumulated depreciation and
amortization of $2,045 at May 31, 2001 and $1,934 at November 30,
2000)................................................................. 2,884 2,685
Aircraft under operating leases (less accumulated depreciation of
$360 at May 31, 2001 and $257 at November 30, 2000)................... 4,207 3,927
Other assets........................................................... 8,894 7,658
-------- --------
Total assets........................................................... $497,381 $426,794
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Commercial paper and other short-term borrowings....................... $46,102 $ 27,754
Deposits............................................................... 12,506 11,930
Financial instruments sold, not yet purchased:
U.S. government and agency securities............................... 12,381 13,578
Other sovereign government obligations.............................. 10,910 6,959
Corporate and other debt............................................ 7,472 6,772
Corporate equities.................................................. 22,623 15,091
Derivative contracts................................................ 27,944 27,547
Physical commodities................................................ 1,912 1,462
Securities sold under agreements to repurchase......................... 115,749 97,230
Obligation to return securities received as collateral................. 24,499 8,353
Securities loaned...................................................... 35,785 35,211
Payables:
Customers........................................................... 91,051 94,546
Brokers, dealers and clearing organizations......................... 1,864 3,072
Interest and dividends.............................................. 3,235 2,766
Other liabilities and accrued expenses................................. 12,236 12,731
Long-term borrowings................................................... 50,623 42,051
-------- --------
476,892 407,053
-------- --------
Capital Units.......................................................... 70 70
-------- --------
Preferred Securities Issued by Subsidiaries............................ 400 400
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock..................................................... 545 545
Common stock ($0.01 par value, 3,500,000,000 shares authorized,
1,211,685,904 and 1,211,685,904 shares issued, 1,110,061,470 and
1,107,270,331 shares outstanding at May 31, 2001 and November 30,
2000, respectively)................................................ 12 12
Paid-in capital..................................................... 3,568 3,377
Retained earnings................................................... 22,217 20,802
Employee stock trust................................................ 2,999 3,042
Cumulative translation adjustments.................................. (142) (91)
Other comprehensive income.......................................... (60) --
-------- --------
Subtotal.......................................................... 29,139 27,687
Note receivable related to ESOP..................................... (43) (44)
Common stock held in treasury, at cost ($0.01 par value,
101,624,434 and 104,415,573 shares at May 31, 2001 and November
30, 2000).......................................................... (6,078) (6,024)
Common stock issued to employee trust............................... (2,999) (2,348)
-------- --------
Total shareholders' equity........................................ 20,019 19,271
-------- --------
Total liabilities and shareholders' equity............................. $497,381 $426,794
======== ========
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 Six Months
Ended May 31, Ended May 31,
------------------------------- ------------------------------
2001 2000 2001 2000
--------------- --------------- --------------- --------------
(unaudited) (unaudited)
Revenues:
Investment banking........................................ $ 801 $ 1,370 $ 1,758 $ 2,705
Principal transactions:
Trading................................................ 2,109 2,496 3,818 4,768
Investments............................................ (107) (236) (153) 195
Commissions............................................... 836 972 1,685 1,956
Fees:
Asset management, distribution and administration...... 1,040 1,094 2,114 2,078
Merchant and cardmember................................ 448 453 894 902
Servicing.............................................. 476 349 903 636
Interest and dividends.................................... 6,950 5,123 14,186 9,872
Other..................................................... 139 91 264 183
-------------- -------------- -------------- --------------
Total revenues......................................... 12,692 11,712 25,469 23,295
Interest expense.......................................... 6,413 4,420 12,592 8,352
Provision for consumer loan losses........................ 231 204 444 427
-------------- -------------- -------------- --------------
Net revenues........................................... 6,048 7,088 12,433 14,516
-------------- -------------- -------------- --------------
Non-interest expenses:
Compensation and benefits.............................. 2,742 3,097 5,593 6,505
Occupancy and equipment................................ 232 174 452 349
Brokerage, clearing and exchange fees.................. 170 149 330 288
Information processing and communications.............. 414 365 809 695
Marketing and business development..................... 454 501 953 972
Professional services.................................. 296 233 588 433
Other.................................................. 275 274 550 547
-------------- -------------- -------------- --------------
Total non-interest expenses......................... 4,583 4,793 9,275 9,789
-------------- -------------- -------------- --------------
Income before income taxes and cumulative effect of
accounting change...................................... 1,465 2,295 3,158 4,727
Provision for income taxes................................ 535 837 1,153 1,725
-------------- -------------- -------------- --------------
Income before cumulative effect of accounting change...... 930 1,458 2,005 3,002
Cumulative effect of accounting change.................... -- -- (59) --
-------------- -------------- -------------- --------------
Net income................................................ $ 930 $ 1,458 $ 1,946 $ 3,002
============== ============== ============== ==============
Preferred stock dividend requirements..................... $ 9 $ 9 $ 18 $ 18
============== ============== ============== ==============
Earnings applicable to common shares...................... $ 921 $ 1,449 $ 1,928 $ 2,984
============== ============== ============== ==============
Earnings per common share:
Basic before cumulative effect of accounting change.... $ 0.85 $ 1.32 $ 1.83 $ 2.72
Cumulative effect of accounting change................. -- -- (0.05) --
-------------- -------------- -------------- --------------
Basic.................................................. $ 0.85 $ 1.32 $ 1.78 $ 2.72
============== ============== ============== ==============
Diluted before cumulative effect of accounting change.. $ 0.82 $ 1.26 $ 1.76 $ 2.60
Cumulative effect of accounting change................. -- -- (0.05) --
-------------- -------------- -------------- --------------
Diluted................................................ $ 0.82 $ 1.26 $ 1.71 $ 2.60
============== ============== ============== ==============
Average common shares outstanding:........................
Basic.................................................. 1,085,305,558 1,098,245,490 1,087,205,706 1,096,007,767
============== ============== ============== ==============
Diluted................................................ 1,120,687,197 1,145,401,309 1,127,129,224 1,146,322,769
============== ============== ============== ==============
See Notes to Condensed Consolidated Financial Statements.
2
MORGAN STANLEY DEAN WITTER & CO.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in millions)
Three Months Six Months
Ended May 31, Ended May 31,
------------- ---------------
2001 2000 2001 2000
---- ------ ------ ------
(unaudited) (unaudited)
Net income................................. $930 $1,458 $1,946 $3,002
Other comprehensive income, net of tax:
Foreign currency translation adjustment. (33) (51) (51) (63)
Cumulative effect of accounting change.. -- -- (13) --
Net change in cash flow hedges.......... 13 -- (47) --
---- ------ ------ ------
Comprehensive income....................... $910 $1,407 $1,835 $2,939
==== ====== ====== ======
See Notes to Condensed Consolidated Financial Statements.
3
MORGAN STANLEY DEAN WITTER & CO.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in millions)
Six Months Ended
May 31,
-------------------
2001 2000
- - --------- ---------
(unaudited)
Cash flows from operating activities
Net income................................................................................... $ 1,946 $ 3,002
Adjustments to reconcile net income to net cash (used for) provided by operating
activities:
Non-cash charges included in net income:
Cumulative effect of accounting change................................................ 59 --
Other non-cash charges included in net income......................................... 937 900
Changes in assets and liabilities:
Cash and securities deposited with clearing organizations or segregated under
federal and other regulations....................................................... 2,967 (16,257)
Financial instruments owned, net of financial instruments sold, not yet purchased..... (19,063) 16,037
Securities borrowed, net of securities loaned......................................... (22,523) (23,137)
Receivables and other assets.......................................................... (2,562) (3,075)
Payables and other liabilities........................................................ (4,605) 31,407
-------- --------
Net cash (used for) provided by operating activities......................................... (42,844) 8,877
-------- --------
Cash flows from investing activities
Net (payments for) proceeds from:
Office facilities..................................................................... (437) (121)
Purchase of Quilter Holdings Limited, net of cash acquired............................ (183) --
Purchase of Ansett Worldwide, net of cash acquired.................................... -- (199)
Net principal disbursed on consumer loans............................................. (6,783) (6,234)
Sales of consumer loans............................................................... 7,112 4,313
-------- --------
Net cash used for investing activities....................................................... (291) (2,241)
-------- --------
Cash flows from financing activities
Net proceeds from short-term borrowings................................................... 18,348 1,566
Securities sold under agreements to repurchase, net of securities purchased under
agreements to resell.................................................................... 24,966 (11,052)
Net proceeds from:
Deposits.............................................................................. 576 692
Issuance of common stock.............................................................. 139 196
Issuance of put options............................................................... 5 18
Issuance of long-term borrowings...................................................... 16,162 12,622
Payments for:
Repurchases of common stock........................................................... (994) (1,856)
Repayments of long-term borrowings.................................................... (7,263) (4,583)
Redemption of Capital Units........................................................... -- (144)
Cash dividends........................................................................ (527) (464)
-------- --------
Net cash provided by (used for) financing activities......................................... 51,412 (3,005)
-------- --------
Net increase in cash and cash equivalents.................................................... 8,277 3,631
Cash and cash equivalents, at beginning of period............................................ 18,819 12,325
-------- --------
Cash and cash equivalents, at end of period.................................................. $ 27,096 $ 15,956
======== ========
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, Investment Management and Credit Services. The
Company's Securities business includes securities underwriting and
distribution; merger, acquisition, restructuring, real estate, project finance
and other corporate finance advisory activities; full-service brokerage and
financial advisory services; sales, trading, financing and market-making in
equity and fixed income securities, foreign exchange and commodities, and
derivatives; and private equity and other principal investing activities. The
Company's Investment Management business provides global asset management
products and services to individual and institutional investors through three
principal distribution channels: the Company's financial advisors; a
non-proprietary channel, consisting of broker-dealers, banks and financial
planners; and the Company's proprietary institutional channel. The Company's
Credit Services business includes the issuance of the Discover(R) Card, the
Discover Platinum Card, the Morgan Stanley Dean Witter(TM) Card and other
proprietary general purpose credit cards; and the operation of Discover
Business Services, a proprietary network of merchant and cash access locations
in the U.S.
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"), Morgan Stanley
DW Inc. (formerly Dean Witter Reynolds Inc.) ("MSDWI"), Morgan Stanley
Investment Advisors Inc. (formerly 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 accounting principles generally accepted in the U.S., 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 condensed consolidated 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, 2000 (the "Form 10-K"). The condensed consolidated
financial statements reflect all adjustments (consisting only of normal
recurring adjustments) that 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 the liquidation of the Company's positions would reasonably be
expected to impact market prices, fair value is determined
5
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 that 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. 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 initially are 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 that 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 that 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 enters into various derivative financial instruments for
non-trading purposes. These instruments include interest rate swaps, foreign
currency swaps, equity swaps and foreign exchange forwards. The Company uses
interest rate and currency swaps and equity derivatives to manage interest
rate, currency and equity price risk arising from certain borrowings. The
Company also utilizes interest rate swaps to match the repricing
characteristics of consumer loans with those of the borrowings that fund these
loans. Certain of these derivative financial instruments are designated and
qualify as fair value hedges and cash flow hedges in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended (see "New Accounting
Pronouncements"). For qualifying fair value hedges, the changes in the fair
value of the derivative and the gain or loss on the hedged asset or liability
relating to the risk being hedged are recorded currently in earnings. These
amounts are recorded in interest expense and provide offset of one another. For
qualifying cash flow hedges, the changes in the fair value of the derivative
are recorded in other comprehensive income, and amounts in other comprehensive
income are reclassified into earnings in the same period or periods during
which the hedged forecasted transaction affects earnings. Ineffectiveness
relating to fair value and cash flow hedges, if any, is recorded within
interest expense.
The Company also utilizes foreign exchange forward contracts to manage
currency exposure relating to its net monetary investments 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. The interest elements (forward
points) on these foreign exchange forward contracts are recorded in earnings.
Securitization Activities
The Company engages in securitization activities related to commercial and
residential mortgage loans, corporate bonds and loans, credit card loans, and
other types of financial assets. The Company may retain interests in the
securitized financial assets as one or more tranches of the securitization, an
undivided seller's
6
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
interest, cash collateral accounts, servicing rights, and rights to any excess
cash flows remaining after payments to investors in the securitization trusts
of their contractual rate of return and reimbursement of credit losses. The
exposure to credit losses from securitized loans is limited to the Company's
retained contingent risk, which represents the Company's retained interest in
securitized loans, including any credit enhancement provided. The gain or loss
on the sale of financial assets depends in part on the previous carrying amount
of the assets involved in the transfer, and each subsequent transfer in
revolving structures, allocated between the assets sold and the retained
interests based upon their respective fair values at the date of sale. To
obtain fair values, quoted market prices are used if available. However, quoted
market prices are generally not available for retained interests, so the
Company estimates fair value based on the present value of expected future cash
flows using management's best estimates of the key assumptions, including
credit losses, payment rates, forward yield curves and discount rates
commensurate with the risks involved. The present value of future net servicing
revenues that the Company estimates it will receive over the term of the
securitized loans is recognized in income as the loans are securitized. A
corresponding asset also is recorded and then amortized as a charge to income
over the term of the securitized loans, with actual net servicing revenues
continuing to be recognized in income as they are earned. The impact of
recognizing the present value of estimated future net servicing revenues as
loans are securitized has not been material to the Company's consolidated
statements of income. Retained interests in securitized financial assets, other
than credit card loans (see Note 3), were not material to the Company's
condensed consolidated statement of financial condition at May 31, 2001. For
the six months ended May 31, 2001, cash proceeds from securitizations totaled
$15.4 billion.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, which establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. In June 1999, the FASB issued SFAS No.
137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of
the Effective Date of FASB Statement No. 133," which 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 adopted SFAS No. 133, as amended by SFAS No.
138, effective December 1, 2000. The Company recorded an after-tax charge to
net income from the cumulative effect of the adoption of SFAS No. 133, as
amended, of $59 million and an after-tax decrease to other comprehensive income
of $13 million. The Company's adoption of SFAS No. 133, as amended, affects 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." While SFAS No. 140 carries over most of
the provisions of SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," it provides new
guidelines for reporting financial assets transferred as collateral and new
guidelines for the derecognition of financial assets, in particular
transactions involving the use of special purpose entities. SFAS No. 140 also
prescribes additional disclosures for collateral transactions and for
securitization transactions accounted for as sales. The new guidelines for
collateral transactions are effective for fiscal years ending after December
15, 2000, while the new guidelines for the derecognition of financial assets
are effective for transfers made after March 31, 2001. The additional
disclosure requirements for collateral and securitization transactions were
effective for the second quarter of fiscal 2001 and are reflected in the Notes
to the condensed consolidated financial statements. The adoption of SFAS No.
140 for financial assets transferred after March 31, 2001 did not have a
material impact on the Company's consolidated financial statements. The Company
is in the process of evaluating the impact of the collateral guidelines of SFAS
No. 140 on its consolidated financial statements for the fiscal year ending
November 30, 2001.
7
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2. Securities Financing Transactions
Securities purchased under agreements to resell ("reverse repurchase
agreements") and securities sold under agreements to repurchase ("repurchase
agreements"), principally government and agency securities, are treated as
financing transactions and are carried at the amounts at which the securities
subsequently will be resold or reacquired as specified in the respective
agreements; such amounts include accrued interest. Reverse repurchase
agreements and repurchase agreements are presented on a net-by-counterparty
basis, when appropriate. It is the Company's policy to take possession of
securities purchased under agreements to resell. Securities borrowed and
securities loaned are also treated as financing transactions and are carried at
the amounts of cash collateral advanced and received in connection with the
transactions.
The Company enters into reverse repurchase agreements, repurchase
agreements, securities borrowed and securities loaned transactions to, among
other things, finance the Company's inventory positions, acquire securities to
cover short positions and settle other securities obligations, and accommodate
customers' needs. The Company also engages in securities financing transactions
for customers through margin lending. Under these agreements and transactions,
the Company either receives or provides collateral, including U.S. government
and agency securities, other sovereign government obligations, corporate and
other debt, and corporate equities. The Company receives collateral in the form
of securities in connection with reverse repurchase agreements, securities
borrowed transactions, customer margin loans and certain derivative
transactions. In many cases, the Company is permitted to sell or repledge these
securities held as collateral and use the securities to secure repurchase
agreements, to enter into securities lending transactions or for delivery to
counterparties to cover short positions. At May 31, 2001, the fair value of
securities received as collateral where the Company is permitted to sell or
repledge the securities was $351 billion, and the fair value of the portion
that has been sold or repledged was $318 billion.
The Company manages credit exposure arising from reverse repurchase
agreements, repurchase agreements, securities borrowed and securities loaned
transactions by, in appropriate circumstances, entering into master netting
agreements and collateral arrangements with counterparties that provide the
Company, in the event of a customer default, the right to liquidate collateral
and the right to offset a counterparty's rights and obligations. The Company
also monitors the fair value of the underlying securities as compared with the
related receivable or payable, including accrued interest, and, as necessary,
requests additional collateral to ensure such transactions are adequately
collateralized. Where deemed appropriate, the Company's agreements with third
parties specify its rights to request additional collateral. Customer
receivables generated from margin lending activity are collateralized by
customer-owned securities held by the Company. For these transactions, the
Company's collateral policies significantly limit the Company's credit exposure
in the event of customer default. The Company may request additional margin
collateral from customers, if appropriate, and if necessary may sell securities
that have not been paid for or purchase securities sold but not delivered from
customers.
Collateral received under securities financing transactions, such as reverse
repurchase agreements, is recognized, together with a corresponding obligation
to return the collateral, if the collateral provider does not have the
contractual right to substitute collateral or redeem collateral on short
notice. Collateral transferred under securities financing transactions, such as
repurchase agreements, is reclassified from financial instruments owned to
securities provided as collateral if the Company does not have the contractual
right to substitute collateral or redeem collateral on short notice.
Additionally, as a result of the Company's adoption of SFAS No. 140, effective
April 1, 2001 (see "New Accounting Pronouncements"), the Company was required
to recognize securities received as collateral (as opposed to cash) in certain
securities lending transactions in the condensed consolidated statement of
financial condition as of May 31, 2001. At May 31, 2001 and November 30, 2000,
the Company recorded obligations to return securities received as collateral of
$24,499 million and $8,353 million, respectively. The related assets received
as collateral were recorded among several captions included in the
8
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company's condensed consolidated statements of financial condition. At May 31,
2001 and November 30, 2000, after giving effect to reclassifications, the net
increase in total assets and total liabilities was $21,826 million and $5,515
million, respectively.
The Company pledges its financial instruments owned to collateralize
repurchase agreements and other securities financings. The carrying value and
classification of securities owned by the Company that have been loaned or
pledged to counterparties where those counterparties do not have the right to
sell or repledge the collateral were as follows:
At May 31, 2001
---------------------
(dollars in millions)
Financial instruments owned category:
U.S. government and agency securities. $18,974
Corporate and other debt.............. 3,123
Corporate equities.................... 2,300
-------
Total............................. $24,397
=======
3. Consumer Loans
Activity in the allowance for consumer loan losses was as follows (dollars
in millions):
Three Months Six Months
Ended May 31, Ended May 31,
----------------- -----------------
2001 2000 2001 2000
-------- -------- -------- --------
Balance, beginning of period $ 786 $ 775 $ 783 $ 773
Provision for loan losses... 231 204 444 427
Less deductions:
Charge-offs.............. 255 227 492 485
Recoveries............... (25) (24) (52) (61)
------- ------- ------- -------
Net charge-offs.......... 230 203 440 424
------- ------- ------- -------
Balance, end of period...... $ 787 $ 776 $ 787 $ 776
======= ======= ======= =======
Interest accrued on loans subsequently charged off, recorded as a reduction
of interest revenue, was $41 million and $81 million in the quarter and six
month periods ended May 31, 2001 and $26 million and $63 million in the quarter
and six month periods ended May 31, 2000.
The Company's retained interests in credit card asset securitizations
include an undivided seller's interest, cash collateral accounts, servicing
rights, and rights to any excess cash flows ("Residual Interests") remaining
after payments to investors in the securitization trust of their contractual
rate of return and reimbursement of credit losses. The Company receives annual
servicing fees of 2% of the investor principal balance outstanding. At May 31,
2001, the Company had $10.6 billion of retained interests, including $8.4
billion of undivided seller's interest, in credit card asset securitizations.
The Company's undivided seller's interest ranks pari passu with investors'
interests in the securitization trust and the remaining retained interests are
subordinate to investors' interests. The retained interests are subject to
credit, payment and interest rate risks on the transferred credit card assets.
The investors and the securitization trust have no recourse to the Company's
other assets for failure of cardmembers to pay when due.
During the six months ended May 31, 2001, the Company completed credit card
asset securitizations of $6.8 billion. Net securitization gains related to
credit card asset securitizations of $74 million were recorded as servicing
fees in the Company's condensed consolidated statement of income for the six
months ended May 31, 2001.
9
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Key economic assumptions used in measuring the Residual Interests at the
date of securitization resulting from credit card asset securitizations
completed during the six months ended May 31, 2001 were as follows:
Weighted average life (in months) 6.4
Payment rate (rate per month).... 16.88%--16.93%
Credit losses (rate per annum)... 5.23%--5.98%
Discount rate (rate per annum)... 16.50%--17.50%
Key economic assumptions and the sensitivity of the current fair value of
the Residual Interests to immediate 10 percent and 20 percent adverse changes
in those assumptions are as follows (dollars in millions):
At May 31, 2001
---------------
Residual Interests (carrying amount/fair value) $ 220
Weighted average life (in months).............. 6.4
Payment rate (rate per month).................. 16.93%
Impact on fair value of 10% adverse change.. $ (15.4)
Impact on fair value of 20% adverse change.. $ (28.7)
Credit losses (rate per annum)................. 5.98%
Impact on fair value of 10% adverse change.. $ (62.6)
Impact on fair value of 20% adverse change.. $(124.9)
Discount rate (rate per annum)................. 16.50%
Impact on fair value of 10% adverse change.. $ (2.7)
Impact on fair value of 20% adverse change.. $ (5.4)
The sensitivity analysis in the table above is hypothetical and should be
used with caution. Changes in fair value based on a 10 percent variation in an
assumption generally cannot be extrapolated because the relationship of the
change in the assumption to the change in fair value may not be linear. Also,
the effect of a variation in a particular assumption on the fair value of the
Residual Interests is calculated independent of changes in any other
assumption; in practice, changes in one factor may result in changes in another
(for example, increases in market interest rates may result in lower payments
and increased credit losses), which might magnify or counteract the
sensitivities. In addition, the sensitivity analysis does not consider any
corrective action that management may take to mitigate the impact of any
adverse changes in the key assumptions.
The table below summarizes certain cash flows received from the
securitization master trust (dollars in billions):
Six Months Ended
May 31, 2001
----------------
Proceeds from new securitizations................................................. $ 6.8
Proceeds from collections reinvested in previous credit card asset securitizations $23.1
Contractual servicing fees received............................................... $ 0.3
Cash flows received from retained interests....................................... $ 0.8
10
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The table below presents quantitative information about delinquencies, net
credit losses and components of managed general purpose credit card loans,
including securitized loans (dollars in billions):
Six Months Ended
At May 31, 2001 May 31, 2001
---------------------- ------------------
Loans Loans Average Net Credit
Outstanding Delinquent Loans Losses
----------- ---------- ------- ----------
Managed general purpose credit card loans.......... $50.2 $2.9 $49.5 $1.2
Less: Securitized general purpose credit card loans 29.3
-----
Owned general purpose credit card loans............ $20.9
=====
4. Long-Term Borrowings
Long-term borrowings at May 31, 2001 scheduled to mature within one year
aggregated $9,838 million.
During the six month period ended May 31, 2001, the Company issued senior
notes aggregating $15,720 million, including non-U.S. dollar currency notes
aggregating $4,654 million. The weighted average coupon interest rate of these
notes was 5.53% at May 31, 2001; 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: 2002, $483 million; 2003, $1,251 million; 2004, $3,802 million;
2005, $970 million; 2006, $5,371 million and thereafter, $3,843 million. In the
six month period ended May 31, 2001, $7,263 million of senior notes were
repaid.
5. Preferred Stock, Capital Units and Preferred Securities Issued by
Subsidiaries
Preferred stock is composed of the following issues:
Shares Outstanding at Balance at
---------------------- ---------------------
May 31, November 30, May 31, November 30,
2001 2000 2001 2000
--------- ------------ -------- ------------
(dollars in millions)
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 $545
==== ====
Each issue of outstanding preferred stock ranks in parity with all other
outstanding preferred stock of the Company.
MSDW Capital Trust I, a Delaware statutory business trust (the "Capital
Trust"), all of the common securities of which are owned by the Company, has
$400 million of 7.10% Capital Securities (the "Capital Securities") outstanding
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 ("MSF"), a U.K. subsidiary. A Capital Unit
consists of (a) a Subordinated Debenture of MSF guaranteed by the Company and
maturing in 2017 and (b) a related Purchase Contract issued by the Company,
which may be accelerated by the Company, requiring the holder to purchase one
Depositary Share representing shares (or fractional shares) of the Company's
Cumulative Preferred Stock. The aggregate amount of the Capital Units
outstanding was $70 million at May 31, 2001.
11
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Common Stock and Shareholders' Equity
MS&Co. and MSDWI 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 MSDWI have
consistently operated in excess of these requirements. MS&Co.'s net capital
totaled $4,618 million at May 31, 2001, which exceeded the amount required by
$4,021 million. MSDWI's net capital totaled $1,330 million at May 31, 2001,
which exceeded the amount required by $1,185 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, 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 May 31, 2001, 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. Morgan Stanley
Derivative Products, Inc., the Company's triple-A rated derivative products
subsidiary, also has established certain operating restrictions that have been
reviewed by various rating agencies.
The Company repurchased approximately 14 million and 26 million shares of
its common stock during the six month periods ended May 31, 2001 and May 31,
2000, respectively.
7. 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):
Three Months Ended Six Months Ended
May 31, May 31,
--------------------- ---------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Basic EPS:
Income before cumulative effect of accounting change.... $ 930 $ 1,458 $ 2,005 $ 3,002
Cumulative effect of accounting change.................. -- -- (59) --
Preferred stock dividend requirements................... (9) (9) (18) (18)
--------- --------- --------- ---------
Net income available to common shareholders............. $ 921 $ 1,449 $ 1,928 $ 2,984
========= ========= ========= =========
Weighted-average common shares outstanding.............. 1,085 1,098 1,087 1,096
========= ========= ========= =========
Basic EPS before cumulative effect of accounting change. $ 0.85 $ 1.32 $ 1.83 $ 2.72
Cumulative effect of accounting change.................. -- -- (0.05) --
--------- --------- --------- ---------
Basic EPS.................................................. $ 0.85 $ 1.32 $ 1.78 $ 2.72
========= ========= ========= =========
12
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Three Months Ended Six Months Ended
May 31, May 31,
------------------- -------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Diluted EPS:
Income before cumulative effect of accounting change........ $ 930 $ 1,458 $ 2,005 $ 3,002
Cumulative effect of accounting change...................... -- -- (59) --
Preferred stock dividend requirements....................... (9) (9) (18) (18)
-------- -------- -------- --------
Net income available to common shareholders................. $ 921 $ 1,449 $ 1,928 $ 2,984
======== ======== ======== ========
Weighted-average common shares outstanding.................. 1,085 1,098 1,087 1,096
Effect of dilutive securities:
Stock options........................................... 35 47 40 46
Convertible debt........................................ 1 -- -- --
ESOP convertible preferred stock........................ -- -- -- 4
-------- -------- -------- --------
Weighted-average common shares outstanding and common stock
equivalents............................................... 1,121 1,145 1,127 1,146
======== ======== ======== ========
Diluted EPS before cumulative effect of accounting change... $ 0.82 $ 1.26 $ 1.76 $ 2.60
Cumulative effect of accounting change...................... -- -- (0.05) --
-------- -------- -------- --------
Diluted EPS.................................................... $ 0.82 $ 1.26 $ 1.71 $ 2.60
======== ======== ======== ========
8. 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.
At May 31, 2001 and November 30, 2000, the Company had approximately $5.8
billion and $6.1 billion, respectively, of letters of credit outstanding to
satisfy various collateral requirements.
9. 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 and other derivatives in managing its interest
rate exposure. The Company also uses forward and option contracts, futures and
swaps in its trading activities; these 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, 2000, included in the Form 10-K.
13
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
The credit quality of the Company's trading-related derivatives at May 31,
2001 and November 30, 2000 is summarized in the tables below, showing the fair
value of the related assets by counterparty credit rating. The actual credit
ratings are determined by external rating agencies or by equivalent ratings
used by the Company's Credit Department:
Collateralized
Non- Other Non-
Investment Investment
AAA AA A BBB Grade Grade Total
------- ------- ------- ------- -------------- ---------- --------
(dollars in millions)
At May 31, 2001
Interest rate and currency swaps and options
(including caps, floors and swap options) and
other fixed income securities contracts............ $2,621 $3,944 $4,570 $ 842 $ 314 $ 570 $12,861
Foreign exchange forward contracts and options...... 484 1,171 1,514 223 -- 669 4,061
Equity securities contracts (including equity swaps,
warrants and options).............................. 1,594 1,715 1,356 127 1,435 431 6,658
Commodity forwards, options and swaps............... 528 970 1,153 1,906 174 1,308 6,039
Mortgage-backed securities forward contracts,
swaps and options.................................. 19 42 46 6 -- 61 174
------ ------ ------ ------ ------ ------ -------
Total............................................ $5,246 $7,842 $8,639 $3,104 $1,923 $3,039 $29,793
====== ====== ====== ====== ====== ====== =======
Percent of total.................................... 18% 26% 29% 10% 7% 10% 100%
====== ====== ====== ====== ====== ====== =======
At November 30, 2000
Interest rate and currency swaps and options
(including caps, floors and swap options) and
other fixed income securities contracts............ $1,649 $3,964 $3,336 $1,113 $ 150 $ 396 $10,608
Foreign exchange forward contracts and options...... 112 909 1,144 111 -- 195 2,471
Equity securities contracts (including equity swaps,
warrants and options).............................. 1,774 2,172 910 169 1,840 320 7,185
Commodity forwards, options and swaps............... 222 1,450 2,139 1,485 337 1,289 6,922
Mortgage-backed securities forward contracts,
swaps and options.................................. 43 48 38 15 -- 3 147
------ ------ ------ ------ ------ ------ -------
Total............................................ $3,800 $8,543 $7,567 $2,893 $2,327 $2,203 $27,333
====== ====== ====== ====== ====== ====== =======
Percent of total.................................... 14% 31% 28% 11% 8% 8% 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
14
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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" in the Form 10-K for discussions of the Company's
risk management policies and procedures for its securities businesses.
10. 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, Investment Management and Credit Services, through which it
provides a wide range of financial products and services to its customers.
The Company's Securities business includes securities underwriting and
distribution; merger, acquisition, restructuring, real estate, project finance
and other corporate finance advisory activities; full-service brokerage and
financial advisory services; sales, trading, financing and market-making in
equity and fixed income securities, foreign exchange and commodities, and
derivatives; and private equity and other principal investment activities. The
Company's Investment Management business provides global asset management
products and services to individual and institutional investors through three
principal distribution channels: the Company's financial advisors; a
non-proprietary channel, consisting of broker-dealers, banks and financial
planners; and the Company's proprietary institutional channel. The Company's
Credit Services business includes the issuance of the Discover Card, the
Discover Platinum Card, the Morgan Stanley Dean Witter Card and other
proprietary general purpose credit cards; and the operation of Discover
Business Services, a proprietary network of merchant and cash access locations
in the U.S.
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 table below:
Investment
Three Months Ended May 31, 2001(1) Securities Management Credit Services Total
- ---------------------------------- ---------- ---------- --------------- ------
(dollars in millions)
All other net revenues........ $4,226 $592 $ 693 $5,511
Net interest.................. 191 14 332 537
------ ---- ------ ------
Net revenues.................. $4,417 $606 $1,025 $6,048
====== ==== ====== ======
Income before taxes........... $ 974 $212 $ 279 $1,465
Provision for income taxes.... 339 88 108 535
------ ---- ------ ------
Net income.................... $ 635 $124 $ 171 $ 930
====== ==== ====== ======
15
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Investment
Three Months Ended May 31, 2000(1) Securities Management Credit Services Total
- ---------------------------------- ---------- ---------- --------------- ---------
(dollars in millions)
All other net revenues.............................. $ 5,123 $ 664 $ 598 $ 6,385
Net interest........................................ 285 16 402 703
-------- ------ ------- --------
Net revenues........................................ $ 5,408 $ 680 $ 1,000 $ 7,088
======== ====== ======= ========
Income before taxes................................. $ 1,688 $ 264 $ 343 $ 2,295
Provision for income taxes.......................... 598 107 132 837
-------- ------ ------- --------
Net income.......................................... $ 1,090 $ 157 $ 211 $ 1,458
======== ====== ======= ========
Investment
Six Months Ended May 31, 2001(1) Securities Management Credit Services Total
- -------------------------------- ---------- ---------- --------------- ---------
(dollars in millions)
All other net revenues.............................. $ 8,261 $1,225 $ 1,353 $ 10,839
Net interest........................................ 893 36 665 1,594
-------- ------ ------- --------
Net revenues........................................ $ 9,154 $1,261 $ 2,018 $ 12,433
======== ====== ======= ========
Income before income taxes and cumulative effect of
accounting change................................. $ 2,188 $ 460 $ 510 $ 3,158
Provision for income taxes.......................... 769 187 197 1,153
-------- ------ ------- --------
Income before cumulative effect of accounting change 1,419 273 313 2,005
Cumulative effect accounting change................. (46) -- (13) (59)
-------- ------ ------- --------
Net income.......................................... $ 1,373 $ 273 $ 300 $ 1,946
======== ====== ======= ========
Investment
Six Months Ended May 31, 2000(1) Securities Management Credit Services Total
- -------------------------------- ---------- ---------- --------------- ---------
(dollars in millions)
All other net revenues.............................. $ 10,586 $1,299 $ 1,111 $ 12,996
Net interest........................................ 702 30 788 1,520
-------- ------ ------- --------
Net revenues........................................ $ 11,288 $1,329 $ 1,899 $ 14,516
======== ====== ======= ========
Income before taxes................................. $ 3,619 $ 536 $ 572 $ 4,727
Provision for income taxes.......................... 1,285 219 221 1,725
-------- ------ ------- --------
Net income.......................................... $ 2,334 $ 317 $ 351 $ 3,002
======== ====== ======= ========
Investment
Total Assets(1) Securities Management Credit Services Total
- --------------- ---------- ---------- --------------- ---------
(dollars in millions)
May 31, 2001........................................ $465,919 $4,801 $26,661 $497,381
======== ====== ======= ========
November 30, 2000................................... $395,026 $4,872 $26,896 $426,794
======== ====== ======= ========
- --------
(1)Credit Services business segment information includes the operating results
of Morgan Stanley Dean Witter Credit Corporation ("MSDWCC"). Previously, the
Company had included MSDWCC's results within its Securities business
segment. In addition, the operating results of the Investment Management
business segment includes certain revenues and expenses associated with the
Company's Investment Consulting Services business. Previously, such revenues
and expenses were recorded within the Company's Securities business segment.
The segment data for all periods presented have been restated to reflect
these changes.
(2)Corporate assets have been fully allocated to the Company's business
segments.
16
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Business Acquisition
During the quarter ended May 31, 2001, the Company completed its acquisition
of Quilter Holdings Limited ("Quilter"). Quilter is a well-established
U.K.-based investment management business providing segregated account
management and advisory services to private individuals, pension funds and
trusts. The Company's fiscal 2001 results include the operations of Quilter
since March 13, 2001, the date of acquisition. In connection with the
acquisition of Quilter, the Company issued approximately $37 million of notes
payable, including approximately $13 million of notes that are convertible into
common shares of the Company.
17
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 May 31,
2001, and the related condensed consolidated statements of income and
comprehensive income for the three and six month periods ended May 31, 2001 and
2000, and condensed consolidated statements of cash flows for the six month
periods ended May 31, 2001 and 2000. 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, 2000, 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, 2000; and, in our report dated January 12, 2001, we expressed an
unqualified opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying condensed consolidated statement
of financial condition as of November 30, 2000 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
July 10, 2001
18
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, Investment Management and Credit Services. The
Company's Securities business includes securities underwriting and
distribution; merger, acquisition, restructuring, real estate, project finance
and other corporate finance advisory activities; full-service brokerage and
financial advisory services; sales, trading, financing and market-making in
equity and fixed income securities, foreign exchange and commodities, and
derivatives; and private equity and other principal investing activities. The
Company's Investment Management business provides global asset management
products and services to individual and institutional investors through three
principal distribution channels: the Company's financial advisors; a
non-proprietary channel consisting of broker-dealers, banks and financial
planners; and the Company's proprietary institutional channel. The Company's
Credit Services business includes the issuance of the Discover(R) Card, the
Discover Platinum Card, the Morgan Stanley Dean Witter(TM) Card and other
proprietary general purpose credit cards; and the operation of Discover
Business Services, a proprietary network of merchant and cash access locations
in the U.S.
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,
commodity 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 continued development of electronic
communications 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 the expansion of its Credit Services
business.
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 or from
assets under management and supervision and the way in which such capital is
allocated among money market, equity, fixed income or other investment
alternatives, which could cause fluctuations to occur in the Company's
Investment 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. Included among the principal competitive factors affecting
the Securities business are the quality of its professionals and other
personnel, its products and services, relative pricing and innovation.
Competition in the Company's
- --------
*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.
19
Investment 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 cardmember acquisition and customer
utilization of credit cards, all of which are impacted by the type of fees,
interest rates and other features offered.
In addition to competition from firms traditionally engaged in the financial
services business, there has been increased competition 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 also
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 addition,
the passage of the Gramm-Leach-Bliley Act in the U.S. has allowed commercial
banks, securities firms and insurance firms to affiliate, which has accelerated
consolidation and may lead to increasing competition in markets which
traditionally have been dominated by investment banks and retail securities
firms. The Company also continues to experience competition for qualified
employees. 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 while managing compensation costs.
For a detailed discussion of the competitive factors in the Company's
Securities, Investment Management and Credit Services businesses, see the
Company's Annual Report on Form 10-K for the fiscal year ended November 30,
2000.
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, and managing
risks and 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 has led 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 or enhancing client communication, information and services as well
as making investments, or otherwise participating, in alternative trading
systems, electronic communications 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 May 31, 2001
The overall weakness in global market and economic conditions that emerged
during the latter half of fiscal 2000 persisted during the quarter ended May
31, 2001, which contributed to the decline in the Company's net revenues and
net income as compared to the quarter ended May 31, 2000.
In the U.S., market and economic conditions were generally difficult during
the quarter. The rate of U.S. economic growth remained sluggish, reflecting
lower levels of corporate investment and consumer confidence,
20
as well as higher levels of unemployment. These conditions, coupled with
indications of slowing corporate earnings growth, the impact of the overall
global economic slowdown and uncertainty about future business prospects
continued to exert pressure on the U.S. equity markets. As a result, the
Federal Reserve Board (the "Fed") continued its aggressive easing of interest
rates in order to stimulate economic activity and prevent the U.S. economy from
slipping into recession. During the quarter ended May 31, 2001, the Fed lowered
the overnight lending rate by 0.50% on three separate occasions, and also
lowered the discount rate by an aggregate of 1.5%. During the six month period
ended May 31, 2001, the Fed has lowered both the overnight lending rate and the
discount rate by an aggregate of 2.50%. Subsequent to quarter end, the Fed
lowered the overnight lending rate by an additional 0.25% in June 2001.
In Europe, the pace of economic growth was also sluggish during the quarter
ended May 31, 2001, reflecting lower levels of employment and industrial
production. As a result of increasing indications of slowing economic growth
within the European Union, particularly in Germany, coupled with the impact of
the overall slowdown in global economic activity, the European Central Bank
elected to lower interest rates within the European Union by 0.25% in May 2001.
In the U.K., slowing economic growth also prompted the Bank of England to lower
interest rates by 0.25% in May 2001. Previously, the Bank of England had
lowered rates by 0.25% in February 2001. At the end of the quarter, there
remained much uncertainty as to the European region's future growth prospects
in light of slower U.S. economic performance and a weakened global economy.
Economic and market conditions continued to be weak in the Far East during
the second quarter of fiscal 2001. In Japan, financial markets continued to be
adversely impacted by lingering concerns about the nation's banking system, its
growing budget deficit and slow rate of economic growth. The pace of Japan's
economic recovery has been slowed due to the deceleration of global economic
growth, which has negatively impacted the level of exports. As a result, the
Bank of Japan lowered the official discount rate on two occasions during the
first quarter of fiscal 2001, although during the second quarter of fiscal 2001
the Bank of Japan decided to leave rates unchanged. Conditions elsewhere in the
Far East were also difficult during the quarter, as the region's levels of
exports and production continued to be adversely impacted by the overall
decline in global economic activity.
The difficult market and economic conditions that characterized the first
six months of fiscal 2001, including lower levels of market volatility,
investment banking activity and retail investor participation in the financial
markets, have further deteriorated thus far in the third fiscal quarter. It is
currently not clear when these market and economic conditions will improve. In
addition, certain of the Company's businesses, particularly its Securities
business, have historically experienced a seasonal slowdown of business
activity during the third fiscal quarter.
Results of the Company for the Quarter and Six Month Period ended May 31,
2001
The Company's net income in the quarter and six month period ended May 31,
2001 was $930 million and $1,946 million, respectively, a decrease of 36% and
35% from the comparable periods of fiscal 2000. The Company's net income for
the six month period ended May 31, 2001 included a charge of $59 million for
the cumulative effect of an accounting change associated with the Company's
adoption, on December 1, 2000, of Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities." Excluding the cumulative effect of the accounting change, the
Company's net income for the six month period ended May 31, 2001 was $2,005
million, 33% below the comparable period of fiscal 2000.
Diluted earnings per common share were $0.82 and $1.71 in the quarter and
six month period ended May 31, 2001, respectively, as compared to $1.26 and
$2.60 in the quarter and six month period ended May 31, 2000. Excluding the
cumulative effect of the accounting change, the Company's diluted earnings per
share for the six month period ended May 31, 2001 was $1.76. The Company's
annualized return on common equity for the quarter and six month period ended
May 31, 2001 was 19.1% and 20.8% (excluding the cumulative effect of the
accounting change) as compared to 33.0% and 34.7% in the comparable prior year
periods.
21
The decrease in net income in the quarter and six month period ended May 31,
2001 was primarily attributable to the Company's Securities business,
reflecting lower investment banking, principal trading and commission revenues,
as well as increased non-compensation expenses. The decrease in net income for
the six month period ended May 31, 2001 also reflected principal investment
losses in fiscal 2001 as compared to principal investment gains in the
comparable period of fiscal 2000.
At May 31, 2001, the Company had approximately 63,000 employees worldwide,
an increase of 8% from May 31, 2000. The Company has incurred incremental
compensation and non-compensation expenses for these additional employees. In
light of the weakening global economy, the Company is seeking to balance cost
control with investment spending. Accordingly, during the remainder of fiscal
2001, the Company will continue to invest in strategic global initiatives and
expects to reduce the level of certain discretionary expenses.
Business Acquisition
During the quarter ended May 31, 2001, the Company completed its acquisition
of Quilter Holdings Limited ("Quilter"). Quilter is a well-established
U.K.-based investment management business providing segregated account
management and advisory services to private individuals, pension funds and
trusts. The Company's fiscal 2001 results include the operations of Quilter
since March 13, 2001, the date of acquisition.
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, Investment 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
Credit Services business segment information includes the operating results of
Morgan Stanley Dean Witter Credit Corporation ("MSDWCC"), the Company's
provider of mortgage and other consumer lending services. Previously, the
Company had included MSDWCC's results within its Securities business segment.
In addition, the operating results of the Investment Management business
segment includes certain revenues and expenses associated with the Company's
Investment Consulting Services ("ICS") business. Previously, such revenues and
expenses were included within the Company's Securities business segment. The
segment data for 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.
22
Securities
Statements of Income (dollars in millions)
Three Months Six Months
Ended May 31, Ended May 31,
---------------- ----------------
2001 2000 2001 2000
-------- ------- -------- -------
(unaudited) (unaudited)
Revenues:
Investment banking................................................ $ 786 $1,337 $ 1,724 $ 2,628
Principal transactions:
Trading....................................................... 2,109 2,496 3,818 4,768
Investments................................................... (107) (242) (153) 181
Commissions....................................................... 828 961 1,667 1,934
Asset management, distribution and administration fees............ 475 490 956 909
Interest and dividends............................................ 6,279 4,341 12,818 8,332
Other............................................................. 135 81 249 166
------- ------ ------- -------
Total revenues................................................ 10,505 9,464 21,079 18,918
Interest expense.................................................. 6,088 4,056 11,925 7,630
------- ------ ------- -------
Net revenues.................................................. 4,417 5,408 9,154 11,288
------- ------ ------- -------
Non-interest expenses:...............................................
Compensation and benefits......................................... 2,353 2,741 4,798 5,786
Occupancy and equipment........................................... 188 134 363 271
Brokerage, clearing and exchange fees............................. 127 110 244 212
Information processing and communications......................... 266 237 521 445
Marketing and business development................................ 127 177 275 329
Professional services............................................. 216 164 431 302
Other............................................................. 166 157 334 324
------- ------ ------- -------
Total non-interest expenses................................... 3,443 3,720 6,966 7,669
------- ------ ------- -------
Income before income taxes and cumulative effect of accounting change 974 1,688 2,188 3,619
Provision for income taxes........................................... 339 598 769 1,285
------- ------ ------- -------
Income before cumulative effect of accounting change................. 635 1,090 1,419 2,334
Cumulative effect of accounting change............................... -- -- (46) --
------- ------ ------- -------
Net income........................................................ $ 635 $1,090 $ 1,373 $ 2,334
======= ====== ======= =======
Securities net revenues were $4,417 million and $9,154 million in the
quarter and six month period ended May 31, 2001, a decrease of 18% and 19% from
the comparable periods of fiscal 2000. Securities net income for the quarter
and six month period ended May 31, 2001 was $635 million and $1,373 million, a
decrease of 42% and 41% from the comparable periods of fiscal 2000. Securities
net income for the six month period ended May 31, 2001 included a charge of $46
million from the cumulative effect of an accounting change associated with the
Company's adoption of SFAS No. 133 on December 1, 2000. Excluding the
cumulative effect of the accounting change, Securities net income was $1,419
million, a decrease of 39% from the comparable period of fiscal 2000. The
decreases in net revenues and net income in both periods were primarily
attributable to lower revenues from the Company's investment banking,
institutional sales and trading and individual securities activities, as well
as higher non-compensation expenses. These decreases were partially offset by
lower levels of incentive-based compensation expenses. The decreases in net
revenues and net income for the six month period ended May 31, 2001 also
reflected principal investment losses in fiscal 2001 as compared to principal
investment gains in the comparable period of fiscal 2000.
23
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 May 31, 2001 decreased 41% from the comparable period of fiscal
2000. The decrease was primarily due to lower revenues from equity underwriting
transactions and merger, acquisition and restructuring activities, partially
offset by higher revenues from fixed income underwriting transactions.
Revenues from merger, acquisition and restructuring activities decreased 55%
to $291 million in the quarter ended May 31, 2001 from the comparable period of
fiscal 2000. The level of the Company's revenues generally reflected merger and
acquisition transactions that were announced in prior periods but were
completed during the quarter. The global market for such transactions continued
to be negatively affected by the difficult global economic conditions and
uncertainty in the global financial markets. The sharp decline in the volume of
merger and acquisition transaction activity continued to be significant across
many industries and geographic locations. The reduction in the volume of
announced merger and acquisition transactions in the quarter ended May 31, 2001
will likely have a negative impact on the level of the Company's revenues from
merger, acquisition and restructuring activities in future periods.
Revenues from equity and fixed income underwriting transactions decreased
29% to $495 million in the quarter ended May 31, 2001 from the comparable
period of fiscal 2000.
Equity underwriting revenues in the quarter ended May 31, 2001 decreased,
primarily reflecting a lower volume of equity offerings that occurred during
the quarter. The volume of equity underwriting transactions continued to be
adversely affected by uncertainty in the global equity markets, particularly in
the technology and telecommunications sectors. Given current economic and
market conditions, it is uncertain at what pace transactions will be announced
and completed in future periods.
Fixed income underwriting revenues increased in the quarter ended May 31,
2001. The volume of fixed income underwriting transactions was generally strong
for investment grade debt and structured credit products during the quarter, as
many issuers took advantage of the relatively low global interest rate
environment, particularly in the U.S.
Investment banking revenues in the six month period ended May 31, 2001
decreased 34% from the comparable period of fiscal 2000. The decrease was
attributable to lower revenues from merger, acquisition and restructuring
activities and equity underwritings, reflecting lower levels of transaction
volume. Such decreases were partially offset by higher revenues from investment
grade debt underwritings, reflecting increased transaction volume as issuers
sought to take advantage of a generally favorable interest rate environment.
Principal Transactions
Principal transactions include revenues from customers' purchases and sales
of securities in which the Company acts as principal and gains and losses on
securities held for resale. Decisions relating to principal transactions in
securities are based on an overall review of the 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. The Company also engages in proprietary trading activities
for its own account. Principal transaction trading revenues decreased 16% in
the quarter ended May 31, 2001 from the comparable period of fiscal 2000. The
decrease primarily reflected lower levels of equity trading revenues, partially
offset by an increase in fixed income trading revenues.
Equity trading revenues decreased in the quarter ended May 31, 2001,
primarily reflecting lower revenues from trading derivative and cash equity
products. Despite higher customer trading volumes in both listed and
24
over-the-counter securities, conditions in the equity markets were generally
less favorable in comparison to the second quarter of fiscal 2000, particularly
in the U.S. and in Europe. In particular, the level of market volatility was
significantly lower in the second quarter of fiscal 2001 as compared to the
prior year. The decline in equity trading revenues also reflected lower new
issue volume, increased margin pressure resulting from the decimalization of
equity securities and lower revenues from certain proprietary trading
activities.
Fixed income trading revenues increased during the quarter ended May 31,
2001, reflecting higher revenues from trading investment grade and government
fixed income securities, partially offset by lower revenues from interest rate
swaps trading. Revenues from trading investment grade and government fixed
income securities benefited from a generally favorable interest rate
environment, higher trading volumes and market liquidity, partially reflecting
the Fed's interest rate actions during the quarter. Commodity trading revenues
increased slightly in the quarter ended May 31, 2001 as compared to the prior
year period, primarily driven by higher revenues from electricity trading.
Electricity prices continued to be volatile during the quarter, reflecting
energy shortages and fluctuations in the level of demand due to changing
weather conditions. Foreign exchange trading revenues decreased modestly in the
quarter ended May 31, 2001 as compared to the prior year period. The decrease
was primarily due to lower levels of customer trading volumes, partially offset
by higher levels of volatility in the foreign exchange markets primarily
reflecting the euro's decline relative to the U.S. dollar during the quarter.
Principal transaction investment losses aggregating $107 million were
recorded in the quarter ended May 31, 2001, as compared to losses of $242
million in the quarter ended May 31, 2000. Fiscal 2001's results included
unrealized losses in the Company's private equity portfolio and certain other
principal investments, primarily reflecting markdowns of non-publicly traded
investments. Fiscal 2000's results primarily consisted of unrealized losses
from certain private equity and venture capital investments, including
Allegiance Telecom, Inc. and InterNAP Network Services Corporation.
Principal transaction trading revenues decreased 20% in the six month period
ended May 31, 2001 from the comparable period of fiscal 2000, primarily
reflecting a decline in equity and fixed income trading revenues partially
offset by higher commodity trading revenues. The decrease in equity trading
revenues reflected lower revenues from both cash and derivative equity products
due to lower levels of market volatility and new issue volume. Fixed income
trading revenues decreased, primarily reflecting lower revenues from interest
rate swap and global high-yield trading activities, partially offset by higher
revenues from trading investment grade and government fixed income securities.
Commodity trading revenues increased, primarily due to higher revenues from
electricity trading. Foreign exchange trading revenues for the six month period
ended May 31, 2001 were comparable to the prior year period.
Principal transaction investment losses aggregating $153 million were
recognized in the six month period ended May 31, 2001 as compared to gains of
$181 million in the six month period ended May 31, 2000. Fiscal 2001's results
included unrealized losses in the Company's private equity portfolio and
certain other principal investments, primarily reflecting difficult market
conditions in the technology and telecommunications sectors. Fiscal 2000's
results primarily reflected gains from certain investments in the Company's
private equity portfolio, including Commerce One, Inc. and Equant N.V., as well
as net gains from certain other principal investments.
Commissions
Commission revenues primarily arise from agency transactions in listed and
over-the-counter equity securities, and sales of mutual funds, futures,
insurance products and options. Commission revenues decreased 14% in both the
quarter and six month period ended May 31, 2001 from the comparable periods of
fiscal 2000. The decline in both periods was primarily related to lower
commission revenues in the U.S., reflecting a significant decline in the level
of retail investor participation in the equity markets as compared to the prior
year. This decline was partially offset by higher institutional commissions
from markets in Europe, benefiting from high trading volumes.
25
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 its 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. Reverse
repurchase and repurchase agreements and securities borrowed and securities
loaned transactions may be entered into with different customers using the same
underlying securities and thereby generating a spread between the interest
revenue on the reverse repurchase agreements or securities borrowed
transactions and the interest expense on the repurchase agreements or
securities loaned transactions. Net interest revenues decreased 33% in the
quarter and increased 27% in the six month period ended May 31, 2001 from the
comparable periods of fiscal 2000. Both the decrease in the quarter and the
increase in the six month period reflect the level and mix of interest earning
assets and interest bearing 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 decrease in the quarter was also due to lower net
revenues from brokerage services provided to institutional and individual
customers, including a decrease in the level of customer margin loans. In
addition, lower margins associated with brokerage services provided to
institutional customers contributed to the decline in net interest revenues
during the quarter.
Asset Management, Distribution and Administration Fees
Asset management, distribution and administration fees include revenues from
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 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/SM/ service and technology platform.
Asset management, distribution and administration revenues decreased 3% in
the quarter and increased 5% in the six month period ended May 31, 2001 from
the comparable periods of fiscal 2000. The decrease in the quarter reflected
lower 12b-1 fees from promoting and distributing mutual funds. The decline in
the quarter also reflected lower revenues from individual investors electing
fee-based pricing. The increase in the six month period primarily reflected
higher revenues from investment management services associated with the ICS
business, and increased revenues from individual investors electing fee-based
pricing.
Non-Interest Expenses
Total non-interest expenses decreased 7% and 9% in the quarter and six month
period ended May 31, 2001 from the comparable periods of fiscal 2000.
Compensation and benefits expense decreased 14% and 17% in the quarter and six
month period ended May 31, 2001, principally reflecting lower incentive-based
compensation due to lower levels of revenues and earnings. Excluding
compensation and benefits expense, non-interest expenses increased 11% and 15%
in the quarter and six month period ended May 31, 2001. Occupancy and equipment
expense increased 40% and 34% in the quarter and six month period ended May 31,
2001, primarily due to increased office space in New York and London as well as
additional rent associated with new individual securities branches in the U.S.
Brokerage, clearing and exchange fees increased 15% in both the quarter and six
26
month period ended May 31, 2001, primarily reflecting higher brokerage and
clearing costs due to increased institutional global securities trading volume,
particularly in the U.S. and Europe. Information processing and communications
expense increased 12% and 17% in the quarter and six month period ended May 31,
2001, primarily due to increased costs associated with the Company's
information processing infrastructure, including data processing, equipment
upgrades and maintenance, telecommunication costs and market data services. A
higher number of employees utilizing information technology, communications
systems and certain data services also contributed to the increase. Marketing
and business development expense decreased 28% and 16% in the quarter and six
month period ended May 31, 2001, primarily reflecting lower advertising
expenses associated with the individual securities business. A lower level of
travel and entertainment costs also contributed to the decrease in the quarter.
Professional services expense increased 32% and 43% in the quarter and six
month period ended May 31, 2001, primarily reflecting higher consulting costs
associated with certain strategic initiatives, including e-commerce. The
increase in the six month period also reflected higher legal and temporary
staffing costs. Other expenses increased 6% and 3% in the quarter and six month
period ended May 31, 2001, reflecting higher operating expenses.
27
Investment Management
Statements of Income (dollars in millions)
Three Months Six Months
Ended May 31, Ended May 31,
------------- -------------
2001 2000 2001 2000
---- ---- ------ ------
(unaudited) (unaudited)
Revenues:
Investment banking..................................... $ 15 $ 33 $ 34 $ 77
Principal transactions:
Investments........................................ -- 6 -- 14
Commissions............................................ 8 11 18 22
Asset management, distribution and administration fees. 565 604 1,158 1,169
Interest and dividends................................. 17 20 42 34
Other.............................................. 4 10 15 17
---- ---- ------ ------
Total revenues..................................... 609 684 1,267 1,333
Interest expense....................................... 3 4 6 4
---- ---- ------ ------
Net revenues....................................... 606 680 1,261 1,329
---- ---- ------ ------
Non-interest expenses:
Compensation and benefits.............................. 202 214 419 415
Occupancy and equipment................................ 26 24 52 47
Brokerage, clearing and exchange fees.................. 43 39 86 76
Information processing and communications.............. 26 22 50 43
Marketing and business development..................... 41 42 77 81
Professional services.................................. 32 27 60 49
Other.................................................. 24 48 57 82
---- ---- ------ ------
Total non-interest expenses........................ 394 416 801 793
---- ---- ------ ------
Income before income taxes................................ 212 264 460 536
Provision for income taxes................................ 88 107 187 219
---- ---- ------ ------
Net income......................................... $124 $157 $ 273 $ 317
==== ==== ====== ======
Investment Management net revenues were $606 million and $1,261 million in
the quarter and six month period ended May 31, 2001, a decrease of 11% and 5%
from the comparable periods of fiscal 2000. Investment Management net income
was $124 million and $273 million in the quarter and six month period ended May
31, 2001, a decrease of 21% and 14% from the comparable periods of fiscal 2000.
The decreases in net income in both periods primarily reflected lower asset
management, distribution and administration fees and investment banking
revenues.
Investment Banking
Investment Management generates investment banking revenues primarily from
the underwriting of unit investment trust products. Investment banking revenues
decreased 55% in the quarter and 56% in the six month period ended May 31, 2001
from the comparable prior year periods, primarily reflecting a lower volume of
equity-related unit investment trust underwriting transactions.
Principal Transactions
Investment Management primarily generates principal transaction revenues
from the Company's net gains on capital investments in certain of its funds and
other investments.
28
The Company did not record any net principal investment gains or losses in
the quarter and six month period ended May 31, 2001. In the quarter and six
month period ended May 31, 2000, principal transaction investment revenues
primarily consisted of net gains from the Company's capital investments in
certain of its funds.
Commissions
Investment Management generates commission revenues primarily from dealer
and distribution concessions on sales of certain funds as well as certain
allocated commission revenues.
Commission revenues decreased 27% and 18% in the quarter and six month
period ended May 31, 2001 from the comparable periods of fiscal 2000, primarily
reflecting lower levels of transaction volume and allocated commission
revenues.
Net Interest
Investment Management generates net interest revenues from investment
positions as well as from certain allocated interest revenues and expenses.
Net interest revenues decreased 13% in the quarter ended May 31, 2001 from
the comparable period of fiscal 2000, primarily reflecting lower net revenues
from investment positions, generally attributable to a lower interest rate
environment in fiscal 2001. Net interest revenues increased 20% in the six
month period ended May 31, 2001, reflecting higher net revenues from higher
levels of interest earning assets, coupled with a higher level of allocated net
interest revenues.
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
pursuant to various contractual arrangements. Generally, the Company receives
fees primarily based upon mutual fund average net assets or quarterly assets
for other vehicles.
In the quarter and six month period ended May 31, 2001, asset management,
distribution and administration fees decreased 6% and 1% from the comparable
periods of fiscal 2000. In both periods, the decrease in revenues primarily
reflected lower fund management fees and other revenues resulting from a lower
level of average assets under management or supervision. This decrease also
reflected a less favorable asset mix, as the difficult market conditions that
have existed during the fourth quarter of fiscal 2000 and the first half of
fiscal 2001 have resulted in a shift of customer assets from equity products,
which typically generate higher management fees, to money market products.
As of May 31, 2001, assets under management or supervision decreased $21
billion from May 31, 2000. The majority of the decrease was attributable to
market depreciation, reflecting the declines in many global financial markets
that occurred during the fourth quarter of fiscal 2000 and the first six months
of fiscal 2001.
29
The Company's customer assets under management or supervision were as
follows:
At May 31,
-----------------------
2001 2000
----------- -----------
(dollars in billions)
Products offered primarily to individuals:
Mutual funds:
Equity...................................................... $ 94 $ 106
Fixed income................................................ 41 49
Money markets............................................... 63 52
----------- -----------
Total mutual funds....................................... 198 207
ICS assets...................................................... 32 28
Separate accounts, unit investment trust and other arrangements. 73 79
----------- -----------
Total individual......................................... 303 314
----------- -----------
Products offered primarily to institutional clients:
Mutual funds.................................................... 39 35
Separate accounts, pooled vehicle and other arrangements........ 145 159
----------- -----------
Total institutional...................................... 184 194
----------- -----------
Total assets under management or supervision(1).................... $ 487 $ 508
=========== ===========
- --------
(1)Revenues and expenses associated with certain assets are included in the
Company's Securities segment.
Non-Interest Expenses
Investment Management's non-interest expenses decreased 5% in the quarter
ended May 31, 2001 and increased 1% in the six month period ended May 31, 2001
from the comparable periods of fiscal 2000. Compensation and benefits expense
decreased 6% in the quarter ended May 31, 2001, primarily reflecting lower
levels of incentive-based compensation due to lower revenues and earnings.
Compensation and benefits expense increased 1% in the six month period ended
May 31, 2001, reflecting higher compensation costs due to integration-related
severance costs, partially offset by lower levels of incentive-based
compensation and employment levels. Excluding compensation and benefits
expense, non-interest expenses decreased 5% and increased 1% in the quarter and
six month period ended May 31, 2001. Occupancy and equipment expense increased
8% and 11% in the quarter and six month period ended May 31, 2001, due to
higher occupancy costs at certain office locations. Brokerage, clearing and
exchange fees increased 10% and 13% in the quarter and six month period ended
May 31, 2001, primarily attributable to a higher level of deferred commission
amortization associated with the sales of certain funds. Information processing
and communications expense increased 18% and 16% in the quarter and six month
period ended May 31, 2001, primarily reflecting higher costs incurred for data
processing and market data services. Marketing and business development expense
decreased 2% and 5%, primarily related to lower marketing, advertising and
travel and entertainment costs. Professional services expense increased 19% and
22% in the quarter and six month period ended May 31, 2001, primarily
reflecting higher consulting costs incurred for certain strategic initiatives,
including e-commerce and the ongoing integration of Investment Management's
operating platforms, as well as higher legal expenses. Other expenses decreased
50% and 30% in the quarter and six month period ended May 31, 2001, primarily
reflecting a lower level of allocated costs as compared to the prior year
periods.
30
Credit Services
Statements of Income (dollars in millions)
Three Months Six Months
Ended May 31, Ended May 31,
------------- --------------
2001 2000 2001 2000
------ ------ ------- ------
(unaudited) (unaudited)
Fees:
Merchant and cardmember........................................... $ 448 $ 453 $ 894 $ 902
Servicing......................................................... 476 349 903 636
------ ------ ------ ------
Total non-interest revenues................................... 924 802 1,797 1,538
------ ------ ------ ------
Interest revenue..................................................... 654 762 1,326 1,506
Interest expense..................................................... 322 360 661 718
------ ------ ------ ------
Net interest income............................................... 332 402 665 788
Provision for consumer loan losses................................... 231 204 444 427
------ ------ ------ ------
Net credit income................................................. 101 198 221 361
------ ------ ------ ------
Net revenues...................................................... 1,025 1,000 2,018 1,899
------ ------ ------ ------
Non-interest expenses:
Compensation and benefits......................................... 187 142 376 304
Occupancy and equipment........................................... 18 16 37 31
Information processing and communications......................... 122 106 238 207
Marketing and business development................................ 286 282 601 562
Professional services............................................. 48 42 97 82
Other............................................................. 85 69 159 141
------ ------ ------ ------
Total non-interest expenses................................... 746 657 1,508 1,327
------ ------ ------ ------
Income before income taxes and cumulative effect of accounting change 279 343 510 572
Provision for income taxes........................................... 108 132 197 221
------ ------ ------ ------
Income before cumulative effect of accounting change................. 171 211 313 351
Cumulative effect of accounting change............................... -- -- (13) --
------ ------ ------ ------
Net income.................................................... $ 171 $ 211 $ 300 $ 351
====== ====== ====== ======
Credit Services net revenues were $1,025 million and $2,018 million in the
quarter and six month period ended May 31, 2001, an increase of 3% and 6% from
the comparable periods of fiscal 2000. Credit Services net income of $171
million and $300 million in the quarter and six month period ended May 31, 2001
decreased 19% and 15% from the comparable periods of fiscal 2000. Net income
for the six month period ended May 31, 2001 included a charge of $13 million
from the cumulative effect of an accounting change associated with the
Company's adoption of SFAS No. 133 on December 1, 2000. Excluding the
cumulative effect of the accounting change for the six month period ended May
31, 2001, net income decreased 11%. The increase in net revenues for both
periods was primarily attributable to increased servicing fees, partially
offset by lower net interest income and a higher provision for consumer loan
losses. The decrease in net income in both periods was due to higher
non-interest expenses, partially offset by higher net revenues.
Non-Interest Revenues
Total non-interest revenues increased 15% and 17% in the quarter and six
month period ended May 31, 2001 from the comparable periods of fiscal 2000.
31
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 decreased 1% in both the
quarter and six month period ended May 31, 2001 from the comparable periods of
fiscal 2000. The decrease was primarily due to higher charge-offs of late
payment and overlimit fees, partially offset by higher merchant discount
revenue associated with the use of the Discover Card. The increase in Discover
Card merchant discount revenue was due to a higher level of sales volume in
both the quarter and six month period ended May 31, 2001.
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 credit
card asset securitizations of $2.4 billion and $6.8 billion in the quarter and
six month period ended May 31, 2001. During the comparable periods of fiscal
2000, the Company completed credit card asset securitizations of $3.0 billion
and $4.3 billion. The credit card asset securitization transactions completed
in the quarter ended May 31, 2001 have expected maturities ranging from
approximately three to five years from the date of issuance.
The table below presents the components of servicing fees (dollars in
millions):
Three Months Six Months
Ended May 31, Ended May 31,
-------------- ---------------
2001 2000 2001 2000
------- ------ ------- -------
Merchant and cardmember fees...... $ 188 $ 143 $ 371 $ 285
Interest revenue.................. 1,091 808 2,166 1,515
Interest expense.................. (409) (335) (867) (630)
Provision for consumer loan losses (394) (267) (767) (534)
------ ----- ------ ------
Servicing fees.................... $ 476 $ 349 $ 903 $ 636
====== ===== ====== ======
Servicing fees are affected by the level of securitized loans, the spread
between the interest yield on the securitized loans and the yield paid to the
investors, the rate of credit losses on securitized loans and the level of
cardmember fees earned from securitized loans. Servicing fees increased 36% and
42% in the quarter and six month period ended May 31, 2001 from the comparable
periods of fiscal 2000. The increase was due to higher levels of net interest
cash flows and increased cardmember fee revenue, primarily due to a higher
level of average securitized general purpose credit card loans. This increase
was partially offset by higher credit losses due to a higher level of average
securitized general purpose credit card loans, coupled with a higher rate of
charge-offs related to the securitized portfolio. Net securitization gains on
general purpose credit card loans, included in servicing fees, were $49 million
and $74 million in the quarter and six month period ended May 31, 2001, an
increase of 88% and 54% from the comparable periods of fiscal 2000, partially
reflecting modifications to certain assumptions in the gain calculations.
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, currently 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 any interest rate contracts entered into by the Company as part of its
interest rate risk
32
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 decreased 17% and 16% in the quarter and six month
period ended May 31, 2001 from the comparable periods of fiscal 2000. The
decrease in both periods was primarily due to lower levels of average credit
card loans and a lower yield on these loans, partially offset by a decline in
interest expense. The decrease in the level of average credit card loans for
both periods was due to a higher level of securitized credit card loans,
partially offset by higher levels of sales and balance transfer volume. The
lower yield on Discover Card loans in both periods was primarily due to lower
interest rates offered to new cardmembers and certain existing cardmembers, as
well as higher charge-offs. The decrease in interest expense in the quarter
ended May 31, 2001 was primarily due to a lower level of interest bearing
liabilities, coupled with a decrease in the Company's average cost of
borrowings, which was 6.30% in the quarter ended May 31, 2001 as compared to
6.34% in the quarter ended May 31, 2000. The decrease in interest expense in
the six month period ended May 31, 2001 reflected a lower level of interest
bearing liabilities, partially offset by an increase in the Company's average
cost of borrowings, which was 6.46% for the six month period ended May 31, 2001
as compared to 6.34% in the six month period ended May 31, 2000.
33
The following tables present analyses of Credit Services average balance
sheets and interest rates for the quarters and six month periods ended May 31,
2001 and 2000 and changes in net interest income during those periods:
Average Balance Sheet Analysis (dollars in millions)
Three Months Ended May 31,
-------------------------------------------------
2001 2000(3)
------------------------ ------------------------
Average Average
Balance Rate Interest Balance Rate Interest
-------- ------ -------- -------- ------ --------
ASSETS
Interest earning assets:
General purpose credit card........................... $21,301 11.13% $ 598 $23,456 12.10% $ 714
Other consumer loans.................................. 542 8.65 12 546 9.39 13
Investment securities................................. 650 4.70 8 574 6.12 9
Other................................................. 2,474 5.94 36 1,686 6.33 26
------- ----- ------- -----
Total interest earning assets.................. 24,967 10.40 654 26,262 11.54 762
Allowance for loan losses............................. (788) (776)
Non-interest earning assets........................... 2,195 1,796
------- -------
Total assets................................... $26,374 $27,282
======= =======
LIABILITIES AND SHAREHOLDER'S EQUITY
Interest bearing liabilities:
Interest bearing deposits
Savings............................................ $ 1,719 4.60% $ 20 $ 1,492 5.44% $ 20
Brokered........................................... 9,001 6.72 152 7,618 6.55 126
Other time......................................... 3,007 6.10 46 3,018 6.11 46
------- ----- ------- -----
Total interest bearing deposits................ 13,727 6.32 218 12,128 6.31 192
Other borrowings...................................... 6,528 6.28 104 10,459 6.39 168
------- ----- ------- -----
Total interest bearing liabilities............. 20,255 6.30 322 22,587 6.34 360
Shareholder's equity/other liabilities................ 6,119 4,695
------- -------
Total liabilities and shareholder's equity..... $26,374 $27,282
======= =======
Net interest income................................... $ 332 $ 402
===== =====
Net interest margin(1)................................ 5.28% 6.08%
Interest rate spread(2)............................... 4.10% 5.20%
- --------
(1)Net interest margin represents net interest income as a percentage of total
average interest earning assets.
(2)Interest rate spread represents the difference between the rate on total
average interest earning assets and the rate on total average interest
bearing liabilities.
(3)Certain prior-year information has been reclassified to conform to the
current year's presentation.
34
Average Balance Sheet Analysis (dollars in millions)
Six Months Ended May 31,
-------------------------------------------------
2001 2000(3)
- - ------------------------ ------------------------
Average Average
Balance Rate Interest Balance Rate Interest
-------- ------ -------- -------- ------ --------
ASSETS
Interest earning assets:
General purpose credit card........................... $21,426 11.22% $1,199 $23,322 12.04% $1,404
Other consumer loans.................................. 542 9.12 25 525 9.24 24
Investment securities................................. 726 5.54 20 628 6.13 19
Other................................................. 2,516 6.55 82 1,680 7.01 59
------- ------ ------- ------
Total interest earning assets.................. 25,210 10.55 1,326 26,155 11.51 1,506
Allowance for loan losses............................. (787) (777)
Non-interest earning assets........................... 2,162 1,793
------- -------
Total assets................................... $26,585 $27,171
======= =======
LIABILITIES AND SHAREHOLDER'S EQUITY
Interest bearing liabilities:
Interest bearing deposits
Savings............................................ $ 1,746 5.17 $ 45 $ 1,531 5.25% $ 40
Brokered........................................... 8,904 6.72 298 7,447 6.52 243
Other time......................................... 3,010 6.19 93 3,030 6.07 92
------- ------ ------- ------
Total interest bearing deposits................ 13,660 6.40 436 12,008 6.25 375
Other borrowings...................................... 6,873 6.56 225 10,640 6.45 343
------- ------ ------- ------
Total interest bearing liabilities............. 20,533 6.46 661 22,648 6.34 718
Shareholder's equity/other liabilities................ 6,052 4,523
------- -------
Total liabilities and shareholder's equity..... $26,585 $27,171
======= =======
Net interest income................................... $ 665 $ 788
====== ======
Net interest margin(1)................................ 5.29% 6.02%
Interest rate spread(2)............................... 4.09% 5.17%
- --------
(1)Net interest margin represents net interest income as a percentage of total
average interest earning assets.
(2)Interest rate spread represents the difference between the rate on total
average interest earning assets and the rate on total average interest
bearing liabilities.
(3)Certain prior-year information has been reclassified to conform to the
current year's presentation.
35
Rate/Volume Analysis (dollars in millions)
Three Months Ended Six Months Ended
May 31, 2001 vs. 2000 May 31, 2001 vs. 2000
--------------------- ---------------------
Increase/(Decrease) Increase/(Decrease)
Due to Changes in Due to Changes in
--------------------- ---------------------
Volume Rate Total Volume Rate Total
------ ----- ------ ------ ------ ------
INTEREST REVENUE
General purpose credit card................ $(65) $(51) $(116) $(116) $ (89) $(205)
Other consumer loans....................... -- (1) (1) 1 -- 1
Investment securities...................... 1 (2) (1) 3 (2) 1
Other...................................... 9 1 10 23 -- 23
----- -----
Total interest revenue.............. (37) (71) (108) (56) (124) (180)
----- -----
INTEREST EXPENSE
Interest bearing deposits:
Savings................................. 3 (3) -- 6 (1) 5
Brokered................................ 22 4 26 46 9 55
Other time.............................. -- -- -- (1) 2 1
----- -----
Total interest bearing deposits..... 26 -- 26 51 10 61
Other borrowings........................... (63) (1) (64) (122) 4 (118)
----- -----
Total interest expense.............. (37) (1) (38) (69) 12 (57)
----- -----
Net interest income........................ $ -- $(70) $ (70) $ 13 $(136) $(123)
==== ==== ===== ===== ===== =====
The supplemental table below provides average managed loan balance and rate
information that takes into account both owned and securitized loans:
Supplemental Average Managed Loan Balance Sheet Information (dollars in
millions)
Three Months Ended May 31,
---------------------------------------------------
2001 2000(1)
------------------------- -------------------------
Avg. Bal. Rate % Interest Avg. Bal. Rate % Interest
--------- ------ -------- --------- ------ --------
General purpose credit card..................... $49,658 13.34% $1,669 $42,957 13.69% $1,478
Total interest earning assets................... 54,241 12.76 1,745 45,904 13.60 1,570
Total interest bearing liabilities.............. 49,529 5.85 730 43,284 6.39 695
General purpose credit card interest rate spread 7.49 7.30
Interest rate spread............................ 6.91 7.21
Net interest margin............................. 7.42 7.58
Six Months Ended May 31,
---------------------------------------------------
2001 2000(1)
------------------------- -------------------------
Avg. Bal. Rate % Interest Avg. Bal. Rate % Interest
--------- ------ -------- --------- ------ --------
General purpose credit card..................... $49,468 13.50% $3,329 $41,993 13.52% $2,839
Total interest earning assets................... 54,088 12.95 3,492 44,950 13.44 3,021
Total interest bearing liabilities.............. 49,411 6.21 1,528 42,380 6.36 1,348
General purpose credit card interest rate spread 7.29 7.16
Interest rate spread............................ 6.74 7.08
Net interest margin............................. 7.28 7.44
- --------
(1)Certain prior-year information has been reclassified to conform to the
current year's presentation.
36
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 $787 million at May 31, 2001 and $783 million
at November 30, 2000.
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 13% and 4% in the quarter and six month period
ended May 31, 2001 from the comparable periods of fiscal 2000. The increase in
both periods was primarily due to higher net charge-off rates, partially offset
by lower levels of average general purpose credit card loans.
General purpose credit card loans are considered delinquent when interest or
principal payments become 30 days past due. General purpose credit card loans
are charged-off when they become 180 days past due, 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.
During the quarter ended May 31, 2001, net charge-offs in both the owned and
managed portfolios increased as compared to the quarter ended February 28,
2001. In the U.S., the increase in unemployment, reduced overtime and the
rising debt service burden on borrowers, coupled with the seasoning of the
Company's consumer loan portfolio, have contributed to the higher net
charge-off rate. In addition, during the quarter ended May 31, 2001, there was
a significant increase in the number of accounts with bankruptcy notifications,
which are charged-off 60 days after receipt of such notification. If these
conditions and trends continue to persist, the rate of net charge-offs may be
higher in future periods.
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 general purpose credit card loan
delinquencies and charge-offs, changes in consumer spending and payment
behaviors, bankruptcy trends, the seasoning of the Company's consumer 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.
The following table presents owned and managed general purpose credit card
loan delinquency and net charge-off rate information:
Asset Quality (dollars in millions)
May 31, 2001 May 31, 2000 November 30, 2000
----------------- ----------------- -----------------
Owned Managed Owned Managed Owned Managed
-------- -------- -------- -------- -------- --------
General purpose credit card loans at period-end $20,909 $50,227 $22,503 $43,698 $21,866 $47,123
General purpose credit card loans contractually
past due as a percentage of period-end
general purpose credit card loans:
30 to 89 days........................... 2.93% 3.24% 2.52% 3.10% 3.01% 3.50%
90 to 179 days.......................... 2.32% 2.60% 1.62% 2.01% 2.04% 2.42%
Net charge-offs as a percentage of average
general purpose credit card loans
(year-to-date)............................... 4.11% 4.88% 3.60% 4.43% 3.63% 4.40%
37
Non-Interest Expenses
Non-interest expenses increased 14% in both the quarter and six month period
ended May 31, 2001 from the comparable periods of fiscal 2000. Compensation and
benefits expense increased 32% and 24% in the quarter and six month period
ended May 31, 2001. The increase in both periods was primarily due to higher
costs associated with increased employment levels resulting from higher levels
of transaction volume and collection activities. Occupancy and equipment
expense increased 13% and 19% in the quarter and six month period ended May 31,
2001. The increase in both periods was primarily due to higher occupancy costs
associated with increased office space, including new transaction processing
centers. Information processing and communications expense increased 15% in
both the quarter and six month period ended May 31, 2001 from the comparable
periods of fiscal 2000. The increase in both periods primarily reflects higher
volume-related external data and transaction processing costs. Marketing and
business development expense increased 1% and 7% in the quarter and six month
period ended May 31, 2001. The increase in both periods was primarily due to
increased promotional costs and higher advertising expense associated with a
new advertising campaign for the Discover Card. These increases were partially
offset by lower direct mailing costs. The increase in the six month period also
reflected higher cardmember rewards expense. Professional services expense
increased 14% and 18% in the quarter and six month period ended May 31, 2001.
The increase in both periods was primarily due to increased costs associated
with account collection activities, as well as higher technology consulting
costs. Other expense increased 23% and 13% in the quarter and six month period
ended May 31, 2001, primarily reflecting increases in certain operating
expenses due to higher levels of transaction volume and business activity. The
increase in the six month period was partially offset by a decline in inquiry
fees resulting from fewer new account applications.
Liquidity and Capital Resources
The Company's total assets increased to $497.4 billion at May 31, 2001 from
$426.8 billion at November 30, 2000, primarily attributable to increases in
cash and cash equivalents, financial instruments owned and securities borrowed.
Securities provided as collateral also increased primarily due to the adoption
of SFAS No. 140, which required the Company to recognize securities received as
collateral (as opposed to cash) in certain securities lending transactions in
the condensed consolidated statement of financial condition as of May 31, 2001.
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, in the future may expand or contract
its capital base to address the changing needs of its businesses. The Company
returns internally generated equity capital that 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 raises
funding for its Securities and Investment Management businesses 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 borrowings; securities
lending; buy/sell agreements; municipal reinvestments; master notes; and
committed and uncommitted lines of credit. Repurchase agreement transactions,
38
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.
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; deposits; Federal Funds; and short-term bank
notes. The Company sells consumer loans through asset securitizations using
several transaction structures, including an extendible asset-backed
certificate program.
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 deposit accounts sold directly to
cardmembers and 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 individual and institutional
certificates of deposits. The Company, through Discover Bank, an 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 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 June 30, 2001, the Company's credit ratings were as follows:
Commercial Senior
Paper Debt
------------ --------
Dominion Bond Rating Service Limited... R-1 (middle) AA (low)
Fitch.................................. F1+ AA
Moody's Investors Service.............. P-1 Aa3
Rating and Investment Information, Inc. a-1+ AA
Standard & Poor's...................... A-1+ 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.
During the six months ended May 31, 2001, the Company issued senior notes
aggregating $15,720 million, including non-U.S. dollar currency notes
aggregating $4,654 million. These notes have maturities from 2002 to 2031 and a
weighted average coupon interest rate of 5.53% at May 31, 2001. The Company has
entered into certain transactions to obtain floating interest rates based
primarily on short-term London Interbank Offered Rates ("LIBOR") trading
levels. At May 31, 2001, the aggregate outstanding principal amount of the
Company's Senior Indebtedness (as defined in the Company's public debt shelf
registration statements) was approximately $93.8 billion (including Senior
Indebtedness consisting of guaranteed obligations of the indebtedness of
subsidiaries). Between May 31, 2001 and June 30, 2001, the Company's long-term
borrowings, net of repayments and repurchases, decreased by approximately
$1,198 million, which primarily represented the early extinguishment of debt
issued by Morgan Stanley Aircraft Finance.
39
During the six months ended May 31, 2001, the Company purchased $994 million
of its common stock. Subsequent to May 31, 2001 and through June 30, 2001, the
Company purchased an additional $61 million of its common 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 specified levels of shareholders' equity. The Company believes that
the covenant restrictions will not impair the Company's ability to pay its
current level of dividends. At May 31, 2001, 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, each as defined. At May 31, 2001, no borrowings were
outstanding under the MS&Co. Facility.
The Company also maintains a revolving credit facility that enables Morgan
Stanley & Co. International Limited ("MSIL"), the Company's London-based
broker-dealer subsidiary, to obtain committed funding from a syndicate of banks
(the "MSIL Facility"). The MSIL Facility incorporates a revolving securities
repo facility and an unsecured revolving credit facility. MSIL provides a broad
range of collateral under repurchase agreements for the secured repo facility
and a Company guarantee for the unsecured facility. The syndicate of banks are
committed to provide up to an aggregate of $1.95 billion, available in six
major currencies. The facility agreement contains restrictive covenants which
require, among other things, that MSIL maintain specified levels of
Stockholder's Equity and Financial Resources, each as defined in the MSIL
Facility. At May 31, 2001 no borrowings were outstanding under the MSIL
Facility.
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 May 31, 2001,
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 May 31, 2001, certain assets of the Company, such as real property,
equipment and leasehold improvements of $2.9 billion, aircraft assets of $4.2
billion, and goodwill and other intangible assets of $1.5 billion, were
illiquid. The Company also has commitments to fund certain fixed assets and
other less liquid investments.
Certain equity investments made in connection with the Company's private
equity and other principal investment activities, high-yield debt securities,
certain collateralized mortgage obligations and mortgage-related loan products,
bridge financings, and certain senior secured loans and positions are not
highly liquid. At May 31, 2001, the Company had aggregate principal investments
(including direct investments and partnership interests) with a carrying value
of approximately $1.2 billion, of which approximately $0.4 billion represented
the Company's investments in its real estate funds. The Company also has
approximately $832 million in commitments related to its private equity and
other principal investment activities. The Company has provided, and will
continue to provide, financing (including margin lending and other extensions
of credit) to clients.
40
In connection with the Company's fixed income securities activities, the
Company underwrites, trades, invests and makes markets in non-investment grade
instruments ("high-yield instruments"). For purposes of this discussion,
high-yield instruments are defined as fixed income, emerging market and
preferred equity securities and distressed debt rated BB+ or lower (or
equivalent ratings by recognized credit rating agencies) as well as non-rated
securities which, in the opinion of the Company, contain credit risks
associated with non-investment grade instruments. High-yield instruments
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, therefore, are more sensitive to adverse economic
conditions. In addition, the market for high-yield instruments is, and may
continue to be, characterized by periods of volatility and illiquidity. The
Company has credit and other risk policies and procedures to monitor total
inventory positions and risk concentrations for high-yield instruments that are
administered in a manner consistent with the Company's overall risk management
policies and control structure. The Company records high-yield instruments at
fair value. Unrealized gains and losses are recognized currently in the
Company's consolidated statements of income. At May 31, 2001 and November 30,
2000, the Company had exposure to high-yield instruments owned with a market
value of approximately $2.3 billion and $2.2 billion, respectively, and
exposure to high-yield instruments sold, not yet purchased with a market value
of $0.5 billion and $0.5 billion, respectively.
In connection with certain of its business activities, the Company provides,
on a selective basis, financing or financing commitments to companies in the
form of senior and subordinated debt, including bridge financing. The borrowers
may be rated investment grade or non-investment grade. These loans and funding
commitments typically are secured against the borrower's assets (in the case of
senior loans), have varying maturity dates and are generally contingent upon
certain representations, warranties and contractual conditions applicable to
the borrower. As part of these activities, the Company may syndicate and trade
certain positions of these loans. At May 31, 2001 and November 30, 2000, the
aggregate value of investment grade loans and positions was $2.1 billion and
$2.1 billion, respectively, and the aggregate value of non-investment grade
loans and positions was $1.7 billion and $2.2 billion, respectively. At May 31,
2001, the Company also had provided additional commitments associated with
these activities to investment grade issuers aggregating $8.9 billion and
commitments to non-investment grade issuers aggregating $0.9 billion.
The Company is building a one million-square-foot office tower in New York
City. 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 fiscal 2002. The total investment in this project is estimated
to be approximately $700 million.
At May 31, 2001, 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 $29.8 billion. The net replacement cost of
all derivative products in a gain position represents the Company's maximum
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 procedures. 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 May 31, 2001, 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 $53 million. Aggregate VaR increased
41
from $42 million at the quarter ended February 28, 2001, as an increase in
equity price VaR was partially offset by decreases in foreign exchange rate and
commodity price VaR, and a higher diversification benefit. The increase in the
quarter-end equity price VaR reflects certain trading risk exposures that were
subsequently reduced. For a more representative summary of the Company's
trading and related market risk profile during the course of the quarter ended
May 31, 2001, see the average VaR for each of the Company's primary risk
categories in the table below.
The Company uses VaR as one of a range of 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, 2000.
The table below presents the Company's VaR for each of the Company's primary
risk exposures and on an aggregate basis at May 31, 2001, February 28, 2001 and
November 30, 2000, incorporating substantially all financial instruments
generating market risk that are managed by the Company's institutional trading
businesses. This measure of VaR incorporates most of the Company's
trading-related market risks. Aggregate VaR also incorporates (a) the funding
liabilities related to institutional trading positions and (b) public-company
equity positions recorded as principal investments by the Company. The
incremental impact on VaR of these non-trading positions was not material as of
May 31, 2001, February 28, 2001 and November 30, 2000, and, therefore, the
table below does not separately report trading and non-trading VaRs.
Primary Market Risk Category 99%/One-Day VaR
- ---------------------------- ------------------------------------------
At May 31, At February 28, At November 30,
2001 2001 2000
---------- --------------- ---------------
(dollars in millions, pre-tax)
Interest rate.................. $28 $28 $28
Equity price................... 41 20 27
Foreign exchange rate.......... 4 6 5
Commodity price................ 25 27 17
--- --- ---
Subtotal....................... 98 81 77
Less diversification benefit(1) 45 39 35
--- --- ---
Aggregate VaR.................. $53 $42 $42
=== === ===
- --------
(1)Equals the difference between Aggregate VaR and the sum of the VaRs for the
four risk categories. This benefit arises because the simulated 99%/one-day
losses for each of the four primary market risk categories occur on
different days; similar diversification benefits also are taken into account
within each such category.
In order to facilitate comparisons with other global financial services
firms, the Company notes that its Aggregate 95%/one-day VaR at May 31, 2001 was
$37 million.
The table below presents the high, low and average 99%/one-day Trading VaR
over the course of the second quarter of fiscal 2001 for substantially all of
the Company's institutional trading activities. Certain market risks included
in the quarter-end Aggregate VaR discussed above are excluded from this measure
(e.g., equity price risk in public-company equity positions recorded as
principal investments by the Company and certain funding liabilities related to
institutional trading positions).
Daily 99%/One-Day VaR
for the Second Quarter of
Primary Market Risk Category Fiscal 2001
- ---------------------------- ------------------------------
High Low Average
---- --- -------
(dollars in millions, pre-tax)
Interest rate............ $44 $25 $32
Equity price............. 47 14 23
Foreign exchange rate.... 10 3 4
Commodity price.......... 31 18 24
Trading VaR.............. 61 41 47
42
The histogram below presents the Company's daily 99%/one-day VaR for its
institutional trading activities during the quarter ended May 31, 2001:
Description of Histogram: The horizontal axis of the chart categorizes the
99%/one-day Value-at-Risk into numerical ranges. The vertical axis of the chart
indicates the number of trading days that Value-at-Risk fell into a given
numerical range. The histogram shows that distribution of daily 99%/one-day
Value-at-Risk during the quarter ended May 31, 2001 was:
Value-at-Risk
(in millions of U.S. dollars) Number of Days
----------------------------- --------------
less than 42 5
42 to 44 13
44 to 46 16
46 to 48 11
48 to 50 8
50 to 52 3
52 to 54 3
54 to 56 1
greater than 56 4
The histogram below presents the distribution of daily net revenues during
the quarter ended May 31, 2001 for the Company's institutional trading
businesses (net of interest expense and including commissions and primary
revenue credited to the trading businesses):
Description of Histogram: The horizontal axis of the chart categorizes daily net
revenue of the institutional trading businesses into numerical ranges. The
vertical axis of the chart indicates the number of trading days that revenue
fell into a given numerical range. The histogram shows that distribution of
daily institutional trading revenue during the quarter ended May 31, 2001 was:
Daily Institutional Trading Revenue
(in millions of U.S. dollars) Number of Days
----------------------------------- --------------
less than -10 1
-10 to -5 0
-5 to 0 1
0 to 5 0
5 to 10 2
10 to 15 3
15 to 20 6
20 to 25 5
25 to 30 4
30 to 35 5
35 to 40 10
40 to 45 4
45 to 50 5
50 to 55 4
55 to 60 3
60 to 65 3
65 to 70 2
70 to 75 0
75 to 80 1
80 to 85 1
85 to 90 2
greater than 90 2
As of May 31, 2001 the level of interest rate risk exposure associated with
the Company's consumer lending activities, as measured by the reduction in
pre-tax income resulting from a hypothetical, immediate 100-basis-point
increase in interest rates, had not changed significantly from November 30,
2000.
43
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, 2000 and in the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended February 28, 2001.
Penalty Bid Litigation. In the Myers litigation, on May 16, 2001, the U.S.
Court of Appeals for the Ninth Circuit affirmed the district court's dismissal
of the complaint.
IPO Fee Litigation. On April 11, 2001, the court entered an order denying
plaintiffs' motion to vacate or in the alternative for reconsideration in In re
Public Offering Fee Antitrust Litigation. On May 10, 2001, plaintiffs filed a
notice of appeal.
On May 23, 2001, the court consolidated the issuer plaintiff actions,
including CHS Electronics and Weinman, under a new caption entitled In re
Issuer Plaintiff Initial Public Offering Fee Antitrust Litigation. On July 6,
2001, plaintiffs filed a consolidated class action complaint.
IPO Allocation Matters. Several other purported class action antitrust
complaints have been filed in the U.S. District Court for the Southern District
of New York. Numerous other purported class action securities complaints have
been filed in the U.S. District Court for the Southern District of New York. In
addition, other purported class action complaints alleging federal securities
violations and either federal or state antitrust violations have been filed in
the same court. Some of these complaints allege that continuous "buy"
recommendations by defendants' research analysts improperly increased or
sustained the prices at which the securities traded after the IPO.
On June 5, 2001, a purported derivative action, captioned Albrect v. Bauman,
et al., was filed in the U.S. District Court for the Southern District of New
York against the directors of the Company and the Company as a nominal
defendant. The complaint alleges that the directors breached their duties of
loyalty, due care and good faith by exposing the Company to losses as a result
of its IPO allocation practices and that the directors allowed the Company to
violate antitrust and securities laws. The complaint seeks unspecified damages.
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders of the Company was held on March 22,
2001. Further details concerning matters submitted to a vote of stockholders
can be found in the Company's Quarterly Report on Form 10-Q for the fiscal
quarter ended February 28, 2001.
44
Item 5. Other Information
The following table sets forth certain supplemental financial information
regarding the quarterly revenues for the Company's Securities business for the
first and second quarters of fiscal 2001 and first, second, third and fourth
quarters of fiscal 2000 and fiscal l999.
Three Months Ended
---------------------
May 31, Feb. 28,
2001 2001
------- --------
(dollars in millions)
Securities advisory revenues.............................. $ 291 $ 450
Securities underwriting revenues.......................... $ 495 $ 488
Institutional securities sales and trading net revenues(1) $2,537 $2,564
Individual investor group net revenues.................... $1,141 $1,196
Three Months Ended
----------------------------------
Nov. 30, Aug. 31, May 31, Feb. 29,
2000 2000 2000 2000
-------- -------- ------- --------
(dollars in millions)
Securities advisory revenues.............................. $ 566 $ 515 $ 640 $ 420
Securities underwriting revenues.......................... $ 542 $ 630 $ 697 $ 871
Institutional securities sales and trading net revenues(1) $1,436 $1,938 $2,790 $2,698
Individual investor group net revenues.................... $1,276 $1,313 $1,498 $1,461
Three Months Ended
----------------------------------
Nov. 30, Aug. 31, May 31, Feb. 28,
1999 1999 1999 1999
-------- -------- ------- --------
(dollars in millions)
Securities advisory revenues.............................. $ 693 $ 502 $ 342 $ 358
Securities underwriting revenues.......................... $ 622 $ 685 $ 652 $ 576
Institutional securities sales and trading net revenues(1) $1,381 $1,411 $1,903 $1,960
Individual investor group net revenues.................... $1,136 $1,017 $1,153 $ 980
- --------
(1)Includes principal trading, commissions and net interest revenues.
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 March 21, 2001 reporting Item 5 and Item 7 in connection
with the announcement of the Company's financial results for the fiscal
quarter ended February 28, 2001.
Form 8-K dated April 18, 2001 reporting Item 5 and Item 7.
45
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)
By: /s/ JOANNE PACE
-----------------------------------
Joanne Pace, Controller and
Principal Accounting Officer
Date: July 13, 2001
46
EXHIBIT INDEX
MORGAN STANLEY DEAN WITTER & CO.
Quarter Ended May 31, 2001
Exhibit
No. Description
- ------- -----------
10 Summary of Arrangement between the Company and John J. Mack dated as of March 20, 2001.
11 Computation of earnings per share.
12 Computation of ratio of earnings to fixed charges.
15 Letter of awareness from Deloitte & Touche LLP, dated July 10, 2001, concerning unaudited interim
financial information.
E-1