Business Context and Reporting Period
Company: Morgan Stanley Dean Witter & Co.
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Quarter and nine months ended August 31, 1999
Business Overview: A global financial services firm operating primarily through two segments: Securities and Asset Management (investment banking, trading, asset management) and Credit Services (Discover Card and related credit products).
Key Financial Metrics
| Metric (in millions, except per share) | Q3 1999 | Q3 1998 | 9M 1999 | 9M 1998 |
|---|---|---|---|---|
| Total Revenues | $9,702 | $7,498 | $27,161 | $23,511 |
| Net Revenues | $5,343 | $3,841 | $16,351 | $12,475 |
| Net Income | $970 | $626 | $3,158 | $2,052 |
| Diluted EPS | $1.65 | $1.01 | $5.35 | $3.28 |
| Return on Common Equity (Annualized) | 25.9% | 18.9% | 28.9% | 20.3% |
| Total Assets | $340,870 | $317,590 | $340,870 | $317,590 |
| Cash and Cash Equivalents | $13,382 | $16,878 | $13,382 | $16,878 |
| Long-Term Borrowings | $29,038 | $27,435 | $29,038 | $27,435 |
| Shareholders' Equity | $15,445 | $14,119 | $15,445 | $14,119 |
Material Changes vs. Prior Period
- Profitability Surge: Net income increased 55% in the quarter and 54% for the nine-month period compared to the prior year. Excluding a $117 million cumulative effect of an accounting change in the prior year, the nine-month increase was 46%.
- Revenue Drivers: Growth was driven by higher principal trading revenues (up 137% in the quarter), investment banking fees (up 47% in the quarter), and improved Credit Services results.
- Expense Growth: Non-interest expenses rose 35% in the quarter, primarily due to a 48% increase in compensation and benefits linked to higher revenues and earnings.
- Asset Quality Improvement: The provision for consumer loan losses decreased 60% in the quarter and 57% for the nine months, reflecting lower charge-offs and the sale of certain credit portfolios in the prior year.
- Balance Sheet Expansion: Total assets grew by $23.3 billion, driven by increases in financial instruments owned, securities borrowed, and customer receivables.
Guidance, Outlook, Risks, and Unusual Items
- Accounting Change: The prior year (1998) results included a $117 million charge for the cumulative effect of adopting SOP 98-5 regarding start-up costs for closed-end funds. This non-recurring item reduced prior year comparability.
- Year 2000 (Y2K) Risk: Management identified Y2K as a significant risk. The company has completed remediation and testing phases, with integration testing complete as of September 30, 1999. Estimated total costs are between $225 million and $250 million, with approximately $190 million expended through August 31, 1999. A specific Y2K Funding Plan is in place to ensure liquidity.
- Market Conditions: Global markets were favorable but less robust than the first two quarters of 1999. The Federal Reserve raised interest rates twice during the quarter to combat inflation fears.
- Acquisition: The company completed the acquisition of AB Asesores (Spain) in March 1999, contributing to international growth.
- Capital Management: The company repurchased $1.732 billion of common stock during the nine-month period and maintains a strong capital position exceeding regulatory requirements.
Investor Verification Checklist
- Y2K Contingency: Verify the status of external counterparty testing and the adequacy of the $225-$250 million budget for remaining Y2K remediation costs.
- Trading Volatility: Assess the sustainability of the 137% increase in principal trading revenues, which are highly sensitive to market volatility and liquidity.
- Consumer Loan Quality: Monitor net charge-off rates and delinquency trends in the Discover Card portfolio to ensure the reduced provision for loan losses remains appropriate.
- Compensation Leverage: Review the correlation between revenue growth and the 48% spike in compensation expenses to evaluate margin sustainability.
- Illiquid Assets: Examine the $1.35 billion in mortgage-related portfolio positions and $1.55 billion in high-yield/emerging market debt that are noted as having lower liquidity.