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, 1998.
Context: The Company operates two primary segments: Securities and Asset Management, and Credit and Transaction Services. The reporting period was characterized by extreme turbulence in global financial markets, particularly in August 1998, driven by economic turmoil in Asia, Russia, and emerging markets. The Company recently completed the sale of its Correspondent Clearing business and its Prime Option MasterCard portfolio, and announced the sale of its Global Custody business to Chase Manhattan Corporation.
Key Financial Metrics
| Metric (in millions, except per share) | Q3 1998 | Q3 1997 | 9M 1998 | 9M 1997 |
|---|---|---|---|---|
| Total Revenues | $7,498 | $7,257 | $23,511 | $20,193 |
| Net Revenues | $3,841 | $4,107 | $12,475 | $11,101 |
| Net Income | $645 | $678 | $2,190 | $1,776 |
| Diluted EPS | $1.05 | $1.09 | $3.51 | $2.85 |
| Total Assets (Aug 31, 1998) | $360,929 | |||
| Total Liabilities (Aug 31, 1998) | $345,888 | |||
| Shareholders' Equity (Aug 31, 1998) | $13,642 | |||
| Cash and Cash Equivalents (Aug 31, 1998) | $9,820 | |||
| Long-Term Borrowings (Aug 31, 1998) | $28,070 |
Material Changes vs. Prior Period
- Quarterly Performance: Net income decreased 5% to $645 million compared to the prior year quarter. This decline was primarily driven by lower revenues from principal trading and principal investment activities, partially offset by higher commission revenues and lower incentive-based compensation expenses.
- Nine-Month Performance: Net income increased 19% to $2,190 million compared to the prior year period. Growth was fueled by higher revenues in investment banking, commissions, and asset management fees, despite lower principal investment revenues.
- Segment Results:
- Securities and Asset Management: Quarterly net income fell 14% due to a 36% drop in principal trading revenues (impacted by fixed income market volatility) and investment losses of $174 million. However, nine-month net income rose 21%.
- Credit and Transaction Services: Quarterly net income reached a record $175 million (up 31%), driven by a 27% decrease in the provision for consumer loan losses and increased fee revenue.
- Balance Sheet: Total assets grew 19% to $360.9 billion, reflecting increases in securities borrowed, financial instruments owned, and resale agreements.
Outlook, Risks, and Unusual Items
- Market Conditions: Management noted that global financial markets remained extremely turbulent, particularly in August, due to the Russian debt restructuring and Asian economic difficulties. This led to reduced liquidity in credit-sensitive fixed income securities.
- Strategic Dispositions: The Company is divesting non-core businesses to focus on core segments. Completed sales include the Correspondent Clearing business and Prime Option portfolio. The sale of the Global Custody business to Chase was completed in September 1998 (subsequent to period end).
- LTCP Investment: In September 1998, the Company invested $300 million in the Long-Term Capital Portfolio, L.P. as part of a consortium recapitalization effort.
- Year 2000 and EMU: The Company estimates total Year 2000 compliance costs between $225 million and $250 million, with approximately $117 million expended through Q3 1998. Estimated costs for Euro (EMU) preparation are approximately $70 million. Risks include potential system failures and third-party non-compliance.
- Legal Proceedings: The Company is a defendant in various lawsuits, including class actions regarding "flipping" restrictions in public offerings and the Sumitomo Copper litigation (settled pending court approval). Management believes the resolution of these matters will not have a material adverse effect on financial condition.
Investor Verification Checklist
- Trading Volatility Impact: Verify the extent of unrealized losses in the fixed income and emerging markets debt portfolios given the August 1998 market turmoil.
- Consumer Loan Quality: Monitor net charge-off rates and the provision for loan losses, noting the recent decrease in charge-offs but potential sensitivity to economic downturns.
- Year 2000 Readiness: Confirm the status of remediation and testing for mission-critical applications and the compliance status of key third-party counterparties.
- Liquidity Position: Review the composition of short-term borrowings and the availability of committed credit facilities ($6.0 billion MSDW Facility, $1.875 billion MS&Co. Facility) in light of market stress.
- LTCP Exposure: Assess the risk profile of the $300 million investment in Long-Term Capital Portfolio and the potential for future capital calls or losses.