Business Context and Reporting Period
Company: Morgan Stanley Dean Witter & Co. (formerly Morgan Stanley, Dean Witter, Discover & Co.)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Quarter and six months ended May 31, 1998
Fiscal Year End: November 30 (changed from December 31 following the 1997 merger with Dean Witter Discover)
Business Overview: The Company operates two primary segments: Securities and Asset Management (investment banking, trading, asset management) and Credit and Transaction Services (Discover Card, merchant services). The financial statements reflect the merger as a pooling of interests.
Key Financial Metrics
| Metric (in millions, except per share) | Q2 1998 | Q2 1997 | 6 Months 1998 | 6 Months 1997 |
|---|---|---|---|---|
| Total Revenues | $8,428 | $6,376 | $16,013 | $12,936 |
| Net Revenues | $4,599 | $3,520 | $8,634 | $6,994 |
| Net Income | $854 | $527 | $1,545 | $1,098 |
| Earnings Per Share (Diluted) | $1.37 | $0.84 | $2.47 | $1.75 |
| Total Assets (May 31, 1998) | $380,665 | |||
| Total Liabilities (May 31, 1998) | $365,441 | |||
| Shareholders' Equity (May 31, 1998) | $13,825 | |||
| Cash and Cash Equivalents (May 31, 1998) | $9,271 | |||
| Long-Term Borrowings (May 31, 1998) | $28,354 |
Return on Common Equity (Annualized): 25.0% for the quarter ended May 31, 1998 (vs. 18.3% in 1997).
Material Changes vs. Prior Period
- Revenue Growth: Net revenues increased 31% in the quarter and 23% in the six-month period compared to the prior year. This was driven by higher investment banking fees, principal transaction trading revenues, and asset management fees.
- Profitability: Net income rose 62% in the quarter and 41% over six months. Diluted EPS increased significantly due to higher earnings and share repurchases.
- Expense Increases: Non-interest expenses increased 21% in the quarter and 18% over six months. Compensation and benefits rose 34% (quarter) and 27% (six months), primarily due to higher incentive compensation linked to revenue growth.
- Balance Sheet Expansion: Total assets grew from $302.3 billion to $380.7 billion. This increase includes growth in financial instruments owned and securities borrowed, as well as a $13.5 billion increase in assets and liabilities due to the adoption of SFAS No. 127 (recognition of collateral).
- Loan Loss Provision: The provision for consumer loan losses decreased 27% in the quarter and 10% over six months, attributed to lower net charge-offs and the sale of the Prime Option portfolio.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Strategic Moves
- Strategic Divestitures: The Company announced agreements to sell non-core businesses to focus on Securities/Asset Management and Credit/Transaction Services:
- Global Custody Business: Agreed to sell to Chase Manhattan Corporation.
- Correspondent Clearing Business: Agreed to sell to NationsBanc Montgomery Securities.
- SPS Transaction Services: Agreed to sell substantially all assets to Associates First Capital Corporation.
- Prime Option Portfolio: Completed sale of the MasterCard portfolio; gain was not material.
- Capital Management: The Board authorized a $3 billion common stock repurchase program. The Company repurchased $1.5 billion of stock in the six-month period. Dividends paid totaled $265 million.
- Market Conditions: Management noted favorable conditions in U.S. and European markets but highlighted volatility in Southeast Asia and Russia. The Company expects results to fluctuate based on market activity and economic factors.
Risks and Contingencies
- Legal Proceedings: The Company is involved in various lawsuits, including class actions regarding Term Trusts and litigation involving the Global Opportunity Fund. Management believes outcomes will not materially affect financial condition but could impact operating results for specific periods.
- Year 2000 and EMU: Estimated total expenditures for Year 2000 compliance are approximately $125 million. Costs are being expensed as incurred. The Company is also incurring costs to prepare for the European Economic and Monetary Union (EMU).
- Liquidity and Credit Risk: The Company relies on external financing. While credit ratings remain strong (A-1/A+), access to capital markets is critical. The Company holds significant derivative positions ($21.2 billion net replacement cost) and non-investment grade securities, which carry market and credit risks.
Investor Verification Checklist
- Divestiture Closing: Verify the closing dates and final proceeds for the sales of the Global Custody, Correspondent Clearing, and SPS Transaction Services businesses.
- Year 2000 Costs: Monitor actual Year 2000 compliance expenditures against the $125 million estimate and assess potential operational disruptions.
- Loan Portfolio Quality: Track net charge-off rates and delinquency trends in the consumer loan portfolio, particularly given the sale of the Prime Option portfolio and economic volatility in Asia.
- Derivative Exposure: Review the composition of the $21.2 billion derivative portfolio and the effectiveness of hedging strategies against market volatility.
- Regulatory Capital: Confirm continued compliance with net capital requirements for broker-dealer subsidiaries (MS&Co., DWR) and FDIC leverage ratios for bank subsidiaries.