MS

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 1997, for Dean Witter, Discover & Co. (the Company). The Company is a financial services organization providing credit and investment products, primarily through its Credit Services (Discover Card) and Securities (Dean Witter) segments. A material event during this period was the announcement on February 5, 1997, of a definitive merger agreement with Morgan Stanley Group Inc., expected to close in mid-1997.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net operating revenues increased 7% year-over-year, driven by credit card fee enhancements, higher average consumer loan levels, and increased assets under management.
• Profitability: Net income rose 12% to a record $276.3 million. Credit Services net income increased 18%, while Securities net income grew 7%.
• Credit Losses: The provision for loan losses surged 66% to $378.4 million. Net charge-offs as a percentage of average consumer loans increased to 6.88% from 4.44% in the prior year, reflecting industry-wide trends of higher consumer debt and bankruptcy rates.
• Expense Management: Total non-interest expenses increased 4% primarily due to higher employee compensation. In the Securities segment, expenses rose 8% due to variable compensation and software development costs.
• Balance Sheet: Total assets remained relatively flat, though cash and cash equivalents decreased by approximately $814 million from the prior quarter. Consumer loan balances declined slightly from year-end 1996.

Outlook, Risks, and Management Commentary

• Merger with Morgan Stanley: The Company and Morgan Stanley agreed to a tax-free exchange (1.65 Dean Witter shares for 1 Morgan Stanley share). Shareholder votes are scheduled for May 28, 1997. The Company has rescinded all stock repurchase authorizations.
• Credit Quality Outlook: Management anticipates that the trend of increasing net charge-off rates may continue throughout 1997. Steps taken in 1996 to tighten credit standards are expected to have a greater impact in 1997.
• Liquidity and Capital: The Company renewed its $4.0 billion senior bank credit facility in April 1997. Credit rating agencies (Moody's and S&P) placed the Company's ratings on review/credit watch with positive implications following the merger announcement. Regulatory capital ratios for FDIC-insured institutions and the broker-dealer subsidiary (DWR) significantly exceed minimum requirements.
• Legal Proceedings: The Company is subject to various lawsuits. Notably, an antitrust investigation regarding OTC market practices was resolved via an Order and Stipulation in April 1997. A class action regarding NASDAQ trading practices was expanded to include institutional investors.

Investor Verification Checklist

• Merger Approval: Confirm the outcome of the shareholder votes scheduled for May 28, 1997, and the receipt of necessary regulatory approvals for the Morgan Stanley merger.
• Credit Loss Trajectory: Monitor subsequent quarters for the persistence of the elevated net charge-off rate (6.88%) and the effectiveness of tightened credit standards.
• Fee Revenue Sustainability: Verify if the 26% increase in merchant and cardmember fees (driven by late payment and overlimit fees) remains sustainable as delinquency rates fluctuate.
• Assets Under Management (AUM): Track the growth of AUM, which reached a record $91.6 billion, as a key driver for the Securities segment's fee income.
• Regulatory Capital: Ensure continued compliance with FDIC and SEC net capital requirements, particularly as the merger integration process begins.