<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): February 28, 1997
MORGAN STANLEY GROUP INC.
(Exact name of registrant as specified in its charter)
DELAWARE 1-9085 13-2838811
(STATE OR OTHER (COMMISSION (I.R.S. EMPLOYER
JURISDICTION OF FILE NUMBER) IDENTIFICATION NUMBER)
INCORPORATION)
1585 Broadway, New York, New York 10036
(Address of principal executive offices including zip code)
Registrant's telephone number, including area code: (212) 761-4000
<PAGE>
Item 5. Other Events
As previously disclosed in Morgan Stanley Group Inc.'s ("Morgan Stanley")
current report on Form 8-K dated February 5, 1997, Morgan Stanley and Dean
Witter, Discover & Co. ("DWD") announced a definitive agreement to merge (the
"Merger"). The transaction is intended to be accounted for as a pooling of
interests and the new company will be named Morgan Stanley, Dean Witter,
Discover & Co. Under the terms of the merger agreement, each of Morgan
Stanley's common shares will be exchanged for 1.65 of DWD's common shares. The
Merger, which is expected to be completed in mid-1997, is subject to customary
closing conditions, including certain regulatory approvals and the approval of
the stockholders of both companies.
Attached and incorporated by reference herein as Exhibits 99.1 and 99.2,
respectively, are certain financial information for DWD and unaudited pro forma
combined financial information for the combined entity giving effect to the
Merger.
Attached and incorporated herein by reference as Exhibit 23.1 is a copy of
the consent of Deloitte & Touche LLP.
Item 7(c). Financial Statements, Pro Forma Financial Statements and Exhibits
Exhibit No. Description
- ----------- -----------
23.1 Consent of Deloitte & Touche LLP.
99.1 The audited consolidated balance sheets of DWD as of December 31,
1996 and 1995, and the related consolidated statements of income,
cash flows and changes in shareholders' equity for each of the years
in the three year period ended December 31, 1996 (incorporated by
reference from pages 30 to 45 of DWD's Current Report on Form 8-K
dated February 27, 1997 (File no. 1-11758)).
99.2 The Morgan Stanley, Dean Witter, Discover & Co. unaudited pro forma
condensed combined statement of financial condition at November 30,
1996, and unaudited pro forma condensed combined statements of
income for the twelve months ended November 30, 1996, 1995 and 1994.
2
<PAGE>
SIGNATURES
----------
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 hereunto duly authorized.
MORGAN STANLEY GROUP INC.
Registrant
Date: February 28, 1997 /s/ Philip N. Duff
---------------------------
Philip N. Duff
Chief Financial Officer
3
<PAGE>
Index to Exhibits
Exhibit No. Description
- ----------- -----------
23.1 Consent of Deloitte & Touche LLP.
99.1 The audited consolidated balance sheets of DWD as of December 31,
1996 and 1995, and the related consolidated statements of income,
cash flows and changes in shareholders' equity for each of the years
in the three year period ended December 31, 1996 (incorporated by
reference from pages 30 to 45 of DWD's Current Report on Form 8-K
dated February 27, 1997 (File no. 1-11758)).
99.2 The Morgan Stanley, Dean Witter, Discover & Co. unaudited pro forma
condensed combined statement of financial condition at November 30,
1996, and unaudited pro forma condensed combined statements of
income for the twelve months ended November 30, 1996, 1995 and 1994.
4
<PAGE>
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the following Registration
Statements of Morgan Stanley Group Inc. of our report dated February 21, 1997,
with respect to the consolidated financial statements of Dean Witter, Discover &
Co. for the year ended December 31, 1996, appearing in the Current Report on
Form 8-K of Dean Witter, Discover & Co. filed on February 27, 1997:
Filed on Form S-3
Registration Statement No. 333-18005
Registration Statement No. 333-01655
Registration Statement No. 33-58611
Registration Statement No. 33-51413
Filed on Form S-8
Registration Statement No. 333-08571
Registration Statement No. 33-13177
Registration Statement No. 33-37652
Registration Statement No. 33-18184
Registration Statement No. 33-42464
DELOITTE & TOUCHE LLP
New York, New York
February 28, 1997
<PAGE>
EXHIBIT 99.1
MANAGEMENT'S STATEMENT OF FINANCIAL
REPORTING RESPONSIBILITY
The management of Dean Witter, Discover & Co. and its subsidiaries prepared the
accompanying consolidated financial statements and related footnotes and is
responsible for their integrity and objectivity. The consolidated financial
statements, which include amounts that are based on management's estimates and
judgments, were prepared in accordance with generally accepted accounting
principles. Management also prepared the other information in this annual report
and is responsible for its accuracy and consistency with the consolidated
financial statements.
Management maintains a system of internal controls over the preparation of
its consolidated financial statements. In management's opinion, these internal
controls provide reasonable assurance that assets are safeguarded and that
transactions are properly recorded and executed in accordance with management's
authorization. Judgments are required to assess and balance the relative cost
and expected benefits of these internal controls. To assure the effectiveness of
the system of internal controls, the organizational structure provides for
defined lines of responsibility and delegation of authority. Further, the
Company maintains an internal audit function that independently assesses the
effectiveness of internal controls and the Company's compliance with established
policies and procedures.
The Company's consolidated financial statements have been audited by
Deloitte & Touche LLP, independent auditors, and their report follows. They have
advised the Company that their audits were conducted in accordance with
generally accepted auditing standards and considered the Company's internal
accounting controls in determining the auditing procedures they deem necessary
to express an opinion on the consolidated financial statements.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets with the internal auditors, management and the independent
auditors to review their work and discuss the Company's financial controls and
audit and reporting practices. The independent auditors and the internal
auditors independently have full and free access to the Audit Committee, without
the presence of management, to discuss any matters that they feel require
attention.
/s/ Philip J. Purcell
Philip J. Purcell
Chairman and Chief Executive Officer
/s/ Thomas C. Schneider
Thomas C. Schneider
Executive Vice President and Chief Financial Officer
/s/ Robert P. Seass
Robert P. Seass
Senior Vice President and Controller
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Dean Witter, Discover & Co.:
We have audited the accompanying consolidated balance sheets of Dean Witter,
Discover & Co. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, cash flows and changes in
shareholders' equity for each of the three years in the period ended December
31, 1996. These financial statements, appearing on pages 31 through 45, are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the accompanying consolidated financial statements present
fairly, in all material respects, the consolidated financial position of Dean
Witter, Discover & Co. and subsidiaries at December 31, 1996 and 1995 and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996 in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
New York, New York
February 21, 1997
Dean Witter, Discover & Co. 1996
30
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
(in millions, except per share data)
<TABLE>
<CAPTION>
Year ended December 31, 1996 1995 1994
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Merchant and cardmember fees $ 1,506.2 $ 1,135.3 $ 940.0
Commissions 1,163.1 1,022.5 874.3
Asset management and administration fees 1,149.8 1,006.8 973.0
Servicing fees 819.0 696.9 586.4
Principal transactions 449.3 478.9 421.9
Investment banking 246.1 181.5 197.9
Other 107.8 93.5 101.9
-------------------------------------
Total non-interest revenues 5,441.3 4,615.4 4,095.4
-------------------------------------
Interest revenue 3,587.3 3,319.0 2,507.2
Interest expense 1,566.2 1,514.8 1,048.5
-------------------------------------
Net interest income 2,021.1 1,804.2 1,458.7
Provision for losses on receivables 1,232.3 743.7 548.4
-------------------------------------
Net credit income 788.8 1,060.5 910.3
-------------------------------------
Net operating revenues 6,230.1 5,675.9 5,005.7
-------------------------------------
Employee compensation and benefits 2,208.2 1,981.6 1,764.2
Marketing and business development 856.8 735.1 607.2
Information processing and communications 767.7 687.5 596.7
Facilities and equipment 256.1 235.5 228.1
Other 596.2 640.3 594.9
-------------------------------------
Total non-interest expenses 4,685.0 4,280.0 3,791.1
-------------------------------------
Income before income taxes 1,545.1 1,395.9 1,214.6
Income tax expense 593.7 539.5 473.7
-------------------------------------
Net income $ 951.4 $ 856.4 $ 740.9
=====================================================================================
Earnings per common share(1)
Primary $ 2.79 $ 2.44 $ 2.14
Fully diluted 2.77 2.44 2.14
- -------------------------------------------------------------------------------------
Average common shares outstanding(1)
Primary 341.2 350.7 346.7
Fully diluted 343.3 350.9 346.7
=====================================================================================
</TABLE>
(1) Per share and share data have been restated to reflect the Company's
two-for-one stock split.
See notes to the consolidated financial statements.
Dean Witter, Discover & Co. 1996
31
<PAGE>
CONSOLIDATED BALANCE SHEETS
(in millions)
<TABLE>
<CAPTION>
December 31, 1996 1995
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 1,999.2 $ 1,464.5
Cash and securities segregated under federal and other regulations 2,044.5 1,926.4
Receivables
Consumer loans (net of allowances of $815.3 in 1996 and $721.8 in 1995) 22,372.9 20,834.6
Securities clients (net of allowances of $15.3 in 1996 and $16.2 in 1995) 2,839.1 2,588.8
Other 804.5 732.4
Amounts due from asset securitizations 869.2 653.4
Securities borrowed 3,866.3 2,358.2
Securities purchased under agreements to resell 3,563.6 3,571.9
Securities owned, at market value 1,913.6 1,848.8
Deferred income taxes 820.3 736.9
Office facilities, at cost (less accumulated depreciation
and amortization of $446.0 in 1996 and $380.5 in 1995) 379.7 341.0
Other assets 940.7 1,151.3
- --------------------------------------------------------------------------------------------------------------------
Total assets $42,413.6 $38,208.2
====================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Commercial paper $ 4,736.8 $ 4,688.5
Other short-term borrowings 1,128.2 1,637.0
Deposits 7,212.6 6,191.1
Payables
Securities clients 3,433.3 3,183.0
Drafts 616.1 485.5
Income taxes 156.8 99.3
Securities loaned 3,932.1 2,535.0
Securities sold under agreements to repurchase 3,566.6 3,813.4
Securities sold but not yet purchased, at market value 1,274.1 1,125.2
Other liabilities and accrued expenses 3,048.4 2,884.1
Long-term borrowings 8,144.2 6,732.4
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 37,249.2 33,374.5
- --------------------------------------------------------------------------------------------------------------------
Shareholders' Equity
Preferred stock ($0.01 par value, 10.0 shares authorized, none issued) -- --
Common stock(1) ($0.01 par value, 500.0 shares authorized, 342.0
shares issued, 319.7 and 337.7 shares outstanding at
December 31, 1996 and 1995) 3.4 3.4
Paid-in capital(1) 2,702.5 2,716.6
Retained earnings 2,972.7 2,165.7
-------------------------
5,678.6 4,885.7
Common stock held in treasury, at cost(1) ($0.01 par value, 22.3 and 4.3 shares
at December 31, 1996 and 1995) (598.3) (106.8)
Stock compensation plans 141.8 85.1
Employee stock benefit trust (46.3) (21.5)
Unearned stock compensation (11.4) (8.8)
-------------------------
Total shareholders' equity 5,164.4 4,833.7
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $42,413.6 $38,208.2
====================================================================================================================
</TABLE>
(1) Amounts have been restated to reflect the Company's two-for-one stock split.
See notes to the consolidated financial statements.
Dean Witter, Discover & Co. 1996
32
<PAGE>
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK(1) TREASURY STOCK
--------------- --------------
NUMBER PAID-IN RETAINED NUMBER
(in millions) OF SHARES AMOUNT CAPITAL(1) EARNINGS OF SHARES(1) AMOUNT
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1994 341.2 $ 3.4 $ 2,713.6 $ 762.6 -- $ --
Net income 740.9
Dividends to common shareholders (85.2)
Purchase of treasury stock, at cost (4.6) (82.0)
Issuance of common stock
Employee stock purchase plan (0.8) 0.2 4.3
Stock option exercises 0.8 11.0 0.2 3.1
Restricted stock grants 0.5
Unearned stock compensation,
net of amortization
Stock compensation plans
Minimum pension liability adjustment
- ----------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1994 342.0 3.4 2,724.3 1,418.3 (4.2) (74.6)
Net income 856.4
Dividends to common shareholders (109.0)
Purchase of treasury stock, at cost (5.0) (121.2)
Issuance of common stock
Employee stock purchase plan (0.6) 0.8 15.3
Employee benefit plans 0.1 2.3 41.4
Stock option exercises (7.5) 1.8 33.2
Restricted stock grants 0.2
Unearned stock compensation,
net of amortization
Stock compensation plans 0.1 (0.9)
Employee stock benefit trust
- ----------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1995 342.0 3.4 2,716.6 2,165.7 (4.3) (106.8)
Net income 951.4
Dividends to common shareholders (144.4)
Purchase of treasury stock, at cost (23.1) (625.5)
Issuance of common stock
Employee stock purchase plan (2.4) 0.7 19.8
Employee benefit plans 2.4 59.0
Stock option exercises (14.7) 2.0 52.9
Restricted stock grants 2.6
Unearned stock compensation,
net of amortization 0.3 0.1
Stock compensation plans 0.1 2.2
Employee stock benefit trust
- ----------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 342.0 $3.4 $2,702.5 $2,972.7 (22.3) $(598.3)
================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
TOTAL
SHAREHOLDERS'
(in millions) OTHER EQUITY
- -------------------------------------------------------------------
<S> <C> <C>
BALANCE, JANUARY 1, 1994 $ (2.5) $ 3,477.1
Net income 740.9
Dividends to common shareholders (85.2)
Purchase of treasury stock, at cost (82.0)
Issuance of common stock
Employee stock purchase plan 3.5
Stock option exercises 14.1
Restricted stock grants 0.5
Unearned stock compensation,
net of amortization (4.4) (4.4)
Stock compensation plans 42.2 42.2
Minimum pension liability adjustment 1.3 1.3
- -------------------------------------------------------------------
BALANCE, DECEMBER 31, 1994 36.6 4,108.0
Net income 856.4
Dividends to common shareholders (109.0)
Purchase of treasury stock, at cost (121.2)
Issuance of common stock
Employee stock purchase plan 14.7
Employee benefit plans 41.5
Stock option exercises 25.7
Restricted stock grants 0.2
Unearned stock compensation,
net of amortization (3.2) (3.2)
Stock compensation plans 42.9 42.1
Employee stock benefit trust (21.5) (21.5)
- -------------------------------------------------------------------
BALANCE, DECEMBER 31, 1995 54.8 4,833.7
Net income 951.4
Dividends to common shareholders (144.4)
Purchase of treasury stock, at cost (625.5)
Issuance of common stock
Employee stock purchase plan 17.4
Employee benefit plans 59.0
Stock option exercises 38.2
Restricted stock grants 2.6
Unearned stock compensation,
net of amortization (2.6) (2.2)
Stock compensation plans 56.7 59.0
Employee stock benefit trust (24.8) (24.8)
- -------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 $ 84.1 $5,164.4
===================================================================
</TABLE>
(1) Amounts have been restated to reflect the Company's two-for-one stock split.
See notes to the consolidated financial statements.
Dean Witter, Discover & Co. 1996
33
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
<TABLE>
<CAPTION>
Year ended December 31, 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net income $ 951.4 $ 856.4 $ 740.9
Adjustments to reconcile net income to net cash flows from
operating activities
Depreciation and amortization 83.3 70.0 58.8
Provision for losses on receivables 1,232.3 743.7 548.4
Employee compensation settled through the issuance of
common stock 87.1 57.2 37.0
Deferred income taxes (83.4) (93.4) (155.6)
Decrease (increase) in operating assets
Cash and securities segregated under federal and other regulations (118.1) (432.0) 227.9
Receivables
Securities clients (262.0) (22.2) 70.9
Other (72.1) (74.1) (111.4)
Securities borrowed (1,508.1) (6.6) (250.8)
Amounts due from asset securitizations (215.8) (231.4) 269.6
Matched securities purchased under agreements to resell, net (223.8) (27.1) 4.0
Securities owned and securities sold but not yet purchased, at
market value, net 84.1 (299.4) 1,023.3
Other assets 128.3 106.2 (32.4)
Increase (decrease) in operating liabilities
Payables
Securities clients 250.3 447.0 (40.9)
Drafts 130.6 10.5 2.9
Income taxes 57.5 (26.2) (89.5)
Securities loaned 1,397.1 (23.3) 165.0
Other liabilities and accrued expenses 289.7 421.5 408.3
------------------------------------------
Cash provided by operating activities 2,208.4 1,476.8 2,876.4
------------------------------------------
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Net principal disbursed on consumer loans (7,531.7) (7,429.2) (6,166.3)
Purchases of consumer loans (51.3) (306.9) (85.8)
Sales of consumer loans 4,824.1 1,827.3 1,970.1
Other (39.8) (116.2) (118.7)
------------------------------------------
Cash used in investing activities (2,798.7) (6,025.0) (4,400.7)
------------------------------------------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Proceeds from issuance of commercial paper, net (77.6) 2,061.9 194.0
Net increase (decrease) in other short-term borrowings (508.8) 36.4 343.1
Deposits, net 1,021.5 982.4 320.6
Proceeds from issuance of long-term borrowings, net 1,420.1 1,433.5 2,142.1
Securities sold under agreements to repurchase, net (14.8) 347.3 (826.3)
Dividends paid (134.0) (102.3) (81.1)
Proceeds from issuance of common stock 44.1 40.6 17.7
Purchase of treasury stock (625.5) (121.2) (82.0)
------------------------------------------
Cash provided by financing activities 1,125.0 4,678.6 2,028.1
------------------------------------------
Increase in cash and cash equivalents 534.7 130.4 503.8
Cash and cash equivalents, beginning of period 1,464.5 1,334.1 830.3
- -----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $1,999.2 $1,464.5 $1,334.1
=======================================================================================================================
</TABLE>
See notes to the consolidated financial statements.
Dean Witter, Discover & Co. 1996
34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. INTRODUCTION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Dean Witter,
Discover & Co. and subsidiaries (the "Company"). The Company is a financial
services organization that provides a broad range of credit and investment
products, with a primary focus on individual customers. Through its wholly-owned
subsidiary NOVUS Credit Services Inc. ("NCSI"), the Company conducts its credit
services business, including the operation of the NOVUS(sm) Network, a
proprietary network of merchant and cash access locations, and the issuance of
proprietary general purpose credit cards. The Company's securities business is
conducted primarily through its wholly-owned subsidiaries Dean Witter Reynolds
Inc. ("DWR") and Dean Witter InterCapital Inc. All material intercompany
balances and transactions have been eliminated.
The preparation of the consolidated financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts in the financial statements.
Actual results could differ from these estimates.
Certain reclassifications have been made to prior year amounts to conform to
the current presentation.
2. SUBSEQUENT EVENT
On February 5, 1997, the Company and Morgan Stanley Group Inc. ("Morgan
Stanley") announced a definitive agreement to merge. Under the terms of the
merger agreement unanimously approved by the Boards of Directors of both
companies, each of Morgan Stanley's common shares will be exchanged for 1.65
common shares of the Company. Morgan Stanley preferred shares outstanding at the
date of the merger will be exchanged for preferred shares of the Company having
substantially identical terms. The transaction, which is expected to be
completed in mid-1997, is intended to be a tax free exchange and accounted for
as a pooling of interests and is subject to customary closing conditions,
including certain regulatory approvals and the approval of shareholders of both
companies. Prior to the time of closing each company will formally rescind its
remaining stock repurchase authorizations.
The following table sets forth certain unaudited pro forma combined selected
financial data giving effect to the merger under the pooling of interests method
of accounting. The amounts presented have been prepared by combining the
Company's financial data for the years ended 1996, 1995 and 1994 with Morgan
Stanley's financial data for the fiscal year ended 1996 and the twelve months
ended November 30, 1995 and 1994. The pro forma combined primary and fully
diluted earnings per common share for the respective periods presented are based
on the combined weighted average number of common shares and share equivalents
of the Company and Morgan Stanley. The number of common shares and share
equivalents of Morgan Stanley is based on the exchange ratio of 1.65 shares of
the Company's common shares for each issued and outstanding share and share
equivalent of Morgan Stanley.
<TABLE>
<CAPTION>
(Unaudited, in millions,
except per share amounts) 1996 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Income Statement Data(1)
Net revenues $ 12,006 $ 9,798 $ 8,612
Income before income taxes 3,117 2,292 1,962
Net income 1,980 1,465 1,257
Primary earnings per share 3.22 2.30 1.96
Fully diluted earnings per share 3.14 2.25 1.93
- --------------------------------------------------------------------------------
Balance Sheet Data (at end of period)(2)
Total assets $238,860
Total liabilities 227,158
Total equity 11,702
================================================================================
</TABLE>
(1) The income statement data presented in this table exclude the effect of (i)
the positive effects of potential increased revenues or operating synergies
which may be achieved upon combining the resources of the companies (ii)
investment banking, legal and miscellaneous transaction costs of the merger,
which will be reflected as an expense in the period the merger is
consummated, and (iii) costs associated with the integration and
consolidation of the companies which are not presently estimable.
(2) Pro forma balances for 1996 represent the Company's balance sheet amounts at
December 31, 1996 combined with Morgan Stanley's balance sheet amounts at
November 30, 1996.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and highly liquid investments not held
for resale with maturities, when purchased, of three months or less.
CONSUMER LOANS
Consumer loans, which consist primarily of credit card, real estate-secured and
other consumer installment loans, are reported at their principal amounts
outstanding, less applicable allowances and unearned finance charges. Interest
on consumer loans is credited to income as earned.
Dean Witter, Discover & Co. 1996
35
<PAGE>
Interest is accrued on credit card loans until the date of charge-off, which
generally occurs at the end of the month during which an account becomes 180
days past due, except in the case of bankruptcies and fraudulent transactions,
which are charged off earlier. The interest portion of charged off credit card
loans is written off against interest revenue. Origination costs related to the
issuance of credit cards are charged to earnings over periods not exceeding
twelve months.
Interest generally is not accrued on real estate-secured loans which are
delinquent by six monthly payments and other consumer installment loans which
are delinquent by four or more monthly payments. Origination fees, net of
certain direct loan origination costs, are deferred and amortized over the
estimated life of the loans using the interest method. Any unamortized net
origination fees and costs on real estate-secured and other consumer installment
loans fully repaid are recognized as income in the period such loans are repaid.
ALLOWANCE FOR CONSUMER LOAN LOSSES
The allowance for consumer loan losses is a significant estimate that is
regularly evaluated by management for adequacy on a portfolio by portfolio basis
and is established through a charge to the provision for loan losses. The
evaluations take into consideration such factors as changes in the nature and
volume of the loan portfolio, overall portfolio quality, review of specific
problem loans and current economic conditions that may affect the borrower's
ability to pay.
The Company uses the results of these evaluations to provide an allowance
for loan losses. The exposure for credit losses for owned loans is influenced by
the performance of the portfolio and other factors discussed above, with the
Company absorbing all related losses. The exposure for credit losses for
securitized loans is represented by the Company retaining a contingent risk
based on the amount of credit enhancement provided.
Management believes that its estimates have been historically prudent in
light of the need to allow the market for asset securitizations, in particular
those backed by credit card receivables, to mature, and in light of the
uncertainty of accounting standards for asset securitizations. In 1996, the
Company revised its estimate of the allowance for losses for loans intended to
be securitized. This revision was based on the Company's experience with credit
losses related to securitized loans in a mature asset securitization market and
the recent issuance of Statement of Financial Accounting Standards ("SFAS") No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities", by the Financial Accounting Standards Board
("FASB"), which eliminated the uncertainty surrounding the appropriate
accounting treatment for asset securitization transactions. The Company intends
to maintain existing loan loss allowances for securitizations outstanding until
the related loans are liquidated.
SECURITIZATION OF CONSUMER LOANS
The Company periodically sells consumer loans through asset securitizations and
continues to service these loans. The revenues derived from servicing these
loans are recorded in the consolidated statements of income as servicing fees
over the term of the securitized loans rather than at the time the loans are
sold. The effects of recording these revenues over the term of the securitized
loans rather than at the time the loans were sold have not been material.
Amounts due from asset securitizations in the consolidated balance sheets
represent cash and receivables from third parties. These receivables include the
Company's share of cash collections on certain securitized credit card loans
which are held by third parties and paid to the Company during the month
subsequent to collection, credit enhancement reserve funds maintained with third
parties and advances made by the Company as the servicer of the securitized
loans.
SECURITIES TRANSACTIONS
Clients' securities transactions are recorded on a settlement date basis with
related commission revenues and expenses recorded on trade date. Principal
transactions are recorded on trade date. Securities are recorded at market, with
gains and losses reflected in income.
Securities transactions under agreements to resell and repurchase are
collateralized financing transactions and are carried at the contract amounts at
which the securities will be resold or reacquired, including accrued interest.
Securities borrowed and securities loaned are recorded at the amount of cash
collateral advanced or received. Securities borrowed transactions require the
Company to deposit cash, or other collateral with the lender. With respect to
securities loaned the Company receives collateral in the form of cash or other
collateral in an amount generally in excess of the market value of securities
loaned.
OFFICE FACILITIES
Office facilities are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization of buildings and improvements are
provided principally by the straight-line method, while depreciation and
amortization of furniture, fixtures and equipment is provided principally by
accelerated methods. Property and equipment are depreciated over the esti-
Dean Witter, Discover & Co. 1996
36
<PAGE>
mated useful lives of the related assets, while leasehold improvements are
amortized over the lesser of the economic useful life of the asset or the term
of the lease.
GOODWILL
Goodwill, which is included in other assets, is amortized on a straight-line
basis over periods not exceeding 40 years.
INCOME TAXES
Income tax expense is provided for using the asset and liability method, under
which deferred tax assets and liabilities are determined based upon the
temporary differences between the financial statement and income tax bases of
assets and liabilities, using currently enacted tax rates.
EARNINGS PER SHARE
The calculations of earnings per common share are based on the weighted average
number of common shares outstanding during the period, adjusted for the dilutive
effects of stock options and unissued stock awards under deferred compensation
plans.
STOCK SPLIT
Effective December 26, 1996, the Company declared a two-for-one stock split,
which was effected in the form of a dividend, distributable on January 14, 1997.
All prior period per share, share outstanding and shareholders' equity data has
been restated to reflect this split.
CARDMEMBER REWARDS
The liability for cardmember rewards expense, included in other liabilities and
accrued expenses, is accrued at the time that qualified cardmember transactions
occur and is calculated on an individual cardmember basis.
INTEREST RATE CONTRACTS
The Company has entered into various interest rate contracts as hedges against
specific assets, liabilities or anticipated transactions. These contracts
include interest rate swap, foreign currency exchange, cost of funds and
interest rate cap agreements. For contracts that are designated as hedges of the
Company's assets and liabilities, gains and losses are deferred and recognized
as adjustments to interest income or expense over the remaining life of the
underlying assets or liabilities. For contracts that are hedges of asset
securitizations, gains and losses are recognized as adjustments to servicing
fees.
EMPLOYEE STOCK PLANS
Employee stock plans are accounted for under the provisions of Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB
No. 25"). In accordance with the provisions of APB No. 25, no charge to earnings
is recorded for those stock-based benefits issued to employees which are deemed
"non-compensatory".
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which became effective January 1, 1996 and requires the
determination of the fair value, as defined, of stock options granted. The
Company has elected, as permitted, to provide only the pro forma disclosure of
the effect of SFAS No. 123 on earnings in Note 9 to the consolidated financial
statements.
OTHER ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1996, the Company adopted SFAS Nos. 121 and 122. SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of", generally requires that long-lived assets be reported
at the lower of their carrying cost or net realizable value. SFAS No. 122,
"Accounting for Mortgage Servicing Rights, an amendment of SFAS No. 65",
requires that rights to service mortgage loans for others, however acquired, be
recorded as separate assets when the mortgage loans are sold and the servicing
rights are retained. This statement also requires that capitalized mortgage
servicing rights be assessed for impairment based on the fair value of those
rights. The adoption of these statements was not material to the Company's
financial position or results of operations.
The FASB has issued SFAS No. 125, effective for transfers of financial
assets made after December 31, 1996, except for transfers of certain financial
assets for which the effective date has been delayed for one year. SFAS No. 125
provides financial reporting standards for the derecognition and recognition of
financial assets, including the distinction between transfers of financial
assets which should be recorded as sales and those which should be recorded as
secured borrowings. SFAS No. 125 supersedes and incorporates the essential
provisions of SFAS No. 122. The Company believes that the effect of the adoption
of SFAS No. 125 will not be material to its financial position or results of
operations.
Dean Witter, Discover & Co. 1996
37
<PAGE>
4. CONSUMER LOANS
Consumer loans were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- ------------------------------------------------------------
<S> <C> <C>
Credit card $22,062.0 $20,440.4
Real estate-secured and
other consumer installment 1,203.8 1,233.1
- ------------------------------------------------------------
23,265.8 21,673.5
Less
Unearned finance charges and
unamortized discounts and fees 77.6 117.1
Allowance for loan losses 815.3 721.8
- ------------------------------------------------------------
Consumer loans, net $22,372.9 $20,834.6
============================================================
</TABLE>
Activity in the allowance for consumer loan losses was as follows.
<TABLE>
<CAPTION>
1996 1995 1994
- ------------------------------------------------------------
<S> <C> <C> <C>
Balance, January 1 $ 721.8 $565.7 $436.8
Additions
Provision for loan losses 1,220.6 730.5 537.0
Purchase of loan portfolios 4.0 30.6 4.3
- ------------------------------------------------------------
Total additions 1,224.6 761.1 541.3
- ------------------------------------------------------------
Deductions
Charge-offs 1,189.2 716.8 470.6
Recoveries (156.2) (121.3) (89.1)
- ------------------------------------------------------------
Net charge-offs 1,033.0 595.5 381.5
- ------------------------------------------------------------
Other(1) (98.1) (9.5) (30.9)
- ------------------------------------------------------------
Balance, December 31 $ 815.3 $721.8 $565.7
- ------------------------------------------------------------
</TABLE>
(1) Primarily reflects net transfers related to asset securitizations.
Interest accrued on loans subsequently charged off, recorded as a reduction of
interest revenue, was $180.9 million, $114.8 million and $69.8 million in 1996,
1995 and 1994.
At December 31, 1996 and 1995, $5,788.6 million and $7,000.2 million of the
Company's consumer loans had minimum contractual maturities of less than one
year. Because of the uncertainty regarding consumer loan repayment patterns,
which historically have been higher than contractually required minimum
payments, and variable rate loan pricing utilized by the Company, this amount
may not necessarily be indicative of the Company's consumer loan repricing
schedule.
At December 31, 1996 and 1995, the Company had commitments to extend credit
in the amounts of $156.6 billion and $133.3 billion. Commitments to extend
credit arise from agreements to extend to customers unused lines of credit on
certain credit cards and home equity lines of credit issued by the Company,
provided there is no violation of conditions established in the related
agreement. These commitments, substantially all of which the Company can
terminate at any time and which do not necessarily represent future cash
requirements, are periodically reviewed based on account usage and customer
creditworthiness.
The Company received proceeds from asset securitizations of $4,527.5
million, $1,827.3 million, and $1,970.1 million in 1996, 1995 and 1994. The
uncollected balances of consumer loans sold through asset securitizations were
$13,384.6 million and $10,219.5 million at December 31, 1996 and 1995. The
allowance for loan losses related to securitized loans, included in other
liabilities and accrued expenses, was $447.3 million and $341.7 million at
December 31, 1996 and 1995.
The Company's consumer loan portfolio, including securitized loans, is
geographically diverse, with a distribution approximating that of the population
of the United States.
5. SECURITIES -- AT MARKET VALUE
Securities owned and securities sold but not yet purchased, at market value,
were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- --------------------------------------------------------------
<S> <C> <C>
Owned
U.S. government and agency obligations $ 950.4 $1,023.2
Corporate bonds 551.3 615.7
Municipal bonds 148.3 159.9
Other 263.6 50.0
- --------------------------------------------------------------
Total $1,913.6 $1,848.8
==============================================================
Sold but not yet purchased
U.S. government and agency obligations $1,198.8 $ 994.2
Corporate bonds 61.6 116.0
Other 13.7 15.0
- --------------------------------------------------------------
Total $1,274.1 $1,125.2
==============================================================
</TABLE>
Securities sold but not yet purchased represent obligations of the Company
to deliver specified securities at contracted prices, thereby creating a
liability to purchase the securities at prevailing market prices.
Dean Witter, Discover & Co. 1996
- --------------------------------
38
<PAGE>
6. BORROWINGS
SHORT-TERM BORROWINGS
Short-term borrowings and related interest rates were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- ------------------------------------------------------------------------------------
AMOUNT INTEREST AMOUNT INTEREST
OUTSTANDING RATE(1) OUTSTANDING RATE(1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial paper $4,736.8 5.52% $4,688.5 5.84%
Other
Federal funds
purchased 458.8 5.51 720.0 5.79
Bank borrowings 410.3 5.45 385.3 6.75
Bank notes 259.1 5.45 529.6 5.85
Note payable
to Tandy -- -- 2.1 6.49
- --------------------------------------------------------------------------------------
Total $5,865.0 5.51% $6,325.5 5.89%
======================================================================================
</TABLE>
(1) Interest rates are presented on a weighted average basis and exclude the
effects of interest rate contracts.
At December 31, 1996 and 1995, short-term borrowings were subject to interest
rate exchange agreements of $778.8 million and $1,002.3 million, and interest
rate cap agreements of $30.0 million and $405.0 million. The interest rate
exchange agreements, which consist of interest rate swap and cost of funds
agreements, primarily converted the related borrowings to fixed rates.At
December 31, 1996 and 1995, the weighted average interest rates on short-term
borrowings, including the effects of interest rate contracts, were 5.55% and
5.97%.
The Company maintains a senior bank credit facility to support general
liquidity needs, including the issuance of commercial paper at the corporate
level. In 1996, the Company renewed this facility and increased its amount to
$4.0 billion from $3.25 billion. The facility expires in April 1997 and contains
certain extension provisions. The Company currently plans to renew or replace
this facility prior to its expiration. This facility contains covenants that
require the Company to maintain minimum net worth requirements and specified
financial ratios. The Company believes that the covenant restrictions will not
impair its ability to pay its current level of dividends. As of December 31,
1996, the Company had never borrowed from its senior bank credit facility.
Riverwoods Funding Corporation ("RFC"), an entity included in the
consolidated financial statements of the Company, maintains a senior bank credit
facility to support the issuance of asset-backed commercial paper. In 1996, RFC
renewed this facility and increased its amount to $2.1 billion from $1.75
billion. RFC currently plans to renew or replace this facility prior to its
expiration in October 1997. Under the terms of the asset-backed commercial paper
program, certain assets of RFC were subject to a lien in the amount of $2.2
billion at December 31, 1996. RFC has never borrowed from its senior bank credit
facility.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
At December 31, 1996 and 1995, the weighted average interest rates on amounts
borrowed through repurchase agreements were 5.98% and 5.55%. Substantially all
of the Company's proprietary positions in U.S. government and agency obligations
are pledged as collateral in connection with repurchase agreements.
LONG-TERM BORROWINGS
Long-term borrowings, which consisted of senior long-term notes net of
unamortized discount, and related interest rates were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- --------------------------------------------------------------------------------------
AMOUNT INTEREST AMOUNT INTEREST
OUTSTANDING RATE(1) OUTSTANDING RATE(1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Floating rate notes $4,257.1 5.78% $3,275.5 6.05%
Fixed rate notes 3,409.1 6.59 3,398.0 6.44
Foreign
denominated 478.0 4.98 58.9 2.06
- --------------------------------------------------------------------------------------
Total $8,144.2 6.07% $6,732.4 6.21%
======================================================================================
</TABLE>
(1) Interest rates are presented on a weighted average basis and exclude the
effects of interest rate exchange agreements.
At December 31, 1996 and 1995, the use of interest rate exchange agreements
effectively converted $2,021.3 million and $2,071.3 million of fixed rate
borrowings to floating rates and in 1995, $75.0 million of floating rate
borrowings to fixed rates. At December 31, 1996 and 1995, $275.0 million and
$325.0 million of floating rate borrowings were converted to floating rates with
different repricing indices. At December 31, 1996 and 1995, the Company had
$492.2 million and $59.1 million of foreign currency exchange agreements which
effectively converted the related foreign denominated borrowing to floating US
indexed interest rates. At December 31, 1996 and 1995, the weighted average
interest rates on long-term borrowings, including the effects of interest rate
exchange agreements, were 6.02% and 6.28%.
At December 31, 1996, floating rate notes had a weighted average remaining
maturity of two years, fixed rate notes had a weighted average remaining
maturity of six years and foreign denominated notes had a weighted average
remaining maturity of five years.
Dean Witter, Discover & Co. 1996
--------------------------------
39
<PAGE>
At December 31, 1996, the principal amounts of long-term borrowings maturing
over the next five years were as follows.
<TABLE>
- ------------------------------------------------------------
<S> <C>
1997 $1,073.1
1998 1,705.2
1999 819.6
2000 1,510.0
2001 577.9
============================================================
</TABLE>
Cash paid for interest for the Company's borrowings and deposits was $2,130.2
million, $1,997.9 million and $1,288.8 million in 1996, 1995 and 1994.
7. DEPOSITS
Deposits were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- ------------------------------------------------------------
<S> <C> <C>
Demand, passbook, and money
market accounts $1,715.9 $1,552.0
Consumer certificate accounts 1,354.0 1,222.2
$100,000 minimum certificate accounts 4,142.7 3,416.9
- ------------------------------------------------------------
Total $7,212.6 $6,191.1
============================================================
</TABLE>
The weighted average interest rates of interest-bearing deposits outstanding
during 1996 and 1995 were 6.29% and 6.55%.
At December 31, 1996 and 1995, $495.0 million and $20.0 million of the
Company's deposits were converted to floating rates through the use of interest
rate exchange agreements. At December 31, 1996, the weighted average interest
rate of the Company's deposits including the effect of interest rate exchange
agreements was 6.23%.
At December 31, 1996, certificate accounts maturing over the next five years
were as follows.
<TABLE>
- ------------------------------------------------------------
<S> <C>
1997 $1,410.9
1998 1,720.7
1999 878.9
2000 424.5
2001 688.2
============================================================
</TABLE>
8. EMPLOYEE BENEFIT PLANS
PENSION PLANS
Substantially all employees of the Company are eligible to participate, after
meeting certain age and service requirements, in Company sponsored
non-contributory defined benefit pension plans. Pension benefits are based on
length of service and average annual compensation. The Company's policy is to
contribute an amount at or above that which is required under the Employee
Retirement Income Security Act.
Pension expense consisted of the following.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 1995 1994
- --------------------------------------------------------------
<S> <C> <C> <C>
Service cost $38.3 $ 27.5 $ 35.0
Interest on projected benefit
obligation 43.2 37.1 35.7
Actual return on plan assets (76.0) (68.9) (12.7)
Net amortization and deferral 38.0 34.4 (19.9)
- --------------------------------------------------------------
Total $43.5 $ 30.1 $ 38.1
============================================================
</TABLE>
The expected long-term rate of return on plan assets was 9.0% in 1996, 1995 and
1994.
The funded status of these plans was as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
Actuarial present value of benefit obligations:
Vested benefit obligation $490.2 $470.5
Accumulated benefit obligation 523.3 497.5
===============================================================================
Projected benefit obligation $632.8 $595.9
Plan assets at fair value 566.3 478.7
- --------------------------------------------------------------------------------
Plan assets less than projected benefit
obligation 66.5 117.2
Unrecognized transitional obligation (10.8) (13.4)
Unrecognized net (loss) gain (15.1) (56.3)
Unrecognized prior service cost (2.4) (3.1)
Adjustment required to recognize
minimum liability 0.3 1.4
- --------------------------------------------------------------------------------
Accrued pension liability $ 38.5 $ 45.8
===============================================================================
</TABLE>
Assumptions used in calculating the projected benefit obligation were as
follows.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Discount rate 7.50% 7.25% 8.50%
Rate of increase in compensation levels 5.00 5.00 5.00
================================================================================
</TABLE>
Dean Witter, Discover & Co. 1996
- --------------------------------
40
<PAGE>
OTHER PLANS
The Company has unfunded postretirement benefit plans that provide medical and
life insurance for eligible retirees, employees and dependents. At December 31,
1996 and 1995, the Company's obligation for these benefits was $36.0 million and
$32.9 million.
Employees of the Company are eligible to participate in the Company's 401(k)
plan upon meeting certain eligibility requirements. The Company matches a
portion of each participant's contribution based upon the performance of the
Company. The Company's contributions to the 401(k) plan were $41.6 million,
$37.3 million and $34.3 million in 1996, 1995 and 1994.
9. STOCK PLANS
The Company maintains equity-based incentive plans under which various types of
stock awards are granted to officers, directors and key employees of the
Company.
EQUITY-BASED EMPLOYEE INCENTIVE AWARDS
The Company is authorized to issue up to 38.2 million shares of its common stock
in connection with awards under several equity-based employee incentive plans.
Stock option activity under these plans was as follows.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 1995
- --------------------------------------------------------------------------------
NUMBER AVERAGE NUMBER AVERAGE
OF OPTION OF OPTION
SHARES PRICE SHARES PRICE
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Options outstanding at
beginning of the year 27.7 $15.00 16.6 $12.53
Granted 0.1 25.96 13.1 17.65
Exercised (2.0) 13.58 (1.8) 11.39
Forfeited (0.4) 17.49 (0.2) 15.43
Options outstanding at
Year end 25.4 15.10 27.7 15.00
- --------------------------------------------------------------------------------
Eligible for exercise at
year end 17.0 $13.82 11.2 $12.36
================================================================================
</TABLE>
<TABLE>
<CAPTION>
OPTIONS OPTIONS
DECEMBER 31, 1996 OUTSTANDING EXERCISABLE
- ------------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE
RANGE OF NUMBER REMAINING OPTION NUMBER OPTION
EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- ------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$8.00 to $12.99 3.4 5 $10.11 3.4 $10.11
$13.00 to $19.99 21.7 7 15.78 13.5 14.69
$20.00 to $27.99 0.3 9 24.52 0.1 24.49
====================================================================================
</TABLE>
At December 31, 1996, 12.5 million shares were available for future grant under
these plans.
These plans are "non-compensatory" under APB No. 25, and, accordingly, no
charge to earnings has been recorded. On a pro forma basis, under SFAS No. 123,
if the fair value of options granted in 1996 and 1995 had been charged to
earnings, net income as recorded would have been reduced by $14.5 million in
both 1996 and 1995. Primary and fully diluted earnings per common share as
reported, would have been reduced by $0.04 in both 1996 and 1995.
The fair value of each option grant is estimated on the date of grant using
a binomial option-pricing model with the following weighted average assumptions
used for grants in 1996 and 1995: dividend yield of 1.72% and 1.82%; expected
volatility of 22.19%; risk-free interest rates of 5.31% and 7.74%; and expected
lives of 5.5 years.
EMPLOYEE STOCK PURCHASE PLAN
Under the Employee Stock Purchase Plan, employees may purchase shares of the
Company's common stock at not less than 85% of the fair market value on the date
of purchase. The Company is authorized to issue up to 2.2 million shares of
common stock under this plan. In 1996 and 1995, employees of the Company
purchased 0.7 million and 0.8 million shares of common stock.
The discount to fair market value was $2.4 million for 1996 and $0.6 million
for 1995. The plan is "non-compensatory" under APB No. 25, and, accordingly, no
charge to earnings has been recorded for the amount of the discount to fair
market value. On a pro forma basis, if the discount had been charged to
earnings, net income would have been reduced by $1.5 million and $0.4 million in
1996 and 1995.
DEFERRED COMPENSATION AWARDS
The Company is authorized to issue up to 16.3 million shares of its common stock
under the terms of its deferred compensation plans. These plans provide for the
deferral of a portion of certain employees' compensation with payment made in
the form of shares of the Company's common stock. In 1996 and 1995, the Company
recorded compensation expense of $87.1 million and $57.2 million and unearned
compensation of $7.7 million and $6.1 million in connection with the award of
approximately 3.0 million and 2.4 million shares of common stock under these
plans in 1996 and 1995. These shares were issued in 1997 and 1996 and are held
in custodial or trust accounts pending employee eligibility to receive the
shares. Unearned compensation is recognized over the related plan vesting
periods.
Dean Witter, Discover & Co. 1996
--------------------------------
41
<PAGE>
NON-EMPLOYEE DIRECTOR AWARDS
The Company sponsors stock plans for non-employee directors under which 0.4
million shares of the Company's common stock have been authorized for issuance
in the form of option grants, stock awards or deferred compensation. The fair
value of awards granted under this plan is charged to expense over the vesting
period of the related grant. The effect of these grants on results of operations
was not material.
10. INCOME TAXES
Income tax expense (benefit) was as follows.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $596.5 $537.5 $540.3
State and local 80.6 95.4 89.0
- --------------------------------------------------------------------------------
677.1 632.9 629.3
- --------------------------------------------------------------------------------
Deferred:
Federal (77.5) (75.0) (136.2)
State and local (5.9) (18.4) (19.4)
- --------------------------------------------------------------------------------
(83.4) (93.4) (155.6)
- --------------------------------------------------------------------------------
Total $593.7 $539.5 $473.7
================================================================================
</TABLE>
Deferred income taxes were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Loan loss allowances $ 437.7 $ 366.7
Deferred compensation 248.7 207.8
Other valuation and liability allowances 282.6 279.9
Other deferred tax assets 91.9 87.2
- --------------------------------------------------------------------------------
1,060.9 941.6
- --------------------------------------------------------------------------------
Liabilities:
Prepaid commissions (143.3) (125.8)
Other deferred tax liabilities (97.3) (78.9)
- --------------------------------------------------------------------------------
(240.6) (204.7)
- --------------------------------------------------------------------------------
Total $ 820.3 $ 736.9
================================================================================
</TABLE>
A reconciliation from the statutory federal income tax rate to the effective tax
rate was as follows.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 1995 1994
- ---------------------------------------------------------------
<S> <C> <C> <C>
U.S. statutory rate 35.0% 35.0% 35.0%
State and local taxes, net of
federal benefit 3.3 3.5 3.5
Other 0.1 0.1 0.5
- ---------------------------------------------------------------
Effective tax rate 38.4% 38.6% 39.0%
===============================================================
</TABLE>
Prior to June 30, 1993, the Company was a subsidiary of Sears, Roebuck and Co.
("Sears"). The Company and Sears have an agreement under which the Company is
responsible for additional taxes arising as the result of amendment or audit
that are attributable to the business of the Company for any period during which
it was owned by Sears. Sears will reimburse the Company for any tax benefits
attributable to the business of the Company for the applicable periods.
Cash paid for income taxes was $598.6 million, $653.9 million and $719.0
million in 1996, 1995 and 1994.
11. REGULATORY CAPITAL REQUIREMENTS
Under regulatory net capital requirements adopted by the Federal Deposit
Insurance Corporation ("FDIC") and other regulatory capital guidelines, FDIC
insured financial institutions must maintain (a) 3% to 5% of Tier 1 capital, as
defined, to total assets ("leverage ratio") and (b) 8% combined Tier 1 and Tier
2 capital, as defined, to risk-weighted assets ("risk-weighted capital ratio").
At December 31, 1996, the leverage ratio and risk-weighted capital ratio of each
of the Company's FDIC insured financial institutions exceeded these and all
other regulatory minimums.
DWR, the Company's primary broker-dealer, is subject to the uniform net
capital rule under the Securities Exchange Act of 1934. Under the alternative
method permitted by this Rule, the required net capital, as defined, shall not
be less than the greater of (a) one million dollars, (b) 2% of aggregate debit
balances arising from client transactions pursuant to the Securities Exchange
Act of 1934 Rule 15c3-3, or (c) 4% of the funds required to be segregated
pursuant to the Commodity Exchange Act. The New York Stock Exchange, Inc. may
also require a member organization to reduce its business if its net capital is
less than the greater of (a) 4% of aggregate debit balances or (b) 6% of the
funds required to be segregated and may prohibit a member organization from
expanding its business and declaring cash dividends if its net capital is less
than the greater of (a) 5% of aggregate debit balances or (b) 7% of the funds
required to be segregated. At December 31, 1996, DWR's net capital was $588.8
million and net capital in excess of the minimum required was $474.5 million.
DWR's net capital was 19.7% of aggregate debit balances and 20.6% of funds
required to be segregated.
The regulatory capital requirements referred to above, and certain covenants
contained in various agreements governing indebtedness of the Company, may
restrict the Company's ability to withdraw capital from its subsidiaries. At
December 31, 1996, approximately $1.7 billion of net assets of consolidated
subsidiaries may be restricted as to the payment of cash dividends and advances
to the Company.
Dean Witter, Discover & Co. 1996
- --------------------------------
42
<PAGE>
12. COMMITMENTS AND CONTINGENT LIABILITIES
The Company has non-cancelable operating leases covering office space and
equipment. At December 31, 1996, future minimum rental commitments under such
leases (net of subleases, principally on office rentals) were as follows.
<TABLE>
- ------------------------------------------------------------
<S> <C>
1997 $ 162.6
1998 143.5
1999 128.1
2000 115.4
2001 110.7
Thereafter 427.9
- ------------------------------------------------------------
Total $1,088.2
============================================================
</TABLE>
Occupancy lease agreements, in addition to base rentals, generally provide for
rent and operating expense escalations resulting from increased assessments for
real estate taxes and other charges. Total rent expense, net of sublease rental
income, was $162.6 million, $153.1 million and $148.5 million in 1996, 1995 and
1994.
The Company has an agreement with Advantis, a joint venture between Sears
and IBM, under which the Company receives information processing, data
networking and related services. Under the terms of the agreement, the Company
has an aggregate minimum annual commitment of $166.0 million subject to annual
cost of living adjustments.
At December 31, 1996, the Company had outstanding letters of credit of
approximately $61.5 million which expire on various dates through June 30, 1997.
The letters of credit are written in favor of clearing associations to satisfy
margin requirements and with the trustee for various unit investment trust
underwritings. Annual fees of 0.25% are paid on the amounts of these letters of
credit.
In the normal course of business, the Company has been named as a defendant
in various lawsuits. Some of these lawsuits involve claims for substantial
amounts. Although the ultimate outcome of these suits cannot be ascertained at
this time, it is the opinion of management, after consultation with outside
counsel, that the resolution of such suits 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 income for such period.
13. FINANCIAL INSTRUMENTS
TRADING ACTIVITIES
Certain market and credit risks arise from the Company's securities brokerage
activities. These activities primarily facilitate clients' trading and financing
transactions in financial instruments, which may include derivatives.
The Company's client activities involve the execution, settlement and
financing of various client securities and commodities transactions. Client
securities activities are transacted on either a cash or margin basis, and
client commodity transactions are generally transacted on a margin basis subject
to individual exchange regulations. These transactions include the purchase and
sale of securities, the writing of options and the purchase and sale of
commodity futures and forward contracts. These activities may expose the Company
to off-balance sheet risk from clients that may fail to satisfy their
obligations, requiring the Company to purchase or sell financial instruments at
prevailing market prices. The Company believes that the settlement of these
transactions will not have a material effect on the Company's consolidated
financial statements.
The Company's exposure to credit risk associated with these transactions is
measured on an individual basis, as well as by groups that share similar
attributes. The Company services a diverse group of domestic and foreign
corporations, governments, and institutional and individual investors. Credit
risk may also be impacted by trading market volatility. The Company seeks to
control risks associated with its clients' activities by requiring clients to
maintain collateral in compliance with internal and regulatory guidelines. The
Company monitors required margin levels and establishes credit limits daily and,
pursuant to such guidelines, requires clients to deposit additional collateral,
or reduce positions, when necessary.
The Company's client financing and securities settlement activities may
require the Company to pledge client securities as collateral (1) in support of
various secured financing sources such as bank loans, securities loaned and
repurchase agreements and (2) to satisfy margin requirements on various
exchanges. In the event the counterparty is unable to meet its contractual
obligation to return the client securities pledged as collateral, the Company
may be exposed to the risk of acquiring the securities at prevailing market
prices in order to satisfy its client obligations. The Company controls this
risk by monitoring the market value of securities pledged on a daily basis and
by requiring adjustments of collateral levels in the event of excess market
exposure. Additionally, the Company establishes credit limits for such
activities and monitors compliance on a daily basis. At December 31, 1996, the
market value of client securities
Dean Witter, Discover & Co. 1996
--------------------------------
43
<PAGE>
pledged under these secured financing transactions approximated the amounts due.
The Company's derivative trading activities are generally limited to
facilitating client trading activity. The Company's derivative trading
activities primarily involve foreign currency forward contracts and foreign
currency options. All financial instruments are carried at market value. Gains
and losses from financial instruments are recorded in the consolidated
statements of income as principal transactions revenue. Market risk is generally
controlled by holding substantially offsetting purchase and sell positions. In
certain cases, the Company has entered into master netting agreements which
allow for net settlement of offsetting transactions with counterparties. The
table below presents the Company's trading derivatives. Where derivative
instruments are subject to netting arrangements, the amounts disclosed are
presented on a net settlement basis.
Foreign currency forward contracts represent obligations to purchase or sell
with the seller agreeing to make delivery at a specified future date and a
specified price. Foreign currency options provide the holder the right, but not
the obligation, to purchase or sell on a certain date and at a specified price.
The fair values of these instruments represent quoted market prices.
Principal transactions revenues include revenues from purchases and sales in
which the Company acts as a principal, as well as gains and losses on securities
held for resale. Revenues from fixed income principal trading activities were
$240.5 million, $261.6 million and $247.2 million in 1996, 1995 and 1994.
Revenues from equity securities principal trading activities were $208.8
million, $217.3 million and $174.7 million in 1996, 1995 and 1994. The net gains
or losses from derivative financial instruments in 1996, 1995 and 1994 were not
material.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
CONTRACT OR AVERAGE CONTRACT OR AVERAGE
NOTIONAL FAIR FAIR NOTIONAL FAIR FAIR
AMOUNT VALUE VALUE AMOUNT VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Foreign currency forward contracts
Assets $6,298.4 $ 61.3 $ 64.5 $5,640.2 $ 62.7 $ 53.3
Liabilities 6,251.9 (61.1) (64.3) 5,584.2 (62.5) (53.3)
Foreign currency options
Assets 675.2 2.2 9.6 1,589.1 6.8 11.1
Liabilities 675.2 (2.2) (9.6) 1,589.1 (6.8) (11.1)
==============================================================================================================================
</TABLE>
OTHER THAN TRADING ACTIVITIES
The Company uses interest rate contracts, which consist of interest rate
exchange agreements and purchased interest rate cap agreements, as part of its
interest rate risk management program. This program is designed to reduce the
volatility of earnings resulting from changes in interest rates, including the
interest rate risk inherent in servicing fees received by the Company from
consumer loans sold through asset securitizations. This is accomplished
primarily through matched financing, which entails matching the repricing
schedules of consumer loans and the related financing. The Company utilizes
interest rate contracts where asset and funding repricing characteristics are
not matched effectively. These contracts are entered into as hedges of interest
rate risk, and gains or losses from these contracts generally offset
counterbalancing gains or losses on hedged risk. The Company attempts to match
the recognition of the gains or losses in the periods in which the hedged risk
is realized. Thus, gains or losses may be recognized as part of periodic
settlements or, upon early termination of an interest rate contract, deferred
and amortized over the remaining period of the hedged risk to achieve the
appropriate matching. Interest rate contracts are subject to credit risk for
counterparty nonperformance. The fair value of these agreements is the estimated
amount that the Company would receive (or pay) to terminate the underlying
contract, taking into account current market conditions.
Interest rate exchange agreements, which include interest rate swap and cost
of funds agreements, are settled by reference to the difference between the base
interest rates being exchanged, multiplied by the notional amount of the
contract. These agreements subject the Company to market risk in excess of
amounts recorded in the consolidated balance sheets in the event of unfavorable
market interest rate movements. Interest rate swap agreements are derivative
financial instruments which are entered into with institutions that are
established dealers and that maintain certain minimum credit criteria
established by the Company. Cost of funds agreements are entered into as part of
agreements pursuant to which the Company provides private label credit card
processing services to certain of its merchant clients.
Dean Witter, Discover & Co. 1996
- --------------------------------
44
<PAGE>
Interest rate exchange agreements outstanding were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- ----------------------------------------------------------------------------------------
NOTIONAL FAIR NOTIONAL FAIR
AMOUNT VALUE AMOUNT VALUE
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate swaps
Pay floating rate,
receive fixed rate $5,021.3 $(32.4) $4,164.8 $ 79.3
Pay fixed rate,
receive floating rate 669.0 (8.1) 837.7 (19.2)
Pay floating rate,
receive floating rate 275.0 (0.5) 425.0 (1.4)
Cost of funds agreements 513.8 1.6 631.3 0.9
========================================================================================
</TABLE>
In addition to the interest rate exchange agreements described above, the
Company has entered into foreign currency exchange agreements on its foreign
denominated borrowings. These agreements hedge the Company's exposure to
currency fluctuations and primarily converted the repricing characteristics of
the related foreign denominated borrowings to floating US indexed rates. At
December 31, 1996 and 1995, $492.2 million and $59.1 million of these agreements
were outstanding. At December 31, 1996 and 1995, the fair value of these
agreements were ($6.0) million and ($2.5) million.
Purchased interest rate cap agreements are derivative financial instruments
which, by their nature, have no off-balance sheet risk of loss due to
unfavorable interest rate movements. The Company pays an initial premium, which
is recorded on the balance sheet and amortized to interest expense over the term
of the cap agreement. Benefits received are recorded as a reduction of interest
expense. The Company had outstanding interest rate cap agreements with notional
amounts of $40.0 million and $415.0 million at December 31, 1996 and 1995, of
which $40.0 million were in effect at December 31, 1996 and 1995. At December
31, 1996 and 1995, the fair values of these agreements were $0.3 million and
$0.9 million.
In connection with certain asset securitizations, the Company has written
interest rate cap agreements with notional amounts of $240.0 million and strike
rates of 11%. Any settlement payments made under these agreements will generally
be passed back to the Company through an adjustment of servicing fees, although
this is subject to the risk of counterparty nonperformance. At December 31, 1996
and 1995, the fair values of these agreements were not material. No payments
have been made by the Company under these agreements, which expire in 1997.
FAIR VALUE
The estimated fair value amounts of the Company's financial instruments have
been determined using available market information and appropriate valuation
methodologies. Considerable judgment is required to develop estimates of fair
value. Accordingly, the estimates are not necessarily indicative of the amounts
the Company could realize in a current market exchange. The use of different
assumptions or estimation methodologies may have a material effect on the
estimated fair value amounts.
At December 31, 1996 and 1995, the carrying amounts of the Company's
financial assets and liabilities were reasonable estimates of fair value.
14. SEGMENT INFORMATION
The Company is in the business of providing financial services, and operates in
two distinct business segments -- Credit Services and Securities. Credit
Services is engaged in the issuance and servicing of general purpose credit
cards, consumer lending and electronic transaction processing services.
Securities engages in delivering a broad range of financial products and
services to individual and institutional investors.
The following table presents certain information regarding these business
segments.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Total revenues
Credit Services $ 5,161.8 $ 4,333.7 $ 3,460.2
Securities 3,866.8 3,600.7 3,142.4
Income before income taxes
Credit Services 714.4 720.9 671.7
Securities 830.7 675.0 542.9
Identifiable assets at
end of period(1)
Credit Services 26,091.2 23,857.5 17,901.4
Securities 16,322.4 14,350.7 13,958.0
================================================================================
</TABLE>
(1) Corporate assets have been fully allocated to the Company's business
segments.
Dean Witter, Discover & Co. 1996
--------------------------------
45
<PAGE>
EXHIBIT 99.2
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS -
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
The following unaudited pro forma condensed combined statement of financial
condition combines the historical consolidated statement of financial condition
of Morgan Stanley Group Inc. ("Morgan Stanley") and the historical consolidated
balance sheet of Dean Witter, Discover & Co. ("DWD") giving effect to the Merger
as though it had been consummated on the date of such statement after giving
effect to the pro forma adjustments described in the notes to the pro forma
combined financial statements. The following unaudited pro forma condensed
combined statements of income combine the historical consolidated statements of
income of Morgan Stanley and DWD giving effect to the Merger, which is intended
to be accounted for as a pooling of interests after giving effect to the pro
forma adjustments described in the notes to the pro forma condensed combined
financial statements. This information should be read in conjunction with the
audited consolidated financial statements and other financial information
contained in Morgan Stanley's Annual Report on Form 10-K for the fiscal year
ended November 30, 1996, including the notes thereto, and the audited
consolidated financial statements for the year ended December 31, 1996 and
related disclosures contained in DWD's Current Report on Form 8-K dated February
27, 1997, including the notes thereto incorporated by reference herein. These
unaudited pro forma condensed combined financial statements are not necessarily
indicative of the operating results and financial position that might have been
achieved had the Merger occurred as of the beginning of the earliest period
presented nor are they necessarily indicative of operating results and financial
position which may occur in the future.
<PAGE>
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
Morgan Stanley DWD
Historical Historical
November 30, December 31, Pro Forma Pro Forma
(Dollars in Millions) 1996 1996 Adjustments(a) Combined
---------------- ----------------------------- -----------
Assets
<S> <C> <C> <C> <C>
Cash and cash equivalents $4,545 $1,999 - $6,544
Cash and securities deposited with clearing organizations
or segregated under federal and other regulations 3,164 2,045 - 5,209
Financial instruments owned:
U.S. government and agency securities 11,079 951 - 12,030
Other sovereign government obligations 19,473 - - 19,473
Corporate and other debt 15,978 923 - 16,901
Corporate equities 12,622 40 - 12,662
Derivative contracts 11,220 - - 11,220
Physical commodities 375 - - 375
Securities purchased under agreements to resell 60,457 3,564 - 64,021
Securities borrowed 39,680 3,866 - 43,546
Receivables:
Consumer loans (net of allowances of $815) - 22,373 - 22,373
Customers, net 5,761 2,839 - 8,600
Brokers, dealers and clearing organizations 5,421 - - 5,421
Fees, interest and other 2,065 805 - 2,870
Other assets 4,606 3,009 - 7,615
----------------------------------------------------------
Total assets $196,446 $42,414 - $238,860
==========================================================
Liabilities and Stockholders' Equity
Commercial paper and other short-term borrowings $20,461 $5,865 - $26,326
Deposits - 7,213 - 7,213
Financial instruments sold, not yet purchased:
U.S. government and agency securities 10,196 1,199 - 11,395
Other sovereign government obligations 6,513 - - 6,513
Corporate and other debt 1,112 64 - 1,176
Corporate equities 8,889 11 - 8,900
Derivative contracts 9,982 - - 9,982
Physical commodities 476 - - 476
Securities sold under agreements to repurchase 83,296 3,567 - 86,863
Securities loaned 8,975 3,932 - 12,907
Payables:
Customers 18,629 3,433 - 22,062
Brokers, dealers and clearing organizations 1,820 - - 1,820
Interest and dividends 1,478 200 - 1,678
Other liabilities and accrued expenses 2,718 3,622 - 6,340
Long-term borrowings 14,498 8,144 - 22,642
----------------------------------------------------------
189,043 37,250 - 226,293
----------------------------------------------------------
Capital Units 865 - - 865
----------------------------------------------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock 1,223 - 1,223
Common Stock(1) 163 3 ($160)(b) 6
Paid-in capital(1) 1,144 2,703 160 (b) 4,007
Retained earnings 4,504 2,973 (407)(b) 7,070
Cumulative translation adjustments (11) - - (11)
----------------------------------------------------------
Subtotal 7,023 5,679 (407) 12,295
----------------------------------------------------------
Less:
Stock compensation related deductions 78 (83) - (5)
Common stock held in treasury, at cost 407 598 (407)(b) 598
----------------------------------------------------------
Total stockholders' equity 6,538 5,164 0 11,702
----------------------------------------------------------
----------------------------------------------------------
Total liabilities and stockholders' equity $196,446 $42,414 $0 $238,860
=========================================================
</TABLE>
(1) DWD historical amounts have been restated to reflect a two-for-one stock
split which became effective January 14, 1997.
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements.
<PAGE>
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
<TABLE>
<CAPTION>
Morgan Stanley DWD
Historical Historical
Twelve Months Twelve Months
Ended Ended Pro Forma
(Dollars in Millions, Except Share Data) November 30, 1996 December 31, 1996 Combined
----------------------- ----------------------- -----------------------
Revenues:
<S> <C> <C> <C>
Investment banking $1,944 $246 $2,190
Principal transactions:
Trading 2,210 449 2,659
Investments 86 - 86
Commissions 613 1,163 1,776
Merchant and cardmember fees - 1,506 1,506
Servicing fees - 819 819
Interest and dividends 7,701 3,587 11,288
Asset management and administration 582 1,150 1,732
Other 8 108 116
----------------------- ----------------------- -----------------------
Total revenues 13,144 9,028 22,172
Interest expense 7,368 1,566 8,934
Provision for losses on credit receivables - 1,232 1,232
----------------------- ----------------------- -----------------------
Net revenues 5,776 6,230 12,006
----------------------- ----------------------- -----------------------
Expenses excluding interest:
Compensation and benefits 2,863 2,208 5,071
Occupancy and equipment 237 256 493
Brokerage, clearing and exchange fees 274 43 317
Information processing and communications 271 725 996
Business development 170 857 1,027
Professional services 226 108 334
Other 163 488 651
----------------------- ----------------------- -----------------------
Total expenses excluding interest 4,204 4,685 8,889
----------------------- ----------------------- -----------------------
Income before income taxes 1,572 1,545 3,117
Provision for income taxes 543 594 1,137
----------------------- ----------------------- -----------------------
Net income $1,029 $951 $1,980
----------------------- ----------------------- -----------------------
Preferred stock dividend requirements $66 - $66
----------------------- ----------------------- -----------------------
Earnings applicable to common shares(1) $963 $951 $1,914
----------------------- ----------------------- -----------------------
Average common and common equivalent
shares outstanding(1) (2) 153,514,483 341,179,638 594,478,535
----------------------- ----------------------- -----------------------
Primary earnings per share(2) $6.27 $2.79 $3.22
----------------------- ----------------------- -----------------------
Fully diluted earnings per share(2) $5.96 $2.77 $3.14
----------------------- ----------------------- -----------------------
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) DWD historical share and per share amounts have been restated to reflect a
two-for-one stock split which became effective January 14, 1997.
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements.
<PAGE>
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
<TABLE>
<CAPTION>
Morgan Stanley DWD
Historical Historical
Twelve Months Twelve Months
Ended Ended Pro Forma
(Dollars in Millions, Except Share Data) November 30, 1995 December 31, 1995 Combined
----------------------- ----------------------- -----------------------
<S> <C> <C> <C>
Revenues:
Investment banking $1,374 $182 $1,556
Principal transactions:
Trading 1,206 479 1,685
Investments 121 - 121
Commissions 510 1,023 1,533
Merchant and cardmember fees - 1,135 1,135
Servicing fees - 697 697
Interest and dividends 7,211 3,319 10,530
Asset management and administration 370 1,007 1,377
Other 5 93 98
----------------------- ----------------------- -----------------------
Total revenues 10,797 7,935 18,732
Interest expense 6,675 1,515 8,190
Provision for losses on credit receivables - 744 744
----------------------- ----------------------- -----------------------
Net revenues 4,122 5,676 9,798
----------------------- ----------------------- -----------------------
Expenses excluding interest:
Compensation and benefits 2,023 1,982 4,005
Occupancy and equipment 219 235 454
Brokerage, clearing and exchange fees 247 42 289
Information processing and communications 243 646 889
Business development 139 735 874
Professional services 161 85 246
Other 135 555 690
Relocation charge 59 - 59
----------------------- ----------------------- -----------------------
Total expenses excluding interest 3,226 4,280 7,506
----------------------- ----------------------- -----------------------
Income before income taxes 896 1,396 2,292
Provision for income taxes 287 540 827
----------------------- ----------------------- -----------------------
Net income $609 $856 $1,465
----------------------- ----------------------- -----------------------
Preferred stock dividend requirements $65 - $65
----------------------- ----------------------- -----------------------
Earnings applicable to common shares(1) $544 $856 $1,400
----------------------- ----------------------- -----------------------
Average common and common equivalent
shares outstanding(1) (2) (3) 156,073,008 350,725,970 608,246,433
----------------------- ----------------------- -----------------------
Primary earnings per share(2) (3) $3.49 $2.44 $2.30
----------------------- ----------------------- -----------------------
Fully diluted earnings per share(2) (3) $3.33 $2.44 $2.25
----------------------- ----------------------- -----------------------
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) Morgan Stanley historical share and per share amounts have been
retroactively adjusted to give effect for a two-for-one stock split,
effected in the form of a 100% stock dividend, which became effective on
January 26, 1996.
(3) DWD historical share and per share amounts have been restated to reflect a
two-for-one stock split which became effective January 14, 1997.
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements.
<PAGE>
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
<TABLE>
<CAPTION>
Morgan Stanley DWD
Historical Historical
Twelve Months Twelve Months
Ended Ended Pro Forma
(Dollars in Millions, Except Share Data) November 30, 1994 December 31, 1994 Combined
----------------------- ----------------------- -----------------------
<S> <C> <C> <C>
Revenues:
Investment banking $904 $198 $1,102
Principal transactions:
Trading 1,192 422 1,614
Investments 154 - 154
Commissions 449 874 1,323
Merchant and cardmember fees - 940 940
Servicing fees - 586 586
Interest and dividends 6,208 2,507 8,715
Asset management and administration 344 973 1,317
Other 4 102 106
----------------------- ----------------------- -----------------------
Total revenues 9,255 6,602 15,857
Interest expense 5,649 1,048 6,697
Provision for losses on credit receivables - 548 548
----------------------- ----------------------- -----------------------
Net revenues 3,606 5,006 8,612
----------------------- ----------------------- -----------------------
Expenses excluding interest:
Compensation and benefits 1,771 1,764 3,535
Occupancy and equipment 193 228 421
Brokerage, clearing and exchange fees 231 45 276
Information processing and communications 215 552 767
Business development 166 607 773
Professional services 159 85 244
Other 124 510 634
----------------------- ----------------------- -----------------------
Total expenses excluding interest 2,859 3,791 6,650
----------------------- ----------------------- -----------------------
Income before income taxes 747 1,215 1,962
Provision for income taxes 231 474 705
----------------------- ----------------------- -----------------------
Net income $516 $741 $1,257
----------------------- ----------------------- -----------------------
Preferred stock dividend requirements $65 - $65
----------------------- ----------------------- -----------------------
Earnings applicable to common shares(1) $451 $741 $1,192
----------------------- ----------------------- -----------------------
Average common and common equivalent
shares outstanding(1) (2) (3) 157,578,446 346,717,026 606,721,462
----------------------- ----------------------- -----------------------
Primary earnings per share(2) (3) $2.86 $2.14 $1.96
----------------------- ----------------------- -----------------------
Fully diluted earnings per share(2) (3) $2.75 $2.14 $1.93
----------------------- ----------------------- -----------------------
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) Morgan Stanley historical share and per share amounts have been
retroactively adjusted to give effect for a two-for-one stock split,
effected in the form of a 100% stock dividend, which became effective on
January 26, 1996.
(3) DWD historical share and per share amounts have been restated to reflect a
two-for-one stock split which became effective January 14, 1997.
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements.
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
NOTE (a): BASIS OF PRESENTATION
The unaudited pro forma condensed combined statement of financial condition
combines the historical consolidated statement of financial condition of Morgan
Stanley at November 30, 1996 with the historical consolidated balance sheet of
DWD at December 31, 1996. The unaudited pro forma condensed combined statements
of income combine the historical consolidated statements of income of Morgan
Stanley for the fiscal year ended November 30, 1996, and the twelve months ended
November 30, 1995 and 1994 (recast to reflect a twelve month presentation) with
the historical consolidated statements of income of DWD for the years ended
December 31, 1996, 1995 and 1994. Certain amounts reflected in the historical
financial statement presentations of both companies have been reclassified to
conform to the unaudited pro forma condensed combined presentation.
The unaudited pro forma condensed combined financial statements exclude (i) the
positive effects of potential increased revenues or operating synergies which
may be achieved upon combining the resources of the companies (ii) investment
banking, legal and miscellaneous transaction costs of the Merger, which will be
reflected as an expense in the period the Merger is consummated, and (iii) costs
associated with the integration and consolidation of the companies which are not
presently estimable.
Transactions between Morgan Stanley and DWD are not material in relation to the
unaudited pro forma condensed combined financial statements and therefore,
intercompany balances have not been eliminated from the pro forma combined
amounts. Morgan Stanley and DWD are in the process of reviewing their
respective accounting policies and do not expect there to be any significant
adjustments necessary in order to conform such policies.
During 1996, Morgan Stanley acquired Miller Anderson & Sherrerd, LLP and Van
Kampen American Capital, Inc., both accounted for as purchase transactions.
Subsequent to fiscal 1996 year-end, Morgan Stanley announced that it had reached
an agreement with Barclays PLC to acquire its institutional global custody
business. In January 1997, DWD acquired Lombard Brokerage, Inc. which was
accounted for as a purchase transaction. No pro forma effect has been given to
these transactions as the effect is not material.
<PAGE>
NOTE (b): PRO FORMA ADJUSTMENTS
The pro forma adjustments to common stock, paid in capital, and retained
earnings at November 30, 1996 reflect (i) an exchange of 153.3 million shares of
common stock, par value $1.00 per share of Morgan Stanley for 253.0 million
shares (using the exchange ratio of 1.65) of common stock, par value $.01 per
share of DWD and (ii) the cancellation and retirement of all shares of Morgan
Stanley common stock held in treasury. The number of shares of DWD common stock
to be issued at consummation of the Merger will be based upon the actual number
of shares of Morgan Stanley common stock outstanding at that time.
NOTE (c): PRO FORMA EARNINGS PER SHARE
The pro forma combined primary and fully diluted earnings per common share for
the respective periods presented is based on the combined weighted average
number of common shares and share equivalents of Morgan Stanley and DWD. The
number of common shares and share equivalents of Morgan Stanley is based on an
exchange ratio of 1.65 shares of DWD common shares for each issued and
outstanding share and share equivalent of Morgan Stanley.
