<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-11758
DEAN WITTER, DISCOVER & CO.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
----------------
DELAWARE 36-3145972
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
TWO WORLD TRADE CENTER 10048
NEW YORK, NY (ZIP CODE)
(ADDRESS OF PRINCIPAL
EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 392-2222
----------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
As of October 31, 1996, there were 160,756,769 shares of Registrant's Common
Stock, par value $.01 per share, outstanding.
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<PAGE>
DEAN WITTER, DISCOVER & CO.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income--Three and Nine Months
Ended September 30, 1996 and 1995 (unaudited)........................ 1
Consolidated Balance Sheets--September 30, 1996 (unaudited) and
December 31, 1995.................................................... 2
Consolidated Statements of Cash Flows--Nine Months
Ended September 30, 1996 and 1995 (unaudited)........................ 3
Notes to Consolidated Financial Statements (unaudited)................ 4
Independent Accountants' Report....................................... 9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................. 10
PART II--OTHER INFORMATION
Item 1. Legal Proceedings............................................... 24
Item 6. Exhibits and Reports on Form 8-K................................ 24
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
DEAN WITTER, DISCOVER & CO.
CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1996 1995 1996 1995
--------- --------- -------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Merchant and cardmember fees............. $ 379.5 $ 285.8 $1,045.6 $ 791.7
Commissions.............................. 264.3 266.2 868.8 748.7
Asset management and administration fees. 289.8 251.7 850.5 748.2
Servicing fees........................... 222.7 187.8 614.5 534.3
Principal transactions................... 107.0 121.6 340.4 367.8
Investment banking....................... 45.7 45.1 168.0 132.7
Other.................................... 20.7 16.2 79.0 69.3
--------- --------- -------- --------
Total non-interest revenues............ 1,329.7 1,174.4 3,966.8 3,392.7
--------- --------- -------- --------
Interest revenue......................... 893.7 844.2 2,618.4 2,414.0
Interest expense......................... 390.4 374.7 1,160.8 1,112.0
--------- --------- -------- --------
Net interest income.................... 503.3 469.5 1,457.6 1,302.0
Provision for losses on receivables...... 307.0 192.7 809.2 451.0
--------- --------- -------- --------
Net credit income...................... 196.3 276.8 648.4 851.0
--------- --------- -------- --------
Net operating revenues................. 1,526.0 1,451.2 4,615.2 4,243.7
--------- --------- -------- --------
Employee compensation and benefits....... 525.8 511.5 1,649.0 1,484.7
Marketing and business development....... 209.9 204.4 603.2 511.1
Information processing and
communications.......................... 190.2 169.9 558.2 496.0
Facilities and equipment................. 63.8 60.8 188.7 173.6
Other.................................... 143.3 148.9 434.6 475.0
--------- --------- -------- --------
Total non-interest expenses............ 1,133.0 1,095.5 3,433.7 3,140.4
--------- --------- -------- --------
Income before income taxes............... 393.0 355.7 1,181.5 1,103.3
Income tax expense....................... 154.0 137.0 457.9 425.0
--------- --------- -------- --------
Net income............................... $ 239.0 $ 218.7 $ 723.6 $ 678.3
========= ========= ======== ========
Primary net income per share............. $ 1.42 $ 1.24 $ 4.21 $ 3.87
========= ========= ======== ========
Primary average common shares
outstanding............................. 168.9 176.5 171.7 175.2
========= ========= ======== ========
Fully diluted net income per share....... $ 1.41 $ 1.23 $ 4.21 $ 3.83
========= ========= ======== ========
Fully diluted average common shares
outstanding............................. 169.2 177.3 171.9 176.9
========= ========= ======== ========
</TABLE>
See notes to the consolidated financial statements.
1
<PAGE>
DEAN WITTER, DISCOVER & CO.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(UNAUDITED)
ASSETS
<S> <C> <C>
Cash and cash equivalents........................... $ 1,102.2 $ 1,464.5
Cash and securities segregated under federal and
other regulations.................................. 1,801.8 1,926.4
Receivables
Consumer loans (net of allowances of $688.1 in 1996
and $721.8 in 1995)............................... 19,594.6 20,834.6
Securities clients (net of allowances of $15.7 in
1996 and $16.2 in 1995)........................... 2,739.6 2,588.8
Brokers or dealers................................. 3,197.4 2,683.7
Other.............................................. 732.7 732.4
Amounts due from asset securitizations.............. 852.6 653.4
Securities purchased under agreements to resell..... 3,524.4 3,571.9
Securities owned, at market value................... 1,695.8 1,848.8
Deferred income taxes............................... 776.6 736.9
Office facilities, at cost (less accumulated
depreciation and amortization of $435.1 in 1996 and
$380.5 in 1995).................................... 376.8 341.0
Goodwill............................................ 161.1 161.9
Other assets........................................ 635.7 663.9
--------- ---------
Total assets..................................... $37,191.3 $38,208.2
========= =========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
<S> <C> <C>
Liabilities
Commercial paper................................... $ 1,966.9 $ 4,688.5
Other short-term borrowings........................ 430.3 1,637.0
Deposits........................................... 6,598.2 6,191.1
Payables
Securities clients................................ 2,822.0 3,183.0
Brokers or dealers................................ 3,204.2 2,629.7
Drafts............................................ 400.5 485.5
Income taxes...................................... 162.8 99.3
Securities sold under agreements to repurchase..... 3,425.9 3,813.4
Securities sold but not yet purchased, at market
value............................................. 1,302.7 1,125.2
Other liabilities and accrued expenses............. 3,076.4 2,789.4
Long-term borrowings............................... 8,823.2 6,732.4
--------- ---------
Total liabilities................................ 32,213.1 33,374.5
--------- ---------
Shareholders' Equity
Preferred stock ($0.01 par value, 10.0 shares
authorized, none issued).......................... -- --
Common stock ($0.01 par value, 500.0 shares
authorized, 171.0 and 171.0 shares issued, 161.3
and 168.8 shares outstanding at September 30, 1996
and December 31, 1995)............................ 1.7 1.7
Paid-in capital.................................... 2,708.0 2,718.3
Retained earnings.................................. 2,780.1 2,165.7
--------- ---------
5,489.8 4,885.7
--------- ---------
Common stock held in treasury, at cost ($0.01 par
value, 9.7 and 2.2 shares at September 30, 1996 and
December 31, 1995)................................. (507.2) (106.8)
Stock compensation plans............................ 46.6 85.1
Employee stock benefit trust........................ (46.0) (21.5)
Unearned stock compensation......................... (5.0) (8.8)
--------- ---------
Total shareholders' equity....................... 4,978.2 4,833.7
--------- ---------
Total liabilities and shareholders' equity....... $37,191.3 $38,208.2
========= =========
</TABLE>
See notes to the consolidated financial statements.
2
<PAGE>
DEAN WITTER, DISCOVER & CO.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1996 1995
--------- ---------
(UNAUDITED)
<S> <C> <C>
Cash flows provided by (used in) operating activities
Net income............................................... $ 723.6 $ 678.3
Adjustments to reconcile net income to net cash flows
from operating activities
Depreciation and amortization........................... 58.8 50.8
Provision for losses on receivables..................... 809.2 451.0
Deferred income taxes................................... (39.7) (68.8)
Decrease (increase) in operating assets
Cash and securities segregated under federal and other
regulations............................................ 124.6 (225.2)
Receivables
Securities clients..................................... (159.5) 144.8
Brokers or dealers..................................... (513.7) (51.3)
Other.................................................. (0.3) 24.9
Amounts due from asset securitizations.................. (199.2) (166.7)
Matched securities purchased under agreements to resell,
net.................................................... (132.9) 179.9
Securities owned and securities sold but not yet
purchased, at market value, net........................ 330.5 (547.5)
Other assets............................................ (3.8) 41.6
Increase (decrease) in operating liabilities
Payables
Securities clients..................................... (361.0) (172.9)
Brokers or dealers..................................... 574.5 42.0
Drafts................................................. (85.0) (66.0)
Income taxes........................................... 63.5 (27.1)
Other liabilities and accrued expenses.................. 377.2 499.6
--------- ---------
Cash provided by (used in) operating activities....... 1,566.8 787.4
--------- ---------
Cash flows provided by (used in) investing activities
Net principal disbursed on consumer loans............... (4,373.3) (3,016.5)
Purchases of consumer loans............................. (5.1) (296.6)
Sales of consumer loans................................. 4,817.9 1,677.3
Other................................................... (61.8) (58.1)
--------- ---------
Cash provided by (used in) investing activities....... 377.7 (1,693.9)
--------- ---------
Cash flows provided by (used in) financing activities
Proceeds from issuance (repayments) of commercial paper,
net.................................................... (2,811.8) (965.7)
Net decrease in other short-term borrowings............. (1,206.6) (991.7)
Deposits, net........................................... 407.1 490.0
Proceeds from issuance of long-term borrowings, net..... 2,093.5 1,574.7
Securities sold under agreements to repurchase, net..... (207.3) 454.7
Dividends paid.......................................... (98.4) (75.2)
Proceeds from issuance of common stock.................. 34.8 34.7
Purchase of treasury stock.............................. (518.1) (16.1)
--------- ---------
Cash provided by (used in) financing activities....... (2,306.8) 505.4
--------- ---------
Decrease in cash and cash equivalents.................... (362.3) (401.1)
Cash and cash equivalents, beginning of period........... 1,464.5 1,334.1
--------- ---------
Cash and cash equivalents, end of period................. $ 1,102.2 $ 933.0
========= =========
</TABLE>
See notes to the consolidated financial statements.
3
<PAGE>
DEAN WITTER, DISCOVER & CO.
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 NOVUSSM 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.
The interim consolidated financial statements as of September 30, 1996, and
for the three and nine months ended September 30, 1996 and 1995, are
unaudited; however, in the opinion of management, all adjustments, consisting
only of normal recurring accruals necessary for fair presentation, have been
reflected. All material intercompany balances and transactions have been
eliminated.
The consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto for the year ended
December 31, 1995 incorporated by reference in the Company's 1995 Annual
Report on Form 10-K filed by the Company under the Securities Exchange Act of
1934. The results of operations for interim periods are not necessarily
indicative of results for the entire year. Certain reclassifications have been
made to prior period amounts to conform to the current presentation.
The calculations of earnings per common share were based on the weighted
average number of common shares outstanding during the three and nine month
periods ended September 30, 1996 and 1995, adjusted for the dilutive effects
of stock options and unissued stock awards under deferred compensation plans.
2. ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards ("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 Financial Accounting Standards Board has issued SFAS No. 123,
"Accounting for Stock-Based Compensation", effective for fiscal years
beginning after December 15, 1995. The Company has elected, as permitted by
SFAS No. 123, to adopt the disclosure requirement of that standard but
continue to account for stock-based compensation under APB Opinion No. 25,
"Accounting for Stock Issued to Employees."
The Financial Accounting Standards Board has also issued SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," effective for transfers of financial assets
made after December 31, 1996. (The Financial Accounting Standards Board has
recently proposed to delay the effective date of this statement for twelve
months for transfers of certain financial assets.) This statement 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.
4
<PAGE>
DEAN WITTER, DISCOVER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. RISKS AND UNCERTAINTIES
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.
The allowance for consumer loan losses is a significant estimate that is
regularly evaluated by management for adequacy on a portfolio by portfolio
basis. 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 the third
quarter of 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 SFAS No. 125 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. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" on page 16 for the effect of this change on the
provision for loan losses.
4. CONSUMER LOANS
Consumer loans, classified as to type, were as follows (in millions).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Credit card...................................... $19,204.4 $20,440.4
Real estate-secured and other consumer
installment..................................... 1,163.6 1,233.1
--------- ---------
Total............................................ 20,368.0 21,673.5
Less
Unearned finance charges and unamortized loan
discounts and fees............................. 85.3 117.1
Allowance for loan losses....................... 688.1 721.8
--------- ---------
Consumer loans, net.............................. $19,594.6 $20,834.6
========= =========
</TABLE>
5
<PAGE>
DEAN WITTER, DISCOVER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Activity in the allowance for consumer loan losses was as follows (in
millions).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- -------------------
1996 1995 1996 1995
--------- --------- --------- --------
<S> <C> <C> <C> <C>
Balance, beginning of period...... $ 671.0 $ 604.6 $ 721.8 $ 565.7
Additions
Provision for loan losses....... 304.2 190.2 800.5 443.4
Purchase of loan portfolios..... -- -- 0.1 29.8
--------- --------- --------- --------
Total additions............... 304.2 190.2 800.6 473.2
--------- --------- --------- --------
Deductions
Charge-offs..................... 300.6 183.6 833.2 478.7
Recoveries...................... (36.7) (29.9) (107.6) (87.7)
--------- --------- --------- --------
Net charge-offs............... 263.9 153.7 725.6 391.0
--------- --------- --------- --------
Other(1).......................... (23.2) (15.7) (108.7) (22.5)
--------- --------- --------- --------
Balance, end of period............ $ 688.1 $ 625.4 $ 688.1 $ 625.4
========= ========= ========= ========
</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 $45.6 million and $122.8 million in the three and
nine months ended September 30, 1996 and $28.8 million and $73.5 million in
the three and nine months ended September 30, 1995.
The Company received net proceeds from asset securitizations of $860.8
million and $4,527.5 million in the three and nine months ended September 30,
1996 compared to $1,052.6 million and $1,684.2 million in the three and nine
months ended September 30, 1995. The uncollected balances of consumer loans
sold through securitizations were $13,511.1 million and $10,219.5 million at
September 30, 1996 and December 31, 1995. The allowance for loan losses
related to securitized consumer loans, included in other liabilities and
accrued expenses, was $455.1 million and $341.7 million at September 30, 1996
and December 31, 1995. The Company had, under the provisions of certain
securitization transactions, limited recourse obligations at September 30,
1996 and December 31, 1995 of $137.1 million and $123.9 million, of which
$29.7 million and $30.0 million were included in the allowance for loan losses
related to securitized consumer loans.
6
<PAGE>
DEAN WITTER, DISCOVER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. BORROWINGS
Short-term borrowings
Short-term borrowings consisted of the following (in millions).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Commercial paper................................. $1,966.9 $4,688.5
Other
Bank borrowings.................................. 410.3 385.3
Federal funds purchased.......................... 20.0 720.0
Bank notes....................................... -- 529.6
Note payable to Tandy............................ -- 2.1
-------- --------
Total............................................ $2,397.2 $6,325.5
======== ========
</TABLE>
The weighted average interest rate on short-term borrowings, including the
effects of interest rate contracts, was 5.82% at September 30, 1996 and 5.97%
at December 31, 1995.
To support the issuance of asset-backed commercial paper, Riverwoods Funding
Corporation ("RFC"), a consolidated subsidiary of the Company, renewed its
agreement with a syndicate of banks, effective October 18, 1996, for its
senior bank credit facility. This agreement will expire on October 17, 1997.
In conjunction with renewing this agreement the amount of the credit facility
was increased to $2.1 billion from the previous amount of $1.75 billion.
Long-term borrowings
Long-term borrowings, which consisted of senior long-term notes, net of
unamortized discount, were as follows (in millions).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Floating rate notes............................... $5,167.0 $3,275.5
Fixed rate notes.................................. 3,656.2 3,456.9
-------- --------
Total............................................. $8,823.2 $6,732.4
======== ========
</TABLE>
The weighted average interest rate on long-term borrowings, including the
effects of interest rate contracts, was 5.91% at September 30, 1996 and 6.28%
at December 31, 1995.
In April 1996, the Company renewed its senior bank credit facility and
increased its amount to $4.0 billion from $3.25 billion. The facility expires
in April 1997 and includes certain extension provisions. 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 September 30, 1996, the Company had never borrowed from its
senior bank credit facility.
In August 1996, the Company registered $2.0 billion of debt securities with
the Securities and Exchange Commission ("SEC").
7
<PAGE>
DEAN WITTER, DISCOVER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
6. 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 September 30, 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 of the SEC. 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 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 September 30, 1996, DWR's net capital was $655.4 million
and net capital in excess of the minimum required was $545.1 million. DWR's
net capital was 22.7% of aggregate debit balances and 23.8% of funds required
to be segregated.
7. CONTINGENT LIABILITIES
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.
8
<PAGE>
INDEPENDENT ACCOUNTANTS' REPORT
To the Directors and Shareholders of
Dean Witter, Discover & Co.:
We have reviewed the accompanying consolidated balance sheet of Dean Witter,
Discover & Co. and subsidiaries as of September 30, 1996, and the related
consolidated statements of income for the three and nine month periods ended
September 30, 1996 and 1995, and cash flows for the nine month periods ended
September 30, 1996 and 1995. These financial statements are the responsibility
of the management of Dean Witter, Discover & Co.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data and making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to such consolidated financial statements for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Dean Witter, Discover & Co. and
subsidiaries as of December 31, 1995, and the related consolidated statements
of income, cash flows and changes in shareholders' equity for the year then
ended (not presented herein); and in our report dated February 21, 1996, we
expressed an unqualified opinion on those consolidated financial statements.
Deloitte & Touche LLP
New York, New York
November 13, 1996
9
<PAGE>
DEAN WITTER, DISCOVER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
RESULTS OF OPERATIONS
The Company's net income was $239.0 million in the third quarter of 1996, a
9% increase over the third quarter of 1995. In the first nine months of 1996
net income was $723.6 million, a 7% increase over the first nine months of
1995. Primary earnings per common share were $1.42 and $4.21 in the third
quarter and first nine months of 1996 compared to $1.24 and $3.87 in 1995.
Fully diluted earnings per common share were $1.41 and $4.21 in the third
quarter and first nine months of 1996 compared to $1.23 and $3.83 in 1995.
Net operating revenues increased 5% and 9% in the third quarter and first
nine months of 1996 from the comparable periods of 1995. The increases in both
periods were due to higher merchant and cardmember fees, net interest income,
asset management and administration fees, servicing fees and, in the first
nine months, higher commissions revenue, partially offset in both periods by
higher provisions for losses on receivables.
Non-interest expenses increased 3% and 9% in the third quarter and first
nine months of 1996 from the comparable periods of 1995. The increase in the
third quarter was due to higher information processing and employee
compensation and benefits expenses related to Credit Services activities. The
increase in the first nine months reflected higher variable compensation
expenses related to Securities revenue, increased marketing and business
development expenses and information processing expenses.
10
<PAGE>
CREDIT SERVICES
STATEMENTS OF INCOME (IN MILLIONS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1996 1995 1996 1995
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Merchant and cardmember fees............. $ 379.5 $ 285.8 $1,045.6 $ 791.7
Servicing fees........................... 222.7 187.8 614.5 534.3
Other.................................... 1.1 0.8 7.4 1.5
--------- --------- -------- --------
Total non-interest revenues............ 603.3 474.4 1,667.5 1,327.5
--------- --------- -------- --------
Interest revenue......................... 702.9 639.9 2,051.5 1,800.3
Interest expense......................... 270.2 247.5 802.9 709.6
--------- --------- -------- --------
Net interest income.................... 432.7 392.4 1,248.6 1,090.7
Provision for loan losses................ 304.2 190.2 800.5 443.4
--------- --------- -------- --------
Net credit income...................... 128.5 202.2 448.1 647.3
--------- --------- -------- --------
Net operating revenues................. 731.8 676.6 2,115.6 1,974.8
--------- --------- -------- --------
Employee compensation and benefits....... 129.8 112.3 373.3 319.4
Marketing and business development....... 187.5 187.6 525.9 444.1
Information processing and
communications.......................... 123.6 107.2 354.9 303.5
Facilities and equipment................. 15.6 13.5 45.8 37.4
Other.................................... 83.2 77.1 263.1 253.6
--------- --------- -------- --------
Total non-interest expenses............ 539.7 497.7 1,563.0 1,358.0
--------- --------- -------- --------
Income before income taxes............... 192.1 178.9 552.6 616.8
Income tax expense....................... 72.1 66.9 204.9 232.2
--------- --------- -------- --------
Net income............................... $ 120.0 $ 112.0 $ 347.7 $ 384.6
========= ========= ======== ========
</TABLE>
Credit Services net income of $120.0 million and $347.7 million in the third
quarter and first nine months of 1996 represented an increase of 7% over the
third quarter of 1995 and a decrease of 10% from the first nine months of
1995. The increase in the third quarter was due to higher fee and interest
revenues partially offset by a higher provision for loan losses and increased
employee compensation and information processing expenses. In the first nine
months of 1996 higher fee and interest revenues were more than offset by the
combined effect of a higher provision for loan losses and increased non-
interest expenses.
The Company announced changes to the terms of its cardmember agreements in
the third quarter of 1996 which will become effective during the fourth
quarter of 1996. These changes primarily affect delinquent and overlimit
accounts and are designed to increase interest and fee revenues. The Company
expects that interest and fee revenues in the fourth quarter of 1996 will be
higher than such revenues would have been absent the changes in cardmember
agreement terms. For a discussion of important factors that might cause actual
results to differ materially from those in this forward-looking statement,
please refer to the discussion under the heading "Cautionary Statement" on
page 23.
Non-Interest Revenues. Total non-interest revenues increased 27% and 26% in
the third quarter and first nine months of 1996 from the comparable periods of
1995.
11
<PAGE>
Merchant and cardmember fees include revenues from fees charged to merchants
on credit card sales, late payment fees, insurance fees, cash advance fees,
overlimit fees, the administration of credit card programs and transaction
processing services. Merchant and cardmember fees increased 33% and 32% in the
third quarter and first nine months of 1996 from the comparable periods of
1995. The increases were due to higher merchant fee revenues, overlimit fees,
late payment fees and insurance fees. The increases in merchant fee revenues
were due to continued growth in credit card transaction volume and higher
merchant fee rates. Overlimit fees were implemented in March 1996. The
increases in late payment fees were due to an increase, in March 1996, in the
amount of the late fee charged and higher incidences of delinquent accounts.
The increases in insurance fees were due to increased enrollments and
favorable experience rebates.
Servicing fees are revenues derived from consumer loans that have been sold
to investors through asset securitizations. Cash flows from the interest yield
and cardmember fees generated by securitized loans are used to pay investors
in these loans a predetermined fixed or floating rate of return on their
investment, to reimburse the investors for losses of principal through charged
off loans and to pay the Company a fee for servicing the loans. Any excess net
cash flows remaining are paid to the Company. The servicing fees and excess
net cash flows paid to the Company are reported as servicing fees in the
consolidated statements of income. The sale of consumer loans through asset
securitizations therefore has the effect of converting portions of net credit
income and fee income to servicing fees.
The table below presents the components of servicing fees (in millions).
<TABLE>
<CAPTION>
THREE MONTHS
ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------- ------------------
1996 1995 1996 1995
------- ------- -------- --------
<S> <C> <C> <C> <C>
Cardmember fees........................ $ 83.3 $ 36.8 $ 204.2 $ 101.3
Interest revenue....................... 533.0 435.9 1,529.6 1,262.3
Interest expense....................... (209.1) (179.3) (601.1) (530.8)
Provision for loan losses.............. (184.5) (105.6) (518.2) (298.5)
------- ------- -------- --------
Servicing fees....................... $ 222.7 $ 187.8 $ 614.5 $ 534.3
======= ======= ======== ========
</TABLE>
Servicing fees increased 19% and 15% in the third quarter and first nine
months of 1996 from the comparable periods of 1995. These increases were due
to higher average levels of securitized loans, which resulted in higher net
interest cash flows and cardmember fees (as discussed previously), partially
offset by higher levels of credit losses on securitized loans.
Net Interest Income. Net interest income is equal to the difference between
interest revenue derived from Credit Services consumer loan and short-term
investment assets and interest expense incurred to finance those assets.
Credit Services assets, primarily consumer loans, earn interest revenue at
both fixed rates and market indexed variable rates. The Company incurs
interest expense at fixed and floating rates to finance Credit Services
assets. Interest expense also includes the effects of interest rate contracts
entered into by the Company 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 and is accomplished primarily through
matched financing, which entails matching the repricing schedules of consumer
loans and the related financing. Net interest income increased 10% and 14% in
the third quarter and first nine months of 1996 from the comparable periods of
1995. These increases were due to higher average levels of consumer loans
outstanding partially offset by a shift in the mix of consumer loans from
fixed rate loans to lower yielding variable rate loans and the effect of
higher charge-offs on interest revenue. The effects of declining market
interest rates on the Company's variable rate consumer loans were offset by
declines in the Company's cost of funds for the related financing.
12
<PAGE>
The following tables present analyses of Credit Services average balance
sheets and interest rates for the three and nine months ended September 30,
1996 and 1995 and changes in net interest income during those periods.
TABLE 1
CREDIT SERVICES AVERAGE BALANCE SHEET ANALYSIS (DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------
1996 1995
--------------------------- ---------------------------
AVG. BAL. RATE % INTEREST AVG. BAL. RATE % INTEREST
--------- ------ -------- --------- ------ --------
ASSETS
<S> <C> <C> <C> <C> <C> <C>
Interest earning assets:
General purpose credit
card loans.............. $17,050.6 13.92% $596.6 $14,745.2 14.73% $547.5
Other consumer loans..... 2,711.5 12.73 86.7 2,459.4 12.84 79.5
Investment securities.... 225.6 5.40 3.1 217.9 5.81 3.2
Federal funds sold and
securities purchased
under agreements to
resell.................. 46.2 5.33 0.6 27.4 5.65 0.4
Other.................... 1,124.7 5.59 15.9 618.2 5.91 9.3
--------- ------ --------- ------
Total interest earning
assets................ 21,158.6 13.22 702.9 18,068.1 14.05 639.9
Allowance for loan
losses.................. (669.2) (608.5)
Non-interest earning
assets.................. 1,371.6 1,216.5
--------- ---------
Total assets........... $21,861.0 $18,676.1
========= =========
<CAPTION>
LIABILITIES & SHAREHOLDER'S EQUITY
<S> <C> <C> <C> <C> <C> <C>
Interest bearing
liabilities:
Interest bearing deposits
Savings................. $ 1,021.0 4.58% $ 11.8 $ 1,024.9 4.57% $ 11.8
Brokered................ 3,492.7 6.85 60.1 3,227.6 7.17 58.3
Other time.............. 1,946.5 5.99 29.3 1,376.7 6.54 22.7
--------- ------ --------- ------
Total interest bearing
deposits.............. 6,460.2 6.23 101.2 5,629.2 6.54 92.8
Federal funds purchased
and securities sold
under agreements to
repurchase.............. 79.9 5.44 1.1 98.7 5.92 1.5
Other borrowings......... 10,933.4 6.11 167.9 9,102.9 6.68 153.2
--------- ------ --------- ------
Total interest bearing
liabilities........... 17,473.5 6.15 270.2 14,830.8 6.62 247.5
Shareholder's
equity/other
liabilities............. 4,387.5 3,845.3
--------- ---------
Total liabilities &
shareholder's equity.. $21,861.0 $18,676.1
========= =========
Net interest income...... $432.7 $392.4
====== ======
Net interest margin...... 8.14% 8.61%
Interest rate spread..... 7.07% 7.43%
</TABLE>
13
<PAGE>
TABLE 2
CREDIT SERVICES AVERAGE BALANCE SHEET ANALYSIS (DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------
1996 1995
--------------------------- ---------------------------
AVG. BAL. RATE % INTEREST AVG. BAL. RATE % INTEREST
--------- ------ -------- --------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest earning assets:
General purpose credit
card loans............. $16,682.0 13.86% $1,730.5 $14,165.3 14.87% $1,575.5
Other consumer loans.... 2,807.0 12.53 263.3 2,160.3 11.71 189.2
Investment securities... 262.9 5.36 10.6 178.5 5.90 7.9
Federal funds sold and
securities purchased
under agreements to
resell................. 54.7 5.37 2.2 52.6 5.88 2.3
Other................... 1,071.9 5.59 44.9 556.8 6.08 25.4
--------- -------- --------- --------
Total interest earning
assets................ 20,878.5 13.13 2,051.5 17,113.5 14.06 1,800.3
Allowance for loan
losses................. (664.6) (592.2)
Non-interest earning
assets................. 1,357.1 1,228.3
--------- ---------
Total assets........... $21,571.0 $17,749.6
========= =========
<CAPTION>
LIABILITIES & SHAREHOLDER'S EQUITY
<S> <C> <C> <C> <C> <C> <C>
Interest bearing
liabilities:
Interest bearing deposits
Savings................ $ 1,012.7 4.58% $ 34.7 $ 1,065.5 4.76% $ 37.9
Brokered............... 3,312.4 7.00 173.6 3,212.9 7.24 174.0
Other time............. 1,890.5 6.05 85.6 1,168.2 6.42 56.1
--------- -------- --------- --------
Total interest bearing
deposits.............. 6,215.6 6.32 293.9 5,446.6 6.58 268.0
Federal funds purchased
and securities sold
under agreements to
repurchase............. 135.1 5.69 5.8 70.9 5.98 3.2
Other borrowings........ 10,940.4 6.14 503.2 8,635.1 6.79 438.4
--------- -------- --------- --------
Total interest bearing
liabilities........... 17,291.1 6.20 802.9 14,152.6 6.70 709.6
Shareholder's
equity/other
liabilities............ 4,279.9 3,596.8
--------- ---------
Total liabilities &
shareholder's equity.. $21,571.0 $17,749.4
========= =========
Net interest income..... $1,248.6 $1,090.7
======== ========
Net interest margin..... 7.99% 8.52%
Interest rate spread.... 6.93% 7.36%
</TABLE>
14
<PAGE>
TABLE 3
CREDIT SERVICES RATE/VOLUME ANALYSIS (DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
THREE MONTHS ENDED SEPTEMBER 30, 1996 VS
SEPTEMBER 30, 1996 VS 1995 1995
------------------------------ -----------------------
INCREASE/(DECREASE) INCREASE/(DECREASE)
DUE TO CHANGES IN DUE TO CHANGES IN
------------------------------ -----------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
--------- --------- -------- ------ ------- ------
<S> <C> <C> <C> <C> <C> <C>
INTEREST REVENUE
General purpose credit
card loans............. $ 84.3 $ (35.2) $ 49.1 $280.7 $(125.7) $155.0
Other consumer loans.... 8.2 (1.0) 7.2 56.8 17.3 74.1
Investment securities... 0.1 (0.2) (0.1) 3.8 (1.1) 2.7
Federal funds sold and
securities purchased
under agreements to
resell................. 0.2 -- 0.2 0.1 (0.2) (0.1)
Other................... 7.5 (0.9) 6.6 23.4 (3.9) 19.5
-------- ------
Total interest revenue. 109.4 (46.4) 63.0 396.4 (145.2) 251.2
-------- ------
INTEREST EXPENSE
Interest bearing deposits
Savings................ -- -- -- (1.8) (1.4) (3.2)
Brokered............... 4.7 (2.9) 1.8 5.5 (5.9) (0.4)
Other time............. 9.3 (2.7) 6.6 34.7 (5.2) 29.5
-------- ------
Total.................. 13.5 (5.1) 8.4 38.0 (12.1) 25.9
Federal funds purchased
and securities sold
under agreements to
repurchase............. (0.3) (0.1) (0.4) 2.9 (0.3) 2.6
Other borrowings........ 30.9 (16.2) 14.7 117.7 (52.9) 64.8
-------- ------
Total interest expense. 44.2 (21.5) 22.7 157.8 (64.5) 93.3
-------- ------
Net interest income..... $ 65.2 $ (24.9) $ 40.3 $238.6 $ (80.7) $157.9
========= ========= ======== ====== ======= ======
</TABLE>
15
<PAGE>
The supplemental table below provides average managed loan balance and rate
information which takes into effect both owned and securitized loans.
TABLE 4
SUPPLEMENTAL CREDIT SERVICES AVERAGE MANAGED LOAN BALANCE SHEET INFORMATION
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
-----------------------------------------------------
1996 1995
-------------------------- --------------------------
AVG. BAL. RATE % INTEREST AVG. BAL. RATE % INTEREST
--------- ------ -------- --------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Consumer loans............. $33,163.8 14.59% $1,216.3 $27,606.0 15.28% $1,062.9
General purpose credit card
loans..................... 29,552.8 14.72 1,093.9 24,128.8 15.48 941.2
Total interest earning
assets.................... 34,560.3 14.23 1,235.9 28,469.5 14.99 1,075.8
Total interest bearing
liabilities............... 30,875.2 6.18 479.3 25,232.3 6.71 426.8
Consumer loan interest rate
spread.................... 8.41 8.57
Interest rate spread....... 8.05 8.28
Net interest margin........ 8.71 9.04
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-----------------------------------------------------
1996 1995
-------------------------- --------------------------
AVG. BAL. RATE % INTEREST AVG. BAL. RATE % INTEREST
--------- ------ -------- --------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Consumer loans............. $32,145.9 14.64% $3,523.4 $26,562.7 15.24% $3,027.0
General purpose credit card
loans..................... 28,399.5 14.79 3,144.7 23,354.2 15.49 2,705.8
Total interest earning
assets.................... 33,535.4 14.26 3,581.1 27,350.5 14.97 3,062.6
Total interest bearing
liabilities............... 29,948.0 6.26 1,404.0 24,389.6 6.80 1,240.4
Consumer loan interest rate
spread.................... 8.38 8.44
Interest rate spread....... 8.00 8.17
Net interest margin........ 8.67 8.91
</TABLE>
Provision for Loan Losses. The provision for loan losses is the amount
necessary to establish the allowance for loan losses at a level the Company
believes is adequate to absorb estimated losses in its consumer loan portfolio
at the balance sheet date. The Company's allowance for loan losses is
regularly evaluated by management for adequacy on a portfolio by portfolio
basis and was $688.1 million and $625.4 million at September 30, 1996 and
1995. The provision for loan losses is affected by net charge-offs, loan
volume and changes in the amount of consumer loans estimated to be
uncollectable. The provision for loan losses increased 60% and 81% in the
third quarter and first nine months of 1996 from the comparable periods of
1995 due to increases in net charge-off rates and higher levels of consumer
loans outstanding. Net charge-offs as a percentage of average consumer loans
increased to 5.31% in the third quarter of 1996 from 3.54% in the comparable
period of 1995 and to 4.97% in the first nine months of 1996 from 3.20% in the
comparable period of 1995. The increases in the Company's net charge-off rates
were consistent with the industry-wide trend of increasing credit loss rates.
The Company believes that the current industry-wide trend of increasing credit
loss rates is related, in part, to increased consumer debt levels and
bankruptcy rates. The Company believes that the trend may continue and the
Company may experience a higher net charge-off rate in the fourth quarter of
1996. For a discussion of important factors that might cause actual results to
differ materially from those in this forward-looking statement, please refer
to the discussion under the heading "Cautionary Statement" on page 23.
In the third quarter of 1996, the Company reduced its estimate of the
allowance for losses for loans intended to be securitized. The effect of this
change in estimate on the provision for loan losses was approximately offset
by an increase in the Company's estimate of the allowance for losses for other
owned loans.
16
<PAGE>
Consumer loans are considered delinquent when interest or principal payments
become 30 days past due. Consumer loans are charged off when they become 180
days past due, except in the case of bankruptcies, where loans are charged off
after receipt and processing of written notification, and in fraudulent
transactions, where loans are charged off when identified. Loan delinquencies
and charge-offs are primarily affected by changes in economic conditions and
also vary throughout the year due to seasonal consumer spending and payment
patterns. The Company believes the increase in consumer loan delinquency rates
was related to the industry-wide credit conditions discussed previously. The
following table presents delinquency and net charge-off rates with
supplemental managed loan information.
CREDIT SERVICES ASSET QUALITY (DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996 SEPTEMBER 30, 1995 DECEMBER 31, 1995
-------------------- -------------------- --------------------
OWNED MANAGED OWNED MANAGED OWNED MANAGED
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Consumer loans.......... $20,282.7 $33,793.8 $17,474.6 $28,161.3 $21,556.4 $31,775.9
Consumer loans
contractually
past due as a
percentage of consumer
loans
30 to 89 days......... 4.03% 4.13% 3.95% 3.99% 4.03% 4.05%
90 to 179 days........ 2.42% 2.40% 2.01% 2.00% 2.10% 2.09%
Net charge-offs as a
percentage
of average consumer
loans.................. 4.97% 5.17% 3.20% 3.49% 3.50% 3.75%
</TABLE>
Non-Interest Expenses. Non-interest expenses increased 8% and 15% in the
third quarter and first nine months of 1996 from the comparable periods of
1995.
Employee compensation and benefits expense increased 16% and 17% in the
third quarter and first nine months of 1996 from the comparable periods of
1995. These increases reflected costs associated with processing increased
transaction volumes and servicing additional NOVUS Network merchants and
active credit card accounts. Marketing and business development expense
remained level in the third quarter of 1996 and increased 18% in the first
nine months of 1996 from the comparable periods of 1995. In the third quarter
of 1996, higher cardmember rewards expense was offset by declines in other
marketing and development business expenses. The third quarter of 1995
included expenses related to the relaunch of the Private Issue Card(R). The
increase in the first nine months of 1996 was due to higher cardmember rewards
expense and increased costs associated with the growth of the Company's new
and existing credit card brands. In both periods cardmember rewards expense,
which includes the Cashback Bonus(R) award, increased due to continued growth
in credit card transaction volume and increased cardmember qualification for
higher award levels. Information processing and communications expense
increased 15% and 17% in the third quarter and first nine months of 1996 from
the comparable periods of 1995. These increases principally reflected costs
associated with processing increased transaction volumes, servicing additional
NOVUS Network merchants and active credit card accounts and development of the
systems supporting the Company's multi-card strategy.
17
<PAGE>
SECURITIES
STATEMENTS OF INCOME (IN MILLIONS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -----------------
1996 1995 1996 1995
------ ------ -------- --------
<S> <C> <C> <C> <C>
Commissions..................................... $264.3 $266.2 $ 868.8 $ 748.7
Asset management and administration fees........ 289.8 251.7 850.5 748.2
Principal transactions.......................... 107.0 121.6 340.4 367.8
Investment banking.............................. 45.7 45.1 168.0 132.7
Other........................................... 19.6 15.4 71.6 67.8
------ ------ -------- --------
Total non-interest revenues................... 726.4 700.0 2,299.3 2,065.2
------ ------ -------- --------
Interest revenue................................ 190.8 204.3 566.9 613.7
Interest expense................................ 120.2 127.2 357.9 402.4
------ ------ -------- --------
Net interest income........................... 70.6 77.1 209.0 211.3
Provision for losses on receivables............. 2.8 2.5 8.7 7.6
------ ------ -------- --------
Net credit income............................. 67.8 74.6 200.3 203.7
------ ------ -------- --------
Net operating revenues........................ 794.2 774.6 2,499.6 2,268.9
------ ------ -------- --------
Employee compensation and benefits.............. 396.0 399.2 1,275.7 1,165.3
Marketing and business development.............. 22.4 16.8 77.3 67.0
Information processing and communications....... 66.6 62.7 203.3 192.5
Facilities and equipment........................ 48.2 47.3 142.9 136.2
Other........................................... 60.1 71.8 171.5 221.4
------ ------ -------- --------
Total non-interest expenses................... 593.3 597.8 1,870.7 1,782.4
------ ------ -------- --------
Income before income taxes...................... 200.9 176.8 628.9 486.5
Income tax expense.............................. 81.9 70.1 253.0 192.8
------ ------ -------- --------
Net income...................................... $119.0 $106.7 $ 375.9 $ 293.7
====== ====== ======== ========
</TABLE>
Securities net income was $119.0 million in the third quarter of 1996, a 12%
increase over the third quarter of 1995. In the first nine months of 1996 net
income was $375.9 million, a 28% increase from 1995. The increase in the third
quarter was due to higher asset management and administration fees partially
offset by a decline in principal transaction revenue. The increase in the
first nine months of 1996 was due to increased commissions revenue and asset
management and administration fees, partially offset by an increase in
employee compensation and benefits expense.
Commissions. Commission revenues arise from agency transactions in listed
and over-the-counter equity securities, and sales of mutual funds, insurance
products, futures and options. Commissions revenue remained level in the third
quarter of 1996 as increased revenues from insurance activities and mutual
fund sales were offset by a decline in revenues from listed agency
transactions. Commissions revenue increased 16% in the first nine months of
1996 from the comparable period of 1995 due to higher revenues from over-the-
counter transactions, mutual fund sales and listed agency transactions.
18
<PAGE>
Asset Management and Administration Fees. Asset management and
administration fees include fund management fees, distribution-related fees
and other administrative fees. Asset management and administration fees
increased 15% and 14% in the third quarter and first nine months of 1996 from
the comparable periods of 1995. The increases in both periods were due to
higher revenues from fund management fees, 12b-1 distribution fees and
Investment Consulting Services ("ICS") fees. Period end assets under
management increased 13% from September 30, 1995, and 9% from December 31,
1995, to a record $86.5 billion at September 30, 1996. The increases in both
periods were due to net sales and market value increases. Average assets under
management were 13% and 17% higher in the third quarter and first nine months
of 1996 than the comparable periods of 1995.
Components of assets under management and administration were as follows (in
billions)(1).
<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31,
1996 1995 1995
------------- ------------- ------------
<S> <C> <C> <C>
Equity funds....................... $35.8 $27.9 $29.9
Fixed income funds................. 24.0 25.1 25.4
Money market funds................. 23.8 21.0 21.6
Investment management services..... 2.9 2.4 2.6
----- ----- -----
Assets under management and
administration.................. $86.5 $76.4 $79.5
===== ===== =====
</TABLE>
- --------
(1) Excludes ICS assets of $9.8 billion and $7.8 billion at September 30, 1996
and 1995, and $8.9 billion at December 31, 1995.
Fund management fees arise from investment management services that the
Company provides to registered investment companies (the "funds") pursuant to
various contractual arrangements. The Company receives management fees based
upon each fund's average net assets. Fund management fees increased 19% and
20% in the third quarter and first nine months of 1996 from the comparable
periods of 1995 due to higher average asset levels.
Components of fund management fees were as follows (in millions).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1996 1995 1996 1995
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Equity funds........................... $ 51.1 $ 38.1 $ 143.5 $ 107.3
Fixed income funds..................... 28.5 28.0 84.9 82.7
Money market funds..................... 19.5 16.9 56.4 48.3
--------- --------- -------- --------
Fund management fees................. $ 99.1 $ 83.0 $ 284.8 $ 238.3
========= ========= ======== ========
</TABLE>
The Company receives 12b-1 distribution fees for services it provides in
promoting and distributing certain open-ended Dean Witter Funds. These fees
are based on the lesser of average daily fund asset balances or average daily
aggregate net fund sales and are affected by changes in the overall level and
mix of assets under management and administration. In the third quarter and
first nine months of 1996, 12b-1 distribution fees increased 15% and 14% from
the comparable periods of 1995.
ICS fees are derived from private portfolio management services arranged by
the Company for individual investors and are affected by changes in the level
of ICS assets. ICS fees increased 21% and 24% in the third quarter and first
nine months of 1996 from the comparable periods of 1995.
19
<PAGE>
Principal Transactions. Principal transactions include revenues from
customers' purchases and sales of securities in which the Company acts as a
principal and includes gains and losses on securities held for resale. The
Company holds securities for resale primarily to facilitate customer trading
requirements. Principal transaction revenues decreased 12% and 7% in the third
quarter and first nine months of 1996 from the comparable periods of 1995. The
decrease in the third quarter resulted from a decline in revenues from over-
the-counter equity securities transactions partially offset by higher revenues
from fixed income securities transactions. The decrease in the first nine
months was due to a decline in revenues from fixed income securities
transactions.
Investment Banking Revenues. Investment banking revenues are derived from
the underwriting of public offerings of securities and fees from advisory
services. Investment banking revenues remained level in the third quarter of
1996 and increased 27% in the first nine months of 1996 from the comparable
periods of 1995. The increase in the first nine months was attributable to
higher advisory fees and increased underwriting activity.
Non-Interest Expenses. Total non-interest expenses remained level in the
third quarter of 1996 and increased 5% in the first nine months of 1996 from
the comparable periods of 1995. As a percentage of net operating revenues,
total non-interest expenses decreased to 74.7% and 74.8% in the third quarter
and first nine months of 1996 from 77.2% and 78.6% in the third quarter and
first nine months of 1995. Employee compensation and benefits expense remained
level in the third quarter of 1996 and increased 9% in the first nine months
of 1996 from the comparable periods of 1995. The increase in the first nine
months was due to increased variable compensation due to higher revenues and
increased costs related to training new account executives. As a percentage of
net operating revenues, employee compensation and benefits expense was 49.9%
and 51.0% in the third quarter and first nine months of 1996 compared to 51.5%
and 51.4% in the third quarter and first nine months of 1995. Other non-
interest expenses include legal expenses, other professional fees, stationary
and supplies and other administrative costs. Other non-interest expenses
declined 16% and 23% in the third quarter and first nine months of 1996 from
the comparable periods of 1995 due to a reduction in legal expenses and other
professional fees.
20
<PAGE>
LIQUIDITY AND CAPITAL
LIQUIDITY
The Company's liquidity policies are designed to provide funding for the
Company's current and future business requirements and to ensure access to
cost effective funding in all business environments. This is accomplished
through diversification of funding sources, extension of funding terms and
staggering of maturities. The Company expects that its future funding and
refinancing requirements will be met through its traditional sources of funds.
In the third quarter of 1996, the Company issued $1.0 billion of senior
long-term notes with a weighted average maturity of 2.2 years from the date of
issuance.
In the third quarter of 1996, the Company completed an asset securitization
of $0.9 billion with an expected term of 3.0 years.
To support the issuance of asset-backed commercial paper, Riverwoods Funding
Corporation ("RFC"), a consolidated subsidiary of the Company, renewed its
agreement with a syndicate of banks, effective October 18, 1996, for its
senior bank credit facility. This agreement will expire on October 17, 1997.
In conjunction with renewing this agreement the amount of the credit facility
was increased to $2.1 billion from the previous amount of $1.75 billion.
INTEREST RATE RISK
The Company's interest rate risk policies are designed to reduce the
volatility of earnings resulting from changes in interest rates. This is
accomplished primarily through matched financing. The Company is exposed to
the risk that changes in market interest rates will result in declines in net
interest income and servicing fees. Matched financing reduces this risk by
matching the repricing schedules of consumer loans and the related financing.
When necessary, the Company utilizes interest rate contracts to achieve its
matched financing objectives. Interest rate contracts include interest rate
swap, cost of funds and interest rate cap agreements. Under interest rate
exchange agreements, which include interest rate swap and cost of funds
agreements, the Company effectively exchanges the interest payments on its
financing with those of a counterparty. Interest rate swap and cap agreements
are entered into with institutions that are established dealers in these
instruments 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.
Notional amounts of interest rate exchange agreements outstanding were as
follows (in millions).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Agreements that converted the interest rate on
financing.
From fixed to floating....................... $5,271.9 $4,223.9
From floating to fixed....................... 1,123.2 1,469.0
From floating to floating.................... 616.5 425.0
-------- --------
Total...................................... $7,011.6 $6,117.9
======== ========
</TABLE>
The Company had $40.0 million and $415.0 million of interest rate cap
agreements outstanding at September 30, 1996 and December 31, 1995, of which
$40.0 million were in effect at both dates.
21
<PAGE>
CAPITAL
The Company's shareholders' equity increased to $4,978.2 million at
September 30, 1996 from $4,833.7 million at December 31, 1995. At September
30, 1996, $3,670.4 million of the Company's shareholders' equity was invested
in the equity of its subsidiaries. The remainder of the Company's
shareholders' equity was advanced to its subsidiaries to finance their
operations.
For purposes of evaluating the financial performance of its segments, the
Company's shareholders' equity was allocated as follows at September 30, 1996:
Credit Services, $2,862.7 million; Securities, $1,467.6 million.
The Company purchases shares of its common stock under a general stock
repurchase program and a repurchase program designed specifically for shares
issued in connection with the Company's equity-based compensation plans. In
the first quarter of 1996, the Board of Directors of the Company increased the
Company's authorization to purchase its shares under its general stock
repurchase program by $250.0 million. In the third quarter of 1996, the
Company purchased 3.6 million shares of its common stock.
22
<PAGE>
CAUTIONARY STATEMENT
Statements about the Company's future economic performance, strategic plans
or objectives, revenue or earnings projections or other financial items and
similar statements are not guarantees of future performance but are forward-
looking statements which by their nature are subject to numerous uncertainties
that could cause actual results to differ materially from those in the
forward-looking statement.
Important factors that might cause Credit Services actual results to differ
materially include, but are not limited to, the following:
. Changes, including in consumer payment patterns, bankruptcy trends and
the seasoning of the Company's loan portfolio, that affect the level and
direction of consumer loan delinquencies and write-offs;
. Changes in management's estimate of the adequacy of loan loss
allowances;
. Interest rate movements and their impact on consumer behavior and the
Company's net interest spread and margin;
. The rate and magnitude of changes in the Company's consumer loan
portfolio, including the overall mix of accounts, products and loan
balances within the portfolio;
. The impact of account repricing and competitors' pricing initiatives on
consumers' usage of the Company's general purpose credit cards;
. The Company's ability to add new accounts and to activate both new and
existing accounts;
. The Company's ability to increase usage of its cards and to increase
transaction volume;
. The Company's ability to add merchants and cash advance locations to its
network;
. The Company's ability to adapt successfully to technological changes to
meet consumers' needs and developments in the marketplace;
. The Company's ability to access cost-effective funding (including
through the securitization markets) and the continued legal and
commercial availability of interest rate contracts utilized by the
Company to reduce earnings volatility;
. The amount of consumer loans the Company determines to securitize and
the Company's ability to access the securitization markets;
. The Company's ability to minimize fraud losses in its credit card
businesses;
. Federal and state legislative and regulatory developments; and
. National and international economic conditions.
Important factors that might cause Securities actual results to differ
materially include, but are not limited to, the following:
. The Company's ability to attract and retain customer assets;
. The Company's ability to grow assets under management and
administration;
. The Company's ability to attract, retain and grow its professional
account executive sales force;
. The Company's ability to adapt successfully to technological changes to
meet its competition in the financial services markets and serve the
needs of its customers;
. The Company's ability to obtain cost-effective funding to finance
customer borrowings;
. The Company's ability to minimize customer and employee fraud;
. The level of prices in the securities, foreign exchange, futures and
options markets and the volume of transactions in such markets;
. Federal and state legislative and regulatory developments; and
. National and international economic conditions.
23
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
With respect to the class action lawsuits related to the TCW/DW North
American Government Income Trust (the "TNORA Actions") pending in the United
States District Court for the Southern District of New York and discussed in
the Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
1996, on August 28, 1996 the court dismissed several of the Plaintiffs'
claims, clarified its earlier opinion denying the defendants' motion to
dismiss and granted the plaintiffs' motion for class certification.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
An exhibit index has been filed as part of this Report on Page E-1.
(b) Reports on Form 8-K
Form 8-K dated July 18, 1996 reporting Items 5 and 7.
24
<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 THEREUNTO DULY AUTHORIZED.
Dean Witter, Discover & Co.
(REGISTRANT)
/s/ Robert P. Seass
By: _________________________________
Robert P. Seass
Senior Vice President and
Controller
(Principal Accounting Officer and
dulyauthorized Officer of
Registrant)
Date: November 13, 1996
25
<PAGE>
EXHIBIT INDEX
DEAN WITTER, DISCOVER & CO.
QUARTER ENDED SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
11 Computation of earnings per share.
12 Computation of ratio of earnings to fixed charges.
15 Letter of awareness from Deloitte & Touche LLP, dated November 13,
1996, concerning unaudited interim financial information.
27 Financial Data Schedule.
</TABLE>
E-1
<PAGE>
Exhibit 11
DEAN WITTER, DISCOVER & CO.
COMPUTATION OF EARNINGS PER COMMON SHARE
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1996 1995 1996 1995
-------- ------- ------- -------
<S> <C> <C> <C> <C>
Net Income $239.0 $218.7 $723.6 $678.3
====== ====== ====== ======
Average common shares outstanding, excluding the dilutive
effects of stock options and unissued stock awards 163.4 170.7 165.6 170.1
====== ====== ====== ======
Earnings per common share:
Primary dilution basis (1)
Earnings per common share $ 1.42 $ 1.24 $ 4.21 $ 3.87
====== ====== ====== ======
Average common shares outstanding 168.9 176.5 171.7 175.2
====== ====== ====== ======
Full dilution basis (2)
Earnings per common share 1.41 1.23 4.21 3.83
====== ====== ====== ======
Average common shares outstanding 169.2 177.3 171.9 176.9
====== ====== ====== ======
</TABLE>
(1) Earnings per common share on a primary dilution basis for the three and
nine months ended September 30, 1996 and 1995 was calculated using the
weighted average price per share of the Company's common stock during the
period, and included the dilutive effects of stock options and unissued
stock awards under deferred compensation plans.
(2) Earnings per common share on a full dilution basis for the three and nine
months ended September 30, 1996 and 1995 was calculated using the greater
of the period-end price per share of the Company's common stock or the
weighted average price per share of the Company's common stock during the
period and included the dilutive effects of stock options and unissued
stock awards under deferred compensation plans.
<PAGE>
Exhibit 12
DEAN WITTER, DISCOVER & CO.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1996 1995 1996 1995
------- ------- -------- --------
<S> <C> <C> <C> <C>
Earnings
Income before income taxes $ 393.0 $ 355.7 $1,181.5 $1,103.3
Interest expense 390.4 374.7 1,160.8 1,112.0
Interest factor in rent expense 13.3 13.1 39.7 38.1
------- ------- -------- --------
Total earnings $ 796.7 $ 743.5 $2,382.0 $2,253.4
======= ======= ======== ========
Fixed charges
Interest expense 390.4 374.7 1,160.8 1,112.0
Interest factor in rent expense 13.3 13.1 39.7 38.1
------- ------- -------- --------
Total fixed charges $ 403.7 $ 387.8 $1,200.5 $1,150.1
======= ======= ======== ========
Ratio of earnings to fixed charges 2.0 1.9 2.0 2.0
======= ======= ======== ========
</TABLE>
"Earnings" consist of income before income taxes and fixed charges. "Fixed
charges" consist of interest costs, including interest on deposits, and that
portion of rent expense estimated to be representative of the interest factor.
<PAGE>
EXHIBIT 15
To the Directors and Shareholders of
Dean Witter, Discover & Co.:
We have made a review, in accordance with standards established by the
American Institute of Certified Public Accountants, of the unaudited interim
consolidated financial information of Dean Witter, Discover & Co. and
subsidiaries as of September 30, 1996 and for the three and nine month periods
ended September 30, 1996 and 1995, as indicated in our report dated November 13,
1996; because we did not perform an audit, we expressed no opinion on that
information.
We are aware that our report referred to above, which is included in your
Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, is
incorporated by reference in the following Registration Statements of Dean
Witter, Discover & Co.:
Filed on Form S-3:
Registration Statement No. 33-57202
Registration Statement No. 33-60734
Registration Statement No. 33-89748
Registration Statement No. 33-92172
Registration Statement No. 333-7947
Filed on Form S-8:
Registration Statement No. 33-62374
Registration Statement No. 33-63024
Registration Statement No. 33-63026
Registration Statement No. 33-78038
Registration Statement No. 33-79516
Registration Statement No. 33-82240
Registration Statement No. 33-82242
Registration Statement No. 33-82244
Registration Statement No. 333-4212
We are also aware that the aforementioned report, pursuant to Rule 436(c)
under the Securities Act of 1933, is not considered a part of the Registration
Statement prepared or certified by an accountant or a report prepared or
certified by an accountant within the meaning of Sections 7 and 11 of that Act.
Deloitte & Touche LLP
New York, New York
November 13, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 1,102
<SECURITIES> 0
<RECEIVABLES> 26,952
<ALLOWANCES> 704
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 812
<DEPRECIATION> 435
<TOTAL-ASSETS> 37,191
<CURRENT-LIABILITIES> 0
<BONDS> 8,823
0
0
<COMMON> 0
<OTHER-SE> 4,978
<TOTAL-LIABILITY-AND-EQUITY> 37,191
<SALES> 0
<TOTAL-REVENUES> 6,585
<CGS> 0
<TOTAL-COSTS> 3,434
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 809
<INTEREST-EXPENSE> 1,161
<INCOME-PRETAX> 1,182
<INCOME-TAX> 458
<INCOME-CONTINUING> 724
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 724
<EPS-PRIMARY> 4.21
<EPS-DILUTED> 4.21
</TABLE>
