<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 27, 1997
Dean Witter, Discover & Co.
---------------------------
(Exact name of Registrant as specified
in its charter)
Delaware 1-11758 36-3145972
-------------------------------------------------------------------------
(state or other (Commission (I.R.S. Employer
jurisdiction of File Number) Identification No.)
incorporation)
Two World Trade Center, New York, New York 10048
------------------------------------------------
(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (212) 392-2222
--------------
-------------------------------------------------------------------------
(Former address, if changed since last report.)
<PAGE>
Item 5. Other Events
- ---------------------
On February 27, 1997, Dean Witter, Discover & Co. (the "Registrant")
released financial information with respect to the twelve months ended December
31, 1996. A copy of such financial information is annexed as Exhibit 99.1 to
this Report and by this reference incorporated herein and made a part hereof.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits
- --------------------------------------------------------------------------
23.1 Consent of Deloitte & Touche LLP
99.1 Management's discussion and analysis of financial condition
and results of operations and other selected financial data
and audited consolidated financial information for the
registrant as of December 31, 1996 and 1995 and for the years
ended December 31, 1996, 1995 and 1994.
<PAGE>
SIGNATURE
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, thereto duly authorized.
DEAN WITTER, DISCOVER & CO.
-----------------------------------
(Registrant)
By: /s/ Ronald T. Carman
-----------------------------------
Ronald T. Carman
Senior Vice President
Dated: February 27, 1997
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
DEAN WITTER, DISCOVER & CO.
EXHIBITS
TO CURRENT REPORT ON
FORM 8-K DATED FEBRUARY 27, 1997
Commission File Number 1-11758
<PAGE>
Exhibit No. Description
- ------------- -----------
23.1 Consent of Deloitte & Touche LLP
99.1 Management's discussion and analysis of financial condition and
results of operations and other selected financial data and
audited consolidated financial information for the registrant as
of December 31, 1996 and 1995 and for the years ended December
31, 1996, 1995 and 1994.
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the following Registration
Statements of Dean Witter, Discover & Co. 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 this Current
Report on Form 8-K of Dean Witter, Discover & Co. to be filed on February 27,
1997:
Filed on Form S-3:
Registration Statement No. 33-92172
Registration Statement No. 33-57202
Registration Statement No. 33-60734
Registration Statement No. 33-89748
Registration Statement No. 333-7947
Registration Statement No. 333-22409
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
Deloitte & Touche LLP
New York, New York
February 27, 1997
<PAGE>
EXHIBIT 99.1
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
(dollars in millions, except per share data) 1996 1995 1994
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
NET OPERATING REVENUES
Credit Services $ 2,851.5 $ 2,617.7 $ 2,240.1
Securities 3,378.6 3,058.2 2,765.6
- ----------------------------------------------------------------------------------------
Consolidated $ 6,230.1 $ 5,675.9 $ 5,005.7
- ----------------------------------------------------------------------------------------
NET INCOME
Credit Services $ 449.5 $ 446.9 $ 414.7
Securities 501.9 409.5 326.2
- ----------------------------------------------------------------------------------------
Consolidated $ 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
- ----------------------------------------------------------------------------------------
Total assets $42,413.6 $38,208.2 $31,859.4
Shareholders' equity $ 5,164.4 $ 4,833.7 $ 4,108.0
- ----------------------------------------------------------------------------------------
Return on average shareholders' equity 19.0% 19.2% 19.5%
- ----------------------------------------------------------------------------------------
</TABLE>
(1) Per share data has been restated to reflect the Company's two-for-one stock
split.
See accompanying consolidated financial statements and footnotes beginning on
page 31.
<PAGE>
FIVE-YEAR SUMMARY OF FINANCIAL INFORMATION
(dollars in millions, except per share data)
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA
Non-interest revenues $ 5,441.3 $ 4,615.4 $ 4,095.4 $ 3,912.4 $ 3,208.4
Interest revenue 3,587.3 3,319.0 2,507.2 1,909.2 1,975.1
Interest expense 1,566.2 1,514.8 1,048.5 815.3 965.8
Provision for losses on receivables 1,232.3 743.7 548.4 457.6 484.1
Net credit income 788.8 1,060.5 910.3 636.3 525.2
Net operating revenues 6,230.1 5,675.9 5,005.7 4,548.7 3,733.6
Non-interest expenses 4,685.0 4,280.0 3,791.1 3,552.5 3,062.8
Income before income taxes and cumulative
effect of accounting change 1,545.1 1,395.9 1,214.6 996.2 702.9
Income tax expense 593.7 539.5 473.7 392.6 263.8
Cumulative effect of accounting change,
net of income taxes -- -- -- -- 28.6
Net income 951.4 856.4 740.9 603.6 410.5
- -----------------------------------------------------------------------------------------------------------------
PER SHARE DATA(1)
Earnings per common share
Primary $ 2.79 $ 2.44 $ 2.14 $ 1.81 --
Fully diluted 2.77 2.44 2.14 1.81 --
Book value per common share 16.16 14.31 12.16 10.19 --
Dividends per common share 0.44 0.32 0.25 0.15 --
- -----------------------------------------------------------------------------------------------------------------
BALANCE SHEET AND OTHER OPERATING DATA
Consumer loans $23,188.2 $21,556.4 $16,174.1 $12,148.2 $ 9,794.5
Total assets 42,413.6 38,208.2 31,859.4 27,662.3 23,821.5
Short-term borrowings 5,865.0 6,325.5 4,049.6 3,260.7 5,665.1
Deposits 7,212.6 6,191.1 5,208.7 4,888.1 4,857.1
Long-term borrowings 8,144.2 6,732.4 5,292.6 3,140.3 --
Shareholders' equity 5,164.4 4,833.7 4,108.0 3,477.1 2,673.3
Return on average shareholders' equity(2) 19.0% 19.2% 19.5% 19.6% 17.6%
Supplemental information (in billions)
Managed consumer loans $ 36.6 $ 31.8 $ 26.1 $ 21.2 $ 18.5
Assets under management and administration 90.0 79.5 66.9 71.2 59.0
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying consolidated financial statements and notes beginning on page
31.
(1) Per share data has been restated to reflect the Company's two-for-one stock
split.
(2) Return on average shareholders' equity for 1992 excludes the effects of a
$28.6 million charge for the cumulative effect of a change in the method of
accounting for postretirement benefits other than pensions, a non-recurring gain
of $32.1 million from the initial public offering of SPS Transaction Services,
Inc. common stock and a $133.0 million capital contribution from Sears, Roebuck
and Co. on December 31, 1992.
Dean Witter, Discover & Co. 1996
--------------------------------
17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
Dean Witter, Discover & Co. and subsidiaries (collectively referred to as the
"Company") is a diversified financial services organization that provides a
broad range of nationally-marketed credit and investment products, with a
principal focus on individual customers. The Company has two lines of business:
Credit Services -- providing general purpose credit cards, transaction
processing services, private-label credit card services and real estate-secured
loans -- and Securities -- providing a variety of financial products, services
and investment advice.
The Company's business activities are affected by changes in economic
variables that directly impact the markets in which the Company operates and by
competitive factors. Changes in economic variables affect consumer loan growth,
credit quality and activity in securities markets, including the flow of
investment dollars into mutual funds. Competition in the credit services
industry centers on merchant acceptance of credit cards, credit card account
acquisition and customer utilization of credit cards. Merchant acceptance is
based on both competitive transaction pricing and the volume of credit cards in
circulation. Credit card account acquisition and customer utilization are driven
by the offering of credit cards with competitive and appealing features such as
no annual fees, low introductory interest rates and other customized features
targeting specific consumer groups. Competition in the securities industry,
which includes traditional securities firms as well as mutual fund groups, banks
and insurance companies, centers on the attraction and retention of clients and
their assets. Success in attracting and retaining clients and assets revolves
around the ability to meet investors' saving and investment needs through
consistency of investment performance and accessibility to financial products
and investment advice.
Changes in economic and competitive factors may cause earnings to vary from
year to year. The Company focuses on reducing the impact these changes have on
earnings by managing interest rate risk, emphasizing fee-based assets that are
designed to generate a continuing stream of revenues, evaluating credit product
pricing and controlling costs.
SUBSEQUENT EVENT
On February 5, 1997, the Company and Morgan Stanley Group Inc. ("Morgan
Stanley") announced a definitive agreement to merge. The combined company would
be a preeminent global financial services firm with a market capitalization of
approximately $21.0 billion (as of the merger announcement). The merger would
combine the Company's strengths in retail distribution, asset gathering and
credit services with Morgan Stanley's strengths in investment banking and
institutional sales and trading. The new company will be named Morgan Stanley,
Dean Witter, Discover & Co.
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. For certain
selected pro forma financial data giving effect to the merger, see Note 2 to the
Consolidated Financial Statements.
RESULTS OF OPERATIONS
The Company achieved record net income of $951.4 million in 1996, an 11%
increase from 1995. In 1995, net income increased 16% to $856.4 million. Primary
earnings per common share increased 14% to $2.79 in 1996 and 14% to $2.44 in
1995. Fully diluted earnings per common share increased 14% to $2.77 in 1996 and
14% to $2.44 in 1995.
In 1996, consumer demand and retail sales continued to increase, favorably
impacting credit card transaction volume and consumer loan growth. In 1996, the
Company continued to invest in growth through the expansion of its NOVUS(SM)
Network and by increasing its marketing and solicitation activities. The NOVUS
Network is the third largest credit card network in the United States and
consists of merchant and cash access locations that accept the Discover(R) Card
and other cards that carry the NOVUS logo. In 1996, the Company launched its
first NOVUS affinity credit card -- the National Alliance for Species
Survival(SM) Card. Credit Services ended the year with record levels of NOVUS
Network merchant locations, general purpose credit card accounts and transaction
volume, and consumer loans.
In 1996, securities equity market volumes and price indices increased to
record levels favorably affecting Securities revenues and the level of assets
under management and administration. Securities continued to focus on customer
account and asset growth, increasing the number of its account executives,
building assets
Dean Witter, Discover & Co. 1996
- --------------------------------
18
<PAGE>
under management and administration, and controlling costs. Securities ended the
year with record levels of account executives, customer accounts and assets, and
assets under management and administration.
Net operating revenues increased 10% to a record $6.2 billion in 1996 and
13% in 1995. The growth in both years reflected higher credit card transaction
volume and consumer loan balances and favorable securities market conditions
partially offset by higher credit losses. In 1996, consumer debt and personal
bankruptcies continued to increase, contributing to an industry-wide decline in
consumer credit quality which caused an increase in the rate of consumer loans
charged off.
Non-interest expenses increased 9% to $4.7 billion in 1996 and 13% in 1995.
The increases in both years reflected higher variable compensation expenses
related to increased Securities revenue and higher costs associated with
increases in the general purpose credit card portfolio and the NOVUS Network.
Non-interest expenses as a percentage of net operating revenues was 75.2% in
1996, 75.4% in 1995 and 75.7% in 1994.
The Company's return on average shareholders' equity was 19.0% in 1996,
19.2% in 1995 and 19.5% in 1994.
The remainder of Management's Discussion and Analysis is presented on a
business segment basis. Substantially all of the operating revenues and
operating expenses of the Company can be directly attributed to its two business
segments. Certain reclassifications have been made to prior period amounts to
conform to the current presentation.
CREDIT SERVICES
Credit Services focuses on the delivery of financial products to consumers
through its four business units: NOVUS Services, Prime Option Services, SPS and
NOVUS Financial.
Credit Services is the largest single issuer of general purpose credit cards
in the United States as measured by number of accounts and cardmembers.
Consumers use general purpose credit cards to purchase goods and services and
obtain cash advances. Credit Services proprietary general purpose credit cards
are issued by NOVUS Services, which operates the NOVUS Network. These include
the Discover Card, the Private Issue(R) Card, the BRAVO(SM) Card and an affinity
program card. The Prime Option(SM) MasterCard(R) is a co-branded general purpose
credit card issued by NationsBank of Delaware, N.A., and serviced by Prime
Option Services. SPS is a 74% owned, publicly held subsidiary. SPS services
include electronic transaction processing, consumer private label credit card
program administration, commercial accounts receivable processing and call
center teleservices. NOVUS Financial is a consumer finance business which
emphasizes real estate-secured lending. NOVUS Financial originates loans through
the Dean Witter Reynolds Inc. account executive sales organization, Allstate
insurance agents, other third-party sales forces and direct response marketing.
<TABLE>
<CAPTION>
CREDIT SERVICES STATEMENTS OF INCOME (in millions)
YEAR ENDED DECEMBER 31, 1996 1995 1994 1993 1992
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Merchant and cardmember fees $1,506.2 $1,135.3 $ 940.0 $ 770.4 $ 641.1
Servicing fees 819.0 696.9 586.4 533.2 412.8
Other 8.8 2.6 0.8 2.3 11.1
- -------------------------------------------------------------------------------------------------------------------------
Total non-interest revenues 2,334.0 1,834.8 1,527.2 1,305.9 1,065.0
- -------------------------------------------------------------------------------------------------------------------------
Interest revenue 2,827.8 2,498.9 1,933.0 1,473.6 1,566.0
Interest expense 1,089.7 985.5 683.1 540.7 699.5
- -------------------------------------------------------------------------------------------------------------------------
Net interest income 1,738.1 1,513.4 1,249.9 932.9 866.5
Provision for loan losses 1,220.6 730.5 537.0 443.0 472.1
- -------------------------------------------------------------------------------------------------------------------------
Net credit income 517.5 782.9 712.9 489.9 394.4
- -------------------------------------------------------------------------------------------------------------------------
Net operating revenues 2,851.5 2,617.7 2,240.1 1,795.8 1,459.4
- -------------------------------------------------------------------------------------------------------------------------
Employee compensation and benefits 505.4 438.6 374.0 326.5 295.3
Marketing and business development 736.5 645.3 514.5 377.8 317.9
Information processing and communications 487.2 419.0 340.6 303.9 257.5
Facilities and equipment 63.9 51.1 47.3 38.4 39.3
Other 344.1 342.8 292.0 238.9 219.7
- -------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 2,137.1 1,896.8 1,568.4 1,285.5 1,129.7
- -------------------------------------------------------------------------------------------------------------------------
Gain on sale of subsidiary stock -- -- -- -- 32.1
- -------------------------------------------------------------------------------------------------------------------------
Income before income taxes and cumulative
effect of accounting change 714.4 720.9 671.7 510.3 361.8
Income tax expense 264.9 274.0 257.0 190.6 122.4
- -------------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of accounting change 449.5 446.9 414.7 319.7 239.4
Cumulative effect of accounting change, net of income taxes -- -- -- -- 7.2
- -------------------------------------------------------------------------------------------------------------------------
Net income $ 449.5 $ 446.9 $ 414.7 $ 319.7 $ 232.2
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
Dean Witter, Discover & Co. 1996
--------------------------------
19
<PAGE>
In 1996, Credit Services net income of $449.5 million remained level compared to
1995. Credit Services net income increased 8% in 1995 to $446.9 million. In
1996, the effects of higher levels of general purpose credit card accounts,
transaction volume and loans, and increased credit card fee revenues were offset
by a higher rate of credit losses. The increase in 1995 was primarily due to
higher levels of general purpose credit card accounts, transaction volume and
loans, partially offset by increased investments in growth and a higher rate of
credit losses.
Merchant and Cardmember Fees
Merchant and cardmember fees include revenues from fees charged to merchants on
credit card sales, late payment fees, credit insurance fees, overlimit fees,
cash advance fees, transaction processing services and the administration of
credit card programs.
OWNED AND MANAGED
CONSUMER LOANS
(at December 31)
($ billions)
<TABLE>
<CAPTION>
Owned Managed
<S> <C> <C>
"92" $ 9.8 $18.5
"93" 12.1 21.2
"94" 16.2 26.1
"95" 21.6 31.8
"96" 23.2 36.6
</TABLE>
Merchant and cardmember fees increased 33% in 1996 and 21% in 1995. The
increase in 1996 was due to higher revenues from overlimit fees, merchant fees,
late payment fees and credit insurance fees. The increase in 1995 was due to
higher revenues from merchant fees, credit insurance fees and late payment fees,
partially offset by the absence of fees from Income Tax Refund Anticipation
Loans. Overlimit fees were implemented in March 1996 and the amount of the fee
was increased in the fourth quarter of 1996. In both years, the increases in
merchant fee revenues were due to continued growth in general purpose credit
card transaction volume. The increase in late payment fee revenues in 1996 was
due to an increase in the amount of the late payment fee charged, an increase in
the incidence of late payments and a tightening, in the fourth quarter of 1996,
of late payment fee terms. The increased incidence of late payments was
attributable to a higher level of delinquent accounts and an increase in active
credit card accounts. The increase in late payment fee revenues in 1995 was due
to an increase in the incidence of late payments due to an increased number of
active credit card accounts and a higher incidence of delinquent accounts. In
both years, the increases in credit insurance fees were due to higher
enrollments and favorable loss experience rebates.
GENERAL PURPOSE
CREDIT CARD
TRANSACTION VOLUME
($ billions)
<TABLE>
<CAPTION>
<S> <C>
"92" $27.5
"93" 32.8
"94" 40.1
"95" 47.5
"96" 53.6
</TABLE>
Servicing Fees
Servicing fees are revenues derived from consumer loans which have been sold
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 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.
<TABLE>
COMPONENTS OF SERVICING FEES (in millions)
YEAR ENDED DECEMBER 31, 1996 1995 1994 1993 1992
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Merchant and cardmember fees $ 307.4 $ 137.3 $ 109.6 $ 97.5 $ 68.8
Interest revenue 2,054.8 1,695.2 1,385.3 1,457.1 1,232.5
Interest expense (809.1) (708.6) (573.2) (641.2) (570.9)
Provision for loan losses (734.1) (427.0) (335.3) (380.2) (317.6)
- -----------------------------------------------------------------------------------------------
Servicing fees $ 819.0 $ 696.9 $ 586.4 $ 533.2 $ 412.8
- -----------------------------------------------------------------------------------------------
</TABLE>
Dean Witter, Discover & Co. 1996
- --------------------------------
20
<PAGE>
Servicing fees are affected by the level of securitized loans, the spread
between the interest yield on the securitized loans and the yield paid to the
investors, the rate of credit losses on securitized loans and the level of
cardmember fees earned from securitized loans. Servicing fees also include the
effects of interest rate contracts entered into by the Company as part of its
interest rate risk management program. Servicing fees increased 18% in 1996 and
19% in 1995. The increases in both years were due to higher net interest cash
flows and cardmember fees from securitized loans partially offset by increased
credit losses from securitized loans. The increased net interest cash flows were
due to higher average levels of securitized loans. As discussed under merchant
and cardmember fees, the higher cardmember fees were due to increased late
payment fees and in 1996, overlimit fees. The increases in credit losses were
due to a higher rate of credit losses on securitized loans and an increase in
the average level of securitized loans. The higher rate of credit losses was
consistent with the industry-wide trend of increasing credit loss rates as
discussed under provision for loan losses.
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.
The following tables present analyses of Credit Services average balance
sheets and interest rates in 1996, 1995 and 1994, and changes in net interest
income during those years.
<TABLE>
<CAPTION>
CREDIT SERVICES AVERAGE BALANCE SHEET ANALYSIS (dollars in millions)
YEAR ENDED DECEMBER 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE
BALANCE RATE INTEREST BALANCE RATE INTEREST BALANCE RATE INTEREST
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest earning assets:
General purpose
credit card loans $17,083.2 13.99% $2,390.6 $14,691.5 14.75% $2,167.2 $11,913.9 14.81% $1,764.0
Other consumer loans 2,834.1 12.72 360.4 2,318.6 12.08 280.1 1,131.2 11.71 132.5
Investment securities 234.0 5.38 12.6 194.8 5.85 11.4 196.2 4.56 8.9
Other 1,149.0 5.59 64.2 667.5 6.02 40.2 577.6 4.78 27.6
- -------------------------------------------------------------------------------------------------------------------------
Total interest earning assets 21,300.3 13.28 2,827.8 17,872.4 13.98 2,498.9 13,818.9 13.99 1,933.0
Allowance for loan losses (682.2) (609.5) (471.6)
Non-interest earning assets 1,379.6 1,249.3 993.7
- ---------------------------------------------------------------------------------------------------------------------------
Total assets $21,997.7 $18,512.2 $14,341.0
- ---------------------------------------------------------------------------------------------------------------------------
LIABILITIES & SHAREHOLDER'S EQUITY
Interest bearing liabilities:
Interest bearing deposits
Savings $ 1,021.0 4.58% $ 46.8 $ 1,050.0 4.71% $ 49.5 $ 1,182.2 3.92% $ 46.4
Brokered 3,418.1 6.93 236.9 3,221.6 7.21 232.2 3,067.3 7.30 223.8
Other time 1,921.4 6.05 116.2 1,278.1 6.41 82.0 769.0 5.46 42.0
- ---------------------------------------------------------------------------------------------------------------------------
Total interest
bearing deposits 6,360.5 6.29 399.9 5,549.7 6.55 363.7 5,018.5 6.22 312.2
Other borrowings 11,281.5 6.11 689.8 9,262.1 6.71 621.8 6,377.4 5.82 370.9
- ---------------------------------------------------------------------------------------------------------------------------
Total interest bearing
liabilities 17,642.0 6.18 1,089.7 14,811.8 6.65 985.5 11,395.9 5.99 683.1
Shareholder's equity/
other liabilities 4,355.7 3,700.4 2,945.1
- ---------------------------------------------------------------------------------------------------------------------------
Total liabilities &
shareholder's equity $21,997.7 $18,512.2 $14,341.0
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income $1,738.1 $1,513.4 $1,249.9
- ---------------------------------------------------------------------------------------------------------------------------
Net interest margin(1) 8.16% 8.47% 9.05%
- ---------------------------------------------------------------------------------------------------------------------------
Interest rate spread(2) 7.10% 7.33% 8.00%
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Net interest margin represents net interest income as a percentage of total
interest earning assets.
(2) Interest rate spread represents the difference between the rate on total
interest earning assets and the rate on total interest bearing liabilities.
Dean Witter, Discover & Co. 1996
--------------------------------
21
<PAGE>
<TABLE>
<CAPTION>
CREDIT SERVICES RATE/VOLUME ANALYSIS (in millions)
YEAR ENDED DECEMBER 31, 1996 VS 1995 1995 VS 1994
- ----------------------------------------------------------------------------------------------------------
INCREASE/(DECREASE) DUE TO CHANGES IN: VOLUME RATE TOTAL VOLUME RATE TOTAL
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INTEREST REVENUE
General purpose credit card loans $ 353.1 $ (129.7) $ 223.4 $ 412.0 $ (8.8) $ 403.2
Other consumer loans 62.2 18.1 80.3 139.0 8.6 147.6
Investment securities 2.3 (1.1) 1.2 (0.1) 2.6 2.5
Other 29.0 (5.0) 24.0 4.3 8.3 12.6
- ----------------------------------------------------------------------------------------------------------
Total interest revenue 478.3 (149.4) 328.9 567.7 (1.8) 565.9
- ----------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest bearing deposits
Savings (1.4) (1.3) (2.7) (5.2) 8.3 3.1
Brokered 14.3 (9.6) 4.7 11.3 (2.9) 8.4
Other time 41.3 (7.1) 34.2 27.7 12.3 40.0
- ----------------------------------------------------------------------------------------------------------
Total interest bearing deposits 52.8 (16.6) 36.2 33.1 18.4 51.5
Other borrowings 135.3 (67.3) 68.0 171.7 79.2 250.9
- ----------------------------------------------------------------------------------------------------------
Total interest expense 187.4 (83.2) 104.2 204.6 97.8 302.4
- ----------------------------------------------------------------------------------------------------------
Net interest income $ 290.9 $ (66.2) $ 224.7 $ 363.1 $ (99.6) $ 263.5
- ----------------------------------------------------------------------------------------------------------
</TABLE>
Net interest income increased 15% in 1996 and 21% in 1995. The increases in both
years were due to higher average levels of consumer loans outstanding partially
offset by a shift in the mix of general purpose credit card loans from fixed
rate loans to lower yielding variable rate loans and the effect of higher
charge-offs on interest revenue. In both years, the effects of changes in market
interest rates on the Company's variable rate consumer loans were substantially
offset by comparable changes in the Company's cost of funds for the related
financing. Variable rate consumer loans were approximately 57%, 46% and 41% of
the Company's consumer loan portfolio at December 31, 1996, 1995 and 1994. The
Company believes that the effect of changes in market interest rates on net
interest income were mitigated due to its liquidity and interest rate risk
policies.
The supplemental table below provides average managed loan balance and rate
information which takes into account both owned and securitized loans.
<TABLE>
<CAPTION>
SUPPLEMENTAL CREDIT SERVICES AVERAGE MANAGED LOAN INFORMATION (dollars in millions)
- -----------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Consumer loans $ 32,777.2 14.66% $ 27,304.9 15.17% $ 21,780.7 15.07%
General purpose credit card loans 29,020.6 14.81 23,969.7 15.41 19,554.8 15.30
Total interest earning assets 34,160.2 14.29 28,167.1 14.89 22,554.5 14.71
Total interest bearing liabilities 30,501.9 6.22 25,106.5 6.75 20,131.6 6.24
- -----------------------------------------------------------------------------------------------------------------------
Consumer loan interest rate spread 8.44% 8.42% 8.83%
Interest rate spread 8.07 8.14 8.47
Net interest margin 8.73 8.88 9.14
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
Dean Witter, Discover & Co. 1996
- --------------------------------
22
<PAGE>
Provision for Loan Losses
The provision for loan losses is the amount necessary to establish the allowance
for loan losses at a level that 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 $815.3 million, $721.8
million and $565.7 million at December 31, 1996, 1995 and 1994. 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 67% in 1996 and 36% in 1995. The increase in 1996 was primarily
due to higher net charge-offs which resulted from an increase in the percentage
of consumer loans charged off and a higher level of consumer loans outstanding.
The effect of an increase in the Company's estimate of the allowance for loan
losses, primarily in the fourth quarter of 1996, was partially offset by a lower
provision for losses for consumer loans intended to be securitized. (See Note 3
to the Consolidated Financial Statements, "Significant Accounting Policies.")
The increase in 1995 was due to a higher level of consumer loans outstanding and
an increase in net charge-off rates partially offset by a reduction in the
allowance for loan losses for one of the Company's owned loan portfolios in the
fourth quarter of 1995. The increases in both years in the Company's net
charge-off rate were consistent with the industry-wide trend of increasing
credit loss rates that the Company believes is related, in part, to increased
consumer debt levels and bankruptcy rates. The Company believes this trend may
continue and the Company may experience a higher net charge-off rate in 1997. In
1996, the Company took steps to reduce the impact of this trend, including
raising credit quality standards for new accounts, selectively reducing credit
limits and increasing collection activity. The Company believes these credit
quality improvements had a minimal impact in 1996, but believes they may have an
increased effect in 1997. The Company's expectations about future charge-off
rates and credit quality improvements are subject to uncertainties that could
cause actual results to differ materially from what has been projected above.
Factors that influence the level and direction of consumer loan delinquencies
and charge-offs include changes in consumer loan payment patterns, bankruptcy
trends, the seasoning of the Company's loan portfolio, interest rate movements
and their impact on consumer behavior, and 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.
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 and fraudulent transactions
which are charged off earlier. Loan delinquencies and charge-offs are primarily
affected by changes in economic conditions and may vary throughout the year due
to seasonal consumer spending and payment behaviors. The Company believes the
increases in consumer loan delinquency rates in 1996 and 1995 were related to
the industry-wide credit conditions discussed previously. The following table
presents delinquency and net charge-off rates with supplemental managed loan
information.
<TABLE>
<CAPTION>
CREDIT SERVICES ASSET QUALITY (dollars in millions)
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
OWNED MANAGED OWNED MANAGED OWNED MANAGED
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Consumer loans at period end $23,188.2 $36,572.8 $21,556.4 $31,775.9 $16,174.1 $26,050.5
Consumer loans contractually past
due as a percentage of period
end consumer loans
30 to 89 days 4.25% 4.29% 4.03% 4.05% 3.21% 3.26%
90 to 179 days 2.81 2.77 2.10 2.09 1.44 1.47
Net charge-offs as a percentage of
average consumer loans 5.19 5.40 3.50 3.75 2.92 3.30
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Dean Witter, Discover & Co. 1996
--------------------------------
23
<PAGE>
Non-Interest Expenses
Total non-interest expenses increased 13% to $2.1 billion in 1996 and 21% to
$1.9 billion in 1995.
Employee compensation and benefits expense increased 15% in 1996 and 17% in
1995. The increases in both years were due to costs associated with processing
increased credit card transaction volume and servicing additional NOVUS Network
merchants and active credit card accounts.
Marketing and business development expense increased 14% in 1996 and 25% in
1995. The increase in 1996 was due to higher cardmember rewards expense and
increased costs associated with the growth of new and existing credit card
brands. The increase in 1995 was due to higher mailing and promotional costs
associated with the launch of new credit card brands, higher cardmember rewards
expense and continued investment in the growth of existing credit card products.
In both years 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 16% in 1996 and
23% in 1995. The increases in both years were due to higher costs associated
with processing increased transaction volume, servicing additional NOVUS Network
merchants and active credit card accounts and the development of the systems
supporting the multi-card strategy.
Facilities and equipment expense increased 25% in 1996 and 8% in 1995. In
1996, the Company opened several new facilities to accommodate the growth of its
NOVUS Network and its multi-card strategy.
Other non-interest expenses remained level in 1996 and increased 17% in
1995. These expenses include fraud losses, professional fees, credit inquiry
fees and other administrative costs. The increase in 1995 was due to higher
credit card fraud losses. In 1995, the Company began implementing several
measures designed to reduce fraud losses. Since the Company began implementing
these measures, fraud losses as a percentage of transaction volume has declined.
Seasonal Factors
The credit card lending activities of Credit Services are affected by seasonal
patterns of retail purchasing. A substantial percentage of credit card loan
growth occurs in the fourth quarter, followed by a flattening or decline of
consumer loans in the subsequent first quarter. Merchant fees increase in the
fourth quarter, reflecting higher sales activity. Additionally, higher
cardmember rewards expense is accrued in the fourth quarter, reflecting seasonal
growth in retail sales volume.
Dean Witter, Discover & Co. 1996
- --------------------------------
24
<PAGE>
SECURITIES
<TABLE>
<CAPTION>
SECURITIES STATEMENTS OF INCOME (in millions)
YEAR ENDED DECEMBER 31, 1996 1995 1994 1993 1992
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commissions $ 1,163.1 $ 1,022.5 $ 874.3 $ 904.0 $ 721.9
Asset management and administration fees 1,149.8 1,006.8 973.0 838.0 679.2
Principal transactions 449.3 478.9 421.9 405.1 433.4
Investment banking 246.1 181.5 197.9 394.9 254.6
Other 99.0 90.9 101.1 64.5 54.3
- --------------------------------------------------------------------------------------------------------------------------
Total non-interest revenues 3,107.3 2,780.6 2,568.2 2,606.5 2,143.4
- --------------------------------------------------------------------------------------------------------------------------
Interest revenue 759.5 820.1 574.2 435.6 409.1
Interest expense 476.5 529.3 365.4 274.6 266.3
- --------------------------------------------------------------------------------------------------------------------------
Net interest income 283.0 290.8 208.8 161.0 142.8
- --------------------------------------------------------------------------------------------------------------------------
Provision for losses on receivables 11.7 13.2 11.4 14.6 12.0
- --------------------------------------------------------------------------------------------------------------------------
Net credit income 271.3 277.6 197.4 146.4 130.8
- --------------------------------------------------------------------------------------------------------------------------
Net operating revenues 3,378.6 3,058.2 2,765.6 2,752.9 2,274.2
- --------------------------------------------------------------------------------------------------------------------------
Employee compensation and benefits 1,702.8 1,543.0 1,390.2 1,377.4 1,168.8
Marketing and business development 120.3 89.8 92.7 92.6 79.3
Information processing and communications 280.5 268.5 256.1 242.0 215.4
Facilities and equipment 192.2 184.4 180.8 179.4 174.5
Other 252.1 297.5 302.9 375.6 295.1
- --------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 2,547.9 2,383.2 2,222.7 2,267.0 1,933.1
- --------------------------------------------------------------------------------------------------------------------------
Income before income taxes and cumulative
effect of accounting change 830.7 675.0 542.9 485.9 341.1
Income tax expense 328.8 265.5 216.7 202.0 141.4
- --------------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of accounting change 501.9 409.5 326.2 283.9 199.7
Cumulative effect of accounting change, net of income taxes -- -- -- -- 21.4
- --------------------------------------------------------------------------------------------------------------------------
Net income $ 501.9 $ 409.5 $ 326.2 $ 283.9 $ 178.3
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
Securities provides a wide range of financial products, services and investment
advice, primarily to individual investors. Securities has the third largest
sales organization in the domestic securities industry with 9,080 account
executives in 371 branch offices, serving the investment needs of over three
million individual and institutional clients with assets of $251.2 billion at
December 31, 1996. Dean Witter Reynolds Inc. ("DWR"), the Company's primary
broker-dealer, is among the largest members of the NYSE and is a member of other
major securities, futures and options exchanges. Securities, through Dean Witter
InterCapital Inc., has one of the largest asset management operations with total
assets under management and administration of $90.0 billion at December 31,
1996.
Securities achieved record net income of $501.9 million in 1996, a 23%
increase from 1995. Securities net income increased 26% to $409.5 million in
1995. While the growth in net income in both years occurred in favorable
business environments, enhancing and supporting earnings growth was the
Company's focus on accumulating client assets, building fee-based assets under
management and administration and controlling costs.
Commissions
Commission revenues arise from agency transactions in listed and
over-the-counter ("OTC") equity securities, and sales of mutual funds, futures,
insurance products and options. Commission revenues increased 14% in 1996 and
17% in 1995. The increase in 1996 was due to higher revenues from OTC and listed
agency equity transactions, mutual fund sales and insurance products. The
increase in 1995 was due to higher revenues from listed agency and OTC equity
transactions. The increases in both years resulted from increased trading volume
in the equity markets.
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 14% in 1996 and 3% in 1995. The increase in 1996
was due to higher revenues from fund management, 12b-1 distribution and
Investment Consulting Services ("ICS") fees. The increase in 1995 was due to
higher revenues from fund management and ICS fees. Period-end assets under
management increased 13% to a record $90.0 billion in 1996 and
Dean Witter, Discover & Co. 1996
--------------------------------
25
<PAGE>
19% to $79.5 in 1995. Average assets under management and administration
increased 16% in 1996 and 3% in 1995. Components of assets under management and
administration were as follows.
ASSETS UNDER MANAGEMENT (in billions)
AND ADMINISTRATION(1)
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995 1994
- --------------------------------------------------------------
<S> <C> <C> <C>
Equity funds $38.1 $29.9 $23.0
Fixed income funds 24.1 25.4 24.1
Money market funds 24.7 21.6 17.8
Investment management services 3.1 2.6 2.0
- --------------------------------------------------------------
Total assets under management
and administration $90.0 $79.5 $66.9
- --------------------------------------------------------------
</TABLE>
(1) Excludes ICS assets of $10.4, $8.9 and $6.5 billion.
Fund management fees arise from investment management services 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 daily net assets. Fund management fees increased 19% in 1996 and
4% in 1995. Components of fund management fees were as follows.
FUND MANAGEMENT FEES (in millions)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 1995 1994
- --------------------------------------------------------------
<S> <C> <C> <C>
Equity funds $197.0 $147.5 $128.5
Fixed income funds 113.5 110.9 126.0
Money market funds 76.1 65.6 57.8
- --------------------------------------------------------------
Total fund management fees $386.6 $324.0 $312.3
- --------------------------------------------------------------
</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. 12b-1 distribution fees
increased 14% in 1996 and remained level in 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% in 1996 and 6% in 1995.
Principal Transactions
Principal transactions include revenues from customers' purchases and sales of
securities in which the Company acts as a principal, and gains and losses on
securities held for resale. The Company holds securities for resale primarily to
facilitate customer trading requirements. Principal transaction revenues
decreased 6% in 1996 and increased 14% in 1995. The decrease in 1996 was due to
a decline in revenues primarily from fixed income securities transactions.
Increased customer interest in equity markets resulted in a decline in fixed
income activity. The increase in 1995 was due to higher revenues from OTC and
corporate securities which resulted from increased securities market trading
volumes.
Investment Banking
Investment banking revenues are derived from the underwriting of public
offerings of securities and fees from advisory services. Investment banking
revenues increased 36% in 1996 and declined 8% in 1995. The increase in 1996 was
attributable to higher advisory fees and increased underwriting activity. The
decrease in 1995 was the result of declines in both the number and size of
closed-end mutual fund underwritings.
Net Credit Income
Net credit income consists primarily of interest revenue from customer margin
loans less the cost of financing these loans and credit losses. Net credit
income is affected by the levels of margin loans, borrowings that finance these
loans and market interest rates. Net credit income remained level in 1996 and
increased 41% in 1995. The increase in 1995 was due to higher net interest
income from margin lending, clearing organization deposits and real
estate-related transactions. Average aggregate customer margin balances were
$2.5 billion, $2.3 billion and $2.4 billion in 1996, 1995 and 1994.
Non-Interest Expenses
Total non-interest expenses increased 7% in both 1996 and 1995. As a percentage
of net operating revenues, total non-interest expenses were 75.4% in 1996, 77.9%
in 1995, and 80.4% in 1994. Employee compensation and benefits expense increased
10% in 1996 and 11% in 1995. The increases in both years were due to higher
variable employee compensation expense resulting from increased revenues and
higher costs related to training new account executives. Employee compensation
and benefits expense as a percentage of net operating revenues was 50.4% in
1996, 50.5% in 1995 and 50.3% in 1994. Marketing and business development
expense increased 34% in 1996 and remained level in 1995. The increase in 1996
was due to higher promotional expenses associated with the Company's investments
in new business activities. Other non-interest expenses decreased 15% in 1996
and remained level in 1995. Other non-interest expenses include legal expenses
and other professional fees and other administrative costs. The decrease in 1996
was due to a reduction in legal expenses and other professional fees.
Dean Witter, Discover & Co. 1996
- --------------------------------
26
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
Financing activities are managed centrally. Funding and capital plans are
developed and implemented for each business unit, consistent with its financial
objectives and in coordination with business unit management. The Company
pursues conservative liquidity, interest rate risk and capital policies for its
businesses.
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 the diversification of funding sources, extension of funding terms and
staggering of maturities. The Company's interest rate risk policies are designed
to reduce the volatility of earnings resulting from changes in market interest
rates. This is accomplished primarily through matched financing which entails
matching the repricing schedules of consumer loans and the related financing.
The Company's capital policies seek to maintain balance sheet ratios that the
Company believes are conservative relative to the risks of each business unit's
activities as well as regulatory and rating agency requirements.
The Company expects that its future funding and refinancing requirements
will be met through the traditional sources of funds available to the Company.
The Company believes its current sources of funding are sufficient to meet its
future growth plans and financing requirements.
CORPORATE FUNDING POLICIES AND ACTIVITIES
Liquidity
Diversification of funding sources is an important element of the Company's
liquidity policies. The Company accesses funding at the corporate level through
the issuance of commercial paper, short-term bank borrowings and senior
long-term notes, which include medium-term and underwritten notes. The Company's
debt securities are sold globally and are denominated in multiple currencies. In
1996, the Company filed a shelf registration for $2.0 billion of debt securities
with the Securities and Exchange Commission and increased its capacity to issue
debt securities under its Euro Medium-term Note Program by $2.0 billion. The
proceeds from the issuance of corporate level borrowings are loaned to Credit
Services and Securities at terms which substantially match the terms of the
public debt. The proceeds from the issuance of commercial paper and senior
long-term notes are loaned predominantly to Credit Services.
The Company's segments access financing sources which are specific to their
businesses. Credit Services obtains funding from the sale of consumer loans
through asset securitizations to both domestic and foreign investors, deposit
taking, the issuance of asset-backed commercial paper, the purchase of federal
funds and short-term bank notes. Securities funds its operations primarily
through the use of repurchase and securities lending agreements. Both Credit
Services and Securities utilize cash provided by operations to meet liquidity
needs.
The Company's credit ratings at December 31, 1996 and 1995 were as follows.
CORPORATE LEVEL DEBT RATINGS
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- ----------------------------------------------------------
SENIOR SENIOR
COMMERCIAL LONG-TERM COMMERCIAL LONG-TERM
PAPER NOTES PAPER NOTES
- ----------------------------------------------------------
<S> <C> <C> <C> <C>
Moody's P1 A2 P1 A2
S&P A1 A A1 A
Fitch F-1+ AA- F-1+ AA-
Duff & Phelps D1 A+ D1 A+
- ----------------------------------------------------------
</TABLE>
Subsequent to the announcement of the Company's definitive merger agreement with
Morgan Stanley, Moody's placed the Company's long-term borrowings on review for
possible upgrade. S&P placed the Company's long-term and short-term borrowings
on CreditWatch with positive implications.
At December 31, 1996 and 1995, $3,511.6 million and $3,444.9 million of
unsecured commercial paper issued at the corporate level was outstanding.
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.
The Company issues senior long-term notes through underwritten public
offerings and continuous offerings of medium-term notes. Proceeds received from
the issuance of senior long-term notes were $2,687.5 million in 1996 and
$1,833.5 million in 1995.
Dean Witter, Discover & Co. 1996
--------------------------------
27
<PAGE>
At December 31, 1996, the maturity profiles of the Company's deposits,
senior long-term notes and asset securitizations were as follows.
<TABLE>
<CAPTION>
(in millions)
- ------------------------------------------------------------------
SENIOR ASSET
DEPOSITS NOTES SECURITIZATIONS
- ------------------------------------------------------------------
<S> <C> <C> <C>
Under 1 year $3,126.8 $1,073.1 $1,274.7
1-2 years 1,720.7 1,705.2 3,482.1
2-3 years 878.9 819.6 2,132.6
3-5 years 1,112.7 2,087.9 2,248.6
5-10 years 373.5 2,032.6 3,193.9
Over 10 years -- 440.0 1,052.7
- ------------------------------------------------------------------
</TABLE>
Senior long-term notes totaling $1,267.4 million matured in 1996 and were
replaced with new borrowings.
CAPITAL
The Company's shareholders' equity increased to $5,164.4 million at December 31,
1996 from $4,833.7 million at December 31, 1995. At December 31, 1996 and 1995,
$3,766.4 million and $3,129.8 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. Certain of the Company's subsidiaries have regulatory and other
restrictions on the amount of net assets available for transfer to the Company
in the form of dividends or loans. The aggregate amount of these restrictions
was $1.7 billion at December 31, 1996. The Company believes that these
restrictions will not have a material effect on its ability to meet future
dividend or funding requirements.
For purposes of evaluating the financial performance of its segments, the
Company's shareholders' equity is allocated to its segments based on amounts the
Company believes the segments would require if they were stand-alone companies.
At December 31, 1996 and 1995, the Company's shareholders' equity was allocated
as follows: Credit Services, $2,938.6 million and $2,574.2 million; Securities,
$1,372.5 million and $1,366.4 million.
On December 16, 1996, the Company's Board of Directors declared a
two-for-one stock split, in the form of a dividend, payable to shareholders of
record on December 26, 1996 and distributable on January 14, 1997. The Company
paid quarterly dividends of $0.11 per common share for 1996. The Company raised
its quarterly dividend per common share to $0.14 effective for first quarter
1997 dividends.
The Company purchases shares of its common stock under a general repurchase
plan and for issuance in equity-based compensation plans. In 1996, the Company
purchased 23.1 million shares of common stock. Through January 31, 1997, the
Company had purchased an additional 0.6 million shares of its common stock at an
average price of $34.21 per share.
CREDIT SERVICES
LIQUIDITY
The Company seeks to reduce refinancing risk at Credit Services through the
application of liquidity policies that emphasize the diversification of funding
sources, extension of funding terms and staggering of funding maturities. Credit
Services relies upon asset securitizations, the issuance of asset-backed
commercial paper, corporate borrowings, deposit taking, the purchase of federal
funds, short-term bank notes, and cash generated by operations to fund its
business activities.
Asset Securitizations
The Company sells consumer loans through asset securitizations using several
transaction structures. At December 31, 1996 and 1995, outstanding asset
securitizations totaled $13,384.6 million and $10,219.5 million. The Company
received proceeds from asset securitizations of $4,527.5 million in 1996 and
$1,827.3 million in 1995.
Asset-Backed Commercial Paper
Credit Services, through Riverwoods Funding Corporation ("RFC"), an entity
included in the consolidated financial statements of the Company, issues
asset-backed commercial paper. At December 31, 1996 and 1995, $1,225.2 million
and $1,243.6 million of asset-backed commercial paper was outstanding.
RFC 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 its 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.
Corporate Borrowings
Credit Services businesses borrow from the Company on terms that generally match
the terms of the underlying corporate borrowings issued by the Company. (See
"Corporate Funding Policies and Activities.")
Deposits and Federal Funds
The Company's bank subsidiaries solicit deposits from consumers and purchase
federal funds. Interest bearing
Dean Witter, Discover & Co. 1996
- --------------------------------
28
<PAGE>
deposits are classified by type as savings, brokered and other time. Savings
deposits consist primarily of money market deposit and certificate of deposit
accounts sold directly to cardmembers and savings deposits solicited from DWR
clients. Brokered deposits consist primarily of certificates of deposit issued
by the Company's bank subsidiaries, which are sold through the DWR account
executive sales organization and a syndicate of firms managed by DWR. Other time
deposits include institutional certificates of deposit.
Bank Notes
Credit Services, through Greenwood Trust Company, an indirect subsidiary of the
Company, sells notes under a short-term bank note program. These notes have
maturities of up to 270 days.
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 exchange agreements
and interest rate caps. 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 cap agreements effectively establish a maximum interest rate on
certain of the Company's floating rate financings. 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.
At December 31, 1996 and 1995, notional amounts of interest rate exchange
agreements outstanding were as follows.
<TABLE>
<CAPTION>
(in millions)
DECEMBER 31, 1996 1995
- ------------------------------------------------------------
<S> <C> <C>
Agreements that converted the
interest rate on financing:
From fixed to floating $5,021.3 $4,164.8
From floating to fixed 1,182.8 1,469.0
From floating to floating 275.0 425.0
- ------------------------------------------------------------
Total $6,479.1 $6,058.8
- ------------------------------------------------------------
</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 Company had $40.0 million and $415.0
million of interest rate cap agreements outstanding, of which $40.0 million were
in effect in both years.
CAPITAL
The Company endeavors to maintain, for all Credit Services businesses,
conservative capital positions based on regulatory and rating agency guidelines.
The Company's capital policies require the maintenance of capital at its
regulated banking subsidiaries at levels considered, for regulatory purposes,
"significantly" in excess of applicable minimum capital requirements. (See Note
11 to the Consolidated Financial Statements, "Regulatory Capital Requirements".)
SECURITIES
LIQUIDITY
The Company's liquidity goal for its Securities operations is to maintain access
to cost-effective financing in all market conditions. Historically, the
Company's broker-dealer operations have been self-funding. The Company believes
that these operations will continue to have the capacity to be self-funding.
Consistent with its historical practices, the principal sources relied upon
by the Company to fund its broker-dealer operations include repurchase and
securities lending agreements and bank borrowings. In 1996, the Company had
sufficient collateral to secure bank borrowings if the availability of unsecured
funds had required such action.
CAPITAL
The Company maintains a conservative capital position for Securities based on
regulatory and rating agency guidelines. (See Note 11 to the Consolidated
Financial Statements, "Regulatory Capital Requirements".)
Dean Witter, Discover & Co. 1996
--------------------------------
29
<PAGE>
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>
QUARTERLY INFORMATION
(in millions, except per share data)
<TABLE>
<CAPTION>
(unaudited) QUARTER
- -----------------------------------------------------------------------------------------------
1996 FIRST SECOND THIRD FOURTH
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
RESULTS OF OPERATIONS
Net operating revenues $1,547.5 $1,541.7 $1,526.0 $1,614.9
Income before income taxes 400.4 388.1 393.0 363.6
Net income 245.8 238.8 239.0 227.8
PER SHARE DATA (1)
Earnings per common share
Primary $ 0.71 $ 0.69 $ 0.71 $ 0.68
Fully Diluted 0.70 0.69 0.71 0.68
Average shares outstanding
Primary 348.3 344.2 337.7 334.3
Fully Diluted 349.6 344.3 338.4 334.9
Dividends declared per common share $ 0.11 $ 0.11 $ 0.11 $ 0.11
STOCK PRICE DATA(1)
High $ 29.00 $ 31.06 $ 28.88 $ 34.38
Low 22.50 25.56 24.13 27.56
Close 28.63 28.56 27.50 33.13
===============================================================================================
</TABLE>
<TABLE>
<CAPTION>
QUARTER
- -----------------------------------------------------------------------------------------------
1995 FIRST SECOND THIRD FOURTH
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
RESULTS OF OPERATIONS
Net operating revenues $1,367.6 $1,424.9 $1,451.2 $1,432.2
Income before income taxes 362.3 385.3 355.7 292.6
Net income 222.1 237.5 218.7 178.1
PER SHARE DATA(1)
Earnings per common share
Primary $ 0.64 $ 0.68 $ 0.62 $ 0.51
Fully Diluted 0.64 0.68 0.62 0.51
Average shares outstanding
Primary 347.0 350.7 353.0 351.7
Fully Diluted 347.8 351.0 354.5 351.7
Dividends declared per common share $ 0.08 $ 0.08 $ 0.08 $ 0.08
STOCK PRICE DATA(1)
High $ 21.69 $ 24.38 $ 29.13 $ 28.06
Low 16.75 20.00 23.19 23.25
Close 20.38 23.50 28.13 23.50
===============================================================================================
</TABLE>
(1) Per share and stock price data have been restated to reflect the Company's
two-for-one stock split.
Dean Witter, Discover & Co. 1996
--------------------------------
46
