<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 20, 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
As previously disclosed in Dean Witter, Discover & Co.'s ("Dean Witter") current
report on Form 8-K dated February 12, 1997, Dean Witter and Morgan Stanley Group
Inc. ("Morgan Stanley") announced a definitive agreement to merge ("the
Merger"). This transaction is intended to be accounted for as a pooling of
interests and the new company will be named Morgan Stanley, Dean Witter,
Discover & Co. Under the terms of the definitive agreement each of Morgan
Stanley's common shares will be exchanged for 1.65 of Dean Witter's common
shares. The Merger, which is expected to be completed in mid-1997, is subject
to customary closing conditions, including certain regulatory approvals and the
approval of the stockholders of both companies.
Certain financial information for Morgan Stanley and unaudited pro forma
combined financial information for the combined entity giving effect to the
merger is set forth under Item 7(c) below as Exhibits 99.1, 99.2 and 99.3.
respectively.
Attached and incorporated herein by reference as Exhibit 23.1 is a copy of the
consent of Ernst & Young LLP.
Item 7(c). FINANCIAL STATEMENTS, PRO FORMA FINANCIAL STATEMENTS AND
EXHIBITS.
Exhibit No. Description
- ------------- -----------
23.1 Consent of Ernst & Young LLP
99.1 The audited consolidated balance sheets of Morgan Stanley as of
November 30, 1995 and January 31, 1995, and the related
consolidated statements of income, cash flows and changes in
shareholders' equity for each of the years in the three year
period ended November 30, 1995.
99.2 The unaudited consolidated balance sheet of Morgan Stanley as of
August 31, 1996 and the unaudited consolidated statements of
income and cash flows of Morgan Stanley for the nine months ended
August 31, 1996 and 1995.
99.3 The Morgan Stanley, Dean Witter, Discover & Co. unaudited pro
forma condensed combined statement of financial condition at
September 30, 1996, and unaudited pro forma condensed combined
statements of income for the twelve months ended December 31,
1995, 1994 and 1993 and for the nine months ended September 30,
1996 and 1995.
<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 20, 1997
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
DEAN WITTER, DISCOVER & CO.
EXHIBITS
TO CURRENT REPORT ON
FORM 8-K DATED FEBRUARY 20, 1997
Commission File Number 1-11758
<PAGE>
Exhibit No. Description
- ------------- -----------
23.1 Consent of Ernst & Young LLP
99.1 The audited consolidated balance sheets of Morgan Stanley as of
November 30, 1995 and January 31, 1995, and the related
consolidated statements of income, cash flows and changes in
shareholders' equity for each of the years in the three year
period ended November 30, 1995.
99.2 The unaudited consolidated balance sheet of Morgan Stanley as of
August 31, 1996 and the unaudited consolidated statements of
income and cash flows of Morgan Stanley for the nine months ended
August 31, 1996 and 1995.
99.3 The Morgan Stanley, Dean Witter, Discover & Co. unaudited pro
forma condensed combined statement of financial condition at
September 30, 1996, and unaudited pro forma condensed combined
statements of income for the twelve months ended December 31,
1995, 1994 and 1993 and for the nine months ended September 30,
1996 and 1995.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-3 No. 33-92172, Form S-3 No. 33-57202, Form S-3 No. 33-60734, Form S-3
No. 33-89748, Form S-3 No. 333-7947 and Form S-8 No. 33-62374, Form S-8 No. 33-
63024, Form S-8 No. 33-63026, Form S-8 No. 33-78038, Form S-8 No. 33-79516, Form
S-8 No. 33-82240, Form S-8 No. 33-82242, Form S-8 No. 33-82244, and Form S-8 No.
333-4212) of Dean Witter, Discover & Co. of our reports dated January 4, 1996
and February 23, 1996 with respect to the consolidated financial statements and
financial statement schedule, respectively, of Morgan Stanley Group Inc.
included in and incorporated by reference in this Current Report on Form 8-K of
Dean Witter, Discover & Co. to be filed on February 20, 1997.
ERNST & YOUNG LLP
New York, New York
February 20, 1997
<PAGE>
EXHIBIT 99.1
- --------------------------------------------------------------------------------
Report of Independent Auditors
The Stockholders and
Board of Directors of
Morgan Stanley Group Inc.
We have audited the accompanying Consolidated Statement of Financial Condition
of Morgan Stanley Group Inc. as of November 30, 1995 and January 31, 1995 and
the related Consolidated Statements of Income, Cash Flows and Changes in
Stockholders' Equity for the ten-month period ended November 30, 1995 and the
years ended January 31, 1995 and January 31, 1994. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Morgan Stanley
Group Inc. at November 30, 1995 and January 31, 1995, and the consolidated
results of its operations and its cash flows for the ten-month period ended
November 30, 1995 and the years ended January 31, 1995 and January 31, 1994, in
conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
New York, New York
January 4, 1996
1
<PAGE>
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NOVEMBER 30, January 31,
(Dollars in Millions, Except Share Data) 1995 1995
----------------------------------
<S> <C> <C>
ASSETS
Cash and interest-bearing equivalents $ 2,471 $ 2,510
Cash and securities deposited with clearing organizations or segregated under
federal and other regulations (securities at fair value of $859 at November
30, 1995 and $1,507 at January 31, 1995) 1,339 2,116
Financial instruments owned:
U.S. government and agency securities 12,480 9,107
Other sovereign government obligations 13,792 12,931
Corporate and other debt 10,690 10,545
Corporate equities 13,185 5,483
Derivative contracts 8,043 8,623
Physical commodities 410 420
Securities purchased under agreements to resell 45,886 35,913
Securities borrowed 27,069 20,042
Receivables:
Customers 3,413 4,823
Brokers, dealers and clearing organizations 1,475 1,376
Interest and dividends 1,082 731
Fees and other 506 548
Property, equipment and leasehold improvements, at cost, net of accumulated
depreciation and amortization of $462 at November 30, 1995
and $364 at January 31, 1995 1,286 1,061
Other assets 626 465
----------------------------------
Total assets $143,753 $116,694
----------------------------------
</TABLE>
- --------------------------------------------------------------------------------
* All amounts have been retroactively adjusted to give effect for a two-for-one
stock split, effected in the form of a 100% stock dividend, which became
effective on January 26, 1996.
See Notes to Consolidated Financial Statements.
2
<PAGE>
- --------------------------------------------------------------------------------
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
NOVEMBER 30, January 31,
1995 1995
----------------------------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings $ 11,703 $ 10,273
Financial instruments sold, not yet purchased:
U.S. government and agency securities 6,459 6,177
Other sovereign government obligations 8,972 7,251
Corporate and other debt 1,076 1,174
Corporate equities 3,585 3,006
Derivative contracts 7,537 7,322
Physical commodities 71 377
Securities sold under agreements to repurchase 60,738 50,123
Securities loaned 9,340 2,860
Payables:
Customers 13,818 11,588
Brokers, dealers and clearing organizations 1,974 953
Interest and dividends 1,019 825
Other liabilities and accrued expenses 595 458
Accrued compensation and benefits 1,192 938
Long-term borrowings 9,635 8,462
----------------------------------
137,714 111,787
----------------------------------
Capital Units 865 352
----------------------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock 818 819
Common stock, $1.00 par value; authorized 300,000,000 shares; issued
162,838,920 shares at November 30, 1995 and 159,548,556 shares
at January 31, 1995* 163 160
Paid-in capital* 730 626
Retained earnings 3,815 3,338
Cumulative translation adjustments (9) (10)
----------------------------------
Subtotal 5,517 4,933
Less:
Note receivable related to sale of preferred stock to ESOP 89 100
Common stock held in treasury, at cost
(7,635,174 shares at November 30, 1995
and 8,954,990 shares at January 31, 1995)* 254 278
----------------------------------
Total stockholders' equity 5,174 4,555
----------------------------------
Total liabilities and stockholders' equity $ 143,753 $ 116,694
----------------------------------
</TABLE>
- --------------------------------------------------------------------------------
3
<PAGE>
- --------------------------------------------------------------------------------
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
FISCAL PERIOD ENDED Fiscal Year Ended Fiscal Year Ended
NOVEMBER 30, January 31, January 31,
(Dollars in Millions, Except Share Data) 1995 1995 1994
---------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Investment banking $ 1,211 $ 919 $ 1,238
Principal transactions:
Trading 1,122 1,104 1,459
Investments 102 139 158
Commissions 437 449 393
Interest and dividends 5,939 6,406 5,660
Asset management and administration 310 350 258
Other 3 9 10
---------------------------------------------------------------
Total revenues 9,124 9,376 9,176
Interest expense 5,501 5,875 5,020
---------------------------------------------------------------
Net revenues 3,623 3,501 4,156
---------------------------------------------------------------
Expenses excluding interest:
Compensation and benefits 1,795 1,733 2,049
Occupancy and equipment 276 303 248
Brokerage, clearing and exchange fees 211 230 196
Communications 108 122 100
Business development 110 165 134
Professional services 131 164 120
Other 109 131 109
Relocation charge -- 59 --
---------------------------------------------------------------
Total expenses excluding interest 2,740 2,907 2,956
---------------------------------------------------------------
Income before income taxes 883 594 1,200
Provision for income taxes 283 199 414
---------------------------------------------------------------
Net income $ 600 $ 395 $ 786
---------------------------------------------------------------
Preferred stock dividend requirements $ 54 $ 65 $ 55
---------------------------------------------------------------
Earnings applicable to common shares (1) $ 546 $ 330 $ 731
---------------------------------------------------------------
Average common and common equivalent shares
outstanding (1) (2) 156,912,678 157,793,216 152,416,576
---------------------------------------------------------------
Primary earnings per share (2) $ 3.48 $ 2.09 $ 4.80
---------------------------------------------------------------
Fully diluted earnings per share (2) $ 3.33 $ 2.02 $ 4.58
- -------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) All share and per share amounts have been retroactively adjusted to give
effect for a two-for-one stock split, effected in the form of a 100% stock
dividend, which became effective on January 26, 1996.
See Notes to Consolidated Financial Statements.
4
<PAGE>
- --------------------------------------------------------------------------------
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FISCAL PERIOD ENDED Fiscal Year Ended Fiscal Year Ended
NOVEMBER 30, January 31, January 31,
(Dollars in Millions) 1995 1995 1994
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 600 $ 395 $ 786
Adjustments to reconcile net income to net
cash (used for) provided by operating activities:
Non-cash charges included in net income:
Deferred income taxes (111) (128) (266)
Compensation payable in common
or preferred stock 165 116 408
Depreciation and amortization 107 104 64
Relocation charge -- 59 --
Changes in assets and liabilities:
Cash and securities deposited with
clearing organizations or segregated
under federal and other regulations 777 (1,454) 726
Financial instruments owned, net of
financial instruments sold, not yet
purchased (9,098) (1,086) 445
Securities borrowed, net of
securities loaned (547) (3,063) (3,601)
Receivables and other assets 813 1,076 (2,889)
Payables and other liabilities, net of
deferred liabilities 3,947 258 4,614
-----------------------------------------------------------
Net cash (used for) provided by operating activities (3,347) (3,723) 287
Cash flows from investing activities:
Net payments for:
Property, equipment and leasehold improvements (336) (415) (290)
-----------------------------------------------------------
Net cash used for investing activities (336) (415) (290)
Cash flows from financing activities:
Net proceeds related to short-term borrowings 1,430 1,707 878
Securities sold under agreements to repurchase,
net of securities purchased under agreements
to resell 642 1,451 (3,803)
Proceeds from:
Issuance of preferred stock -- -- 194
Issuance of common stock 79 20 27
Issuance of long-term borrowings 2,402 2,955 3,355
Issuance of Capital Units 513 230 122
Payments for:
Repurchases of common stock (103) (287) (245)
Repayments of long-term borrowings (1,196) (1,202) (636)
Cash dividends (123) (151) (134)
-----------------------------------------------------------
Net cash provided by (used for) financing activities 3,644 4,723 (242)
-----------------------------------------------------------
Net (decrease) increase in cash and
interest-bearing equivalents (39) 585 (245)
Cash and interest-bearing equivalents, at
beginning of period 2,510 1,925 2,170
-----------------------------------------------------------
Cash and interest-bearing equivalents, at end of period $ 2,471 $ 2,510 $ 1,925
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
Cash payments for income taxes totaled $233 million, $657 million and $299
million in fiscal 1995, fiscal 1994 and fiscal 1993, respectively.
Cash payments for interest approximated interest expense for all periods.
See Notes to Consolidated Financial Statements.
5
<PAGE>
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Preferred Common
(Dollars in Millions) Stock Stock(1)
---------------------------
<S> <C> <C>
Balance, January 31, 1993 $ 621 $154
Issuance of 7-3/8% Cumulative Preferred Stock 200 --
Conversion of ESOP Preferred Stock (1) --
Issuance of common stock -- 2
Repurchases of common stock -- --
Compensation payable in common stock -- --
ESOP shares allocated, at cost -- --
Net income -- --
Cash dividends -- --
Translation adjustments -- --
------------------------------------------------------------------------------
Balance, January 31, 1994 820 156
Conversion of ESOP Preferred Stock (1) --
Issuance of common stock -- 2
Repurchases of common stock -- --
Compensation payable in common stock -- 2
ESOP shares allocated, at cost -- --
Net income -- --
Cash dividends -- --
Translation adjustments -- --
------------------------------------------------------------------------------
Balance, January 31, 1995 819 160
Conversion of ESOP Preferred Stock (1) --
Issuance of common stock -- 3
Repurchases of common stock -- --
Compensation payable in common stock -- --
ESOP shares allocated, at cost -- --
Net income -- --
Cash dividends -- --
Translation adjustments -- --
---------------------------
Balance, November 30, 1995 $ 818 $163
- -------------------------------------------------------------------------------
</TABLE>
(1) All amounts have been retroactively adjusted to give effect for a
two-for-one stock split, effected in the form of a 100% stock dividend,
which became effective on January 26, 1996.
See Notes to Consolidated Financial Statements.
6
<PAGE>
- --------------------------------------------------------------------------------
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY -- (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Note Receivable Common Stock
Cumulative Related to Sale Held in
Paid-in Retained Translation of Preferred Treasury,
(Dollars in Millions) Capital(1) Earnings Adjustments Stock to ESOP at Cost Total
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 31, 1993 $ 474 $ 2,442 $ (2) $(116) $(139) $ 3,434
Issuance of 7-3/8% Cumulative Preferred Stock (6) -- -- -- -- 194
Conversion of ESOP Preferred Stock 1 -- -- -- -- 0
Issuance of common stock (131) -- -- -- 156 27
Repurchases of common stock -- -- -- -- (245) (245)
Compensation payable in common stock 401 -- -- -- -- 401
ESOP shares allocated, at cost -- -- -- 7 -- 7
Net income -- 786 -- -- -- 786
Cash dividends -- (134) -- -- -- (134)
Translation adjustments -- -- (1) -- -- (1)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, January 31, 1994 739 3,094 (3) (109) (228) 4,469
Conversion of ESOP Preferred Stock 1 -- -- -- -- 0
Issuance of common stock 18 -- -- -- -- 20
Repurchases of common stock -- -- -- -- (287) (287)
Compensation payable in common stock (132) -- -- -- 237 107
ESOP shares allocated, at cost -- -- -- 9 -- 9
Net income -- 395 -- -- -- 395
Cash dividends -- (151) -- -- -- (151)
Translation adjustments -- -- 1 -- -- 1
--------------------------------------------------------------------------------
Balance, November 30, 1995 $ 730 $ 3,815 $ (9) $ (89) $(254) $ 5,174
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
7
<PAGE>
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
The Consolidated Financial Statements include the accounts of Morgan Stanley
Group Inc. and its U.S. and international subsidiaries (collectively, the
"Company"), including Morgan Stanley & Co. Incorporated ("MS&Co.") and Morgan
Stanley & Co. International Limited ("MSIL").
The Company, through its subsidiaries, provides a wide range of financial
services on a global basis. Its businesses include securities underwriting,
distribution and trading; merger, acquisition, restructuring, real estate,
project finance and other corporate finance advisory activities; merchant
banking and other principal investment activities; brokerage and research
services; asset management; the trading of foreign exchange and commodities as
well as derivatives on a broad range of asset categories, rates and indices; and
global custody, securities clearance services and securities lending. These
services are provided to a large and diversified group of clients and customers,
including corporations, governments, financial institutions and individual
investors.
All material intercompany accounts and transactions have been eliminated
in consolidation. Certain amounts in the Consolidated Financial Statements for
prior years have been reclassified to conform with the fiscal 1995 presentation.
CHANGE IN FISCAL YEAR-END
On February 28, 1995, the Board of Directors approved a change in the Company's
fiscal year-end from January 31 to November 30. This change became effective for
the fiscal period ended November 30, 1995, and, accordingly, this report
includes the results for the ten-month period from February 1, 1995 through
November 30, 1995 ("fiscal 1995"), as well as those for the fiscal years ended
January 31, 1995 and January 31, 1994 ("fiscal 1994" and "fiscal 1993,"
respectively).
FINANCIAL INSTRUMENTS USED FOR TRADING AND INVESTMENT
Financial instruments, including derivatives, used in the Company's trading
activities are recorded at fair value, and unrealized gains and losses are
reflected in trading revenues. Interest revenue and expense arising from
financial instruments used in trading activities are reflected in the
Consolidated Statement of Income as interest income or expense. The fair values
of the trading positions generally are based on listed market prices. If listed
market prices are not available or if liquidating the Company's positions would
reasonably be expected to impact market prices, fair value is determined based
on other relevant factors, including dealer price quotations and price
quotations for similar instruments traded in different markets, including
markets located in different geographic areas. Fair values for certain
derivative contracts are derived from pricing models which consider current
market and contractual prices for the underlying financial instruments or
commodities, as well as time value and yield curve or volatility factors
underlying the positions. Purchases and sales of financial instruments are
recorded in the accounts on trade date. Unrealized gains and losses arising from
the Company's dealings in over-the-counter ("OTC") financial instruments,
including derivative contracts related to financial instruments and commodities,
are presented in the accompanying Consolidated Statement of Financial Condition
on a net-by-counterparty basis consistent with Financial Accounting Standards
Board ("FASB") Interpretation No. 39, "Offsetting of Amounts Related to Certain
Contracts."
Equity securities purchased in connection with merchant banking and other
principal investment activities are initially carried in the Consolidated
Financial Statements at their original cost; the carrying value of such
investments is adjusted upward only when changes in the underlying fair values
are readily ascertainable, generally as evidenced by substantial transactions
occurring in the marketplace which directly affect their value. Downward
adjustments relating to such equity securities are made in the event that the
Company determines that the eventual realizable value is less than the carrying
value. Loans made in connection with such activities are carried at unpaid
principal balances plus accrued interest less reserves, if deemed necessary, for
estimated losses.
8
<PAGE>
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
FINANCIAL INSTRUMENTS USED FOR ASSET AND LIABILITY MANAGEMENT
The Company uses interest rate and currency swaps to manage the interest rate
and currency exposure arising from certain borrowings. Swaps used to hedge debt
are designated as hedges and are matched to the debt as to notional amount and
maturity. The periodic receipts or payments from each swap are recognized
ratably over the term of the swap as an adjustment to interest expense. Gains
and losses resulting from the termination of hedge contracts prior to their
stated maturity are recognized ratably over the remaining life of the instrument
being hedged. The Company also uses foreign exchange forward contracts to manage
the currency exposure relating to its net monetary investment in non-U.S. dollar
functional currency operations. In accordance with Statement of Financial
Accounting Standards ("SFAS") No. 52, the gain or loss from revaluing these
contracts is deferred and reported within cumulative translation adjustments in
stockholders' equity, net of tax effects, with the related unrealized amounts
due from or to counterparties included in receivables from or payables to
brokers, dealers and clearing organizations.
COLLATERALIZED SECURITIES TRANSACTIONS
Securities purchased under agreements to resell and securities sold under
agreements to repurchase (principally government and agency securities) are
treated as financing transactions and are carried at the amounts at which the
securities will subsequently be resold or reacquired as specified in the
respective agreements; such amounts include accrued interest. Reverse repurchase
and repurchase agreements are presented net-by-counterparty in the accompanying
Consolidated Statement of Financial Condition where net presentation is
consistent with FASB Interpretation No. 41, "Offsetting of Amounts Related to
Certain Repurchase and Reverse Repurchase Agreements." It is the Company's
policy to take possession of securities purchased under agreements to resell.
The Company monitors the fair value of the underlying securities as compared
with the related receivable or payable, including accrued interest, and, as
necessary, requests additional collateral. Where deemed appropriate, the
Company's agreements with third parties specify its rights to request additional
collateral.
Securities borrowed and securities loaned are carried at the amounts of
cash collateral advanced and received in connection with the transactions. The
Company measures the fair value of the securities borrowed and loaned against
the cash collateral on a daily basis. Additional cash is obtained as necessary
to ensure such transactions are adequately collateralized.
TRANSLATION OF FOREIGN CURRENCIES
Assets and liabilities of operations having non-U.S. dollar functional
currencies are translated at year-end rates of exchange, and the income
statements are translated at weighted average rates of exchange for the year. In
accordance with SFAS No. 52, gains or losses resulting from translating foreign
currency financial statements, net of hedge gains or losses and related tax
effects, are reflected in cumulative translation adjustments, a separate
component of stockholders' equity. Gains or losses resulting from foreign
currency transactions are included in net income.
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Depreciation of property and equipment is provided on a straight-line basis over
the estimated useful lives of the related assets. Amortization of leasehold
improvements is provided on a straight-line basis over the lesser of the
estimated useful life of the asset or, where applicable, the remaining life of
the lease.
COMMON SHARE DATA
Earnings per share is based on the weighted average number of common shares and
share equivalents outstanding and gives effect to preferred stock dividend
requirements. Common share and stock option share data for all periods presented
have been retroactively adjusted throughout the Consolidated Financial
Statements to reflect a two-for-one
9
<PAGE>
===============================================================================
common stock split, effected in the form of a 100% stock dividend, declared on
January 4, 1996 and payable on January 26, 1996 to holders of record on January
16, 1996.
CONSOLIDATED STATEMENT OF CASH FLOWS
The Company considers all highly liquid debt instruments purchased and not held
for resale, with an original maturity of three months or less, to be
interest-bearing equivalents for purposes of this statement.
INCOME TAXES
Income taxes are provided in accordance with SFAS No. 109, "Accounting for
Income Taxes." SFAS No. 109 requires the calculation of deferred taxes using the
asset and liability method. Under this method, deferred tax balances must be
adjusted to reflect enacted changes in income tax rates, and deferred taxes
generally must be provided on all book and tax basis differences.
NOTE 2 SHORT-TERM BORROWINGS
Short-term funding is generally obtained at rates related to U.S., Euro or Asian
money rates for the currency and term borrowed and includes loans payable on
demand. Secured borrowings included in these loans, which may fluctuate
significantly from time to time, were $29 million and $2,694 million at November
30, 1995 and January 31, 1995, respectively. Short-term borrowings at November
30, 1995 and January 31, 1995 also included commercial paper of $8,412 million
and $5,228 million, respectively, with approximate weighted average interest
rates of 5.9% and 6.3%, respectively.
The Company maintains a senior revolving credit agreement with a group of
banks. Under the terms of the credit agreement, the banks are committed to
provide up to $2.5 billion for up to 364 days. Any loans outstanding on the
commitment termination date will mature on the first anniversary of the
commitment termination date. The agreement contains restrictive covenants which
require, among other things, that the Company maintain stockholders' equity of
at least $3,391 million as of November 30, 1995.
The Company maintains a master collateral facility that enables MS&Co. to
pledge certain collateral to secure loan arrangements, letters of credit and
other financial accommodations. As part of this facility, MS&Co. maintains a
secured committed credit agreement with a group of banks that are parties to the
master collateral facility under which such banks are committed to provide up to
$1 billion for up to 364 days. Any loans outstanding on the commitment
termination date will mature on the first anniversary of the commitment
termination date. The credit agreement contains restrictive covenants which
require, among other things, that MS&Co. maintain specified levels of
consolidated stockholders' equity and Net Capital, as defined. Subsequent to
November 30, 1995, the credit agreement was renewed with the commitment
increased to $1.25 billion.
Subsequent to November 30, 1995, the Company established a revolving
committed financing facility that enables MSIL to secure committed funding from
a syndicate of banks by providing a broad range of collateral under repurchase
agreements. Such banks are committed to provide up to an aggregate of $1.25
billion available in twelve major currencies for up to 364 days. Any amounts
outstanding on the commitment termination date may, at MSIL's option, be
extended to mature on or before the first anniversary of the commitment
termination date. The facility agreements contain restrictive covenants which
require, among other things, that MSIL maintain specified levels of
Shareholders' Equity and Financial Resources, each as defined.
There were no borrowings outstanding under any of the foregoing facilities
at November 30, 1995; however, the Company anticipates utilizing these
facilities for short-term funding from time to time.
10
<PAGE>
================================================================================
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
NOTE 3 LONG-TERM BORROWINGS
MATURITIES AND TERMS
Long-term borrowings at fiscal year-end consist of the following:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
U.S. Dollar Non-U.S. Dollar (1)
------------------------------------ ----------------------
Index/ NOV. 30, Jan. 31,
Fixed Floating Equity Fixed Floating 1995 1995
(Dollars in Millions) Rate Rate Linked Rate Rate TOTAL Total
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Due in fiscal 1995 $ -- $ -- $-- $-- $-- $ -- $1,059
Due in fiscal 1996 496 401 83 12 337 1,329 1,797
Due in fiscal 1997 636 1,430 160 56 422 2,704 1,470
Due in fiscal 1998 354 599 30 299 142 1,424 583
Due in fiscal 1999 356 200 21 211 -- 788 791
Due in fiscal 2000 60 10 -- -- -- 70 20
Thereafter 2,937 -- 26 337 20 3,320 2,742
-------------------------------------------------------------------------------------------
Total $4,839 $2,640 $320 $915 $921 $9,635 $8,462
-------------------------------------------------------------------------------------------
Weighted average
coupon at fiscal year-end 7.8% 6.0% n/a 5.9% 4.5% 6.8% 7.0%
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Weighted average coupon was calculated utilizing non-U.S. dollar interest
rates.
MEDIUM TERM NOTES
Included in the table above are medium term notes of $2,882 million at November
30, 1995 and $2,774 million at January 31, 1995. The effective weighted average
interest rate on all medium term notes was 6.2% in fiscal 1995. Maturities of
these notes range from fiscal 1996 through fiscal 2023.
STRUCTURED DEBT
U.S. dollar index/equity linked debt includes various structured instruments
whose payments and redemption values are linked to the performance of a specific
index (i.e., Standard & Poor's 500), a basket of stocks or a specific equity
security. To minimize the exposure resulting from movements in the underlying
equity position or index, the Company has entered into various equity swap
contracts and purchased options which effectively convert the borrowing costs
into floating rates based upon London Interbank Offered Rates ("LIBOR").
OTHER DEBT
U.S. dollar contractual floating rate debt bears interest based on a variety of
money market indices, including LIBOR and Fed Funds rates. Non-U.S. dollar
contractual floating rate debt bears interest based on Euro floating rates.
Included in the Company's long-term debt are subordinated notes of $1,298
million at November 30, 1995 and $832 million at January 31, 1995. The effective
weighted average interest rate on these subordinated notes was 7.0% in fiscal
1995. Maturities of the subordinated notes range from fiscal 1999 to fiscal
2016.
Certain of the Company's long-term debt is redeemable prior to maturity at
the option of the holder. These notes contain certain provisions which
effectively
11
<PAGE>
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enable noteholders to put the notes back to the Company and therefore are
scheduled in the foregoing table to mature in fiscal 1996 and fiscal 1997. The
stated maturities of these notes, which aggregate $540 million, are from 1998 to
2000.
In fiscal 1995, MS&Co., the Company's U.S. broker-dealer subsidiary,
issued approximately $263 million of 6.81% fixed rate subordinated Series C
notes, $96 million of 7.03% fixed rate subordinated Series D notes, $82 million
of 7.28% fixed rate subordinated Series E notes and $25 million of 7.82% fixed
rate subordinated Series F notes. These notes have maturities from 2001 to 2016.
The terms of such notes contain restrictive covenants which require, among other
things, that MS&Co. maintain specified levels of Consolidated Tangible Net Worth
and Net Capital, each as defined. In December 1995, MS&Co. issued an additional
$50 million of Series C notes.
ASSET AND LIABILITY MANAGEMENT
A substantial portion of the Company's fixed rate long-term debt is used to fund
highly liquid marketable securities and short-term receivables arising from
securities transactions. The Company uses interest rate swaps to more closely
match the duration of this debt to the duration of the assets being funded and
to minimize interest rate risk. These swaps effectively convert certain of the
Company's fixed rate debt into floating rate obligations. In addition, for
non-U.S. dollar currency debt that is not used to fund assets in the same
currency, the Company has entered into currency swaps which effectively convert
the debt into U.S. dollar obligations. The Company's use of swaps for asset and
liability management reduced its interest expense and effective average
borrowing rate as follows:
<TABLE>
<CAPTION>
FISCAL Fiscal Fiscal
(Dollars in Millions) 1995 1994 1993
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net reduction in interest expense from swaps
for the fiscal year $ 22 $ 93 $ 93
Weighted average coupon of long-term
debt at fiscal year-end(1) 6.8% 7.0% 6.0%
Effective average borrowing rate for
long-term debt after swaps at fiscal year-end(1) 6.5% 6.7% 4.2%
- --------------------------------------------------------------------------------------------
</TABLE>
(1) Included in the weighted average and effective average calculations are
non-U.S. dollar interest rates.
The effective weighted average interest rate on the Company's index/equity
linked notes, which are not included in the table above, was 6.0% in fiscal 1995
after giving effect to the related hedges.
12
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MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
The table below summarizes the notional or contract amounts of these swaps
by maturity and weighted average interest rates to be received and paid as of
November 30, 1995:
<TABLE>
<CAPTION>
U.S. Dollar Non-U.S. Dollar (1)
------------------------------------ ----------------------
Receive Receive Receive Receive
Fixed Floating Index/ Fixed Floating NOV. 30, Jan. 31,
Pay Pay Equity Pay Pay 1995 1995
(Dollars in Millions) Floating Floating Linked Floating Floating(2) TOTAL Total
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Maturing in fiscal 1995 $ -- $ -- $ -- $ -- $ -- $ -- $ 359
Maturing in fiscal 1996 494 106 69 12 -- 681 601
Maturing in fiscal 1997 636 -- 160 56 386 1,238 569
Maturing in fiscal 1998 269 154 30 299 108 860 354
Maturing in fiscal 1999 156 200 21 211 -- 588 572
Maturing in fiscal 2000 60 10 -- -- -- 70 10
Thereafter 1,025 -- 26 337 -- 1,388 1,275
------------------------------------------------------------------------------------
Total $2,640 $ 470 $ 306 $ 915 $ 494 $4,825 $ 3,740
------------------------------------------------------------------------------------
Weighted average at
fiscal year-end(3)
Receive rate 7.6% 5.4% n/a 5.9% 3.4%
Pay rate 6.1% 6.4% n/a 5.3% 6.3%
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) The differences between the receive rate and the pay rate may reflect
differences in the rate of interest associated with the underlying currency.
(2) These amounts include currency swaps used to effectively convert debt
denominated in one currency into obligations denominated in another
currency.
(3) The table was prepared under the assumption that interest rates remain
constant at year-end levels. The variable interest rates to be received or
paid will change to the extent that rates fluctuate. Such changes may be
substantial. Variable rates presented generally are based on LIBOR or
Treasury bill rates.
As noted above, the Company uses interest rate and currency swaps to
modify the terms of its existing debt. Activity during the periods in the
notional value of the swap contracts used by the Company for asset and liability
management (and the unrecognized gain (loss) at period end) are summarized in
the table below:
<TABLE>
<CAPTION>
FISCAL Fiscal
(Dollars in Millions) 1995 1994
-------------------------
<S> <C> <C>
Notional value at beginning of period $ 3,740 $ 3,649
Additions 1,546 931
Matured (359) (859)
Terminated (108) --
Effect of foreign currency translation on non-U.S. dollar
notional values 6 19
-------------------------
Notional value at fiscal year-end $ 4,825 $ 3,740
-------------------------
Unrecognized gain (loss) at fiscal year-end $ 225 $ (3)
- ----------------------------------------------------------------------------------------
</TABLE>
The Company also uses interest rate swaps to modify certain of its
repurchase financing agreements. The Company had interest rate swaps with
notional values of approximately $2.1 billion and $3.8 billion as of November
30, 1995 and January 31, 1995, respectively, and unrecognized gains (losses) of
approximately $45 million and $(47) million as
13
<PAGE>
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of November 30, 1995 and January 31, 1995, respectively, for such purpose. The
unrecognized gains (losses) on these swaps were offset by unrecognized (losses)
gains on certain of the Company's repurchase financing agreements.
The estimated fair value of the Company's long-term debt, based on rates
available to the Company at November 30, 1995 for debt with similar terms and
maturities, and the aggregate carrying value of this debt are presented in the
following table:
<TABLE>
<CAPTION>
NOV. 30, Jan. 31,
(Dollars in Millions) 1995 1995
----------------------------
<S> <C> <C>
Fair value of long-term debt $ 9,954 $8,334
Unrecognized (loss) gain (319) 128
----------------------------
Carrying value of long-term debt $ 9,635 $8,462
- --------------------------------------------------------------------------------
</TABLE>
NOTE 4 COMMITMENTS AND CONTINGENCIES
LEASES AND RELATED COMMITMENTS
The Company incurred rent expense under operating leases in the amounts of $97
million, $113 million and $101 million in fiscal 1995, fiscal 1994 and fiscal
1993, respectively. Minimum remaining rental payments, excluding amounts related
to the Company's termination of certain leased office space as described below,
are approximately as follows:
<TABLE>
<CAPTION>
Fiscal Year (Dollars in Millions)
---------------------
<S> <C>
1996 $116
1997 98
1998 84
1999 60
2000 52
Thereafter 241
- ----------------------------------------------------
</TABLE>
Rentals are subject to periodic escalation charges.
During 1995, the Company relocated the majority of its New York City
employees from existing leased space at 1221 and 1251 Avenue of the Americas to
space in the Company's buildings at 1585 Broadway and 750 Seventh Avenue that
were purchased in fiscal 1993 and fiscal 1994, respectively. The total
investment in these two buildings will aggregate approximately $700 million,
which is being capitalized and depreciated over the useful lives of the
individual assets comprising the investment.
During fiscal 1994, the Company recognized a pre-tax charge of $59 million
($39 million after tax, which reduced primary and fully diluted earnings per
share by $.25 and $.24, respectively). The charge was in connection with the
Company's move to the New York City facilities and to new leased office space in
Tokyo. The charge specifically covers the Company's termination of certain
leased office space and the write-off of remaining leasehold improvements in
both cities.
OTHER COMMITMENTS AND CONTINGENCIES
The Company had approximately $2.2 billion of letters of credit outstanding at
November 30, 1995 to satisfy various collateral requirements.
Financial instruments sold, not yet purchased represent obligations of the
Company to deliver specified financial instruments at contracted prices, thereby
creating commitments to purchase the securities in the market at prevailing
prices. Consequently, the Company's ultimate obligation to satisfy the sale of
financial instruments sold, not yet purchased may exceed the amounts recognized
in the Consolidated Statement of Financial Condition.
The Company also has commitments to fund certain fixed assets and other
less liquid investments, including at November 30, 1995 approximately $209
million in connection with its merchant banking and other principal investment
activities, and an estimated $80 million for fit-out and related costs
associated with its buildings located in New York City and Tokyo. Additionally,
the Company has provided and will continue to provide financing, including
margin lending and other extensions of credit to clients (including subordinated
loans on an interim basis to leveraged companies associated with its merchant
14
<PAGE>
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MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
banking and other principal investment activities), that may subject the Company
to increased credit and liquidity risks.
The Company and its subsidiaries have been named as defendants in certain
legal actions and have been involved in certain investigations and proceedings
in the ordinary course of business. It is the opinion of management, based on
current knowledge and after consultation with counsel, that the outcome of such
matters will not have a material adverse effect on the Company's Consolidated
Financial Statements contained herein.
NOTE 5 TRADING ACTIVITIES
TRADING REVENUES
The Company manages its trading businesses by product groupings and therefore
has established distinct, worldwide business units having responsibility for
equity, fixed income, foreign exchange and commodities products. Because of the
integrated nature of the markets for such products, each product area trades
cash instruments as well as related derivative products (i.e., options, swaps,
futures, forwards and other contracts with respect to such underlying
instruments or commodities). Revenues related to trading are summarized below by
business unit. The "Total" column includes all trading revenues plus the portion
of those commission and interest revenues and expenses which result from trading
activities. Commissions and Net Interest (interest revenues less interest
expense) as reported in the Company's Consolidated Statement of Income also
include results from the Company's securities services business and other
business activities:
<TABLE>
<CAPTION>
(Dollars in Millions) Trading Commissions Net Interest Total
-----------------------------------------------------
<S> <C> <C> <C> <C>
FISCAL 1995
Equities $ 409 $367 $ 103 $ 879
Fixed Income 489 52 306 847
Foreign Exchange 156 -- 3 159
Commodities 68 -- (16) 52
-----------------------------------------------------
Trading-related revenues 1,122 419 396 1,937
Securities services and other -- 18 42 60
-----------------------------------------------------
$1,122 $437 $ 438 $1,997
-----------------------------------------------------
FISCAL 1994
Equities $ 510 $351 $ (60) $ 801
Fixed Income 347 60 419 826
Foreign Exchange 148 1 4 153
Commodities 99 2 5 106
-----------------------------------------------------
Trading-related revenues 1,104 414 368 1,886
Securities services and other -- 35 163 198
-----------------------------------------------------
$1,104 $449 $ 531 $2,084
-----------------------------------------------------
FISCAL 1993
Equities $ 407 $312 $ 7 $ 726
Fixed Income 788 54 544 1,386
Foreign Exchange 205 1 (1) 205
Commodities 59 1 13 73
-----------------------------------------------------
Trading-related revenues 1,459 368 563 2,390
Securities services and other -- 25 77 102
-----------------------------------------------------
$1,459 $393 $ 640 $2,492
- ---------------------------------------------------------------------------------------
</TABLE>
15
<PAGE>
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The Company's trading activities are both client-driven and proprietary.
The Company enters into specific contracts and carries inventories to meet the
needs of its clients. Its trading portfolios also are managed with a view toward
the risk and profitability of the portfolios to the Company. The nature of the
equities, fixed income, foreign exchange and commodities activities conducted by
the Company, including the use of derivative products in these businesses, and
the market, credit and concentration risk management policies and procedures
covering these activities, are discussed below.
EQUITIES
The Company makes markets and trades in the global secondary markets for
equities and convertible debt and is a dealer in equity warrants, exchange
traded and OTC equity options, index futures, equity swaps and other
sophisticated equity derivatives. The Company's activities as a dealer primarily
are client-driven, with the objective of meeting clients' needs while earning a
spread between the premiums paid or received on its contracts with clients and
the cost of hedging such transactions in the cash or forward market or with
other derivative transactions. The Company limits its market risk related to
these contracts, which stems primarily from underlying equity/index price and
volatility movements, by employing a variety of hedging strategies, such as
delta hedging (delta is a measure of a derivative contract's price movement
based on the movement of the price of the security or index underlying the
contract). The Company also takes proprietary positions in the global equity
markets by using derivatives, most commonly futures and options, in addition to
cash positions, intending to profit from market price and volatility movements
in the underlying equities or indices positioned.
Equity option contracts give the purchaser of the contract the right to
buy (call) or sell (put) the equity security or index underlying the contract at
an agreed-upon price (strike price) during or at the conclusion of a specified
period of time. The seller (writer) of the contract is subject to market risk,
and the purchaser is subject to market risk (to the extent of the premium paid)
and credit risk. Equity swap contracts are contractual agreements whereby one
counterparty receives the appreciation (or pays the depreciation) on an equity
investment in return for paying another rate, often based upon equity index
movements or interest rates. The counterparties to the Company's equity
transactions include commercial banks, investment banks, broker-dealers,
investment funds and industrial companies.
FIXED INCOME
The Company is a market-maker for U.S. and non-U.S. government securities,
corporate bonds, money market instruments, medium-term notes and Eurobonds,
high-yield securities, emerging market debt, mortgage- and other asset-backed
securities, preferred stock and tax-exempt securities. In addition, the Company
is a dealer in interest rate and currency swaps and other related derivative
products, OTC options on U.S. and foreign government bonds and mortgage-backed
forward agreements ("TBA"), options and swaps. In this capacity, the Company
facilitates asset and liability management for its customers in interest rate
and currency swaps and related products and OTC government bond options.
Swaps used in fixed income trading are, for the most part, contractual
agreements to exchange interest payment streams (i.e., an interest rate swap may
involve exchanging fixed for floating interest payments) or currencies (i.e., a
currency swap may involve exchanging yen for U.S. dollars in one year at an
agreed-upon exchange rate). The Company profits by earning a spread between the
premium paid or received for these contracts and the cost of hedging such
contracts. The Company seeks to manage the market risk of its swap portfolio,
which stems from interest rate and currency movements and volatility, by using
modeling that quantifies the sensitivity of its portfolio to movements in
interest rates and currencies, and by adding positions to or selling positions
from its portfolio as needed to minimize such sensitivity. Typically, the
Company adjusts its positions by entering into additional swaps or interest rate
and foreign currency futures, foreign currency forwards and underlying
government bonds. The Company manages the risk related to its option portfolio
by using a
16
<PAGE>
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MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
variety of hedging strategies such as delta hedging, which includes the use of
futures and forward contracts to hedge market risk. The Company also is involved
in using debt securities to structure products with multiple risk/return factors
designed to suit investor objectives.
The Company is an underwriter of and a market-maker in mortgage-backed
securities and collateralized mortgage obligations ("CMO") as well as
commercial, residential and real estate loan products. The Company also
structures mortgage-backed swaps for its clients, enabling them to derive the
cash flows from an underlying mortgage-backed security without purchasing the
cash position. It earns the spread between the premium inherent in the swap and
the cost of hedging the swap contract through the use of cash positions or TBA
contracts. The Company also uses TBAs in its role as a dealer in mortgage-backed
securities and facilitates customer trades by taking positions in the TBA
market. Typically, these positions are hedged by offsetting TBA contracts or
underlying cash positions. The Company profits by earning the bid-offer spread
on such transactions. Further, the Company uses TBAs to ensure delivery of
underlying mortgage-backed securities in its CMO issuance business. As is the
case with all mortgage-backed products, market risk associated with these
instruments results from interest rate fluctuations and changes in mortgage
prepayment speeds. The counterparties to the Company's fixed income transactions
include investment advisors, commercial banks, insurance companies, investment
funds and industrial companies.
FOREIGN EXCHANGE
The Company is a market-maker in a number of foreign currencies. In this
business, it actively trades currencies in the spot and forward markets earning
a dealer spread. The Company seeks to manage its market risk by entering into
offsetting positions. The Company conducts an arbitrage business in which it
seeks to profit from inefficiencies between the futures, spot and forward
markets. The Company also makes a market in foreign currency options. This
business largely is client-driven and involves the purchasing and writing of
European and American style options and certain sophisticated products to meet
specific client needs. The Company profits in this business by earning spreads
between the options' premiums and the cost of the hedging of such positions. The
Company limits its market risk by using a variety of hedging strategies,
including the buying and selling of the currencies underlying the options based
upon the options' delta equivalent. Foreign exchange option contracts give the
purchaser of the contract the right to buy (call) or sell (put) the currency
underlying the contract at an agreed-upon strike price at or over a specified
period of time. Forward contracts and futures represent commitments to purchase
or sell the underlying currencies at a specified future date at a specified
price. The Company also takes proprietary positions in major currencies to
profit from market price and volatility movements in the currencies positioned.
The majority of the Company's foreign exchange business relates to major
foreign currencies such as deutsche marks, yen, pound sterling, French francs,
Swiss francs, lire and Canadian dollars. The balance of the business covers a
broad range of other currencies. The counterparties to the Company's foreign
exchange transactions include commercial banks, investment banks,
broker-dealers, investment funds and industrial companies.
COMMODITIES
The Company, as a major participant in the world commodities markets, trades in
physical metals, electricity, energy products (principally oil and natural gas)
and soft commodities as well as a variety of derivatives related to these
commodities such as futures, forwards and exchange traded and OTC options and
swaps. Through these activities, the Company provides clients with a ready
market to satisfy end users' current raw material needs and facilitates their
ability to hedge price fluctuations related to future inventory needs. The
former activity at times requires the positioning of physical commodities.
17
<PAGE>
================================================================================
Derivatives on those commodities, such as futures, forwards and options, often
are used to hedge price movements in the underlying physical inventory. The
Company profits as a market-maker in physical commodities by capturing the bid
and offer spread inherent in the physical markets.
To facilitate hedging for its clients, the Company often is required to
take positions in the commodity markets in the form of forward, option and swap
contracts involving oil, natural gas and electricity. The Company generally
hedges these positions by using a variety of hedging techniques such as delta
hedging, whereby the Company takes positions in the physical markets and/or
positions in other commodity derivatives such as futures and forwards to offset
the market risk in the underlying derivative. The Company profits from this
business by earning a spread between the premiums paid or received for these
derivatives and the cost of hedging such derivatives.
The Company also maintains proprietary trading positions in commodity
derivatives, including futures, forwards and options in addition to physical
commodities, to profit from price and volatility movements in the underlying
commodities markets.
Forward, option and swap contracts on commodities are structured similarly
to like-kind derivative contracts for cash financial instruments. The
counterparties to OTC commodity contracts include precious metals producers,
refiners and consumers as well as shippers, central banks, and oil, gas and
electricity producers.
RISK MANAGEMENT
Risk management at the Company is an integrated process with independent
oversight which requires constant communication, judgment and knowledge of
specialized products and markets. The Company's senior management takes an
active role in the risk management process and has developed policies and
procedures that require specific administration and business functions to assist
in the identification, assessment and control of various risks. The Company has
developed a control infrastructure to manage and monitor each type of risk on a
global basis throughout the Company. In recognition of the increasingly varied
and complex nature of the financial services business, the Company's risk
management policies and procedures are evolutionary in nature and are subject to
ongoing review, modification and revision.
The Company has developed a multi-tiered approach for monitoring and
managing its risks. The Finance and Risk Committee, authorized by the Company's
Board of Directors, is chaired by the Company's Chief Financial Officer and
composed of senior officers with familiarity and expertise in dealing with risk
management principles. It establishes the overall risk management policies of
the Company, reviews the Company's performance relative to these policies,
allocates capital among business activities of the Company, monitors the
availability of sources of financing, reviews the foreign exchange risk of the
Company, and oversees liquidity and interest rate sensitivity of the Company's
asset and liability position. The Firm Risk Manager heads the Firm Risk
Management Group (described below) and assists senior management and the Finance
and Risk Committee in establishing, monitoring and controlling the Company's
overall risk profile. With respect to the Company's major trading divisions
(fixed income, equity, commodities and foreign exchange), division risk managers
monitor and manage positions and set the overall division risk profile within
established market risk limits, review major trading positions and strategies,
and report unusual market and position events. Desk risk managers perform
similar functions with respect to a product area or particular product at the
business unit and trading desk level.
The Firm Risk Management Group has operational responsibility for
identifying, monitoring and reporting to senior management on the Company's
exposure to risk. The Firm Risk Management Group includes three departments that
are all independent of the Company's business areas: the Market Risk Department
monitors the Company's
18
<PAGE>
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MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
market risk profile, which includes all divisional, geographic and product-line
market risks; the Credit Department manages and monitors counterparty exposure
limits on a worldwide basis; the Internal Audit Department, which also reports
to the Audit Committee of the Board of Directors, assesses the Company's
operations and control environment through periodic examinations of business and
operational areas.
Other departments within the Company, which are independent of the
Company's business areas, that are also actively involved in monitoring the
Company's risk profile include: Controllers, Corporate Treasury, Information
Technology, Legal and Compliance, Tax and Operations.
In addition, the Company has certain commitment committees that are
involved in managing and monitoring the risks associated with the Company's
diverse businesses. These committees are composed of a cross-section of the
Company's senior officers from various disciplines. The High-Yield Commitment
Committee and Equity Commitment Committee determine whether the Company should
participate in a transaction involving the underwriting or placement of
high-yield or equity securities, respectively, where the Company's capital and
reputation may be at risk, and evaluate the potential revenues and risks
involved with respect to a particular transaction.
MARKET RISK
Market risk refers to the risk that a change in the level of one or more market
prices, rates, indices, volatilities, correlations or other market factors, such
as liquidity, will result in losses for a specified position or portfolio.
The Company manages the market risk associated with its trading activities
Company-wide, on a divisional level worldwide and on an individual product
basis. Specific market risk guidelines and limits have been approved for the
Company and each trading division of the Company worldwide by the Finance and
Risk Committee. Discrete market risk limits are assigned to business units and
trading desks within trading areas which are compatible with the trading
division limits. Division risk managers, desk risk managers, and the Market Risk
Department all monitor market risk measures against limits.
The Company may use measures, such as rate sensitivity, convexity,
volatility and time decay measurements, to estimate market risk and to assess
the sensitivity of positions to changes in market conditions. Trading divisions
generally make use of valuation and risk models. Stress testing, which measures
the impact on the value of existing portfolios of specified changes in market
factors, for certain products is performed periodically and reviewed by division
risk managers and the Market Risk Department. The Company also regularly uses a
variety of measures to help reduce and control the market risk associated with
its market-making and proprietary trading activities.
CREDIT RISK
The Company's exposure to credit risk arises from the possibility that a
counterparty to a transaction might fail to perform under its contractual
commitment, resulting in the Company incurring losses. The Finance and Risk
Committee has approved Company-wide credit guidelines which limit the Company's
credit exposure to any one counterparty. Specific credit risk limits based on
the credit guidelines have also been approved by the Finance and Risk Committee
for each type of counterparty (by rating category) as well as certain
inventories of high-yield and emerging market debt. The Credit Department
administers the credit limits among trading divisions.
The Credit Department has procedures to monitor credit exposures, and all
counterparties of the Company are reviewed periodically to assess financial
soundness. In addition to monitoring credit limits, the Company manages the
credit exposure relating to its trading activities by entering into master
netting agreements and collateral
19
<PAGE>
================================================================================
arrangements with counterparties in appropriate circumstances, and limiting the
duration of exposure. In certain cases, the Company also may close out
transactions or assign them to other counterparties to mitigate credit risk.
CONCENTRATION RISK
The Company is subject to concentration risk by holding large positions in
certain types of securities or commitments to purchase securities of a single
issuer, including sovereign governments and other entities, issuers located in a
particular country or geographic area, public and private issuers involving
developing countries or issuers engaged in a particular industry. Financial
instruments owned by the Company include U.S. government and agency securities
and securities issued by other sovereign governments (principally Japan,
Germany, France and Italy), which, in the aggregate, represented approximately
18% of the Company's total assets at November 30, 1995. In addition,
substantially all of the collateral held by the Company for resale agreements or
bonds borrowed, which together represented approximately 37% of the Company's
total assets at November 30, 1995, consists of securities issued by the U.S.
government, federal agencies or non-U.S. governments. Positions taken and
commitments made by the Company, including positions taken and underwriting and
financing commitments made in connection with its merchant banking activities,
often involve substantial amounts and significant exposure to individual issuers
and businesses, including non-investment grade issuers. The Company seeks to
limit concentration risk through the use of the systems and procedures described
in the preceding discussions of market and credit risk.
CUSTOMER ACTIVITIES
The Company's customer activities involve the execution, settlement, custody and
financing of various securities and commodities transactions on behalf of
customers. Customer securities activities are transacted on either a cash or
margin basis. Customer commodities activities, which include the execution of
customer transactions in commodity futures transactions (including options on
futures), are transacted on a margin basis.
The Company's customer activities may expose it to off-balance sheet
credit risk. The Company may have to purchase or sell financial instruments at
prevailing market prices in the event of the failure of a customer to settle a
trade on its original terms or in the event cash and securities in customer
margin accounts are not sufficient to fully cover customer losses. The Company
seeks to control the risks associated with customer activities by requiring
customers to maintain margin collateral in compliance with various regulations
and Company policies.
NOTIONAL/CONTRACT AMOUNTS AND FAIR VALUES OF DERIVATIVES
The gross notional or contract amounts of derivative instruments and fair value
(carrying amount) of the related assets and liabilities at November 30, 1995 and
January 31, 1995, as well as the average fair value of those assets and
liabilities for the period ended November 30, 1995 and the year ended January
31, 1995, are presented in the table which follows. Fair value represents the
cost of replacing these instruments and is further described in Note 1. Future
changes in interest rates, foreign currency exchange rates or the market values
of the financial instruments, commodities or indices underlying these contracts
may ultimately result in cash settlements exceeding fair value amounts
recognized in the Consolidated Statement of Financial Condition. Assets
represent unrealized gains on purchased exchange traded and OTC options and
other contracts (including interest rate, foreign exchange and other forward
contracts and swaps) in gain positions net of any unrealized losses owed to
these counterparties on offsetting positions in situations where netting is
consistent with FASB Interpretation No. 39. Similarly, liabilities rep-
20
<PAGE>
================================================================================
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
resent net amounts owed to counterparties. These amounts will vary based on
changes in the fair values of underlying financial instruments and/or the
volatility of such underlying instruments:
<TABLE>
<CAPTION>
===============================================================================================================================
- -------------------------------------------------------------------------------------------------------------------------------
Fiscal Year-End Fiscal Year-End Average
Gross Notional/ Fair Values(2) Fair Values(2)(3)
Contract Amount --------------------------- --------------------------
Assets Liabilities Assets Liabilities
--------------------------- --------------------------
1995 1994 (Dollars in Billions, at fiscal year-end)(1) 1995 1994 1995 1994 1995 1994 1995 1994
---------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 401 $ 299 Interest rate and currency swaps
and options (including caps,
floors and swap options) $ 3.8 $3.9 $3.8 $2.2 $ 3.7 $3.8 $3.8 $ 2.4
260 170 Foreign exchange forward and
futures contracts and options 1.9 1.1 1.9 1.3 2.0 1.3 2.2 1.5
21 39 Mortgage-backed securities forward
contracts, swaps and options 0.1 0.2 0.1 0.1 0.1 0.1 0.1 0.1
199 235 Other fixed income securities
contracts (including futures
contracts and options) 0.1 0.4 0.4 0.6 0.3 0.7 0.3 1.3
57 57 Equity securities contracts (including
equity swaps, futures contracts,
and warrants and options) 1.4 1.1 0.8 1.2 1.5 1.1 0.9 1.1
47 35 Commodity forwards, futures,
options and swaps 0.7 1.9 0.5 1.9 1.0 1.8 0.9 1.7
- -------------------------------------------------------------------------------------------------------------------------------
$ 985 $ 835 Total $ 8.0 $8.6 $7.5 $7.3 $ 8.6 $8.8 $8.2 $ 8.1
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) The Company has a limited number of leveraged transactions. The notional
amounts of derivatives have been adjusted to reflect the effects of
leverage, where applicable.
(2) These amounts represent carrying value (exclusive of collateral) at
November 30, 1995 and January 31, 1995, respectively, and do not include
receivables or payables related to exchange traded futures contracts.
(3) Amounts are calculated using a monthly average.
The gross notional or contract amounts of these instruments are indicative
of the Company's degree of use of derivatives for trading purposes but do not
represent the Company's exposure to market or credit risk. Credit risk arises
from the failure of a counterparty to perform according to the terms of the
contract. The Company's exposure to credit risk at any point in time is
represented by fair value of the contracts reported as assets. These amounts are
presented on a net-by-counterparty basis consistent with FASB Interpretation No.
39, but are not reported net of collateral, which the Company obtains with
respect to certain of these transactions to reduce its exposure to credit
losses. The Company monitors the creditworthiness of counterparties to these
transactions on an ongoing basis and requests additional collateral when deemed
necessary. The Company believes that the ultimate settlement of the transactions
outstanding at November 30, 1995 will not have a material effect on the
Company's financial condition.
21
<PAGE>
================================================================================
The remaining maturities of the Company's swaps and other derivative
products at November 30, 1995 and January 31, 1995 are summarized in the
following table, showing notional values by year of expected maturity:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
Less than 1 to 3 3 to 5 Greater than
(Dollars in Billions) 1 Year Years Years 5 Years Total
-----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NOVEMBER 30, 1995
Interest rate and currency swaps
and options (including caps,
floors and swap options) $ 97 $138 $ 74 $ 92 $ 401
Foreign exchange forward and
futures contracts and options 253 4 3 -- 260
Mortgage-backed securities forward
contracts, swaps and options 16 -- 2 3 21
Other fixed income securities
contracts (including futures
contracts and options) 142 34 16 7 199
Equity securities contracts
(including equity swaps,
futures contracts, and
warrants and options) 54 3 -- -- 57
Commodity forwards, futures
options and swaps 38 7 2 -- 47
-----------------------------------------------------------
Total $ 600 $186 $ 97 $102 $ 985
-----------------------------------------------------------
Percent of total 61% 19% 10% 10% 100%
-----------------------------------------------------------
JANUARY 31, 1995
Interest rate and currency swaps
and options (including caps,
floors and swap options) $ 74 $108 $ 68 $ 49 $ 299
Foreign exchange forward and
futures contracts and options 163 7 -- -- 170
Mortgage-backed securities forward
contracts, swaps and options 35 1 1 2 39
Other fixed income securities
contracts (including futures
contracts and options) 152 68 15 -- 235
Equity securities contracts
(including equity swaps,
futures contracts, and
warrants and options) 50 5 1 1 57
Commodity forwards, futures
options and swaps 30 4 1 -- 35
-----------------------------------------------------------
Total $ 504 $193 $ 86 $ 52 $ 835
-----------------------------------------------------------
Percent of total 61% 23% 10% 6% 100%
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
22
<PAGE>
================================================================================
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
The credit quality of the Company's trading-related derivatives at
November 30, 1995 and January 31, 1995 is summarized in the table below, showing
the fair value of the related assets by counterparty credit rating. The actual
credit ratings are determined by external rating agencies or by equivalent
ratings used by the Company's Credit Department:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
Collater-
alized Other
Non- Non-
Invest- Invest-
ment ment
(Dollars in Millions) AAA AA A BBB Grade Grade Total
-----------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
NOVEMBER 30, 1995
Interest rate and currency swaps
and options (including caps, floors
and swap options) $ 660 $1,269 $ 1,148 $535 $ 88 $ 141 $ 3,841
Foreign exchange forward contracts
and options 548 531 674 83 -- 27 1,863
Mortgage-backed securities forward
contracts, swaps and options 23 31 36 7 12 14 123
Other fixed income securities
contracts (including options) 25 33 33 42 -- 4 137
Equity securities contracts (including
equity swaps, warrants and options) 612 98 232 143 178 159 1,422
Commodity forwards, options and swaps 103 129 152 126 -- 147 657
-----------------------------------------------------------------
Total $1,971 $2,091 $ 2,275 $936 $ 278 $ 492 $ 8,043
-----------------------------------------------------------------
Percent of total 25% 26% 28% 12% 3% 6% 100%
-----------------------------------------------------------------
JANUARY 31, 1995
Interest rate and currency swaps
and options (including caps, floors
and swap options) $ 723 $1,617 $ 965 $182 $ 294 $ 78 $ 3,859
Foreign exchange forward contracts
and options 409 345 251 76 -- 46 1,127
Mortgage-backed securities forward
contracts, swaps and options 14 69 75 28 -- 22 208
Other fixed income securities
contracts (including options) 302 26 42 26 -- 19 415
Equity securities contracts (including
equity swaps, warrants and options) 379 188 217 188 145 18 1,135
Commodity forwards, options and swaps 300 216 667 490 -- 206 1,879
-----------------------------------------------------------------
Total $2,127 $2,461 $ 2,217 $990 $ 439 $ 389 $ 8,623
-----------------------------------------------------------------
Percent of total 25% 29% 26% 11% 5% 4% 100%
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
23
<PAGE>
================================================================================
NOTE 6 PREFERRED STOCK AND CAPITAL UNITS
Preferred stock is composed of the following issues:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
Shares Outstanding at Balance at
----------------------- -----------------------
NOV. 30, Jan. 31, NOV. 30, Jan. 31,
(Dollars in Millions) 1995 1995 1995 1995
-----------------------------------------------------
<S> <C> <C> <C> <C>
ESOP Convertible Preferred Stock,
liquidation preference $35.88 3,758,133 3,795,588 $ 135 $ 136
9.36% Cumulative Preferred Stock, stated value $25 5,500,000 5,500,000 138 138
7-3/8% Cumulative Preferred Stock, stated value $200 1,000,000 1,000,000 200 200
8.88% Cumulative Preferred Stock, stated value $200 975,000 975,000 195 195
8-3/4% Cumulative Preferred Stock, stated value $200 750,000 750,000 150 150
-----------------------------------------------------
Total $ 818 $ 819
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
Each issue of preferred stock ranks in parity with all other preferred
stock.
The Company has Capital Units outstanding which were issued by the Company
and Morgan Stanley Finance plc, a U.K. subsidiary ("MS plc"). A Capital Unit
consists of (a) a Subordinated Debenture of MS plc in the principal amount of
$25 guaranteed by the Company and having maturities from 2013 to 2015, and (b) a
related Purchase Contract issued by the Company, which may be accelerated by the
Company beginning approximately one year after the issuance of each Capital
Unit, requiring the holder to purchase one Depositary Share representing
ownership of a 1/8 interest in the Company's Cumulative Preferred Stock. The
aggregate amount of Capital Units outstanding was $865 million and $352 million
at November 30, 1995 and January 31, 1995, respectively.
The estimated fair value of the Capital Units was $872 million and $308
million at November 30, 1995 and January 31, 1995, respectively.
NOTE 7 COMMON STOCK AND STOCKHOLDERS' EQUITY
During the period ended November 30, 1995, the Company repurchased or acquired
shares of its common stock at an aggregate cost of $103 million. The Company's
unused portion of its stock repurchase authorization at November 30, 1995 was
approximately $213 million. On January 4, 1996, the Board of Directors
authorized the purchase, in the open market or otherwise, subject to market
conditions and certain other factors, of an additional $400 million of the
Company's common stock.
MS&Co. is a registered broker-dealer and a registered futures commission
merchant and, accordingly, is subject to the minimum net capital requirements of
the Securities and Exchange Commission ("SEC"), the New York Stock Exchange
("NYSE") and the Commodity Futures Trading Commission. MS&Co. has consistently
operated in excess of these requirements with aggregate net capital, as defined,
totaling $1,332 million at November 30, 1995, which exceeded the amount required
by $1,134 million. MSIL, a London-based broker-dealer subsidiary, is subject to
the capital requirements of the Securities and Futures Authority, and Morgan
Stanley Japan Limited ("MSJL"), a Tokyo-based broker-dealer, is subject to the
capital requirements of the Japanese Ministry of Finance. MSIL and MSJL have
consistently operated in excess of their respective regulatory capital
requirements.
Certain other U.S. and non-U.S. subsidiaries are subject to various
securities, commodities and banking regulations, and capital adequacy
requirements promulgated by the regulatory and exchange authorities of the
countries in which they operate. These subsidiaries have consistently operated
in excess of their local capital adequacy requirements.
24
<PAGE>
================================================================================
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
Advances, dividend payments and other equity withdrawals from MS&Co.,
MSIL, MSJL and other regulated subsidiaries are restricted by the regulations of
the SEC, NYSE, other regulatory agencies and by subordinated noteholders and
certain banks. Morgan Stanley Derivative Products Inc., the Company's triple-A
rated derivative products subsidiary, also has established certain operating
restrictions which have been reviewed by various rating agencies. At November
30, 1995, approximately $1,630 million of equity of the Company's subsidiaries
may be restricted as to the payment of dividends and advances.
Cumulative translation adjustments include gains or losses resulting from
translating foreign currency financial statements from their respective
functional currencies to U.S. dollars, net of hedge gains or losses and related
tax effects. The Company uses foreign currency contracts and designates certain
non-U.S. dollar currency debt as hedges to manage the currency exposure relating
to its net monetary investments in non-U.S. dollar functional currency
subsidiaries. Increases or decreases in the value of the Company's net foreign
investments generally are tax-deferred for U.S. purposes, but the related hedge
gains and losses are taxable currently. Therefore, the gross notional amounts of
the contracts and debt designated as hedges exceed the Company's net foreign
investments to result in effective hedging on an after-tax basis. The Company
attempts to protect its net book value from the effects of fluctuations in
currency exchange rates on its net monetary investments in non-U.S. dollar
subsidiaries by selling the appropriate non-U.S. dollar currency in the forward
market. However, under some circumstances, the Company may elect not to hedge
its net monetary investments in certain foreign operations due to market
conditions, including the availability of various currency contracts at
acceptable costs. Information relating to the hedging of the Company's net
monetary investments in non-U.S. dollar functional currency subsidiaries and
their effects on cumulative translation adjustments is summarized below:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
NOV. 30, Jan. 31,
(Dollars in Millions) 1995 1995
----------------------
<S> <C> <C>
Net investment in non-U.S. dollar functional
currency subsidiaries $1,243 $ 1,122
----------------------
Gross notional amounts of foreign exchange contracts
and non-U.S. dollar debt designated as hedges(1) $2,082 $ 1,960
----------------------
Cumulative translation adjustments resulting from
net investments in subsidiaries with a non-U.S. dollar
functional currency $ 185 $ 188
Cumulative translation adjustments resulting from
realized or unrealized gains or losses on hedges,
net of tax (194) (198)
---------------------
Total cumulative translation adjustments $ (9) $ (10)
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Notional amounts represent the contractual currency amount translated at
respective fiscal year-end spot rates.
NOTE 8 EMPLOYEE COMPENSATION PLANS
The Company has adopted a variety of compensation plans for certain of its
employees. These plans are designed to facilitate a pay-for-performance policy,
provide compensation commensurate with other leading financial service industry
companies and align the interests of employees with the long-term interests of
the Company's stockholders. The following summarizes these plans.
CAPITAL ACCUMULATION PLAN
Under the Capital Accumulation Plan ("CAP"), vested units consisting of
unsecured rights to receive payments based on notional interests in existing and
future risk-capital
25
<PAGE>
================================================================================
investments made directly or indirectly by the Company ("CAP
Units") are granted to key employees. The value of the CAP Units awarded for
services rendered in fiscal 1995, fiscal 1994 and fiscal 1993 was approximately
$9 million, $14 million and $15 million, respectively, all of which relate to
vested units.
CARRIED INTEREST PLAN
Under the Carried Interest Plan, certain key employees effectively participate
in a portion of the Company's realized gains from certain of its equity
investments in merchant banking transactions. Compensation expense for fiscal
1995, fiscal 1994 and fiscal 1993 related to this plan aggregated $10 million,
$24 million and $29 million, respectively.
REAL ESTATE FUND PLANS
On September 26, 1995, the Board of Directors approved the adoption of the
Morgan Stanley Real Estate Compensation Plan and the Morgan Stanley Real Estate
Profits Participation Plan. Under these plans, select employees and consultants
may participate in certain gains realized by the Company's real estate funds.
Compensation expense relating to these plans was $9 million for fiscal 1995.
EQUITY INCENTIVE COMPENSATION PLAN
Pursuant to the 1988 Equity Incentive Compensation Plan ("EICP"), stock units
representing employees' rights to receive unrestricted common shares ("Stock
Units") are awarded annually to key employees; compensation expense for all such
awards (including those subject to forfeiture) recorded in fiscal 1995, fiscal
1994 and fiscal 1993 was determined based on the fair value of the Company's
common stock as defined in the plan.
Stock Units generally will convert to shares of the Company's common stock
within five or 10 years from grant (or earlier in the event of the holder's
death or retirement, as defined). Holders of Stock Units generally have all the
rights of a common stockholder, subject to restrictions on transfer of ownership
of the units for the five- or 10-year period. Holders of the Stock Units
generally will forfeit ownership only in certain limited situations, including
termination for cause during the restriction period. In addition, holders of the
Stock Units having a 10-year restriction period, which were first awarded in
respect of fiscal 1992 services, will forfeit ownership of a portion of their
Stock Units if their employment is terminated before the end of the 10-year
restriction period.
Activity related to Stock Units accrued pursuant to the EICP is as
follows:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
Stock Units
-----------------------------------------------
FISCAL 1995(1) Fiscal 1994(1) Fiscal 1993(1)
-----------------------------------------------
<S> <C> <C> <C>
Outstanding at beginning of period 27,828,734 24,035,010 13,626,330
Awarded 3,776,284 4,515,630 10,682,806
Issued as unrestricted shares(2) (395,122) (362,548) (165,654)
Forfeited (287,720) (359,358) (108,472)
-----------------------------------------------
Outstanding at end of period 30,922,176 27,828,734 24,035,010
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Approximately 29%, 24% and 21% of the Stock Units awarded in fiscal 1995,
fiscal 1994 and fiscal 1993, respectively, were subject to a 10-year
restriction period.
(2) Amounts represent awards of Stock Units exchanged for unrestricted common
shares.
On May 2, 1991, the Company's stockholders approved the reservation of
48,000,000 shares of common stock for awards under the Company's equity-based
employee benefit plans. At November 30, 1995, approximately 5,000,000 shares
reserved for future awards under such employee benefit plans remain (net of
fiscal 1995 awards).
26
<PAGE>
================================================================================
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
STOCK OPTION AWARDS
The Company's 1986 Stock Option Plan provides for the granting of stock options
having an exercise price not less than the fair value of the Company's common
stock (as defined in the plan) on the date of grant. Such options generally
become exercisable over a three-year period and expire 10 years from the date of
the grant. The EICP also provides for the award of options; options awarded
under this plan are exercisable at a price equal to the fair value of the
Company's common stock (as defined in the plan) and will generally expire seven
years (for options awarded for fiscal 1993 service and prior) or 10 years (for
options awarded for fiscal 1995 and fiscal 1994 service) from grant.
Exercise prices for all options deemed outstanding at November 30, 1995,
January 31, 1995 and January 31, 1994 ranged from $9.42 to $37.93. The following
table sets forth activity relating to the number of shares covered by stock
options:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
Fiscal 1995 Fiscal 1994 Fiscal 1993
-----------------------------------------------
<S> <C> <C> <C>
Options outstanding at beginning of period 24,709,000 14,493,848 15,134,974
Granted 124,360 11,277,708 1,212,000
Exercised (3,215,456) (991,056) (1,812,428)
Forfeited (184,784) (71,500) (40,698)
-----------------------------------------------
Options outstanding at end of period 21,433,120 24,709,000 14,493,848
-----------------------------------------------
Options exercisable at end of period 15,045,750 18,274,658 13,845,148
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
The Company has also established a worldwide profit sharing plan and an
employee stock ownership plan for the benefit of substantially all its U.S.
employees. The following summarizes these plans:
PROFIT SHARING PLAN
The Company has a qualified non-contributory profit sharing plan covering
substantially all its U.S. employees and also provides cash payment of profit
sharing to employees of its international subsidiaries. Contributions are made
at the discretion of management based upon the financial performance of the
Company. Total profit sharing expense for fiscal 1995, fiscal 1994 and fiscal
1993 (excluding Company contributions to the Employee Stock Ownership Plan,
which increased in fiscal 1995) was $10 million, $23 million and $21 million,
respectively.
EMPLOYEE STOCK OWNERSHIP PLAN
In July 1990, the Company's Board of Directors authorized the establishment of a
$140 million leveraged employee stock ownership plan, funded through an
independently managed trust. The Morgan Stanley Group Inc. and Subsidiaries
Employee Stock Ownership Plan ("ESOP") was established to broaden internal
ownership in the Company and allow it to provide benefits to its employees in a
cost-effective manner. Each of the 3,758,133 preferred shares outstanding at
November 30, 1995 is held by the ESOP trust, is convertible into two shares of
the Company's common stock and is entitled to annual dividends of $2.78 per
share. The ESOP trust funded its stock purchase through a loan of $140 million
from the Company. The ESOP trust note, due September 19, 2010 (extendable at the
option of the ESOP trust to September 19, 2015), bears a 10-3/8% interest rate
per annum with principal payable without penalty on or before the due date. The
ESOP trust expects to make principal and interest payments on the note from
funds provided by dividends on the shares of convertible preferred stock and
contributions from the Company. The note receivable from the ESOP trust is
reflected as a reduction in the Company's stockholders' equity.
Contributions to the ESOP by the Company and allocation of ESOP shares to
employees are made annually at the discretion of the Board of Directors. The
cost of shares allocated to participants' accounts amounted to $11 million in
fiscal 1995, $10 million in fiscal 1994 and $7 million in fiscal 1993. The ESOP
debt service costs for fiscal 1995, fiscal 1994 and fiscal 1993 were paid from
27
<PAGE>
===============================================================================
dividends received on preferred stock held by the plan and from Company
contributions. Shares allocated to employees generally may not be withdrawn
until the employee's death, disability, retirement or termination. Upon
withdrawal, each share of ESOP preferred stock generally will be converted into
two shares of the Company's common stock. If the fair value of such two common
shares at conversion is less than the $35.88 liquidation value of an ESOP
preferred share, the Company will pay the withdrawing employee the difference in
additional common shares or cash.
NOTE 9 EMPLOYEE BENEFIT PLANS
The Company sponsors various pension plans for the majority of its worldwide
employees. It provides certain other postretirement benefits, primarily health
care and life insurance, to eligible employees. The Company also provides
certain benefits to former or inactive employees prior to retirement. The
following summarizes these plans:
PENSION PLANS
Substantially all of the employees of the Company and its U.S. affiliates are
covered by a non-contributory pension plan qualified under Section 401(a) of the
Internal Revenue Code (the "Qualified Plan"). Two unfunded supplementary plans
(the "Supplemental Plans") cover certain executives. In addition to the
Qualified Plan and the Supplemental Plans (collectively, the "U.S. Plans"), the
Company also maintains a separate pension plan which covers substantially all
employees of the Company's U.K. subsidiaries (the "U.K. Plan"). Eight other
international subsidiaries also have pension plans covering substantially all of
their employees. These pension plans generally provide pension benefits that are
based on each employee's years of credited service and compensation during the
final years of employment. The Company's policy is to fund the accrued cost of
the Qualified Plan, the U.K. Plan and the other international plans currently.
Liabilities for benefits payable under the Supplemental Plans are accrued by the
Company and are funded when paid to the beneficiaries.
Pension expense for fiscal 1995, fiscal 1994 and fiscal 1993 includes the
following components:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
(Dollars in Millions) Fiscal 1995 Fiscal 1994 Fiscal 1993
--------------------------------------
<S> <C> <C> <C>
U.S. Plans
Service cost, benefits earned during the period $ 6 $ 8 $ 6
Interest cost on projected benefit obligation 11 11 10
Return on plan assets (34) 1 (16)
Difference between actual and expected return on assets 22 (15) 3
Net amortization (3) (3) (4)
--------------------------------------
Total U.S. Plans 2 2 (1)
U.K. Plan
Service cost, benefits earned during the period 6 6 5
Interest cost on projected benefit obligation 3 2 2
Return on plan assets (5) -- (10)
Difference between actual and expected return on assets 2 (3) 8
--------------------------------------
Total U.K. Plan 6 5 5
Other international plans 5 5 3
--------------------------------------
Total pension expense $ 13 $ 12 $ 7
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
28
<PAGE>
================================================================================
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
The following table provides the assumptions used in determining the
projected benefit obligation for the U.S. Plans and the U.K. Plan as of November
30, 1995 and January 31, 1995:
<TABLE>
<CAPTION>
====================================================================================================================
- --------------------------------------------------------------------------------------------------------------------
November 30, 1995 January 31, 1995
------------------------ ------------------------
U.S. Plans U.K. Plan U.S. Plans U.K. Plan
---------------------------------------------------
<S> <C> <C> <C> <C>
Weighted average
discount rate 7.5% 9.0% 8.5% 9.0%
Rate of increase in future
compensation levels 5.0% 7.0% 5.0% 7.0%
Expected long-term rate of
return on plan assets 9.0% 9.0% 9.0% 9.0%
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
29
<PAGE>
The following table sets forth the funded status of the U.S. Plans and the
U.K. Plan as of November 30, 1995 and January 31, 1995:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
November 30, 1995 January 31, 1995
------------------------------------ -----------------------------------
U.S. Plans U.K. Plan U.S. Plans U.K. Plan
----------------------- --------- ----------------------- ---------
Qualified Supplemental Qualified Supplemental
(Dollars in Millions) Plan Plans Plan Plans
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Actuarial present value of
vested benefit obligation $ (100) $(24) $(31) $ (75) $(19) $ (25)
----------------------------------------------------------------------------
Accumulated benefit obligation $ (112) $(44) $(31) $ (84) $(34) $ (25)
Effect of future salary increases (33) (16) (8) (22) (12) (6)
----------------------------------------------------------------------------
Projected benefit obligation (145) (60) (39) (106) (46) (31)
Plan assets at fair market
value (primarily listed stocks
and bonds) 192 -- 43 160 -- 35
----------------------------------------------------------------------------
Projected benefit obligation
less than or (in excess of)
plan assets 47 (60) 4 54 (46) 4
Unrecognized net (gain) or loss (3) 9 (13) (9) (2) (11)
Unrecognized prior service cost (1) (1) -- (1) (1) --
Unrecognized net (asset)
obligation at January 1, 1987,
net of amortization (13) 5 -- (16) 5 --
----------------------------------------------------------------------------
Prepaid (accrued) pension
cost at fiscal year-end $ 30 $(47) $ (9) $ 28 $(44) $ (7)
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
30
<PAGE>
================================================================================
POSTRETIREMENT BENEFITS
The Company's obligation for certain postretirement benefits provided to
eligible employees is accounted for in accordance with SFAS No. 106, "Employers
Accounting for Postretirement Benefits Other Than Pensions."
The net postretirement benefit cost consists of the following components:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
(Dollars in Millions) Fiscal 1995 Fiscal 1994 Fiscal 1993
--------------------------------------
<S> <C> <C> <C>
Service cost of benefits earned during the period $ 1 $2 $ 2
Interest cost on accumulated postretirement benefit obligation 2 2 2
--------------------------------------
Net postretirement benefit cost $ 3 $4 $ 4
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table provides information on the status of the Company's
postretirement benefit plans as of November 30, 1995 and January 31, 1995:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
Nov. 30, Jan. 31,
(Dollars in Millions) 1995 1995
----------------------
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees $(13) $ (10)
Fully eligible active plan participants (5) (4)
Other active plan participants (17) (14)
----------------------
Total (35) (28)
Unrecognized net loss 7 2
----------------------
Accrued postretirement benefit cost $(28) $ (26)
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
The accumulated postretirement benefit obligation was determined utilizing
a discount rate of 7.5% at November 30, 1995 and 8.5% at January 31, 1995, and
by applying the provisions of the Company's medical plans, the established
maximums and sharing of costs, the relevant actuarial assumptions and the health
care cost trend rates which are projected at 11.0% and which grade down to 7.0%
in 2000 and decrease further to 5.5% in 2040.
The effect of a 1% change in the assumed cost trend rate would change the
accumulated postretirement benefit obligation by approximately $4 million as of
November 30, 1995 and would change the net periodic postretirement benefit cost
by $1 million for fiscal 1995.
POSTEMPLOYMENT BENEFITS
Effective February 1, 1994, the Company adopted SFAS No. 112, "Employers'
Accounting for Postemployment Benefits." Among its provisions, SFAS No. 112
establishes accounting standards for employers who provide benefits to former or
inactive employees after employment but before retirement. Postemployment
benefits include, but are not limited to, salary continuation, supplemental
unemployment benefits, severance benefits, disability-related benefits, and
continuation of benefits such as health care benefits and life insurance
coverage. The effect of the adoption of SFAS No. 112 was not material to the
Company's fiscal 1995 or fiscal 1994 Consolidated Financial Statements.
31
<PAGE>
================================================================================
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
NOTE 10 INCOME TAXES
The provision for income taxes consists of:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
Fiscal Fiscal Fiscal
(Dollars in Millions) 1995 1994 1993
---------------------------------
<S> <C> <C> <C>
Current:
U.S. federal $ 180 $ 165 $ 266
U.S. state and local 103 142 175
Non-U.S. 111 20 239
---------------------------------
394 327 680
---------------------------------
Deferred:
U.S. federal (40) (75) (161)
U.S. state and local (33) (64) (97)
Non-U.S. (38) 11 (8)
---------------------------------
(111) (128) (266)
---------------------------------
Provision for income taxes $ 283 $ 199 $ 414
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table reconciles the provision to the U.S. federal statutory
income tax rate:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
Fiscal Fiscal Fiscal
(Dollars in Millions) 1995 1994 1993
---------------------------------
<S> <C> <C> <C>
U.S. federal statutory income tax rate 35.0% 35.0% 35.0%
U.S. state and local income taxes, net of
U.S. federal income tax benefits 5.1 8.5 4.2
Lower tax rates applicable to non-U.S. earnings (8.6) (9.1) (5.7)
Reduced tax rate applied to dividends (0.5) (0.6) (0.6)
Other 1.0 (0.3) 1.6
---------------------------------
Effective income tax rate 32.0% 33.5% 34.5%
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
Lower tax rates applicable to non-U.S. earnings include the benefit of
foreign tax credits utilized against U.S. federal income taxes. The Company
intends to permanently reinvest earnings of international subsidiaries or
repatriate such earnings only when it is tax effective to do so. U.S. federal
income taxes that would be payable upon repatriation are estimated to be $504
million. Under SFAS No. 109, deferred income taxes reflect the net tax effects
of temporary differences between the financial reporting and tax bases of assets
and liabilities and are measured using the enacted tax rates and laws that
32
<PAGE>
================================================================================
will be in effect when such differences are expected to reverse. Significant
components of the Company's deferred tax assets and liabilities as of November
30, 1995 and January 31, 1995 are as follows:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
Nov. 30, Jan. 31,
(Dollars in Millions) 1995 1995
----------------------
<S> <C> <C>
Deferred tax assets:
Employee compensation and benefit plans $ 585 $ 467
Accrued expenses not yet deductible for tax purposes 21 51
----------------------
Total deferred tax assets 606 518
----------------------
Deferred tax liabilities:
Valuation of inventory, investments and receivables 245 260
Depreciation and amortization 28 65
Other 31 6
----------------------
Total deferred tax liabilities 304 331
----------------------
Net deferred tax assets $ 302 $ 187
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
The Company's income tax provision excludes a currency hedging-related
income tax provision of $3 million in fiscal 1995, as well as income tax
benefits of $72 million in fiscal 1994 and $57 million in fiscal 1993, credited
directly to the cumulative translation adjustments component of consolidated
stockholders' equity. Also not included in the Company's income tax provision
are income tax benefits of $38 million in fiscal 1995, $9 million in fiscal 1994
and $13 million in fiscal 1993, attributable to the vesting of Stock Unit awards
and the exercise of stock options, credited directly to paid-in capital; and $9
million in fiscal 1995, $10 million in fiscal 1994 and $8 million in fiscal
1993, attributable to Stock Unit and ESOP dividends, credited directly to
retained earnings.
33
<PAGE>
================================================================================
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
NOTE 11 GEOGRAPHIC AREA DATA
The Company's business activities are highly integrated and constitute a single
industry segment for purposes of SFAS No. 14. Total revenues, net revenues,
income before taxes and identifiable assets of the Company's operations by
geographic area are as follows:
<TABLE>
<CAPTION>
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
Total Revenues Net Revenues
---------------------------------- -----------------------------------
Fiscal Fiscal Fiscal Fiscal Fiscal Fiscal
(Dollars in Millions) 1995 1994 1993 1995 1994 1993
---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
International
Europe $ 3,856 $ 3,942 $ 4,617 $ 1,018 $ 776 $ 1,466
Asia 649 603 468 565 475 396
---------------------------------------------------------------------------
Total 4,505 4,545 5,085 1,583 1,251 1,862
North America 8,553 8,332 6,341 2,264 2,516 2,538
Eliminations (3,934) (3,501) (2,250) (224) (266) (244)
---------------------------------------------------------------------------
Total $ 9,124 $ 9,376 $ 9,176 $ 3,623 $ 3,501 $ 4,156
- ------------------------------------------------------------------------------------------------------------------
<CAPTION>
Income before Taxes Identifiable Assets
---------------------------------- -----------------------------------
Fiscal Fiscal Fiscal Fiscal Fiscal Fiscal
1995 1994 1993 1995 1994 1993
---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
International
Europe $ 262 $ 11 $ 720 $ 85,393 $ 65,110 $ 63,279
Asia 186 56 24 17,363 18,413 15,910
---------------------------------------------------------------------------
Total 448 67 744 102,756 83,523 79,189
North America 435 527 456 139,801 120,360 100,483
Eliminations -- -- -- (98,804) (87,189) (82,430)
---------------------------------------------------------------------------
Total $ 883 $ 594 $ 1,200 $143,753 $116,694 $ 97,242
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
Because of the international nature of the financial markets and the
resulting geographic integration of the Company's business, the Company manages
its business with a view to the profitability of the enterprise as a whole, and,
as such, profitability by geographic area is not necessarily meaningful.
NOTE 12 SUBSEQUENT EVENT
On January 3, 1996, the Company completed its purchase of Miller Anderson &
Sherrerd, LLP, an institutional investment manager, for approximately $350
million, payable in a combination of cash, notes and common stock of the
Company.
34
<PAGE>
================================================================================
MORGAN STANLEY GROUP INC. AND SUBSIDIARIES
NOTE 13 QUARTERLY RESULTS (UNAUDITED)
<TABLE>
<CAPTION>
================================================================================================================================
- --------------------------------------------------------------------------------------------------------------------------------
Fiscal 1995(1)
-------------------------------------------------------------------------------------------
Month Quarter Quarter Quarter
Ended Ended Ended Ended
(Dollars in Millions, Feb. 28, May 31, Aug. 31, Nov. 30,
Except Share Data) 1995 1995 1995 1995
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Investment banking $ 80 $ 273 $ 355 $ 503
Principal transactions:
Trading 114 438 352 218
Investments -- (6) 69 39
Commissions 37 131 130 139
Interest and dividends 588 1,742 1,899 1,710
Asset management
and administration 31 88 96 95
Other 1 1 1 --
-------------------------------------------------------------------------------------------
Total revenues 851 2,667 2,902 2,704
Interest expense 558 1,656 1,751 1,536
-------------------------------------------------------------------------------------------
Net revenues 293 1,011 1,151 1,168
-------------------------------------------------------------------------------------------
Expenses excluding interest:
Compensation and benefits 138 475 575 607
Occupancy and equipment 27 80 84 85
Brokerage, clearing and
exchange fees 20 66 64 61
Communications 11 34 31 32
Business development 14 34 30 32
Professional services 14 40 37 40
Other 11 31 32 35
Relocation charge -- -- -- --
-------------------------------------------------------------------------------------------
Total expenses
excluding interest 235 760 853 892
-------------------------------------------------------------------------------------------
Income before income
taxes 58 251 298 276
Provisions for income taxes 20 85 89 89
-------------------------------------------------------------------------------------------
Net income $ 38 $ 166 $ 209 $ 187
-------------------------------------------------------------------------------------------
Earnings applicable to
common shares(2) $ 33 $ 150 $ 192 $ 171
-------------------------------------------------------------------------------------------
Per common share:(3)
Primary earnings(4) $ 0.22 $ 0.95 $ 1.23 $ 1.08
Fully diluted earnings(4) $ 0.21 $ 0.91 $ 1.17 $ 1.04
Cash dividends $ -- $ 0.16 $ 0.16 $ 0.16
Book value $ 24.13 $ 25.19 $ 26.34 $ 28.18
Average common and
equivalent shares(2)(3) 154,037,668 157,595,614 157,236,918 158,415,826
Stock price range(3)(5) $30 7/16-33 11/16 $33 1/16-39 13/16 $37 15/16-43 7/16 $41 7/8-49 3/4
- --------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
================================================================================================================================
- --------------------------------------------------------------------------------------------------------------------------------
Fiscal 1994(1)
----------------------------------------------------------------------------------------
Quarter Quarter Quarter Quarter
Ended Ended Ended Ended
(Dollars in Millions, April 30, July 31, Oct. 31, Jan. 31,
Except Share Data) 1994 1994 1994 1995
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Investment banking $ 260 $ 211 $ 190 $ 258
Principal transactions:
Trading 258 300 297 249
Investments 10 23 82 24
Commissions 119 112 104 114
Interest and dividends 1,561 1,525 1,714 1,606
Asset management
and administration 81 89 95 85
Other 3 2 3 1
</TABLE>
35
<PAGE>
<TABLE>
<S> <C> <C> <C> <C>
Total revenues 2,292 2,262 2,485 2,337
Interest expense 1,404 1,349 1,575 1,547
----------------------------------------------------------------------------------------
Net revenues 888 913 910 790
----------------------------------------------------------------------------------------
Expenses excluding interest:
Compensation and benefits 440 460 460 373
Occupancy and equipment 68 74 79 82
Brokerage, clearing and
exchange fees 58 59 56 57
Communications 29 28 31 34
Business development 39 41 41 44
Professional services 41 39 41 43
Other 29 30 32 40
Relocation charge -- -- -- 59
----------------------------------------------------------------------------------------
Total expenses
excluding interest 704 731 740 732
----------------------------------------------------------------------------------------
Income before income
taxes 184 182 170 58
Provisions for income taxes 67 61 52 19
----------------------------------------------------------------------------------------
Net income $ 117 $ 121 $ 118 $ 39
----------------------------------------------------------------------------------------
Earnings applicable to
common shares(2) $ 101 $ 104 $ 102 $ 23
----------------------------------------------------------------------------------------
Per common share:(3)
Primary earnings(4) $ 0.64 $ 0.66 $ 0.65 $ 0.15
Fully diluted earnings(4) $ 0.61 $ 0.63 $ 0.63 $ 0.15
Cash dividends $ 0.15 $ 0.15 $ 0.15 $ 0.15
Book value $ 23.34 $ 23.76 $ 24.21 $ 24.89
Average common and
equivalent shares(2)(3) 159,657,342 159,211,010 156,708,032 155,068,008
Stock price range(3)(5) $30 7/16-39 3/4 $27 13/16-31 1/8 $29 11/16-34 7/8 $27 5/8-32 9/16
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Fiscal 1995's quarterly periods reflect the change in the Company's
fiscal year-end (see Note 1). Since fiscal 1995 consists of the
ten-month period from February 1, 1995 to November 30, 1995, the first
quarter consists only of the results for the month ended February 28,
1995. Fiscal 1994's quarterly periods are presented based upon the
previous fiscal year-end date.
(2) Amounts shown are used to calculate primary earnings per share.
(3) Amounts shown have been retroactively adjusted to give effect for a
two-for-one stock split, effected in the form of a 100% stock dividend,
which became effective on January 26, 1996.
(4) Summation of the quarters' earnings per common share does not equal the
annual amounts due to the averaging effect of the number of shares and
share equivalents throughout the year.
(5) Prices represent the range of sales per share on the New York Stock
Exchange for the periods indicated. The number of stockholders of
record at November 30, 1995 approximated 1,235. The number of
beneficial owners of common stock is believed to exceed this number.
36
<PAGE>
EXHIBIT 99.2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MORGAN STANLEY GROUP INC.
CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
(IN MILLIONS)
<TABLE>
<CAPTION>
ASSETS
August 31,
1996 November 30,
(Unaudited) 1995
----------- -------------
<S> <C> <C>
Cash and interest-bearing equivalents $ 3,460 $ 2,471
Cash and securities deposited with clearing organizations or segregated under
federal and other regulations (securities at market value of $2,479 at
August 31, 1996 and $859
at November 30, 1995) 2,758 1,339
Financial instruments owned:
U.S. government and agency securities 10,232 12,480
Other sovereign government obligations 13,598 13,792
Corporate and other debt 13,347 10,690
Corporate equities 9,352 13,185
Derivative contracts 8,245 8,043
Physical commodities 396 410
Securities purchased under agreements to resell 61,673 45,886
Securities borrowed 35,023 27,069
Receivables:
Customers 5,087 3,413
Brokers, dealers and clearing organizations 1,943 1,475
Interest and dividends 1,123 1,082
Fees and other 586 506
Property, equipment and leasehold improvements, at cost, net of accumulated
depreciation and amortization of $576 at August 31, 1996 and $462
at November 30, 1995 1,287 1,286
Other assets 1,116 626
-------- --------
Total assets $169,226 $143,753
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
Page 3
<PAGE>
Morgan Stanley Group Inc.
Condensed Consolidated Statement of Financial Condition
(In millions, except share data)
Liabilities and Stockholders' Equity
<TABLE>
<CAPTION>
August 31,
1996 November 30,
(Unaudited) 1995
---------- ------------
<S> <C> <C>
Short-term borrowings $ 11,581 $ 11,703
Financial instruments sold, not yet purchased:
U.S. government and agency securities 10,489 6,459
Other sovereign government obligations 6,417 8,972
Corporate and other debt 933 1,076
Corporate equities 7,378 3,585
Derivative contracts 6,733 7,537
Physical commodities 76 71
Securities sold under agreements to repurchase 76,992 60,738
Securities loaned 7,726 9,340
Payables:
Customers 15,486 13,818
Brokers, dealers and clearing organizations 1,429 1,974
Interest and dividends 1,142 1,019
Other liabilities and accrued expenses 908 595
Accrued compensation and benefits 1,676 1,192
Long-term borrowings 13,864 9,635
-------- --------
162,830 137,714
-------- --------
Capital Units 865 865
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock 878 818
Common stock, $1.00 par value; authorized
600,000,000 shares; issued 166,366,653
shares at August 31, 1996 and 162,838,920
shares at November 30, 1995 166 163
Paid-in capital 690 730
Retained earnings 4,473 3,815
Cumulative translation adjustments (14) (9)
-------- --------
Subtotal 6,193 5,517
Less:
Note receivable related to sale of
preferred stock to ESOP 87 89
Common stock held in treasury, at cost
(13,946,864 shares at August 31, 1996 and
7,635,174 shares at November 30, 1995) 575 254
-------- --------
Total stockholders' equity 5,531 5,174
-------- --------
Total liabilities and stockholders' equity $169,226 $143,753
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
Page 4
<PAGE>
Morgan Stanley Group Inc.
Condensed Consolidated Statement of Income (Unaudited)
(In millions, except share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
August 31, August 31, August 31, August 31,
1996 1995 1996 1995
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Investment banking $ 431 $ 355 $ 1,372 $ 871
Principal transactions:
Trading 427 352 1,696 989
Investments 29 69 60 82
Commissions 148 130 461 372
Interest and dividends 2,144 1,899 6,023 5,501
Asset management and administration 137 96 402 275
Other -- 1 3 4
------------ ------------ ------------ ------------
Total revenues 3,316 2,902 10,017 8,094
Interest expense 2,029 1,751 5,753 5,139
------------ ------------ ------------ ------------
Net revenues 1,287 1,151 4,264 2,955
------------ ------------ ------------ ------------
Expenses excluding interest:
Compensation and benefits 645 575 2,100 1,416
Occupancy and equipment 89 84 261 247
Brokerage, clearing and exchange fees 65 64 199 185
Communications 38 31 105 99
Business development 37 30 116 107
Professional services 58 37 153 121
Other 40 32 119 100
Relocation charge -- -- -- 59
------------ ------------ ------------ ------------
Total expenses excluding
interest 972 853 3,053 2,334
------------ ------------ ------------ ------------
Income before income taxes 315 298 1,211 621
Provision for income taxes 96 89 418 199
------------ ------------ ------------ ------------
Net income $ 219 $ 209 $ 793 $ 422
============ ============ ============ ============
Earnings applicable to common shares (1) $ 204 $ 192 $ 745 $ 373
============ ============ ============ ============
Average common and common equivalent
shares outstanding (1)(2) 154,034,233 157,236,918 155,305,534 155,249,074
============ ============ ============ ============
Primary earnings per share (2) $ 1.32 $ 1.23 $ 4.79 $ 2.41
============ ============ ============ ============
Fully diluted earnings per share (2) $ 1.27 $ 1.17 $ 4.59 $ 2.29
============ ============ ============ ============
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) 1995 share and per share amounts have been retroactively adjusted to give
effect for the two-for-one common stock split, effected in the form of a
100% stock dividend, which became effective in January, 1996.
See Notes to Condensed Consolidated Financial Statements.
Page 5
<PAGE>
Morgan Stanley Group Inc.
Condensed Consolidated Statement of Cash Flows (Unaudited)
(In millions)
<TABLE>
<CAPTION>
Nine Months Ended
August 31, August 31,
1996 1995
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 793 $ 422
Adjustments to reconcile net income
to net cash used for operating activities:
Relocation Charge -- 59
Non-cash charges included in net income 120 223
Changes in assets and liabilities:
Cash and securities deposited with
clearing organizations or segregated
under federal and other regulations (1,419) 1,671
Financial instruments owned, net of
financial instruments sold, not yet purchased 7,756 (435)
Securities borrowed, net of securities loaned (9,568) 5,176
Receivables and other assets (2,420) 440
Payables and other liabilities 2,008 (2,686)
------- -------
Net cash (used for)/provided by for operating activities (2,730) 4,870
Cash flows from investing activities:
Net payments for:
Property, equipment and leasehold
improvements (114) (308)
------- -------
Net cash used for investing activities (114) (308)
Cash flows from financing activities:
Net proceeds related to short-term borrowings (137) (1,261)
Securities sold under agreements to
repurchase, net of securities
purchased under agreements to resell 467 (2,083)
Proceeds from:
Issuance of common stock 88 56
Issuance of long-term borrowings 5,724 1,832
Issuance of Capital Units -- 344
Issuance of 7-3/4% Cumulative Preferred Stock 195 --
Payments for:
Purchase of Miller Anderson & Sherrerd, LLP, net
of cash acquired (200) --
Repurchases of common stock (507) (113)
Repayments of long-term borrowings (1,532) (1,141)
Redemption of 9.36% Cumulative Preferred Stock (138) --
Cash dividends (127) (95)
------- -------
Net cash provided by/(used for) financing activities 3,833 (2,461)
------- -------
Net increase in cash and interest-bearing equivalents 989 2,101
Cash and interest-bearing equivalents, at
beginning of period 2,471 2,135
------- -------
Cash and interest-bearing equivalents, at end of period $ 3,460 $ 4,236
======= =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
Page 6
<PAGE>
MORGAN STANLEY GROUP INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(IN MILLIONS)
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
In connection with the Company's acquisition of Miller Anderson & Sherrerd, LLP,
the Company issued approximately $66 million of notes payable, as well as
2,012,264 shares of common stock having a fair value on the date of acquisition,
January 3, 1996, of approximately $83 million.
Page 7
<PAGE>
MORGAN STANLEY GROUP INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Presentation
On February 28, 1995, the Board of Directors approved a change in the Company's
fiscal year-end from January 31 to November 30. The change became effective for
the fiscal period ended November 30, 1995, and, accordingly, this report
includes the results for the third quarter and nine months ended August 31,
1996. As a result of this change, the comparable nine month period of the prior
year includes the final two months of fiscal 1994 (December 1994 and January
1995) and the first seven months of fiscal 1995.
The information furnished in this quarterly report has been prepared pursuant to
the Securities and Exchange Commission's rules and regulations. The Condensed
Consolidated Financial Statements reflect all adjustments (consisting only of
normal recurring adjustments) which are, in the opinion of management, necessary
for the fair statement of the results for the interim period and should be read
in connection with the Annual Report on Form 10-K for the fiscal period ended
November 30, 1995 (file no. 1-9085)("Form 10-K"). The nature of the business of
Morgan Stanley Group Inc. and its domestic and foreign subsidiaries
(collectively, the "Company") is such that the results of any interim period may
not be indicative of the results for the full year. Prior period financial
statements have been reclassified, where appropriate, to conform to the fiscal
1996 presentation.
Financial instruments, including derivatives, used in the Company's trading
activities are recorded at fair value, and unrealized gains and losses are
reflected in trading revenues. Interest revenue and expense arising from
financial instruments used in trading activities are reflected in the Condensed
Consolidated Statement of Income as interest income or expense. The fair values
of the trading positions generally are based on listed market prices. If listed
market prices are not available or if liquidating the Company's positions would
reasonably be expected to impact market prices, fair value is determined based
on other relevant factors, including dealer price quotations and price
quotations for similar instruments traded in different markets, including
markets located in different geographic areas. Fair values for certain
derivative contracts are derived from pricing models which consider current
market and contractual prices for the underlying financial instruments or
commodities, as well as time value and yield curve or volatility factors
underlying the positions. Purchases and sales of financial instruments are
recorded in the accounts on trade date. Unrealized gains and losses arising from
the Company's dealings in over-the-counter ("OTC") financial instruments,
including derivative contracts related to financial instruments and commodities,
are presented in the accompanying Condensed Consolidated Statement of Financial
Condition on a net-by-counterparty basis consistent with Financial Accounting
Standards Board ("FASB") Interpretation No. 39, "Offsetting of Amounts Related
to Certain Contracts." Reverse repurchase and repurchase agreements are
presented net-by-counterparty where net presentation is consistent with FASB
Interpretation No. 41, "Offsetting of Amounts Related to Certain Repurchase and
Reverse Repurchase Agreements."
The Company also enters into various financial instrument related derivative
contracts, such as interest rate swaps, currency swaps and forward contracts, as
an end user to manage the interest rate and currency exposure arising from
certain borrowings. Net revenues from derivatives used in the Company's own
asset and liability management are recognized ratably over the term of the
contract as an adjustment to interest expense.
Page 8
<PAGE>
Equity securities purchased in connection with merchant banking and other
principal investment activities are initially carried in the Condensed
Consolidated Financial Statements at their original cost; the carrying value of
such investments is adjusted upward only when changes in the underlying fair
values are readily ascertainable, generally as evidenced by substantial
transactions occurring in the marketplace which directly affect their value.
Downward adjustments relating to such equity securities are made in the event
that the Company determines that the eventual realizable value is less than the
carrying value. Loans made in connection with such activities are carried at
unpaid principal balances plus accrued interest less reserves, if deemed
necessary, for estimated losses.
Included in the Company's Condensed Consolidated Statement of Financial
Condition at August 31, 1996 and November 30, 1995 are $865 million of Capital
Units issued by the Company and Morgan Stanley Finance plc., a U.K. subsidiary
("MS plc"). A Capital Unit consists of (a) a Subordinated Debenture of MS plc in
the principal amount of $25 guaranteed by the Company and having maturities from
2013 to 2015, and (b) a related Purchase Contract issued by the Company, which
may be accelerated by the Company beginning approximately one year after the
issuance of each Capital Unit, requiring the holder to purchase one Depositary
Share representing ownership of a 1/8 interest in the Company's Cumulative
Preferred Stock.
Earnings per share is based on the weighted average number of common shares and
share equivalents outstanding and gives effect to preferred stock dividend
requirements. Common share data for fiscal 1995 have been retroactively adjusted
to reflect a two-for-one common stock split, effected in the form of a 100%
stock dividend, declared on January 4, 1996 and payable on January 26, 1996 to
holders of record on January 16, 1996.
On April 3, 1996, the Company's stockholders approved an increase in the number
of authorized shares of common stock from 300,000,000 to 600,000,000.
2. New Accounting Pronouncements
In October 1995, the FASB issued Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), which is
effective for fiscal years beginning after December 15, 1995. SFAS No. 123
encourages, but does not require, companies to record compensation costs for the
fair value of stock-based employee compensation awards, including options. The
Company has elected not to adopt the cost recognition provisions of SFAS No.
123.
In June 1996, the FASB issued Statement of Financial Accounting Standards No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" ("SFAS No. 125"), which is effective for
transactions occurring after December 31, 1996. SFAS No. 125 prescribes the
accounting for the transfer of financial assets, including securitizations,
repurchase and securities lending transactions. The adoption of SFAS No. 125
would not have a material effect on the Company's results of operations. It may,
however, have a material effect on the Consolidated Statement of Financial
Condition of the Company and other companies in the securities industry, but the
effect has not been quantified at this time.
3. Long-Term Borrowings
Long-term borrowings at August 31, 1996 scheduled to mature within one year
aggregate $3,108 million.
Page 9
<PAGE>
During the nine month period ended August 31, 1996, the Company issued senior
notes aggregating $5,801 million, including non-U.S. dollar currency notes
aggregating $836 million, primarily pursuant to its public debt shelf
registration statements. The weighted average coupon interest rate of these
notes at August 31, 1996 was 5.4%; the Company has entered into certain
transactions to obtain floating interest rates based on either short-term LIBOR
or repurchase agreement rates for Treasury securities. Maturities in the
aggregate of these notes for the fiscal years ending November 30 are as follows:
1997, $592 million; 1998, $1,529 million; 1999, $1,494 million; 2000, $84
million; 2001, $1,558 million; and thereafter, $544 million. As of August 31,
1996, the aggregate outstanding principal amount of the Company's Senior
Indebtedness (as defined in the aforementioned registration statements) was
approximately $22.4 billion.
From September 1, 1996 to September 30, 1996, additional senior notes
aggregating $88 million were issued primarily pursuant to the Company's public
debt shelf registration statements. These notes have maturities from 2001 to
2011.
4. Derivative Contracts and Other Commitments and Contingencies
In the normal course of business, the Company enters into a variety of
derivative contracts related to financial instruments and commodities. The
Company uses swap agreements in its trading activities and in managing its
interest rate exposure. The Company also uses forward and option contracts,
futures and swaps in its trading activities; these financial instruments also
are used to hedge the U.S. dollar cost of certain foreign currency exposures. In
addition, financial futures and forward contracts are actively traded by the
Company and are used to hedge proprietary inventory. The Company also enters
into delayed delivery, when-issued, and warrant and option contracts involving
securities. These instruments generally represent future commitments to swap
interest payment streams, exchange currencies or purchase or sell other
financial instruments on specific terms at specified future dates. Many of these
products have maturities that do not extend beyond one year; swaps and options
and warrants on equities typically have longer maturities. For further
discussion of these matters, refer to "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Derivative Financial
Instruments", and Note 5 to the Consolidated Financial Statements, included in
the Form 10-K.
These derivative instruments involve varying degrees of off-balance sheet market
risk. Future changes in interest rates, foreign currency exchange rates or the
fair values of the financial instruments, commodities or indices underlying
these contracts ultimately may result in cash settlements exceeding fair value
amounts recognized in the Condensed Consolidated Statement of Financial
Condition, which, as described in Note 1, are recorded at fair value,
representing the cost of replacing those instruments.
The Company's exposure to credit risk with respect to these derivative
instruments at any point in time is represented by the fair value of the
contracts reported as assets. These amounts are presented on a
net-by-counterparty basis consistent with FASB Interpretation No. 39, but are
not reported net of collateral, which the Company obtains with respect to
certain of these transactions to reduce its exposure to credit losses.
The credit quality of the Company's trading-related derivatives at August 31,
1996 and November 30, 1995 is summarized in the tables below, showing the fair
value of the related assets by counterparty credit rating. The actual credit
ratings are determined by external rating agencies or by equivalent ratings used
by the Company's Credit Department:
Page 10
<PAGE>
<TABLE>
<CAPTION>
August 31, 1996
- -----------------------------------------------------------------------------------------------------------------------------
Collater-
alized Other
Non- Non-
Invest- Invest-
ment ment
(Dollars in millions) AAA AA A BBB Grade Grade Total
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Interest rate
and currency
swaps and options
(including caps,
floors and swap
options) $ 731 $1,258 $1,495 $ 301 $ 2 $ 164 $3,951
Foreign exchange
forward contracts
and options 511 483 259 12 -- 51 1,316
Mortgage-backed
securities forward
contracts, swaps
and options 97 42 136 18 -- 16 309
Other fixed income
securities contracts
(including options) 8 18 25 5 -- 15 71
Equity securities
contracts
(including equity
swaps, warrants
and options) 505 223 248 136 385 38 1,535
Commodity forwards,
options and swaps 63 241 262 195 -- 302 1,063
------ ------ ------ ------ ------ ------ ------
Total $1,915 $2,265 $2,425 $ 667 $ 387 $ 586 $8,245
====== ====== ====== ====== ====== ====== ======
Percent of total 23% 27% 30% 8% 5% 7% 100%
====== ====== ====== ====== ====== ====== ======
</TABLE>
Page 11
<PAGE>
<TABLE>
<CAPTION>
November 30, 1995
- --------------------------------------------------------------------------------------------------------------------------
Collater-
alized Other
Non- Non-
Invest- Invest-
ment ment
(Dollars in millions) AAA AA A BBB Grade Grade Total
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Interest rate
and currency
swaps and options
(including caps,
floors and swap
options) $ 660 $1,269 $1,148 $ 535 $ 88 $ 141 $3,841
Foreign exchange
forward contracts
and options 548 531 674 83 -- 27 1,863
Mortgage-backed
securities forward
contracts, swaps
and options 23 31 36 7 12 14 123
Other fixed income
securities contracts
(including options) 25 33 33 42 -- 4 137
Equity securities
contracts
(including equity
swaps, warrants
and options) 612 98 232 143 178 159 1,422
Commodity forwards,
options and swaps 103 129 152 126 -- 147 657
------ ------ ------ ------ ------ ------ ------
Total $1,971 $2,091 $2,275 $ 936 $ 278 $ 492 $8,043
====== ====== ====== ====== ====== ====== ======
Percent of total 25% 26% 28% 12% 3% 6% 100%
====== ====== ====== ====== ====== ====== ======
</TABLE>
A substantial portion of the Company's securities and commodities transactions
are collateralized and are executed with and on behalf of commercial banks and
other institutional investors, including other brokers and dealers. Positions
taken and commitments made by the Company, including positions taken and
underwriting and financing commitments made in connection with its merchant
banking and other principal investment activities, often involve substantial
amounts and significant exposure to individual issuers and businesses, including
non-investment grade issuers. The Company seeks to limit concentration risk
created in its businesses through a variety of separate but complementary
financial, position and credit exposure reporting systems, including the use of
trading limits based in part upon the Company's review of the financial
condition and credit ratings of its counterparties.
See also "Business -- Risk Management" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Risk Management" in the Form
10-K for discussions of the Company's risk management policies and procedures.
The Company had approximately $3.0 billion of letters of credit outstanding at
August 31, 1996 to satisfy various collateral requirements.
Page 12
<PAGE>
The Company and its subsidiaries have been named as defendants in certain legal
actions and have been involved in certain investigations and proceedings in the
ordinary course of business. It is the opinion of management, based on current
knowledge and after consultation with counsel, that the outcome of such matters
will not have a material adverse effect on the Company's Condensed Consolidated
Financial Statements contained herein.
5. Preferred Stock
Preferred stock is composed of the following issues. Each issue of preferred
stock ranks in parity with all other preferred stock.
<TABLE>
<CAPTION>
Shares Outstanding at Balance at
-------------------------------- ---------------------------------
August 31, November 30, August 31, November 30,
1996 1995 1996 1995
--------------- --------------- --------------- ---------------
(in millions)
<S> <C> <C> <C> <C>
ESOP Convertible
Preferred Stock,
liquidation preference
$35.88 3,711,165 3,758,133 $ 133 $ 135
9.36% Cumulative
Preferred Stock,
stated value $25 - 5,500,000 - 138
7-3/8% Cumulative
Preferred Stock,
stated value $200 1,000,000 1,000,000 200 200
8.88% Cumulative
Preferred Stock,
stated value $200 975,000 975,000 195 195
8-3/4% Cumulative
Preferred Stock,
stated value $200 750,000 750,000 150 150
7-3/4% Cumulative
Preferred Stock,
stated value $200 1,000,000 - 200 -
------ ------
Total $ 878 $ 818
====== ======
</TABLE>
On May 23, 1996, the Company announced that it had called for redemption, on
June 24, 1996, all 5,500,000 shares of its 9.36% Cumulative Preferred Stock at a
redemption price of $25.156 per share, which reflects the stated value of $25
per share together with an amount equal to all dividends accrued and unpaid to,
but excluding, June 24, 1996.
On July 22, 1996, the Company issued 4,000,000 Depositary Shares, representing
1,000,000 shares of 7-3/4% Cumulative Preferred Stock, in an aggregate amount of
$200 million. Each Depositary Share represents 1/4 of a share of such preferred
stock.
Page 13
<PAGE>
6. Stockholders' Equity
Morgan Stanley & Co. Incorporated ("MS&Co.") is a registered broker-dealer and
a registered futures commission merchant and, accordingly, is subject to the
minimum net capital requirements of the Securities and Exchange Commission, the
New York Stock Exchange and the Commodity Futures Trading Commission. MS&Co. has
consistently operated in excess of these requirements with aggregate net
capital, as defined, totaling $1,172 million at August 31, 1996, which exceeded
the amount required by $929 million. Morgan Stanley & Co. International Limited
("MSIL"), a London-based broker-dealer subsidiary, is subject to capital
requirements of the Securities and Futures Authority, and Morgan Stanley Japan
Limited ("MSJL"), a Tokyo-based broker-dealer, is subject to the capital
requirements of the Japanese Ministry of Finance. MSIL and MSJL have
consistently operated in excess of their respective regulatory capital
requirements.
Certain other U.S. and non-U.S. subsidiaries are subject to various securities,
commodities and banking regulations, and capital adequacy requirements
promulgated by the regulatory and exchange authorities of the countries in which
they operate. These subsidiaries have consistently operated in excess of their
applicable local capital adequacy requirements.
7. Miller Anderson & Sherrerd, LLP ("MAS")
During the first quarter of fiscal 1996, the Company completed its acquisition
of MAS, a Philadelphia-based investment manager, for approximately $350 million.
The goodwill associated with this transaction is being amortized on a
straight-line basis over 25 years. The Company's results for the nine months
ended August 31, 1996 include the results of MAS since January 3, 1996, the date
of acquisition.
8. Van Kampen American Capital, Inc.
The Company announced on June 24, 1996 that it had signed a definitive agreement
to purchase VK/AC Holding, Inc. ("VKAC"), the parent of Van Kampen American
Capital, Inc. ("Van Kampen"), for $745 million. Van Kampen is the fourth largest
non-proprietary mutual fund provider in the United States with more than $57
billion in assets under management or supervision. The consideration for the
purchase of the equity of VKAC will consist of cash and $25 million of preferred
securities exchangeable into common stock of the Company. As of August 31, 1996,
VKAC had long-term debt outstanding of approximately $400 million. The
acquisition is expected to close in the fourth quarter of fiscal 1996 and is
subject to customary closing conditions. The acquisition will be accounted for
as a purchase.
Page 14
<PAGE>
EXHIBIT 99.3
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
The following unaudited pro forma condensed combined statement of financial
condition combines the historical consolidated balance sheet of Dean Witter,
Discover and Co. ("Dean Witter") and the historical consolidated statement of
financial condition of Morgan Stanley Group Inc. ("Morgan Stanley") giving
effect to the Merger as though it had been consummated on the date of such
statement after giving effect to the pro forma adjustments described in the
notes to the pro forma condensed combined financial statements. The following
unaudited pro forma condensed combined statements of income combines the
historical consolidated statements of income of Dean Witter and Morgan Stanley
giving effect to the Merger, is intended to be accounted for as a pooling of
interests after giving effect to the pro forma adjustments described in the
notes to the pro forma condensed combined financial statements. This information
should be read in conjunction with the audited consolidated financial statements
and other financial information contained in Dean Witter's Annual Report on Form
10-K for the year ended December 31, 1995 and the unaudited consolidated interim
financial statements contained in Dean Witter's Quarterly Report on Form 10-Q
for the period ended September 30, 1996, including the notes thereto and the
audited consolidated financial statements and other financial information
contained in Morgan Stanley's Annual Report on Form 10-K for the fiscal period
ended November 30, 1995 and the unaudited consolidated interim financial
statements contained in Morgan Stanley's Quarterly Report on Form 10-Q for the
period ended August 31, 1996, including the notes thereto, and in each case
incorporated by reference herein. These unaudited pro forma condensed combined
financial statements are not necessarily indicative of the operating results and
financial position that might have been achieved had the merger occurred as of
the beginning of the earliest period presented nor are they necessarily
indicative of operating results and financial position which may occur in the
future.
<PAGE>
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF FINANCIAL CONDITION
(IN MILLIONS)
<TABLE>
<CAPTION>
Dean Witter Morgan Stanley
Historical Historical Pro Forma Pro Forma
September 30, 1996 August 31, 1996 Adjustments(a) Combined
------------------------------------------------ ---------
<S> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents $ 1,102 $ 3,460 $ 4,562
Cash and securities deposited with clearing organizations
or segregated under federal and other regulations 1,802 2,758 4,560
Financial instruments owned:
U.S. government and agency securities 961 10,232 11,193
Other sovereign government obligations 0 13,598 13,598
Corporate and other debt 696 13,347 14,043
Corporate equities 39 9,352 9,391
Derivative contracts 0 8,245 8,245
Physical commodities 0 396 396
Securities purchased under agreements to resell 3,524 61,673 65,197
Securities borrowed 2,947 35,023 37,970
Receivables:
Consumer loans (net of allowances of $688) 19,595 0 19,595
Customers, net 2,739 5,087 7,826
Brokers, dealers and clearing organizations 250 1,943 2,193
Fees, interest and other 733 1,709 2,442
Other assets 2,803 2,403 5,206
------------------------------------------------ ---------
Total assets $37,191 $169,226 $206,417
------------------------------------------------ ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Commercial paper and other short-term borrowings $2,397 $ 11,581 $ 13,978
Deposits 6,598 0 6,598
Financial instruments sold, not yet purchased:
U.S. government and agency securities 1,213 10,489 11,702
Other sovereign government obligations 0 6,417 6,417
Corporate and other debt 75 933 1,008
Corporate equities 15 7,378 7,393
Derivative contracts 0 6,733 6,733
Physical commodities 0 76 76
Securities sold under agreements to repurchase 3,426 76,992 80,418
Securities loaned 3,124 7,726 10,850
Payables:
Customers 2,822 15,486 18,308
Brokers, dealers and clearing organizations 80 1,429 1,509
Interest and dividends 176 1,142 1,318
Other liabilities and accrued expenses 3,464 2,584 6,048
Long-term borrowings 8,823 13,864 22,687
------------------------------------------------ ---------
32,213 162,830 195,043
------------------------------------------------ ---------
Capital units 0 865 865
------------------------------------------------ ---------
Commitments and contingencies
</TABLE>
<PAGE>
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
<TABLE>
<CAPTION>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF FINANCIAL CONDITION
(IN MILLIONS)
Dean Witter Morgan Stanley
Historical Historical Pro Forma Pro Forma
September 30, 1996 August 31, 1996 Adjustments (a) Combined
------------------------------------------------------- -----------
<S> <C> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Stockholders' equity:
Preferred stock 0 878 878
Common stock (1) 3 166 (163) (b) 6
Paid-in capital (1) 2,707 690 163 (b) 3,560
Retained earnings 2,780 4,473 (575) (b) 6,678
Cumulative translation adjustments 0 (14) (14)
------------------------------------------------------- -----------
Subtotal 5,490 6,193 (575) 11,108
Less:
Stock compensation related deductions 5 87 92
Common stock held in treasury, at cost 507 575 (575) (b) 507
------------------------------------------------------- -----------
Total stockholders' equity 4,978 5,531 0 10,509
------------------------------------------------------- -----------
Total liabilities and stockholders' equity $37,191 $169,226 $0 $206,417
------------------------------------------------------- -----------
</TABLE>
(1) Dean Witter historical amounts have been restated to reflect a two-for-one
stock split which became effective January 14, 1997.
See Notes to the Unaudited Pro Forma Condensed Combined Financial Statements
<PAGE>
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Dean Witter Morgan Stanley
Historical Historical
Nine Months Nine Months
Ended Ended Pro Forma
September 30, 1996 August 31, 1996 Combined
----------------------------------- ------------
<S> <C> <C> <C>
Revenues:
Investment banking $168 $1,372 $1,540
Principal transactions:
Trading 340 1,696 2,036
Investments 0 60 60
Commissions 869 461 1,330
Merchant and cardmember fees 1,046 0 1,046
Servicing fees 614 0 614
Interest and dividends 2,618 6,023 8,641
Asset management and administration 851 402 1,253
Other 79 3 82
------------------------------------ ------------
Total revenues 6,585 10,017 16,602
Interest expense 1,161 5,753 6,914
Provision for losses on credit receivables 809 0 809
------------------------------------ ------------
Net revenues 4,615 4,264 8,879
------------------------------------ ------------
Expenses excluding interest:
Compensation and benefits 1,649 2,100 3,749
Occupancy and equipment 189 172 361
Brokerage, clearing and exchange fees 33 199 232
Information processing and communications 525 194 719
Business development 603 116 719
Professional services 75 153 228
Other 359 119 478
------------------------------------ ------------
Total expenses excluding interest 3,433 3,053 6,486
------------------------------------ ------------
Income before income taxes 1,182 1,211 2,393
Provision for income taxes 458 418 876
------------------------------------ ------------
Net income $724 $793 $1,517
------------------------------------ ------------
Preferred stock dividend requirements 0 48 48
------------------------------------ ------------
Earnings applicable to common shares (1) $724 $745 $1,469
------------------------------------ ------------
Average common and common equivalent
shares outstanding (1) (2) 343,413,644 155,305,534 599,667,775
Primary earnings per share (2) $2.11 $4.79 $2.45
Fully diluted earnings per share (2) $2.11 $4.59 $2.40
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) Dean Witter historical share and per share amounts have been restated to
reflect a two-for-one stock split which became effective January 14, 1997.
See Notes to the Unaudited Pro Forma Condensed Combined Financial Statements
<PAGE>
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Dean Witter Morgan Stanley
Historical Historical
Nine Months Nine Months
Ended Ended Pro Forma
September 30, 1995 August 31, 1995 Combined
----------------------------------- ---------
<S> <C> <C> <C>
Revenues:
Investment banking $133 $871 $1,004
Principal transactions:
Trading 368 989 1,357
Investments 0 82 82
Commissions 749 372 1,121
Merchant and cardmember fees 792 0 792
Servicing fees 534 0 534
Interest and dividends 2,414 5,501 7,915
Asset management and administration 748 275 1,023
Other 69 4 73
----------------------------------- ---------
Total revenues 5,807 8,094 13,901
Interest expense 1,112 5,139 6,251
Provision for losses on credit receivables 451 0 451
----------------------------------- ---------
Net revenues 4,244 2,955 7,199
----------------------------------- ---------
Expenses excluding interest:
Compensation and benefits 1,485 1,416 2,901
Occupancy and equipment 174 164 338
Brokerage, clearing and exchange fees 32 185 217
Information processing and communications 464 182 646
Business development 511 107 618
Professional services 61 121 182
Other 414 100 514
Relocation charge 0 59 59
----------------------------------- ---------
Total expenses excluding interest 3,141 2,334 5,475
----------------------------------- ---------
Income before income taxes 1,103 621 1,724
Provision for income taxes 425 199 624
----------------------------------- ---------
Net income $ 678 $ 422 $1,100
----------------------------------- ---------
Preferred stock dividend requirements 0 49 49
----------------------------------- ---------
Earnings applicable to common shares (1) $ 678 $ 373 $1,051
----------------------------------- ---------
Average common and common equivalent
shares outstanding (1) (2) (3) 350,347,300 155,249,074 606,508,272
Primary earnings per share (2) (3) $1.94 $2.41 $1.73
Fully diluted earnings per share (2) (3) $1.92 $2.29 $1.69
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) Dean Witter historical share and per share amounts have been restated to
reflect a two-for-one stock split which became effective January 14, 1997.
(3) All Morgan Stanley historical share and per share amounts have been
retroactively adjusted to give effect for a two-for-one stock split,
effected in the form of a 100% stock dividend, which became effective on
January 26, 1996.
See Notes to the Unaudited Pro Forma Condensed Combined Financial Statements
<PAGE>
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Dean Witter Morgan Stanley
Historical Historical
Twelve Months Twelve Months
Ended Ended Pro Forma
December 31, 1995 November 30, 1995 Combined
-------------------------------------- ------------
<S> <C> <C> <C>
Revenues:
Investment banking $ 182 $ 1,374 $ 1,556
Principal transactions:
Trading 479 1,206 1,685
Investments 0 121 121
Commissions 1,023 510 1,533
Merchant and cardmember fees 1,135 0 1,135
Servicing fees 697 0 697
Interest and dividends 3,319 7,211 10,530
Asset management and administration 1,007 370 1,377
Other 93 5 98
-------------------------------------- ------------
Total revenues 7,935 10,797 18,732
Interest expense 1,515 6,675 8,190
Provision for losses on credit receivables 744 0 744
-------------------------------------- ------------
Net revenues 5,676 4,122 9,798
-------------------------------------- ------------
Expenses excluding interest:
Compensation and benefits 1,982 2,023 4,005
Occupancy and equipment 235 219 454
Brokerage, clearing and exchange fees 42 247 289
Information processing and communications 646 243 889
Business development 735 139 874
Professional services 85 161 246
Other 555 135 690
Relocation charge 0 59 59
-------------------------------------- ------------
Total expenses excluding interest 4,280 3,226 7,506
-------------------------------------- ------------
Income before income taxes 1,396 896 2,292
Provision for income taxes 540 287 827
-------------------------------------- ------------
Net income $ 856 $ 609 $ 1,465
-------------------------------------- ------------
Preferred stock dividend requirements 0 65 65
-------------------------------------- ------------
Earnings applicable to common shares (1) $ 856 $ 544 $ 1,400
-------------------------------------- ------------
Average common and common equivalent
shares outstanding (1) (2) (3) 350,725,970 156,073,008 608,246,433
Primary earnings per share (2) (3) $2.44 $3.49 $2.30
Fully diluted earnings per share (2) (3) $2.44 $3.33 $2.25
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) Dean Witter historical share and per share amounts have been restated to
reflect a two-for-one stock split which became effective January 14, 1997.
(3) All Morgan Stanley historical share and per share amounts have been
retroactively adjusted to give effect for a two-for-one stock split,
effected in the form of a 100% stock dividend, which became effective on
January 26, 1996.
See Notes to the Unaudited Pro Forma Condensed Combined Financial Statements
<PAGE>
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Dean Witter Morgan Stanley
Historical Historical
Twelve Months Twelve Months
Ended Ended Pro Forma
December 31, 1994 November 30, 1994 Combined
-------------------------------------- ---------------
<S> <C> <C> <C>
Revenues:
Investment banking $ 198 $ 904 $ 1,102
Principal transactions:
Trading 422 1,192 1,614
Investments 0 154 154
Commissions 874 449 1,323
Merchant and cardmember fees 940 0 940
Servicing fees 586 0 586
Interest and dividends 2,507 6,208 8,715
Asset management and administration 973 344 1,317
Other 102 4 106
-------------------------------------- --------------
Total revenues 6,602 9,255 15,857
Interest expense 1,048 5,649 6,697
Provision for losses on credit receivables 548 0 548
-------------------------------------- --------------
Net revenues 5,006 3,606 8,612
-------------------------------------- --------------
Expenses excluding interest:
Compensation and benefits 1,764 1,771 3,535
Occupancy and equipment 228 193 421
Brokerage, clearing and exchange fees 45 231 276
Information processing and communications 552 215 767
Business development 607 166 773
Professional services 85 159 244
Other 510 124 634
-------------------------------------- --------------
Total expenses excluding interest 3,791 2,859 6,650
-------------------------------------- --------------
Income before income taxes 1,215 747 1,962
Provision for income taxes 474 231 705
-------------------------------------- --------------
Net income $ 741 $ 516 $ 1,257
-------------------------------------- --------------
Preferred stock dividend requirements 0 65 65
-------------------------------------- --------------
Earnings applicable to common shares (1) $ 741 $ 451 $ 1,192
-------------------------------------- --------------
Average common and common equivalent
shares outstanding (1) (2) (3) 346,717,026 157,578,446 606,721,462
Primary earnings per share (2) (3) $2.14 $2.86 $1.96
Fully diluted earnings per share (2) (3) $2.14 $2.75 $1.93
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) Dean Witter historical share and per share amounts have been restated to
reflect a two-for-one stock split which became effective January 14, 1997.
(3) All Morgan Stanley historical share and per share amounts have been
retroactively adjusted to give effect for a two-for-one stock split,
effected in the form of a 100% stock dividend, which became effective on
January 26, 1996.
See Notes to the Unaudited Pro Forma Condensed Combined Financial Statements
<PAGE>
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Dean Witter Morgan Stanley
Historical Historical
Twelve Months Twelve Months
Ended Ended Pro Forma
December 31, 1993 November 30, 1993 Combined
------------------------------------ ------------
<S> <C> <C> <C>
Revenues:
Investment banking $395 $1,247 $1,642
Principal transactions:
Trading 405 1,373 1,778
Investments 0 157 157
Commissions 904 380 1,284
Merchant and cardmember fees 771 0 771
Servicing fees 533 0 533
Interest and dividends 1,909 5,427 7,336
Asset management and administration 838 236 1,074
Other 67 10 77
------------------------------------ ------------
Total revenues 5,822 8,830 14,652
Interest expense 815 4,805 5,620
Provision for losses on credit receivables 458 0 458
------------------------------------ ------------
Net revenues 4,549 4,025 8,574
------------------------------------ ------------
Expenses excluding interest:
Compensation and benefits 1,704 1,983 3,687
Occupancy and equipment 218 167 385
Brokerage, clearing and exchange fees 44 186 230
Information processing and communications 502 168 670
Business development 470 122 592
Professional services 74 115 189
Other 540 106 646
------------------------------------ ------------
Total expenses excluding interest 3,552 2,847 6,399
------------------------------------ ------------
Income before income taxes 997 1,178 2,175
Provision for income taxes 393 410 803
------------------------------------ ------------
Net income $604 $768 $1,372
------------------------------------ ------------
Preferred stock dividend requirements 0 55 55
------------------------------------ ------------
Earnings applicable to common shares (1) $604 $713 $1,317
------------------------------------- ------------
Average common and common equivalent
shares outstanding (1) (2) (3) 333,823,498 153,222,010 586,639,815
Primary earnings per share (2) (3) $1.81 $4.65 $2.24
Fully diluted earnings per share (2) (3) $1.81 $4.44 $2.20
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) Dean Witter historical share and per share amounts have been restated to
reflect a two-for-one stock split which became effective January 14,
1997.
(3) All Morgan Stanley historical share and per share amounts have been
retroactively adjusted to give effect for a two-for-one stock split,
effected in the form of a 100% stock dividend, which became effective on
January 26, 1996.
See Notes to the Unaudited Pro Forma Condensed Combined Financial Statements
<PAGE>
NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
Note (a): Basis of Presentation
The unaudited pro forma condensed combined statement of financial condition
combines the historical consolidated balance sheet of Dean Witter at September
30, 1996 with the historical consolidated statement of financial condition of
Morgan Stanley at August 31, 1996. The unaudited pro forma condensed combined
statements of income combine the historical consolidated statements of income of
Dean Witter for the years ended December 31, 1995, 1994 and 1993 and the nine
months ended September 30, 1996 and September 30, 1995 with the historical
consolidated statements of income of Morgan Stanley (recast to reflect a twelve
month presentation) for the twelve months ended November 30, 1995, 1994 and 1993
and the nine months ended August 31, 1996 and August 31, 1995. Certain amounts
reflected in the historical financial statement presentations of both companies
have been reclassified to conform to the unaudited pro forma condensed combined
presentation.
The unaudited pro forma condensed combined financial statements exclude 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.
Transactions between Dean Witter and Morgan Stanley are not material in relation
to the unaudited pro forma condensed combined financial statements and
therefore, intercompany balances have not been eliminated from the pro forma
combined amounts. Dean Witter and Morgan Stanley are in the process of
reviewing their respective accounting policies and do not expect there to be any
significant adjustments necessary in order to conform such policies.
In January 1997, Dean Witter acquired Lombard Brokerage, Inc. which was
accounted for as a purchase transaction. During 1996, Morgan Stanley acquired
Miller Anderson & Sherrerd, LLP and Van Kampen American Capital, Inc., both
accounted for as purchase transactions. Subsequent to fiscal 1996 year-end,
Morgan Stanley announced that it had reached an agreement with Barclays PLC to
acquire its institutional global custody business. No pro forma effect has been
given to these transactions as the effect is not material.
<PAGE>
NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
Note (b): Pro Forma Adjustments
The pro forma adjustments to common stock, paid-in capital and retained earnings
accounts at September 30, 1996 reflect (i) an exchange of 152.4 million shares
of common stock, par value $1.00 per share of Morgan Stanley for 251.5 million
shares (using the exchange ratio of 1.65) of common stock, par value $.01 per
share of Dean Witter and (ii) the cancellation and retirement of all shares of
Morgan Stanley common stock held in treasury. The number of shares of Dean
Witter common stock to be issued at consummation of the Merger will be based
upon the actual number of shares of Morgan Stanley common stock outstanding at
that time.
Note (c): Pro Forma Earnings Per Share
The pro forma combined primary and fully diluted earnings per common share for
the respective periods presented are based on the combined weighted average
number of common shares and share equivalents of Dean Witter and Morgan Stanley.
The number of common shares and share equivalents of Morgan Stanley is based on
an exchange ratio of 1.65 shares of Dean Witter common shares for each issued
and outstanding share and share equivalent of Morgan Stanley.
