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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 2000
Commission File Number 1-11758
Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co.
(Exact name of Registrant as specified in its charter)
Delaware 00-0000000
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
0000 Xxxxxxxx 10036
New York, N.Y. (Zip Code)
(Address of principal executive
offices)
Registrant's telephone number, including area code: (000) 000-0000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
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Common Stock, $.01 par value New York Stock Exchange
Pacific Exchange
Rights to Purchase Series A Junior Participating
Preferred Stock New York Stock Exchange
Pacific Exchange
Depositary Shares, each representing 1/4 of a share
of 7 3/4% Cumulative Preferred Stock, $200 stated
value New York Stock Exchange
Depositary Shares, each representing 1/4 of a share
of Series A Fixed/Adjustable Rate Cumulative
Preferred Stock, $200 stated value New York Stock Exchange
8.03% Capital Units New York Stock Exchange
6% Reset PERQS SM Due March 15, 2001; 6% Reset PERQS
Due May 30, 2001; 6% Reset PERQS Due August 1,
2001; 7% Reset PERQS Due August 15, 2001; 6% Reset
PERQS Due December 15, 2001; 8% Reset PERQS Due
April 30, 2002; 6% Reset PERQS Due May 30, 2002;
10% Reset PERQS Due June 28, 2002; 8% Reset PERQS
Due October 30, 2002; Convertible Note PERQS Due
October 31, 2001; 9% Reset PERQS Due December 30,
2002; 8% Reset PERQS Due February 28, 2003 American Stock Exchange
Exchangeable Notes Due July 31, 2003; Exchangeable
Notes Due December 30, 2005; Exchangeable Notes Due
August 15, 2006; Exchangeable Notes Due March 2,
2006 (2 issuances); Exchangeable Notes Due May 30,
2006; Exchangeable Notes Due June 5, 2006;
Exchangeable Notes Due July 7, 2006; Exchangeable
Notes Due August 6, 2006; Exchangeable Notes Due
October 19, 2006; Exchangeable Notes Due December
13, 2004; Exchangeable Notes Due March 30, 2007;
Exchangeable Notes Due November 30, 2007 (2
issuances) New York Stock Exchange
Exchangeable Notes Due July 29, 2005 (two
issuances); Exchangeable Notes Due April 15, 2005;
Exchangeable Notes Due August 17, 2005 American Stock Exchange
PEEQS SM Due May 1, 2001 American Stock Exchange
PERKS SM Due March 30, 2004 American Stock Exchange
Nikkei 225 Protection Step-Up Exchangeable Notes Due
July 31, 2003 New York Stock Exchange
Dow Xxxxx Industrial Average XXXXXXX XX Due April 30,
2004; Standard & Poor's 500 BRIDGES
Due December 31, 2003; Dow Xxxxx Euro Stoxx 50
BRIDGES Due July 30, 2004; Redeemable BRIDGES Due
May 30, 2005 (based on Xxxxxx Xxxxxxx High-Tech 35
Index) New York Stock Exchange
5 5/8% Notes Due January 20, 2004; 7.25% Notes Due
June 17, 2029 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check xxxx whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]
Indicate by check xxxx if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Aggregate market value of the voting stock held by non-affiliates of the
Registrant at January 22, 2001 was approximately $92,180,363,561. This
calculation does not reflect a determination that persons are affiliates for
any other purposes.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date:
As of January 22, 2001, there were 1,116,902,168 shares of Common Stock,
$.01 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Registrant's definitive proxy statement to be issued in
conjunction with Registrant's annual stockholders' meeting to be held on March
22, 2001 are incorporated by reference in this Form 10-K in response to Part
III, Items 10, 11, 12 and 13.
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PART I
Item 1. Business
Overview
Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co. ("MSDW"*) is a global financial services
firm that maintains leading market positions in each of its three business
segments:
. Securities
. Asset Management
. Credit Services
MSDW's securities business segment ("Securities") includes:
. Investment banking, including:
. securities underwriting and distribution
. financial advisory services, including advice on mergers and
acquisitions, restructurings, real estate and project finance
. financing and investing
. Sales, trading, financing and market-making activities to facilitate
client orders and on a proprietary basis, in such products as:
. equity securities and related products
. fixed income securities and related products, including foreign
exchange and commodities
. derivatives
. Principal investing, including private equity activities
. Securities services to accommodate individual investor needs,
including:
. full-service brokerage services for investors seeking financial
advice
. online execution capabilities for self-directed investors
desiring to invest with limited professional assistance
. financial advisory services for high net worth clients
MSDW's asset management business segment ("Asset Management") includes:
. Global asset management products and services for individual and
institutional investors, through:
. Xxxxxx Xxxxxxx Xxxx Xxxxxx Advisors ("MSDW Advisors")
. Xxx Xxxxxx Investments ("Xxx Xxxxxx")
. Xxxxxx Xxxxxxx Xxxx Xxxxxx Investment Management ("MSDW
Investment Management")
. Xxxxxx Xxxxxxxx & Xxxxxxxx ("Xxxxxx Xxxxxxxx")
MSDW's credit services business segment ("Credit Services") includes:
. Discover Financial Services ("DFS"), which offers the Discover(R)
Card, the Discover Platinum Card ("Discover Platinum"), the Xxxxxx
Xxxxxxx Xxxx Xxxxxx Card(TM) (the "MSDW Card") and other proprietary
general purpose credit cards
. Discover Business Services, a proprietary network of merchant and
cash access locations
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* Unless the context otherwise requires, the terms "MSDW" and the "Company"
mean Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co. and its consolidated subsidiaries.
MSDW combines global strength in investment banking and institutional sales
and trading with strength in providing full-service brokerage services,
investment and global asset management services and, primarily through its
Discover Card brand, quality consumer credit products. MSDW provides its
products and services to a large and diversified group of clients and
customers, including corporations, governments, financial institutions and
individuals.
MSDW had the second largest financial advisor sales organization in the U.S.
On a global basis, MSDW had 13,910 professional financial advisors and 603
securities branch offices at November 30, 2000. MSDW also had one of the
largest global asset management operations of any full-service securities
firm, with total assets under management or supervision of $502 billion. In
addition, based on its approximately 42.6 million general purpose credit card
accounts as of November 30, 2000, MSDW is one of the largest credit card
issuers in the U.S., with the largest proprietary merchant and cash access
network.
MSDW conducts its worldwide businesses through several highly integrated
subsidiaries and affiliates, which frequently participate together in the
facilitation and consummation of a single transaction. Because of the
increasing integration of the international financial markets, MSDW manages
its principal operating subsidiaries on a coordinated global basis with a view
to the profitability of the enterprise as a whole. Financial information
concerning MSDW for each of the three fiscal years ended November 30, 2000,
November 30, 1999 and November 30, 1998 is set forth in the consolidated
financial statements and the notes thereto included in "Financial Statements
and Supplementary Data" in Part II, Item 8 of this Report.
MSDW conducts its business from its headquarters in New York City, its
regional offices and branches throughout the U.S. and its principal offices in
London, Tokyo, Hong Kong and other financial centers throughout the world. At
November 30, 2000, MSDW had 62,679 employees worldwide, with 53,365 employees
in the U.S. and 9,314 employees internationally. MSDW is a combination of Xxxx
Xxxxxx, Discover & Co. ("Xxxx Xxxxxx Discover") and Xxxxxx Xxxxxxx Group Inc.
("Xxxxxx Xxxxxxx") and was formed pursuant to a merger of equals that was
effected on May 31, 1997 (the "Merger"). MSDW was originally incorporated
under the laws of the State of Delaware in 1981, and its predecessor companies
date back to 1924.
MSDW believes that technological advancements in the Internet and the growth
of electronic commerce will continue to present both challenges and
opportunities to MSDW and has led to significant changes and innovations in
financial markets and the financial services industry as a whole. MSDW's
initiatives in this area include Web-enabling existing businesses or enhancing
client communication and access to information and services. For example,
Client Link SM provides institutional and investment banking clients with a
private, secure Internet platform that delivers browser-based information,
products and services across many of MSDW's business units; Client Serv(R)
allows individual investors online trading capabilities, access to real-time
account activity, business news and research; and Xxxxxxxxxxxx.xxx enables
cardmembers to access financial management services online. MSDW has also
invested in, or otherwise participated in, alternative trading systems,
electronic communications networks and related businesses or technologies.
* * *
Certain statements contained in this Report, including (without limitation)
certain statements made under "Legal Proceedings" in Part I, Item 3 of this
Report, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in Part II, Item 7 of this Report ("MD&A"), and
"Quantitative and Qualitative Disclosure about Market Risk" in Part II, Item
7A of this Report, may constitute forward-looking statements. These forward-
looking statements are not historical facts and represent only MSDW's beliefs
regarding future events, many of which, by their nature, are inherently
uncertain and beyond its control. The risks and uncertainties involved in
MSDW's businesses could affect the matters referred to in such statements,
including (without limitation) the effect of economic and market conditions,
the level and volatility of interest rates and currency values and equity and
commodity prices, the actions of current and potential competitors, the impact
of current, pending or future legislation and regulation in the U.S. and
throughout the world, the potential effects of technological changes and other
risks and uncertainties detailed under "Certain Factors Affecting Results of
Operations" in MD&A and in "Competition and Regulation" under each of
"Securities," "Asset Management" and "Credit Services" in Part I, Item 1 of
this Report. Accordingly, readers are cautioned not to place undue reliance on
forward-looking statements, which speak only as of the date on which they are
made. MSDW undertakes no obligation to update publicly or revise any forward-
looking statements.
2
SECURITIES
MSDW provides worldwide financial advisory and capital-raising services to a
diverse group of domestic and international corporate and other institutional
clients, primarily through Xxxxxx Xxxxxxx & Co. Incorporated ("MS&Co."),
Xxxxxx Xxxxxxx & Co. International Limited, Xxxxxx Xxxxxxx Xxxx Xxxxxx Japan
Limited and Xxxxxx Xxxxxxx Xxxx Xxxxxx Asia Limited. These subsidiaries also
conduct sales and trading activities around the world, both as principal and
as agent, as well as related financing services, on behalf of a wide range of
institutional investors and on a proprietary basis. MSDW also conducts a
variety of activities broadly described as principal investing. In addition,
MSDW provides individual investors with a broad range of securities and
savings products and services, primarily through Xxxx Xxxxxx Xxxxxxxx Inc.
("DWR").
Investment Banking
Underwriting
MSDW manages and participates in public offerings and private placements of
debt, equity and other securities worldwide. MSDW is a leading underwriter of
common stock, preferred stock and other equity-related securities, including
convertible securities and American Depositary Receipts ("ADRs"). MSDW is also
a leading underwriter of debt and other fixed income securities, including
investment grade debt, high-yield securities (debt issued by non-investment
grade issuers), mortgage-related and other asset-backed securities, tax-exempt
securities and commercial paper and other short-term securities.
Financial Advisory Services
MSDW provides domestic and international corporate and other institutional
clients with a wide range of advisory services on key strategic matters, such
as mergers and acquisitions, divestitures, corporate defense strategies, joint
ventures, privatizations, spin-offs, restructurings, proxy and consent
solicitations, tender offers, exchange offers and leveraged buyouts. Other
services include advice with respect to recapitalizations, rights offerings,
dividend policy, valuations, foreign exchange exposure, financial risk
management strategies, long-range financial planning and the formation and
development of new technology-driven enterprises such as industrial business-
to-business electronic exchanges. MSDW also furnishes advice and services in
connection with project financings, including infrastructure, electric power
and natural resource projects. In addition, MSDW provides advisory services in
connection with the purchase, sale, leasing and financing of real estate.
Financing and Investing
In connection with its investment banking activities, MSDW from time to time
provides financing or financing commitments. For example, MSDW may provide
financing to leveraged companies in the form of senior or subordinated debt,
as well as bridge financing on a select basis. MSDW also conducts senior
lending activities, including the origination and syndication of senior
secured loans of non-investment grade companies. MSDW also engages in a
variety of principal investing activities. See "Principal Investing" below.
Sales, Trading, Financing and Market-Making Activities
Equity Securities and Related Products
MSDW's equity sales, trading and market-making activities cover domestic and
foreign equity and equity-related products, including ADRs, iSharesSM and
restricted/control stock, convertible debt and preferred securities, including
Performance Equity-linked Redemption Quarterly-pay Securities ("PERQSSM") and
warrants, equity index products, equity swaps, options and other structured
products. MSDW also advises clients and executes transactions in connection
with international index arbitrage, equity repurchase strategies and program
trading and block trades. In addition, MSDW engages in a variety of
proprietary trading and arbitrage activities in equity securities and equity-
related products for its own account. MSDW conducts its equity sales,
3
trading and market-making activities both on stock exchanges and in over-the-
counter ("OTC") transactions. MSDW is a member of the major stock exchanges
around the world, including the New York, London, Frankfurt, Tokyo and Hong
Kong stock exchanges.
MSDW also provides various equity financing services, including prime
brokerage, which offers consolidated clearance and settlement of securities
trades, custody, financing and portfolio reporting services. In addition, MSDW
acts both as principal and agent in stock borrowing and stock loan
transactions in support of its domestic and international trading and
brokerage, asset management and clearing activities and as an intermediary
between broker-dealers.
Fixed Income Securities and Related Products
MSDW trades and makes markets in domestic and international debt and other
fixed income securities and related products, including non-convertible
preferred stock, investment grade corporate debt, high-yield securities,
senior loans, government securities, municipal securities, commercial paper,
money market and other short-term securities. MSDW also makes markets in, and
acts as principal with respect to, mortgage-related and other asset-backed
securities and real estate loan products. MSDW is a primary dealer of U.S.
government securities and a member of the selling groups that distribute
various U.S. agency and other debt securities. MSDW is also a member of the
primary syndicates that underwrite German and Japanese government bonds and is
a primary dealer in Austrian, Belgian, Canadian, French, Italian and U.K.
government bonds. In addition, MSDW is a dealer in interest rate and currency
swaps and other related derivative products, OTC options on government bonds
and mortgage-backed forward agreements, options and swaps.
MSDW advises institutional accounts and other clients on investment
strategies, develops swap and other risk management strategies for its clients
and assists corporations in their repurchases of debt. MSDW is also involved
in structuring debt securities and derivatives with multiple risk/return
factors designed to suit investor objectives, including using repackaged asset
vehicles through which investors can restructure asset portfolios to provide
liquidity or recharacterize risk profiles. MSDW borrows and lends fixed income
securities and acts as an intermediary between borrowers and lenders of short-
term funds utilizing repurchase and reverse repurchase agreements. MSDW also
provides financing to customers for commercial, residential and real estate
loan products.
MSDW is a market-maker in a number of foreign currencies. The majority of
MSDW's foreign exchange business relates to major foreign currencies such as
yen, euro, pound sterling, Swiss francs and Canadian dollars. The balance of
its business covers a broad range of other currencies. MSDW actively trades
currencies with its clients on a principal basis in the spot, forward and
currency option markets and also takes proprietary positions in currencies.
MSDW is also a leading participant in currency futures trading at the
International Monetary Market division of the Chicago Mercantile Exchange.
MSDW also trades as principal in the spot, forward and futures markets in a
variety of commodities, including precious metals, base metals, crude oil, oil
products, natural gas, electric power and related energy products. MSDW is a
market-maker in swaps and OTC options on commodities, such as metals, crude
oil, oil products, natural gas and electricity, and offers a range of hedging
programs to customers relating to production, consumption and
reserve/inventory management. MSDW is an electricity power marketer in the
U.S. and owns majority equity interests in two exempt wholesale generators (as
defined in the Public Utility Holding Company Act of 1935) from which MSDW is
the exclusive purchaser of electric power. MSDW also maintains proprietary
trading positions in commodity derivatives, including futures, forwards and
options, in addition to physical commodities.
Derivatives
MSDW offers to clients, and takes proprietary positions in, a variety of
financial instruments known as "derivative products" or "derivatives." These
products may be in the form of exchange-traded futures and
4
options or OTC forwards, options, swaps, caps, collars, floors, swap options
or similar instruments that derive their value from underlying interest rates,
foreign exchange rates, commodities, equity instruments, equity indices,
reference credits or other assets. Derivatives facilitate risk transfer and
enhance liquidity in the marketplace and are often utilized to adjust risk
profiles, such as exposure to equity price, interest rate, currency or credit
risk, or to take proprietary positions. In addition, MSDW uses derivative
products to assist in its asset and liability management and to reduce
borrowing costs. All of MSDW's trading-related business units use derivative
products as an integral part of their respective trading strategies and to
manage market exposure. In addition, as a dealer in certain derivative
products (most notably interest rate and currency swaps), MSDW structures and
enters into derivative contracts to meet a variety of client-driven
investment, risk management and other financial objectives. Through its
triple-A rated subsidiary, Xxxxxx Xxxxxxx Derivative Products Inc., MSDW also
enters into swap and related derivative transactions with certain clients
seeking a triple-A rated counterparty.*
MSCI
MSDW's majority-owned subsidiary, Xxxxxx Xxxxxxx Capital International Inc.
("MSCI"), markets and distributes over 10,000 country, industry and regional
equity and fixed income benchmark indices (including The World, EAFE(R) and
Emerging Market Free Indices) covering 51 countries, and has a 31-year
historical database that includes fundamental and valuation data on over 5,000
companies in developed and emerging market countries. Investment professionals
around the world use MSCI data for many purposes, including performance
measurement.
* * *
See also "Risk Management" in Part II, Item 7A of this Report for a
description of MSDW's trading risk management structure, policies and
procedures.
Principal Investing
MSDW's principal investing activities include making commitments to
purchase, and making negotiated investments in, equity and debt securities
either for the accounts of private equity funds that MSDW manages or for its
own account. These activities may be in connection with merger, acquisition,
restructuring, private investment and leveraged capital transactions and may
include investments in operating companies and real estate as well as venture
capital and strategic investments.
MSDW generally acts as general partner of the private equity funds through
which certain of its principal investing activities are conducted and
typically contributes a minority of the capital of such funds. MSDW conducts a
substantial portion of its principal investing business through two groups of
investment funds, MSDW Capital Partners and MSDW Venture Partners, making
private equity and venture capital investments in a range of industries
throughout the world. MSDW conducts its real estate principal investing
business primarily through the Xxxxxx Xxxxxxx Real Estate Fund and the Real
Estate Special Situations Program, entities that invest in U.S. and
international real estate assets and companies. MSDW also makes equity and
equity-related investments that arise out of its worldwide investment banking
activities through Princes Gate Investors, a group of investment funds that
invest in special situation and venture capital opportunities. From time to
time, MSDW expects to sponsor additional funds and commit to invest in such
funds.
MSDW also makes investments for its own account. These investments may,
among other things, be in conjunction with the investments made by the private
equity funds described above or in connection with MSDW's investment banking
and sales and trading activities. In addition, these investments include
purchases of equity or debt securities of companies that may have strategic
value for MSDW, such as alternative trading systems, electronic commerce
networks and related businesses or technologies.
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* For a detailed discussion of MSDW's use of derivatives, see "Derivative
Financial Instruments" in Part II, Item 7 of this Report, "Notes to
Consolidated Financial Statements, Note 6" in Part II, Item 8 of this
Report and "Notes to Consolidated Financial Statements, Note 9" in Part II,
Item 8 of this Report.
5
Securities Services to Individual Investors
Individual Investor Group
The Individual Investor Group (formerly the Private Client Group) provides
its clients with comprehensive financial planning services, tailored to meet
individual investment goals and risk profiles, through a flexible platform
designed to accommodate individual investment preferences. Principally through
DWR, the Individual Investor Group offers a broad range of securities and
investment products that are supported by MSDW's investment banking, research,
asset management, execution and operational resources. MSDW provided
securities and investment services to approximately 5.4 million client
accounts in the U.S. and had client assets of $659 billion at November 30,
2000.
MSDW's ichoice SM service platform for individual investors combines the
products and services offered by the Individual Investor Group with the
technological capabilities of online execution. MSDW provides its clients the
flexibility to select the particular financial service relationship that best
suits their needs, including a traditional full-service brokerage relationship
through a financial advisor, self-directed investing online or some
combination of both. MSDW also provides financial advisory services for high
net worth clients. MSDW provides a range of pricing options, including fee-
based pricing.
Products and Services
MSDW provides execution, trading and research services to its individual
clients for listed equity securities, OTC equity securities, options and ADRs.
MSDW also provides execution, trading and research services to individual
clients for a broad range of fixed income securities, including U.S.
government obligations, mortgage and other asset-backed securities, corporate
bonds, preferred stocks, municipal securities and certificates of deposit.
MSDW's financial advisors work together with the institutional fixed income
platform to provide mid-sized institutions with greater access to MSDW's
comprehensive products and research capabilities.
In addition, MSDW provides its clients with an extensive array of investment
and credit products and services, including mutual funds, unit investment
trusts ("UITs"), insurance products, financial planning, retirement planning,
personal trust and estate planning, tax planning, credit management and
account services. MSDW's Active Assets Account program permits clients to
consolidate their financial assets into a single account, invest in a wide
variety of investment products and automatically invest funds daily in a
variety of money market options, or in a designated bank account at Xxxxxx
Xxxxxxx Xxxx Xxxxxx Bank, Inc. ("MSDW Bank") insured by the Federal Deposit
Insurance Corporation ("FDIC"). The program also offers a debit card and a
checking account. BusinesScapeSM, a related financial service program, offers
similar services and features, including enhanced check writing privileges and
a commercial line of credit, to qualified business clients.
MSDW also offers customers a broad array of investment choices for
individual retirement planning and provides individual annuities and complete
defined contribution plan services for businesses, including 401(k) plans.
MSDW's investment consulting services business assists clients in analyzing
their investment objectives and in selecting investment advisory services
offered by affiliated and unaffiliated investment advisers. Through its
wholly-owned insurance agency subsidiaries, MSDW acts as a national general
agency for leading insurance carriers to meet the insurance and annuity needs
of individual investors. MSDW also offers trust and fiduciary services to both
individual and corporate clients, primarily trustee services for personal
trusts and tax-qualified retirement plans.
Private Wealth Management
The Private Wealth Management Group ("PWM") provides financial solutions to
individuals, families and foundations controlling significant pools of wealth.
PWM provides access to MSDW's trading capabilities, research and analytical
products and its securities underwritings. PWM financial advisors manage
specific financial asset classes and provide tailored global asset allocation
strategies for its clients. PWM also offers
6
certain private investors the opportunity to co-invest with MSDW in its
principal investing activities and specialized funds.
Online Capabilities
MSDW's online capabilities, including Xxxxxx Xxxxxxx Xxxx Xxxxxx Online,
permit customers to invest and trade through the Internet, through automated
telephone trading, wireless trading or through a registered representative.
MSDW provides a broad range of investment options online, including detailed
account information, real-time securities price quotes, graphs and portfolio
performance information and trade execution. Clients can also subscribe to
proprietary equity research reports and analysts' ratings. MSDW also offers
customers extended trading hours through MarketXT(TM), the ability to trade
U.S. treasury securities and certain municipal securities online every
weekday, 24 hours per day and, to qualified customers, access to initial
public offerings and other issues underwritten by MSDW. In addition, MSDW's
NetworthSM service aggregates, summarizes and delivers individual clients'
personal banking and investment account information in one convenient and
secure online location.
International Private Client Group
The International Private Client Group encompasses all of MSDW's activities
relating to individual securities, asset management and electronic commerce
for private investors located outside the U.S. These activities include mutual
fund offerings in Japan as well as financial advisory services in Japan and
non-Japan Asia. These activities also include private banking services and
other financial advisory services provided through Bank Xxxxxx Xxxxxxx XX,
MSDW's Swiss bank subsidiary, as well as MSDW's Societes d'investissement a
capital variable (SICAV) mutual funds based in Luxembourg. MSDW provides asset
management and brokerage services for individual investors in Europe through
Xxxxxx Xxxxxxx Xxxx Xxxxxx, X.X., S.A. (formerly AB Asesores) and its network
of financial advisors in Spain and Portugal, and its minority equity stake in
Area Banca, a retail bank with a network of financial advisors in Italy. In
December 2000, MSDW agreed to acquire Quilter Holdings Limited, a leading
U.K.-based investment management business providing segregated account
management and advisory services to private individuals, pension funds and
trusts. See also "Asset Management."
Research
MSDW's global research departments ("Research"), comprised of economists,
industry analysts and strategists, engage in a wide range of research
activities in the equity, fixed income and high-yield areas. Research produces
reports and studies on the economy, financial markets, portfolio strategy,
technical market analyses and industry developments. It analyzes worldwide
trends covering a broad range of industries and more than 2,300 individual
companies, half of which are located outside of the U.S. Research also
provides analyses and forecasts relating to economic and monetary developments
affecting matters such as interest rates, foreign currencies and securities
and economic trends. Research provides support for the sales and trading of
fixed income securities in the form of quantitative and credit analyses and
the development of research products that are distributed to MSDW's individual
and institutional clients. Research's numerous publications, such as the
"Investment Strategy Chartbook" and "The Competitive Edge", disseminate timely
data to both individual and institutional investors through a proprietary
database accessible via Client Link (one of MSDW's Internet technology
services) and through MSDW's financial advisors. In addition, Research
provides analytical support and publishes reports on mortgage-related
securities and the markets in which they are traded and does original research
on valuation techniques.
Other
MSDW also engages in other businesses, including acting as principal and
agent in aircraft finance transactions. Acting as principal, MSDW acquires
aircraft outright or under leases, some of which are financed by the issuance
of non-recourse debt in the securitization markets. During fiscal 2000, MSDW
acquired Ansett Worldwide Aviation Services, one of the world's leading
aircraft leasing groups, supplying new and used commercial jet aircraft to
airlines around the world and providing a range of aviation support services.
7
Competition and Regulation
Competition
MSDW encounters intense competition in all aspects of its Securities
business and competes directly in the U.S. and on a worldwide basis with other
securities and financial services firms. Among the principal competitive
factors affecting MSDW's Securities business are MSDW's reputation, the
quality of its professionals and other personnel, its products and services,
relative pricing and its capability in originating and marketing innovative
products and services. In recent years, MSDW has experienced increased
competition for qualified employees, including from companies engaged in
Internet-related businesses and private equity funds, in addition to the
traditional competition for employees from the financial services, insurance
and management consulting industries. MSDW's ability to sustain or improve its
competitive position will substantially depend on its ability to continue to
attract and retain qualified employees. MSDW's competitive position is also
affected by its ability to access capital at competitive rates (which is
generally dependent on MSDW's credit ratings) and to commit capital
efficiently, particularly in its capital-intensive investment banking and
sales, trading, financing and market-making activities.
In addition to competition from firms traditionally engaged in the financial
services business, MSDW has experienced increasing competition in recent years
from other sources, such as commercial banks, insurance companies, online
financial services providers, sponsors of mutual funds and other companies
offering financial services both in the U.S. and on a worldwide basis. The
financial services industry has continued to experience consolidation and
convergence as institutions involved in a broad range of financial services
industries, such as investment banking, brokerage, asset management,
commercial banking and insurance, have merged. Convergence is expected to
continue and could result in MSDW's competitors gaining greater capital and
other resources, such as a broader range of products and services and
geographic diversity. In addition, the passage of the Xxxxx-Xxxxx-Xxxxxx Act
of 1999 (the "GLBA") in the U.S. has allowed commercial banks, securities
firms and insurance firms to affiliate, which has accelerated consolidation
and led to increasing competition in markets traditionally dominated by
investment banks and retail securities firms. The complementary trends in the
financial services industry of consolidation and globalization also present
technological, risk management and other infrastructure challenges that
require effective resource allocation in order for MSDW to remain competitive.
Regulation
MSDW's Securities business is, and the securities, commodities and financial
services industries generally are, subject to extensive regulation in the U.S.
at both the federal and state levels, and internationally. MSDW is subject to
the rules and regulations of the various regulatory bodies that are charged
with safeguarding the integrity of the securities and other financial markets
and with protecting the interests of customers participating in those markets.
MS&Co. and DWR are registered as broker-dealers with the Securities and
Exchange Commission (the "SEC") and in all 50 states, the District of Columbia
and Puerto Rico, and are members of various self-regulatory organizations,
including the National Association of Securities Dealers, Inc. (the "NASD"),
and various securities exchanges, including the New York Stock Exchange, Inc.
(the "NYSE"). Broker-dealers are subject to regulation by securities
administrators in those states in which they conduct business. Broker-dealers
are also subject to regulations that cover all aspects of the securities
business, including sales and trading practices, use and safekeeping of
customers' funds and securities, capital structure, record-keeping and the
conduct of directors, officers and employees. The SEC, other governmental
regulatory authorities, including state securities commissions, and self-
regulatory organizations may institute administrative proceedings against
broker-dealers or members, which could result in censure, fine, the issuance
of cease-and-desist orders, the suspension or expulsion from the securities
industry of such broker-dealer or member or its officers or employees, or
other similar consequences. Occasionally, MSDW's subsidiaries have been
subject to investigations, other proceedings and fines relating to infractions
of various regulations relating to their activities as broker-dealers, none of
which, to date, has had a material adverse effect on MSDW or its business.
8
Margin lending by certain subsidiaries is subject to the margin rules of the
Federal Reserve Board restricting lending in connection with customer
purchases of securities, and such subsidiaries are also required by NASD and
NYSE rules to impose maintenance requirements on the amount of securities
contained in margin accounts. In many cases, MSDW's margin policies are more
stringent than these rules.
As futures commission merchants, MS&Co. and DWR are registered with the
Commodity Futures Trading Commission (the "CFTC"), and their activities in the
futures and options-on-futures markets are subject to regulation by the CFTC
and various domestic boards of trade and other commodity exchanges. Certain
subsidiaries of MSDW are registered with the CFTC as commodity trading
advisers and/or commodity pool operators. MSDW's futures and options-on-
futures business is also regulated by the National Futures Association, a not-
for-profit membership corporation that the CFTC has designated as a registered
futures association, and of which MS&Co. and DWR are members.
Certain of MSDW's government securities activities are conducted through
Xxxxxx Xxxxxxx Market Products Inc., a member of the NASD registered as a
government securities broker-dealer with the SEC and in certain states. The
Department of the Treasury has promulgated regulations concerning, among other
things, capital adequacy, custody and use of government securities and
transfers and control of government securities subject to repurchase
transactions. The rules of the Municipal Securities Rulemaking Board, which
are enforced by the NASD, govern the municipal securities activities of MSDW.
MSDW's Securities business is also subject to extensive regulation by
various non-U.S. governments, securities exchanges, central banks and
regulatory bodies, especially in those jurisdictions in which MSDW maintains
an office. For example, the Financial Services Authority, the Securities and
Futures Authority and a number of exchanges, including the London Stock
Exchange and the London International Financial Futures and Options Exchange,
regulate MSDW's Securities business in the U.K.; the Deutsche Borse AG, the
Bundesaufsichtsamt fur das Kreditwesen (the Federal Banking Supervisory
Authority) and Bundesaufsichtsamt fur den Wertpapierhandel (the Federal
Securities Trading Supervisory Authority), among others, regulate MSDW's
activities in the Federal Republic of Germany; the Financial Services Agency,
the Japanese Ministry of Finance, the Bank of Japan and the Japanese
Securities Dealers Association and several Japanese securities and futures
exchanges, including the Tokyo Stock Exchange, the Osaka Securities Exchange
and the Tokyo International Financial Futures Exchange, regulate MSDW's
Securities business in Japan; the Hong Kong Securities and Futures Commission,
The Stock Exchange of Hong Kong Limited and the Hong Kong Futures Exchange
Limited regulate MSDW's Securities operations in Hong Kong; and the Monetary
Authority of Singapore and the Singapore Exchange Derivatives Trading Limited
regulate MSDW's business in Singapore.
As registered broker-dealers and member firms of the NYSE, certain
subsidiaries of MSDW, including MS&Co. and DWR, are subject to the SEC's net
capital rule, and, as futures commission merchants, MS&Co. and DWR are subject
to the net capital requirements of the CFTC and various commodity exchanges.
Many non-U.S. securities exchanges and regulatory authorities also either have
imposed or are imposing rules relating to capital requirements that apply to
MSDW's subsidiaries. These rules, which specify minimum capital requirements,
are designed to measure general financial integrity and liquidity and require
that at least a minimum amount of assets be kept in relatively liquid form.
Compliance with the capital requirements may limit MSDW's operations that
require the intensive use of capital, such as underwriting, principal
investing, trading activities and the financing of customer account balances.
Such requirements also restrict MSDW's ability to withdraw capital from its
subsidiaries, which in turn may limit MSDW's ability to pay dividends, repay
debt or redeem or purchase shares of its outstanding capital stock. A change
in such rules or the imposition of new rules affecting the scope, coverage,
calculation or amount of capital requirements, or a significant operating loss
or any unusually large charge against capital, could adversely affect MSDW's
ability to pay dividends or to expand or maintain present business levels.
New legislation or regulation, including any relating to the activities of
affiliates of broker-dealers, changes in rules promulgated by the SEC or other
U.S. or international governmental, regulatory or self-regulatory authorities
(such as changes to the U.S. Internal Revenue Code and related regulations or
rules promulgated by the Financial Accounting Standards Board) or changes in
the interpretation or enforcement of existing laws and regulations, may
materially adversely affect the financial condition or results of operation of
MSDW.
9
ASSET MANAGEMENT
At November 30, 2000, MSDW had $502 billion of assets under management or
supervision (which includes certain assets managed in the Securities
business). MSDW manages and administers a wide range of asset management
products for individual and institutional investors through MSDW Advisors, Xxx
Xxxxxx, MSDW Investment Management and Xxxxxx Xxxxxxxx.
Xxxxxx Xxxxxxx Xxxx Xxxxxx Advisors
MSDW Advisors develops, markets and manages a broad spectrum of proprietary
open- and closed-end mutual funds, and provides professional money management
services on a customized basis to affluent individuals, institutional
investors and retirement plan sponsors. MSDW Advisors' assets under management
include equities, taxable and tax-exempt fixed income securities and money
market instruments. Xxxxxx Xxxxxxx Xxxx Xxxxxx Distributors Inc., a wholly-
owned subsidiary of MSDW and a registered broker-dealer ("MSDW Distributors"),
distributes shares of MSDW Advisors products that are open-end mutual funds
and has entered into agreements with DWR and other selected broker-dealers for
the marketing and distribution of such products.
Xxx Xxxxxx Investments
Xxx Xxxxxx sponsors and markets open- and closed-end mutual funds for
individual and institutional shareholders and provides ongoing evaluation and
credit review for equity and fixed income UITs. Mutual fund offerings include
a broad range of fixed-income (taxable and tax-exempt) and equity products,
some of which are focused domestically and others with international scope.
Sponsored UITs include portfolios of equity securities and nationally
diversified and single-state insured and uninsured municipal securities and,
depending on market demand, also include portfolios of government securities,
insured and uninsured corporate debt securities and global fixed income
securities. Xxx Xxxxxx distributes its investment products through a large and
diversified network of unaffiliated national and regional broker-dealers,
commercial banks and thrifts, insurance companies and their affiliated broker-
dealers and financial planners ("retail distribution firms"), as well as
MSDW's financial advisors. Xxx Xxxxxx has preferred distribution relationships
with several unaffiliated retail distributors and a relatively small number of
retail distribution firms account for a substantial portion of sales of Xxx
Xxxxxx products.
Xxxxxx Xxxxxxx Xxxx Xxxxxx Investment Management and Xxxxxx Xxxxxxxx &
Xxxxxxxx
MSDW Investment Management and Xxxxxx Xxxxxxxx primarily manage financial
assets for institutions around the world, including pension funds,
corporations, non-profit organizations and governmental agencies. They offer a
full range of equity, fixed income and alternative investments in developed
and emerging markets, and a variety of investment styles, including value,
growth and blended; active and passive management; and diversified and
concentrated portfolios. Products are available through separate account
management, pooled vehicles, U.S. and non-U.S. mutual funds and variable
annuities. They also offer a broad range of fiduciary services for pension
funds and trusts. MSDW distributes certain domestic and international
investment products advised or sub-advised by MSDW Investment Management and
Xxxxxx Xxxxxxxx through the distribution networks of MSDW Advisors and Xxx
Xxxxxx and other non-proprietary distribution networks. See also
"International Private Client Group."
Competition and Regulation
Competition
MSDW's Asset Management business competes in the highly competitive
investment management industry, in which approximately 8,150 open-end funds
held over $6.8 trillion in assets as of November 30, 2000. A number of factors
affect competition in the sale of mutual funds, including investment
objectives and performance, advertising and sales promotion efforts, fee
levels, distribution channels and types and quality of services offered. In
addition to fund products offered by other broker-dealers, the funds offered
by MSDW compete with funds sold directly by investment management firms and
other providers, as well as with other investment alternatives sold by such
companies and by other financial institutions.
10
Regulation
MSDW and certain subsidiaries, including MS&Co., DWR, MSDW Advisors and
those related to Xxx Xxxxxx, MSDW Investment Management and Xxxxxx Xxxxxxxx,
are registered as investment advisers with the SEC and in certain states. Many
aspects of MSDW's investment advisory business are subject to federal and
state laws and regulations primarily intended to benefit the investment
product holder. These laws and regulations generally grant supervisory
agencies and bodies broad administrative powers, including the power to limit
or restrict MSDW from carrying on its investment advisory business in the
event that it fails to comply with such laws and regulations. Sanctions that
may be imposed for such failure include the suspension of individual
employees, limitations on MSDW's engaging in the investment advisory business
for specified periods of time, the revocation of registrations, other censures
and fines.
MSDW's Asset Management business is also subject to regulation outside the
U.S. For example, the Investment Management Regulatory Organization Limited
regulates MSDW's business in the U.K.; the Japanese Ministry of Finance and
the Japan Securities Investment Advisors Association regulates MSDW's business
in Japan; the Securities and Exchange Board of India regulates MSDW's business
in India; and the Monetary Authority of Singapore regulates MSDW's business in
Singapore.
Xxxxxx Xxxxxxx Xxxx Xxxxxx Trust FSB ("MSDWT"), a wholly-owned subsidiary of
MSDW, is a federally chartered savings bank subject to comprehensive
regulation and periodic examination by the federal Office of Thrift
Supervision ("OTS") and by the FDIC. MSDWT is also a registered transfer agent
and shareholder servicing agent subject to regulation and examination in such
capacity by the SEC. As a result of its ownership of MSDWT, MSDW is registered
with the OTS as a unitary savings and loan holding company ("SLHC") and
subject to regulation and examination by the OTS as a SLHC.
11
CREDIT SERVICES
Based on its approximately 42.6 million general purpose credit card accounts
as of November 30, 2000, MSDW, through its Credit Services business, is one of
the largest single issuers of general purpose credit cards in the U.S. MSDW's
Credit Services business includes DFS, which operates Credit Services'
proprietary general purpose credit card business, and its Discover Business
Services, MSDW's proprietary merchant and cash access network.
Credit Cards and Services
DFS offers general purpose credit cards designed to appeal to different
market segments of consumers for use through Discover Business Services. DFS
offers several brands of proprietary cards, including Discover Card, Discover
Platinum, the MSDW Card (offered in the U.K. on the Europay/MasterCard
network), as well as affinity cards. DFS offers cardmembers various products
and financial services, including home loans, credit insurance coverage and
auto insurance products. Cardmembers are also offered certificates of deposit
and money market accounts as well as the ability to transfer balances from
other credit sources.
DFS also offers cardmembers numerous customer services, including many
available online. For instance, cardmembers may register their account online
with the Discover Card Account Center, which offers Discover Inter@ctive SM, a
menu of free e-mail notifications that regularly inform cardmembers about the
status of their accounts, including reminders that a cardmember's credit limit
is approaching or that a minimum payment is due. Cardmembers may also view
detailed account information online, such as recent transactions and account
payments. Cardmembers may pay their Discover Card bills online via the
SmartCheck SM payment option at no cost and receive exclusive discounts and
special Cashback Bonus(R) awards by shopping online at the Internet
ShopCenter SM. In addition, the Discover desksh.p SM 2.0 virtual credit card
enables cardmembers to use a single use credit card number (a unique credit
card number used for purchases at a single Web site) for online purchases so
that the cardmembers never have to reveal their actual card number online. As
of November 30, 2000, DFS had more than 4.5 million cardmembers registered on
the Discover Card Account Center.
Merchants
Discover Card and Discover Platinum, as well as DFS's other proprietary
general purpose credit cards (exclusive of the MSDW Card), are accepted only
by merchants that are members of the Discover Business Services network. Since
its establishment in 1986, the Discover Business Services network has expanded
rapidly and is the largest independent credit card network in the U.S.,
consisting of approximately 4 million merchant and cash access locations
accepting credit cards carrying the Discover logo.
DFS operates both the issuing and acquiring businesses in the U.S. and
accordingly retains the entire merchant fee paid for transactions effected
through the Discover Business Services network. Because of its independence
from the bankcard associations, DFS has the flexibility to provide customized
programs to its merchants in such areas as processing and the exchange of
business surplus online and to otherwise tailor program terms to meet specific
merchant needs. DFS employs its own national sales and support force, as well
as some independent sales agents, to increase and maintain its merchant base.
In addition, DFS conducts telemarketing operations for the purpose of
acquiring merchant business.
Marketing
DFS, operating through Discover Bank (formerly Greenwood Trust Company) and
other domestic banking subsidiaries that issue its proprietary general purpose
credit cards, is distinguishable from credit card issuers that are members of
bankcard associations because it directly controls the brand image, features,
service level and pricing of the Discover Card and its other U.S. proprietary
general purpose credit cards to both cardmembers and merchants. In contrast,
bankcard association credit card issuers compete directly with other issuers
using the same brands and sharing common processes. Because DFS manages all
aspects of both cardmember and
12
merchant relationships with respect to its proprietary credit card programs,
it can determine and promote its advertising campaign on a consistent,
nationwide basis and control the campaign's content, timing and promotional
features.
DFS promotes its proprietary general purpose credit cards through the use of
different and distinctive features that are designed to appeal to different
consumer bases. For instance, Discover Card and Discover Platinum offer the
Cashback Bonus award and no annual fee. Pursuant to the Cashback Bonus award
program, each year DFS pays cardmembers up to one percent of their purchase
amounts based upon their annual level and type of purchases. The Cashback
Bonus award is remitted to cardmembers in the form of a check or as a credit
to their accounts. If the Cashback Bonus award is five dollars or more,
Discover Platinum offers cardmembers the opportunity to exchange their
Cashback Bonus award checks for certificates from participating merchants
valued at double the check amounts.
Credit
Credit reviews are conducted to establish that all cardmembers meet
standards of ability and willingness to pay. Applications that are not pre-
selected are evaluated by using a credit scoring system (a statistical
evaluation model) based on information provided by applicants and by the
credit bureaus. Applications not approved under the credit scoring system may
be selectively reviewed and approved by DFS's credit analysts.
Applicants receiving pre-selected solicitations must satisfy DFS's specified
criteria. All recipients of pre-selected solicitations have been pre-screened
through credit bureaus utilizing industry and customized models. Pre-screening
is a process by which an independent credit reporting agency identifies
individuals satisfying creditworthiness criteria supplied by DFS (in the form
of a point scoring model or other screening factors) that are intended to
provide a general indication, based on available information, of such person's
ability and willingness to pay their financial obligations. Recipients who
respond to DFS's pre-selected solicitations are post-screened prior to
enrollment in order to confirm continued satisfaction of DFS's
creditworthiness criteria.
Each cardmember's credit line is reviewed at least annually and may be
reviewed more frequently if requested by the cardmember or if DFS deems more
frequent review appropriate. Such reviews include scoring the cardmember's
payment behavior on the applicable account as well as reviewing the
cardmember's credit bureau record. Based on an account review the cardmember's
credit line may be raised or lowered or the account may be closed. In
addition, DFS, on a portfolio basis, performs periodic monitoring and review
of consumer behavior and risk profiles.
Operations
DFS performs the functions required to service and operate its proprietary
cards' accounts either by itself or through agreements with third parties.
These functions include new account solicitation, application processing, new
account fulfillment, transaction authorization and processing, cardmember
billing, payment processing, fraud prevention and investigation, cardmember
services and collection of delinquent accounts. DFS maintains several
operations centers throughout the U.S. and one in Scotland. DFS's operations
are also supported by systems at computer centers operated by an unaffiliated
communication services provider.
Competition and Regulation
Competition
MSDW's Credit Services business competes in the highly competitive credit
card industry. The credit card market includes other bank-issued credit cards
(the vast majority of which bear the MasterCard or Visa servicemark) and
charge cards and credit cards issued by travel and entertainment companies.
Competition centers on merchant acceptance, account acquisition and customer
utilization. Merchant acceptance is based on both competitive transaction
pricing and the volume and usage of credit cards in circulation. Account and
13
customer utilization are driven by the offering of credit cards with
competitive and appealing features, such as no annual fees, low introductory
interest rates and other customized features targeting specific consumer
groups. The credit card industry has seen increased use of advertising,
targeted marketing and pricing competition in interest rates, annual fees and
reward programs. More recently, issuers have increased their efforts to
attract balances from competing sources of credit via low-priced balance
transfer programs.
Regulation
MSDW conducts portions of its Credit Services business in the U.S. through
various wholly-owned indirect subsidiaries that are banking institutions.
Discover Bank and Bank of New Castle are state banks chartered under the laws
of the State of Delaware, and MSDW Bank is an industrial loan company
chartered under the laws of the State of Utah (each a "Domestic Bank" and,
collectively, the "Domestic Banks"). Each of the Domestic Banks has its
deposits insured by the FDIC, pays FDIC assessments and is subject to
comprehensive regulation and periodic examination by the state banking
commissioner of the state in which it is chartered and by the FDIC.
Generally, a company that controls a "bank," as defined in the Bank Holding
Company Act of 1956 (the "BHCA"), is required to register as a bank holding
company and is subject to regulation as a bank holding company by the Board of
Governors of the Federal Reserve System. MSDW is permitted to own Bank of
New Castle and MSDW Bank without registering as a bank holding company because
neither of these institutions is considered to be a "bank" under the BHCA.
Pursuant to the BHCA (as amended by the Competitive Equality Banking Act of
1987 (the "CEBA") and more recently by the GLBA), Discover Bank may engage in
either commercial lending or taking demand deposits (but not both), in order
for MSDW to maintain its non-bank holding company status under the grandfather
provisions of the CEBA amendments to the BHCA.
Federal and state consumer protection laws and regulations extensively
regulate the relationships among cardholders and credit card issuers. Under
federal law, each of the Domestic Banks may charge interest at the rate
allowed by the law of the state in which it is located and export such
interest rate to all other states. The states where the Domestic Banks are
domiciled do not limit the amount of interest that may be charged on loans of
the types offered by the Domestic Banks. Therefore, each of the Domestic Banks
may export interest rates pursuant to federal law. The application of federal
and state bankruptcy and debtor relief laws affect MSDW to the extent such
laws result in any loans being charged off as uncollectible.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), the federal bank regulatory agencies are required to take "prompt
corrective action" in respect of banks that do not meet minimum capital
requirements, and certain restrictions are imposed upon banks that meet
certain capital requirements but are not "well capitalized" for purposes of
FDICIA. A bank that is not well capitalized, as defined for purposes of
FDICIA, is, among other consequences, generally prohibited from accepting
brokered deposits and offering interest rates on any deposits significantly
higher than the prevailing rate in its normal market area or nationally
(depending upon where the deposits are solicited). Discover Bank currently
uses brokered deposits as a funding source and if it were not able to do so,
its funding costs could increase.
Certain acquisitions of MSDW's common stock may be subject to regulatory
approval and notice under federal and state banking law. In addition, Discover
Bank would no longer qualify for grandfather rights under CEBA (as amended by
the GLBA) if direct or indirect control of Discover Bank were transferred to
an unaffiliated third party. In that event, the third party would have to
operate in a manner permissible for a bank holding company under the BHCA (as
amended by the GLBA).
Xxxxxx Xxxxxxx Xxxx Xxxxxx Bank Limited ("MSDW Bank Limited"), MSDW's
chartered bank in the U.K., is governed primarily by the U.K.'s Banking Xxx
0000. MSDW Bank Limited is subject to regulation related to capital adequacy,
consumer protection and deposit protection. The activities of MSDW Bank
Limited are supervised by the Financial Services Authority, which conducts
periodic examinations of its operations and records, and by the Office of Fair
Trading in relation to consumer credit activities.
14
Item 2. Properties*
MSDW owns its executive offices, located at 0000 Xxxxxxxx, Xxx Xxxx, Xxx
Xxxx, where it occupies approximately 958,000 square feet as its New York
headquarters. MSDW also owns a 600,000 square foot building in Riverwoods,
Illinois that houses Credit Services' executive offices and an adjacent 44
acre parcel that is currently planned for further office development.
In 1999, construction began on a 1,100,000 square foot office tower at 000
Xxxxxxx Xxxxxx, Xxx Xxxx, Xxx Xxxx, which MSDW will own. MSDW leases the land
under the building pursuant to a 99-year ground lease. MSDW intends to occupy
the building upon project completion, which is anticipated in fiscal 2002.
MSDW leases 864,000 square feet at Two World Trade Center, New York, New
York, pursuant to a lease expiring on May 31, 2006, and also occupies space
aggregating approximately 2,000,000 square feet at various other locations in
New York City under leases expiring between 2001 and 2013. In addition, MSDW
leases space aggregating approximately 417,000 square feet in Brooklyn, New
York under a lease expiring in 2013.
MSDW's London headquarters are located at 00 Xxxxx Xxxxxx, Xxxxxx Wharf, and
occupy approximately 641,000 square feet (inclusive of common areas). MSDW
owns the ground lease obligation and the freehold interest in the land and the
building. MSDW also leases approximately 350,000 square feet at 00 Xxxxx
Xxxxxx, Xxxxxx Wharf, under a lease arrangement expiring in 2020. In fiscal
2000, MSDW committed to leasing for 25 years an aggregate of approximately
677,000 square feet in two buildings currently under construction at Canary
Wharf. The leases are expected to commence in 2001 and 2003.
MSDW's Tokyo headquarters are located in Sapporo's Yebisu Garden Place,
Ebisu, Shibuya-ku, where MSDW occupies approximately 287,058 square feet of
office space under a lease arrangement expiring in 2002, but renewable at
MSDW's option in two-year increments.
MSDW's subsidiaries have offices, operations and processing centers and
warehouse facilities located throughout the U.S., and certain subsidiaries
maintain offices and other facilities in international locations. MSDW's
properties that are not owned are leased on terms and for durations that are
reflective of commercial standards in the communities where these properties
are located. Facilities owned or occupied by MSDW and its subsidiaries are
believed to be adequate for the purposes for which they are currently used and
are well maintained.
Item 3. Legal Proceedings
MSDW is involved in the following litigation matters:
I. Term Trust Class Actions. A putative class action, Xxxxxx X. Xxxxxx, et
al. v. Xxxx Xxxxxx Xxxxxxxx Inc. et al. (the "Keeley Action"), was commenced
in the California Superior Court, Orange County, on October 27, 1994 and later
consolidated with three similar class actions. Defendants are MSDW, DWR, Xxxx
Xxxxxx Distributors, Xxxx Xxxxxx InterCapital Inc., Xxxx Xxxxxx Services
Company Inc., TCW Management Co., Trust Company of the West, TCW Asset
Management Co., Inc., TCW Funds Management, Inc. and eight individuals,
including two DWR employees. Plaintiffs allege breach of fiduciary duty,
unjust enrichment, fraud, deceit and violation of the California Corporation
Code in the marketing and selling of the TCW/DW Term Trusts 2000, 2002 and
2003. Plaintiffs seek unspecified compensatory and punitive damages. In the
Keeley Action, defendants' motions for judgment on the pleadings were denied
on June 23, 1997. On June 1, 1998, the plaintiff's motion to certify the class
was granted as to a California statewide class and denied as to a nationwide
class. On December 14, 2000, the parties announced an agreement, subject to
court approval, to settle the matter. On October 13, 1998, three separate
state court actions were filed in New Jersey, New York and Florida. The
defendants' motions to dismiss the New Jersey and New York actions were
granted on February 2, 2000 and May 3, 2000, respectively, and the dismissals
were not appealed. The Florida action was removed to the U.S. District Court
for the Middle District of Florida on November 10, 1998 and was remanded to
state court by order dated October 2, 2000.
--------
* The indicated total aggregate square footage leased by MSDW does not include
space occupied by MSDW's securities branch offices.
15
On November 20, 2000 the Department of Enforcement of the National
Association of Securities Dealers Regulation, Inc. ("NASDR") issued a
complaint against DWR and two individual respondents alleging violations of
certain NASDR Conduct Rules, including misrepresentation and omissions, in
connection with the internal marketing relating to the sale of three TCW/DW
Term Trusts in 1992 and 1993. The complaint generally requests sanctions,
disgorgement and costs that are not specified in detail. All three respondents
filed answers to the complaint denying all material allegations on December
18, 2000.
II. In re Xxxxxxx Xxxxx, et al. Securities Litigation. On January 19, 1995,
a putative class action was filed in the U.S. District Court for the District
of New Jersey on behalf of all persons who placed market orders to purchase or
sell securities listed on the National Association of Securities Dealers
Automated Quotation System ("NASDAQ") with DWR between November 4, 1992 and
November 4, 1994. The complaint, consolidated with another action against
other brokerage firms, seeks unspecified damages and alleges that DWR failed
to provide best execution of customer market orders for NASDAQ securities. The
complaint asserts claims for violations of Section 10(b) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and state law
claims for breach of fiduciary duty and unjust enrichment. On December 15,
0000, xxx xxxxxxxx xxxxx granted summary judgment in favor of DWR and, on June
19, 1997, a three-judge panel of the U.S. Court of Appeals for the Third
Circuit affirmed. On January 30, 1998, the full Court of Appeals, sitting in
banc, reversed and remanded the action to the district court for further
proceedings. On April 30, 1998, a petition for a writ of certiorari to the
U.S. Supreme Court was filed by the defendants. On June 12, 1998, plaintiffs
filed a motion for leave to file an amended complaint to extend the end date
for the class period from November 4, 1994 to August 28, 1996 and to name new
class representatives. On July 21, 1998, the Magistrate granted the
plaintiffs' motion to file an amended complaint. Defendants have appealed that
ruling to the district court judge. On October 5, 1998, the U.S. Supreme Court
denied the petition for certiorari. On November 8, 0000, xxx xxxxxxxx xxxxx
denied plaintiffs' motion for class certification. The U.S. Court of Appeals
for the Third Circuit agreed to hear plaintiffs' appeal of the denial of class
certification by order dated May 12, 2000.
III. Penalty Bid Litigation. On or about August 21, 1998, a purported class
action complaint, Xxxxxxxx, et al. x. Xxxxxxx Xxxxx Xxxxxx, et al., was filed
in the U.S. District Court for the Southern District of New York against MSDW
and nine other underwriters of securities. An amended complaint dated February
15, 1999, was filed against MSDW and sixteen other underwriters of securities.
The amended plaintiff class purports to consist of all retail brokerage
customers who purchased securities in public offerings from defendants and
their alleged co-conspirators at artificially inflated prices. The amended
complaint alleges that defendants and their co-conspirators engaged in anti-
competitive activity with respect to the distribution of securities in public
offerings by agreeing (i) to discourage retail customers from "flipping" or
selling shares purchased in public offerings prior to the expiration of a
purported "retail restricted period" (a period alleged to have been
arbitrarily set by the syndicate manager during which restraints on retail
accounts are imposed), and/or (ii) to penalize retail customers who "flipped,"
and/or (iii) otherwise to prevent retail customers from "flipping." The
amended complaint also alleges that similar restraints were not imposed on
institutional purchasers of shares in public offerings. The amended complaint
alleges violations of Section 1 of the Xxxxxxx Act and breach of fiduciary
duty, and seeks compensatory, treble and punitive damages in unspecified
amounts, injunctive relief, costs and expenses, including attorneys',
accountants' and experts' fees. On December 7, 2000, defendants' motion to
dismiss was granted with prejudice. On January 22, 2001, plaintiffs' motion
for reconsideration was denied.
Another purported class action, captioned Xxxxx x. Xxxxxxx Xxxxx & Co.,
Inc., et al., was filed on or about August 17, 1998 in California Superior
Court, San Francisco County, against Xxxxxxx Xxxxx & Co., Inc., Xxxxx Xxxxxx
Group Incorporated, MSDW, Travelers Group Inc., Xxxx Xxxxx Inc., X.X. Xxxxxx &
Co., Inc. and The Bear Xxxxxxx Companies Inc. The complaint alleges that
defendants sold the stock of public companies to investors in public offerings
without disclosing the existence of restrictions on "flipping" and serious
conflicts of interest with investors resulting from financial and other
penalties imposed on brokers and clients for "flipping." The complaint also
alleges that similar restrictions were not imposed on larger institutional
purchasers of stock in those offerings. The complaint asserts claims for
unfair competition and false advertising under various sections of the
California Business and Professions Code (the "Business Code"), negligent
16
misrepresentations under the California Civil Code and unfair, fraudulent and
unlawful business practices under the Business Code. The complaint seeks
injunctive relief and an award of costs and expenses, including attorneys' and
experts' fees. On September 15, 1998, the action was removed to the U.S.
District Court for the Northern District of California. On October 30, 1998,
defendants filed a motion to dismiss the complaint. On August 23, 1999, the
court denied plaintiffs' motion to remand the action and granted a motion
filed by certain defendants to dismiss the complaint on the grounds of
preemption. On September 23, 1999, plaintiffs appealed the decision to the
U.S. Court of Appeals for the Ninth Circuit.
IV. IPO Fee Litigation. On March 15, 1999, a consolidated amended complaint
(consolidating three purported class action complaints filed in November and
December of 1998 in the U.S. District Court for the Southern District of New
York), captioned In re Public Offering Fee Antitrust Litigation, was filed
against MSDW and 24 other underwriters in the U.S. District Court for the
Southern District of New York. The consolidated amended complaint alleges that
defendants conspired to fix the "fee" paid by purported class members to buy
and sell IPO securities of U.S. companies by invariably setting the
underwriters' spread at 7%, particularly in issuances of $20 to $80 million,
in violation of Section 1 of the Xxxxxxx Act. The consolidated amended
complaint seeks treble damages and injunctive relief, as well as costs,
including reasonable attorneys' fees. On April 29, 1999, defendants filed a
motion to dismiss the amended complaint. On July 21, 2000, plaintiffs filed a
motion to amend the complaint to add an issuer plaintiff.
Two additional purported class actions were filed by issuer plaintiffs
against MSDW and other underwriters, captioned CHS Electronics, Inc. v. Credit
Suisse First Boston Corporation, et al. (U.S. District Court for the Southern
District of Florida on or about August 3, 2000) and Xxxxxxx x. Xxxxxxx Xxxxx
Xxxxxx Inc., et al. (U.S. District Court for the Southern District of New York
on or about October 13, 2000), respectively. By court order, both actions were
consolidated with In re Public Offering Fee Antitrust Litigation on January
12, 2001.
On February 9, 2001, the court in In re Public Offering Fee Antitrust
Litigation dismissed the consolidated amended complaint with prejudice and
also denied plaintiffs' motion to further amend the complaint to add an issuer
plaintiff. The CHS Electronics and Xxxxxxx actions were not affected by this
decision.
V. Other. In addition to the matters described above, MSDW, including MS&Co.
and DWR, has been named from time to time as a defendant in various legal
actions, including arbitrations, arising in connection with its activities as
a global diversified financial services institution, certain of which include
large claims for punitive damages. MSDW, including MS&Co. and DWR, is also
involved, from time to time, in investigations and proceedings by governmental
and self-regulatory agencies. Some of these legal actions, investigations and
proceedings may result in adverse judgments, penalties or fines.
In view of the inherent difficulty of predicting the outcome of such
matters, particularly in cases, such as some of those described above in which
substantial damages are sought, MSDW cannot state what the eventual outcome of
pending matters will be. MSDW is contesting the allegations made in each
pending matter and believes, based on current knowledge and after consultation
with counsel, that the outcome of such matters will not have a material
adverse effect on the consolidated financial condition of MSDW, but may be
material to MSDW's operating results for any particular period, depending on
the level of MSDW's income for such period.
17
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information concerning executive
officers of MSDW (all of whom are members of MSDW's Management Committee) as
of February 16, 2001.
Name and Age Present Title and Principal Occupation
------------ --------------------------------------
Xxxxxx X. Xxxxxxx, 57...... Chairman of the Board of Directors and Chief
Executive Officer of MSDW since the Merger. Xx.
Xxxxxxx was the Chairman of the Board of Directors
and Chief Executive Officer of Xxxx Xxxxxx
Discover from 1986 until the Merger. He is a
trustee or director of approximately 100
registered investment companies for which MSDW
Advisors serves as investment manager or
investment adviser. Xx. Xxxxxxx is also a director
of AMR Corporation.
Xxxx X. Xxxx, 56*.......... President, Chief Operating Officer and Director of
MSDW since the Merger. Xx. Xxxx was the President
of Xxxxxx Xxxxxxx from June 1993 until the Merger.
He was a Director and a Managing Director of
Xxxxxx Xxxxxxx from December 1987 until the
Merger.
Xxxxx X. Xxxxx-Xxxxxx, 45.. Head of MSDW's Worldwide Investment Banking
Division since September 2000. Xx. Xxxxx-Xxxxxx
was deputy head of MSDW's Worldwide Investment
Banking Division from 1997 until September 2000
and was deputy head and then head of Xxxxxx
Xxxxxxx'x Corporate Finance Department from June
1995 until the Merger. He has been a Managing
Director of MS&Co. since 1991.
Xxxxxxx X. Xxxxxxxx, 36*... Executive Vice President and Chief Strategic and
Administrative Officer of MSDW since June 2000.
Xx. Xxxxxxxx joined Xxxxxx Xxxxxxx in 1986 and has
been a Managing Director of MS&Co. since 1998.
Xxx Xxxx, 46............... Head of MSDW's Worldwide Fixed Income Division
since September 2000. Xx. Xxxx was head of MSDW's
Foreign Exchange Division from August 1993 until
September 2000. Xx. Xxxx has been a Managing
Director of MS&Co. since 1990.
Xxxx X. Xxxxxx, 44......... Head of MSDW's Worldwide Institutional Equity
Division since September 2000. Xx. Xxxxxx has been
a Managing Director of MS&Co. since January 1990.
Xxxxxx X. Xxxxx, Xx., 63... Executive Vice President, Chief Legal Officer and
Secretary of MSDW since December 1999. Prior to
joining MSDW, Xx. Xxxxx had been a partner at the
law firm of Xxxxxxxx & Xxxxx from 1971 and a
member of its management committee from 1981 until
1998.
Xxxxxxxx X. Xxxxx, 47...... President and Chief Operating Officer of the Asset
Management Division since December 1998. Xx. Xxxxx
has been President and Director of MSDW Advisors
since April 1997 and its Chief Executive Officer
since June 1998. He was Executive Vice President
and Chief Administrative Officer of Xxxx Xxxxxx
Discover from 1994 until the Merger. He is
President of approximately 100 registered
investment companies for which MSDW Advisors
serves as investment manager or investment
adviser. He is also a trustee or director of
approximately 25 registered investment companies
for which Xxx Xxxxxx (or a subsidiary thereof)
serves as investment manager or investment
adviser.
18
Name and Age Present Title and Principal Occupation
------------ --------------------------------------
Xxxxx X. Xxxxx, 39....... President and Chief Operating Officer of Discover
Financial Services and Chairman of Discover Bank
since September 1998. Xx. Xxxxx was a senior
executive from 1992 until 1998 at MBNA America Bank
where his last position was Vice Chairman.
Xxxxxxx X. Xxxxxxxx, 53.. Co-President and Chief Operating Officer of MSDW's
Institutional Securities Group since September 2000
and Chairman of Xxxxxx Xxxxxxx International
Incorporated since January 2001. Xx. Xxxxxxxx was
deputy head of MSDW's Institutional Securities Group
from December 1997 until September 2000.
Xx. Xxxxxxxx has been a Director and Vice Chairman
of MS&Co. since December 1997 and a Managing
Director of MS&Co. since 1988.
Xxxxxx X. Xxxxxx, 44..... Co-President and Chief Operating Officer of MSDW's
Institutional Securities Group since September 2000.
Xx. Xxxxxx was head of MSDW's Worldwide
Institutional Equity Division from the Merger until
September 2000. Xx. Xxxxxx was head of Xxxxxx
Xxxxxxx'x Equity Division from January 1997 until
the Merger and was head of Xxxxxx Xxxxxxx'x Equity
Derivatives business from May 1994 until December
1996. Xx. Xxxxxx has been a Managing Director of
MS&Co. since January 1990.
Xxxxxx X. Xxxxxxx, 59.... Chairman of MSDW's Institutional Securities Group
since September 2000. Xx. Xxxxxxx was head of MSDW's
Worldwide Investment Banking Division from the
Merger until September 2000. He was head of Xxxxxx
Xxxxxxx'x Investment Banking Division from January
1997 until the Merger and was head of Xxxxxx
Xxxxxxx'x Corporate Finance Department from May 1995
until December 1996. He has been a Director of
MS&Co. since March 1994 and a Managing Director of
MS&Co. since November 1993.
Xxxx X. Xxxxxxxx, 48..... President and Chief Operating Officer of MSDW's
Individual Investor Group since June 2000. Xx.
Xxxxxxxx was Executive Vice President and Chief
Strategic and Administrative Officer of MSDW from
June 1998 until June 2000. Xx. Xxxxxxxx was head of
Corporate and Strategic Planning for MSDW from the
Merger until June 1998. Xx. Xxxxxxxx was Executive
Vice President and Director of Corporate Finance for
Xxxx Xxxxxx Discover from 1991 until the Merger.
Xxxxxx X. Xxxxx, 55*..... Executive Vice President and Chief Financial Officer
of MSDW since the Merger. Xx. Xxxxx was the head of
Xxxxxx Xxxxxxx'x Investment Banking Division from
1994 to 1996 and has been a Director and a Managing
Director of MS&Co. since 1979.
--------
* Xx. Xxxx resigned from MSDW and the Board of Directors, effective March 21,
2001. Xx. Xxxxx has been named to succeed Xx. Xxxx as President, Chief
Operating Officer and a member of the Board (term expiring in 2003) and Xx.
Xxxxxxxx has been named to succeed Xx. Xxxxx as Chief Financial Officer.
19
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fiscal
quarter ended November 30, 2000.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
MSDW's common stock trades on the NYSE and The Pacific Exchange. MSDW had
approximately 130,000 stockholders of record at November 30, 2000; however,
the number of beneficial owners of common stock is believed to exceed this
number.
Set forth below is the low and high sales prices per share of MSDW's common
stock for each full quarterly period within the two most recent fiscal periods
and the frequency and amount of any cash dividends declared per share of
MSDW's common stock for the two most recent fiscal periods.
Low High
Sale Price Sale Price Dividends
---------- ---------- ---------
Fiscal 2000:
Fourth Quarter............................. $60.63 $110.00 $0.20
Third Quarter.............................. $70.13 $108.50 $0.20
Second Quarter............................. $62.38 $ 97.38 $0.20
First Quarter.............................. $58.63 $ 71.44 $0.20
Fiscal 1999:(1)
Fourth Quarter............................. $42.00 $ 63.75 $0.12
Third Quarter.............................. $40.50 $ 52.59 $0.12
Second Quarter............................. $44.28 $ 58.47 $0.12
First Quarter.............................. $31.16 $ 48.94 $0.12
--------
(1) Amounts have been retroactively adjusted to give effect to a two-for-one
common stock split, effected in the form of a 100% stock dividend, which
became effective on January 26, 2000.
To enhance its ongoing stock repurchase program, during the quarter ended
November 30, 2000, MSDW sold European-style put options on an aggregate of 3.5
million shares of its common stock, of which put options on 3 million shares
remained outstanding at November 30, 2000. The sale of these put options,
which were made as private placements to third parties, generated proceeds to
MSDW of approximately $14.9 million. At November 30, 2000, the outstanding put
options had various maturity dates that ranged from January 2001 through April
2001. The outstanding put options entitled the holders to sell common stock to
MSDW at prices ranging from $72.00 to $81.88 per share.
20
Item 6. Selected Financial Data
XXXXXX XXXXXXX XXXX XXXXXX & CO.
SELECTED FINANCIAL DATA
(dollars in millions, except share and per share data)
Fiscal Year(1)
----------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------- -------
Income Statement Data:
Revenues:
Investment banking................. $ 5,008 $ 4,523 $ 3,340 $ 2,694 $ 2,190
Principal transactions:
Trading.......................... 7,393 5,830 3,159 3,191 2,659
Investments...................... 193 725 89 463 86
Commissions.......................... 3,645 2,774 2,208 2,066 1,776
Fees:
Asset management, distribution and
administration.................... 4,219 3,324 3,003 2,525 1,732
Merchant and cardmember............ 1,780 1,492 1,647 1,704 1,505
Servicing.......................... 1,450 1,194 928 762 809
Interest and dividends............... 21,234 14,880 16,386 13,583 11,288
Other................................ 491 248 282 144 126
------- ------- ------- ------- -------
Total revenues..................... 45,413 34,990 31,042 27,132 22,171
Interest expense..................... 18,176 12,515 13,464 10,806 8,934
Provision for consumer loan losses... 810 529 1,173 1,493 1,214
------- ------- ------- ------- -------
Net revenues....................... 26,427 21,946 16,405 14,833 12,023
------- ------- ------- ------- -------
Non-interest expenses:
Compensation and benefits.......... 10,936 8,398 6,636 6,019 5,071
Other.............................. 7,000 5,820 5,069 4,466 3,835
Merger-related expenses............ -- -- -- 74 --
------- ------- ------- ------- -------
Total non-interest expenses........ 17,936 14,218 11,705 10,559 8,906
------- ------- ------- ------- -------
Gain on sale of businesses........... 35 -- 685 -- --
------- ------- ------- ------- -------
Income before income taxes and
cumulative effect of accounting
change.............................. 8,526 7,728 5,385 4,274 3,117
Provision for income taxes........... 3,070 2,937 1,992 1,688 1,137
------- ------- ------- ------- -------
Income before cumulative effect of
accounting change................... 5,456 4,791 3,393 2,586 1,980
Cumulative effect of accounting
change.............................. -- -- (117) -- --
------- ------- ------- ------- -------
Net income........................... $ 5,456 $ 4,791 $ 3,276 $ 2,586 $ 1,980
======= ======= ======= ======= =======
Earnings applicable to common
shares(2)........................... $ 5,420 $ 4,747 $ 3,221 $ 2,520 $ 1,914
======= ======= ======= ======= =======
Per Share Data(3):
Earnings per common share:
Basic before cumulative effect of
accounting change................. $ 4.95 $ 4.33 $ 2.90 $ 2.19 $ 1.67
Cumulative effect of accounting
change............................ -- -- (0.10) -- --
------- ------- ------- ------- -------
Basic.............................. $ 4.95 $ 4.33 $ 2.80 $ 2.19 $ 1.67
======= ======= ======= ======= =======
Diluted before cumulative effect of
accounting change................. $ 4.73 $ 4.10 $ 2.76 $ 2.08 $ 1.58
Cumulative effect of accounting
change............................ -- -- (0.09) -- --
------- ------- ------- ------- -------
Diluted............................ $ 4.73 $ 4.10 $ 2.67 $ 2.08 $ 1.58
======= ======= ======= ======= =======
21
Fiscal Year(1)
-------------------------------------------------------------------------
2000 1999 1998 1997 1996
------------- ------------- ------------- ------------- -------------
Book value per common
share.................. $ 16.91 $ 14.85 $ 11.94 $ 11.06 $ 9.22
Dividends per common
share.................. $ 0.80 $ 0.48 $ 0.40 $ 0.28 $ 0.22
Balance Sheet and Other
Operating Data:
Total assets............ $ 426,794 $ 366,967 $ 317,590 $ 302,287 $ 238,860
Consumer loans, net..... 21,090 20,229 15,209 20,033 21,262
Total capital(4)........ 49,637 39,699 37,922 33,577 31,152
Long-term
borrowings(4).......... 30,366 22,685 23,803 19,621 19,450
Shareholders' equity.... 19,271 17,014 14,119 13,956 11,702
Return on average common
shareholders' equity... 30.9% 32.6% 24.5% 22.0% 20.0%
Average common and
equivalent
shares(2)(3)........... 1,095,858,438 1,096,789,720 1,151,645,450 1,149,636,466 1,146,713,860
--------
(1) Fiscal 1996 represents the combination of Xxxxxx Xxxxxxx Group Inc.'s
financial statements for the fiscal year ended November 30 with Xxxx
Xxxxxx, Discover & Co.'s financial statements for the year ended December
31.
(2) Amounts shown are used to calculate basic earnings per common share.
(3) Amounts have been retroactively adjusted to give effect for a two-for-one
common stock split, effected in the form of a 100% stock dividend, which
became effective on January 26, 2000.
(4) These amounts exclude the current portion of long-term borrowings and
include Capital Units and Preferred Securities Issued by Subsidiaries.
22
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Introduction
The Company
Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co. (the "Company") is a global financial
services firm that maintains leading market positions in each of its three
business segments--Securities, Asset Management and Credit Services. The
Company's Securities business includes securities underwriting and
distribution; merger, acquisition, restructuring, real estate, project finance
and other corporate finance advisory activities; full-service brokerage and
financial advisory services; sales, trading, financing and market-making in
equity and fixed income securities, foreign exchange and commodities, and
derivatives; and private equity and other principal investing activities. The
Company's Asset Management business provides global asset management products
and services to individual and institutional investors primarily through
Xxxxxx Xxxxxxx Xxxx Xxxxxx Advisors, Xxx Xxxxxx Investments, Xxxxxx Xxxxxxx
Xxxx Xxxxxx Investment Management and Xxxxxx Xxxxxxxx & Xxxxxxxx. The
Company's Credit Services business includes the issuance of the Discover(R)
Card, the Discover Platinum Card, the Xxxxxx Xxxxxxx Xxxx WitterSM Card and
other proprietary general purpose credit cards; and the operation of Discover
Business Services, a proprietary network of merchant and cash access locations
in the U.S.
The Company's results of operations for the 12 months ended November 30,
2000 ("fiscal 2000"), November 30, 1999 ("fiscal 1999") and November 30, 1998
("fiscal 1998") are discussed below.
Results of Operations
Certain Factors Affecting Results of Operations
The Company's results of operations may be materially affected by market
fluctuations and by economic factors. In addition, results of operations in
the past have been, and in the future may continue to be, materially affected
by many factors of a global nature, including economic and market conditions;
the availability and cost of capital; the level and volatility of equity
prices and interest rates; currency values and other market indices;
technological changes and events (such as the increased use of the Internet to
conduct electronic commerce and the continued development of electronic
communications trading networks); the availability and cost of credit;
inflation; investor sentiment; and legislative, legal and regulatory
developments. Such factors also may have an impact on the Company's ability to
achieve its strategic objectives on a global basis, including (without
limitation) continued increased market share in its securities activities,
growth in assets under management and the expansion of its Credit Services
business.
The Company's Securities business, particularly its involvement in primary
and secondary markets for all types of financial products, including
derivatives, is subject to substantial positive and negative fluctuations due
to a variety of factors that cannot be predicted with great certainty,
including variations in the fair value of securities and other financial
products and the volatility and liquidity of global trading markets.
Fluctuations also occur due to the level of global market activity, which,
among other things, affects the size, number and timing of investment banking
client assignments and transactions and the realization of returns from the
Company's private equity and other principal investments. The level of global
market activity also could impact the flow of investment capital into mutual
funds and the way in which such capital is allocated among money market,
equity, fixed income or other investment alternatives, which could cause
fluctuations to occur in the Company's Asset Management business. In the
Company's Credit Services business, changes in economic variables, such as the
number and size of personal bankruptcy filings, the rate of unemployment and
the level of consumer debt, may substantially affect consumer loan levels and
credit quality, which, in turn, could impact overall Credit Services results.
The Company's results of operations also may be materially affected by
competitive factors. Included among the principal competitive factors
affecting the Securities business are the quality of its professionals and
23
other personnel, its products and services, relative pricing and innovation.
Competition in the Company's Asset Management business is affected by a number
of factors, including investment objectives and performance; advertising and
sales promotion efforts; and the level of fees, distribution channels and
types and quality of services offered. In Credit Services, competition centers
on merchant acceptance of credit cards, credit cardmember acquisition and
customer utilization of credit cards, all of which are impacted by the type of
fees, interest rates and other features offered.
In addition to competition from firms traditionally engaged in the financial
services business, there has been increased competition in recent years from
other sources, such as commercial banks, insurance companies, online service
providers, sponsors of mutual funds and other companies offering financial
services both in the U.S. and globally. The financial services industry has
continued to experience consolidation and convergence as financial
institutions involved in a broad range of financial services industries have
merged. This convergence trend is expected to continue and could result in the
Company's competitors gaining greater capital and other resources, such as a
broader range of products and services and geographic diversity. In addition,
the passage of the Xxxxx-Xxxxx-Xxxxxx Act in the U.S., effectively repealing
certain sections of the 1933 Xxxxx-Xxxxxxxx Act, has allowed commercial banks,
securities firms and insurance firms to affiliate, which has accelerated
consolidation and may lead to increasing competition in markets which
traditionally have been dominated by investment banks and retail securities
firms.
The Company also has experienced increased competition for qualified
employees in recent years, including from companies engaged in Internet-
related businesses and private equity funds, in addition to the traditional
competition for employees from the financial services, insurance and
management consulting industries. The Company's ability to sustain or improve
its competitive position will substantially depend on its ability to continue
to attract and retain qualified employees.
As a result of the above economic and competitive factors, net income and
revenues in any particular period may not be representative of full-year
results and may vary significantly from year to year and from quarter to
quarter. The Company intends to manage its business for the long term and to
mitigate the potential effects of market downturns by strengthening its
competitive position in the global financial services industry through
diversification of its revenue sources and enhancement of its global
franchise. The Company's overall financial results will continue to be
affected by its ability and success in maintaining high levels of profitable
business activities, emphasizing fee-based assets that are designed to
generate a continuing stream of revenues, evaluating credit product pricing,
managing risks in the Securities, Asset Management and Credit Services
businesses, and managing costs. In addition, the complementary trends in the
financial services industry of consolidation and globalization present, among
other things, technological, risk management and other infrastructure
challenges that will require effective resource allocation in order for the
Company to remain competitive.
The Company believes that technological advancements in the Internet and the
growth of electronic commerce will continue to present both challenges and
opportunities to the Company and has led to significant changes and
innovations in the financial markets and financial services industry as a
whole. The Company's initiatives in this area have included Web-enabling
existing businesses or enhancing client communication and access to
information and services as well as making investments, or otherwise
participating, in alternative trading systems, electronic communications
networks and related businesses or technologies. The Company expects to
continue to augment these initiatives in the future.
Global Market and Economic Conditions in Fiscal 2000
Global market and economic conditions during fiscal 2000 were generally more
challenging in comparison with those experienced during the prior fiscal year.
During fiscal 1999 and the first half of fiscal 2000, the vigorous pace of
global economic expansion frequently gave rise to indications of increasing
inflationary pressures. In an effort to mitigate these conditions, several
interest rate increases were initiated by major central banks globally,
particularly in the U.S. and Europe, which increased corporate and consumer
borrowing costs. As a result of the rising global interest rate environment
and a sharp rise in the level of energy prices, it appeared
24
more likely that the rate of global economic growth would decelerate in the
future. These conditions, coupled with indications of slowing corporate
earnings growth, led to difficult conditions in global equity and fixed income
securities markets, particularly during the latter half of fiscal 2000.
However, despite the presence of less favorable global market and economic
conditions, the Company achieved record results in fiscal 2000 as each of its
three business segments (Securities, Asset Management and Credit Services)
generated record levels of net income. The Company's Securities business
benefited from record revenues in its investment banking, equity trading and
commodity trading activities and ended the fiscal year with record levels of
financial advisors and customer accounts. In the Company's Asset Management
business, customer assets under management or supervision increased to record
levels during fiscal 2000, while results in the Company's Credit Services
business reflected a continued improvement in the credit quality of cardmember
receivables as well as record levels of cardmember transaction volume and
managed consumer loans (see "Business Segments" herein).
In the U.S., the domestic economy exhibited positive fundamentals and a
strong rate of growth during much of fiscal 2000. Several favorable economic
trends, such as historically low levels of unemployment, high levels of
consumer confidence and spending, strong productivity gains and a high demand
for imports, continued to persist. However, throughout fiscal 1999 and the
first half of fiscal 2000, the ongoing expansion of the U.S. economy, coupled
with a tight domestic labor market, increased fears of accelerating inflation.
In an effort to slow the U.S. economy and to mitigate inflationary pressures,
the Federal Reserve Board (the "Fed") continued to tighten monetary policy
during fiscal 2000 by raising the overnight lending rate on two separate
occasions by an aggregate of 0.75%. Between June 1999 and May 2000, the Fed
raised the overnight lending rate on six occasions aggregating 1.75%. During
the latter half of fiscal 2000, there were indications that the Fed's interest
rate actions were beginning to have the desired impact on the U.S. economy.
However, the prospects for slower economic growth in the future and its impact
on corporate earnings contributed to declines in U.S. financial markets as the
major stock market indices (the Standard & Poor's 500, the Dow Xxxxx
Industrial Average and the NASDAQ) all were lower at the end of fiscal 2000
than at the beginning of the year. The decline in the market values of
Internet and technology stocks and high-yield fixed income securities was
particularly significant. The sharp rise in global energy prices, coupled with
lingering uncertainty over the resolution of the U.S. presidential election,
also contributed to periods of increased volatility in the financial markets
during the latter half of fiscal 2000. At fiscal year-end, there remained much
uncertainty as to whether the Fed would ease its interest rate policy should
the indications of slowing economic growth in the U.S. persist in the future.
Economic conditions within Europe also contributed to periods of heightened
volatility in the region's financial markets during fiscal 2000. The rates of
economic growth within the U.K. and the European Union (the "EU") were
generally strong in the first half of fiscal 2000, although the euro fell to
record lows against the U.S. dollar during fiscal 2000 as the growth rate of
the U.S. economy continued to outpace the growth rate within the EU. The
region's level of economic growth, coupled with the falling value of the euro
and the sharp rise in global energy prices, gave rise to fears of accelerating
inflation. As a result, during fiscal 2000, the European Central Bank (the
"ECB") raised interest rates within the EU on six occasions by an aggregate of
1.75%. The Bank of England also raised interest rates within the U.K. on two
occasions by an aggregate of 0.50%. Investor uncertainty as to the region's
future growth prospects in light of rising energy prices and a potential
slowdown of the U.S. economy contributed to the decline in many of the major
stock market indices within the European region during fiscal 2000.
Economic conditions also were challenging in the Far East during fiscal
2000. In Japan, there were indications that the steps taken by its government
to increase economic activity, including bank bailouts, emergency loans,
stimulus packages and tax cuts for both individuals and corporations, were
beginning to have a favorable impact on the nation's economic performance. As
a result, during fiscal 2000, the Bank of Japan raised interest rates by 0.25%
amid indications of growing business confidence and industrial production.
However, Japan's financial markets were adversely impacted by continuing
concerns about the nation's banking system, its growing budget deficit and the
economy's future growth prospects. Investors also were concerned with the
impact of rising energy prices and the potential for a slowdown in the level
of global economic growth, which would have an adverse effect on the level of
Japan's exports. Certain financial markets elsewhere in the Far East also
experienced declines during fiscal 2000, reflecting lower levels of economic
activity. In addition,
25
political instability existed within the region, particularly in Thailand,
Indonesia and the Philippines, which had an adverse impact on the region's
financial markets during the year.
The worldwide market for mergers and acquisitions continued to be robust
during fiscal 2000. The volume of global merger and acquisition transactions
reached record levels and contributed to record revenues by the Company's
investment banking business. The merger and acquisition market reflected
ongoing consolidation and globalization, and transaction activity was strong
across many industries, particularly in the technology, media and
telecommunications sectors. The volume of merger and acquisition transactions
was particularly strong during the first half of fiscal 2000, while increased
volatility in the financial markets adversely impacted transaction activity in
the latter part of the year. During fiscal 2000, the level of cross-border
transactions remained strong, although the level of activity in the European
merger and acquisition markets declined, reflecting volatility in the region's
financial markets and the continued depreciation in the value of the euro.
Similarly, the worldwide market for debt and equity underwriting
transactions was generally strong in fiscal 2000, fueled by a need to raise
capital to finance merger and acquisition transactions and other strategic
initiatives. However, increased uncertainty in the global financial markets
significantly reduced transaction volumes during the latter half of fiscal
2000. Declines in the global equity markets led to the postponement or
cancellation of many new equity issues, particularly during the fourth quarter
of fiscal 2000. Fixed income underwriting activity was negatively affected by
the rising global interest rate environment, which increased borrowing costs.
The market for new issuances of high-yield fixed income securities was
particularly difficult during the latter half of fiscal 2000 as heightened
concerns of deteriorating credit quality and rising default rates reduced
investor demand for these securities.
In fiscal 2000, U.S. consumer demand and purchases continued to increase at
a strong pace. The relatively strong domestic economy that continued to exist
in the U.S. for much of the year enabled consumers to manage finances
advantageously while still allowing for steady growth in consumer credit.
Similarly, the level of loan losses and personal bankruptcies continued to
decline. U.S. economic growth moderated during the latter half of fiscal 2000,
reflecting, among other things, the Fed's efforts to slow the rate of economic
growth. The Company continued to invest in the growth of its credit card
business through the expansion of Discover Business Services, as evidenced by
a record number of new merchant enrollments in fiscal 2000, the second
consecutive year of achieving record new merchant enrollments. The Company
also increased its marketing and solicitation activities with respect to the
Discover Card brand, as well as the Xxxxxx Xxxxxxx Xxxx Xxxxxx Card in the
U.K.
Fiscal 2000 and Fiscal 1999 Results of the Company
The Company achieved record net income of $5,456 million in fiscal 2000, a
14% increase from fiscal 1999. In fiscal 1999, the Company's net income was
$4,791 million, an increase of 46% from fiscal 1998. Fiscal 1998's net income
included a net gain of $345 million from the sale of the Company's Global
Custody business, its interest in the operations of SPS Transaction Services,
Inc. ("SPS") and certain BRAVO(R) Card receivables ("BRAVO") (see "Results of
Operations--Business Acquisitions and Dispositions" herein). Fiscal 1998's net
income also included a $117 million charge resulting from the cumulative
effect of an accounting change. This charge represents the effect of an
accounting change adopted in the fourth quarter of fiscal 1998 (effective
December 1, 1997) with respect to the accounting for offering costs paid by
investment advisors of closed-end funds, where such costs are not specifically
reimbursed through separate advisory contracts (see Note 2 to the consolidated
financial statements). Excluding the net gain from the sale of the businesses
noted above and the charge resulting from the cumulative effect of an
accounting change, fiscal 1999's net income increased 57%.
The Company's income tax rate was 36%, 38% and 37% in fiscal 2000, fiscal
1999 and fiscal 1998, respectively. The decrease in fiscal 2000 primarily
reflected reduced U.S. state and local taxes. The increase in fiscal 1999
reflected an increase in provisions for certain tax matters, partially offset
by reduced U.S. state and local taxes resulting from the resolution of certain
audit issues.
Basic earnings per common share increased 14% to $4.95 in fiscal 2000 and
55% to $4.33 in fiscal 1999. Excluding the net gain from the sale of the
businesses noted above and the impact of the cumulative effect of an
26
accounting change, fiscal 1999's basic earnings per common share increased
67%. Diluted earnings per common share increased 15% to $4.73 in fiscal 2000
and 54% to $4.10 in fiscal 1999. Excluding the net gain from the sale of the
businesses noted above and the impact of the cumulative effect of an
accounting change, fiscal 1999's diluted earnings per common share increased
65%.
The Company's return on average shareholders' equity was 31%, 33% and 25% in
fiscal 2000, fiscal 1999 and fiscal 1998, respectively. Excluding the net gain
from the sale of the businesses noted above and the impact of the cumulative
effect of an accounting change, fiscal 1998's return on average shareholders'
equity was 23%.
Business Acquisitions and Dispositions
In December 2000, the Company announced that it had entered into a
definitive agreement to acquire Quilter Holdings Limited ("Quilter"). Quilter
is a leading U.K.-based investment management business providing segregated
account management and advisory services to private individuals, pension funds
and trusts. The transaction is subject to certain regulatory and other
consents and is expected to be completed in the first quarter of fiscal 2001.
In fiscal 2000, the Company completed its acquisition of Ansett Worldwide
Aviation Services ("Ansett Worldwide"). Ansett Worldwide is one of the world's
leading aircraft leasing groups, supplying new and used commercial jet
aircraft to airlines around the world. The Company's fiscal 2000 results
include the operations of Ansett Worldwide since April 27, 2000, the date of
acquisition.
In fiscal 1999, the Company completed its acquisition of Xxxxxx Xxxxxxx Xxxx
Xxxxxx, X.X., S.A. (formerly AB Asesores), the largest independent financial
services firm in Spain. Xxxxxx Xxxxxxx Xxxx Xxxxxx, X.X., S.A. has leading
positions in personal investment, asset management, institutional research and
brokerage. Through its financial advisors, it offers its individual investors
proprietary mutual funds and other financial products. The Company's fiscal
1999 results include the operations of Xxxxxx Xxxxxxx Xxxx Xxxxxx, X.X., S.A.
since March 25, 1999, the date of acquisition.
In fiscal 1998, the Company completed the sale of its Global Custody
business. At that time, the Company recorded a pre-tax gain of $323 million
from the sale. Such gain included estimates for certain payments and purchase
price adjustments which, under certain circumstances pursuant to the sales
agreement, were payable by the Company to the buyer. As a result of the
resolution of these payments and purchase price adjustments, during fiscal
2000, the Company recorded an additional pre-tax gain of $35 million related
to the sale of the Global Custody business.
In fiscal 1998, the Company sold its interest in the operations of SPS, a
73%-owned, publicly held subsidiary of the Company. In addition, the Company
sold certain credit card receivables relating to its discontinued BRAVO Card.
The Company's aggregate net pre-tax gain resulting from these transactions was
$362 million.
In addition, during fiscal 1998, the Company sold its Prime Option SM
MasterCard(R) portfolio ("Prime Option"), a business it had operated with
NationsBank of Delaware, N.A., and its Correspondent Clearing business. The
gains resulting from the sale of these businesses were not material to the
Company's results of operations or financial condition.
Business Segments
The remainder of "Results of Operations" is presented on a business segment
basis. Substantially all of the operating revenues and operating expenses of
the Company can be directly attributed to its three business segments:
Securities, Asset Management and Credit Services. Certain revenues and
expenses have been allocated to each business segment, generally in proportion
to their respective revenues or other relevant measures. The segment data
presented below reflect the Company's fiscal 1999 adoption of Statement of
Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments
of an Enterprise and Related Information." Prior to the adoption of SFAS No.
131, the Company had presented the results of its Securities and Asset
Management segments on a combined basis. The following discussion excludes the
cumulative effect of the accounting change in references to fiscal 1998 net
income. Certain reclassifications have been made to prior-period amounts to
conform to the current year's presentation.
27
SECURITIES
STATEMENTS OF INCOME
(dollars in millions)
Fiscal Fiscal Fiscal
2000 1999 1998
------- ------- -------
Revenues:
Investment banking.................................... $ 4,881 $ 4,430 $ 3,314
Principal transactions:
Trading.............................................. 7,393 5,830 3,159
Investments.......................................... 133 712 390
Commissions........................................... 3,629 2,770 2,208
Asset management, distribution and administration
fees................................................. 1,967 1,374 1,079
Interest and dividends................................ 18,308 12,573 13,405
Other................................................. 491 248 250
------- ------- -------
Total revenues....................................... 36,802 27,937 23,805
Interest expense....................................... 16,822 11,625 12,305
------- ------- -------
Net revenues......................................... 19,980 16,312 11,500
------- ------- -------
Compensation and benefits.............................. 9,557 7,225 5,428
Occupancy and equipment................................ 621 493 419
Brokerage, clearing and exchange fees.................. 425 378 354
Information processing and communications.............. 986 756 591
Marketing and business development..................... 706 511 414
Professional services.................................. 817 578 445
Other.................................................. 631 507 408
------- ------- -------
Total non-interest expenses.......................... 13,743 10,448 8,059
------- ------- -------
Income before income taxes............................. 6,237 5,864 3,441
Provision for income taxes............................. 2,190 2,183 1,199
------- ------- -------
Net income............................................. $ 4,047 $ 3,681 $ 2,242
======= ======= =======
Securities provides a wide range of financial products, services and
investment advice to individual and institutional investors. Securities
business activities are conducted in the U.S. and throughout the world and
include investment banking, institutional sales and trading, full-service
brokerage services and principal investing activities. At November 30, 2000,
the Company's financial advisors provided securities and investment services
to more than 5.4 million client accounts in the U.S. and had client assets of
$659 billion. The Company had the second largest financial advisor sales
organization in the U.S. On a global basis, the Company had 13,910
professional financial advisors at November 30, 2000.
Securities achieved record net revenues of $19,980 million and record net
income of $4,047 million in fiscal 2000, increases of 22% and 10%,
respectively, from fiscal 1999. In fiscal 1999, Securities net revenues and
net income increased 42% and 64%, respectively, from fiscal 1998. In both
fiscal 2000 and fiscal 1999, the levels of net revenues and net income in the
Company's Securities business reflected a strong global market for mergers and
acquisitions and securities underwritings, higher principal trading and
commission revenues, higher levels of customer trading volume and the
continued increase in the levels of client accounts and asset balances. The
results of both years were partially offset by increased costs for incentive-
based compensation, as well as increased non-compensation expenses associated
with the Company's higher level of global business activities. In addition,
fiscal 2000's results were negatively affected by more difficult economic and
market conditions during the latter half of the year, which reduced the volume
of merger and acquisition and underwriting transactions and contributed to a
more difficult trading environment. In fiscal 2000, declines in certain equity
markets also resulted in unrealized losses in the Company's private equity
business.
28
Investment Banking
Investment banking revenues are derived from the underwriting of securities
offerings and fees from advisory services. Investment banking revenues were as
follows:
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
(dollars in
millions)
Advisory fees from merger, acquisition and
restructuring transactions.......................... $2,137 $1,886 $1,322
Equity underwriting revenues......................... 1,741 1,272 815
Fixed income underwriting revenues................... 1,003 1,272 1,177
------ ------ ------
Total investment banking revenues.................... $4,881 $4,430 $3,314
====== ====== ======
Investment banking revenues increased 10% to record levels in fiscal 2000,
surpassing the Company's previous record attained in fiscal 1999. Revenues in
fiscal 2000 reflected higher advisory fees from merger, acquisition and
restructuring transactions and increased revenues from underwriting equity
securities, partially offset by lower revenues from underwriting fixed income
securities. In fiscal 1999, the 34% increase in investment banking revenues
reflected higher advisory fees from merger, acquisition and restructuring
transactions as well as increased revenues from underwriting both equity and
fixed income securities.
The worldwide merger and acquisition markets remained robust with $3.5
trillion of activity announced during calendar year 2000 (per Thomson
Financial Securities Data), an increase of 6% over 1999's then-record volume.
The pace of transactions slowed, however, during the fourth quarter as
activity in Europe declined. During calendar year 2000, the Company's volume
of announced merger and acquisition transactions surpassed $1 trillion for the
second consecutive year. In fiscal 2000, the high level of transaction
activity reflected the continuing trends of consolidation and globalization as
well as a high level of merger and acquisition transaction volume in the
technology, media and telecommunications sectors. However, transaction volume
decreased in the latter half of fiscal 2000 as volatility in the global equity
markets and a decrease in equity valuations reduced the purchasing power of
potential acquirers. The high transaction volumes in the merger and
acquisition markets, coupled with the Company's global presence and strong
market share, had a positive impact on advisory fees, which increased 13% in
fiscal 2000. The 43% increase in advisory fees in fiscal 1999 also reflected
high transaction volumes resulting from the strong global market for merger,
acquisition and restructuring activities as well as increased revenues from
real estate advisory transactions.
Equity underwriting revenues increased 37% to a record level in fiscal 2000,
reflecting the Company's strong global market share. Equity underwriting
revenues also benefited from a high volume of equity issuances, particularly
in the technology, telecommunications and energy sectors. However, new issue
volume declined toward the end of fiscal 2000 due to difficult conditions in
the global financial markets, including reduced investor confidence. Equity
underwriting revenues increased 56% in fiscal 1999 and reflected a high volume
of equity offerings and the Company's strong global market share. In fiscal
1999, the Company's equity underwriting revenues benefited from favorable
global economic conditions, which led major equity market indices higher and
new issue activity to then-record levels. The primary market for equity
issuances was particularly strong in the U.S. and in Europe and reflected the
Company's participation in some of the year's largest transactions and its
leadership in the underwriting of technology-related issuances.
Fixed income underwriting revenues decreased 21% in fiscal 2000. The volume
of fixed income underwriting transactions was adversely affected by a higher
interest rate environment in both the U.S. and Europe, resulting in higher
borrowing costs. Revenues from underwriting global high-yield fixed income
securities declined significantly, reflecting difficult conditions in this
market sector. In addition, investor demand for these securities declined due
to heightened concerns over credit quality. Revenues from underwriting
derivative fixed income products also declined. These decreases were partially
offset by higher revenues from securitized debt issuances, resulting from an
increased volume of asset-backed transactions. Revenues from fixed income
underwriting increased 8% in fiscal 1999. The volume of fixed income
underwritings was generally
29
strong during much of fiscal 1999, reflecting favorable global market
conditions. In addition, the relatively low levels of interest rates in the
U.S. during much of the year allowed issuers to take advantage of lower
borrowing costs. The European Economic and Monetary Union, which permitted
many corporate issuers to access the euro-denominated credit market, and the
need for strategic financing in light of the robust global market for mergers
and acquisitions also had a favorable impact on the volume of fixed income
underwriting transactions. Higher revenues from underwriting derivative fixed
income products also contributed to the increase in fiscal 1999.
Principal Transactions
Principal transactions include revenues from customers' purchases and sales
of securities in which the Company acts as principal and gains and losses on
securities held for resale. Decisions relating to principal transactions in
securities are based on an overall review of aggregate revenues and costs
associated with each transaction or series of transactions. This review
includes an assessment of the potential gain or loss associated with a trade
and the interest income or expense associated with financing or hedging the
Company's positions. The Company also engages in proprietary trading
activities for its own account.
Principal transaction trading revenues were as follows:
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
(dollars in
millions)
Equities............................................... $4,705 $3,065 $2,048
Fixed income........................................... 1,760 1,937 331
Foreign exchange....................................... 349 397 587
Commodities............................................ 579 431 193
------ ------ ------
Total principal transaction trading revenues........... $7,393 $5,830 $3,159
====== ====== ======
Principal transaction trading revenues increased 27% in fiscal 2000,
primarily reflecting higher equity and commodity trading revenues, partially
offset by a decline in fixed income and foreign exchange trading revenues.
Principal transaction trading revenues increased 85% in fiscal 1999, primarily
reflecting higher fixed income, equity and commodity trading revenues,
partially offset by a decline in foreign exchange trading revenues.
Equity trading revenues increased 54% to a record level in fiscal 2000,
reflecting higher revenues from both cash and derivative equity products.
Higher revenues from trading in equity cash products were primarily driven by
significantly increased levels of customer trading volumes and volatility in
both over-the-counter and listed securities, particularly in the U.S. and
Europe. Revenues from equity derivative products also benefited from these
conditions. Higher revenues from certain proprietary trading activities also
contributed significantly to the increase in equity trading revenues. In
fiscal 1999, equity trading revenues increased 50%, primarily reflecting
higher revenues from equity cash products. The increase was primarily driven
by higher levels of customer trading volumes in both listed and over-the-
counter securities, particularly in the U.S. and Europe, as generally
favorable global market and economic conditions increased investor demand for
equity securities. Higher revenues from trading equity derivative products,
which benefited from strong trading volumes and periods of market volatility,
and certain proprietary trading activities also contributed significantly to
the increase.
Fixed income trading revenues decreased 9% in fiscal 2000, primarily
reflecting lower revenues from global high-yield and investment grade fixed
income securities. Trading revenues from global high-yield fixed income
securities decreased significantly due to lighter trading activity and
decreased market liquidity, which resulted in markdowns of certain high-yield
positions. During fiscal 2000, several high-yield issuers experienced
financial difficulties, triggering an increased number of credit downgrades
and defaults, particularly in the telecommunications sector. As a result,
investors became more concerned about the credit quality of issuers,
particularly during the latter half of fiscal 2000. Revenues from investment
grade fixed income securities also declined, reflecting more difficult market
conditions, which resulted in reduced liquidity and widening credit spreads.
These decreases were partially offset by higher revenues from trading
derivative and government agency
30
products. In fiscal 1999, fixed income trading revenues increased 485%,
primarily reflecting higher revenues from investment grade, high-yield and
securitized fixed income securities as well as swap transactions. Fiscal
1999's revenues benefited from significantly improved conditions in the global
fixed income markets as compared with the periods of extreme volatility and
illiquidity that existed at the end of fiscal 1998. During the first half of
fiscal 1999, the continuing recovery of global economic and market conditions
led to strong investor demand for fixed income products and contributed to
high transaction volumes. In addition, fears of accelerating inflation in the
U.S. and the interest rate actions taken by the Fed and the ECB resulted in
periods of volatility in the global fixed income markets, which resulted in
increased trading opportunities. Market conditions and trading volumes were
more moderate during the latter half of fiscal 1999, primarily reflecting a
rising interest rate environment in the U.S. and Europe.
Foreign exchange revenues decreased 12% in fiscal 2000, reflecting lower
levels of trading volumes and volatility in the global foreign exchange
markets. Trading volumes were negatively affected by the exit of certain hedge
funds from the foreign exchange market and by reduced liquidity in the
Japanese yen and euro markets. During fiscal 2000, volatility levels between
the U.S. dollar and Japanese yen decreased to a 10-year low, creating reduced
market liquidity. In addition, the euro continued to depreciate against the
U.S. dollar, reflecting the strong relative performance of the U.S. economy.
However, at the end of fiscal 2000, economic indicators in the U.S. signaled a
potential slowing of the economy, and, as a result, the euro strengthened
against the U.S. dollar. In fiscal 1999, foreign exchange revenues declined
32% from the record level of revenues achieved in fiscal 1998. The decrease
primarily reflected reduced customer trading volumes and lower levels of
volatility in the global foreign exchange markets as compared with the prior
year.
Commodity trading revenues rose 34% to a record level in fiscal 2000,
primarily driven by higher revenues from certain energy-related products,
including electricity, natural gas and crude oil. Trading revenues from
energy-related products benefited from periods of rising prices and increased
volatility across the entire energy sector. Such conditions were primarily
attributable to low inventory levels, strong demand and concerns regarding the
adequacy of production levels. In fiscal 1999, commodities trading revenues
rose 123%, primarily driven by higher revenues from certain energy-related
products, including crude oil, refined energy products, electricity and
natural gas. Revenues from trading energy-related products benefited from the
sharp rise in energy prices that occurred during the latter half of fiscal
1999. Increases in energy prices were primarily attributable to strong demand
for energy products, relatively low inventory levels and reduced production
volumes. Revenues from natural gas trading benefited from periods of price
volatility during the year, which was primarily attributable to changing
weather conditions and varying levels of demand. Higher revenues from metals
trading also contributed to the increase.
Principal transaction investment revenues aggregating $133 million were
recognized in fiscal 2000 as compared with $712 million in fiscal 1999. Fiscal
2000's revenues included realized gains from certain of the Company's private
equity investments, including Commerce One, Inc. and Equant N.V., as well as
gains from the Company's other principal investment activities. These gains
were partially offset by unrealized losses in the private equity business,
reflecting difficult market conditions in the telecommunications, technology
and Internet sectors. Fiscal 1999's revenues reflected a record level of
revenues recorded by the Company's private equity business and included
realized and unrealized gains from the Company's positions in Equant N.V. and
Knight/Trimark Group Inc. Net gains from increases in the value of certain
other private equity and venture capital investments also contributed to
fiscal 1999's results.
Securities purchased in principal investment transactions generally are held
for appreciation and are not readily marketable. It is not possible to
determine when the Company will realize the value of such investments since,
among other factors, such investments are generally subject to sales
restrictions. Moreover, estimates of the eventual realizable value of the
investments fluctuate significantly over time in light of business, market,
economic and financial conditions generally or in relation to specific
transactions.
31
Commissions
Commission revenues primarily arise from agency transactions in listed and
over-the-counter equity securities and sales of mutual funds, futures,
insurance products and options. Commission revenues increased 31% in fiscal
2000, primarily reflecting higher revenues from equity cash products from
markets located in Europe, the U.S. and the Far East. Revenues from European
markets benefited from a significant increase in market volumes, particularly
in the telecommunications and technology sectors. In the U.S., trading volumes
on the New York Stock Exchange and the NASDAQ increased to record levels.
Commission revenues from markets in Japan and elsewhere in the Far East
increased as improved economic prospects within the region during the first
half of fiscal 2000 increased investor interest and led to higher transaction
volumes. Commission revenues increased 25% in fiscal 1999, reflecting higher
revenues from equity cash products in markets located in the U.S., Europe, and
the Far East. In the U.S., favorable market conditions and strong investor
demand for equity products contributed to a high volume of customer securities
transactions, including listed and over-the-counter equity securities.
Revenues from markets in Europe also benefited from strong customer
transaction volumes, as improved economic and market conditions in the region
increased investor demand for European equity securities. Commission revenues
from markets in Japan and elsewhere in the Far East increased as improved
economic prospects within the region increased investor interest and led to
higher transaction volumes. In both fiscal 2000 and fiscal 1999, commission
revenues also benefited from higher sales of mutual funds and the continued
growth in the number of the Company's financial advisors.
In October 1999, the Company launched ichoiceSM, a new service and
technology platform available to individual investors. ichoice provides each
of the Company's individual investor clients with the choice of self-directed
investing online; a traditional full-service brokerage relationship through a
financial advisor; or some combination of both. ichoice provides a range of
pricing options, including fee-based pricing. As a result, the amount of
revenues recorded within the "Commissions" and "Asset management, distribution
and administration fees" income statement categories is affected by the number
of the Company's clients electing a fee-based pricing arrangement.
Net Interest
Interest and dividend revenues and interest expense are a function of the
level and mix of total assets and liabilities, including financial instruments
owned, reverse repurchase and repurchase agreements, trading strategies
associated with the Company's institutional securities business, customer
margin loans and the prevailing level, term structure and volatility of
interest rates. Interest and dividend revenues and interest expense are
integral components of trading activities. In assessing the profitability of
trading activities, the Company views net interest and principal trading
revenues in the aggregate. In addition, decisions relating to principal
transactions in securities are based on an overall review of aggregate
revenues and costs associated with each transaction or series of transactions.
This review includes an assessment of the potential gain or loss associated
with a trade and the interest income or expense associated with financing or
hedging the Company's positions. Net interest revenues increased 57% in fiscal
2000 and decreased 14% in fiscal 1999, partially reflecting the level and mix
of interest earning assets and interest bearing liabilities (including
liabilities associated with the Company's aircraft financing activities)
during the respective periods as well as certain trading strategies utilized
in the Company's institutional securities business. In fiscal 2000, higher net
interest revenues from brokerage services provided to institutional and
individual customers, including an increase in the level of customer margin
loans, also had a positive impact on net interest revenues.
Asset Management, Distribution and Administration Fees
Asset management, distribution and administration fees include revenues from
asset management services, including fees for promoting and distributing
mutual funds ("12b-1 fees") and fees from investment management services
provided to segregated customer accounts pursuant to various contractual
arrangements in connection with the Company's Investment Consulting Services
("ICS") business. The Company receives 12b-1 fees for services it provides in
promoting and distributing certain open-ended mutual funds. These fees are
based
32
on either the average daily fund net asset balances or average daily aggregate
net fund sales and are affected by changes in the overall level and mix of
assets under management or supervision. Asset management, distribution and
administration fees also include revenues from individual investors electing a
fee-based pricing arrangement under the Company's ichoice service and
technology platform.
Asset management, distribution and administration fees increased 43% in
fiscal 2000 and 27% in fiscal 1999. The increase in both periods was primarily
attributable to higher 12b-1 fees from promoting and distributing mutual funds
to individual investors through the Company's financial advisors. Higher
revenues from investment management services associated with the ICS business
and the continued growth in the level of client asset balances, which rose to
$659 billion at November 30, 2000 from $595 billion at November 30, 1999, also
contributed to the increase. In addition, the increase in fiscal 2000
reflected higher revenues from individual investors electing fee-based
pricing.
Non-Interest Expenses
Fiscal Fiscal Fiscal
2000 1999 1998
------- ------- ------
(dollars in millions)
Compensation and benefits............................ $ 9,557 $ 7,225 $5,428
Occupancy and equipment.............................. 621 493 419
Brokerage, clearing and exchange fees................ 425 378 354
Information processing and communications............ 986 756 591
Marketing and business development................... 706 511 414
Professional services................................ 817 578 445
Other................................................ 631 507 408
------- ------- ------
Total non-interest expenses........................ $13,743 $10,448 $8,059
======= ======= ======
Fiscal 2000's total non-interest expenses increased 32% to $13,743 million.
Compensation and benefits expense increased 32%, reflecting increased levels
of incentive compensation based on record fiscal 2000 revenues and earnings,
incremental costs related to the Company's continued focus on increasing the
number of its financial advisors and increased competitive pressures in
certain institutional businesses. Excluding compensation and benefits expense,
non-interest expenses increased $963 million. Occupancy and equipment expense
increased 26%, primarily due to additional rent associated with new U.S.
branch locations and increased office space in New York and certain other
locations. Brokerage, clearing and exchange fees increased 12%, primarily due
to higher brokerage costs related to increased global trading volume,
particularly in North America and Europe. Brokerage costs associated with the
business activities of Xxxxxx Xxxxxxx Xxxx Xxxxxx, X.X., S.A. also contributed
to the increase. Information processing and communications expense increased
30%, primarily due to increased costs associated with the Company's
information processing infrastructure, including data processing, market data
services and telecommunications costs for network equipment associated with
increased business activity and higher employment levels. These increases were
partially offset by the exclusion of certain Year 2000 costs from fiscal
2000's results. Marketing and business development expense increased 38%,
primarily due to increased travel and entertainment costs associated with a
high level of business activity in the global financial markets, new
advertising campaigns and additional promotional expenses in the individual
securities business. Professional services expense increased 41%, primarily
reflecting higher consulting costs associated with certain strategic
initiatives, including e-commerce. The increase also reflected higher costs
for employment fees and temporary staffing due to increased global business
activity. Other expense increased 24%, reflecting the impact of a higher level
of business activity on various operating expenses. Higher costs associated
with the Company's aircraft leasing business (including Ansett Worldwide that
was acquired in April 2000) and amortization of goodwill associated with the
Company's acquisition of Xxxxxx Xxxxxxx Xxxx Xxxxxx, X.X., S.A. also
contributed to the increase.
33
Fiscal 1999's total non-interest expenses increased 30% to $10,448 million.
Compensation and benefits expense increased 33%, reflecting increased levels
of incentive compensation based on record fiscal 1999 revenues and earnings as
well as an increase in the number of employees. Excluding compensation and
benefits expense, non-interest expenses increased $592 million. Occupancy and
equipment expense increased 18%, principally reflecting additional office
space in New York and certain other locations as well as incremental rent
attributable to the opening of new U.S. branch locations. Brokerage, clearing
and exchange fees increased 7%, primarily attributable to higher brokerage
expenses due to higher levels of trading volume in the global securities
markets. Information processing and communications costs increased 28%,
primarily due to increased costs associated with the Company's information
technology infrastructure, including server and data center costs. A higher
number of employees utilizing communications systems and certain data services
also contributed to the increase. Marketing and business development expense
increased 23%, reflecting higher advertising expenses associated with the
Company's individual securities business. Increased travel and entertainment
costs associated with the high levels of activity in the global financial
markets also contributed to the increase. Professional services expense
increased 30%, primarily reflecting higher consulting costs as a result of
certain information technology initiatives, including the Company's
preparations for the Year 2000. Higher legal costs associated with increased
levels of business activity and higher temporary staffing fees also
contributed to the increase. Other expense increased 24%, primarily reflecting
the impact of a higher level of business activity on various operating
expenses. An increase in charitable donations and the amortization of goodwill
associated with the Company's acquisition of Xxxxxx Xxxxxxx Xxxx Xxxxxx, X.X.,
S.A. in March 1999 also contributed to the increase.
34
ASSET MANAGEMENT
STATEMENTS OF INCOME
(dollars in millions)
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
Revenues:
Investment banking..................................... $ 127 $ 93 $ 26
Principal transactions:
Investments........................................... 60 13 (301)
Commissions............................................ 16 4 --
Asset management, distribution and administration
fees.................................................. 2,252 1,950 1,924
Interest and dividends................................. 78 61 252
Other.................................................. -- -- 27
------ ------ ------
Total revenues........................................ 2,533 2,121 1,928
Interest expense........................................ 7 9 165
------ ------ ------
Net revenues.......................................... 2,526 2,112 1,763
------ ------ ------
Compensation and benefits............................... 751 648 659
Occupancy and equipment................................. 89 96 97
Brokerage, clearing and exchange fees................... 94 107 198
Information processing and communications............... 77 92 87
Marketing and business development...................... 161 127 125
Professional services................................... 101 137 135
Other................................................... 143 138 91
------ ------ ------
Total non-interest expenses........................... 1,416 1,345 1,392
------ ------ ------
Gain on sale of businesses.............................. 35 -- 323
------ ------ ------
Income before income taxes and cumulative effect of
accounting change...................................... 1,145 767 694
Provision for income taxes.............................. 462 319 264
------ ------ ------
Income before cumulative effect of accounting change.... 683 448 430
------ ------ ------
Cumulative effect of accounting change.................. -- -- (117)
------ ------ ------
Net income.............................................. $ 683 $ 448 $ 313
====== ====== ======
Asset Management ranks among the top eight global active asset managers and
provides a wide range of investment advisory products through both proprietary
and non-proprietary distribution channels. Xxxxxx Xxxxxxx Xxxx Xxxxxx Advisors
and Xxx Xxxxxx Investments ("VK") offer individual investors a broad array of
mutual fund and wealth management tools that cover the full spectrum of
investment categories, including growth, income, sector and global. Xxxxxx
Xxxxxxx Xxxx Xxxxxx Investment Management and Xxxxxx Xxxxxxxx & Xxxxxxxx serve
the specialized needs of global institutional and high net worth investors.
Asset Management's product breadth includes mutual funds, closed-end funds,
managed accounts, managed futures funds, pooled vehicles, variable annuities
and unit investment trusts. In fiscal 2000, Asset Management's assets under
management or supervision increased $30 billion to $502 billion at November
30, 2000.
Asset Management achieved record net revenues of $2,526 million in fiscal
2000, an increase of 20% from fiscal 1999. Asset Management's net income for
fiscal 2000 was a record $683 million, an increase of 52% from fiscal 1999.
The increase in net income in fiscal 2000 primarily reflected higher asset
management, distribution and administration fees resulting from the continued
accumulation and management of customer assets and a more favorable asset mix,
partially offset by higher incentive-based compensation expenses. Net income
for fiscal 2000 included a net gain of $21 million from the sale of the
Company's Global Custody business (see "Results of Operations--Business
Acquisitions and Dispositions" herein). Asset Management achieved net revenues
and net income of $2,112 million and $448 million in fiscal 1999, increases of
20% and 43%, respectively, from
35
fiscal 1998. Fiscal 1998's net income included a net gain of $182 million from
the sale of the Company's Global Custody business (see "Results of
Operations--Business Acquisitions and Dispositions" herein). Fiscal 1998 net
income also included a $117 million charge resulting from the cumulative
effect of an accounting change. This charge represents the effect of an
accounting change adopted in the fourth quarter of fiscal 1998 (effective
December 1, 1997) with respect to the accounting for offering costs paid by
investment advisors of closed-end funds, where such costs are not specifically
reimbursed through separate advisory contracts (see Note 2 to the consolidated
financial statements). Excluding the net gain from the sale of the Global
Custody business and the charge resulting from the cumulative effect of an
accounting change, fiscal 1999's net income increased 81%.
Investment Banking
Asset Management primarily generates investment banking revenues from the
underwriting of Unit Investment Trust products. Investment banking revenues
increased 37% in fiscal 2000 and 258% in fiscal 1999. In both periods, the
increases were primarily associated with higher levels of Unit Investment
Trust sales volumes. Unit Investment Trust sales volumes rose 35% to a record
$16.6 billion in fiscal 2000 and increased 36% to $12.3 billion in fiscal
1999.
Principal Transactions
Asset Management's principal transaction revenues are primarily generated
from the Company's net gains on capital investments in certain of its funds
and other investments.
Principal transaction investment revenues aggregating $60 million were
recognized in fiscal 2000 as compared with $13 million in fiscal 1999. In both
periods, principal transaction investment revenues primarily consisted of net
gains from the Company's capital investments in certain of its funds.
Commissions
Asset Management primarily generates commission revenues from dealer and
distribution concessions on sales of certain funds as well as certain
allocated commission revenues.
Commission revenues were $16 million in fiscal 2000 and $4 million in fiscal
1999. In both periods, the fluctuations were associated with changes in the
level of sales volume of certain VK products and allocated commission
revenues.
Net Interest
Asset Management generates net interest revenues from certain investment
positions as well as from certain allocated interest revenues and expenses.
Net interest revenues in fiscal 1998 also included revenues from global
custody and correspondent clearing services.
Net interest revenues increased 37% in fiscal 2000, primarily reflecting
higher net revenues from certain investment positions and allocations. Net
interest revenues decreased 40% in fiscal 1999, primarily reflecting the
Company's sale of its Global Custody and Correspondent Clearing businesses in
fiscal 1998.
Asset Management, Distribution and Administration Fees
Asset management, distribution and administration fees primarily include
revenues from the management and administration of assets. These fees arise
from investment management services the Company provides to investment
vehicles pursuant to various contractual arrangements. Generally, the Company
receives fees primarily based upon mutual fund average net assets or quarterly
assets for other vehicles. Revenues in fiscal 1998 also include other
administrative fees and non-interest revenues earned from global custody and
correspondent clearing services.
36
The Company's customer assets under management or supervision at fiscal
year-end were as follows:
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
(dollars in
billions)
Products offered primarily to individuals:
Mutual funds:
Equity............................................ $103 $ 94 $ 75
Fixed income...................................... 46 53 57
Money markets..................................... 57 47 37
---- ---- ----
Total mutual funds.............................. 206 194 169
---- ---- ----
ICS assets.......................................... 31 23 19
Separate accounts, unit trust and other
arrangements....................................... 82 75 59
---- ---- ----
Total individual................................ 319 292 247
---- ---- ----
Products offered primarily to institutional clients:
Mutual funds........................................ 36 33 27
Separate accounts, pooled vehicle and other
arrangements....................................... 147 147 138
---- ---- ----
Total institutional............................. 183 180 165
---- ---- ----
Total assets under management or supervision(1)....... $502 $472 $412
==== ==== ====
--------
(1) Revenues and expenses associated with ICS and certain other assets are
included in the Company's Securities segment.
Asset management, distribution and administration fees increased 15% in
fiscal 2000 and 1% in fiscal 1999. In both years, the increases in revenues
primarily reflected higher levels of management fees as well as other revenues
resulting from a higher level of assets under management or supervision. The
increase in fiscal 2000 also reflected a more favorable asset mix, primarily
due to a shift in asset mix to a greater percentage of equity products, which
typically generate higher management fees. The increase in fiscal 1999 was
partially offset by the absence of revenues from global custody and
correspondent clearing activities, attributable to the Company's sale of its
Global Custody business in the fourth quarter of fiscal 1998 and its
Correspondent Clearing business in the third quarter of fiscal 1998.
As of November 30, 2000, assets under management or supervision increased
$30 billion from fiscal year-end 1999. In fiscal 2000, virtually all of the
increase in assets under management or supervision was attributable to net
inflows of customer assets. The increases in assets under management or
supervision due to market appreciation in the first three quarters of the
fiscal year were offset by market depreciation during the fourth fiscal
quarter. This market depreciation reflected the declines in many global
financial markets that occurred during that period. In fiscal 1999,
approximately 25% of the increase in assets under management or supervision
was attributable to net inflows of customer assets, while the remaining 75%
reflected market appreciation.
Non-Interest Expenses
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
(dollars in
millions)
Compensation and benefits.............................. $ 751 $ 648 $ 659
Occupancy and equipment................................ 89 96 97
Brokerage, clearing and exchange fees.................. 94 107 198
Information processing and communications.............. 77 92 87
Marketing and business development..................... 161 127 125
Professional services.................................. 101 137 135
Other.................................................. 143 138 91
------ ------ ------
Total non-interest expenses............................ $1,416 $1,345 $1,392
====== ====== ======
37
Fiscal 2000's total non-interest expenses increased 5% to $1,416 million.
Compensation and benefits expense increased 16%, reflecting higher incentive-
based compensation costs due to Asset Management's higher level of revenues
and earnings. Excluding compensation and benefits expense, non-interest
expenses decreased $32 million. Occupancy and equipment expense decreased 7%,
primarily due to lower depreciation expense on certain data processing
equipment. These decreases were partially offset by higher occupancy costs at
certain office locations. Brokerage, clearing and exchange fees decreased 12%,
primarily attributable to lower sales of closed-end funds through the non-
proprietary distribution channel and higher redemption fees associated with
certain VK products. These decreases were partially offset by a higher level
of deferred commission amortization. Information processing and communications
expense decreased 16%, primarily due to lower costs incurred in fiscal 2000
related to outside data processing and computer software costs. Marketing and
business development expense increased 27%, primarily due to higher
promotional and distribution costs for certain mutual funds. Professional
services expense decreased 26%, reflecting higher consulting costs in fiscal
1999 related to the Company's preparation for the Year 2000, partially offset
by higher consulting costs in fiscal 2000 for various e-commerce initiatives.
Other expense increased 4%, primarily due to new and increased business
activity.
Fiscal 1999's total non-interest expenses decreased 3% to $1,345 million.
Compensation and benefits expense decreased 2%, reflecting lower costs due to
the sale of the Company's Global Custody business in fiscal 1998, partially
offset by higher incentive-based compensation costs due to higher fiscal 1999
revenues and earnings. Excluding compensation and benefits expense, non-
interest expenses decreased $36 million. Occupancy and equipment expense was
comparable with the prior year as higher occupancy costs at certain office
locations were offset by lower costs due to the Company's sale of its Global
Custody business. Brokerage, clearing and exchange fees decreased 46%,
primarily attributable to commissions paid in fiscal 1998 in connection with
the Company's launch of the Xxx Xxxxxx Senior Income Trust mutual fund and
lower sales of closed-end funds through the non-proprietary distribution
channel. In addition, lower agent bank costs were incurred in fiscal 1999 due
to the Company's sale of its Global Custody business. These decreases were
partially offset by a higher level of deferred commission amortization.
Information processing and communications costs increased 6%, primarily due to
increased costs associated with the Company's information technology
infrastructure as well as higher market data costs. These increases were
partially offset by lower costs due to the Company's sale of its Global
Custody business. Marketing and business development expense increased 2% as
higher costs due to business growth, including new product launches, were
partially offset by lower costs due to the Company's sale of its Global
Custody business. Professional services expense increased 1% as higher
consulting fees were partially offset by lower legal expenses and lower costs
due to the Company's sale of its Global Custody business. Other expense
increased 52%, reflecting the impact of a higher level of business activity on
various operating expenses, as well as costs associated with the consolidation
of certain office locations.
38
CREDIT SERVICES
STATEMENTS OF INCOME
(dollars in millions)
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
Fees:
Merchant and cardmember.................................. $1,780 $1,492 $1,647
Servicing................................................ 1,450 1,194 928
Other..................................................... -- -- 5
------ ------ ------
Total non-interest revenues.............................. 3,230 2,686 2,580
------ ------ ------
Interest revenue.......................................... 2,848 2,246 2,729
Interest expense.......................................... 1,347 881 994
------ ------ ------
Net interest income....................................... 1,501 1,365 1,735
Provision for consumer loan losses........................ 810 529 1,173
------ ------ ------
Net credit income......................................... 691 836 562
------ ------ ------
Net revenues............................................. 3,921 3,522 3,142
------ ------ ------
Compensation and benefits................................. 628 525 549
Occupancy and equipment................................... 62 54 67
Information processing and communications................. 493 477 462
Marketing and business development........................ 1,191 1,041 872
Professional services..................................... 119 121 97
Other..................................................... 284 207 207
------ ------ ------
Total non-interest expenses............................... 2,777 2,425 2,254
------ ------ ------
Gain on sale of businesses................................ -- -- 362
------ ------ ------
Income before income taxes................................ 1,144 1,097 1,250
Provision for income taxes................................ 418 435 529
------ ------ ------
Net income................................................ $ 726 $ 662 $ 721
====== ====== ======
The Company's Credit Services business is operated by Discover Financial
Services, a business unit which issues quality consumer credit products and
operates Discover Business Services, a proprietary network of merchant and
cash access locations in the U.S. The credit cards issued by the Company
include the Discover Card, the Discover Platinum Card, the Xxxxxx Xxxxxxx Xxxx
Xxxxxx Card and other proprietary general purpose credit cards.
In fiscal 2000, Credit Services achieved record net income of $726 million,
an increase of 10% from fiscal 1999. The increase reflected higher merchant
and cardmember fees, servicing fees and net interest income, reflecting
overall growth of the business, including record levels of transaction volume
and a record level of period-end managed consumer loans. The increase in net
income was partially offset by a higher provision for consumer loan losses and
higher non-interest expenses.
The results of fiscal 2000 and 1999 do not include the results from Prime
Option, the operations of SPS and certain receivables associated with the
discontinued BRAVO Card, all of which were sold during fiscal 1998. Prime
Option, a business the Company had operated with NationsBank of Delaware,
N.A., was sold during the second quarter of fiscal 1998. The Company sold its
interest in the operations of SPS, which was a 73%-owned, publicly held
subsidiary of the Company, in the fourth quarter of fiscal 1998. The Company
discontinued its BRAVO Card in fiscal 1998 and sold certain credit card
receivables associated with the BRAVO Card in the fourth quarter of fiscal
1998. Fiscal 1998's net after-tax gain from the sale of the operations of SPS
and certain receivables associated with the BRAVO Card was $163 million.
39
In fiscal 1999, Credit Services' net income decreased 8% to $662 million,
primarily due to fiscal 1998's inclusion of the $163 million net gain on the
sale of businesses. Excluding this gain, net income increased 19% in fiscal
1999. The increase was primarily attributable to a lower provision for
consumer loan losses and increased servicing fees, partially offset by lower
net interest income and merchant and cardmember fees and higher marketing and
business development expenses.
Credit Services' statistical data were as follows:
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
(dollars in
billions)
Consumer loans at fiscal year-end:
Owned.................................................. $21.9 $21.0 $16.0
Managed................................................ $47.1 $38.0 $32.5
General purpose credit card transaction volume.......... $90.1 $70.6 $58.0
The higher level of managed consumer loans at November 30, 2000 and 1999 was
primarily attributable to growth in the Company's Discover Platinum Card.
Merchant and Cardmember Fees
Merchant and cardmember fees include revenues from fees charged to merchants
on credit card sales, late payment fees, overlimit fees, insurance fees and
cash advance fees.
Merchant and cardmember fees increased 19% to $1,780 million during fiscal
2000 and decreased 9% to $1,492 million during fiscal 1999. The increase in
fiscal 2000 was primarily due to higher merchant discount revenue and late
payment fees associated with the use of the Discover Card. The increase in
Discover Card merchant discount revenues was primarily due to a record level
of sales volume, coupled with an increase in the average merchant discount
rate. Late payment fees increased in fiscal 2000, primarily due to a fee
increase introduced during April 1999, coupled with an increase in the number
of late fee occurrences, reflecting higher levels of transaction volume and
consumer loans subject to such fees. Merchant and cardmember fees decreased in
fiscal 1999, primarily due to the Company's sale of the operations of SPS and
the sale of Prime Option. Fiscal 1999 also was impacted by higher merchant
discount revenue offset by lower levels of overlimit fees and cash advance
fees. The increase in merchant discount revenue was associated with higher
levels of sales volume. Overlimit fees decreased, primarily due to a lower
level of overlimit fee occurrences. Cash advance fees decreased due to lower
cash advance transaction volume, primarily attributable to the Company's
actions to limit cash advances in an effort to improve credit quality.
Servicing Fees
Servicing fees are revenues derived from consumer loans which have been sold
to investors through asset securitizations. Cash flows from the interest yield
and cardmember fees generated by securitized loans are used to pay investors
in these loans a predetermined fixed or floating rate of return on their
investment, to reimburse the investors for losses of principal resulting from
charged-off loans and to pay the Company a fee for servicing the loans. Any
excess cash flows remaining are paid to the Company. The servicing fees and
excess net cash flows paid to the Company are reported as servicing fees in
the consolidated statements of income. The sale of consumer loans through
asset securitizations, therefore, has the effect of converting portions of net
credit income and fee income to servicing fees. The Company completed asset
securitizations of $9.8 billion in fiscal 2000 and $3.0 billion in fiscal
1999. The asset securitizations in fiscal 2000 and 1999 have expected
maturities ranging from approximately three to seven years from the date of
issuance.
40
The table below presents the components of servicing fees:
Fiscal Fiscal Fiscal
2000 1999 1998
------- ------- -------
(dollars in millions)
Merchant and cardmember fees...................... $ 627 $ 552 $ 505
Interest revenue.................................. 3,432 2,694 2,598
Interest expense.................................. (1,462) (996) (1,010)
Provision for consumer loan losses................ (1,147) (1,056) (1,165)
------- ------- -------
Servicing fees.................................... $ 1,450 $ 1,194 $ 928
======= ======= =======
Servicing fees are affected by the level of securitized loans, the spread
between the interest yield on the securitized loans and the yield paid to the
investors, the rate of credit losses on securitized loans and the level of
cardmember fees earned from securitized loans. Servicing fees increased 21% in
fiscal 2000 and 29% in fiscal 1999. The increase in fiscal 2000 was due to
higher levels of net interest cash flows and increased cardmember fee revenue,
partially offset by higher credit losses associated with a higher level of
average securitized consumer loans. The increase in credit losses was
partially offset by a lower level of charge-offs related to the securitized
portfolio. The increase in fiscal 1999 was due to higher levels of cardmember
fees and net interest income, primarily resulting from higher levels of
average securitized loans. The increase also reflected a decline in credit
losses from securitized consumer loans resulting from a lower level of charge-
offs related to the Discover Card portfolio and the positive impact of the
sale of the operations of SPS, partially offset by an increase in the level of
average securitized loans.
41
Net Interest Income
Net interest income represents the difference between interest revenue
derived from Credit Services consumer loans and short-term investment assets
and interest expense incurred to finance those assets. Credit Services assets,
consisting primarily of consumer loans, earn interest revenue at both fixed
rates and market-indexed variable rates. The Company incurs interest expense
at fixed and floating rates. Interest expense also includes the effects of any
interest rate contracts entered into by the Company as part of its interest
rate risk management program. This program is designed to reduce the
volatility of earnings resulting from changes in interest rates and is
accomplished primarily through matched financing, which entails matching the
repricing schedules of consumer loans and related financing. The following
tables present analyses of Credit Services average balance sheets and interest
rates in fiscal 2000, fiscal 1999 and fiscal 1998 and changes in net interest
income during those fiscal years:
Average Balance Sheet Analysis
Fiscal 2000 Fiscal 1999(3) Fiscal 1998(3)
------------------------ ------------------------ ------------------------
Average Average Average
Balance Rate Interest Balance Rate Interest Balance Rate Interest
------- ----- -------- ------- ----- -------- ------- ----- --------
(dollars in millions)
ASSETS
Interest earning assets:
General purpose credit
card and other consumer
loans.................. $21,910 12.15% $2,662 $16,177 13.10% $2,118 $18,558 14.07% $2,612
Investment securities... 594 6.37 38 672 5.16 35 496 6.25 31
Other................... 2,194 6.74 148 1,656 5.61 93 1,465 5.88 86
------- ----- ------ ------- ----- ------ ------- ----- ------
Total interest earning
assets................ 24,698 11.53 2,848 18,505 12.14 2,246 20,519 13.30 2,729
Allowance for loan
losses................. (777) (774) (847)
Non-interest earning
assets................. 1,589 1,544 1,517
------- ------- -------
Total assets........... $25,510 $19,275 $21,189
======= ======= =======
LIABILITIES AND
SHAREHOLDER'S EQUITY
Interest bearing
liabilities:
Interest bearing
deposits
Savings................ $ 1,513 5.62% $ 85 $ 1,492 4.51% $ 67 $ 1,073 4.79% $ 51
Brokered............... 7,732 6.62 512 5,609 6.37 357 5,656 6.62 375
Other time............. 3,032 6.19 188 1,927 5.61 108 2,189 6.16 135
------- ----- ------ ------- ----- ------ ------- ----- ------
Total interest bearing
deposits.............. 12,277 6.39 785 9,028 5.90 532 8,918 6.29 561
Other borrowings........ 8,484 6.62 562 6,046 5.76 349 7,162 6.05 433
------- ----- ------ ------- ----- ------ ------- ----- ------
Total interest bearing
liabilities........... 20,761 6.49 1,347 15,074 5.84 881 16,080 6.18 994
Shareholder's
equity/other
liabilities............ 4,749 4,201 5,109
------- ------- -------
Total liabilities and
shareholder's equity.. $25,510 $19,275 $21,189
======= ======= =======
Net interest income..... $1,501 $1,365 $1,735
====== ====== ======
Net interest margin(1).. 6.08% 7.38% 8.46%
Interest rate
spread(2).............. 5.04% 6.30% 7.12%
--------
(1) Net interest margin represents net interest income as a percentage of
total interest earning assets.
(2) Interest rate spread represents the difference between the rate on total
interest earning assets and the rate on total interest bearing
liabilities.
(3) Certain prior-year information has been reclassified to conform to the
current year's presentation.
42
Rate/Volume Analysis
Fiscal 2000 vs. Fiscal 1999 vs.
Fiscal 1999 Fiscal 1998
------------------- --------------------
Increase/(Decrease) due to Changes
in: Volume Rate Total Volume Rate Total
---------------------------------- ------ ----- ----- ------ ----- -----
(dollars in millions)
Interest Revenue
General purpose credit card and
other consumer loans............... $752 $(208) $544 $(369) $(125) $(494)
Investment securities............... (4) 7 3 11 (7) 4
Other............................... 30 25 55 11 (4) 7
---- -----
Total interest revenue............. 753 (151) 602 (268) (215) (483)
---- -----
Interest Expense
Interest bearing deposits:
Savings............................ 1 17 18 20 (4) 16
Brokered........................... 136 19 155 (3) (15) (18)
Other time......................... 62 18 80 (16) (11) (27)
---- -----
Total interest bearing deposits.... 192 61 253 7 (36) (29)
Other borrowings.................... 140 73 213 (67) (17) (84)
---- -----
Total interest expense............. 331 135 466 (62) (51) (113)
---- -----
Net interest income................. $421 $(285) $136 $(206) $(164) $(370)
==== ===== ==== ===== ===== =====
Net interest income increased 10% in fiscal 2000 and decreased 21% in fiscal
1999. The increase in fiscal 2000 was primarily due to higher average levels
of consumer loans, partially offset by a lower yield on these loans and
increased financing costs incurred by the Company. The increase in average
consumer loans was due to higher levels of sales and balance transfer volume
and promotional programs. The lower yield on Discover Card loans was primarily
due to lower interest rates offered to new cardmembers and certain existing
cardmembers, partially offset by the Company's repricing of certain credit
card receivables discussed below. The lower yield also reflected an increase
in consumer loans from balance transfers and from promotional purchases, which
are generally offered at lower interest rates for an introductory period. The
increase in interest expense was due to a higher level of interest bearing
liabilities, coupled with an increase in the Company's average cost of
borrowings, reflecting interest rate increases made by the Fed in fiscal 1999
and the first half of fiscal 2000. The average prime rate for fiscal 2000 was
9.19% as compared with 7.98% for fiscal 1999. The decrease in net interest
income in fiscal 1999 was primarily due to lower average levels of consumer
loans and a lower yield on these loans. The decrease in average consumer loans
was due to the sale of the operations of SPS, the sale of Prime Option and the
discontinuance of the BRAVO Card in fiscal 1998 as well as a higher level of
securitized Discover Card loans. The lower yield in fiscal 1999 was due to a
lower yield on Discover Card loans, coupled with the exclusion of SPS loans
from the Company's portfolio. The lower yield on Discover Card loans was
primarily due to the more competitive interest rates offered to both existing
and new cardmembers as well as an increase in consumer loans from balance
transfers.
In response to the rising interest rate environment in the U.S., the Company
repriced a substantial portion of its existing credit card receivables to a
market-indexed variable interest rate during the second and third quarters of
fiscal 2000.
43
The supplemental table below provides average managed loan balance and rate
information, which takes into account both owned and securitized loans:
Supplemental Average Managed Loan Information
Fiscal 2000 Fiscal 1999 Fiscal 1998
------------- ------------- -------------
Average Average Average
Balance Rate Balance Rate Balance Rate
------- ----- ------- ----- ------- -----
(dollars in millions)
General purpose credit card and
other consumer loans............ $43,540 13.82% $33,534 14.23% $34,619 14.86%
Total interest earning assets.... 46,328 13.39 35,862 13.66 36,580 14.38
Total interest bearing
liabilities..................... 42,391 6.54 32,431 5.74 32,141 6.15
Consumer loan interest rate
spread.......................... 7.28 8.49 8.71
Interest rate spread............. 6.85 7.92 8.23
Net interest margin.............. 7.40 8.47 8.98
Provision for Consumer Loan Losses
The provision for consumer loan losses is the amount necessary to establish
the allowance for loan losses at a level that the Company believes is adequate
to absorb estimated losses in its consumer loan portfolio at the balance sheet
date. The Company's allowance for loan losses is regularly evaluated by
management for adequacy and was $780 million at November 30, 2000 and $769
million at November 30, 1999.
The provision for consumer loan losses, which is affected by net charge-
offs, loan volume and changes in the amount of consumer loans estimated to be
uncollectable, increased 53% in fiscal 2000 and decreased 55% in fiscal 1999.
The increase in fiscal 2000 was primarily due to higher levels of average
consumer loans in the Discover Card portfolio, partially offset by a lower net
charge-off rate. In addition, the provision for consumer loan losses in fiscal
1999 benefited from a decline in the loan loss allowance in connection with
securitization transactions entered into prior to the third quarter of 1996.
This loan loss allowance was fully amortized by the end of fiscal 1999. The
decrease in fiscal 1999 was primarily due to a lower level of charge-offs
related to the Discover Card portfolio and the positive impact of the sale of
the operations of SPS, the sale of Prime Option and the discontinuance of the
BRAVO Card. The provision for consumer loan losses also was positively
impacted by a decline in the loan loss allowance in connection with
securitization transactions entered into prior to the third quarter of 1996 as
discussed above.
The Company's future charge-off rates and credit quality are subject to
uncertainties that could cause actual results to differ materially from what
has been discussed above. Factors that influence the provision for consumer
loan losses include the level and direction of consumer loan delinquencies and
charge-offs, changes in consumer spending and payment behaviors, bankruptcy
trends, the seasoning of the Company's loan portfolio, interest rate movements
and their impact on consumer behavior, and the rate and magnitude of changes
in the Company's consumer loan portfolio, including the overall mix of
accounts, products and loan balances within the portfolio.
Consumer loans are considered delinquent when interest or principal payments
become 30 days past due. Consumer loans are charged-off when they become 180
days past due, except in the case of bankruptcies and fraudulent transactions,
where loans are charged-off earlier. Loan delinquencies and charge-offs are
primarily affected by changes in economic conditions and may vary throughout
the year due to seasonal consumer spending and payment behaviors. The net
charge-off rate decreased in fiscal 2000 as compared with fiscal 1999,
reflecting the Company's continued focus on credit quality and account
collections and a reduction in consumer bankruptcies as a result of the
favorable U.S. economic environment.
44
The following table presents delinquency and net charge-off rates with
supplemental managed loan information:
Asset Quality
Fiscal 2000 Fiscal 1999 Fiscal 1998
---------------- ---------------- ----------------
Owned Managed Owned Managed Owned Managed
------- ------- ------- ------- ------- -------
(dollars in millions)
Consumer loans at fiscal
year-end............... $21,870 $47,126 $20,998 $37,975 $15,996 $32,502
Consumer loans
contractually past due
as a percentage of
fiscal year-end
consumer loans:
30 to 89 days......... 3.01% 3.50% 3.35% 3.79% 3.54% 3.69%
90 to 179 days........ 2.04% 2.42% 2.20% 2.53% 2.67% 2.84%
Net charge-offs as a
percentage of average
consumer loans......... 3.63% 4.40% 4.78% 5.42% 6.75% 6.90%
Non-Interest Expenses
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
(dollars in
millions)
Compensation and benefits.............................. $ 628 $ 525 $ 549
Occupancy and equipment................................ 62 54 67
Information processing and communications.............. 493 477 462
Marketing and business development..................... 1,191 1,041 872
Professional services.................................. 119 121 97
Other.................................................. 284 207 207
------ ------ ------
Total non-interest expenses............................ $2,777 $2,425 $2,254
====== ====== ======
Total non-interest expenses increased 15% to $2,777 million in fiscal 2000
and 8% to $2,425 million in fiscal 1999. Increased business activity related
to the Discover Platinum Card as well as the expansion of the Xxxxxx Xxxxxxx
Xxxx Xxxxxx Card in the U.K. were contributing factors for a portion of the
increase in non-interest expenses in fiscal 2000.
Employee compensation and benefits expense increased 20% in fiscal 2000 and
decreased 4% in fiscal 1999. The increase in fiscal 2000 reflected higher
domestic and international compensation costs associated with increased
employment levels associated with higher levels of business activity and
transaction volume. The decrease in fiscal 1999 was primarily due to lower
compensation costs resulting from the sale of Prime Option and the operations
of SPS. These decreases in fiscal 1999 were partially offset by higher
compensation costs associated with increased employment levels due to
increased levels of business activity and transaction volume.
Occupancy and equipment expense increased 15% in fiscal 2000 and decreased
19% in fiscal 1999. The increase in fiscal 2000 was due primarily to higher
occupancy costs associated with increased office space, including new
transaction processing centers. The decrease in fiscal 1999 was primarily due
to the exclusion of the results of Prime Option and SPS, partially offset by
higher occupancy costs associated with Discover Financial Services.
Information processing and communications expense increased 3% in both
fiscal 2000 and fiscal 1999. The increase in fiscal 2000 was primarily due to
an increase in volume-related external data processing costs associated with
the Xxxxxx Xxxxxxx Xxxx Xxxxxx Card in the U.K., partially offset by the
termination of an
45
external transaction processing contract in fiscal 1999. The increase in
fiscal 1999 was due to higher external data processing costs incurred for
domestic operations, including cardmember data analysis associated with
increased portfolio activity, partially offset by the exclusion of the results
of Prime Option and SPS in fiscal 1999.
Marketing and business development expense increased 14% in fiscal 2000 and
19% in fiscal 1999. The increase in fiscal 2000 was primarily due to higher
cardmember rewards expense associated with increased sales volume as well as
increased advertising and direct mailing costs associated with both domestic
and international operations. Marketing and business development expense
increased in fiscal 1999 due to direct mailing and other promotional
activities related to the launch and promotion of the Discover Platinum and
Xxxxxx Xxxxxxx Xxxx Xxxxxx Cards, higher cardmember rewards expense and a new
advertising campaign for the Discover Card. Higher cardmember rewards expense
was due to increased sales volume. Cardmember rewards expense includes the
Cashback Bonus(R) award program, pursuant to which the Company annually pays
Discover Card cardmembers and Xxxxxx Xxxxxxx Xxxx Xxxxxx Card cardmembers
electing this feature a percentage of their purchase amounts ranging up to 1%
based upon a cardmember's annual level and type of purchases.
Professional services expense decreased 2% in fiscal 2000 and increased 25%
in fiscal 1999. The decrease in fiscal 2000 reflects the exclusion of Year
2000 consulting costs in fiscal 2000's results, partially offset by higher
costs associated with account collections, consumer credit counseling and the
outsourcing of certain call center operations. The increase in fiscal 1999 was
due to higher costs associated with account collections, consumer credit
counseling and Year 2000 consulting costs, partially offset by a decrease in
expenses associated with the sale of the operations of SPS.
Other expense primarily includes fraud losses, credit inquiry fees and other
administrative costs. Other expense increased 37% in fiscal 2000 and remained
unchanged in fiscal 1999 as compared with fiscal 1998. In fiscal 2000, the
increase was primarily due to increases in certain domestic and international
operating expenses due to higher levels of transaction volume and business
activity. In fiscal 1999, increased operational costs associated with higher
application and transaction volumes and costs associated with the launch of
the Xxxxxx Xxxxxxx Xxxx Xxxxxx Card in the U.K. were offset by a decrease in
expenses associated with the sale of the operations of SPS.
Seasonal Factors
The credit card lending activities of Credit Services are affected by
seasonal patterns of retail purchasing. Historically, a substantial percentage
of credit card loan growth occurs in the fourth calendar quarter, followed by
a flattening or decline of consumer loans in the following calendar quarter.
Merchant fees, therefore, historically have tended to increase in the first
fiscal quarter, reflecting higher sales activity in the month of December.
Additionally, higher cardmember rewards expense historically have been accrued
in the first fiscal quarter, reflecting seasonal growth in retail sales
volume.
Liquidity and Capital Resources
The Balance Sheet
The Company's total assets increased to $426.8 billion at November 30, 2000
from $367.0 billion at November 30, 1999, primarily attributable to increases
in securities borrowed, financial instruments owned, and cash and securities
deposited with clearing organizations or segregated under federal and other
regulations ("Segregated Cash and Deposits"). Segregated Cash and Deposits
increased due to an increase in customer cash balances, coupled with a
decrease in the level of customers trading on margin. Aircraft under operating
leases increased due to the purchase of Ansett Worldwide. These increases were
partially offset by a decrease in securities purchased under agreements to
resell. A substantial portion of the Company's total assets consists of highly
liquid marketable securities and short-term receivables arising principally
from securities transactions. The highly liquid nature of these assets
provides the Company with flexibility in financing and managing its business.
46
Funding and Capital Policies
The Company's senior management establishes the overall funding and capital
policies of the Company, reviews the Company's performance relative to these
policies, monitors the availability of sources of financing, reviews the
foreign exchange risk of the Company, and oversees the liquidity and interest
rate sensitivity of the Company's asset and liability position. The primary
goal of the Company's funding and liquidity activities is to ensure adequate
financing over a wide range of potential credit ratings and market
environments.
Many of the Company's businesses are capital-intensive. Capital is required
to finance, among other things, the Company's securities inventories,
underwritings, principal investments, private equity activities, consumer
loans, bridge loans and other financings, and investments in fixed assets. As
a policy, the Company attempts to maintain sufficient capital and funding
sources in order to have the capacity to finance itself on a fully
collateralized basis at all times, including periods of financial stress.
Currently, the Company believes it has sufficient capital to meet its needs.
In addition, the Company attempts to maintain total equity, on a consolidated
basis, at least equal to the sum of all of its subsidiaries' equity.
Subsidiary equity capital requirements are determined by regulatory
requirements (if applicable), asset mix, leverage considerations and earnings
volatility.
The Company views return on equity to be an important measure of its
performance, in the context of both the particular business environment in
which the Company is operating and its peer group's results. In this regard,
the Company actively manages its consolidated capital position based upon,
among other things, business opportunities, capital availability and rates of
return together with internal capital policies, regulatory requirements and
rating agency guidelines and, therefore, in the future may expand or contract
its capital base to address the changing needs of its businesses. The Company
returns internally generated equity capital which is in excess of the needs of
its businesses to its shareholders through common stock repurchases and
dividends.
The Company's liquidity policies emphasize diversification of funding
sources. The Company also follows a funding strategy that is designed to
ensure that the tenor of the Company's liabilities equals or exceeds the
expected holding period of the assets being financed. Short-term funding
generally is obtained at rates related to U.S., Euro or Asian money market
rates for the currency borrowed. Repurchase transactions are effected at
negotiated rates. Other borrowing costs are negotiated depending upon
prevailing market conditions (see Notes 5 and 6 to the consolidated financial
statements). Maturities of both short-term and long-term financings are
designed to minimize exposure to refinancing risk in any one period.
The volume of the Company's borrowings generally fluctuates in response to
changes in the amount of repurchase transactions outstanding, the level of the
Company's securities inventories and consumer loans receivable, and overall
market conditions. Availability and cost of financing to the Company can vary
depending upon market conditions, the volume of certain trading activities,
the Company's credit ratings and the overall availability of credit. The
Company, therefore, maintains a surplus of unused short-term funding sources
at all times to withstand any unforeseen contraction in credit capacity. In
addition, the Company attempts to maintain cash and unhypothecated marketable
securities equal to at least 110% of its outstanding short-term unsecured
borrowings. The Company has in place a contingency funding strategy, which
provides a comprehensive one-year action plan in the event of a severe
funding disruption.
The Company views long-term debt as a stable source of funding for core
inventories, consumer loans and illiquid assets and, therefore, maintains a
long-term debt-to-capitalization ratio at a level appropriate for the current
composition of its balance sheet. In general, fixed assets are financed with
fixed rate long-term debt, and securities inventories and the majority of
current assets are financed with a combination of short-term funding, floating
rate long-term debt or fixed rate long-term debt swapped to a floating basis.
Both fixed rate and floating rate long-term debt (in addition to sources of
funds accessed directly by the Company's Credit Services business) are used to
finance the Company's consumer loan portfolio. Consumer loan financing is
targeted to match the repricing and duration characteristics of the loans
financed. The Company uses derivative products (primarily interest rate,
currency and equity swaps) to assist in asset and liability management, reduce
borrowing costs and hedge interest rate risk (see Note 6 to the consolidated
financial statements).
47
The Company's reliance on external sources to finance a significant portion
of its day-to-day operations makes access to global sources of financing
important. The cost and availability of unsecured financing generally are
dependent on the Company's short-term and long-term debt ratings. In addition,
the Company's debt ratings can have a significant impact on certain trading
revenues, particularly in those businesses where longer term counterparty
performance is critical, such as over-the-counter derivative transactions.
As of January 31, 2001, the Company's credit ratings were as follows:
Commercial Paper Senior Debt
---------------- -----------
Dominion Bond Rating Service Limited............... R-1 (middle) AA (low)
Fitch(1)........................................... F1+ XX
Xxxxx'x Investors Service.......................... P-1 Aa3
Rating and Investment Information, Inc.(2)......... a-1+ AA
Standard & Poor's(3)............................... A-1+ AA-
--------
(1) Fitch IBCA, Inc. and Duff & Xxxxxx Credit Rating Co. merged on June 1,
2000. In addition, on December 1, 2000, Fitch completed its acquisition of
Thomson Financial BankWatch. The combined company is using the former
Fitch IBCA, Inc. rating scale.
(2) On August 1, 0000, Xxxxx Rating & Investment Information, Inc. changed its
name to Rating and Investment Information, Inc.
(3) On May 17, 2000, Standard & Poor's upgraded the Company's commercial paper
rating from A-1 to A-1+ and upgraded the Company's senior debt rating from
A+ to AA-.
As the Company continues its global expansion and derives revenues
increasingly from various currencies, foreign currency management is a key
element of the Company's financial policies. The Company benefits from
operating in several different currencies because weakness in any particular
currency often is offset by strength in another currency. The Company closely
monitors its exposure to fluctuations in currencies and, where cost-justified,
adopts strategies to reduce the impact of these fluctuations on the Company's
financial performance. These strategies include engaging in various hedging
activities to manage income and cash flows denominated in foreign currencies
and using foreign currency borrowings, when appropriate, to finance
investments outside the U.S.
Principal Sources of Funding
The Company funds its balance sheet on a global basis. The Company's funding
for its Securities and Asset Management businesses is raised through diverse
sources. These sources include the Company's capital, including equity and
long-term debt; repurchase agreements; U.S., Canadian, Euro and Japanese
commercial paper; letters of credit; unsecured bond borrowings; securities
lending; buy/sell agreements; municipal reinvestments; master notes; and
committed and uncommitted lines of credit. Repurchase agreement transactions,
securities lending and a portion of the Company's bank borrowings are made on
a collateralized basis and, therefore, provide a more stable source of funding
than short-term unsecured borrowings.
The funding sources utilized for the Company's Credit Services business
include the Company's capital, including equity and long-term debt; asset-
backed securitizations; deposits; Federal Funds; and short-term bank notes.
The Company sells consumer loans through asset securitizations using several
transaction structures. During the second quarter of fiscal 2000, an
extendible asset-backed certificate program was launched.
The Company's bank subsidiaries solicit deposits from consumers, purchase
Federal Funds and issue short-term bank notes. Interest bearing deposits are
classified by type as savings, brokered and other time deposits. Savings
deposits consist primarily of money market deposits and certificates of
deposit accounts sold directly to cardmembers and savings deposits from
individual securities clients. Brokered deposits consist primarily of
certificates of deposits issued by the Company's bank subsidiaries. Other time
deposits include institutional
48
certificates of deposits. The Company, through Discover Bank (formerly
Greenwood Trust Company), an indirect subsidiary of the Company, sells notes
under a short-term bank note program.
The Company maintains borrowing relationships with a broad range of banks,
financial institutions, counterparties and others from which it draws funds in
a variety of currencies.
The Company maintains a senior revolving credit agreement with a group of
banks to support general liquidity needs, including the issuance of commercial
paper (the "MSDW Facility"). Under the terms of the MSDW Facility, the banks
are committed to provide up to $5.5 billion. The MSDW Facility contains
restrictive covenants which require, among other things, that the Company
maintain specified levels of shareholders' equity. The Company believes that
the covenant restrictions will not impair the Company's ability to pay its
current level of dividends. At November 30, 2000, no borrowings were
outstanding under the MSDW Facility.
The Company maintains a master collateral facility that enables Xxxxxx
Xxxxxxx & Co. Incorporated ("MS&Co."), one of the Company's U.S. broker-dealer
subsidiaries, to pledge certain collateral to secure loan arrangements,
letters of credit and other financial accommodations (the "MS&Co. Facility").
As part of the MS&Co. Facility, MS&Co. also 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
$1.875 billion. The credit agreement contains restrictive covenants which
require, among other things, that MS&Co. maintain specified levels of
consolidated shareholder's equity and Net Capital, each as defined. At
November 30, 2000, no borrowings were outstanding under the MS&Co. Facility.
The Company also maintains a revolving committed financing facility that
enables Xxxxxx Xxxxxxx & Co. International Limited ("MSIL"), the Company's
London-based broker-dealer subsidiary, to secure committed funding from a
syndicate of banks by providing a broad range of collateral under repurchase
agreements (the "MSIL Facility"). Such banks are committed to provide up to an
aggregate of $1.785 billion, available in six major currencies. The facility
agreement contains restrictive covenants which require, among other things,
that MSIL maintain specified levels of Shareholder's Equity and Financial
Resources, each as defined. At November 30, 2000, no borrowings were
outstanding under the MSIL Facility.
Xxxxxx Xxxxxxx Xxxx Xxxxxx Japan Limited ("MSDWJL"), the Company's Tokyo-
based broker-dealer subsidiary, maintains a committed revolving credit
facility, guaranteed by the Company, that provides funding to support general
liquidity needs, including support of MSDWJL's unsecured borrowings (the
"MSDWJL Facility"). Under the terms of the MSDWJL Facility, a syndicate of
banks is committed to provide up to 70 billion Japanese yen. At November 30,
2000, no borrowings were outstanding under the MSDWJL Facility.
The Company anticipates that it will utilize the MSDW Facility, the MS&Co.
Facility, the MSIL Facility or the MSDWJL Facility for short-term funding from
time to time (see Note 5 to the consolidated financial statements).
Fiscal 2000 and Subsequent Activity
During fiscal 2000, the Company issued senior notes aggregating $22,363
million, including non-U.S. dollar currency notes aggregating $3,298 million,
primarily pursuant to its public debt shelf registration statements. These
notes have maturities from 2001 to 2030 and a weighted average coupon interest
rate of 6.55% at November 30, 2000. The Company has entered into certain
transactions to obtain floating interest rates based primarily on short-term
London Interbank Offered Rates ("LIBOR") trading levels. At November 30, 2000,
the aggregate outstanding principal amount of the Company's Senior
Indebtedness (as defined in the Company's public debt shelf registration
statements) was approximately $65.2 billion (including senior indebtedness
consisting of guaranteed obligations of the indebtedness of subsidiaries).
Between November 30, 2000 and January 31, 2001, the Company's long-term
borrowings, net of repayments and repurchases, decreased by approximately $305
million.
49
Effective June 22, 2000, the Company's Board of Directors authorized the
Company to purchase, subject to market conditions and certain other factors,
an additional $1.5 billion of the Company's common stock for capital
management purposes. The Company also has a separate ongoing repurchase
authorization in connection with awards granted under its equity-based
compensation plans. During fiscal 2000, the Company purchased $3,628 million
of its common stock. Subsequent to November 30, 2000 and through January 31,
2001, the Company purchased an additional $256 million of its common stock;
the unused portion of the capital management common stock repurchase
authorization at January 31, 2001 was approximately $911 million (without
giving effect to any outstanding put options).
In an effort to enhance its ongoing stock repurchase program, the Company
may sell put options on shares of its common stock to third parties. These put
options entitle the holder to sell shares of the Company's common stock to the
Company on certain dates at specified prices. As of November 30, 2000, put
options were outstanding on an aggregate of 3 million shares of the Company's
common stock. These put options have various expiration dates that range from
January 2001 through April 2001. The Company may elect cash settlement of the
put options instead of taking delivery of the stock.
In fiscal 2000, the Company and Xxxxxx Xxxxxxx Finance, plc, a U.K.
subsidiary, redeemed all of the outstanding 8.4% Capital Units, 8.2% Capital
Units and 9.0% Capital Units. The aggregate principal amount of the Capital
Units redeemed was $513 million.
At November 30, 2000, certain assets of the Company, such as real property,
equipment and leasehold improvements of $2.7 billion, aircraft assets of $3.9
billion, and goodwill and other intangible assets of $1.3 billion, were
illiquid. Certain equity investments made in connection with the Company's
private equity and other principal investment activities, high-yield debt
securities, certain collateralized mortgage obligations and mortgage-related
loan products, bridge financings, and certain senior secured loans and
positions are not highly liquid. At November 30, 2000, the Company had
aggregate principal investments (including direct investments and partnership
interests) with a carrying value of approximately $1.2 billion. The Company
also has commitments to fund certain fixed assets and other less liquid
investments, including at November 30, 2000 approximately $900 million in
connection with its private equity and other principal investment activities.
Additionally, the Company has provided, and will continue to provide,
financing (including margin lending and other extensions of credit) to
clients.
In connection with the Company's fixed income securities activities, the
Company underwrites, trades, invests and makes markets in non-investment grade
instruments ("high-yield instruments"). For purposes of this discussion, high-
yield instruments are defined as fixed income, emerging market and preferred
equity securities and distressed debt rated BB+ or lower (or equivalent
ratings by recognized credit rating agencies) as well as non-rated securities
which, in the opinion of management, are non-investment grade. High-yield
instruments generally involve greater risk than investment grade securities
due to the lower credit ratings of the issuers, which typically have
relatively high levels of indebtedness and, therefore, are more sensitive to
adverse economic conditions. In addition, the market for high-yield
instruments is, and may continue to be, characterized by periods of volatility
and illiquidity. The Company has in place credit and other risk policies and
procedures to monitor total inventory positions and risk concentrations for
high-yield instruments that are administered in a manner consistent with the
Company's overall risk management policies and control structure. The Company
records high-yield instruments at fair value. Unrealized gains and losses are
recognized currently in the Company's consolidated statements of income. At
November 30, 2000 and 1999, the Company had exposure to high-yield instruments
owned with a market value of approximately $2.2 billion and $3.5 billion,
respectively, and exposure to high-yield instruments sold, not yet purchased
with a market value of $0.5 billion and $0.4 billion, respectively.
In connection with certain of its business activities, the Company provides
financing or financing commitments to companies in the form of senior and
subordinated debt, including bridge financing, on a selective basis. The
borrowers may be rated investment grade or non-investment grade. These loans
and funding commitments typically are secured against the borrower's assets,
have varying maturity dates and are generally
50
contingent upon certain representations, warranties and contractual conditions
applicable to the borrower. As part of these activities, the Company may
syndicate and trade certain positions of these loans. At November 30, 2000 and
1999, the aggregate value of investment grade loans and positions was $2.1
billion and $0.1 billion, respectively, and the aggregate value of non-
investment grade loans and positions was $2.2 billion and $1.3 billion,
respectively. At November 30, 2000, the Company also had provided additional
commitments associated with these activities to investment grade issuers
aggregating $12.2 billion and commitments to non-investment grade issuers
aggregating $2.3 billion.
The Company has contracted to develop a one million-square-foot office tower
in New York City. Pursuant to this agreement, the Company will own the
building and has entered into a 99-year lease for the land at the development
site. Construction began in 1999, and the Company intends to occupy the
building upon project completion, which is anticipated in fiscal 2002. The
total investment in this project is estimated to be approximately $700
million.
The gross notional and fair value amounts of derivatives used by the Company
for asset and liability management and as part of its trading activities are
summarized in Notes 6 and 9, respectively, to the consolidated financial
statements (see also "Derivative Financial Instruments" herein).
Regulatory Capital Requirements
Xxxx Xxxxxx Xxxxxxxx Inc. ("DWR") and MS&Co. are registered broker-dealers
and registered futures commission merchants and, accordingly, are subject to
the minimum net capital requirements of the Securities and Exchange Commission
("SEC"), the New York Stock Exchange and the Commodity Futures Trading
Commission. MSIL, a London-based broker-dealer subsidiary, is regulated by the
Securities and Futures Authority ("SFA") in the U.K. and, accordingly, is
subject to the capital requirements of the SFA. MSDWJL, a Tokyo-based broker-
dealer, is subject to the capital requirements of the Financial Services
Agency. DWR, MS&Co., MSIL and MSDWJL have consistently operated in excess of
their respective regulatory requirements (see Note 11 to the consolidated
financial statements).
Certain of the Company's subsidiaries are Federal Deposit Insurance
Corporation ("FDIC") insured financial institutions. Such subsidiaries,
therefore, are subject to the regulatory capital requirements adopted by the
FDIC. These subsidiaries have consistently operated in excess of these and
other regulatory 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. In
addition, Xxxxxx Xxxxxxx Derivative Products Inc., a triple-A rated subsidiary
through which the Company conducts some of its derivative activities, has
established certain operating restrictions which have been reviewed by various
rating agencies.
Effects of Inflation and Changes in Foreign Exchange Rates
Because the Company's assets to a large extent are liquid in nature, they
are not significantly affected by inflation. However, inflation may result in
increases in the Company's expenses, which may not be readily recoverable in
the price of services offered. To the extent inflation results in rising
interest rates and has other adverse effects upon the securities markets, upon
the value of financial instruments and upon the markets for consumer credit
services, it may adversely affect the Company's financial position and
profitability.
A portion of the Company's business is conducted in currencies other than
the U.S. dollar. Non-U.S. dollar assets typically are financed by direct
borrowing or swap-based funding in the same currency. Changes in foreign
exchange rates affect non-U.S. dollar revenues as well as non-U.S. dollar
expenses. Those foreign exchange exposures that arise and are not hedged by an
offsetting foreign currency exposure are actively managed by the Company to
minimize risk of loss due to currency fluctuations.
51
Derivative Financial Instruments
The Company actively offers to clients and trades for its own account a
variety of financial instruments described as "derivative products" or
"derivatives." These products generally take the form of futures, forwards,
options, swaps, caps, collars, floors, swap options and similar instruments
which derive their value from underlying interest rates, foreign exchange
rates, commodities, equity instruments, equity indices, reference credits or
other assets. All of the Company's trading-related divisions use derivative
products as an integral part of their respective trading strategies, and such
products are used extensively to manage the market exposure that results from
a variety of proprietary trading activities (see Note 9 to the consolidated
financial statements). In addition, as a dealer in certain derivative
products, most notably interest rate and currency swaps, the Company enters
into derivative contracts to meet a variety of risk management and other
financial needs of its clients. Given the highly integrated nature of
derivative products and related cash instruments in the determination of
overall trading division profitability and the context in which the Company
manages its trading areas, it is not meaningful to allocate trading revenues
between the derivative and underlying cash instrument components. Moreover,
the risks associated with the Company's derivative activities, including
market and credit risks, are managed on an integrated basis with associated
cash instruments in a manner consistent with the Company's overall risk
management policies and control structure (see "Risk Management" following
"Management's Discussion and Analysis of Financial Condition and Results of
Operations"). It should be noted that while particular risks may be associated
with the use of derivatives, in many cases derivatives serve to reduce, rather
than increase, the Company's exposure to market, credit and other risks.
The total notional value of derivative trading contracts outstanding at
November 30, 2000 was $3,891 billion (as compared with $3,404 billion at
November 30, 1999). While these amounts are an indication of the degree of the
Company's use of derivatives for trading purposes, they do not represent the
Company's market or credit exposure and may be more indicative of customer
utilization of derivatives. The Company's exposure to market risk relates to
changes in interest rates, foreign currency exchange rates, or the fair value
of the underlying financial instruments or commodities. The Company's exposure
to credit risk at any point in time is represented by the fair value of such
contracts reported as assets. Such total fair value outstanding as of November
30, 2000 was $27.3 billion. Approximately $19.9 billion of that credit risk
exposure was with counterparties rated single-A or better (see Note 9 to the
consolidated financial statements).
The Company also uses derivative products (primarily interest rate, currency
and equity swaps) to assist in asset and liability management, reduce
borrowing costs and hedge interest rate risk (see Note 6 to the consolidated
financial statements).
The Company believes that derivatives are valuable tools that can provide
cost-effective solutions to complex financial problems and remains committed
to providing its clients with innovative financial products. The Company
established Xxxxxx Xxxxxxx Derivative Products Inc. to offer derivative
products to clients that will enter into derivative transactions only with
triple-A rated counterparties. In addition, the Company, through its
continuing involvement with regulatory, self-regulatory and industry
activities, provides leadership in the development of policies and practices
in order to maintain confidence in the markets for derivative products, which
is critical to the Company's ability to assist clients in meeting their
overall financial needs.
52
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
RISK MANAGEMENT
Risk Management Policy and Control Structure
Risk is an inherent part of the Company's business and activities. The
extent to which the Company properly and effectively identifies, assesses,
monitors and manages each of the various types of risk involved in its
activities is critical to its soundness and profitability. The Company's
broad-based portfolio of business activities helps reduce the impact that
volatility in any particular area or related areas may have on its net
revenues as a whole. The Company seeks to identify, assess, monitor and
manage, in accordance with defined policies and procedures, the following
principal risks involved in the Company's business activities: market risk,
credit risk, operational risk, legal risk and funding risk. Funding risk is
discussed in the "Liquidity and Capital Resources" section of "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Risk management at the Company is a multi-faceted process with independent
oversight that 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 administrative and business functions to
assist in the identification, assessment and control of various risks. In
recognition of the increasingly varied and complex nature of the global
financial services business, the Company's risk management policies,
procedures and methodologies are evolutionary in nature and are subject to
ongoing review and modification.
The Management Committee, composed of the Company's most senior officers,
establishes the overall risk management policies for the Company and reviews
the Company's performance relative to these policies. The Management Committee
has created several Risk Committees to assist it in monitoring and reviewing
the Company's risk management practices. These Risk Committees, as well as
other committees established to manage and monitor specific risks, review the
risk monitoring and risk management policies and procedures relating to the
Company's market and credit risk profile, sales practices, pricing of consumer
loans and reserve adequacy, legal enforceability, and operational and systems
risks.
The Firm Risk Management, Controllers, Treasury, and Law and Compliance
Departments, which are all independent of the Company's business units, also
assist senior management and the Risk Committees in monitoring and controlling
the Company's risk profile. The Firm Risk Management Department is responsible
for risk policy development, risk analysis and risk reporting to senior
management and the Risk Committees and has operational responsibility for
measuring and monitoring aggregate market and credit risk with respect to
institutional trading activities. In addition, the Internal Audit Department,
which also reports to senior management, periodically examines and evaluates
the Company's operations and control environment. The Company continues to be
committed to employing qualified personnel with appropriate expertise in each
of its various administrative and business areas to implement effectively the
Company's risk management and monitoring systems and processes.
The following is a discussion of the Company's risk management policies and
procedures for its principal risks (other than funding risk). The discussion
focuses on the Company's securities trading (primarily its institutional
trading activities) and consumer lending and related activities. The Company
believes that these activities generate a substantial portion of its principal
risks. This discussion and the estimated amounts of the Company's market risk
exposure generated by the Company's statistical analyses are forward-looking
statements. However, the analyses used to assess such risks are not
predictions of future events, and actual results may vary significantly from
such analyses due to events in the markets in which the Company operates and
certain other factors described below.
53
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 position or portfolio.
For a discussion of the Company's currency exposure relating to its net
monetary investments in non-U.S. dollar functional currency subsidiaries, see
Note 11 to the consolidated financial statements.
Trading and Related Activities
Primary Market Risk Exposures and Market Risk Management
During fiscal 2000, the Company had exposures to a wide range of interest
rates, equity prices, foreign exchange rates and commodity prices -- and
associated volatilities and spreads -- related to the global markets in which
it conducts its trading activities. The Company is exposed to interest rate
risk as a result of maintaining market-making activities and proprietary
trading in interest rate sensitive financial instruments (e.g., risk arising
from changes in the level or volatility of interest rates, the timing of
mortgage prepayments, the shape of the yield curve and credit spreads for
corporate bonds, asset-backed securities and emerging market debt). The
Company is exposed to equity price and implied volatility risk as a result of
making markets in equity securities and equity derivatives and maintaining
proprietary positions. The Company is exposed to foreign exchange rate and
implied volatility risk in connection with making markets in foreign
currencies and foreign currency options and with maintaining foreign exchange
positions. The Company's foreign exchange trading covers many currencies,
including the yen, euro and pound sterling. The Company is exposed to
commodity price and implied volatility risk as a result of trading in physical
commodities, such as crude and refined oil, natural gas, electricity, precious
and base metals, and in related derivatives.
The Company manages its trading positions by employing a variety of
strategies. These strategies include diversification of risk exposures and
hedging through the purchase or sale of positions in related securities and
financial instruments, including a variety of derivative products (e.g.,
futures, forwards, swaps and options). The Company manages the market risk
associated with its trading activities on a Company-wide basis, on a trading
division level worldwide and on an individual product basis. The Company
manages and monitors its market risk exposures in such a way as to maintain a
portfolio that the Company believes is well-diversified in the aggregate with
respect to market risk factors and reflects the Company's aggregate risk
tolerance as established by the Company's senior management.
Market risk limits have been approved for the Company and each major trading
division of the Company worldwide (equity, fixed income, foreign exchange and
commodities). Additional market risk limits are assigned to trading desks and,
as appropriate, products and regions. Trading division risk managers, desk
risk managers and the Firm Risk Management Department monitor market risk
measures against limits in accordance with policies set by senior management.
The Firm Risk Management Department independently reviews the Company's
trading portfolios on a regular basis from a market risk perspective utilizing
Value-at-Risk ("VaR") and other quantitative and qualitative risk measurements
and analyses. The Company's trading businesses and the Firm Risk Management
Department also use, as appropriate, measures such as sensitivity to changes
in rates, prices, volatilities and time decay to monitor and report market
risk exposures. 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 trading division risk
managers, desk risk managers and the Firm Risk Management Department.
Value-at-Risk
The statistical technique known as VaR is one of the tools used by
management to measure, monitor and review the market risk exposures of the
Company's trading portfolios. The Firm Risk Management Department calculates
and distributes daily VaR-based risk measures to various levels of management.
54
VaR Methodology, Assumptions and Limitations
The Company estimates VaR using a model based on historical simulation for
major market risk factors and Monte Carlo simulation for name-specific risk in
certain equity and fixed income exposures. Historical simulation involves
constructing a distribution of hypothetical daily changes in the value of
trading portfolios based on historical observation of daily changes in key
market indices or other market factors ("market risk factors") and on
information on the sensitivity of the portfolio values to these market risk
factor changes. In the case of the Company's VaR, approximately four years of
historical data are used to characterize potential changes in market risk
factors. The Company's one-day 99% VaR corresponds to the negative change in
portfolio value that, based on observed market risk factor movements, would
have been exceeded with a frequency of 1%, or once in 100 trading days.
The Company's VaR model generally takes into account linear and non-linear
exposures to price and interest rate risk and linear exposure to implied
volatility risks. Market risks that are incorporated in the VaR model include
equity and commodity prices, interest rates, foreign exchange rates and
associated volatilities. As a supplement to the use of historical simulation
for major market risk factors, the Company's VaR model uses Monte Carlo
simulation to capture name-specific risk in equities and in corporate and
high-yield bonds. For example, the model includes measures of name-specific
risk for approximately 10,000 equity names and 100 classes of corporate and
high-yield bonds.
VaR models such as the Company's should be expected to evolve over time in
response to changes in the composition of trading portfolios and to
improvements in modeling techniques and systems capabilities. For example,
during fiscal 2000, as part of the Company's ongoing program of VaR model
enhancement, position and risk coverage were broadened and risk measurement
methodologies were refined for certain energy and fixed income products.
Among their benefits, VaR models permit estimation of a portfolio's
aggregate market risk exposure, incorporating a range of varied market risks;
reflect risk reduction due to portfolio diversification; and can cover a wide
range of portfolio assets yet are relatively easy to interpret. However, VaR
risk measures should be interpreted in light of the methodology's limitations,
which include the following: past changes in market risk factors will not
always yield accurate predictions of the distributions and correlations of
future market movements; changes in portfolio value in response to market
movements may differ from the responses calculated by a VaR model; VaR using a
one-day time horizon does not fully capture the market risk of positions that
cannot be liquidated or hedged within one day; the historical market risk
factor data used for VaR estimation may provide only limited insight into
losses that could be incurred under market conditions that are unusual
relative to the historical period used in estimating the VaR; and published
VaR results reflect past trading positions while future risk depends on future
positions. The Company is aware of these and other limitations and, therefore,
uses VaR as only one component in its risk management review process. This
process also incorporates stress testing and extensive risk monitoring and
control at the trading desk, division and Company levels.
VaR for Fiscal 2000
The table below presents the Company's VaR for each of the Company's primary
market risk exposures and on an aggregate basis at November 30, 2000 and
November 30, 1999, incorporating substantially all financial instruments
generating market risk that are managed by the Company's institutional trading
businesses. This measure of VaR incorporates most of the Company's trading-
related market risks. However, a small proportion of trading positions
generating market risk was not covered, and the modeling of the risk
characteristics of some positions involved approximations that could be
significant under certain circumstances. Aspects of market risk associated
with positions reflected in the VaR results below that the Company has found
particularly difficult to model include certain risks associated with fixed
income instruments (such as prepayment behavior of mortgage-backed securities
and elements of credit derivatives price risk), name-specific equity price
risk in newly public companies, certain commodity price risks (such as
electricity price risk) and certain liquidity risks.
55
Aggregate VaR also incorporates (a) the funding liabilities related to
institutional trading positions and (b) public-company equity positions
recorded as principal investments by the Company. The incremental impact on
VaR of these non-trading positions was not material as of November 30, 2000
and 1999, and, therefore, the table below does not separately report trading
and non-trading VaRs.
Non-publicly traded principal investments made by the Company are not
reflected in the VaR results reported below. As of November 30, 2000, the
total amount of such investments was approximately $1 billion.
Since VaR statistics reported below are estimates based on historical
position and market data, VaR should not be viewed as predictive of the
Company's future financial performance or its ability to monitor and manage
risk. There can be no assurance that the Company's actual losses on a
particular day will not exceed the VaR amounts indicated below or that such
losses will not occur more than once in 100 trading days.
99%/One-Day VaR
Primary Market Risk Category at November 30
---------------------------- --------------------------------
2000 1999
--------------- ----
(dollars in millions, pre-tax)
Interest rate.............................. $ 28 $ 33
Equity price............................... 27 32
Foreign exchange rate...................... 5 3
Commodity price............................ 17 16
--------------- ---------------
Subtotal................................... 77 84
Less diversification benefit(1)............ 35 33
--------------- ---------------
Aggregate VaR.............................. $ 42 $ 51
=============== ===============
--------
(1) Equals the difference between Aggregate VaR and the sum of the VaRs for
the four risk categories. This benefit arises because the simulated
99%/one-day losses for each of the four primary market risk categories
occur on different days; similar diversification benefits also are taken
into account within each such category.
The change in aggregate VaR and its interest rate and equity price
components from November 30, 1999 to November 30, 2000 primarily reflected a
reduction in municipal, emerging market and high-yield debt positions in the
Company's trading portfolio and the sale of certain private equity positions.
In order to facilitate comparisons with other global financial services
firms, the Company notes that its Aggregate VaR values at November 30, 2000
for other confidence levels and time horizons were as follows: $29 million for
95%/one-day VaR and $134 million for 99%/two-week VaR.
The table below presents the high, low and average 99%/one-day trading VaR
over the course of fiscal 2000 for substantially all of the Company's
institutional trading activities. Certain market risks included in the year-
end VaR discussed above are excluded from this measure (e.g., equity price
risk in public-company equity positions recorded as principal investments by
the Company and certain funding liabilities related to trading positions).
Daily 99%/One-
Day VaR
Primary Market Risk Category for Fiscal 2000
---------------------------- ----------------
High Low Average
---- --- -------
(dollars in
millions, pre-
tax)
Interest rate............................................... $48 $21 $29
Equity price................................................ 36 17 24
Foreign exchange rate....................................... 11 3 5
Commodity price............................................. 21 11 16
Trading VaR................................................. $51 $33 $40
56
The histogram below presents the Company's daily 99%/one-day VaR for its
institutional trading activities during fiscal 2000:
Description of Histogram: The horizontal axis of the chart categorizes the
99%/one-day Value-at-Risk into numerical ranges. The vertical axis of the chart
indicates the number of trading days that Value-at-Risk fell into a given
numerical range. The histogram shows that distribution of daily 99%/one-day
Value-at-Risk during fiscal year 2000 was:
---------------------------------------------------------
Value - at - Risk |
(in millions of U.S. dollars) | Number of Days
---------------------------------|-----------------------
Less than 35 | 2
---------------------------------|-----------------------
35 to 36 | 6
---------------------------------|-----------------------
36 to 37 | 10
---------------------------------|-----------------------
37 to 38 | 16
---------------------------------|-----------------------
38 to 39 | 28
---------------------------------|-----------------------
39 to 40 | 31
---------------------------------|-----------------------
40 to 41 | 37
---------------------------------|-----------------------
41 to 42 | 29
---------------------------------|-----------------------
42 to 43 | 28
---------------------------------|-----------------------
43 to 44 | 19
---------------------------------|-----------------------
44 to 45 | 10
---------------------------------|-----------------------
45 to 46 | 14
---------------------------------|-----------------------
46 to 47 | 13
---------------------------------|-----------------------
47 to 48 | 5
---------------------------------|-----------------------
48 to 49 | 3
---------------------------------|-----------------------
49 to 50 | 1
---------------------------------|-----------------------
Greater than 50 | 2
---------------------------------------------------------
The histogram below shows the distribution of daily revenues during fiscal
2000 for the Company's institutional trading businesses (net of interest
expense and including commissions and primary revenue credited to the trading
businesses):
Description of Histogram: The horizontal axis of the chart categorizes daily net
revenue of the institutional trading businesses into numerical ranges. The
vertical axis of the chart indicates the number of trading days that revenue
fell into a given numerical range. The histogram shows that distribution of
daily institutional trading revenue during fiscal year 2000 was:
---------------------------------------------------------
Daily Institutional Trading |
Revenue |
(in millions of U.S. dollars) | Number of Days
---------------------------------|-----------------------
Less than -10 | 4
---------------------------------|-----------------------
-10 to -5 | 3
---------------------------------|-----------------------
-5 to 0 | 5
---------------------------------|-----------------------
0 to 5 | 5
---------------------------------|-----------------------
5 to 10 | 9
---------------------------------|-----------------------
10 to 15 | 13
---------------------------------|-----------------------
15 to 20 | 15
---------------------------------|-----------------------
20 to 25 | 20
---------------------------------|-----------------------
25 to 30 | 28
---------------------------------|-----------------------
30 to 35 | 22
---------------------------------|-----------------------
35 to 40 | 31
---------------------------------|-----------------------
40 to 45 | 22
---------------------------------|-----------------------
45 to 50 | 15
---------------------------------|-----------------------
50 to 55 | 10
---------------------------------|-----------------------
55 to 60 | 17
---------------------------------|-----------------------
60 to 65 | 12
---------------------------------|-----------------------
65 to 70 | 4
---------------------------------|-----------------------
70 to 75 | 6
---------------------------------|-----------------------
75 to 80 | 5
---------------------------------|-----------------------
80 to 85 | 0
---------------------------------|-----------------------
85 to 90 | 2
---------------------------------|-----------------------
90 to 95 | 2
---------------------------------|-----------------------
95 to 100 | 1
---------------------------------|-----------------------
Greater than 100 | 5
---------------------------------------------------------
The Company evaluates the reasonableness of its VaR model by comparing the
potential declines in portfolio values generated by the model with actual
trading results. There were no days during fiscal 2000 in which the Company
incurred daily xxxx-to-market losses (trading revenue net of interest income
and expense
57
and excluding commissions and primary revenue credited to the trading
businesses) in its institutional trading business in excess of the 99%/one-day
VaR.
Consumer Lending and Related Activities
Interest Rate Risk and Management
In its consumer lending activities, the Company is exposed to market risk
primarily from changes in interest rates. Such changes in interest rates
impact interest earning assets, principally credit card and other consumer
loans and net servicing fees received in connection with consumer loans sold
through asset securitizations, as well as the interest-sensitive liabilities
which finance these assets, including asset-backed securitizations; long-term
borrowings; deposits; Federal Funds; and short-term bank notes.
The Company's interest rate risk management policies are designed to reduce
the potential volatility of earnings which may arise from changes in interest
rates. This is accomplished primarily by matching the repricing of credit card
and consumer loans and the related financing. To the extent that asset and
related financing repricing characteristics of a particular portfolio are not
matched effectively, the Company utilizes interest rate derivative contracts,
such as swap agreements, to achieve its matched financing objectives. Interest
rate swap agreements effectively convert the underlying asset or financing
from fixed to variable repricing, from variable to fixed repricing or, in more
limited circumstances, from variable to variable repricing.
Sensitivity Analysis Methodology, Assumptions and Limitations
For its consumer lending activities, the Company uses a variety of
techniques to assess its interest rate risk exposure, one of which is interest
rate sensitivity simulation. For purposes of presenting the possible earnings
effect of a hypothetical, adverse change in interest rates over the 12-month
period from its fiscal year-end, the Company assumes that all interest rate
sensitive assets and liabilities will be impacted by a hypothetical, immediate
100-basis-point increase in interest rates as of the beginning of the period.
Interest rate sensitive assets are assumed to be those for which the stated
interest rate is not contractually fixed for the next 12-month period. In
fiscal 2000, a substantial portion of the Company's credit card receivables
was repriced to a variable interest rate. These assets which have a market-
based index, such as the prime rate, which will reset before the end of the
12-month period, or assets with rates that are fixed at fiscal year-end but
which will mature, or otherwise contractually reset to a market-based indexed
or other fixed rate prior to the end of the 12-month period, are rate-
sensitive. The latter category includes certain credit card loans which may be
offered at below-market rates for an introductory period, such as for balance
transfers and special promotional programs, after which the loans will
contractually reprice in accordance with the Company's normal market-based
pricing structure. For purposes of measuring rate-sensitivity for such loans,
only the effect of the hypothetical 100-basis-point change in the underlying
market-based indexed or other fixed rate has been considered rather than the
full change in the rate to which the loan would contractually reprice. For
assets which have a fixed rate at fiscal year-end but which contractually
will, or are assumed to, reset to a market-based indexed or other fixed rate
during the next 12 months, earnings sensitivity is measured from the expected
repricing date. For the remainder of the Company's credit card receivables
which have a fixed interest rate, the Company has the right, with notice to
cardmembers, to reprice the receivables to a new interest rate. The Company
considers such receivables to be interest rate sensitive, consistent with its
policy of matching the repricing of its credit card receivables and the
related financing. The Company measured the earnings sensitivity for these
assets from the expected repricing date, which takes into consideration the
required notice period and billing cycles. In addition, for all interest rate
sensitive assets, earnings sensitivity is calculated net of expected loan
losses.
Interest rate sensitive liabilities are assumed to be those for which the
stated interest rate is not contractually fixed for the next 12-month period.
Thus, liabilities which have a market-based index, such as the prime,
commercial paper or LIBOR rates, which will reset before the end of the 12-
month period, or liabilities whose
58
rates are fixed at fiscal year-end but which will mature and be replaced with
a market-based indexed rate prior to the end of the 12-month period, are rate-
sensitive. For liabilities which have a fixed rate at fiscal year-end but
which are assumed to reset to a market-based index during the next 12 months,
earnings sensitivity is measured from the expected repricing date.
Assuming a hypothetical, immediate 100-basis-point increase in the interest
rates affecting all interest rate sensitive assets and liabilities as of
November 30, 2000, it is estimated that the pre-tax income of consumer lending
and related activities over the following 12-month period would be reduced by
approximately $62 million. The comparable reduction of pre-tax income for the
12-month period following November 30, 1999 was estimated to be approximately
$10 million. The reduction in pre-tax income at November 30, 2000 was greater
as compared with the prior year primarily due to the Company's consumer loan
repricing actions made during fiscal 2000 and the related impact of the
funding supporting the Company's consumer loans.
The hypothetical model assumes that the balances of interest rate sensitive
assets and liabilities at fiscal year-end will remain constant over the next
12-month period. It does not assume any growth, strategic change in business
focus, change in asset pricing philosophy or change in asset/liability funding
mix. Thus, this model represents a static analysis which cannot adequately
portray how the Company would respond to significant changes in market
conditions. Furthermore, the analysis does not necessarily reflect the
Company's expectations regarding the movement of interest rates in the near
term, including the likelihood of an immediate 100-basis-point change in
market interest rates, nor necessarily the actual effect on earnings if such
rate changes were to occur.
Credit Risk
The Company's exposure to credit risk arises from the possibility that a
customer or counterparty to a transaction might fail to perform under its
contractual commitment, which could result in the Company incurring losses.
With respect to its institutional securities activities, the Company has
credit guidelines which limit the Company's current and potential credit
exposure to any one counterparty and to each type of counterparty (by rating
category). The Credit Department that is responsible for the Company's
institutional securities activities administers and monitors these credit
limits on a worldwide basis. In addition to monitoring credit limits, the
Company manages the credit exposure relating to its trading activities by
reviewing periodically counterparty financial soundness, by entering into
master netting agreements and collateral arrangements with counterparties in
appropriate circumstances, and by limiting the duration of exposure. In
certain cases, the Company also may close out transactions, enter into risk
reducing transactions, assign transactions to other counterparties or purchase
credit protection to mitigate credit risk. With respect to the leveraged
lending business, the Leveraged Financing Commitment Committee, which is
composed of senior managers from various departments within the Company,
including the Credit Department, reviews each leveraged loan request.
With respect to its consumer lending activities, potential credit card
holders undergo credit reviews by the Credit Department of Discover Financial
Services to establish that they meet standards of ability and willingness to
pay. Credit card applications are evaluated using scoring models (statistical
evaluation models) based on information obtained from applicants and credit
bureaus. The Company's credit scoring systems include both industry and
customized models using the Company's criteria and historical data. Each
cardmember's credit line is reviewed at least annually, and actions resulting
from such review may include raising or lowering a cardmember's credit line or
closing the account. In addition, the Company, on a portfolio basis, performs
periodic monitoring and review of consumer behavior and risk profiles. The
Company also reviews the creditworthiness of prospective Discover Business
Services merchants and conducts annual reviews of merchants with the greatest
scrutiny given to merchants with substantial sales volume.
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 (see Note 9
to the consolidated financial statements).
59
Operational Risk
Operational risk refers generally to the risk of loss resulting from the
Company's operations, including, but not limited to, improper or unauthorized
execution and processing of transactions, deficiencies in the Company's
operating systems, and inadequacies or breaches in the Company's control
processes. The Company operates different businesses in diverse markets and is
reliant on the ability of its employees and systems to process high numbers of
transactions. These transactions may cross multiple markets and involve
different currencies. In the event of a breakdown or improper operation of
systems or improper action by employees, the Company could suffer financial
loss, regulatory sanctions and damage to its reputation.
In order to mitigate and control operational risk, the Company has developed
and continues to enhance specific policies and procedures that are designed to
identify and manage operational risk at appropriate levels. For example, the
Company's securities business has procedures that require that all
transactions are accurately recorded and properly reflected in the Company's
books and records and are confirmed on a timely basis; that position
valuations are subject to periodic independent review procedures; and that
collateral and adequate documentation (e.g., master agreements) are obtained
from counterparties in appropriate circumstances. With respect to its consumer
lending activities, the Company manages operational risk through its system of
internal controls which provides checks and balances to ensure that
transactions and other account-related activity (e.g., new account
solicitation, transaction authorization and processing, billing and collection
of delinquent accounts) are properly approved, processed, recorded and
reconciled. Disaster recovery plans are in place for critical systems on a
Company-wide basis, and redundancies are built into the systems as deemed
appropriate. The Company also uses periodic self-assessments and Internal
Audit reviews as a further check on operational risk.
Legal Risk
Legal risk includes the risk of non-compliance with applicable legal and
regulatory requirements and the risk that a counterparty's performance
obligations will be unenforceable. The Company is generally subject to
extensive regulation in the different jurisdictions in which it conducts its
business. The Company has established procedures based on legal and regulatory
requirements on a worldwide basis that are designed to ensure compliance with
all applicable statutory and regulatory requirements. The Company, principally
through the Law and Compliance Department, also has established procedures
that are designed to ensure that senior management's policies relating to
conduct, ethics and business practices are followed globally. In connection
with its businesses, the Company has various procedures addressing issues,
such as regulatory capital requirements, sales and trading practices, new
products, use and safekeeping of customer funds and securities, credit
granting, collection activities, money-laundering and recordkeeping. The
Company also has established procedures to mitigate the risk that a
counterparty's performance obligations will be unenforceable, including
consideration of counterparty legal authority and capacity, adequacy of legal
documentation, the permissibility of a transaction under applicable law and
whether applicable bankruptcy or insolvency laws limit or alter contractual
remedies.
60
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co.:
We have audited the accompanying consolidated statements of financial
condition of Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co. and subsidiaries (the "Company")
as of fiscal years ended November 30, 2000 and 1999, and the related
consolidated statements of income, comprehensive income, cash flows and
changes in shareholders' equity for each of the three fiscal years in the
period ended November 30, 2000. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the accompanying consolidated financial statements present
fairly, in all material respects, the consolidated financial position of
Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co. and subsidiaries at fiscal years ended
November 30, 2000 and 1999, and the consolidated results of their operations
and their cash flows for each of the three fiscal years in the period ended
November 30, 2000, in conformity with accounting principles generally accepted
in the United States of America.
As discussed in Note 2 to the consolidated financial statements, in fiscal
1998, Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co. changed its method of accounting for
certain offering costs of closed-end funds.
/s/ Deloitte & Touche LLP
New York, New York
January 12, 2001
61
XXXXXX XXXXXXX XXXX XXXXXX & CO.
Consolidated Statements of Financial Condition
(dollars in millions, except share data)
November 30, November 30,
2000 1999
------------ ------------
Assets
Cash and cash equivalents........................... $ 18,819 $ 12,325
Cash and securities deposited with clearing
organizations or segregated under federal and
other regulations (including securities at fair
value of $41,312 at November 30, 2000 and $6,925
at November 30, 1999)............................ 48,637 9,713
Financial instruments owned:
U.S. government and agency securities............. 28,841 25,646
Other sovereign government obligations............ 24,119 17,522
Corporate and other debt.......................... 33,419 30,443
Corporate equities................................ 16,889 14,843
Derivative contracts.............................. 27,333 22,769
Physical commodities.............................. 217 819
Securities purchased under agreements to resell..... 50,992 70,366
Receivable for securities provided as collateral.... 3,563 9,007
Securities borrowed................................. 105,231 85,064
Receivables:
Consumer loans (net of allowances of $780 at
November 30, 2000 and $769 at November 30,
1999)............................................ 21,090 20,229
Customers, net.................................... 26,015 29,299
Brokers, dealers and clearing organizations....... 1,257 2,252
Fees, interest and other.......................... 6,102 5,371
Office facilities, at cost (less accumulated
depreciation of $1,934 at November 30, 2000 and
$1,667 at November 30, 1999)..................... 2,685 2,204
Aircraft under operating leases (less accumulated
depreciation of $257 at November 30, 2000 and
$101 at November 30, 1999)....................... 3,927 1,884
Other assets........................................ 7,658 7,211
-------- --------
Total assets........................................ $426,794 $366,967
======== ========
62
XXXXXX XXXXXXX XXXX XXXXXX & CO.
Consolidated Statements of Financial Condition--(Continued)
(dollars in millions, except share data)
November 30, November 30,
2000 1999
------------ ------------
Liabilities and Shareholders' Equity
Commercial paper and other short-term borrowings..... $ 27,754 $ 38,242
Deposits............................................. 11,930 10,397
Financial instruments sold, not yet purchased:
U.S. government and agency securities.............. 13,578 12,285
Other sovereign government obligations............. 6,959 7,812
Corporate and other debt........................... 6,772 2,322
Corporate equities................................. 15,091 15,402
Derivative contracts............................... 27,547 23,228
Physical commodities............................... 1,462 919
Securities sold under agreements to repurchase....... 97,230 104,450
Obligation to return securities received as
collateral.......................................... 8,353 14,729
Securities loaned.................................... 35,211 30,080
Payables:
Customers.......................................... 94,546 45,775
Brokers, dealers and clearing organizations........ 3,072 1,335
Interest and dividends............................. 2,766 2,951
Other liabilities and accrued expenses............... 12,731 10,439
Long-term borrowings................................. 42,051 28,604
-------- --------
407,053 348,970
-------- --------
Capital Units........................................ 70 583
-------- --------
Preferred Securities Issued by Subsidiaries.......... 400 400
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock.................................... 545 670
Common stock (1) ($0.01 par value, 3,500,000,000
shares authorized, 1,211,685,904 and 1,211,685,904
shares issued, 1,107,270,331 and 1,104,630,098
shares outstanding at November 30, 2000 and
November 30, 1999, respectively).................. 12 12
Paid-in capital (1)................................ 3,377 3,836
Retained earnings.................................. 20,802 16,285
Employee stock trust............................... 3,042 2,426
Cumulative translation adjustments................. (91) (27)
-------- --------
Subtotal......................................... 27,687 23,202
Note receivable related to ESOP.................... (44) (55)
Common stock held in treasury, at cost (1) ($0.01
par value, 104,415,573 and 107,055,806 shares at
November 30, 2000 and November 30, 1999,
respectively)..................................... (6,024) (4,355)
Common stock issued to employee trust.............. (2,348) (1,778)
-------- --------
Total shareholders' equity....................... 19,271 17,014
-------- --------
Total liabilities and shareholders' equity......... $426,794 $366,967
======== ========
--------
(1) Amounts have been retroactively adjusted to give effect for a two-for-one
common stock split, effected in the form of a 100% stock dividend, which
became effective on January 26, 2000.
See Notes to Consolidated Financial Statements.
63
XXXXXX XXXXXXX XXXX XXXXXX & CO.
Consolidated Statements of Income
(dollars in millions, except share and per share data)
Fiscal Year
-----------------------------------------
2000 1999 1998
------------- ------------- -------------
Revenues:
Investment banking................ $ 5,008 $ 4,523 $ 3,340
Principal transactions:
Trading.......................... 7,393 5,830 3,159
Investments...................... 193 725 89
Commissions....................... 3,645 2,774 2,208
Fees:
Asset management, distribution
and administration.............. 4,219 3,324 3,003
Merchant and cardmember.......... 1,780 1,492 1,647
Servicing........................ 1,450 1,194 928
Interest and dividends............ 21,234 14,880 16,386
Other............................. 491 248 282
------------- ------------- -------------
Total revenues................... 45,413 34,990 31,042
Interest expense.................. 18,176 12,515 13,464
Provision for consumer loan
losses........................... 810 529 1,173
------------- ------------- -------------
Net revenues..................... 26,427 21,946 16,405
------------- ------------- -------------
Non-interest expenses:
Compensation and benefits......... 10,936 8,398 6,636
Occupancy and equipment........... 772 643 583
Brokerage, clearing and exchange
fees............................. 519 485 552
Information processing and
communications................... 1,556 1,325 1,140
Marketing and business
development...................... 2,058 1,679 1,411
Professional services............. 1,037 836 677
Other............................. 1,058 852 706
------------- ------------- -------------
Total non-interest expenses...... 17,936 14,218 11,705
------------- ------------- -------------
Gain on sale of businesses......... 35 -- 685
------------- ------------- -------------
Income before income taxes and
cumulative effect of accounting
change............................ 8,526 7,728 5,385
Provision for income taxes......... 3,070 2,937 1,992
------------- ------------- -------------
Income before cumulative effect of
accounting change................. 5,456 4,791 3,393
Cumulative effect of accounting
change............................ -- -- (117)
------------- ------------- -------------
Net income......................... $ 5,456 $ 4,791 $ 3,276
============= ============= =============
Preferred stock dividend
requirements...................... $ 36 $ 44 $ 55
============= ============= =============
Earnings applicable to common
shares (1)........................ $ 5,420 $ 4,747 $ 3,221
============= ============= =============
Earnings per common share (2):
Basic before cumulative effect of
accounting change................ $ 4.95 $ 4.33 $ 2.90
Cumulative effect of accounting
change........................... -- -- (0.10)
------------- ------------- -------------
Basic............................. $ 4.95 $ 4.33 $ 2.80
============= ============= =============
Diluted before cumulative effect
of accounting change............. $ 4.73 $ 4.10 $ 2.76
Cumulative effect of accounting
change........................... -- -- (0.09)
------------- ------------- -------------
Diluted........................... $ 4.73 $ 4.10 $ 2.67
============= ============= =============
Average common shares outstanding
(2):
Basic............................. 1,095,858,438 1,096,789,720 1,151,645,450
============= ============= =============
Diluted........................... 1,145,011,515 1,159,500,670 1,212,588,130
============= ============= =============
--------
(1) Amounts shown are used to calculate basic earnings per common share.
(2) Amounts have been retroactively adjusted to give effect for a two-for-one
common stock split, effected in the form of a 100% stock dividend, which
became effective on January 26, 2000.
See Notes to Consolidated Financial Statements.
64
XXXXXX XXXXXXX XXXX XXXXXX & CO.
Consolidated Statements of Comprehensive Income
(dollars in millions)
Fiscal Year
----------------------
2000 1999 1998
------ ------ ------
Net income............................................... $5,456 $4,791 $3,276
Other comprehensive income, net of tax:
Foreign currency translation adjustment................ (64) (15) (3)
------ ------ ------
Comprehensive income..................................... $5,392 $4,776 $3,273
====== ====== ======
See Notes to Consolidated Financial Statements.
65
XXXXXX XXXXXXX XXXX XXXXXX & CO.
Consolidated Statements of Cash Flows
(dollars in millions)
Fiscal Year
----------------------------
2000 1999 1998
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income...................................... $ 5,456 $ 4,791 $ 3,276
Adjustments to reconcile net income to net cash
(used for) provided by operating activities:
Non-cash charges (credits) included in net
income:
Cumulative effect of accounting change........ -- -- 117
Gain on sale of businesses.................... (35) -- (685)
Deferred income taxes......................... (219) (160) (55)
Compensation payable in common or preferred
stock........................................ 908 735 408
Depreciation and amortization................. 727 541 575
Provision for consumer loan losses............ 810 529 1,173
Changes in assets and liabilities:
Cash and securities deposited with clearing
organizations or segregated under federal and
other regulations............................ (38,924) 839 (3,641)
Financial instruments owned, net of financial
instruments sold, not yet purchased.......... (10,524) (22,081) 11,127
Securities borrowed, net of securities
loaned....................................... (15,036) (8,798) (5,061)
Receivables and other assets.................. 2,077 (11,276) 2,114
Payables and other liabilities................ 52,376 5,656 6,081
-------- -------- --------
Net cash (used for) provided by operating
activities..................................... (2,384) (29,224) 15,429
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Net (payments for) proceeds from:
Office facilities.............................. (836) (656) (358)
Sale of businesses, net of disposal costs...... -- -- 1,399
Purchase of Xxxxxx Xxxxxxx Xxxx Xxxxxx, X.X.,
S.A., net of cash acquired.................... -- (223) --
Purchase of Ansett Worldwide, net of cash
acquired...................................... (199) -- --
Net principal disbursed on consumer loans...... (11,410) (8,769) (2,314)
Sales of consumer loans........................ 9,760 2,997 4,466
-------- -------- --------
Net cash (used for) provided by investing
activities..................................... (2,685) (6,651) 3,193
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net (payments for) proceeds from short-term
borrowings..................................... (10,563) 9,994 5,620
Securities sold under agreements to repurchase,
net of securities purchased under agreements to
resell......................................... 12,154 21,327 (14,407)
Net proceeds from (payments for):
Deposits....................................... 1,533 2,200 (796)
Issuance of common stock....................... 338 223 126
Issuance of put options........................ 42 9 --
Issuance of long-term borrowings............... 22,475 7,552 9,771
Issuance of Preferred Securities Issued by
Subsidiaries.................................. -- -- 400
Payments for:
Repayments of long-term borrowings............. (9,351) (6,618) (7,069)
Redemption of cumulative preferred stock....... -- -- (200)
Redemption of Capital Units.................... (513) (416) --
Repurchases of common stock.................... (3,628) (2,374) (2,925)
Cash dividends................................. (924) (575) (519)
-------- -------- --------
Net cash provided by (used for) financing
activities..................................... 11,563 31,322 (9,999)
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents.................................... 6,494 (4,553) 8,623
Cash and cash equivalents, at beginning of
period......................................... 12,325 16,878 8,255
-------- -------- --------
Cash and cash equivalents, at end of period..... $ 18,819 $ 12,325 $ 16,878
======== ======== ========
See Notes to Consolidated Financial Statements.
66
XXXXXX XXXXXXX XXXX XXXXXX & CO.
Consolidated Statements of Changes in Shareholders' Equity
(dollars in millions)
Common
Common Stock
Note Stock Issued
Employee Cumulative Receivable Held in to
Preferred Common Paid-in Retained Stock Translation Related to Treasury, Employee
Stock Stock(1) Capital(1) Earnings Trust Adjustments ESOP at Cost Trust Total
--------- -------- ---------- -------- -------- ----------- ---------- --------- -------- -------
BALANCE AT
NOVEMBER 30, 1997... $ 876 $12 $3,721 $ 9,330 $1,681 $ (9) $(68) $ (250) $(1,337) $13,956
Net income.......... -- -- -- 3,276 -- -- -- -- -- 3,276
Dividends........... -- -- -- (526) -- -- -- -- -- (526)
Redemption of 7-
3/8% Cumulative
Preferred Stock.... (200) -- -- -- -- -- -- -- -- (200)
Conversion of ESOP
Preferred Stock.... (2) -- (12) -- -- -- -- 14 -- --
Issuance of common
stock.............. -- -- (261) -- -- -- -- 387 -- 126
Repurchases of
common stock....... -- -- -- -- -- -- -- (2,925) -- (2,925)
Compensation payable
in common stock.... -- -- 292 -- 232 -- -- 72 (189) 407
ESOP shares
allocated, at
cost............... -- -- -- -- -- -- 8 -- -- 8
Translation
adjustments........ -- -- -- -- -- (3) -- -- -- (3)
------ --- ------ ------- ------ ---- ---- ------- ------- -------
BALANCE AT
NOVEMBER 30, 1998... 674 12 3,740 12,080 1,913 (12) (60) (2,702) (1,526) 14,119
Net income.......... -- -- -- 4,791 -- -- -- -- -- 4,791
Dividends........... -- -- -- (586) -- -- -- -- -- (586)
Conversion of ESOP
Preferred Stock.... (4) -- (18) -- -- -- -- 22 -- --
Issuance of common
stock.............. -- -- (223) -- -- -- -- 446 -- 223
Repurchases of
common stock....... -- -- -- -- -- -- -- (2,374) -- (2,374)
Compensation payable
in common stock.... -- -- 312 -- 513 -- -- 205 (252) 778
ESOP shares
allocated, at
cost............... -- -- -- -- -- -- 5 -- -- 5
Issuance of common
stock in connection
with Xxxxxx Xxxxxxx
Xxxx Xxxxxx, X.X.,
S.A. acquisition... -- -- 16 -- -- -- -- 48 -- 64
Issuance of put
options............ -- -- 9 -- -- -- -- -- -- 9
Translation
adjustments........ -- -- -- -- -- (15) -- -- -- (15)
------ --- ------ ------- ------ ---- ---- ------- ------- -------
BALANCE AT
NOVEMBER 30, 1999... 670 12 3,836 16,285 2,426 (27) (55) (4,355) (1,778) 17,014
Net income.......... -- -- -- 5,456 -- -- -- -- -- 5,456
Dividends........... -- -- -- (939) -- -- -- -- -- (939)
Conversion of ESOP
Preferred Stock.... (125) -- (817) -- -- -- -- 942 -- --
Issuance of common
stock.............. -- -- (446) -- -- -- -- 784 -- 338
Issuance of put
options............ -- -- 42 -- -- -- -- -- -- 42
Exercise of put
options............ -- -- (4) -- -- -- -- 4 -- --
Repurchases of
common stock....... -- -- -- -- -- -- -- (3,628) -- (3,628)
Compensation payable
in common stock.... -- -- 766 -- 616 -- -- 229 (570) 1,041
ESOP shares
allocated, at
cost............... -- -- -- -- -- -- 11 -- -- 11
Translation
adjustments........ -- -- -- -- -- (64) -- -- -- (64)
------ --- ------ ------- ------ ---- ---- ------- ------- -------
BALANCE AT
NOVEMBER 30, 2000... $ 545 $12 $3,377 $20,802 $3,042 $(91) $(44) $(6,024) $(2,348) $19,271
====== === ====== ======= ====== ==== ==== ======= ======= =======
-------
(1) Amounts have been retroactively adjusted to give effect for a two-for-one
common stock split, effected in the form of a 100% stock dividend, which
became effective on January 26, 2000.
See Notes to Consolidated Financial Statements.
67
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Introduction and Basis of Presentation
The Company
Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co. (the "Company") is a global financial
services firm that maintains leading market positions in each of its three
business segments--Securities, Asset Management and Credit Services. Its
Securities business includes securities underwriting and distribution; merger,
acquisition, restructuring, real estate, project finance and other corporate
finance advisory activities; full-service brokerage and financial advisory
services; sales, trading, financing and market-making in equity and fixed
income securities, foreign exchange and commodities, and derivatives; and
private equity and other principal investing activities. The Company's Asset
Management business provides global asset management products and services to
individual and institutional investors primarily through Xxxxxx Xxxxxxx Xxxx
Xxxxxx Advisors, Xxx Xxxxxx Investments, Xxxxxx Xxxxxxx Xxxx Xxxxxx Investment
Management and Xxxxxx Xxxxxxxx & Xxxxxxxx. The Company's Credit Services
business includes the issuance of the Discover(R) Card, the Discover Platinum
Card, the Xxxxxx Xxxxxxx Xxxx WitterSM Card and other proprietary general
purpose credit cards; and the operation of Discover Business Services, a
proprietary network of merchant and cash access locations in the U.S.
The consolidated financial statements include the accounts of the Company
and its U.S. and international subsidiaries, including Xxxxxx Xxxxxxx & Co.
Incorporated ("MS&Co."), Xxxxxx Xxxxxxx & Co. International Limited ("MSIL"),
Xxxxxx Xxxxxxx Xxxx Xxxxxx Japan Limited ("MSDWJL"), Xxxx Xxxxxx Xxxxxxxx Inc.
("DWR"), Xxxxxx Xxxxxxx Xxxx Xxxxxx Advisors Inc. and NOVUS Credit Services
Inc.
Basis of Financial Information
The consolidated financial statements for the 12 months ended November 30,
2000 ("fiscal 2000"), November 30, 1999 ("fiscal 1999") and November 30, 1998
("fiscal 1998") are prepared in accordance with accounting principles
generally accepted in the U.S., which require management to make estimates and
assumptions regarding certain trading inventory valuations, consumer loan loss
levels, the potential outcome of litigation and other matters that affect the
consolidated financial statements and related disclosures. Management believes
that the estimates utilized in the preparation of the consolidated financial
statements are prudent and reasonable. Actual results could differ materially
from these estimates.
Certain reclassifications have been made to prior-year amounts to conform to
the current presentation. All material intercompany balances and transactions
have been eliminated.
Stock Split
On December 20, 1999, the Company declared a two-for-one common stock split,
effected in the form of a 100% stock dividend, payable to shareholders of
record on January 12, 2000 and distributable on January 26, 2000. All share,
per share and shareholders' equity data have been retroactively restated to
reflect this split.
2. Summary of Significant Accounting Policies
Consolidated Statements of Cash Flows
For purposes of these statements, cash and cash equivalents consist of cash
and highly liquid investments not held for resale with maturities, when
purchased, of three months or less.
In connection with the fiscal 2000 purchase of Ansett Worldwide Aviation
Services, the Company assumed $1,380 million of long-term borrowings.
In connection with the fiscal 1999 purchase of Xxxxxx Xxxxxxx Xxxx Xxxxxx,
X.X., S.A. (formerly AB Asesores), the Company issued 1.4 million shares of
common stock having a fair value on the date of acquisition of $64 million.
68
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Consumer Loans
Consumer loans, which consist primarily of credit card and consumer
installment loans, are reported at their principal amounts outstanding, less
applicable allowances. Interest on consumer loans is credited to income as
earned.
Interest is accrued on credit card loans until the date of charge-off, which
generally occurs at the end of the month during which an account becomes 180
days past due, except in the case of bankruptcies and fraudulent transactions,
which are charged off earlier. The interest portion of charged-off credit card
loans is written off against interest revenue. Origination costs related to
the issuance of credit cards are charged to earnings over periods not
exceeding 12 months.
Allowance for Consumer Loan Losses
The allowance for consumer loan losses is a significant estimate that is
regularly evaluated by management for adequacy and is established through a
charge to the provision for consumer loan losses. The evaluations take into
consideration factors such as changes in the nature and volume of the loan
portfolio, overall portfolio quality, review of specific problem loans and
current economic conditions that may affect a borrower's ability to pay.
The Company uses the results of these evaluations to provide an allowance
for consumer loan losses. The exposure for credit losses for owned loans is
influenced by the performance of the portfolio and other factors discussed
above, with the Company absorbing all related losses.
Securitization of Consumer Loans
The Company periodically sells consumer loans through asset securitizations
and continues to service these loans. The present value of the future net
servicing revenues that the Company estimates it will receive over the term of
the securitized loans is recognized in income as the loans are securitized. A
corresponding asset also is recorded and then amortized as a charge to income
over the term of the securitized loans, with actual net servicing revenues
continuing to be recognized in income as they are earned. The impact of
recognizing the present value of estimated future net servicing revenues as
loans are securitized has not been material to the Company's consolidated
statements of income. The exposure for credit losses for securitized loans is
limited to the Company's retained contingent risk, which represents the
Company's retained interest in securitized loans and any credit enhancement
provided.
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 and dividend revenue and interest
expense arising from financial instruments used in trading activities are
reflected in the consolidated statements of income as interest and dividend
revenue or interest expense. The fair values of the trading positions
generally are based on listed market prices. If listed market prices are not
available or if the liquidation of 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 statements of financial condition on a net-by-
counterparty basis, when appropriate.
69
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Equity securities purchased in connection with private equity and other
principal investment activities initially are carried in the consolidated
financial statements at their original costs. The carrying value of such
equity securities is adjusted when changes in the underlying fair values are
readily ascertainable, generally as evidenced by listed market prices or
transactions that directly affect the value of such equity securities.
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. The carrying value of investments made in connection with
principal real estate activities that do not involve equity securities are
adjusted periodically based on independent appraisals, estimates prepared by
the Company of discounted future cash flows of the underlying real estate
assets or other indicators of fair value. Loans made in connection with
private equity and investment banking activities are carried at cost plus
accrued interest less reserves, if deemed necessary, for estimated losses.
Financial Instruments Used for Asset and Liability Management
The Company has entered into various contracts as xxxxxx against specific
assets, liabilities or anticipated transactions. These contracts include
interest rate swaps, foreign exchange forwards and foreign currency swaps. The
Company uses interest rate and currency swaps to manage the interest rate and
currency exposure arising from certain borrowings and to match the repricing
characteristics of consumer loans with those of the borrowings that fund these
loans. For contracts that are designated as xxxxxx of the Company's assets and
liabilities, gains and losses are deferred and recognized as adjustments to
interest revenue or expense over the remaining life of the underlying assets
or liabilities. 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. The
gain or loss from revaluing these contracts is deferred and reported within
cumulative translation adjustments in shareholders' 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.
Securities Transactions
Clients' securities transactions are recorded on a settlement date basis
with related commission revenues and expenses recorded on the trade date.
Securities purchased under agreements to resell ("reverse repurchase
agreements") and securities sold under agreements to repurchase ("repurchase
agreements"), principally government and agency securities, are treated as
financing transactions and are carried at the amounts at which the securities
subsequently will be resold or reacquired as specified in the respective
agreements; such amounts include accrued interest. Reverse repurchase and
repurchase agreements are presented on a net-by-counterparty basis, when
appropriate. 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 collateral on a daily basis. Additional collateral is obtained as
necessary to ensure such transactions are adequately collateralized.
Collateral received under securities financing transactions, such as reverse
repurchase agreements, is recognized, together with a corresponding obligation
to return the collateral, if the collateral provider does not have the
contractual right to substitute collateral or redeem collateral on short
notice. Collateral transferred under securities financing transactions, such
as repurchase agreements, is reclassified from financial instruments owned
70
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
to receivable for securities provided as collateral if the Company does not
have the contractual right to substitute collateral or redeem collateral on
short notice. At November 30, 2000 and 1999, the Company recorded obligations
to return securities received as collateral of $8,353 million and $14,729
million, respectively. The related assets received as collateral were recorded
among several captions included in the Company's consolidated statements of
financial condition. At November 30, 2000 and 1999, after giving effect to
reclassifications, the net increase in total assets and total liabilities was
$5,515 million and $10,256 million, respectively.
Investment Banking
Underwriting revenues and fees for mergers and acquisitions and advisory
assignments are recorded when services for the transaction are substantially
completed. Transaction-related expenses are deferred and later expensed to
match revenue recognition.
Office Facilities
Office facilities are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization of buildings and leasehold
improvements are provided principally by the straight-line method, while
depreciation and amortization of furniture, fixtures and equipment are
provided by both the straight-line and accelerated methods. Property and
equipment are depreciated over the estimated useful lives of the related
assets, while leasehold improvements are amortized over the lesser of the
economic useful life of the asset or, where applicable, the remaining term of
the lease.
Income Taxes
Income tax expense is provided for using the asset and liability method,
under which deferred tax assets and liabilities are determined based upon the
temporary differences between the financial statement and income tax bases of
assets and liabilities, using currently enacted tax rates.
Earnings per Share
The Company calculates earnings per share ("EPS") in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per
Share." The calculations of earnings per common share are based on the
weighted average number of common shares and share equivalents outstanding and
give effect to preferred stock dividend requirements.
"Basic EPS" reflects no dilution from common stock equivalents, and "diluted
EPS" reflects dilution from common stock equivalents and other dilutive
securities based on the average price per share of the Company's common stock
during the period.
Cardmember Rewards
Cardmember rewards, primarily the Cashback Bonus(R) award, pursuant to which
the Company annually pays Discover Card cardmembers and Xxxxxx Xxxxxxx Xxxx
Xxxxxx Card cardmembers electing this feature a percentage of their purchase
amounts ranging up to 1%, are based upon a cardmember's annual level and type
of purchases. The liability for cardmember rewards expense, included in other
liabilities and accrued expenses, is accrued at the time that qualified
cardmember transactions occur and is calculated on an individual cardmember
basis.
Stock-Based Compensation
SFAS No. 123, "Accounting for Stock-Based Compensation" encourages, but does
not require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company accounts
71
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
for its stock-based compensation plans using the intrinsic value method
prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees." Under the provisions of APB No. 25,
compensation cost for stock options is measured as the excess, if any, of the
quoted market price of the Company's common stock at the date of grant over
the amount an employee must pay to acquire the stock.
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 income statement
accounts are translated at weighted average rates of exchange for the year. In
accordance with SFAS No. 52, "Foreign Currency Translation," 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 shareholders' equity. Gains
or losses resulting from foreign currency transactions are included in net
income.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets are amortized on a straight-line basis
over periods from five to 40 years, generally not exceeding 25 years, and are
periodically evaluated for impairment. At November 30, 2000 and 1999, goodwill
and other intangible assets of approximately $1.3 billion were included in the
Company's consolidated statements of financial condition as a component of
other assets.
Accounting Change
In the fourth quarter of fiscal 1998, the Company adopted American Institute
of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 98-5,
"Reporting on the Costs of Start-Up Activities," with respect to the
accounting for offering costs paid by investment advisors of closed-end funds
where such costs are not specifically reimbursed through separate advisory
contracts. In accordance with SOP 98-5 and per an announcement by the
Financial Accounting Standards Board ("FASB") staff in September 1998, such
costs are to be considered start-up costs and expensed as incurred. Prior to
the adoption of SOP 98-5, the Company deferred such costs and amortized them
over the life of the fund. The Company recorded a charge to earnings for the
cumulative effect of the accounting change as of December 1, 1997, of $117
million, net of taxes of $79 million. The effect of adopting these provisions
on the Company's income before the cumulative effect of the accounting change
for fiscal 1998 was a decrease of $24 million, net of taxes. The effect on
basic and diluted earnings per share was $0.02.
Deferred Compensation Arrangements
In accordance with Emerging Issues Task Force ("EITF") Issue 97-14,
"Accounting for Deferred Compensation Arrangements Where Amounts Earned Are
Held in a Rabbi Trust and Invested," assets of rabbi trusts are to be
consolidated with those of the employer, and the value of the employer's stock
held in rabbi trusts should be classified in shareholders' equity and
generally accounted for in a manner similar to treasury stock. The Company,
therefore, has included its obligations under certain deferred compensation
plans in employee stock trust. Shares that the Company has issued to its rabbi
trusts are recorded in common stock issued to employee trust. Both employee
stock trust and common stock issued to employee trust are components of
shareholders' equity.
New Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments, including certain
72
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
derivative instruments embedded in other contracts, and for hedging
activities. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date
of FASB Statement No. 133," which deferred the effective date of SFAS No. 133
for one year to fiscal years beginning after June 15, 2000. In June 2000, the
FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and
Certain Hedging Activities--an amendment of FASB Statement No. 133." The
Company adopted SFAS No. 133, as amended by SFAS No. 138, effective December
1, 2000. The Company estimates that it will record an after-tax charge to net
income from the cumulative effect of the adoption of SFAS No. 133, as amended,
of approximately $59 million and an after-tax decrease to other comprehensive
income of approximately $13 million. The Company's adoption of SFAS No. 133,
as amended, will affect the accounting for, among other things, the Company's
hedging strategies, including those associated with certain financing
activities.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities--a
replacement of FASB Statement No. 125." While SFAS No. 140 carries over most
of the provisions of SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," it provides new
standards for reporting financial assets transferred as collateral and new
standards for the derecognition of financial assets, in particular
transactions involving the use of special purpose entities. SFAS No. 140 also
prescribes additional disclosures for collateral transactions and for
securitization transactions accounted for as sales. The new collateral
standards and disclosure requirements are effective for fiscal years ending
after December 15, 2000, while the new standards for the derecognition of
financial assets are effective for transfers made after March 31, 2001. The
Company is in the process of evaluating the impact of adopting SFAS No. 140.
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," which is effective
for financial statements for fiscal years beginning after December 15, 1998.
SOP 98-1 provides specific guidance as to when certain costs incurred in
connection with an internal-use software project should be capitalized and
when they should be expensed. The Company adopted SOP 98-1 effective December
1, 1999. The adoption of SOP 98-1 did not have a material impact on the
Company's consolidated financial statements.
73
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Consumer Loans
Consumer loans were as follows:
Nov. Nov.
30, 30,
2000 1999
------- -------
(dollars in
millions)
Credit card and consumer installment........................ $21,870 $20,998
Less:
Allowance for consumer loan losses........................ 780 769
------- -------
Consumer loans, net......................................... $21,090 $20,229
======= =======
Activity in the allowance for consumer loan losses was as follows:
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
(dollars in
millions)
Balance beginning of period.......................... $ 769 $ 787 $ 884
Additions:
Provision for consumer loan losses................. 810 529 1,173
Purchase of loan portfolios........................ -- -- 1
----- ----- ------
Total additions...................................... 810 529 1,174
----- ----- ------
Deductions:
Charge-offs........................................ 904 893 1,423
Recoveries......................................... (105) (120) (170)
----- ----- ------
Net charge-offs...................................... 799 773 1,253
----- ----- ------
Other (1)............................................ -- 226 (18)
----- ----- ------
Balance end of period................................ $ 780 $ 769 $ 787
===== ===== ======
--------
(1) These amounts primarily reflect transfers related to asset securitizations
and the fiscal 1998 sale of consumer loans associated with SPS, Prime
Option and BRAVO (see Note 16).
Interest accrued on loans subsequently charged off, recorded as a reduction
of interest revenue, was $127 million, $116 million and $199 million in fiscal
2000, fiscal 1999 and fiscal 1998, respectively.
At November 30, 2000 and 1999, $5,467 million and $5,248 million of the
Company's consumer loans had minimum contractual maturities of less than one
year. Because of the uncertainty regarding consumer loan repayment patterns,
which historically have been higher than contractually required minimum
payments, this amount may not necessarily be indicative of the Company's
actual consumer loan repayments.
At November 30, 2000, the Company had commitments to extend credit for
consumer loans in the amount of $262 billion. Commitments to extend credit
arise from agreements to extend to customers unused lines of credit on certain
credit cards, provided there is no violation of conditions established in the
related agreement. These commitments, substantially all of which the Company
can terminate at any time and which do not necessarily represent future cash
requirements, are periodically reviewed based on account usage and customer
creditworthiness.
The Company received net proceeds from asset securitizations of $9,760
million, $2,997 million and $4,466 million in fiscal 2000, fiscal 1999 and
fiscal 1998, respectively. The uncollected balances of consumer
74
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
loans sold through asset securitizations were $25,256 million and $16,977
million at November 30, 2000 and 1999, respectively.
The estimated fair value of the Company's consumer loans approximated
carrying value at November 30, 2000 and 1999. The Company's domestic consumer
loan portfolio, including securitized loans, is geographically diverse, with a
distribution approximating that of the population of the U.S.
4. Deposits
Deposits were as follows:
Nov. Nov.
30, 30,
2000 1999
------- -------
(dollars in
millions)
Demand, passbook and money market accounts.................. $ 1,589 $ 1,458
Consumer certificate accounts............................... 1,649 1,698
$100,000 minimum certificate accounts....................... 8,692 7,241
------- -------
Total....................................................... $11,930 $10,397
======= =======
The weighted average interest rates of interest bearing deposits outstanding
during fiscal 2000 and fiscal 1999 were 6.4% and 5.9%, respectively.
At November 30, 2000 and 1999, the notional amounts of interest rate
exchange agreements that hedged deposits outstanding were $493 million and
$473 million and had fair values of $4 million and $6 million, respectively.
Under these interest rate exchange agreements, the Company primarily pays
floating rates and receives fixed rates. At November 30, 2000, the weighted
average interest rate of the Company's deposits, including the effect of
interest rate exchange agreements, was 6.4%.
At November 30, 2000, certificate accounts maturing over the next five years
were as follows:
(dollars in millions)
---------------------
2001................................................... $3,649
2002................................................... 2,022
2003................................................... 1,484
2004................................................... 1,426
2005................................................... 1,274
The estimated fair value of the Company's deposits, using current rates for
deposits with similar maturities, approximated carrying value at November 30,
2000 and 1999.
5. Short-Term Borrowings
At November 30, 2000 and 1999, commercial paper of $18,352 million and
$27,072 million, with weighted average interest rates of 6.0% and 5.3%,
respectively, was outstanding.
At November 30, 2000 and 1999, the notional amounts of interest rate and
currency swaps that hedged commercial paper outstanding were $557 million and
$2,865 million and had fair values of $(1) million and $(3) million,
respectively. These contracts had no material effect on the weighted average
interest rates of commercial paper.
75
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At November 30, 2000 and 1999, other short-term borrowings of $9,402 million
and $11,170 million, respectively, were outstanding. These borrowings included
bank loans, Federal Funds and bank notes.
The Company maintains a senior revolving credit agreement with a group of
banks to support general liquidity needs, including the issuance of commercial
paper (the "MSDW Facility"). Under the terms of the MSDW Facility, the banks
are committed to provide up to $5.5 billion. The MSDW Facility contains
restrictive covenants which require, among other things, that the Company
maintain specified levels of shareholders' equity. The Company believes that
the covenant restrictions will not impair the Company's ability to pay its
current level of dividends. At November 30, 2000, no borrowings were
outstanding under the MSDW Facility.
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 (the "MS&Co. Facility"). As part of the MS&Co.
Facility, MS&Co. also 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 $1.875 billion. The credit agreement
contains restrictive covenants which require, among other things, that MS&Co.
maintain specified levels of consolidated shareholder's equity and Net
Capital, each as defined. At November 30, 2000, no borrowings were outstanding
under the MS&Co. Facility.
The Company also maintains 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 (the "MSIL
Facility"). Such banks are committed to provide up to an aggregate of $1.785
billion, available in six major currencies. The facility agreement contains
restrictive covenants which require, among other things, that MSIL maintain
specified levels of Shareholder's Equity and Financial Resources, each as
defined. At November 30, 2000, no borrowings were outstanding under the MSIL
Facility.
MSDWJL, the Company's Tokyo-based broker-dealer subsidiary, maintains a
committed revolving credit facility, guaranteed by the Company, that provides
funding to support general liquidity needs, including support of MSDWJL's
unsecured borrowings (the "MSDWJL Facility"). Under the terms of the MSDWJL
Facility, a syndicate of banks is committed to provide up to 70 billion
Japanese yen. At November 30, 2000, no borrowings were outstanding under the
MSDWJL Facility.
The Company anticipates that it will utilize the MSDW Facility, the MS&Co.
Facility, the MSIL Facility or the MSDWJL Facility for short-term funding from
time to time.
76
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Long-Term Borrowings
Maturities and Terms
Long-term borrowings at fiscal year-end consist of the following:
U.S. Dollar Non-U.S. Dollar(1) At November 30
------------------------------- --------------------- ----------------
Fixed Floating Index/Equity Fixed Floating 2000 1999
Rate Rate(2) Linked Rate Rate(2) Total Total
------- -------- ------------ --------- ---------- ------- -------
(dollars in millions)
Due in fiscal 2000...... $ -- $ -- $ -- $ -- $ -- $ -- $ 6,902
Due in fiscal 2001...... 1,992 8,204 806 306 847 12,155 5,621
Due in fiscal 2002...... 1,628 3,203 373 91 982 6,277 4,041
Due in fiscal 2003...... 4,063 3,148 80 613 623 8,527 2,818
Due in fiscal 2004...... 2,316 465 163 124 3 3,071 3,205
Due in fiscal 2005...... 2,994 216 95 1,334 -- 4,639 664
Thereafter.............. 4,435 1,601 52 715 579 7,382 5,353
------- ------- ------ --------- --------- ------- -------
Total................... $17,428 $16,837 $1,569 $ 3,183 $ 3,034 $42,051 $28,604
======= ======= ====== ========= ========= ======= =======
Weighted average coupon
at fiscal year-end..... 7.0% 6.8% n/a 4.1% 5.1% 6.5% 5.9%
--------
(1) Weighted average coupon was calculated utilizing non-U.S. dollar interest
rates.
(2) U.S. dollar contractual floating rate borrowings bear interest based on a
variety of money market indices, including London Interbank Offered Rates
("LIBOR") and Federal Funds rates. Non-U.S. dollar contractual floating
rate borrowings bear interest based on euro floating rates.
Medium-Term Notes
Included in the table above are medium-term notes of $20,163 million and
$15,724 million at November 30, 2000 and 1999, respectively. The effective
weighted average interest rate on all medium-term notes was 6.6% in fiscal
2000 and 5.3% in fiscal 1999. Maturities of these notes range from fiscal 2001
through fiscal 2029.
Structured Borrowings
U.S. dollar index/equity linked borrowings include various structured
instruments whose payments and redemption values are linked to the performance
of a specific index (e.g., 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 that effectively convert the
borrowing costs into floating rates based upon LIBOR. These instruments are
included in the preceding table at their redemption values based on the
performance of the underlying indices, baskets of stocks or specific equity
securities at November 30, 2000 and 1999.
Other Borrowings
Included in the Company's long-term borrowings are subordinated notes
(including the notes issued by MS&Co. discussed below) of $1,332 million and
$1,356 million at November 30, 2000 and 1999, respectively. The effective
weighted average interest rate on these subordinated notes was 7.1% in fiscal
2000 and 7.0% in fiscal 1999. Maturities of the subordinated notes range from
fiscal 2001 to fiscal 2016.
77
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Certain of the Company's long-term borrowings are redeemable prior to
maturity at the option of the holder. These notes contain certain provisions
which effectively enable noteholders to put the notes back to the Company and
therefore are scheduled in the foregoing table to mature in fiscal 2001
through fiscal 2002. The stated maturities of these notes, which aggregate
$4,873 million, are from fiscal 2001 to fiscal 2030.
At November 30, 2000, MS&Co., a U.S. broker-dealer subsidiary of the
Company, had outstanding $357 million of 8.22% fixed rate subordinated Series
A notes, $243 million of 8.51% fixed rate subordinated Series B Notes, $313
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 had maturities from fiscal 2001 to fiscal 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. On October 31, 2000, MS&Co.
exercised its option to redeem the Series C Notes prior to the scheduled
maturity, and all the Series C Notes were subsequently redeemed on December 1,
2000.
Asset and Liability Management
A portion of the Company's fixed rate long-term borrowings 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 these borrowings to the duration of the assets being
funded and to manage interest rate risk. These swaps effectively convert
certain of the Company's fixed rate borrowings into floating rate obligations.
In addition, for non-U.S. dollar currency borrowings that are not used to fund
assets in the same currency, the Company has entered into currency swaps that
effectively convert the borrowings into U.S. dollar obligations. The Company's
use of swaps for asset and liability management affected its interest expense
and effective average borrowing rate as follows:
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
(dollars in
millions)
Net increase (reduction) in interest expense from
swaps for the fiscal year............................ $68 $(22) $(48)
=== ==== ====
Weighted average coupon of long-term borrowings at
fiscal year-end(1)................................... 6.5% 5.9% 6.1%
=== ==== ====
Effective average borrowing rate for long-term
borrowings after swaps at fiscal year-end(1)......... 6.7% 5.8% 5.9%
=== ==== ====
--------
(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 is not included in the table above, was 6.8% and 5.8% in
fiscal 2000 and fiscal 1999, respectively, after giving effect to the related
xxxxxx.
78
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The table below summarizes the notional or contract amounts of the swaps
utilized by the Company for asset and liability management by maturity and
weighted average interest rates to be received and paid at November 30, 2000.
Swaps utilized to hedge the Company's structured borrowings are presented at
their redemption values:
U.S. Dollar Non-U.S. Dollar(1)
---------------------------------- --------------------
Receive Receive Receive Receive Receive
Fixed Floating Floating Index/ Fixed Floating Nov. 30, Nov. 30,
Pay Pay Pay Equity Pay Pay 2000 1999
Floating Fixed Floating Linked Floating Floating(2) Total Total
-------- -------- -------- ------ -------- ----------- -------- --------
(dollars in millions)
Maturing in fiscal
2000................... $ -- $ -- $-- $ -- $ -- $ -- $ -- $ 3,116
Maturing in fiscal
2001................... 1,834 -- 85 806 306 320 3,351 2,949
Maturing in fiscal
2002................... 1,250 500 100 373 91 3 2,317 1,545
Maturing in fiscal
2003................... 1,225 -- -- 80 393 544 2,242 1,183
Maturing in fiscal
2004................... 2,141 200 -- 163 124 3 2,631 2,765
Maturing in fiscal
2005................... 2,757 -- -- 95 1,334 -- 4,186 379
Thereafter.............. 2,759 500 20 52 665 529 4,525 4,144
------- ------ ---- ------ ------ ------ ------- -------
Total................... $11,966 $1,200 $205 $1,569 $2,913 $1,399 $19,252 $16,081
======= ====== ==== ====== ====== ====== ======= =======
Weighted average at
fiscal year-end(3)
Receive rate............ 6.7% 6.6% 6.8% n/a 3.8% 5.6%
Pay rate................ 7.0% 6.9% 6.9% n/a 5.6% 5.6%
--------
(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
borrowings 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 xxxx rates.
The above table does not include interest rate floor agreements that are
utilized by the Company to manage interest rate risk. At November 30, 2000 and
1999, interest rate floor agreements with an aggregate notional value of $211
million and $610 million, respectively, were outstanding. Agreements
outstanding at November 30, 2000 have expiration dates from fiscal 2001 to
fiscal 2002 and an aggregate fair value of $0.4 million.
79
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As noted above, the Company uses interest rate and currency swaps to modify
the terms of its existing borrowings. 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 fiscal year-end) is
summarized in the table below:
Fiscal Fiscal
2000 1999
------- -------
(dollars in
millions)
Notional value at beginning of period..................... $16,081 $13,101
Additions................................................. 7,059 5,372
Matured................................................... (2,673) (1,804)
Terminated................................................ (801) (848)
Effect of foreign currency translation on non-U.S. dollar
notional values and changes in redemption values on
structured borrowings.................................... (414) 260
------- -------
Notional value at fiscal year-end......................... $19,252 $16,081
======= =======
Unrecognized gain (loss) at fiscal year-end............... $ 90 $ (243)
======= =======
The estimated fair value of the Company's long-term borrowings approximated
carrying value based on rates available to the Company at year-end for
borrowings with similar terms and maturities.
Cash paid for interest for the Company's borrowings and deposits
approximated interest expense in fiscal 2000, fiscal 1999 and fiscal 1998.
7. Commitments and Contingencies
The Company has non-cancelable operating leases covering office space and
equipment. At November 30, 2000, future minimum rental commitments under such
leases (net of subleases, principally on office rentals) were as follows:
(dollars in millions)
---------------------
2001................................................... $ 488
2002................................................... 409
2003................................................... 357
2004................................................... 316
2005................................................... 310
Thereafter............................................. 2,347
Occupancy lease agreements, in addition to base rentals, generally provide
for rent and operating expense escalations resulting from increased
assessments for real estate taxes and other charges. Total rent expense, net
of sublease rental income, was $422 million, $296 million and $274 million in
fiscal 2000, fiscal 1999 and fiscal 1998, respectively.
The Company has an agreement with IBM Corporation, expiring in 2005, under
which the Company receives information processing, data networking and related
services. Under the terms of the agreement, the Company has an aggregate
minimum annual commitment of $120 million subject to annual cost-of-living
adjustments.
The Company has contracted to develop a one million-square-foot office tower
in New York City. Pursuant to this agreement, the Company will own the
building and has entered into a 99-year lease for the land at the development
site. Construction began in 1999, and the Company intends to occupy the
building upon project completion, which is anticipated in fiscal 2002. The
total investment in this project is estimated to be approximately $700
million.
80
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In the normal course of business, the Company has been named as a defendant
in various lawsuits and has been involved in certain investigations and
proceedings. Some of these matters involve claims for substantial amounts.
Although the ultimate outcome of these matters cannot be ascertained at this
time, it is the opinion of management, after consultation with counsel, that
the resolution of such matters will not have a material adverse effect on the
consolidated financial condition of the Company but may be material to the
Company's operating results for any particular period, depending upon the
level of the Company's income for such period.
At November 30, 2000 and 1999, the Company had approximately $6.1 billion
and $6.3 billion, respectively, of letters of credit outstanding 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 financial instruments 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 statements of financial
condition.
The Company also has commitments to fund certain fixed assets and other less
liquid investments, including at November 30, 2000 approximately $900 million
in connection with its private equity and other principal investment
activities. 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 investment banking and its private equity and
other principal investment activities), that may subject the Company to
increased credit and liquidity risks.
81
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Earnings per Share
Earnings per share were calculated as follows (in millions, except for per
share data):
Fiscal 2000 Fiscal 1999 Fiscal 1998
----------- ----------- -----------
Basic EPS
Income before cumulative effect of
accounting change....................... $5,456 $4,791 $3,393
Cumulative effect of accounting change... -- -- (117)
Preferred stock dividend requirements.... (36) (44) (55)
------ ------ ------
Net income available to common
shareholders............................ $5,420 $4,747 $3,221
====== ====== ======
Weighted average common shares
outstanding............................. 1,096 1,097 1,152
====== ====== ======
Basic EPS before cumulative effect of
accounting change....................... $ 4.95 $ 4.33 $ 2.90
Cumulative effect of accounting change... -- -- (0.10)
------ ------ ------
Basic EPS.................................. $ 4.95 $ 4.33 $ 2.80
====== ====== ======
Fiscal 2000 Fiscal 1999 Fiscal 1998
----------- ----------- -----------
Diluted EPS
Income before cumulative effect of
accounting change....................... $5,456 $4,791 $3,393
Cumulative effect of accounting change... -- -- (117)
Preferred stock dividend requirements.... (36) (36) (47)
------ ------ ------
Net income available to common
shareholders............................ $5,420 $4,755 $3,229
====== ====== ======
Weighted average common shares
outstanding............................. 1,096 1,097 1,152
Effect of dilutive securities:
Stock options.......................... 47 39 37
ESOP convertible preferred stock....... 2 24 24
------ ------ ------
Weighted average common shares
outstanding and common stock
equivalents............................. 1,145 1,160 1,213
====== ====== ======
Diluted EPS before cumulative effect of
accounting change....................... $ 4.73 $ 4.10 $ 2.76
Cumulative effect of accounting change... -- -- (0.09)
------ ------ ------
Diluted EPS................................ $ 4.73 $ 4.10 $ 2.67
====== ====== ======
9. Trading Activities
Trading Revenues
The Company's trading activities include providing securities brokerage,
derivatives dealing and underwriting services to clients. While trading
activities are generated by client order flow, the Company also takes
proprietary positions based on expectations of future market movements and
conditions. The Company's trading strategies rely on the integrated management
of its client-driven and proprietary transactions, along with the hedging and
financing of these positions.
82
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company manages its trading businesses by product groupings and
therefore has established distinct, worldwide trading divisions 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 (e.g., options, swaps, futures, forwards and other contracts with
respect to such underlying instruments or commodities). Revenues related to
principal trading are summarized below by trading division:
Fiscal 2000 Fiscal 1999 Fiscal 1998
----------- ----------- -----------
(dollars in millions)
Equities................................ $4,705 $3,065 $2,048
Fixed income............................ 1,760 1,937 331
Foreign exchange........................ 349 397 587
Commodities............................. 579 431 193
------ ------ ------
Total principal transaction trading
revenues............................. $7,393 $5,830 $3,159
====== ====== ======
Interest and dividend revenue and interest expense are integral components
of trading activities. In assessing the profitability of trading activities,
the Company views net interest and principal trading revenues in the
aggregate.
The Company's trading portfolios 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. 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.
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 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
non-U.S. 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.
83
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company is an underwriter of, makes markets in, and acts as principal
with respect to, commercial and residential mortgage-backed securities and
asset-backed securities as well as commercial, residential and real estate
loan products. The Company provides financing to customers for commercial,
residential and real estate loan products. The Company also uses TBA contracts
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
also acts as principal and agent in aircraft finance transactions. Acting as
principal, the Company acquires aircraft outright or under leases and finances
these assets by issuance of non-recourse debt in the securitization market and
other similar financing arrangements.
The counterparties to the Company's fixed income transactions include
investment advisors, commercial banks, insurance companies, broker-dealers,
investment funds and industrial companies.
Foreign Exchange
The Company is a market-maker in a number of foreign currencies. It actively
trades currencies with its customers on a principal basis in the spot, forward
and currency option markets earning a dealer spread. In connection with its
market-making activities, the Company seeks to manage its market risk by
entering into offsetting positions. The Company also takes proprietary
positions in 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 yen, euro, pound sterling, Swiss francs 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 precious, base and platinum group metals, electricity, energy
products (principally oil, refined oil products and natural gas) 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.
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, precious and base metals, and
electricity. 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.
The counterparties to the Company's OTC commodity business include precious
metals producers, refiners and consumers as well as shippers, central banks,
and oil, gas and electricity producers.
The following discussions of risk management, market risk, credit risk,
concentration risk and customer activities relate to the Company's trading
activities.
84
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Risk Management
Risk management at the Company is a multi-faceted process with independent
oversight that 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 administrative and business functions to
assist in the identification, assessment and control of various risks. In
recognition of the increasingly varied and complex nature of the global
financial services business, the Company's risk management policies,
procedures and methodologies are evolutionary in nature and are subject to
ongoing review and modification. Many of the Company's risk management and
control practices are subject to periodic review by the Company's internal
auditors as well as to interactions with various regulatory authorities.
The Management Committee, composed of the Company's most senior officers,
establishes the overall risk management policies for the Company and reviews
the Company's performance relative to these policies. The Management Committee
has created several Risk Committees to assist it in monitoring and reviewing
the Company's risk management practices. These Risk Committees, as well as
other committees established to manage and monitor specific risks, review the
risk monitoring and risk management policies and procedures relating to the
Company's market and credit risk profile, sales practices, legal
enforceability, and operational and systems risks. The Controllers, Treasury,
Law and Compliance, and Firm Risk Management Departments, which are all
independent of the Company's business units, also assist senior management and
the Risk Committees in monitoring and controlling the Company's risk profile.
In addition, the Internal Audit Department, which also reports to senior
management, periodically examines and evaluates the Company's operations and
control environment. The Company continues to be committed to employing
qualified personnel with appropriate expertise in each of its various
administrative and business areas to implement effectively the Company's risk
management and monitoring systems and processes.
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 position or portfolio.
The Company manages the market risk associated with its trading activities
on a Company-wide basis, on a trading division level worldwide and on an
individual product basis. Market risk limits have been approved for the
Company and each major trading division of the Company worldwide. Additional
market risk limits are assigned to trading desks and, as appropriate, products
and regions. Trading division risk managers, desk risk managers and the Firm
Risk Management Department monitor market risk measures against limits in
accordance with policies set by senior management.
The Firm Risk Management Department independently reviews the Company's
trading portfolios on a regular basis from a market risk perspective utilizing
Value-at-Risk and other quantitative and qualitative risk measurements and
analyses. The Company's trading businesses and the Firm Risk Management
Department also use, as appropriate, measures such as sensitivity to changes
in rates, prices, volatilities and time decay to monitor and report market
risk exposures. 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 is reviewed by trading division risk
managers, desk risk managers and the Firm Risk Management Department.
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, which could result in the Company incurring losses. The
85
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company has credit guidelines which limit the Company's current and potential
credit exposure to any one counterparty. Specific credit risk limits based on
these credit guidelines also are in place for each type of counterparty (by
rating category).
The Credit Department administers and monitors the credit limits among
trading divisions on a worldwide basis. In addition to monitoring credit
limits, the Company manages the credit exposure relating to its trading
activities by reviewing periodically counterparty financial soundness, by
entering into master netting agreements and collateral arrangements with
counterparties in appropriate circumstances and by limiting the duration of
exposure. In certain cases, the Company also may close out transactions, enter
into risk reducing transactions, assign transactions to other counterparties
or purchase credit protection 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, Italy and France), which, in the aggregate, represented approximately
12% of the Company's total assets at November 30, 2000. In addition,
substantially all of the collateral held by the Company for resale agreements
or bonds borrowed, which together represented approximately 24% of the
Company's total assets at November 30, 2000, consist of securities issued by
the U.S. government, federal agencies or other sovereign government
obligations. Positions taken and commitments made by the Company, including
positions taken and underwriting and financing commitments made in connection
with its private equity and 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 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 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 Market 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,
2000 and 1999, as well as the average fair value of those assets and
liabilities for fiscal 2000 and 1999, are presented in the table that follows.
Fair value represents the cost of replacing these instruments and is further
described in Note 2. Future changes in interest rates, foreign currency
exchange rates or the fair values of the financial instruments, commodities or
indices underlying these contracts
86
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
ultimately may result in cash settlements exceeding fair value amounts
recognized in the consolidated statements 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), net of any unrealized losses owed to the counterparties
on offsetting positions in situations where netting is appropriate. Similarly,
liabilities represent 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:
Fiscal Year-End Gross Notional/Contract Fiscal Year-End Average Fair
Amount(1)(2) Fair Values(3) Values(3)(4)
--------------------------------------- ----------------------- -----------------------
Assets Liabilities Assets Liabilities
----------- ----------- ----------- -----------
2000 1999 2000 1999 2000 1999 2000 1999 2000 1999
---- ------ ----- ----- ----- ----- ----- ----- ----- -----
(dollars in billions at fiscal year-end)
$3,140 $2,689 Interest rate and $10.6 $ 9.5 $11.5 $ 9.4 $10.4 $ 9.0 $ 9.5 $ 6.2
currency swaps and
options (including caps,
floors and swap options)
and other fixed income
securities contracts
350 405 Foreign exchange forward 2.5 3.7 2.4 3.6 2.7 3.3 2.6 3.5
and futures contracts
and options
107 110 Equity security 7.2 7.1 5.9 7.3 8.4 5.9 6.9 5.4
contracts (including
equity swaps, futures
contracts, and warrants
and options)
252 170 Commodity forwards, 6.9 2.4 7.6 2.9 4.7 2.3 5.4 2.6
futures, options and
swaps
42 30 Mortgage-backed 0.1 0.1 0.1 -- 0.1 0.1 0.1 0.1
securities forward
contracts, swaps and
options
------ ------ ----- ----- ----- ----- ----- ----- ----- -----
$3,891 $3,404 Total $27.3 $22.8 $27.5 $23.2 $26.3 $20.6 $24.5 $17.8
====== ====== ===== ===== ===== ===== ===== ===== ===== =====
--------
(1) The notional amounts of derivatives have been adjusted to reflect the
effects of leverage, where applicable.
(2) Notional amounts include purchased and written options of $357 billion and
$455 billion, respectively, at November 30, 2000 and $399 billion and $401
billion, respectively, at November 30, 1999.
(3) These amounts represent carrying value (exclusive of collateral) at
November 30, 2000 and 1999, respectively, and do not include receivables
or payables related to exchange traded futures contracts.
(4) 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 the fair value of the contracts reported as assets. These
amounts are presented on a net-by-counterparty basis, when appropriate, 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 the ultimate settlement of the transactions outstanding
at November 30, 2000 will not have a material effect on the Company's
financial condition.
87
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The remaining maturities of the Company's swaps and other derivative products
at November 30, 2000 and 1999 are summarized in the following table, showing
notional values by year of expected maturity:
1 to 3 to
Less Than 3 5 More Than
1 Year Years Years 5 Years Total
--------- ----- ----- --------- ------
(dollars in billions)
At November 30, 2000
Interest rate and currency swaps and
options (including caps, floors and
swap options) and other fixed income
securities contracts.................. $ 608 $823 $608 $1,101 $3,140
Foreign exchange forward and futures
contracts and options................. 344 6 -- -- 350
Equity securities contracts (including
equity swaps, futures contracts, and
warrants and options)................. 76 21 8 2 107
Commodity forwards, futures, options
and swaps............................. 143 78 21 10 252
Mortgage-backed securities forward
contracts, swaps and options.......... 34 1 3 4 42
------ ---- ---- ------ ------
Total.................................. $1,205 $929 $640 $1,117 $3,891
====== ==== ==== ====== ======
Percent of total....................... 31% 24% 16% 29% 100%
====== ==== ==== ====== ======
At November 30, 1999
Interest rate and currency swaps and
options (including caps, floors and
swap options) and other fixed income
securities contracts.................. $ 664 $662 $531 $ 832 $2,689
Foreign exchange forward and futures
contracts and options................. 397 8 -- -- 405
Equity securities contracts (including
equity swaps, futures contracts, and
warrants and options)................. 77 22 8 3 110
Commodity forwards, futures, options
and swaps............................. 97 47 19 7 170
Mortgage-backed securities forward
contracts, swaps and options.......... 21 1 3 5 30
------ ---- ---- ------ ------
Total.................................. $1,256 $740 $561 $ 847 $3,404
====== ==== ==== ====== ======
Percent of total....................... 37% 22% 16% 25% 100%
====== ==== ==== ====== ======
88
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The credit quality of the Company's trading-related derivatives at November
30, 2000 and 1999 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:
Collateralized Other Non-
Non-Investment Investment
AAA AA A BBB Grade Grade Total
------ ------ ------ ------ -------------- ---------- -------
(dollars in millions)
At November 30, 2000
Interest rate and currency swaps and options
(including caps, floors and swap options)
and other fixed income securities
contracts................................... $1,649 $3,964 $3,336 $1,113 $ 150 $ 396 $10,608
Foreign exchange forward contracts and
options..................................... 112 909 1,144 111 -- 195 2,471
Equity securities contracts (including equity
swaps, warrants and options)................ 1,774 2,172 910 169 1,840 320 7,185
Commodity forwards, options and swaps........ 222 1,450 2,139 1,485 337 1,289 6,922
Mortgage-backed securities forward
contracts, swaps and options................ 43 48 38 15 -- 3 147
------ ------ ------ ------ ------ ------ -------
Total........................................ $3,800 $8,543 $7,567 $2,893 $2,327 $2,203 $27,333
====== ====== ====== ====== ====== ====== ======= ===
Percent of total............................. 14% 31% 28% 11% 8% 8% 100%
====== ====== ====== ====== ====== ====== ======= ===
At November 30, 1999
Interest rate and currency swaps and options
(including caps, floors and swap options)
and other fixed income securities
contracts................................... $1,569 $3,842 $2,896 $ 884 $ 117 $ 174 $ 9,482
Foreign exchange forward contracts and
options..................................... 556 1,551 1,285 170 -- 140 3,702
Equity securities contracts (including equity
swaps, warrants and options)................ 1,742 2,310 1,109 260 1,308 320 7,049
Commodity forwards, options and swaps........ 164 571 660 469 52 508 2,424
Mortgage-backed securities forward
contracts, swaps and options................ 41 33 35 1 1 1 112
------ ------ ------ ------ ------ ------ -------
Total........................................ $4,072 $8,307 $5,985 $1,784 $1,478 $1,143 $22,769
====== ====== ====== ====== ====== ====== ======= ===
Percent of total............................. 18% 37% 26% 8% 6% 5% 100%
====== ====== ====== ====== ====== ====== =======
The Company also has obtained assets posted as collateral by investment
grade counterparties amounting to $4.7 billion and $3.6 billion at November
30, 2000 and November 30, 1999, respectively.
89
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Preferred Stock, Capital Units and Preferred Securities Issued by
Subsidiaries
Preferred stock of the Company is composed of the following issues:
Balance at
Shares Outstanding November
at November 30 30
------------------- ----------
2000 1999 2000 1999
--------- --------- ----- ----
(dollars
in
millions)
ESOP Convertible Preferred Stock, liquidation
preference $35.88............................. -- 3,493,477 $ -- $125
Series A Fixed/Adjustable Rate Cumulative
Preferred Stock, stated value $200............ 1,725,000 1,725,000 345 345
7-3/4% Cumulative Preferred Stock, stated value
$200.......................................... 1,000,000 1,000,000 200 200
----- ----
Total.......................................... $ 545 $670
===== ====
Each issue of outstanding preferred stock ranks in parity with all other
outstanding preferred stock of the Company.
In fiscal 1998, MSDW Capital Trust I, a Delaware statutory business trust
(the "Capital Trust"), all of the common securities of which are owned by the
Company, issued $400 million of 7.10% Capital Securities (the "Capital
Securities") that are guaranteed by the Company. The Capital Trust issued the
Capital Securities and invested the proceeds in 7.10% Junior Subordinated
Deferrable Interest Debentures issued by the Company, which are due February
28, 2038.
The Company has Capital Units outstanding which were issued by the Company
and Xxxxxx Xxxxxxx Finance plc ("MSF"), a U.K. subsidiary. A Capital Unit
consists of (a) a Subordinated Debenture of MSF guaranteed by the Company and
maturing in 2017 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 the Capital Unit, requiring the holder to purchase one
Depositary Share representing shares (or fractional shares) of the Company's
Cumulative Preferred Stock. The aggregate amount of Capital Units outstanding
was $70 million and $583 million at November 30, 2000 and 1999, respectively.
In fiscal 2000, the Company and MSF redeemed all of the outstanding 8.4%
Capital Units, 8.2% Capital Units and 9.0% Capital Units. The aggregate
principal amount of the Capital Units redeemed was $513 million.
The estimated fair value of the Capital Units approximated carrying value at
November 30, 2000 and November 30, 1999.
In January 2000, all shares of the ESOP Convertible Preferred Stock were
converted into common shares of the Company (see Note 12).
11. Shareholders' Equity
MS&Co. and DWR are registered broker-dealers and registered futures
commission merchants and, accordingly, are 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. and DWR have
consistently operated in excess of these requirements. MS&Co.'s net capital
totaled $4,510 million at November 30, 2000, which exceeded the amount
required by $3,902 million. DWR's net capital totaled $1,331 million at
November 30, 2000, which exceeded the amount required by $1,119 million. MSIL,
a London-based broker-dealer subsidiary, is subject to the capital
requirements of the Securities and Futures Authority, and MSDWJL, a Tokyo-
based broker-dealer, is subject to the capital requirements of the Financial
Services Agency. MSIL and MSDWJL have consistently operated in excess of their
respective regulatory capital requirements.
90
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Under regulatory capital requirements adopted by the Federal Deposit
Insurance Corporation ("FDIC") and other bank regulatory agencies, FDIC-
insured financial institutions must maintain (a) 3% to 5% of Tier 1 capital,
as defined, to average assets ("leverage ratio"), (b) 4% of Tier 1 capital, as
defined, to risk-weighted assets ("Tier 1 risk-weighted capital ratio") and
(c) 8% of total capital, as defined, to risk-weighted assets ("total risk-
weighted capital ratio"). At November 30, 2000, the leverage ratio, Tier 1
risk-weighted capital ratio and total risk-weighted capital ratio of each of
the Company's FDIC-insured financial institutions exceeded these regulatory
minimums.
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. Xxxxxx Xxxxxxx
Derivative Products Inc., the Company's triple-A rated derivative products
subsidiary, also has established certain operating restrictions that have been
reviewed by various rating agencies.
The regulatory capital requirements referred to above, and certain covenants
contained in various agreements governing indebtedness of the Company, may
restrict the Company's ability to withdraw capital from its subsidiaries. At
November 30, 2000, approximately $6.2 billion of net assets of consolidated
subsidiaries may be restricted as to the payment of cash dividends and
advances to the Company.
The Company repurchased approximately 48 million and 50 million shares of
its common stock in fiscal 2000 and fiscal 1999, respectively. In an effort to
enhance its ongoing stock repurchase program, the Company may sell put options
on shares of its common stock to third parties. These put options entitle the
holder to sell shares of the Company's common stock to the Company on certain
dates at specified prices. As of November 30, 2000, put options were
outstanding on an aggregate of 3 million shares of the Company's common stock.
These put options have various expiration dates that range from January 2001
through April 2001. The Company may elect cash settlement of the put options
instead of taking delivery of the stock.
91
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 xxxxxx 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
xxxxxx 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:
At November
30
--------------
2000 1999
------ ------
(dollars in
millions)
Net monetary investments in non-U.S. dollar functional
currency subsidiaries..................................... $2,336 $1,972
====== ======
Gross notional amounts of foreign exchange transactions and
non-U.S. dollar debt designated as xxxxxx(1).............. $3,897 $3,309
====== ======
Cumulative translation adjustments resulting from net
investments in subsidiaries with a non-U.S. dollar
functional currency....................................... $ (211) $ 57
Cumulative translation adjustments resulting from realized
or unrealized gains or losses on xxxxxx, net of tax....... 120 (84)
------ ------
Total cumulative translation adjustments................... $ (91) $ (27)
====== ======
--------
(1) Notional amounts represent the contractual currency amount translated at
respective fiscal year-end spot rates.
12. 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
services companies and provide for internal ownership in order to align the
interests of employees with the long-term interests of the Company's
shareholders. Certain of these plans are summarized below.
Equity-Based Compensation Plans
The Company is authorized to issue up to approximately 590 million shares of
its common stock in connection with awards under its equity-based compensation
plans. At November 30, 2000, approximately 277 million shares were available
for future grant under these plans.
Stock Option Awards
Stock option awards have been granted pursuant to several equity-based
compensation plans. Historically, these plans have generally provided 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 plans) on the date of
grant. Such options generally become exercisable over a one- to five-year
period and expire seven to 10 years from the date of grant.
92
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table sets forth activity relating to the Company's stock
option awards (share data in millions):
Fiscal 2000 Fiscal 1999 Fiscal 1998
------------------ ------------------ ------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price
--------- -------- --------- -------- --------- --------
Options outstanding at
beginning of period.... 131.3 $26.76 126.6 $20.04 128.2 $13.93
Granted................. 25.5 67.41 23.2 56.65 31.2 34.39
Exercised............... (17.8) 21.26 (15.5) 17.12 (30.6) 9.12
Forfeited............... (1.4) 40.10 (3.0) 23.88 (2.2) 19.70
----- ----- -----
Options outstanding at
end of period.......... 137.6 $34.87 131.3 $26.76 126.6 $20.04
===== ====== ===== ====== ===== ======
Options exercisable at
end of period.......... 88.3 $26.74 93.6 $25.21 81.2 $19.69
===== ====== ===== ====== ===== ======
The following table presents information relating to the Company's stock
options outstanding at November 30, 2000 (share data in millions):
Options Outstanding Options Exercisable
------------------------------ --------------------
Weighted Average Weighted
Average Remaining Average
Number Exercise Life Number Exercise
Range of Exercise Prices Outstanding Price (Years) Exercisable Price
------------------------ ----------- -------- --------- ----------- --------
$ 4.00 - $ 19.99........... 44.0 $10.05 3.7 35.9 $ 9.62
$20.00 - $ 29.99........... 28.2 26.63 6.2 23.5 26.51
$30.00 - $ 49.99........... 21.5 37.08 7.4 16.9 37.32
$50.00 - $ 69.99........... 41.3 62.50 9.5 10.5 59.95
$70.00 - $106.99........... 2.6 85.72 7.9 1.5 90.38
----- ----
Total...................... 137.6 6.6 88.3
===== ====
Deferred Compensation Awards
The Company has made deferred compensation awards pursuant to several
equity-based compensation plans. These plans provide for the deferral of a
portion of certain key employees' compensation with payments made in the form
of the Company's common stock or in the right to receive unrestricted shares
(collectively, "Restricted Stock"). Compensation expense for all such awards
(including those subject to forfeiture) amounted to $855 million, $699 million
and $415 million in fiscal 2000, fiscal 1999 and fiscal 1998, respectively.
Compensation expense for Restricted Stock awards was determined based on the
fair value of the Company's common stock (as defined in the plans). The number
of Restricted Stock shares outstanding was 115 million at November 30, 2000
and 1999 and 118 million at November 30, 1998.
Restricted Stock awarded under these plans are subject to restrictions on
sale, transfer or assignment until the end of a specified restriction period,
generally five to 10 years from the date of grant. Holders of Restricted Stock
generally may forfeit ownership of all or a portion of their award if
employment is terminated before the end of the relevant restriction period.
Holders of vested Restricted Stock generally will also forfeit ownership in
certain limited situations, including termination for cause during the
restriction period.
93
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Profit Sharing Plans
The Company sponsors qualified profit sharing plans covering substantially
all U.S. employees and also provides cash payment of profit sharing to
employees of its international subsidiaries. Contributions are made to
eligible employees at the discretion of the Board of Directors based upon the
financial performance of the Company. Profit sharing expense for fiscal 2000,
fiscal 1999 and fiscal 1998 was $182 million, $153 million and $115 million,
respectively.
Employee Stock Ownership Plan
The Company has a $140 million leveraged employee stock ownership plan,
funded through an independently managed trust. The Employee Stock Ownership
Plan ("ESOP") was established to broaden internal ownership of the Company and
to provide benefits to its employees in a cost-effective manner. In January
2000, each share of the ESOP Convertible Preferred Stock was converted into
6.6 common shares of the Company. The ESOP trust funded its stock purchase
through a loan of $140 million from the Company. The ESOP trust note, due
September 19, 2005 (extendible at the option of the ESOP trust to September
19, 2010), 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 common stock and contributions from the Company, if required.
The note receivable from the ESOP trust is reflected as a reduction in the
Company's shareholders' equity. Shares allocated to employees generally may
not be withdrawn until the employee's death, disability, retirement or
termination. 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 based on the financial performance of the Company. The cost of
shares allocated to participants' accounts amounted to $11 million in fiscal
2000, $5 million in fiscal 1999 and $8 million in fiscal 1998. The ESOP debt
service costs for fiscal 2000 were paid from dividends received on stock held
by the ESOP trust. The ESOP debt service costs for fiscal 1999 and fiscal 1998
were paid from dividends received on stock held by the ESOP trust and from
Company contributions.
Pro Forma Effect of SFAS No. 123
Had the Company elected to recognize compensation cost pursuant to SFAS No.
123 for its stock option plans and its employee stock purchase plan, net
income would have been reduced by $488 million, $327 million and $214 million
for fiscal 2000, fiscal 1999 and fiscal 1998, respectively. Basic and diluted
earnings per common share would have been reduced by $0.45, $0.30 and $0.19
for fiscal 2000, fiscal 1999 and fiscal 1998, respectively.
The weighted average fair value at date of grant for stock options granted
during fiscal 2000, fiscal 1999 and fiscal 1998 was $30.48, $23.58 and $11.19
per option, respectively. The fair value of stock options at date of grant was
estimated using the Black-Scholes option pricing model utilizing the following
weighted average assumptions:
Fiscal 2000 Fiscal 1999 Fiscal 1998
----------- ----------- -----------
Risk-free interest rate.................. 5.6% 5.9% 4.9%
Expected option life in years............ 5.3 5.6 4.8
Expected stock price volatility.......... 43.4% 38.6% 33.2%
Expected dividend yield.................. 1.1% 1.1% 1.3%
13. Employee Benefit Plans
The Company sponsors various pension plans for the majority of its worldwide
employees. The Company 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:
94
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pension Plans
Substantially all of the U.S. employees of the Company and its U.S.
affiliates are covered by non-contributory pension plans that are qualified
under Section 401(a) of the Internal Revenue Code (the "Qualified Plans").
Unfunded supplementary plans (the "Supplemental Plans") cover certain
executives. In addition to the Qualified Plans and the Supplemental Plans
(collectively, the "U.S. Plans"), certain of the Company's 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 on compensation levels
specified in the plans. For the Qualified Plans and the other international
plans, the Company's policy is to fund at least the amounts sufficient to meet
minimum funding requirements under applicable employee benefit and tax
regulations. Liabilities for benefits payable under the Supplemental Plans are
accrued by the Company and are funded when paid to the beneficiaries.
The following tables present information for the Company's pension plans on
an aggregate basis.
Pension expense includes the following components:
Fiscal 2000 Fiscal 1999 Fiscal 1998
----------- ----------- -----------
(dollars in millions)
U.S. Plans:
Service cost, benefits earned during
the period.......................... $ 74 $ 98 $ 72
Interest cost on projected benefit
obligation.......................... 88 80 78
Expected return on plan assets....... (100) (86) (87)
Net amortization..................... 6 8 1
Net settlements and curtailments..... 2 -- --
----- ---- ----
Total U.S. plans....................... 70 100 64
Total international plans.............. 4 16 11
----- ---- ----
Net pension expense.................... $ 74 $116 $ 75
===== ==== ====
The following table provides the assumptions used in determining the
Company's benefit obligation for the U.S. Plans:
Fiscal 2000 Fiscal 1999
----------- -----------
Weighted average discount rate...................... 8.00% 7.50%
Rate of increase in future compensation levels...... 5.00% 5.00%
Expected long-term rate of return on plan assets.... 9.00% 9.00%
95
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table provides a reconciliation of the changes in the U.S.
Plans' benefit obligation and fair value of plan assets for fiscal 2000 and
fiscal 1999 as well as a summary of the U.S. Plans' funded status at November
30, 2000 and 1999:
Fiscal Fiscal
2000 1999
---------- ----------
(dollars in millions)
Reconciliation of benefit obligation:
Benefit obligation at beginning of year............. $ 1,214 $ 1,213
Service cost........................................ 74 98
Interest cost....................................... 88 80
Actuarial gain...................................... (48) (77)
Benefits paid....................................... (84) (100)
Settlements......................................... (10) --
---------- ----------
Benefit obligation at end of year................. $ 1,234 $ 1,214
========== ==========
Reconciliation of fair value of plan assets:
Fair value of plan assets at beginning of year...... $ 1,154 $ 981
Actual return on plan assets........................ 158 185
Employer contributions.............................. 50 88
Benefits paid and settlements....................... (94) (100)
---------- ----------
Fair value of plan assets at end of year.......... $ 1,268 $ 1,154
========== ==========
Funded status:
Funded status....................................... $ 34 $ (60)
Unrecognized transition obligation.................. 2 5
Unrecognized prior-service cost..................... 25 27
Unrecognized (gain)................................. (153) (44)
---------- ----------
Net amount recognized............................. $ (92) $ (72)
========== ==========
Amounts recognized in the consolidated statements of
financial condition consist of:
Prepaid benefit cost................................ $ 53 $ 44
Accrued benefit liability........................... (145) (117)
Intangible asset.................................... -- 1
---------- ----------
Net amount recognized............................. $ (92) $ (72)
========== ==========
For the Supplemental Plans, the aggregate accumulated benefit obligation was
$91 million and $90 million at November 30, 2000 and 1999, respectively.
The Company also maintains separate defined contribution pension plans that
cover substantially all employees of certain non-U.S. subsidiaries. Under such
plans, benefits are determined by the purchasing power of the accumulated
value of contributions paid. In fiscal 2000, fiscal 1999 and fiscal 1998, the
Company's expense related to these plans was $46 million, $27 million and $18
million, respectively.
Postretirement Benefits
The Company has unfunded postretirement benefit plans that provide medical
and life insurance for eligible retirees, employees and dependents. At
November 30, 2000 and 1999, the Company's accrued postretirement benefit
liability was $106 million and $99 million, respectively.
96
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Postemployment Benefits
Postemployment benefits include, but are not limited to, salary
continuation, supplemental unemployment benefits, severance benefits,
disability-related benefits, and continuation of health care and life
insurance coverage provided to former or inactive employees after employment
but before retirement. These benefits were not material to the Company's
consolidated financial statements in fiscal 2000, fiscal 1999 and fiscal 1998.
14. Income Taxes
The provision for income taxes consists of:
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
(dollars in
millions)
Current:
U.S. federal....................................... $2,299 $1,868 $1,199
U.S. state and local............................... 387 491 372
Non-U.S............................................ 603 738 476
------ ------ ------
3,289 3,097 2,047
------ ------ ------
Deferred:
U.S. federal....................................... (140) 37 (26)
U.S. state and local............................... (44) (11) 1
Non-U.S............................................ (35) (186) (30)
------ ------ ------
(219) (160) (55)
------ ------ ------
Provision for income taxes........................... $3,070 $2,937 $1,992
====== ====== ======
The following table reconciles the provision to the U.S. federal statutory
income tax rate:
Fiscal Fiscal Fiscal
2000 1999 1998
------ ------ ------
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.................................. 2.5 3.6 4.6
Lower tax rates applicable to non-U.S. earnings....... (2.0) (2.3) (2.4)
Other................................................. 0.5 1.7 (0.2)
---- ---- ----
Effective income tax rate............................. 36.0% 38.0% 37.0%
==== ==== ====
As of November 30, 2000, the Company had approximately $4.3 billion of
earnings attributable to foreign subsidiaries for which no provisions have
been recorded for income tax that could occur upon repatriation. Except to the
extent such earnings can be repatriated tax efficiently, they are permanently
invested abroad. It is not practicable to determine the amount of income taxes
payable in the event all such foreign earnings are repatriated since such
liability, if any, is dependent on circumstances existing if and when
remittance occurs.
97
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 will be in effect when
such differences are expected to reverse. Significant components of the
Company's deferred tax assets and liabilities at November 30, 2000 and 1999
are as follows:
Nov. 30, Nov. 30,
2000 1999
---------- ----------
(dollars in millions)
Deferred tax assets:
Employee compensation and benefit plans........... $ 2,078 $ 1,486
Loan loss allowance............................... 284 282
Other valuation and liability allowances.......... 690 405
Deferred expenses................................. 138 163
Other............................................. 270 303
---------- ----------
Total deferred tax assets....................... 3,460 2,639
---------- ----------
Deferred tax liabilities:
Prepaid commissions............................... 360 217
Other............................................. 369 194
---------- ----------
Total deferred tax liabilities.................. 729 411
---------- ----------
Net deferred tax assets......................... $ 2,731 $ 2,228
========== ==========
Cash paid for income taxes was $3,401 million, $1,736 million and $1,591
million in fiscal 2000, fiscal 1999 and fiscal 1998, respectively.
The Company recorded income tax benefits of $467 million, $367 million and
$370 million related to employee stock compensation transactions in fiscal
2000, fiscal 1999 and fiscal 1998, respectively. Such benefits were credited
to paid-in capital.
15. Segment and Geographic Information
Pursuant to SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," which establishes standards for disclosures that relate
to business operating segments ("segments"), the Company structures its
segments primarily based upon the nature of the financial products and
services provided to customers and the Company's management organization. The
Company operates in three business segments: Securities, Asset Management and
Credit Services through which it provides a wide range of financial products
and services to its customers.
The Company's Securities business includes securities underwriting and
distribution; merger, acquisition, restructuring, real estate, project finance
and other corporate finance advisory activities; full-service brokerage and
financial advisory services; sales, trading, financing and market-making in
equity and fixed income securities, foreign exchange and commodities, and
derivatives; and private equity and other principal investment activities. The
Company's Asset Management business provides global asset management products
and services to individual and institutional investors primarily through
Xxxxxx Xxxxxxx Xxxx Xxxxxx Advisors, Xxx Xxxxxx Investments, Xxxxxx Xxxxxxx
Xxxx Xxxxxx Investment Management and Xxxxxx Xxxxxxxx & Xxxxxxxx. The
Company's Credit Services business includes the issuance of the Discover Card,
the Discover Platinum Card, the Xxxxxx Xxxxxxx Xxxx Xxxxxx Card and other
proprietary general purpose credit cards; and the operation of Discover
Business Services, a proprietary network of merchant and cash access locations
in the U.S.
98
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenues and expenses directly associated with each respective segment are
included in determining their operating results. Other revenues and expenses
that are not directly attributable to a particular segment are allocated based
upon the Company's allocation methodologies, generally based on each segment's
respective revenues or other relevant measures. Selected financial information
for the Company's segments is presented in the table below:
Asset Credit
Fiscal 2000 Securities Management Services Total
----------- ---------- ---------- -------- --------
(dollars in millions)
All other net revenues............... $ 18,494 $2,455 $ 2,420 $ 23,369
Net interest......................... 1,486 71 1,501 3,058
-------- ------ ------- --------
Net revenues......................... $ 19,980 $2,526 $ 3,921 $ 26,427
======== ====== ======= ========
Gain on sale of business............. $ -- $ 35 $ -- $ 35
======== ====== ======= ========
Income before taxes.................. $ 6,237 $1,145 $ 1,144 $ 8,526
Provision for income taxes........... 2,190 462 418 3,070
-------- ------ ------- --------
Net income........................... $ 4,047 $ 683 $ 726 $ 5,456
======== ====== ======= ========
Total assets(1)...................... $395,641 $4,812 $26,341 $426,794
======== ====== ======= ========
Asset Credit
Fiscal 1999 Securities Management Services Total
----------- ---------- ---------- -------- --------
(dollars in millions)
All other net revenues............... $ 15,364 $2,060 $ 2,157 $ 19,581
Net interest......................... 948 52 1,365 2,365
-------- ------ ------- --------
Net revenues......................... $ 16,312 $2,112 $ 3,522 $ 21,946
======== ====== ======= ========
Income before taxes.................. $ 5,864 $ 767 $ 1,097 $ 7,728
Provision for income taxes........... 2,183 319 435 2,937
-------- ------ ------- --------
Net income........................... $ 3,681 $ 448 $ 662 $ 4,791
======== ====== ======= ========
Total assets(1)...................... $337,558 $4,259 $25,150 $366,967
======== ====== ======= ========
Asset Credit
Fiscal 1998 Securities Management Services Total
----------- ---------- ---------- -------- --------
(dollars in millions)
All other net revenues............... $ 10,400 $1,676 $ 1,407 $ 13,483
Net interest......................... 1,100 87 1,735 2,922
-------- ------ ------- --------
Net revenues......................... $ 11,500 $1,763 $ 3,142 $ 16,405
======== ====== ======= ========
Gain on sale of businesses........... $ -- $ 323 $ 362 $ 685
======== ====== ======= ========
Income before taxes and cumulative
effect of accounting change......... $ 3,441 $ 694 $ 1,250 $ 5,385
Provision for income taxes........... 1,199 264 529 1,992
Cumulative effect of accounting
change.............................. -- (117) -- (117)
-------- ------ ------- --------
Net income........................... $ 2,242 $ 313 $ 721 $ 3,276
======== ====== ======= ========
Total assets(1)...................... $293,401 $4,003 $20,186 $317,590
======== ====== ======= ========
--------
(1) Corporate assets have been fully allocated to the Company's business
segments.
99
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company operates in both U.S. and non-U.S. markets. The Company's non-
U.S. business activities are principally conducted through European and Asian
locations. The following table presents selected income statement information
and the total assets of the Company's operations by geographic area. The
principal methodologies used in preparing the geographic area data are as
follows: commission revenues are recorded based on the location of the sales
force; trading revenues are principally recorded based on location of the
trader; investment banking revenues are based on location of the client; and
asset management and portfolio service fees are recorded based on the location
of the portfolio manager:
Fiscal 2000 U.S. Europe Asia Other Eliminations Total
----------- -------- -------- ------- ------- ------------ --------
(dollars in millions)
Net revenues............ $ 19,843 $ 5,054 $ 1,684 $ 166 $ (320) $ 26,427
Income before taxes..... 6,308 1,646 466 106 -- 8,526
Total assets............ 468,102 210,781 28,025 15,577 (295,691) 426,794
Fiscal 1999 U.S. Europe Asia Other Eliminations Total
----------- -------- -------- ------- ------- ------------ --------
(dollars in millions)
Net revenues............ $ 17,101 $ 3,848 $ 1,192 $ 128 $ (323) $ 21,946
Income before taxes..... 6,040 1,364 244 80 -- 7,728
Total assets............ 367,524 164,974 37,610 14,478 (217,619) 366,967
Fiscal 1998 U.S. Europe Asia Other Eliminations Total
----------- -------- -------- ------- ------- ------------ --------
(dollars in millions)
Net revenues............ $ 12,768 $ 2,867 $ 973 $ 95 $ (298) $ 16,405
Income before taxes and
cumulative effect of
accounting change...... 3,932 1,146 252 55 -- 5,385
Total assets............ 325,562 144,711 23,458 9,492 (185,633) 317,590
16. Business Acquisitions and Dispositions
In December 2000, the Company announced that it had entered into a
definitive agreement to acquire Quilter Holdings Limited ("Quilter"). Quilter
is a leading U.K.-based investment management business providing segregated
account management and advisory services to private individuals, pension funds
and trusts. The transaction is subject to certain regulatory and other
consents and is expected to be completed in the first quarter of fiscal 2001.
In fiscal 2000, the Company completed its acquisition of Ansett Worldwide
Aviation Services ("Ansett Worldwide"). Ansett Worldwide is one of the world's
leading aircraft leasing groups, supplying new and used commercial jet
aircraft to airlines around the world. The Company's fiscal 2000 results
include the operations of Ansett Worldwide since April 27, 2000, the date of
acquisition.
In fiscal 1999, the Company completed its acquisition of Xxxxxx Xxxxxxx Xxxx
Xxxxxx, X.X., S.A. (formerly AB Asesores), the largest independent financial
services firm in Spain. Xxxxxx Xxxxxxx Xxxx Xxxxxx, X.X., S.A. has leading
positions in personal investment, asset management, institutional research and
brokerage. Through its financial advisors, it offers its individual investors
proprietary mutual funds and other financial products. The Company's fiscal
1999 results include the operations of Xxxxxx Xxxxxxx Xxxx Xxxxxx, X.X., S.A.
since March 25, 1999, the date of acquisition.
In fiscal 1998, the Company completed the sale of its Global Custody
business. At that time, the Company recorded a pre-tax gain of $323 million
from the sale. Such gain included estimates for certain payments and purchase
price adjustments which, under certain circumstances pursuant to the sales
agreement, were payable by the Company to the buyer. As a result of the
resolution of these payments and purchase price adjustments, during fiscal
2000, the Company recorded an additional pre-tax gain of $35 million related
to the sale of the Global Custody business.
100
XXXXXX XXXXXXX XXXX XXXXXX & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In fiscal 1998, the Company sold its interest in the operations of SPS
Transaction Services, Inc., a 73%-owned, publicly held subsidiary of the
Company. In addition, the Company sold certain credit card receivables
relating to its discontinued BRAVO Card. The Company's aggregate net pre-tax
gain resulting from these transactions was $362 million.
In addition, during fiscal 1998, the Company sold its Prime OptionSM
MasterCard(R) portfolio ("Prime Option"), a business it had operated with
NationsBank of Delaware, N.A., and its Correspondent Clearing business. The
gains resulting from the sale of these businesses were not material to the
Company's results of operations or financial condition.
17. Quarterly Results (unaudited)
2000 Fiscal Quarter 1999 Fiscal Quarter(2)
------------------------------------------------------ ---------------------------------------------------
First Second Third Fourth First Second Third Fourth
------------- ------------ ------------- ------------- ------------ ------------ ------------ ------------
(dollars in millions, except share and per share data)
Total revenues... $ 11,566 $ 11,692 $ 11,711 $ 10,444 $ 8,658 $ 8,779 $ 8,626 $ 8,927
Interest
expense......... 3,932 4,420 5,242 4,582 3,142 3,015 3,184 3,174
Provision for
consumer loan
losses.......... 223 204 175 208 177 119 113 120
------------- ------------ ------------- ------------- ------------ ------------ ------------ ------------
Net revenues..... 7,411 7,068 6,294 5,654 5,339 5,645 5,329 5,633
------------- ------------ ------------- ------------- ------------ ------------ ------------ ------------
Total non-
interest
expenses........ 4,979 4,773 4,419 3,765 3,667 3,787 3,766 2,998
Gain on sale of
business........ -- -- 35 -- -- -- -- --
------------- ------------ ------------- ------------- ------------ ------------ ------------ ------------
Income before
income taxes.... 2,432 2,295 1,910 1,889 1,672 1,858 1,563 2,635
Provision for
income taxes.... 888 837 664 681 635 707 593 1,002
------------- ------------ ------------- ------------- ------------ ------------ ------------ ------------
Net income....... $ 1,544 $ 1,458 $ 1,246 $ 1,208 $ 1,037 $ 1,151 $ 970 $ 1,633
============= ============ ============= ============= ============ ============ ============ ============
Earnings per
share(1)(3):
Basic........... $ 1.40 $ 1.32 $ 1.14 $ 1.10 $ 0.93 $ 1.03 $ 0.87 $ 1.50
Diluted......... $ 1.34 $ 1.26 $ 1.09 $ 1.06 $ 0.88 $ 0.98 $ 0.83 $ 1.42
Dividends to
common
shareholders(1).. $ 0.20 $ 0.20 $ 0.20 $ 0.20 $ 0.12 $ 0.12 $ 0.12 $ 0.12
Book value(1).... $ 15.31 $ 15.66 $ 16.19 $ 16.91 $ 12.47 $ 13.00 $ 13.27 $ 14.85
Stock price
range(1)(4)..... $ 59.97-71.38 $63.69-95.81 $75.25-107.58 $63.38-109.38 $31.16-48.50 $44.53-57.10 $41.07-51.78 $43.19-63.63
-------
(1) Fiscal 1999 amounts have been retroactively adjusted to give effect for a
two-for-one common stock split, effected in the form of a 100% stock
dividend, which became effective on January 26, 2000.
(2) Certain reclassifications have been made to previously reported 1999
quarterly amounts.
(3) Summation of the quarters' earnings per common share may not equal the
annual amounts due to the averaging effect of the number of shares and
share equivalents throughout the year.
(4) Amounts represent the range of closing prices per share on the New York
Stock Exchange for the periods indicated. The number of stockholders of
record at November 30, 2000 approximated 130,000. The number of beneficial
owners of common stock is believed to exceed this number.
101
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information relating to directors and nominees of MSDW is set forth
under the caption "Item 1--Election of Directors" in MSDW's Proxy Statement
for its 2001 Annual Meeting of Shareholders ("MSDW's Proxy Statement") and is
incorporated by reference herein. The information under the heading "Section
16(a) beneficial ownership reporting compliance" that appears in MSDW's Proxy
Statement is also incorporated by reference herein.
Item 11. Executive Compensation
The information relating to executive compensation is set forth under the
captions "Director compensation," "Summary compensation table," "Option grants
in last fiscal year," "Aggregated option exercises in last fiscal year and
fiscal year-end option values," "Pension plans" and "Termination agreement" in
MSDW's Proxy Statement and such information is incorporated by reference
herein.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information relating to security ownership of management and certain
beneficial owners is set forth under the captions "Stock ownership of
management" and "Principal shareholders" in MSDW's Proxy Statement and such
information is incorporated by reference herein.
Item 13. Certain Relationships and Related Transactions
The information regarding certain relationships and related transactions is
set forth under the caption "Certain transactions" in MSDW's Proxy Statement
and such information is incorporated by reference herein.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)Documents filed as part of this Report
1. Financial Statements
The financial statements required to be filed hereunder are listed on
page S-1 hereof.
2. Financial Statement Schedules
The financial statement schedules required to be filed hereunder are
listed on page S-1 hereof.
3. Exhibits
An exhibit index has been filed as part of this Report beginning on page
E-1 hereto and is incorporated herein by reference.
(b)Reports on Form 8-K
A Current Report on Form 8-K, dated September 21, 2000, was filed with
the SEC in connection with the announcement of MSDW's third fiscal quarter
financial results.
A Current Report on Form 8-K, dated October 11, 2000, was filed with the
SEC in connection with activity in MSDW's high yield business.
102
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, on February 16,
2001.
Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co.
(Registrant)
By: /s/ Xxxxxx X. Xxxxxxx
------------------------------
(Xxxxxx X. Xxxxxxx)
Chairman of the Board and Chief
Executive Officer
POWER OF ATTORNEY
We, the undersigned directors and executive officers of Xxxxxx Xxxxxxx Xxxx
Xxxxxx & Co., hereby severally constitute Xxxxxx X. Xxxxx, Xx., Xxxxxx X.
Xxxxx and Xxxxxx X. Xxxxxx, and each of them singly, our true and lawful
attorneys with full power to them and each of them to sign for us, and in our
names in the capacities indicated below, any and all amendments to the Annual
Report on Form 10-K filed with the Securities and Exchange Commission, hereby
ratifying and confirming our signatures as they may be signed by our said
attorneys to any and all amendments to said Annual Report on Form 10-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on the 16th day of February, 2001.
Signature Title
--------- -----
/s/ Xxxxxx X. Xxxxxxx Chairman of the Board and Chief Executive
___________________________________________ Officer
(Xxxxxx X. Xxxxxxx)
/s/ Xxxx X. Xxxx President, Chief Operating Officer and
___________________________________________ Director
(Xxxx X. Xxxx)
/s/ Xxxxxx X. Xxxxx Executive Vice President and Chief
___________________________________________ Financial Officer (Principal Financial
(Xxxxxx X. Xxxxx) Officer)
/s/ Xxxxxx Xxxx Controller (Principal Accounting Officer)
___________________________________________
(Xxxxxx Xxxx)
/s/ Xxxxxx X. Xxxxxx Director
___________________________________________
(Xxxxxx X. Xxxxxx)
/s/ Xxxxxx X. Xxxxxxx Director
___________________________________________
(Xxxxxx X. Xxxxxxx)
103
Signature Title
--------- -----
/s/ C. Xxxxxx Xxxxxx Director
___________________________________________
(C. Xxxxxx Xxxxxx)
/s/ Xxxxxxx X. Xxxxxx Director
___________________________________________
(Xxxxxxx X. Xxxxxx)
/s/ Xxxx X. Xxxxxxx Director
___________________________________________
(Xxxx X. Xxxxxxx)
/s/ Miles X. Xxxxx Director
___________________________________________
(Miles X. Xxxxx)
/s/ Xxxxxxx X. Xxxxx Director
___________________________________________
(Xxxxxxx X. Xxxxx)
/s/ Xxxxxxxx X. Xxxxxx, Xx. Director
___________________________________________
(Xxxxxxxx X. Xxxxxx, Xx.)
/s/ Xxxxx D'Xxxxxx Xxxxx Director
___________________________________________
(Xxxxx D'Xxxxxx Xxxxx)
104
XXXXXX XXXXXXX XXXX XXXXXX & CO.
INDEX TO FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULES
ITEMS (14)(a)(1) AND (14)(a)(2)
Page
Financial Statements ----
Report of Independent Auditors........................................... 61
Consolidated Statements of Financial Condition at November 30, 2000 and
November 30, 1999....................................................... 62
Consolidated Statements of Income for Fiscal 2000, 1999 and 1998......... 64
Consolidated Statements of Comprehensive Income for Fiscal 2000, 1999 and
1998.................................................................... 65
Consolidated Statements of Cash Flows for Fiscal 2000, 1999 and 1998..... 66
Consolidated Statements of Changes in Shareholders' Equity for Fiscal
2000, 1999 and 1998..................................................... 67
Notes to Consolidated Financial Statements............................... 68
Financial Statement Schedules
Schedule I--Condensed Financial Information of Xxxxxx Xxxxxxx Xxxx
Xxxxxx & Co. (Parent Company Only) at November 30, 2000 and
November 30, 1999 and for each of the Three Fiscal Years in the
Period Ended November 30, 2000................................... S-2--S-5
S-1
SCHEDULE I
XXXXXX XXXXXXX XXXX XXXXXX & CO.
(Parent Company Only)
Condensed Statements of Financial Condition
(dollars in millions, except share data)
November 30, November 30,
2000 1999
------------ ------------
Assets:
Cash and cash equivalents.......................... $ 2,604 $ 1,914
Financial instruments owned........................ 454 2,446
Advances to subsidiaries........................... 72,912 50,121
Investment in subsidiaries, at equity.............. 20,040 17,129
Other assets....................................... 2,987 2,139
------- -------
Total assets..................................... $98,997 $73,749
======= =======
Liabilities and Shareholders' Equity:
Short-term borrowings.............................. $20,720 $25,360
Payables to subsidiaries........................... 20,206 6,044
Other liabilities and accrued expenses............. 1,211 730
Long-term borrowings............................... 37,589 24,601
------- -------
79,726 56,735
------- -------
Commitments and contingencies
Shareholders' equity:
Preferred stock.................................... 545 670
Common stock(1) ($0.01 par value; 3,500,000,000
shares authorized, 1,211,685,904 and 1,211,685,904
shares issued, 1,107,270,331 and 1,104,630,098
shares outstanding at November 30, 2000 and
November 30, 1999, respectively).................. 12 12
Paid-in capital(1)................................. 3,377 3,836
Retained earnings.................................. 20,802 16,285
Employee stock trust............................... 3,042 2,426
Cumulative translation adjustments................. (91) (27)
------- -------
Subtotal......................................... 27,687 23,202
Note receivable related to ESOP.................... (44) (55)
Common stock held in treasury, at cost (1) ($0.01
par value, 104,415,573 and 107,055,806 shares at
November 30, 2000 and November 30, 1999,
respectively)..................................... (6,024) (4,355)
Common stock issued to employee trust.............. (2,348) (1,778)
------- -------
Total shareholders' equity....................... 19,271 17,014
------- -------
Total liabilities and shareholders' equity........... $98,997 $73,749
======= =======
--------
(1) Amounts have been retroactively adjusted to give effect for a two-for-one
common stock split, effected in the form of a 100% stock dividend, which
became effective on January 26, 2000.
See Notes to Condensed Financial Statements.
S-2
SCHEDULE I
XXXXXX XXXXXXX XXXX XXXXXX & CO.
(Parent Company Only)
Condensed Statements of Income and Comprehensive Income
(dollars in millions)
Fiscal 2000 Fiscal 1999 Fiscal 1998
----------- ----------- -----------
Revenues:
Interest and dividends................... $4,076 $2,585 $3,098
Principal transactions................... 48 55 60
Fiduciary fees........................... 2 16 16
Other.................................... 4 2 (1)
------ ------ ------
Total revenues......................... 4,130 2,658 3,173
------ ------ ------
Expenses:
Interest expense......................... 4,123 2,460 2,976
Non-interest expenses.................... 3 29 9
------ ------ ------
Total expenses......................... 4,126 2,489 2,985
------ ------ ------
Income before income tax (benefit) provi-
sion and equity in earnings of subsidi-
aries................................... 4 169 188
Income tax (benefit) provision........... (18) 63 70
------ ------ ------
Income before equity in earnings of sub-
sidiaries............................... 22 106 118
Equity in earnings of subsidiaries, net
of tax.................................. 5,434 4,685 3,158
------ ------ ------
Net income............................... $5,456 $4,791 $3,276
====== ====== ======
Other comprehensive income, net of tax:
Foreign currency translation adjust-
ment.................................. (64) (15) (3)
------ ------ ------
Comprehensive income..................... $5,392 $4,776 $3,273
====== ====== ======
Net income............................... $5,456 $4,791 $3,276
====== ====== ======
Preferred stock dividend requirements.... $ 36 $ 44 $ 55
====== ====== ======
Earnings applicable to common shares..... $5,420 $4,747 $3,221
====== ====== ======
See Notes to Condensed Financial Statements.
S-3
SCHEDULE I
XXXXXX XXXXXXX XXXX XXXXXX & CO.
(Parent Company Only)
Condensed Statements of Cash Flows
(dollars in millions)
Fiscal 2000 Fiscal 1999 Fiscal 1998
----------- ----------- -----------
Cash flows from operating activities:
Net income............................... $5,456 $4,791 $3,276
Adjustments to reconcile net income to
net cash provided by operating
activities:
Non-cash charges (credits) included in
net income:
Compensation payable in common or
preferred stock..................... 908 735 408
Equity in subsidiaries' earnings, net
of dividends........................ (2,414) (1,119) (1,300)
Change in assets and liabilities:
Financial instruments owned.......... 1,786 (2,126) (37)
Other assets......................... (1,654) 242 (589)
Other liabilities and accrued
expenses............................ 628 288 (175)
------ ------ ------
Net cash provided by operating
activities.............................. 4,710 2,811 1,583
------ ------ ------
Cash flows from investing activities:
Investments in and advances to
subsidiaries, at equity............... (9,127) (8,193) 1,605
------ ------ ------
Net cash (used for) provided by investing
activities.............................. (9,127) (8,193) 1,605
------ ------ ------
Cash flows from financing activities:
Net (payments for) proceeds from short-
term borrowings......................... (4,640) 4,001 4,614
Net proceeds from:
Issuance of common stock............... 338 223 126
Issuance of put options................ 42 9 --
Issuance of long-term borrowings....... 20,850 6,519 8,167
Payments for:
Repurchases of common stock............ (3,628) (2,374) (2,925)
Repayments of long-term borrowings..... (6,931) (6,159) (6,944)
Redemption of cumulative preferred
stock................................. -- -- (200)
Cash dividends......................... (924) (575) (519)
------ ------ ------
Net cash provided by financing
activities.............................. 5,107 1,644 2,319
------ ------ ------
Net increase (decrease) in cash and cash
equivalents............................. 690 (3,738) 5,507
Cash and cash equivalents, at beginning
of period............................... 1,914 5,652 145
------ ------ ------
Cash and cash equivalents, at end of
period.................................. $2,604 $1,914 $5,652
====== ====== ======
See Notes to Condensed Financial Statements.
S-4
XXXXXX XXXXXXX XXXX XXXXXX & CO.
(Parent Company Only)
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. Introduction and Basis of Presentation
Basis of Financial Information
The accompanying condensed financial statements (the "Parent Company
Financial Statements"), including the notes thereto, should be read in
conjunction with the consolidated financial statements of Xxxxxx Xxxxxxx Xxxx
Xxxxxx & Co. (the "Company") and the notes thereto found on pages 62 to 101 of
the Company's Annual Report to Shareholders which is included in this Form 10-
K.
The Parent Company Financial Statements for the 12 months ended November 30,
2000 ("fiscal 2000"), November 30, 1999 ("fiscal 1999") and November 30, 1998
("fiscal 1998") are prepared in accordance with accounting principles
generally accepted in the U.S., which require management to make estimates and
assumptions regarding certain trading inventory valuations, the potential
outcome of litigation and other matters that affect the Parent Company
Financial Statements and related disclosures. Management believes that the
estimates utilized in the preparation of the Parent Company Financial
Statements are prudent and reasonable. Actual results could differ materially
from these estimates.
Certain reclassifications have been made to prior-year amounts to conform to
the current presentation. All material intercompany balances and transactions
have been eliminated.
Stock Split
On December 20, 1999, the Company declared a two-for-one common stock split,
effected in the form of a 100% stock dividend, payable to shareholders of
record on January 12, 2000 and distributable on January 26, 2000. All share
and shareholders' equity data have been retroactively restated to reflect this
split.
Employee Stock Ownership Plan
The Company has a $140 million leveraged employee stock ownership plan,
funded through an independently managed trust. The Employee Stock Ownership
Plan ("ESOP") was established to broaden internal ownership of the Company and
to provide benefits to its employees in a cost-effective manner.
In January 2000, each share of the ESOP Convertible Preferred Stock was
converted into 6.6 common shares of the Company.
2. Transactions with Subsidiaries
The Company has transactions with its subsidiaries determined on an agreed-
upon basis and has guaranteed certain unsecured lines of credit and
contractual obligations of certain of its subsidiaries.
The Company received cash dividends from its consolidated subsidiaries
totaling $3,020 million, $3,566 million and $1,858 million in fiscal 2000,
1999 and 1998, respectively.
S-5
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co.:
We have audited the consolidated financial statements of Xxxxxx Xxxxxxx Xxxx
Xxxxxx & Co. and subsidiaries (the "Company") as of fiscal years ended
November 30, 2000 and 1999, and for each of the three fiscal years in the
period ended November 30, 2000, and have issued our report thereon dated
January 12, 2001; such consolidated financial statements and report are
included in your 2000 Annual Report on Form 10-K. Our audits also included
Schedule I listed in the Index to Financial Statements and Financial Statement
Schedules. These financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, based on our audits, the condensed financial statement
schedules of Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co. (Parent Company Only), when
considered in relation to the basic consolidated financial statements taken as
a whole, present fairly in all material respects the information set forth
herein.
/s/ Deloitte & Touche LLP
New York, New York
January 12, 2001
S-6
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXHIBITS
TO
FORM 10-K
For the fiscal year ended November 30, 2000
Commission File No. 1-11758
Xxxxxx Xxxxxxx Xxxx Xxxxxx & Co.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
EXHIBIT INDEX
Certain of the following exhibits, as indicated parenthetically, were
previously filed as exhibits to registration statements filed by MSDW or its
predecessor companies under the Securities Act of 1933, as amended, or to
reports or registration statements filed by MSDW or its predecessor companies
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
respectively, and are hereby incorporated by reference to such statements or
reports. MSDW's Exchange Act file number is 1-11758. Prior to the Merger,
Xxxxxx Xxxxxxx'x Exchange Act file number was 1-9085.
Exhibit
No. Description
------- -----------
3.1* Amended and Restated Certificate of Incorporation of MSDW, as
amended to date.
3.2 By-Laws of MSDW, as amended to date (Exhibit 3.4 to MSDW's
Quarterly Report on Form 10-Q for the quarter ended February 28,
1999).
4.1 Rights Agreement dated as of April 25, 1995 between MSDW and
Chemical Bank, as rights agent, which includes as Exhibit B
thereto the Form of Rights Certificate (Exhibit 1 to MSDW's
Registration Statement on Form 8-A dated April 25, 1995).
4.2 Amendment dated as of February 4, 1997 to the Rights Agreement
between MSDW and The Chase Manhattan Bank, as rights agent
(Exhibit 4.1 to MSDW's Current Report on Form 8-K dated February
4, 1997).
4.3 Second Amendment dated as of June 15, 1999 to the Rights
Agreement between MSDW and The Chase Manhattan Bank (as
successor to Chemical Bank), as rights agent (Exhibit 4.1 to
MSDW's Current Report on Form 8-K dated June 15, 1999).
4.4 Indenture dated as of February 24, 1993 between MSDW and The
First National Bank of Chicago, as trustee (Exhibit 4 to MSDW's
Registration Statement on Form S-3 (No. 33-57202)).
4.5 Amended and Restated Senior Indenture dated as of May 1, 1999
between MSDW and The Chase Manhattan Bank, as trustee (Exhibit
4-e to MSDW's Registration Statement on Form S-3/A (No. 333-
75289)).
4.6 Amended and Restated Subordinated Indenture dated as of May 1,
1999 between MSDW and The First National Bank of Chicago, as
trustee (Exhibit 4-f to MSDW's Registration Statement on Form S-
3/A (No. 333-75289)).
4.7 First Supplemental Senior Indenture dated as of September 15,
2000 between MSDW and The Chase Manhattan Bank, as trustee
(Exhibit 4-f to MSDW's Registration Statement on Form S-3/A (No.
333-47576)).
4.8 Instruments defining the Rights of Security Holders, Including
Indentures--Except as set forth in Exhibits 4.1 through 4.7
above, the instruments defining the rights of holders of long-
term debt securities of MSDW and its subsidiaries are omitted
pursuant to Section (b)(4)(iii) of Item 601 of Regulation S-K.
MSDW hereby agrees to furnish copies of these instruments to the
SEC upon request.
10.1 Services Agreement by and between MSDW and International
Business Machines Corporation, effective as of July 1, 1999
(Exhibit 10.4 to MSDW's Quarterly Report on Form 10-Q for the
quarter ended August 31, 1999; confidential treatment has been
requested for portions of this exhibit).
10.2 Pooling and Servicing Agreement dated as of October 1, 1993
between Discover Bank (formerly Greenwood Trust Company), as
master servicer, servicer and seller, and U.S. Bank National
Association, as trustee (Exhibit 4.1 to the Discover Card Master
Trust I Registration Statement on Form S-1 (No. 33-71502)).
E-1
Exhibit
No. Description
------- -----------
10.3 First Amendment to Pooling and Servicing Agreement dated as of
August 15, 1994 between Discover Bank, as master servicer,
servicer and seller, and U.S. Bank National Association, as
trustee (Exhibit 4.4 to the Discover Card Master Trust I Current
Report on Form 8-K dated August 1, 1995).
10.4 Second Amendment to Pooling and Servicing Agreement dated as of
February 29, 1996 between Discover Bank, as master servicer,
servicer and seller, and U.S. Bank National Association, as
trustee (Exhibit 4.4 to the Discover Card Master Trust I Current
Report on Form 8-K dated April 30, 1996).
10.5 Third Amendment to Pooling and Servicing Agreement dated as of
March 30, 1998 between Discover Bank, as master servicer,
servicer and seller, and U.S. Bank National Association, as
trustee (Exhibit 4.1(d) to the Discover Card Master Trust I
Registration Statement on Form 8-A dated April 9, 1998).
10.6 Fourth Amendment to Pooling and Servicing Agreement dated as of
November 30, 1998 between Discover Bank, as master servicer,
servicer and seller, and U.S. Bank National Association, as
trustee (Exhibit 4.1 to the Discover Card Master Trust I Current
Report on Form 8-K dated November 30, 1998).
10.7 Amended and Restated Trust Agreement dated November 30, 2000
between MSDW and State Street Bank and Trust Company (Exhibit T
to Amendment No. 5 to the Schedule 13D dated November 30, 2000
filed by certain senior officers of MSDW and hereby incorporated
by reference).
10.8 Amended and Restated Trust Agreement of MSDW Capital Trust I
dated as of March 12, 1998 among MSDW, as depositor, The Bank of
New York, as property trustee, The Bank of New York (Delaware),
as Delaware trustee, and the administrators named therein
(Exhibit 4.3 to MSDW's Quarterly Report on Form 10-Q for the
quarter ended February 28, 1998).
10.9+ Xxxx Xxxxxx Xxxxxxxx Inc. Supplemental Pension Plan (formerly
known as the Xxxx Xxxxxx Xxxxxxxx Financial Services Inc.
Supplemental Pension Plan for Executives) (amended and restated)
(Exhibit 10.32 to MSDW's Annual Report on Form 10-K for the
fiscal year ended December 31, 1993).
10.10+ Omnibus Equity Incentive Plan (Exhibit 4.1 to MSDW's
Registration Statement on Form S-8 (No. 33-63024)).
10.11+ Employees Replacement Stock Plan (Exhibit 4.2 to MSDW's
Registration Statement on Form S-8 (No. 33-63024)).
10.12+ Amendment to Employees Replacement Stock Plan (Exhibit 10.1 to
MSDW's Current Report on Form 8-K dated November 18, 1993).
10.13+ Xxxx Xxxxxx START Plan (Saving Today Affords Retirement
Tomorrow) (amended and restated) (Exhibit 10.9 to MSDW's Annual
Report on Form 10-K for the fiscal year ended December 31,
1996).
10.14+ Amendment to Xxxx Xxxxxx START Plan (Exhibit 10.11 to MSDW's
Annual Report on Form 10-K for the fiscal year ended November
30, 1997).
10.15+ Amendment to Xxxx Xxxxxx START Plan (Exhibit 10.2 to MSDW's
Quarterly Report on Form 10-Q for the quarter ended May 31,
1998).
10.16+ Amendment to Xxxx Xxxxxx START Plan (Exhibit 10.3 to MSDW's
Quarterly Report on Form 10-Q for the quarter ended May 31,
1998).
E-2
Exhibit
No. Description
------- -----------
10.17+ Amendment to Xxxx Xxxxxx START Plan (Exhibit 10.19 to MSDW's
Annual Report on Form 10-K for the fiscal year ended November
30, 1998).
10.18+ Amendments to Dean Witter START Plan (Exhibit 10.22 to MSDW's
Annual Report on Form 10-K for the fiscal year ended November
30, 1999).
10.19+* Amendment to Dean Witter START Plan.
10.20+ 1993 Stock Plan for Non-Employee Directors (Exhibit 4.3 to
MSDW's Registration Statement on Form S-8 (No. 33-63024)).
10.21+ Amendment to 1993 Stock Plan for Non-Employee Directors (Exhibit
10.37 to MSDW's Annual Report on Form 10-K for the fiscal year
ended December 31, 1993).
10.22+ Transferred Executives Pension Supplement (amended and restated)
(Exhibit 10 to MSDW's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1995).
10.23+ 1994 Omnibus Equity Plan (Exhibit 10.52 to MSDW's Annual Report
on Form 10-K for the fiscal year ended December 31, 1993).
10.24+ Tax Deferred Equity Participation Plan (amended and restated)
(Exhibit 10.3 to MSDW's Quarterly Report on Form 10-Q for the
quarter ended August 31, 1999).
10.25+ Directors' Equity Capital Accumulation Plan (Exhibit 10.19 to
MSDW's Annual Report on Form 10-K for the fiscal year ended
November 30, 1997).
10.26+ Employees Equity Accumulation Plan (Exhibit 10.34 to MSDW's
Annual Report on Form 10-K for the fiscal year ended December
31, 1996).
10.27+ Employee Stock Purchase Plan (Exhibit 10.28 to MSDW's Annual
Report on Form 10-K for the fiscal year ended November 30,
1998).
10.28+ Amendment to Employee Stock Purchase Plan (Exhibit 10.32 to
MSDW's Annual Report on Form 10-K for the fiscal year ended
November 30, 1999).
10.29+ Form of Agreement under the Morgan Stanley & Co. Incorporated
Owners' and Select Earners' Plan (Exhibit 10.1 to Morgan
Stanley's Annual Report on Form 10-K for the fiscal year ended
January 31, 1993).
10.30+ Form of Agreement under the Officers' and Select Earners' Plan
(Exhibit 10.2 to Morgan Stanley's Annual Report on Form 10-K for
the fiscal year ended January 31, 1993).
10.31+ Morgan Stanley & Co. Incorporated Excess Benefit Plan (Exhibit
10.31 to MSDW's Annual Report on Form 10-K for the fiscal year
ended November 30, 1998).
10.32+* Amendment to Morgan Stanley & Co. Incorporated Excess Benefit
Plan.
10.33+ Supplemental Executive Retirement Plan (Exhibit 10.32 to MSDW's
Annual Report on Form 10-K for the fiscal year ended November
30, 1998).
10.34+ Amendment to Supplemental Executive Retirement Plan (Exhibit
10.37 to MSDW's Annual Report on Form 10-K for the fiscal year
ended November 30, 1999).
E-3
Exhibit
No. Description
------- -----------
10.35+* Amendment to Supplemental Executive Retirement Plan.
10.36+ Performance Unit Plan (amended and restated) (Exhibit 10.8 to
Morgan Stanley's Annual Report on Form 10-K for the fiscal year
ended January 31, 1993).
10.37+ 1988 Equity Incentive Compensation Plan, as amended (Exhibit
10.12 to Morgan Stanley's Annual Report on Form 10-K for the
fiscal year ended January 31, 1993).
10.38+ 1995 Equity Incentive Compensation Plan (Annex A to Morgan
Stanley's Proxy Statement for its 1996 Annual Meeting of
Stockholders).
10.39+* Amendment to 1995 Equity Incentive Compensation Plan.
10.40+ 1988 Capital Accumulation Plan, as amended (Exhibit 10.13 to
Morgan Stanley's Annual Report on Form 10-K for the fiscal year
ended January 31, 1993).
10.41+ Form of Deferred Compensation Agreement under the Pre-Tax
Incentive Program (Exhibit 10.12 to Morgan Stanley's Annual
Report on Form 10-K for the fiscal year ended January 31, 1994).
10.42+ Form of Deferred Compensation Agreement under the Pre-Tax
Incentive Program 2 (Exhibit 10.12 to Morgan Stanley's Annual
Report for the fiscal year ended November 30, 1996).
10.43+* Key Employee Private Equity Recognition Plan.
10.44+ DWR Branch Manager Compensation Plan (amended and restated)
(Exhibit 10.1 to MSDW's Quarterly Report on Form 10-Q for the
quarter ended February 29, 2000).
10.45+ DWR Financial Advisor Productivity Compensation Plan (amended
and restated) (Exhibit 10.2 to MSDW's Quarterly Report on Form
10-Q for the quarter ended August 31, 1999).
10.46+ Change in Employment Status Agreement by and between MSDW and
Peter F. Karches effective as of September 1, 2000 (Exhibit 10
to MSDW's Quarterly Report on Form 10-Q for the quarter ended
August 31, 2000; confidential treatment has been requested for
portions of this exhibit).
11* Statement Re: Computation of Earnings Per Common Share.
12* Statement Re: Computation of Ratio of Earnings to Fixed Charges
and Computation of Earnings to Fixed Charges and Preferred Stock
Dividends.
21* Subsidiaries of MSDW.
23.1* Consent of Deloitte & Touche LLP.
24 Powers of Attorney (included on signature page).
99* The following MSDW financial statements disclosed in Part II,
Item 8 of this Report in XBRL format: Consolidated Statements of
Financial Condition at November 30, 2000 and November 30, 1999;
Consolidated Statements of Income for Fiscal 2000, 1999 and
1998; and Consolidated Statements of Cash Flows for Fiscal 2000,
1999 and 1998 (Pilot Demonstration).
--------
* Filed herewith.
+ Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this Form 10-K pursuant to Item 14(c).
E-4
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