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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-11758
Morgan Stanley
(Exact Name of Registrant as Specified in its Charter)
-----------------
Delaware 36-3145972
(State of Incorporation) (I.R.S. Employer Identification No.)
1585 Broadway
New York, NY 10036
(Address of Principal (Zip Code)
Executive Offices)
Registrant's telephone number, including area code: (212) 761-4000
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
As of September 30, 2002, there were 1,085,621,879 shares of the
Registrant's Common Stock, par value $.01 per share, outstanding.
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MORGAN STANLEY
INDEX TO QUARTERLY REPORT ON FORM 10-Q
Quarter Ended August 31, 2002
Page
----
Part I--Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Financial Condition--August 31, 2002 (unaudited) and
November 30, 2001........................................................................... 1
Condensed Consolidated Statements of Income (unaudited)--Three and Nine Months Ended
August 31, 2002 and 2001.................................................................... 2
Condensed Consolidated Statements of Comprehensive Income (unaudited)--Three and Nine
Months Ended August 31, 2002 and 2001....................................................... 3
Condensed Consolidated Statements of Cash Flows (unaudited)--Nine Months Ended
August 31, 2002 and 2001.................................................................... 4
Notes to Condensed Consolidated Financial Statements (unaudited).............................. 5
Independent Accountants' Report............................................................... 23
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk............................... 53
Item 4. Disclosure Controls and Procedures....................................................... 56
Part II--Other Information
Item 1. Legal Proceedings........................................................................ 56
Item 6. Exhibits and Reports on Form 8-K......................................................... 58
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WHERE YOU CAN FIND MORE INFORMATION
The Company files annual and quarterly reports, proxy statements and other
information with the Securities and Exchange Commission (the "SEC"). You may
read and copy any document we file at the SEC's public reference room at Room
1024, 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at
1-800-SEC-0330 for further information on the public reference room. The SEC
also maintains a website that contains reports, proxy statements and other
information that we electronically file. The address of the SEC's website is
http://www.sec.gov. In addition, the Company maintains its own website where
you may obtain our filings, including our annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and proxy
statements (and any amendments thereto), free of charge, as soon as reasonably
practicable after we electronically file such documents with the SEC. The
information on the Company's website is not incorporated by reference in this
report. The address of the Company's website is http://www.morganstanley.com.
i
Item 1.
MORGAN STANLEY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in millions, except share data)
August 31, November 30,
2002 2001
----------- ------------
(unaudited)
ASSETS
Cash and cash equivalents......................... $ 27,965 $ 26,596
Cash and securities deposited with clearing
organizations or segregated under federal and
other regulations (including securities at fair
value of $29,608 at August 31, 2002 and $36,146
at November 30, 2001)............................ 40,302 46,326
Financial instruments owned (approximately $80
billion at August 31, 2002 and $74 billion at
November 30, 2001 were pledged to various
parties):
U.S. government and agency securities........... 30,881 25,696
Other sovereign government obligations.......... 27,796 22,039
Corporate and other debt........................ 56,178 47,607
Corporate equities.............................. 18,829 23,143
Derivative contracts............................ 39,533 32,078
Physical commodities............................ 547 285
Securities purchased under agreements to resell... 65,512 54,618
Securities provided as collateral................. 10,634 13,163
Securities borrowed............................... 131,496 120,758
Receivables:
Consumer loans (net of allowances of $927 at
August 31, 2002 and $847 at November 30, 2001) 21,898 20,108
Customers, net.................................. 18,626 22,188
Brokers, dealers and clearing organizations..... 6,046 6,462
Fees, interest and other........................ 5,071 5,283
Office facilities, at cost (less accumulated
depreciation and amortization of $2,732 at
August 31, 2002 and $2,124 at November 30, 2001). 2,323 2,579
Aircraft under operating leases (less accumulated
depreciation of $691 at August 31, 2002 and $479
at November 30, 2001)............................ 4,760 4,753
Goodwill.......................................... 1,447 1,438
Other assets...................................... 6,928 7,508
-------- --------
Total assets...................................... $516,772 $482,628
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Commercial paper and other short-term borrowings.. $ 38,773 $ 32,842
Deposits.......................................... 13,711 12,276
Financial instruments sold, not yet purchased:
U.S. government and agency securities........... 14,535 17,203
Other sovereign government obligations.......... 14,934 10,906
Corporate and other debt........................ 12,883 9,125
Corporate equities.............................. 14,393 13,046
Derivative contracts............................ 32,432 27,286
Physical commodities............................ 1,754 2,044
Securities sold under agreements to repurchase.... 125,516 122,695
Obligation to return securities received as
collateral....................................... 10,634 13,163
Securities loaned................................. 45,567 36,776
Payables:
Customers....................................... 91,724 93,719
Brokers, dealers and clearing organizations..... 3,351 4,331
Interest and dividends.......................... 5,879 2,761
Other liabilities and accrued expenses............ 12,867 12,795
Long-term borrowings.............................. 55,127 49,668
-------- --------
494,080 460,636
-------- --------
Capital Units..................................... 66 66
-------- --------
Preferred Securities Subject to Mandatory
Redemption....................................... 1,210 1,210
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock................................. -- 345
Common stock ($0.01 par value, 3,500,000,000
shares authorized, 1,211,685,904 and
1,211,685,904 shares issued, 1,093,052,009
and 1,093,006,744 shares outstanding at
August 31, 2002 and November 30, 2001,
respectively)................................. 12 12
Paid-in capital................................. 3,672 3,745
Retained earnings............................... 24,768 23,270
Employee stock trust............................ 2,895 3,086
Accumulated other comprehensive income (loss)... (225) (262)
-------- --------
Subtotal..................................... 31,122 30,196
Note receivable related to ESOP................. (29) (31)
Common stock held in treasury, at cost ($0.01
par value, 118,633,895 and 118,679,160 shares
at August 31, 2002 and November 30, 2001,
respectively)................................. (6,782) (6,935)
Common stock issued to employee trust........... (2,895) (2,514)
-------- --------
Total shareholders' equity................... 21,416 20,716
-------- --------
Total liabilities and shareholders' equity........ $516,772 $482,628
======== ========
See Notes to Condensed Consolidated Financial Statements.
1
MORGAN STANLEY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(dollars in millions, except share and per share data)
Three Months Ended August 31, Nine Months Ended August 31,
------------------------------ ------------------------------
2002 2001 2002 2001
- - -------------- -------------- -------------- --------------
(unaudited) (unaudited)
Revenues:
Investment banking.... $ 482 $ 807 $ 1,838 $ 2,616
Principal
transactions:
Trading............ 457 1,079 2,266 4,846
Investments........ (64) (59) (47) (212)
Commissions........... 855 720 2,532 2,409
Fees:
Asset
management,
distribution
and
administration.... 971 1,054 3,041 3,237
Merchant and
cardmember........ 364 362 1,064 1,000
Servicing.......... 514 434 1,566 1,337
Interest and
dividends............ 4,373 5,825 12,079 20,011
Other................. 204 110 506 374
-------------- -------------- -------------- --------------
Total revenues..... 8,156 10,332 24,845 35,618
Interest expense...... 3,188 4,869 8,968 17,447
Provision for
consumer loan
losses............... 332 277 1,017 721
-------------- -------------- -------------- --------------
Net revenues....... 4,636 5,186 14,860 17,450
-------------- -------------- -------------- --------------
Non-interest
expenses:
Compensation and
benefits.......... 2,061 2,376 6,786 7,950
Occupancy and
equipment......... 198 224 604 666
Brokerage,
clearing and
exchange fees..... 208 176 563 520
Information
processing and
communications.... 341 363 1,000 1,089
Marketing and
business
development....... 291 280 804 987
Professional
services.......... 273 284 748 954
Other.............. 295 311 792 940
-------------- -------------- -------------- --------------
Total
non-interest
expenses....... 3,667 4,014 11,297 13,106
-------------- -------------- -------------- --------------
Income before
income taxes,
dividends on
preferred
securities subject
to mandatory
redemption,
extraordinary item
and cumulative
effect of
accounting change.... 969 1,172 3,563 4,344
Provision for
income taxes......... 337 423 1,242 1,576
Dividends on
preferred
securities subject
to
mandatory redemption. 21 14 65 28
-------------- -------------- -------------- --------------
Income before
extraordinary item
and cumulative
effect of
accounting change.... 611 735 2,256 2,740
Extraordinary item.... -- (30) -- (30)
Cumulative effect
of accounting
change............... -- -- -- (59)
-------------- -------------- -------------- --------------
Net income............ $ 611 $ 705 $ 2,256 $ 2,651
============== ============== ============== ==============
Preferred stock
dividend
requirements......... $ -- $ 9 $ -- $ 27
============== ============== ============== ==============
Earnings applicable
to common shares..... $ 611 $ 696 $ 2,256 $ 2,624
============== ============== ============== ==============
Earnings per common
share:
Basic before
extraordinary
item and
cumulative
effect of
accounting
change............ $ 0.57 $ 0.67 $ 2.08 $ 2.49
Extraordinary
item.............. -- (0.03) -- (0.03)
Cumulative
effect of
accounting
change............ -- -- -- (0.05)
-------------- -------------- -------------- --------------
Basic.............. $ 0.57 $ 0.64 $ 2.08 $ 2.41
============== ============== ============== ==============
Diluted before
extraordinary
item and
cumulative
effect of
accounting
change............ $ 0.55 $ 0.65 $ 2.03 $ 2.41
Extraordinary
item.............. -- (0.03) -- (0.03)
Cumulative
effect of
accounting
change............ -- -- -- (0.05)
-------------- -------------- -------------- --------------
Diluted............ $ 0.55 $ 0.62 $ 2.03 $ 2.33
============== ============== ============== ==============
Average common
shares outstanding:
Basic.............. 1,081,708,833 1,085,447,127 1,084,059,497 1,089,017,948
============== ============== ============== ==============
Diluted............ 1,105,494,894 1,119,301,107 1,111,980,428 1,126,540,440
============== ============== ============== ==============
See Notes to Condensed Consolidated Financial Statements.
2
MORGAN STANLEY
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in millions)
Three Months Nine Months
Ended Ended
August 31, August 31,
---------- -------------
2002 2001 2002 2001
---- ---- ------ ------
(unaudited) (unaudited)
Net income.................................... $611 $705 $2,256 $2,651
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment.... 17 1 34 (50)
Cumulative effect of accounting change..... -- -- -- (13)
Net change in cash flow hedges............. (30) (27) 3 (74)
---- ---- ------ ------
Comprehensive income.......................... $598 $679 $2,293 $2,514
==== ==== ====== ======
See Notes to Condensed Consolidated Financial Statements.
3
MORGAN STANLEY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in millions)
Nine Months Ended
August 31,
------------------
2002 2001
-------- --------
(unaudited)
Cash flows from operating activities:
Net income................................................... $ 2,256 $ 2,651
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Non-cash charges included in net income:
Gain on sale of building and sale of
self-directed online brokerage accounts........... (125) --
Cumulative effect of accounting change.............. -- 59
Asset impairment charge............................. 74 --
Other non-cash charges included in net income....... 1,695 1,389
Changes in assets and liabilities:
Cash and securities deposited with clearing
organizations or segregated under federal and
other regulations.................................... 6,024 1,573
Financial instruments owned, net of financial
instruments sold, not yet purchased.................. (11,048) (36,874)
Securities borrowed, net of securities loaned.......... (1,947) (19,481)
Receivables and other assets........................... 5,675 1,780
Payables and other liabilities......................... 249 5,230
-------- --------
Net cash provided by (used for) operating activities......... 2,853 (43,673)
-------- --------
Cash flows from investing activities:
Net (payments for) proceeds from:
Office facilities and aircraft under operating
leases............................................... (857) (1,347)
Purchase of Quilter Holdings Limited, net of
cash acquired........................................ -- (183)
Net principal disbursed on consumer loans.............. (6,064) (6,812)
Sale of self-directed online brokerage accounts........ 98 --
Sales of consumer loans................................ 3,259 7,638
-------- --------
Net cash used for investing activities....................... (3,564) (704)
-------- --------
Cash flows from financing activities:
Net proceeds from (payments for) short-term
borrowings.............................................. 5,931 (866)
Securities sold under agreements to repurchase, net
of securities purchased under agreements to resell...... (8,073) 43,233
Net proceeds from:
Deposits............................................... 1,435 966
Issuance of common stock............................... 145 174
Issuance of put options................................ 6 5
Issuance of long-term borrowings....................... 10,338 17,772
Issuance of Preferred Securities Subject to
Mandatory Redemption................................. -- 810
Payments for:
Repurchases of common stock............................ (671) (1,242)
Repayments of long-term borrowings..................... (5,934) (10,137)
Redemption of Capital Units............................ -- (4)
Redemption of Cumulative Preferred Stock............... (345) (200)
Cash dividends......................................... (752) (787)
-------- --------
Net cash provided by financing activities.................... 2,080 49,724
-------- --------
Net increase in cash and cash equivalents.................... 1,369 5,347
Cash and cash equivalents, at beginning of period............ 26,596 18,819
-------- --------
Cash and cash equivalents, at end of period.................. $ 27,965 $ 24,166
======== ========
See Notes to Condensed Consolidated Financial Statements.
4
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Introduction and Basis of Presentation.
The Company
Morgan Stanley (the "Company") is a global financial services firm that
maintains leading market positions in each of its business
segments--Institutional Securities, Individual Investor Group, Investment
Management and Credit Services. The Company's Institutional Securities business
includes securities underwriting and distribution; financial advisory services,
including advice on mergers and acquisitions, restructurings, real estate and
project finance; sales, trading, financing and market-making activities in
equity securities and related products and fixed income securities and related
products, including foreign exchange and commodities; principal investing,
including private equity activities; and aircraft financing activities. The
Company's Individual Investor Group business provides comprehensive financial
planning and investment advisory services designed to accommodate individual
investment goals and risk profiles. The Individual Investor Group provides its
clients with several investment and credit products and services, including
mutual funds, insurance products, financial planning, retirement planning,
personal trust and estate planning, credit management and account services. The
Company's Investment Management business provides global asset management
products and services for individual and institutional investors through three
principal distribution channels: a proprietary channel consisting of the
Company's financial advisors and investment representatives; a non-proprietary
channel consisting of third-party broker-dealers, banks, financial planners and
other intermediaries; and the Company's institutional channel. The Company's
Credit Services business includes the issuance of the Discover(R) Classic Card,
the Discover Gold Card, the Discover Platinum Card, the Morgan Stanley Card/SM/
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.
In June 2002, the Company changed its name from "Morgan Stanley Dean Witter
& Co." to "Morgan Stanley."
Basis of Financial Information
The condensed consolidated financial statements include the accounts of the
Company, its wholly-owned subsidiaries and other entities in which the Company
has a controlling financial interest. In determining whether to consolidate an
entity, the Company considers, among other factors, the nature and extent of
the Company's ownership and financial interests and other attributes of
control. The Company's U.S. and international subsidiaries include Morgan
Stanley & Co. Incorporated ("MS&Co."), Morgan Stanley & Co. International
Limited ("MSIL"), Morgan Stanley Japan Limited ("MSJL"), Morgan Stanley DW Inc.
("MSDWI"), Morgan Stanley Investment Advisors Inc. and NOVUS Credit Services
Inc.
The condensed consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the U.S., which require the
Company to make estimates and assumptions regarding the valuations of certain
financial instruments, consumer loan loss levels, the potential outcome of
litigation and other matters that affect the condensed consolidated financial
statements and related disclosures. The Company believes that the estimates
utilized in the preparation of the condensed 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.
The condensed consolidated financial statements should be read in
conjunction with the Company's consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for
5
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the fiscal year ended November 30, 2001 (the "Form 10-K"). The condensed
consolidated financial statements reflect all adjustments (consisting only of
normal recurring adjustments) that are, in the opinion of management, necessary
for the fair statement of the results for the interim period. The results of
operations for interim periods are not necessarily indicative of results for
the entire year.
Financial instruments, including derivatives and loan products, used in the
Company's trading activities are recorded at fair value, and unrealized gains
and losses are reflected in principal trading revenues. Interest and dividend
revenue and interest expense arising from financial instruments used in trading
activities are reflected in the condensed consolidated statements of income as
interest and dividend revenue or interest expense. The fair values of 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 that 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. To the extent financial instruments have extended
maturity dates, the Company's estimates of fair value may involve greater
subjectivity due to the lack of transparent market data available upon which to
base modeling assumptions. Purchases and sales of financial instruments, as
well as commission revenues and related expenses, are recorded in the accounts
on trade date. Unrealized gains and losses arising from the Company's dealings
in over-the-counter ("OTC") financial instruments, including derivative
contracts related to financial instruments and commodities, are presented in
the accompanying condensed consolidated statements of financial condition on a
net-by-counterparty basis, when appropriate.
Equity securities purchased in connection with private equity and other
principal investment activities initially are carried in the condensed
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. Investments made in connection with principal
real estate activities that do not involve equity securities, primarily
comprised of general partnership and limited partnership interests in real
estate funds sponsored by the Company, are included within other assets in the
Company's condensed consolidated statements of financial condition. Such
investments are recorded at fair value, based upon independent appraisals of
the funds' underlying real estate assets, estimates prepared by the Company of
discounted future cash flows of the underlying real estate assets or other
indicators of fair value.
The Company enters into various derivative financial instruments for
non-trading purposes. These instruments include interest rate swaps, foreign
currency swaps, equity swaps and foreign exchange forwards. The Company uses
interest rate and currency swaps and equity derivatives to manage interest
rate, currency and equity price risk arising from certain borrowings. The
Company also utilizes interest rate swaps to match the repricing
characteristics of consumer loans with those of the borrowings that fund these
loans. Certain of these derivative financial instruments are designated and
qualify as fair value hedges and cash flow hedges in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended. The Company's designated fair
value hedges consist primarily of hedges of fixed rate borrowings, and its
designated cash flow hedges consist primarily of hedges of floating rate
borrowings. For qualifying fair value hedges, the changes in the fair value of
the derivatives and the gains or losses on the hedged assets or liabilities
relating to the risk being hedged are recorded currently in earnings. These
amounts are recorded in interest expense and provide offset of one another. For
qualifying cash flow
6
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
hedges, the changes in the fair value of the derivative are recorded in
accumulated other comprehensive income in shareholders' equity, net of tax
effects, and amounts in accumulated other comprehensive income are reclassified
into earnings in the same period or periods during which the hedged transaction
affects earnings. Ineffectiveness relating to fair value and cash flow hedges,
if any, is recorded within interest expense. The impact of hedge
ineffectiveness on the Company's condensed consolidated statements of income
was not material for all periods presented.
The Company also utilizes foreign exchange forward contracts to manage the
currency exposure relating to its net monetary investments in non-U.S. dollar
functional currency operations. The gain or loss from revaluing these contracts
is deferred and reported within accumulated other comprehensive income 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. The interest elements (forward
points) on these foreign exchange forward contracts are recorded in earnings.
The Company engages in securitization activities related to residential and
commercial mortgage loans, corporate bonds and loans, credit card loans and
other types of financial assets (see Notes 4 and 5). The Company may retain
interests in the securitized financial assets as one or more tranches of the
securitization, an undivided seller's interest, cash collateral accounts,
servicing rights, and rights to any excess cash flows remaining after payments
to investors in the securitization trusts of their contractual rate of return
and reimbursement of credit losses. The exposure to credit losses from
securitized loans is limited to the Company's retained contingent risk, which
represents the Company's retained interest in securitized loans, including any
credit enhancement provided. The gain or loss on the sale of financial assets
depends in part on the previous carrying amount of the assets involved in the
transfer, and each subsequent transfer in revolving structures, allocated
between the assets sold and the retained interests based upon their respective
fair values at the date of sale. To obtain fair values, quoted market prices
are used if available. However, quoted market prices are generally not
available for retained interests, so the Company estimates fair value based on
the present value of expected future cash flows using its best estimates of the
key assumptions, including forecasted credit losses, payment rates, forward
yield curves and discount rates commensurate with the risks involved. The
present value of 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.
2. Cumulative Effect of Accounting Change.
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, which established accounting and reporting standards for derivative
instruments, including certain 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 recorded an after-tax charge to
net income from the cumulative effect of the adoption of SFAS No. 133, as
amended, of $59 million and an after-tax decrease to accumulated other
comprehensive income of $13 million. The Company's adoption of SFAS No. 133, as
amended, affects the accounting for, among other things, the Company's hedging
strategies, including those associated with certain financing activities.
3. Goodwill.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 142 no longer permits the amortization of goodwill and
indefinite-lived intangible assets. Instead, these assets must be reviewed
annually (or more frequently under certain conditions) for impairment.
Intangible assets that do not
7
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
have indefinite lives will continue to be amortized over their useful lives and
reviewed for impairment. The Company early adopted the provisions of SFAS No.
142, and therefore discontinued the amortization of goodwill effective December
1, 2001. During the quarter ended May 31, 2002, the Company completed the
initial transitional goodwill impairment test, which did not indicate any
goodwill impairment and therefore did not have an effect on the Company's
condensed consolidated financial condition or results of operations.
The following table presents a reconciliation of reported net income and
earnings per share to the amounts adjusted for the exclusion of goodwill
amortization, net of the related income tax effect:
Three Months Ended Nine Months Ended
August 31, August 31,
-------------------- ------------------
2002 2001 2002 2001
------ ------ ------ ------
(dollars in millions, except per share amounts)
Net Income
Income before extraordinary item and cumulative effect
of accounting change................................... $ 611 $ 735 $2,256 $2,740
Add: Goodwill amortization, net of tax................... -- 22 -- 60
----- ------ ------ ------
611 757 2,256 2,800
Extraordinary item....................................... -- (30) -- (30)
Cumulative effect of accounting change................... -- -- -- (59)
----- ------ ------ ------
Adjusted................................................. $ 611 $ 727 $2,256 $2,711
===== ====== ====== ======
Basic earnings per common share
Basic before extraordinary item and cumulative effect of
accounting change...................................... $0.57 $ 0.67 $ 2.08 $ 2.49
Add: Goodwill amortization, net of tax................... -- 0.02 -- 0.05
----- ------ ------ ------
0.57 0.69 2.08 2.54
Extraordinary item....................................... -- (0.03) -- (0.03)
Cumulative effect of accounting change................... -- -- -- (0.05)
----- ------ ------ ------
Adjusted................................................. $0.57 $ 0.66 $ 2.08 $ 2.46
===== ====== ====== ======
Diluted earnings per common share
Diluted before extraordinary item and cumulative effect
of accounting change................................... $0.55 $ 0.65 $ 2.03 $ 2.41
Add: Goodwill amortization, net of tax................... -- 0.02 -- 0.05
----- ------ ------ ------
0.55 0.67 2.03 2.46
Extraordinary item....................................... -- (0.03) -- (0.03)
Cumulative effect of accounting change................... -- -- -- (0.05)
----- ------ ------ ------
Adjusted................................................. $0.55 $ 0.64 $ 2.03 $ 2.38
===== ====== ====== ======
Changes in the carrying amount of the Company's goodwill for the nine month
period ended August 31, 2002, were as follows:
Individual
Institutional Investor Investment
Securities Group Management Total
------------- ---------- ---------- ------
(dollars in millions)
Balance as of November 30, 2001 $ 4 $467 $967 $1,438
Translation adjustments........ -- 9 -- 9
--- ---- ---- ------
Balance as of August 31, 2002.. $ 4 $476 $967 $1,447
=== ==== ==== ======
8
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Securities Financing and Securitization Transactions.
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
agreements 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. Securities borrowed and
securities loaned also are treated as financing transactions and are carried at
the amounts of cash collateral advanced and received in connection with the
transactions.
The Company pledges its financial instruments owned to collateralize
repurchase agreements and other securities financings. Pledged securities that
can be sold or repledged by the secured party are identified as financial
instruments owned (pledged to various parties) on the condensed consolidated
statements of financial condition. The carrying value and classification of
securities owned by the Company that have been loaned or pledged to
counterparties where those counterparties do not have the right to sell or
repledge the collateral were as follows:
At At
August 31, November 30,
2002 2001
---------- ------------
(dollars in millions)
Financial instruments owned:
U.S. government and agency securities $ 6,819 $ 9,310
Corporate and other debt............. 7,412 3,350
Corporate equities................... 2,030 2,850
------- -------
Total......................... $16,261 $15,510
======= =======
The Company enters into reverse repurchase agreements, repurchase
agreements, securities borrowed transactions and securities loaned transactions
to, among other things, finance the Company's inventory positions, acquire
securities to cover short positions and settle other securities obligations and
to accommodate customers' needs. The Company also engages in securities
financing transactions for customers through margin lending. Under these
agreements and transactions, the Company either receives or provides
collateral, including U.S. government and agency securities, other sovereign
government obligations, corporate and other debt, and corporate equities. The
Company receives collateral in the form of securities in connection with
reverse repurchase agreements, securities borrowed transactions and customer
margin loans. In many cases, the Company is permitted to sell or repledge these
securities held as collateral and use the securities to secure repurchase
agreements, to enter into securities lending transactions or for delivery to
counterparties to cover short positions. At August 31, 2002, the fair value of
securities received as collateral where the Company is permitted to sell or
repledge the securities was $345 billion, and the fair value of the portion
that has been sold or repledged was $314 billion.
The Company manages credit exposure arising from reverse repurchase
agreements, repurchase agreements, securities borrowed transactions and
securities loaned transactions by, in appropriate circumstances, entering into
master netting agreements and collateral arrangements with counterparties that
provide the Company, in the event of a customer default, the right to liquidate
collateral and the right to offset a counterparty's rights and obligations. The
Company also 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 to ensure such transactions are
adequately collateralized. Where deemed appropriate, the Company's agreements
with third
9
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
parties specify its rights to request additional collateral. Customer
receivables generated from margin lending activity are collateralized by
customer-owned securities held by the Company. For these transactions, the
Company's collateral policies significantly limit the Company's credit exposure
in the event of customer default. The Company may request additional margin
collateral from customers, if appropriate, and if necessary may sell securities
that have not been paid for or purchase securities sold but not delivered from
customers.
In connection with its Institutional Securities business, the Company
engages in securitization activities related to commercial and residential
mortgage loans, corporate bonds and loans and other types of financial assets.
These assets are carried at fair value and any changes in fair value are
recognized in earnings until the time of securitization. The Company may act as
underwriter of the beneficial interests issued by the securitization vehicle.
Underwriting net revenues are recognized in connection with these transactions.
The Company may retain interests in the securitized financial assets as one or
more tranches of the securitization. These retained interests are included in
the condensed consolidated statements of financial condition at fair value. Any
changes in the fair value of such retained interests are recognized in the
condensed consolidated statements of income. Retained interests in securitized
financial assets associated with the Company's Institutional Securities
business were approximately $1.7 billion at August 31, 2002, the majority of
which were related to residential and commercial mortgage loan securitization
transactions.
The following table presents information on the Company's residential and
commercial mortgage loan securitization transactions. Key economic assumptions
and the sensitivity of the current fair value of the retained interests to
immediate 10% and 20% adverse changes in those assumptions at August 31, 2002
were as follows (dollars in millions):
Residential Commercial
Mortgage Mortgage
Loans Loans
----------- -----------
Retained interests (carrying amount/fair Retained interests (carrying amount/
value)................................ $1,140 fair value)....................... $395
Weighted average life (in months)....... 38 Weighted average life (in months)... 42
Credit losses (rate per annum).......... 0.2-4.0% Credit losses (rate per annum)...... 0.43-10.99%
Impact on fair value of 10% adverse Impact on fair value of 10%
change............................. $(8) adverse change................. $(2)
Impact on fair value of 20% adverse Impact on fair value of 20%
change............................. $(17) adverse change................. $(4)
Weighted average discount rate (rate per Weighted average discount rate (rate
annum)................................ 7.80% per annum)........................ 5.91%
Impact on fair value of 10% adverse Impact on fair value of 10%
change............................. $(13) adverse change................. $(5)
Impact on fair value of 20% adverse Impact on fair value of 20%
change............................. $(25) adverse change................. $(11)
Prepayment speed assumption............. 263-680PSA
Impact on fair value of 10% adverse
change............................. $(17)
Impact on fair value of 20% adverse
change............................. $(31)
The table above does not include the offsetting benefit of any financial
instruments that the Company may utilize to hedge risks inherent in its
retained interests. In addition, the sensitivity analysis is hypothetical and
should be used with caution. Changes in fair value based on a 10% or 20%
variation in an assumption generally cannot be extrapolated because the
relationship of the change in the assumption to the change in fair value may
10
not be linear. Also, the effect of a variation in a particular assumption on
the fair value of the retained interests is calculated independent of changes
in any other assumption; in practice, changes in one factor may result in
changes in another, which might magnify or counteract the sensitivities. In
addition, the sensitivity analysis does not consider any corrective action that
the Company may take to mitigate the impact of any adverse changes in the key
assumptions.
In connection with its Institutional Securities business, during the nine
month period ended August 31, 2002 the Company received $22 billion of proceeds
from new securitization transactions and $25 million of cash flows from
retained interests in securitization transactions.
5. Consumer Loans.
Consumer loans were as follows:
At At
August 31, November 30,
2002 2001
---------- ------------
(dollars in millions)
General purpose credit card, mortgage and consumer installment $22,825 $20,955
Less:
Allowance for consumer loan losses......................... 927 847
------- -------
Consumer loans, net........................................... $21,898 $20,108
======= =======
Activity in the allowance for consumer loan losses was as follows:
Three Months Nine Months
Ended Ended
August 31, August 31,
---------- ------------
2002 2001 2002 2001
---- ---- ------ ----
(dollars in millions)
Balance beginning of period........... $899 $787 $ 847 $783
Additions:
Provision for consumer loan losses. 332 277 1,017 721
Deductions:
Charge-offs........................ 333 301 1,012 793
Recoveries......................... (29) (29) (75) (81)
---- ---- ------ ----
Net charge-offs....................... 304 272 937 712
---- ---- ------ ----
Balance end of period................. $927 $792 $ 927 $792
==== ==== ====== ====
Interest accrued on general purpose credit card loans subsequently charged
off, recorded as a reduction of interest revenue, was $53 million and $163
million in the quarter and nine month period ended August 31, 2002, and $43
million and $124 million in the quarter and nine month period ended August 31,
2001.
At August 31, 2002, the Company had commitments to extend credit for
consumer loans of approximately $259 billion. Commitments to extend credit
arise from agreements with customers for 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 do not necessarily represent future cash
requirements, are periodically reviewed based on account usage and customer
creditworthiness.
The Company received net proceeds from consumer loan asset securitizations
of $472 million and $3,259 million in the quarter and nine month period ended
August 31, 2002 and $526 million and $7,638 million in the quarter and nine
month period ended August 31, 2001.
11
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company's retained interests in credit card asset securitizations
include an undivided seller's interest, cash collateral accounts, servicing
rights and rights to any excess cash flows ("Residual Interests") remaining
after payments to investors in the securitization trust of their contractual
rate of return and reimbursement of credit losses. The Company receives annual
servicing fees of 2% of the investor principal balance outstanding. At August
31, 2002, the Company had $9.1 billion of retained interests, including $6.9
billion of undivided seller's interest, in credit card asset securitizations.
The Company's undivided seller's interest ranks pari passu with investors'
interests in the securitization trust, and the remaining retained interests are
subordinate to investors' interests. The retained interests are subject to
credit, payment and interest rate risks on the transferred credit card assets.
The investors and the securitization trust have no recourse to the Company's
other assets for failure of cardmembers to pay when due.
During the nine months ended August 31, 2002, the Company completed credit
card asset securitizations of $2.8 billion and recognized net securitization
gains of $16 million as servicing fees in the Company's condensed consolidated
statements of income. The uncollected balances of general purpose credit card
loans sold through asset securitizations were $27.9 billion at August 31, 2002
and $29.2 billion at November 30, 2001.
Key economic assumptions used in measuring the Residual Interests at the
date of securitization resulting from credit card asset securitizations
completed during the nine months ended August 31, 2002 were as follows:
Weighted average life (in months) 6.1-6.2
Payment rate (rate per month).... 16.88-17.25%
Credit losses (rate per annum)... 6.95%
Discount rate (rate per annum)... 14.00-16.50%
Key economic assumptions and the sensitivity of the current fair value of
the Residual Interests to immediate 10% and 20% adverse changes in those
assumptions were as follows (dollars in millions):
At
August 31,
2002
----------
Residual Interests (carrying amount/fair value) $ 226
Weighted average life (in months).............. 6.1
Payment rate (rate per month).................. 17.25%
Impact on fair value of 10% adverse change.. $ (16)
Impact on fair value of 20% adverse change.. $ (29)
Credit losses (rate per annum)................. 6.95%
Impact on fair value of 10% adverse change.. $ (75)
Impact on fair value of 20% adverse change.. $ (148)
Discount rate (rate per annum)................. 14.00%
Impact on fair value of 10% adverse change.. $ (3)
Impact on fair value of 20% adverse change.. $ (5)
The sensitivity analysis in the table above is hypothetical and should be
used with caution. Changes in fair value based on a 10% or 20% variation in an
assumption generally cannot be extrapolated because the relationship of the
change in the assumption to the change in fair value may not be linear. Also,
the effect of a variation in a particular assumption on the fair value of the
Residual Interests is calculated independent of changes in any other
assumption; in practice, changes in one factor may result in changes in another
(for example, increases in market interest rates may result in lower payments
and increased credit losses), which might magnify or counteract the
sensitivities. In addition, the sensitivity analysis does not consider any
corrective action that the Company may take to mitigate the impact of any
adverse changes in the key assumptions.
12
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The table below summarizes certain cash flows received from the
securitization master trust (dollars in billions):
Nine Months
Ended
August 31,
2002
-----------
Proceeds from new credit card asset securitizations............... $ 2.8
Proceeds from collections reinvested in previous credit card asset
securitizations................................................. $39.5
Contractual servicing fees received............................... $ 0.4
Cash flows received from retained interests....................... $ 1.4
The table below presents quantitative information about delinquencies, net
credit losses and components of managed general purpose credit card loans,
including securitized loans:
Nine Months Ended
At August 31, 2002 August 31, 2002
---------------------- ------------------
Loans Loans Average Net Credit
Outstanding Delinquent Loans Losses
----------- ---------- ------- ----------
(dollars in billions)
Managed general purpose credit card loans.......... $49.7 $2.8 $49.7 $2.3
Less: Securitized general purpose credit card loans 27.9
-----
Owned general purpose credit card loans............ $21.8
=====
6. Long-Term Borrowings.
Long-term borrowings at August 31, 2002 scheduled to mature within one year
aggregated $11,188 million.
During the nine month period ended August 31, 2002, the Company issued
senior notes aggregating $10,605 million, including non-U.S. dollar currency
notes aggregating $1,962 million. The Company has entered into certain
transactions to obtain floating interest rates based primarily on short-term
LIBOR trading levels. Maturities in the aggregate of these notes by fiscal year
are as follows: 2003, $1,159 million; 2004, $1,093 million; 2005, $156 million,
2006, $21 million, 2007, $2,776 million; and thereafter, $5,400 million. In the
nine month period ended August 31, 2002, $5,934 million of senior notes were
repaid.
The weighted average maturity of the Company's long-term borrowings, based
upon stated maturity dates, was approximately 4 years at August 31, 2002.
7. Preferred Stock, Capital Units and Preferred Securities Subject to
Mandatory Redemption.
Preferred stock of the Company was composed of the following issue:
Shares Outstanding at Balance at
----------------------- -----------------------
August 31, November 30, August 31, November 30,
2002 2001 2002 2001
---------- ------------ ---------- ------------
(dollars in millions)
Series A Fixed/Adjustable Rate Cumulative Preferred Stock,
stated value $200 per share............................. -- 1,725,000 $-- $345
On December 3, 2001, the Company redeemed all 1,725,000 outstanding shares
of its Series A Fixed/Adjustable Rate Cumulative Preferred Stock at a
redemption price of $200 per share. The Company also
13
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
simultaneously redeemed all corresponding Depositary Shares at a redemption
price of $50 per Depositary Share. Each Depositary Share represented 1/4 of a
share of the Company's Series A Fixed/Adjustable Rate Cumulative Preferred
Stock.
The Company has Capital Units outstanding that were issued by the Company
and Morgan Stanley 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, 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 $66 million at both August 31, 2002 and November 30, 2001.
Preferred Securities Subject to Mandatory Redemption (also referred to as
"Capital Securities" herein) represent preferred minority interests in certain
of the Company's subsidiaries. Accordingly, dividends paid on Preferred
Securities Subject to Mandatory Redemption are presented as a deduction to
after-tax income (similar to minority interests in the income of subsidiaries)
in the Company's condensed consolidated statements of income.
MSDW Capital Trust I ("Capital Trust I") and Morgan Stanley Capital Trust II
("Capital Trust II") are consolidated Delaware statutory business trusts (all
of the common securities of which are owned by the Company) and have Capital
Securities outstanding. The trusts invested the proceeds of the Capital
Securities offerings and the proceeds from the sale of common securities to the
Company in junior subordinated deferrable interest debentures issued by the
Company, the terms of which parallel the terms of the Capital Securities. The
Capital Securities are fully and unconditionally guaranteed by the Company,
based on the Company's combined obligations under a guarantee, a trust
agreement and a junior subordinated debt indenture.
The significant terms of the Preferred Securities Subject to Mandatory
Redemption issued by Capital Trust I and Capital Trust II, and the
corresponding junior subordinated deferrable interest debentures issued by the
Company, are presented below:
Preferred Securities Subject to Mandatory Redemption Capital Trust I Capital Trust II
Issuance date...................................... March 12, 1998 July 19, 2001
Preferred securities issued........................ 16,000,000 32,400,000
Liquidation preference per security................ $25 $25
Liquidation value (in millions).................... $400 $810
Coupon rate........................................ 7.10% 7.25%
Distribution payable............................... Quarterly Quarterly
Distributions guaranteed by........................ Morgan Stanley Morgan Stanley
Mandatory redemption date.......................... February 28, 2038 July 31, 2031(1)
Redeemable by issuer on or after(2)................ March 12, 2003 July 31, 2006
Junior Subordinated Deferrable Interest Debentures
Principal amount outstanding (in millions)(3)...... $412 $835
Coupon rate........................................ 7.10% 7.25%
Interest payable................................... Quarterly Quarterly
Maturity date...................................... February 28, 2038 July 31, 2031(1)
Redeemable by issuer on or after(2)................ March 12, 2003 July 31, 2006
- --------
(1)May be extended to a date not later than July 31, 2050.
(2)Redeemable prior to this date in whole (but not in part) upon the occurrence
of certain events.
(3)Purchased by the trusts with the proceeds of the Capital Securities
offerings and the proceeds from the sale of common securities to the Company.
14
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Common Stock and Shareholders' Equity.
MS&Co. and MSDWI 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 MSDWI have
consistently operated in excess of these requirements. MS&Co.'s net capital
totaled $5,384 million at August 31, 2002, which exceeded the amount required
by $4,737 million. MSDWI's net capital totaled $1,524 million at August 31,
2002, which exceeded the amount required by $1,422 million. MSIL, a
London-based broker-dealer subsidiary, is subject to the capital requirements
of the Financial Services Authority, and MSJL, a Tokyo-based broker-dealer, is
subject to the capital requirements of the Financial Services Agency. MSIL and
MSJL have consistently operated in excess of their respective regulatory
capital requirements.
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 August 31, 2002, 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.
On May 17, 2002, the FDIC, in conjunction with other bank regulatory
agencies, issued guidance that requires FDIC-insured financial institutions to
treat accrued interest receivable related to credit card securitizations as a
residual interest, which requires holding higher regulatory capital beginning
December 31, 2002. The Company's FDIC-insured financial institutions have the
capacity to meet these additional capital requirements and intend to maintain
capital ratios in excess of the regulatory minimums after implementing this
revised guidance.
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. Morgan Stanley
Derivative Products Inc., the Company's triple-A rated derivative products
subsidiary, maintains certain operating restrictions that have been reviewed by
various rating agencies.
The Company repurchased approximately 14 million and 18 million shares of
its common stock through open market purchases during the nine month periods
ended August 31, 2002 and 2001, 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 August 31, 2002, put options were outstanding on an
aggregate of 3.0 million shares of the Company's common stock. These put
options have expiration dates that range from September 2002 through November
2002 with strike prices ranging from $39.76 to $40.10. The Company may elect
cash settlement of the put options instead of taking delivery of the stock.
15
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Earnings per Share.
Basic EPS reflects no dilution from common stock equivalents. 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. The following table presents the calculation of basic and diluted EPS
(in millions, except for per share data):
Three Months Nine Months
Ended Ended
August 31, August 31,
------------- -------------
2002 2001 2002 2001
------ ------ ------ ------
Basic EPS:
Income before extraordinary item and cumulative effect of accounting
change..................................................................... $ 611 $ 735 $2,256 $2,740
Extraordinary item.......................................................... -- (30) -- (30)
Cumulative effect of accounting change...................................... -- -- -- (59)
Preferred stock dividend requirements....................................... -- (9) -- (27)
------ ------ ------ ------
Net income available to common shareholders................................. $ 611 $ 696 $2,256 $2,624
====== ====== ====== ======
Weighted-average common shares outstanding.................................. 1,082 1,085 1,084 1,089
====== ====== ====== ======
Basic EPS before extraordinary item and cumulative effect of accounting
change..................................................................... $ 0.57 $ 0.67 $ 2.08 $ 2.49
Extraordinary item.......................................................... -- (0.03) -- (0.03)
Cumulative effect of accounting change...................................... -- -- -- (0.05)
------ ------ ------ ------
Basic EPS....................................................................... $ 0.57 $ 0.64 $ 2.08 $ 2.41
====== ====== ====== ======
Diluted EPS:
Income before extraordinary item and cumulative effect of accounting
change..................................................................... $ 611 $ 735 $2,256 $2,740
Extraordinary item.......................................................... -- (30) -- (30)
Cumulative effect of accounting change...................................... -- -- -- (59)
Preferred stock dividend requirements....................................... -- (9) -- (27)
------ ------ ------ ------
Net income available to common shareholders................................. $ 611 $ 696 $2,256 $2,624
====== ====== ====== ======
Weighted-average common shares outstanding.................................. 1,082 1,085 1,084 1,089
Effect of dilutive securities:
Stock options............................................................ 23 33 27 37
Convertible debt......................................................... 1 1 1 1
------ ------ ------ ------
Weighted-average common shares outstanding and common stock equivalents 1,106 1,119 1,112 1,127
====== ====== ====== ======
Diluted EPS before extraordinary item and cumulative effect of accounting
change..................................................................... $ 0.55 $ 0.65 $ 2.03 $ 2.41
Extraordinary item.......................................................... -- (0.03) -- (0.03)
Cumulative effect of accounting change...................................... -- -- -- (0.05)
------ ------ ------ ------
Diluted EPS..................................................................... $ 0.55 $ 0.62 $ 2.03 $ 2.33
====== ====== ====== ======
At August 31, 2002, there were approximately 68 and 65 million stock options
outstanding for the quarter and nine month periods ended August 31, 2002,
respectively, that were excluded from the computation of diluted EPS, as the
exercise price of such options exceeded the average price per share of the
Company's common stock.
10. Commitments and Contingencies.
At August 31, 2002 and November 30, 2001, the Company had approximately $3.5
billion and $4.5 billion, respectively, of letters of credit outstanding to
satisfy various collateral requirements.
16
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company has commitments to fund certain fixed assets and other less
liquid investments, including at August 31, 2002, $588 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 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.
In connection with its aircraft financing business, the Company has entered
into agreements to purchase aircraft and related equipment. As of August 31,
2002, the aggregate amount of such purchase commitments was $213 million. All
of the aircraft to be acquired under these purchase obligations are subject to
contractual lease arrangements.
In connection with certain of its business activities, the Company provides,
on a selective basis, through certain of its subsidiaries (including Morgan
Stanley Bank), financing or financing commitments to companies in the form of
senior and subordinated debt, including bridge financing. The borrowers may be
rated investment grade or non-investment grade. These loans and funding
commitments typically are secured against the borrower's assets (in the case of
senior loans), have varying maturity dates and are generally contingent upon
certain representations, warranties and contractual conditions applicable to
the borrower. As part of these activities, the Company may syndicate and trade
certain of these loans. At August 31, 2002, the Company provided commitments
associated with these activities to investment grade issuers aggregating $11.0
billion and commitments to non-investment grade issuers aggregating $1.4
billion. Since these commitments may expire unused, the total commitment amount
does not necessarily reflect the actual future cash funding 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 condensed consolidated statements of financial
condition.
At August 31, 2002, the Company had commitments to enter into reverse
repurchase and repurchase agreements of approximately $34 billion and $44
billion, respectively.
In the normal course of business, the Company has been named as a defendant
in various legal actions, including arbitrations, arising in connection with
its activities as a global diversified financial services institution. Some of
the legal actions include claims for substantial compensatory and/or punitive
damages or claims for indeterminate amounts of damages. The Company 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 in which claimants seek substantial or indeterminate damages, the Company
cannot predict with certainty what the eventual loss or range of loss related
to such matters will be. The Company 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 condensed consolidated financial condition of
the Company, although the outcome could be material to the Company's operating
results for a particular period, depending, upon other things, on the level of
the Company's income for such period.
11. Derivative Contracts.
In the normal course of business, the Company enters into a variety of
derivative contracts related to financial instruments and commodities. The
Company uses swap agreements and other derivatives in managing its interest
rate exposure. The Company also uses forward and option contracts, futures and
swaps in its trading
17
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
activities; these derivative instruments also are used to hedge the U.S. dollar
cost of certain foreign currency exposures. In addition, financial futures and
forward contracts are actively traded by the Company and are used to hedge
proprietary inventory. The Company also enters into delayed delivery,
when-issued, and warrant and option contracts involving securities. These
instruments generally represent future commitments to swap interest payment
streams, exchange currencies or purchase or sell other financial instruments on
specific terms at specified future dates. Many of these products have
maturities that do not extend beyond one year, although swaps and options and
warrants on equities typically have longer maturities. For further discussion
of these matters, refer to "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Derivative Financial Instruments" and Note
10 to the consolidated financial statements for the fiscal year ended November
30, 2001, included in the Form 10-K.
These derivative instruments involve varying degrees of market risk. Future
changes in interest rates, foreign currency exchange rates or the fair values
of the financial instruments, commodities or indices underlying these contracts
ultimately may result in cash settlements less than or exceeding fair value
amounts recognized in the condensed consolidated statements of financial
condition, which, as described in Note 1, are recorded at fair value,
representing the cost of replacing those instruments.
The Company's exposure to credit risk with respect to these derivative
instruments at any point in time is represented by the fair value of the
contracts reported as assets. These amounts are presented on a
net-by-counterparty basis (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 credit quality of the Company's trading-related derivatives at August
31, 2002 and November 30, 2001 is summarized in the tables below, showing the
fair value of the related assets by counterparty credit rating. The actual
credit ratings are determined by external rating agencies or by equivalent
ratings used by the Company's Credit Risk Department:
Collateralized Other
Non- Non-
Investment Investment
AAA AA A BBB Grade Grade Total
------ ------- ------ ------ -------------- ---------- -------
(dollars in millions)
At August 31, 2002
Interest rate and currency swaps and options
(including caps, floors and swap options) and other
fixed income securities contracts.................. $5,049 $ 7,684 $6,407 $2,541 $3,755 $1,516 $26,952
Foreign exchange forward contracts and options...... 178 1,481 716 180 -- 813 3,368
Equity securities contracts (including equity swaps,
warrants and options).............................. 2,311 816 587 213 11 333 4,271
Commodity forwards, options and swaps............... 191 1,237 1,653 684 116 1,061 4,942
------ ------- ------ ------ ------ ------ -------
Total............................................ $7,729 $11,218 $9,363 $3,618 $3,882 $3,723 $39,533
====== ======= ====== ====== ====== ====== =======
Percent of total.................................... 20% 28% 24% 9% 10% 9% 100%
====== ======= ====== ====== ====== ====== =======
At November 30, 2001
Interest rate and currency swaps and options
(including caps, floors and swap options) and other
fixed income securities contracts.................. $4,465 $ 5,910 $6,144 $1,482 $ 488 $ 631 $19,120
Foreign exchange forward contracts and options...... 76 1,051 1,090 212 -- 269 2,698
Equity securities contracts (including equity swaps,
warrants and options).............................. 1,879 1,392 662 40 85 283 4,341
Commodity forwards, options and swaps............... 367 941 1,690 1,195 173 1,553 5,919
------ ------- ------ ------ ------ ------ -------
Total............................................ $6,787 $ 9,294 $9,586 $2,929 $ 746 $2,736 $32,078
====== ======= ====== ====== ====== ====== =======
Percent of total.................................... 21% 29% 30% 9% 2% 9% 100%
====== ======= ====== ====== ====== ====== =======
18
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A substantial portion of the Company's securities and commodities
transactions are collateralized and are executed with and on behalf of
commercial banks and other institutional investors, including other brokers and
dealers. Positions taken and commitments made by the Company, including
positions taken and underwriting and financing commitments made in connection
with its private equity and other principal investment activities, often
involve substantial amounts and significant exposure to individual issuers and
businesses, including non-investment grade issuers. The Company seeks to limit
concentration risk created in its businesses through a variety of separate but
complementary financial, position and credit exposure reporting systems,
including the use of trading limits based in part upon the Company's review of
the financial condition and credit ratings of its counterparties.
See also "Risk Management" in the Form 10-K for discussions of the Company's
risk management policies and procedures for its Institutional Securities
businesses.
12. Segment Information.
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 four business
segments--Institutional Securities, Individual Investor Group, Investment
Management and Credit Services, through which it provides a wide range of
financial products and services to its customers. Previously, the results of
the Company's institutional and individual securities activities were
aggregated into one reporting segment. Certain reclassifications have been made
to prior-period amounts to conform to the current year's presentation.
The Company's Institutional Securities business includes securities
underwriting and distribution; financial advisory services, including advice on
mergers and acquisitions, restructurings, real estate and project finance;
sales, trading, financing and market-making activities in equity securities and
related products and fixed income securities and related products, including
foreign exchange and commodities; principal investing, including private equity
activities; and aircraft financing activities. The Company's Individual
Investor Group business provides comprehensive financial planning and
investment advisory services designed to accommodate individual investment
goals and risk profiles. The Individual Investor Group provides its clients
with several investment and credit products and services, including mutual
funds, insurance products, financial planning, retirement planning, personal
trust and estate planning, credit management and account services. The
Company's Investment Management business provides global asset management
products and services for individual and institutional investors through three
principal distribution channels: a proprietary channel consisting of the
Company's financial advisors and investment representatives; a non-proprietary
channel consisting of third-party broker-dealers, banks, financial planners and
other intermediaries; and the Company's institutional channel. The Company's
Credit Services business includes the issuance of the Discover Classic Card,
the Discover Gold Card, the Discover Platinum Card, the Morgan Stanley 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.
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 have been allocated
to each business segment, generally in proportion to their respective revenues
or other relevant measures. Allocation decisions in global financial services
businesses are by their nature complex, subjective and involve a high degree of
judgment. Management is currently evaluating the segment allocation methodology
and the effect of any changes may be material to a particular segment.
Therefore, business segment results in the
19
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
future may reflect reallocations of revenues and expenses that result from such
changes. Reallocations of revenues or expenses among segments will have no
effect on the Company's overall results of operations. Selected financial
information for the Company's segments is presented in the table below:
Individual
Institutional Investor Investment Credit
Three Months Ended August 31, 2002 Securities Group Management Services Total
- ---------------------------------- ------------- ---------- ---------- -------- ------
(dollars in millions)
Net revenues excluding net interest................... $1,404 $ 955 $543 $549 $3,451
Net interest.......................................... 734 58 9 384 1,185
------ ------ ---- ---- ------
Net revenues.......................................... $2,138 $1,013 $552 $933 $4,636
====== ====== ==== ==== ======
Income before income taxes and dividends on preferred
securities subject to mandatory redemption.......... $ 413 $ 8 $229 $319 $ 969
Provision for income taxes............................ 132 3 93 109 337
Dividends on preferred securities subject to mandatory
redemption.......................................... 21 -- -- -- 21
------ ------ ---- ---- ------
Net income............................................ $ 260 $ 5 $136 $210 $ 611
====== ====== ==== ==== ======
Individual
Institutional Investor Investment Credit
Three Months Ended August 31, 2001(1) Securities Group Management Services Total
- ------------------------------------- ------------- ---------- ---------- -------- ------
(dollars in millions)
Net revenues excluding net interest................... $2,097 $ 988 $623 $522 $4,230
Net interest.......................................... 482 89 14 371 956
------ ------ ---- ---- ------
Net revenues.......................................... $2,579 $1,077 $637 $893 $5,186
====== ====== ==== ==== ======
Income before income taxes, dividends on preferred
securities subject to mandatory redemption and
extraordinary item.................................. $ 733 $ (95) $216 $318 $1,172
Provision for income taxes............................ 250 (37) 88 122 423
Dividends on preferred securities subject to mandatory
redemption.......................................... 14 -- -- -- 14
------ ------ ---- ---- ------
Income before extraordinary item...................... 469 (58) 128 196 735
Extraordinary item.................................... (30) -- -- -- (30)
------ ------ ---- ---- ------
Net income............................................ $ 439 $ (58) $128 $196 $ 705
====== ====== ==== ==== ======
Individual
Institutional Investor Investment Credit
Nine Months Ended August 31, 2002 Securities Group Management Services Total
- --------------------------------- ------------- ---------- ---------- -------- -------
(dollars in millions)
Net revenues excluding net interest................... $5,498 $2,894 $1,739 $1,618 $11,749
Net interest.......................................... 1,898 179 22 1,012 3,111
------ ------ ------ ------ -------
Net revenues.......................................... $7,396 $3,073 $1,761 $2,630 $14,860
====== ====== ====== ====== =======
Income before income taxes and dividends on preferred
securities subject to mandatory redemption.......... $1,946 $ 41 $ 690 $ 886 $ 3,563
Provision for income taxes............................ 641 17 271 313 1,242
Dividends on preferred securities subject to mandatory
redemption.......................................... 65 -- -- -- 65
------ ------ ------ ------ -------
Net income............................................ $1,240 $ 24 $ 419 $ 573 $ 2,256
====== ====== ====== ====== =======
20
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Individual
Institutional Investor Investment Credit
Nine Months Ended August 31, 2001(1) Securities Group Management Services Total
- ------------------------------------ ------------- ---------- ---------- -------- -------
(dollars in millions)
Net revenues excluding net interest................... $8,196 $3,157 $1,914 $1,619 $14,886
Net interest.......................................... 1,171 307 50 1,036 2,564
------ ------ ------ ------ -------
Net revenues.......................................... $9,367 $3,464 $1,964 $2,655 $17,450
====== ====== ====== ====== =======
Income before income taxes, dividends on preferred
securities subject to mandatory redemption,
extraordinary item and cumulative effect of
accounting change................................... $2,913 $ (84) $ 687 $ 828 $ 4,344
Provision for income taxes............................ 1,004 (26) 279 319 1,576
Dividends on preferred securities subject to mandatory
redemption.......................................... 28 -- -- -- 28
------ ------ ------ ------ -------
Income before extraordinary item and cumulative
effect of accounting change......................... 1,881 (58) 408 509 2,740
Extraordinary item.................................... (30) -- -- -- (30)
Cumulative effect of accounting change................ (46) -- -- (13) (59)
------ ------ ------ ------ -------
Net income............................................ $1,805 $ (58) $ 408 $ 496 $ 2,651
====== ====== ====== ====== =======
Individual
Institutional Investor Investment Credit
Total Assets(2) Securities Group Management Services Total
- --------------- ------------- ---------- ---------- -------- --------
(dollars in millions)
August 31, 2002...................................... $475,913 $8,681 $5,409 $26,769 $516,772
======== ====== ====== ======= ========
November 30, 2001.................................... $442,598 $9,823 $5,076 $25,131 $482,628
======== ====== ====== ======= ========
- --------
(1) Certain reclassifications have been made to prior period amounts to conform
to the current presentation.
(2) Corporate assets have been fully allocated to the Company's business
segments.
13. Terrorist Attacks.
On September 11, 2001, the U.S. experienced terrorist attacks targeted
against New York City and Washington, D.C. The attacks in New York City
destroyed the World Trade Center complex, where approximately 3,700 of the
Company's employees were located. Through the implementation of its business
recovery plans, the Company relocated its displaced employees to other
facilities.
The Company has recognized costs related to the terrorist attacks, which
have been offset by an expected insurance recovery. These costs and the related
expected insurance recovery pertain to write-offs of leasehold improvements and
destroyed technology and telecommunications equipment in the World Trade Center
complex, employee relocation and certain other employee-related expenditures,
and other business recovery costs. Such costs amounted to $7 million for the
quarter and $82 million for the nine month period ended August 31, 2002 and $56
million for the fiscal year ended November 30, 2001.
14. Asset Impairment.
The Company's aircraft financing business has continued to be adversely
affected by the slowdown in the commercial aircraft industry which began in
early 2001 and was exacerbated by the terrorist attacks of September 11, 2001
(see Note 13). In addition, the sustained reduction in passenger volume has
resulted in the
21
MORGAN STANLEY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
grounding of significant numbers of aircraft. Such conditions have contributed
significantly to the decline in lease rates for operating lessors, including
the Company's aircraft financing business. As a result of these conditions, and
in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of," the Company incurred a
non-cash pre-tax charge of $74 million in the third quarter of fiscal 2002 to
reflect the impairment of certain aircraft. The impairment charge is reflected
in other expenses in the Company's condensed consolidated statements of income.
The results of the aircraft financing business are included in the Company's
Institutional Securities business segment (see Note 12).
In accordance with SFAS No. 121, the Company has compared the aggregate
undiscounted cash flows expected to be generated by each of its aircraft with
its carrying value. If an impairment was indicated under this approach, the
aircraft was written down to its estimated fair value, if lower. The Company
determines fair value by obtaining several independent appraisals of its
aircraft, which provide estimates of each aircraft's "base value". "Base value"
is estimated by the appraisers by presuming a transaction between an equally
willing and informed buyer and seller, neither under compulsion to buy or sell,
and with supply and demand for the aircraft in reasonable balance. The Company
believes that "base value" is the relevant measure of the aircraft's value as
it best reflects the fair value of the aircraft in accordance with SFAS No. 121.
In addition, the appraisals received by the Company provide estimates of
each aircraft's market value. "Market value" is estimated by the appraisers by
considering the state of the economy in which the aircraft is used, the status
of supply and demand for the particular aircraft type and the value of recent
transactions. "Market values" generally reflect the probable near-term value of
an aircraft without regard to the factors required to sustain an orderly
market. The Company believes that current industry-wide market values for
aircraft have decreased 20% to 30% from pre-September 11, 2001 market values.
15. Gain on Sale of Building.
During the nine month period ended August 31, 2002, the Company recorded a
pre-tax gain of $73 million related to the sale of a 1 million square-foot
office tower in New York City that had been under construction since 1999. The
gain is included within other revenues in the Company's condensed consolidated
statements of income. The Company allocated $53 million of the gain to its
Institutional Securities segment, $13 million of the gain to its Investment
Management segment and $7 million of the gain to its Individual Investor Group
segment. The allocation was based upon occupancy levels originally planned for
the building.
16. Asset Disposition.
In May 2002, the Company agreed to sell its self-directed online brokerage
accounts to Bank of Montreal's Harrisdirect. The transaction closed during the
third quarter of fiscal 2002. The Company recorded gross proceeds of
approximately $100 million (included within other revenues) and related costs
of approximately $50 million (included within other expenses) in the Individual
Investor Group segment.
22
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Shareholders of
Morgan Stanley:
We have reviewed the accompanying condensed consolidated statement of
financial condition of Morgan Stanley and subsidiaries as of August 31, 2002,
and the related condensed consolidated statements of income and comprehensive
income for the three-month and nine-month periods ended August 31, 2002 and
2001, and condensed consolidated statements of cash flows for the nine-month
periods ended August 31, 2002 and 2001. These condensed consolidated financial
statements are the responsibility of the management of Morgan Stanley.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and of making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with auditing standards generally accepted in the United States
of America, the objective of which is the expression of an opinion regarding
the financial statements taken as a whole. Accordingly, we do not express such
an opinion.
Based on our review, we are not aware of any material modifications that
should be made to such condensed consolidated financial statements for them to
be in conformity with accounting principles generally accepted in the United
States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated statement of
financial condition of Morgan Stanley and subsidiaries as of November 30, 2001,
and the related consolidated statements of income, comprehensive income, cash
flows and changes in shareholders' equity for the fiscal year then ended (not
presented herein) included in Morgan Stanley's Annual Report on Form 10-K for
the fiscal year ended November 30, 2001; and, in our report dated January 11,
2002, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
condensed consolidated statement of financial condition as of November 30, 2001
is fairly stated, in all material respects, in relation to the consolidated
statement of financial condition from which it has been derived.
/s/ DELOITTE & TOUCHE LLP
New York, New York
October 14, 2002
23
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Introduction
Morgan Stanley (the "Company") is a global financial services firm that
maintains leading market positions in each of its business
segments--Institutional Securities, Individual Investor Group, Investment
Management and Credit Services. The Company's Institutional Securities business
includes securities underwriting and distribution; financial advisory services,
including advice on mergers and acquisitions, restructurings, real estate and
project finance; sales, trading, financing and market-making activities in
equity securities and related products and fixed income securities and related
products, including foreign exchange and commodities; principal investing,
including private equity activities; and aircraft financing activities. The
Company's Individual Investor Group business provides comprehensive financial
planning and investment advisory services designed to accommodate individual
investment goals and risk profiles. The Individual Investor Group provides its
clients with several investment and credit products and services, including
mutual funds, insurance products, financial planning, retirement planning,
personal trust and estate planning, credit management and account services. The
Company's Investment Management business provides global asset management
products and services for individual and institutional investors through three
principal distribution channels: a proprietary channel consisting of the
Company's financial advisors and investment representatives; a non-proprietary
channel consisting of third-party broker-dealers, banks, financial planners and
other intermediaries; and the Company's institutional channel. The Company's
Credit Services business includes the issuance of the Discover(R) Classic Card,
the Discover Gold Card, the Discover Platinum Card, the Morgan Stanley Card/SM/
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.
In June 2002, the Company changed its name from "Morgan Stanley Dean Witter
& Co." to "Morgan Stanley."
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 political, economic and market
conditions; the availability and cost of capital; the level and volatility of
equity prices, commodity prices and interest rates; currency values and other
market indices; technological changes and events (such as the use of the
Internet to conduct electronic commerce and the use of electronic
communications trading networks); the availability and cost of credit;
inflation; and investor sentiment and confidence in the financial markets. In
addition, there has been a heightened level of legislative, legal and
regulatory developments related to the financial services industry that may
affect future results of operations. Such factors also may have an impact on
the Company's ability to achieve its strategic objectives on a global basis,
including (without limitation) increased market share in its securities
activities, growth in assets under management and the expansion of its Credit
Services business.
The Company's Institutional 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.
- --------
* This Management's Discussion and Analysis of Financial Condition and Results
of Operations contains forward-looking statements as well as a discussion of
some of the risks and uncertainties involved in the Company's businesses that
could affect the matters referred to in such statements.
24
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. Such factors also
affect the level of individual investor participation in the financial markets,
which impacts the results of the Individual Investor Group. The level of global
market activity also could impact the flow of investment capital into or from
assets under management and supervision 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
Investment 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
confidence and consumer debt, may substantially affect consumer loan levels and
credit quality, which, in turn, could impact the results of Credit Services.
The Company's results of operations also may be materially affected by
competitive factors. Included among the principal competitive factors affecting
the Institutional Securities and Individual Investor Group businesses are the
quality of its professionals and other personnel, its products and services,
relative pricing and innovation. Competition in the Company's Investment
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 the Credit Services business, 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 engage