Morgan Stanley — Q1 2015 Form 10-Q
Period: Three months ended March 31, 2015; balance-sheet comparisons are to December 31, 2014. Morgan Stanley is a global financial services firm operating through Institutional Securities, Wealth Management and Investment Management. Interim financial statements are unaudited; the independent accountant performed a review, not an audit.
Financial performance
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Net revenues | $9.907 billion | $8.996 billion |
| Income before tax from continuing operations | $2.855 billion | $2.370 billion |
| Net income applicable to Morgan Stanley | $2.394 billion | $1.505 billion |
| Diluted EPS | $1.18 | $0.74 |
| Non-interest expenses | $7.052 billion | $6.626 billion |
| Net interest income | $596 million | $308 million |
| Effective tax rate, continuing operations | 13.6% | 33.1% |
Q1 2015 included a $564 million discrete tax benefit, principally from repatriating non-U.S. earnings at a lower-than-expected cost after a U.K. legal-entity restructuring. Excluding this benefit, the effective tax rate was 33.3%. Management also reported net revenues of $9.782 billion and diluted continuing-operations EPS of $1.14 excluding debt valuation adjustment (DVA); these are non-GAAP measures.
Segments and period-to-period changes
| Segment | Net revenues | Pretax income | Key comparison |
|---|---|---|---|
| Institutional Securities | $5.458 billion | $1.813 billion | Revenue rose from $4.677 billion; stronger equity and fixed-income trading and advisory fees. Expenses increased, including legal and activity-related costs. |
| Wealth Management | $3.834 billion | $855 million | Revenue rose from $3.609 billion, supported by net interest income and asset-management fees; transactional revenue declined. |
| Investment Management | $669 million | $187 million | Revenue fell from $752 million, mainly reflecting lower investment gains and deconsolidation of real-estate fund entities; expenses were broadly stable. |
Consolidated non-interest expenses increased 6% year over year. Compensation and benefits rose to $4.524 billion from $4.306 billion; non-compensation expenses rose to $2.528 billion from $2.320 billion. Consolidated pretax margin was 29%, versus 26%. The reported net income improvement therefore reflects stronger business results and the discrete tax benefit; DVA was positive in both periods ($125 million versus $126 million).
Cash flow, balance sheet, debt and liquidity
- Cash flow: Operating activities used $13.055 billion, versus $4.781 billion provided in Q1 2014. The filing attributes substantial cash-flow movement to trading and securities-financing balance changes. Investing activities used $2.905 billion; financing activities provided $9.951 billion. Cash and cash equivalents declined $6.691 billion during the quarter to $40.293 billion.
- Balance sheet: Assets were $829.099 billion, up from $801.510 billion at year-end; liabilities were $753.633 billion and total equity was $75.466 billion. Loans, net of allowance, were $68.703 billion versus $66.577 billion.
- Funding and debt: Deposits were $135.815 billion. Long-term borrowings were $155.545 billion, up from $152.772 billion; short-term borrowings were $2.879 billion. The company issued about $11.3 billion of long-term notes and had about $5.3 billion mature or retire during the quarter. Long-term borrowings maturing within 12 months were $24.229 billion.
- Liquidity: The Global Liquidity Reserve was $195 billion, compared with $193 billion at year-end, and consisted of cash and unencumbered liquid securities. Management said the company maintained sufficient liquidity under its stress tests and was well in compliance with the U.S. Liquidity Coverage Ratio minimum based on current estimates.
- Capital: Advanced Approach Common Equity Tier 1 was 13.1%, Tier 1 capital 14.7%, total capital 17.5%, and Tier 1 leverage 7.8%. The company’s transitional supplementary leverage ratio was 5.5%; management estimated a fully phased-in ratio of about 5.1%, subject to regulatory and other uncertainties. Book value per common share was $33.80; tangible book value per common share was $28.91.
Outlook, management commentary and risks
- Management’s stated goal is a sustainable return on average common equity of at least 10% excluding DVA over time, subject to execution of strategic objectives. This is a goal, not a near-term earnings forecast.
- The Federal Reserve gave no objection to the 2015 capital plan, which permits up to $3.1 billion of common-stock repurchases from Q2 2015 through Q2 2016. The quarterly common dividend increased from $0.10 to $0.15 per share, beginning with the dividend declared April 20, 2015. Repurchases remain subject to regulatory approval and may be suspended.
- Management expects Wealth Management lending to continue to grow. It also describes plans to grow lending through Institutional Securities and Wealth Management client relationships.
- Management characterized global growth as uneven: U.S. GDP grew at a 0.2% annualized rate in Q1, while Europe and Japan showed signs of improvement. It identified market conditions, interest rates, currencies, credit, commodities, regulation, litigation, competition, cybersecurity and risk-management effectiveness among factors that may affect results.
- Legal and regulatory proceedings remain a significant uncertainty. The filing identifies several mortgage-related claims with possible losses estimated in individual matters—for example, up to about $240 million in the CDIB matter and approximately $149 million, $527 million, $173 million, $197 million and $292 million in certain trust-related matters, before applicable interest, fees and costs. Other claims are difficult to estimate; these figures are not a total exposure estimate. The company expects litigation accruals to remain elevated and fluctuate.
- Fair-value estimates involve judgment, including Level 3 instruments. Level 3 assets measured at fair value were $16.515 billion at March 31, 2015. A downgrade could also trigger additional collateral or termination payments; the filing estimates potential calls of $1.610 billion for a one-notch downgrade and an incremental $2.838 billion for a two-notch downgrade under specified derivative contracts.
- The loan-loss allowance rose to $165 million from $149 million, and the allowance for lending-related commitments rose to $185 million from $149 million. Management attributed the increase primarily to portfolio growth and described lending portfolios as high quality. Total lending commitments and other commitments reported were approximately $155 billion; amounts may expire unused and are not equivalent to expected cash funding.
Most important facts for investors to verify
- How much of earnings growth is sustainable after separating the $564 million tax benefit, DVA and other valuation effects.
- Whether stronger trading revenue and Wealth Management net interest income persist, and whether Investment Management results recover.
- The drivers of negative operating cash flow and the liquidity available after considering restricted or encumbered assets and entity-level limits.
- Actual capital ratios under fully phased-in rules, the supplementary leverage ratio, and the effect of planned repurchases and higher dividends.
- Updates to mortgage litigation, regulatory matters, loss accruals and any exposures that the filing says cannot yet be reasonably estimated.
- Credit quality and collateral trends as corporate, securities-based and residential lending expand, including the growing allowance for lending commitments.