Morgan Stanley — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2014. Morgan Stanley is a global financial services firm with Institutional Securities, Wealth Management, and Investment Management businesses. Financial statements are unaudited; Deloitte performed an interim review, not an audit.
Financial results and position
Amounts are in millions of dollars except per-share data, percentages, and where noted.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net revenues | $8,608 | $8,515 | $17,555 | $16,683 |
| Income before taxes from continuing operations | $1,933 | $1,796 | $4,258 | $3,397 |
| Net income | $1,917 | $1,191 | $3,501 | $2,422 |
| Net income applicable to Morgan Stanley | $1,899 | $980 | $3,404 | $1,942 |
| Common earnings per diluted share | $0.92 | $0.41 | $1.66 | $0.89 |
| Net interest income | $267 | $204 | $575 | $386 |
| Non-interest expenses | $6,675 | $6,719 | $13,297 | $13,286 |
| Consolidated pre-tax margin | 23% | 21% | 24% | 20% |
| Effective tax rate, continuing operations | 0.8% | 32.0% | 18.7% | 27.2% |
- Quarterly revenue increased about 1%; six-month revenue increased about 5%. Q2 trading revenue fell to $2,516 from $2,894, while investment banking rose to $1,633 from $1,303 and asset management, distribution and administration fees rose to $2,621 from $2,404.
- Q2 earnings growth was significantly affected by a $609 million discrete tax benefit tied principally to updated information on tax examinations. Management said the effective tax rate would have been 32.3% for Q2 and 33.0% for the first half excluding this benefit. Prior-year Q2 common earnings also reflected a $151 million charge related to the Wealth Management JV purchase.
- Q2 diluted EPS from continuing operations was $0.89 excluding debt valuation adjustment (DVA), versus $0.37 a year earlier. DVA increased reported Q2 revenue by $87 million, versus $175 million in Q2 2013.
- Segment net revenues in Q2 were $4,248 for Institutional Securities, $3,715 for Wealth Management, and $692 for Investment Management. Institutional Securities revenue edged down year over year as higher investment banking was offset by weaker trading; Wealth Management and Investment Management revenue increased.
Balance sheet, cash flow and capital
- At June 30, total assets were $826.6 billion, total liabilities $754.4 billion, and total equity $72.2 billion. Assets declined from $832.7 billion at December 31, 2013.
- Cash and cash equivalents were $40.9 billion at June 30, down from $59.9 billion at year-end. For the six months, operating cash flow was $5.9 billion, investing cash flow was negative $24.1 billion, and financing cash flow was negative $0.8 billion; cash declined by $19.0 billion. These flows reflect substantial balance-sheet and securities-financing activity.
- The Global Liquidity Reserve was $192 billion at June 30, including cash and unencumbered highly liquid securities. Management reported sufficient liquidity under its stress tests; the reserve is distributed across bank and non-bank entities and is not equivalent to unrestricted parent-company cash.
- Long-term borrowings were $149.5 billion, down from $153.6 billion at year-end; commercial paper and other short-term borrowings were $1.8 billion. Long-term debt issuance was about $14.8 billion and maturities or retirements about $21.3 billion during the first half. The filing also reports $117.7 billion of deposits.
- Regulatory capital ratios at June 30, under the applicable transitional/Advanced Approach framework, were 13.9% Common Equity Tier 1, 15.4% Tier 1, 17.4% total capital, and 7.8% Tier 1 leverage. The company estimated fully phased-in Common Equity Tier 1 ratios of approximately 12.3% under the Advanced Approach and 10.7% under the Standardized Approach; these were preliminary, non-GAAP estimates.
- Return on average common equity was 11.3% in Q2 versus 5.4% a year earlier; excluding DVA, it was 10.7% versus 4.6%. The common dividend declared was $0.10 per share, compared with $0.05 a year earlier. The company repurchased $284 million of common stock in Q2.
Material changes and unusual items
- Wealth Management client assets rose to $2.002 trillion from $1.778 trillion a year earlier; fee-based assets reached $762 billion, or 38% of client assets. Q2 fee-based asset flows were $12.5 billion. Wealth Management net interest income increased 30%, primarily on higher deposits and lending balances.
- Investment Management assets under management or supervision rose to $396 billion from $347 billion a year earlier, supported by market appreciation and net inflows. Q2 net inflows were $8 billion.
- The company completed the sale of CanTerm in March 2014, recording an approximately $45 million gain in the first half within discontinued operations. On April 1, it deconsolidated about $1.6 billion of assets associated with a sponsored real estate fund following a change in control circumstances related to the Volcker Rule and an expired credit facility.
- Effective April 1, 2014, the company extended the estimated useful lives of certain software costs from generally 3–5 years to 3–10 years, reducing Q2 amortization expense by approximately $27 million.
- Preferred stock issuance generated approximately $1.8 billion net proceeds during the first half. In July, the company announced a further $3.0 billion senior debt issuance; long-term borrowings, net of repayments, increased about $2.0 billion through July 31.
Outlook, commentary and risks
- Management goals, not formal earnings guidance: Morgan Stanley stated a goal of at least 10% return on average common equity excluding DVA, subject to executing its strategy. Wealth Management targeted a 22%–25% pre-tax margin by year-end 2015; Fixed Income and Commodities targeted return on equity above 10%.
- Management expects Wealth Management lending activity to continue growing and identified U.S. bank deposit growth, expense reduction, capital and balance-sheet optimization, and prudent capital returns as strategic priorities. About $18 billion of additional customer deposits held at Citi were scheduled for transfer to Morgan Stanley depository institutions through June 2015.
- The global oil merchanting unit was held for sale, with a sale to Rosneft expected in the second half of 2014, subject to approvals and other conditions. The TransMontaigne sale closed July 1; the gain was expected to be immaterial.
- Legal exposure remains significant and difficult to estimate. In July, the company agreed in principle to settle three investor matters, subject to court approval; it accrued their full cost by June 30. A subsequent $53 million increase in legal accruals reduced Q2 and first-half diluted EPS by $0.02. Separately, the SEC approved a $275 million settlement in July concerning certain 2007 subprime RMBS transactions.
- Other risks include mortgage-related litigation and investigations, market and credit volatility, counterparty defaults, valuation uncertainty in Level 3 instruments, potential collateral calls after credit-rating downgrades, and regulatory changes. The company reported $161.1 billion of commitments, much of it lending-related; stated amounts may expire unused and do not represent expected cash funding.
- Regulatory capital and liquidity rules remain in transition. The company noted a provisional 1.5% global systemically important bank capital surcharge and estimated a 4.6% supplementary leverage ratio under preliminary assumptions; it expected to exceed 5% in 2015 through capital accretion and other actions.
Most important facts for investors to verify
- How much of the reported earnings improvement reflects recurring business performance versus the $609 million tax benefit and other unusual items.
- Whether Wealth Management’s asset growth, fee-based flows, deposits and lending expansion continue, and how associated credit risk develops.
- Progress toward the stated return and margin goals, including the effect of trading conditions, expenses and regulatory capital requirements.
- Developments in mortgage-related litigation, the SEC settlement, other investigations, and any additional accruals or cash payments.
- Liquidity available at the parent versus regulated subsidiaries, funding and maturity needs, and the effect of collateral calls or regulatory rule changes.
- Changes in capital ratios as Advanced and Standardized Approach requirements phase in, and whether preliminary leverage and fully phased-in capital estimates are achieved.