Morgan Stanley — Q1 2011 Form 10-Q
Business context and reporting period. The filing covers the three months ended March 31, 2011; interim financial statements are unaudited and were reviewed by the independent accountant. Morgan Stanley operates Institutional Securities, Global Wealth Management Group (including its 51% interest in Morgan Stanley Smith Barney Holdings) and Asset Management. Comparisons below are with Q1 2010 unless otherwise stated. Amounts are U.S. dollars.
Financial performance and condition
| Metric | Q1 2011 / March 31, 2011 | Comparable / prior date |
|---|---|---|
| Net revenues | $7.635 billion | $9.072 billion; down 16% |
| Income before tax, continuing operations | $872 million | $2.515 billion |
| Net income | $1.130 billion | $2.011 billion |
| Net income applicable to Morgan Stanley | $968 million | $1.776 billion; down 45% |
| Common-shareholder earnings / diluted EPS | $736 million / $0.50 | $1.411 billion / $0.99 |
| Net interest income | $1 million | $368 million |
| Non-interest expenses | $6.763 billion | $6.557 billion; up 3% |
| Operating cash flow | $(1.322) billion | $21.101 billion |
| Cash and cash equivalents, period end | $52.608 billion | $35.478 billion at March 31, 2010 |
| Total assets | $836.185 billion | $807.698 billion at December 31, 2010 |
| Long-term borrowings | $196.136 billion | $192.457 billion at December 31, 2010 |
| Total equity | $66.508 billion | $65.407 billion at December 31, 2010 |
Continuing-operations pre-tax margin was approximately 11.4%, versus 27.7% in Q1 2010 (calculated from reported income before tax and net revenues). The effective tax rate was a benefit of 29.4%, including a $447 million discrete tax benefit related to Revel; excluding that benefit, management reported an estimated effective tax rate of 22.0%.
Cash flow from investing activities was positive $2.545 billion and financing activities provided $2.816 billion. The resulting net increase in cash and cash equivalents was $4.993 billion. Operating cash flow was negative, driven in part by movements in receivables, loans and securities-financing balances.
Average Global Liquidity Reserve was $172 billion in Q1, compared with $155 billion in Q1 2010. At March 31, 2011, the reserve comprised $47 billion cash and cash equivalents, $88 billion securities purchased under resale agreements/securities borrowed, and $37 billion other unencumbered liquid securities. Basel I capital ratios were 18.4% total capital, 16.5% Tier 1 and 6.1% Tier 1 leverage; Tier 1 common ratio was 11.7% (a company-defined non-GAAP measure).
Material changes and segment results
- Institutional Securities: net revenues fell to $3.592 billion from $5.338 billion and pre-tax income to $397 million from $2.065 billion. Investment banking revenue rose 14%, and equity sales and trading rose 20%; fixed-income and commodities sales and trading fell 35%. Results included a $655 million pre-tax loss on the MUMSS Japanese joint-venture investment, a $318 million loss related to monoline exposures, and negative revenue from Morgan Stanley credit-spread movements.
- Global Wealth Management Group: net revenues increased to $3.437 billion from $3.105 billion; pre-tax income rose to $348 million from $278 million. Retail net new assets were $11.4 billion versus $9.3 billion; global fee-based asset flows were $17.8 billion versus $9.1 billion. Total client assets were $1.718 trillion, up from $1.604 trillion.
- Asset Management: net revenues declined to $626 million from $653 million and pre-tax income to $127 million from $174 million. Assets under management or supervision were $284 billion versus $262 billion, including the effects of market appreciation and the FrontPoint restructuring.
- Consolidated non-interest revenue declined, including a swing in “Other” from $294 million of revenue to a $444 million loss. Interest expense rose to $1.853 billion from $1.368 billion, reducing net interest income to near zero.
Prior-period discontinued operations included the $932 million Revel disposition loss and $775 million gain from a Discover Financial Services settlement. Revel was sold in February 2011 near carrying value, with no material pre-tax gain or loss on sale.
Outlook, management commentary and risks
- No specific consolidated earnings or revenue guidance is provided. Management cited market, economic, geopolitical, regulatory and legal developments as factors that could materially affect results. Q1 conditions included Japan’s earthquake and tsunami, Middle East unrest, higher oil prices and continued European sovereign-debt concerns.
- Management’s preliminary estimate was for a Tier 1 common ratio of 8%–10% by year-end 2012 under Basel III, including the proposed MUFG conversion; the estimate was subject to regulatory implementation details. Basel III, Dodd-Frank and other regulatory changes could alter capital, liquidity and business requirements.
- After quarter end, Morgan Stanley and MUFG announced an agreement for MUFG to exchange $7.8 billion of Series B preferred stock for approximately 385 million common shares, giving MUFG an expected 22.4% ownership interest. The transaction remained subject to closing conditions and regulatory approvals. The company also announced a $0.05 quarterly common dividend.
- Morgan Stanley expected approximately $130 million of costs in Q2 2011 related to forming its China securities joint venture. MUFG contributed approximately $370 million to MUMSS in April; Morgan Stanley said it was not obligated to provide further capital. Further deterioration in MUMSS performance could cause future impairment charges.
- Key market exposures include trading and derivative risk, credit and counterparty risk, monoline insurers, real estate and mortgage-related assets, and Level 3 valuations. Level 3 assets were $33.5 billion before cross-level netting at March 31. Morgan Stanley also disclosed substantial gross derivative and credit-protection notionals; these are not equivalent to expected losses.
- Potential legal exposures include mortgage and credit-crisis litigation. The filing identified possible losses up to $245 million in the Citi Capmark matter and up to $240 million in the China Development Industrial Bank matter; Cheyne Finance plaintiffs had claims relating to approximately $983 million of securities, but had not quantified compensatory damages. The company cautioned that some claims and potential losses cannot be estimated reliably.
- Commitments totaled $130.5 billion, including $59.4 billion of forward-starting resale agreements; commitments may expire unused and are not necessarily expected cash outflows. A one-notch rating downgrade could trigger $1.260 billion of collateral or termination payments under specified agreements, plus $191 million of additional exchange/clearing collateral; corresponding two-notch amounts were $3.336 billion and $1.543 billion.
Most important facts for investors to verify
- How much of reported earnings depended on the $447 million Revel-related tax benefit, and whether future earnings exclude similar discrete items.
- The drivers and potential further effects of the $655 million MUMSS loss, the April capital contribution and the subsequent transfer of trading positions.
- Whether fixed-income and commodities revenue, monoline losses and the near-zero net interest result improve or persist in subsequent quarters.
- Liquidity and funding resilience, including the composition and availability of the $172 billion liquidity reserve, debt maturities and rating-downgrade collateral triggers.
- Progress and dilution implications of the proposed MUFG preferred-stock conversion, and the assumptions underlying the preliminary Basel III capital estimate.
- Developments in mortgage-related litigation, guarantees and representations-and-warranties claims, and the valuation and liquidity of Level 3 assets.