Morgan Stanley 10-Q Summary: Third Quarter 2010
Reporting period: Quarter and nine months ended September 30, 2010. Morgan Stanley is a global financial services firm operating through Institutional Securities, Global Wealth Management Group (including its 51% interest in Morgan Stanley Smith Barney Holdings LLC, or MSSB), and Asset Management. The interim financial statements were reviewed by Deloitte & Touche, not audited.
Key Financial Metrics
Dollar amounts are in millions unless otherwise indicated.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net revenues | $6,779 | $8,468 | $23,805 | $16,596 |
| Income from continuing operations before tax | $800 | $1,493 | $5,012 | $321 |
| Net income | $641 | $793 | $4,636 | $636 |
| Net income applicable to Morgan Stanley | $131 | $757 | $3,867 | $729 |
| Earnings (loss) applicable to common shareholders | $(91) | $498 | $2,971 | $(1,301) |
| Diluted EPS | $(0.07) | $0.38 | $2.15 | $(1.13) |
| Non-interest expenses | $5,979 | $6,975 | $18,793 | $16,275 |
| Net interest income | $105 | $497 | $612 | $222 |
- Cash flow, nine months: Operating activities provided $19.2 billion, versus $50.2 billion used in the prior-year period. Investing activities used $24.1 billion and financing activities provided $5.6 billion. Cash and cash equivalents were $33.1 billion at September 30, up from $32.0 billion at December 31, 2009.
- Balance sheet: Total assets were $841.4 billion, compared with $771.5 billion at year-end 2009. Total equity was $65.6 billion, including $56.9 billion of Morgan Stanley shareholders’ equity. Long-term borrowings were $196.5 billion, versus $193.4 billion.
- Liquidity and capital: Global Liquidity Reserve was $162 billion at quarter-end; average liquidity for the quarter was $160 billion, versus $155 billion in Q3 2009. Basel I Tier 1 and total capital ratios were 16.5% and 17.0%, respectively; Tier 1 leverage was 6.7%. Tangible common equity was $40.2 billion and tangible book value per common share was $26.56.
- Reported operating margins: Q3 pre-tax profit margin was 8% for Institutional Securities, 9% for Global Wealth Management Group, and 35% for Asset Management. The company reported a consolidated Q3 effective tax benefit rate of 2.9%.
Material Changes Versus Comparable Period
- Q3 net revenues fell about 20% year over year, and pre-tax income declined to $800 million from $1.5 billion. Management attributed the revenue decline primarily to Institutional Securities, particularly weaker equity and fixed-income trading. Trading revenue in that segment fell sharply; fixed-income sales and trading revenue decreased 58% and equity sales and trading revenue decreased 22%.
- Q3 non-interest expenses declined 14%, mainly from lower compensation costs, partly offset by higher non-compensation expenses, including technology investment.
- Q3 segment results differed materially: Institutional Securities net revenues were $2.9 billion and pre-tax income $240 million, versus $5.0 billion and $1.3 billion; Global Wealth Management Group net revenues were $3.1 billion and pre-tax income $281 million, broadly stable versus the prior-year quarter; Asset Management net revenues were $802 million and pre-tax income $279 million, versus $447 million and a $124 million pre-tax loss.
- Nine-month net revenues increased 43% and net income applicable to Morgan Stanley rose to $3.9 billion. The comparison reflects MSSB’s inclusion for the full 2010 period but only from May 31, 2009 in the prior-year period, as well as large tax and discontinued-operation items.
- Q3 common shareholders had a loss despite positive net income applicable to Morgan Stanley, principally because preferred dividends and other allocations reduced earnings available to common shareholders.
Outlook, Commentary, Risks and Unusual Items
- No quantified earnings guidance was provided. Management described markets as affected by a weaker-than-expected recovery, high unemployment, regulatory uncertainty and the European sovereign debt crisis. Results remain sensitive to market conditions, client activity, volatility, financing availability, credit ratings and regulation.
- Discontinued operations and transactions: Revel write-downs and related costs were approximately $229 million in Q3 and $1.2 billion for nine months. The sale of Retail Asset Management to Invesco generated a cumulative after-tax gain of $673 million; $514 million was recorded in Q2 2010. A $775 million settlement from Discover Financial Services was recorded as a nine-month discontinued-operations gain. The Japan securities joint venture with MUFG generated a $731 million after-tax gain recorded in paid-in capital.
- Tax items: Nine-month results included a $345 million benefit from remeasurement of unrecognized tax benefits and a $382 million benefit from releasing deferred tax liabilities on earnings designated indefinitely reinvested abroad. A further $176 million tax benefit related to planned repatriation at a lower-than-expected cost. These items materially affected reported effective tax rates.
- Other significant items: Monoline-related losses were $272 million in Q3 and $602 million year to date. A $360 million UK payroll-tax charge on discretionary compensation was recorded in compensation expense over the first nine months. The U.S. pension plan will stop accruing benefits effective January 1, 2011; the company reduced its expected pension contributions from $275 million to $50 million.
- Legal and contingency exposures: The company identified reasonably possible losses of approximately $245 million in the Capmark matter and $274 million in the Tourmaline matter. It also reported increased industry litigation involving residential mortgage-related claims and said additional material losses could arise; many claims could not be reasonably estimated.
- Regulatory and capital outlook: Dodd-Frank implementation and Basel III rules were still developing. Morgan Stanley’s preliminary Basel III analysis estimated a net RWA increase of approximately $140 billion, or 40%, after anticipated runoff and mitigation; the estimate is subject to final rules and implementation guidance.
- Subsequent events: In October, Morgan Stanley agreed to restructure FrontPoint so its management would hold a majority stake; closing was expected in Q4 2010, subject to conditions, with an expected pre-tax loss of approximately $70 million. Long-term borrowings, net of repayments, increased about $1.8 billion after quarter-end through November 3.
Most Important Facts for Investors to Verify
- Whether trading and Institutional Securities performance improved after the sharp Q3 year-over-year decline, and how much reported earnings depend on market-sensitive investment gains.
- The sustainability of nine-month earnings after separating tax benefits, asset-sale gains, the Discover settlement, and Revel losses.
- The scale, timing and liquidity impact of mortgage-related litigation, the Capmark and Tourmaline matters, and other guarantees or commitments.
- How final Dodd-Frank and Basel III requirements affect capital, RWAs, business activities and funding costs; the company’s Basel III impact estimate was preliminary.
- Whether liquidity reserves and capital remain adequate under stress, including potential collateral calls after credit-rating downgrades and the company’s substantial short- and long-term funding needs.