Morgan Stanley — Form 10-Q Summary
Business context and reporting period
Unaudited results cover the quarter and nine months ended September 30, 2009; comparative periods are the same periods in 2008. Morgan Stanley operates Institutional Securities, Global Wealth Management Group and Asset Management. The company became a financial holding company regulated by the Federal Reserve in 2008.
A major change in the reporting base was the May 31, 2009 closing of Morgan Stanley Smith Barney (MSSB), combining Morgan Stanley’s wealth business with businesses contributed by Citi. Morgan Stanley owns 51% and consolidates MSSB; Citi owns 49%. Results include MSSB from closing onward.
Key financial metrics
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Net revenues | $8.675 billion | $18.011 billion | $17.032 billion | $31.940 billion |
| Income (loss) from continuing operations before tax | $1.215 billion | $10.681 billion | $(312) million | $13.570 billion |
| Net income | $793 million | $8.171 billion | $636 million | $10.762 billion |
| Net income applicable to Morgan Stanley | $757 million | $8.151 billion | $729 million | $10.707 billion |
| Earnings (loss) applicable to common shareholders | $498 million | $7.684 billion | $(1.301) billion | $10.030 billion |
| Diluted EPS | $0.38 | $7.38 | $(1.13) | $9.63 |
| Non-interest expenses | $7.460 billion | $7.330 billion | $17.344 billion | $18.370 billion |
- Profitability and margins: Q3 pre-tax income was $1.215 billion on $8.675 billion of net revenue. Nine-month continuing operations posted a pre-tax loss of $312 million. The filing reports segment pre-tax margins of 26% for Institutional Securities, 9% for Global Wealth Management Group and not meaningful for Asset Management in Q3.
- Cash flow: Operating cash flow was $(50.188) billion for the first nine months, versus positive $62.990 billion in 2008, primarily reflecting changes in trading assets and securities financing balances. Investing cash flow was $(3.902) billion; financing cash flow was positive $3.161 billion. Cash and cash equivalents ended at $28.610 billion, down from $78.670 billion at the start of the period.
- Balance sheet and debt: At September 30, total assets were $769.503 billion, total liabilities $717.279 billion and total equity $52.224 billion. Long-term borrowings were $196.437 billion, up from $179.835 billion at December 31, 2008; short-term borrowings were $2.913 billion. Deposits increased to $62.415 billion from $51.355 billion.
- Liquidity and capital: Average total liquidity was $155 billion in Q3, including $58 billion at the parent and $97 billion at banks and other subsidiaries. The quarter-end total liquidity reserve was $153 billion. Regulatory Tier 1 and total capital ratios were 15.4% and 16.5%, respectively; the Tier 1 leverage ratio was 6.2%. All were above stated well-capitalized thresholds.
Material changes versus the prior comparable period
- Q3 net revenue fell 52% year over year; nine-month revenue fell 47%. Results were heavily affected by fair-value changes in the company’s own credit spreads on borrowings: Q3 2009 included a $0.9 billion loss, versus a $9.7 billion gain in Q3 2008; the nine-month comparison was a $4.9 billion loss versus an $11.3 billion gain.
- Institutional Securities Q3 net revenue declined to $4.974 billion from $16.043 billion, while pre-tax income was $1.290 billion versus $10.992 billion. Investment banking revenue increased 11% to $1.039 billion, with underwriting stronger and advisory fees lower.
- Global Wealth Management Group Q3 net revenue rose 91% to $3.029 billion, reflecting MSSB consolidation; pre-tax income was $280 million versus a $1 million loss. Total client assets were $1.532 trillion, up from $647 billion a year earlier, primarily because of MSSB.
- Asset Management Q3 net revenue was $698 million, but the segment recorded a $356 million pre-tax loss. Assets under management or supervision were $386 billion, down 20% year over year, with disclosed net customer outflows of $79.4 billion since Q3 2008.
- Non-interest expenses were broadly stable in Q3, but included MSSB operating and integration costs and a $251 million Crescent impairment. Nine-month expenses declined 6%, partly offset by MSSB-related costs.
Outlook, commentary, risks and unusual items
- Management described improving global markets and recovering capital-market liquidity, while noting continued weakness in real estate, unemployment, consumer spending and business investment. The filing provides no specific earnings or revenue guidance.
- In October 2009, Morgan Stanley agreed to sell its retail asset management business, including Van Kampen, to Invesco for a transaction valued at $1.5 billion; Morgan Stanley is to receive a 9.4% minority interest in Invesco. Closing was expected in mid-2010, subject to approvals and other conditions.
- The company recorded a $334 million Q3 gain from selling participation interests in claims against a bankrupt derivative counterparty. It may have to refund up to $445 million plus interest if the bankruptcy court disallows or reduces claims beyond a specified threshold; a liability was recorded.
- The $10 billion Series D preferred stock issued to the U.S. Treasury was repurchased in June, and the related warrant was repurchased for $950 million in August. Together, these actions reduced total equity by $10.950 billion. The company also raised approximately $6.9 billion from common stock offerings.
- Real estate remained a significant risk: nine-month real estate investment losses were $2.1 billion, including a $420 million Crescent impairment. Morgan Stanley disclosed $2.5 billion of non-recourse Crescent financing, including approximately $2.0 billion with a lender whose maturity had been extended to November 9, 2009; negotiations and restructuring options were ongoing.
- Other risks include extensive legal and regulatory matters, tax examinations, counterparty and credit exposure, fair-value estimates using unobservable inputs, and potential collateral calls after a credit downgrade. The company estimated additional collateral calls of approximately $1.494 billion for a one-notch downgrade and a further $1.128 billion for a two-notch downgrade. Adoption of new securitization and VIE consolidation rules in 2010 could significantly affect reported assets and liabilities.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The independent accountant’s interim review was not an audit and expressed no audit opinion.
Important facts for investors to verify
- How much of future earnings reflects recurring business performance versus own-credit fair-value movements, asset marks and other one-off gains or losses.
- MSSB’s integration costs, contribution to earnings, Citi’s 49% non-controlling interest and the preliminary nature of acquisition valuations and goodwill.
- Liquidity availability by legal entity, funding needs, debt maturities and the effects of expiring or changing government liquidity programs.
- Progress on Crescent financing and real estate exposures, including impairment assumptions and potential additional support or losses.
- Exposure to credit derivatives, monoline insurers, VIEs and securitizations, plus possible balance-sheet effects from the 2010 accounting changes.
- Developments in legal proceedings, tax examinations, and the contingent refund obligation related to the bankruptcy claims sale.