Business Context and Reporting Period
This summary covers Morgan Stanley's Form 10-Q for the quarterly period ended August 31, 2008. The Company is a global financial services firm operating through three primary segments: Institutional Securities, Global Wealth Management Group, and Asset Management. The reporting period coincided with unprecedented volatility in global credit markets, including the bankruptcy of Lehman Brothers and the U.S. government conservatorship of Fannie Mae and Freddie Mac.
Key Financial Metrics
| Metric | Three Months Ended Aug 31, 2008 | Nine Months Ended Aug 31, 2008 | Three Months Ended Aug 31, 2007 | Nine Months Ended Aug 31, 2007 |
|---|---|---|---|---|
| Net Revenues | $8,049 million | $22,881 million | $7,958 million | $28,476 million |
| Net Income | $1,425 million | $4,002 million | $1,543 million | $6,797 million |
| Diluted EPS | $1.32 | $3.72 | $1.44 | $6.40 |
| Total Assets | $987.4 billion | — | $1,045.4 billion (Nov 30, 2007) | — |
| Shareholders' Equity | $35.8 billion | — | $31.3 billion (Nov 30, 2007) | — |
| Long-Term Borrowings | $202.3 billion | — | $190.6 billion (Nov 30, 2007) | — |
| Cash and Cash Equivalents | $23.7 billion | — | $25.6 billion (Nov 30, 2007) | — |
Material Changes vs. Prior Period
- Net Income Decline: Net income decreased 8% in the quarter and 41% in the nine-month period compared to the prior year. The nine-month decline was significantly impacted by the absence of discontinued operations gains (Quilter sale) in the current period.
- Revenue Composition: While consolidated net revenues were relatively flat quarter-over-quarter (+1%), the nine-month period saw a 20% decline. Institutional Securities revenues increased 19% in the quarter, driven by trading gains and a $731 million pre-tax gain from MSCI secondary offerings. Conversely, Asset Management reported a loss of $204 million in the quarter due to principal transaction losses in real estate and private equity.
- Expense Increases: Non-interest expenses increased 7% in the quarter, primarily due to a $288 million charge related to the announced buy-back program for auction rate securities (ARS).
- Balance Sheet Contraction: Total assets decreased by approximately $58 billion from November 30, 2007, reflecting a strategic reduction in leverage and decreases in securities received as collateral and receivables.
Outlook, Risks, and Unusual Items
- Subsequent Equity Investment: On September 29, 2008, Morgan Stanley entered into a definitive agreement to sell $9 billion in equity securities to Mitsubishi UFJ Financial Group, Inc. (MUFG), representing a 21% interest on a fully diluted basis. This transaction was expected to close in October 2008.
- Financial Holding Company Status: In September 2008, the Company obtained approval to become a bank holding company, converting its Utah industrial bank to a national bank (Morgan Stanley Bank, N.A.).
- Credit Market Impacts: The Company recorded significant losses related to credit market dislocation, including $640 million in mortgage proprietary trading losses and $362 million in losses related to monoline insurer exposures in the quarter.
- Auction Rate Securities (ARS): The Company reached an agreement in principle to repurchase illiquid ARS at par for certain retail clients and pay a $35 million penalty to state regulators.
- Goodwill Impairment: An interim goodwill impairment test performed at the end of the third quarter did not result in a charge, though management noted the possibility of a charge in the fourth quarter given subsequent market events.
Investor Verification Checklist
- Level 3 Fair Value Assets: Verify the valuation assumptions for Level 3 assets, which totaled $78.1 billion (before netting), representing 19% of assets measured at fair value. Significant reclassifications from Level 2 to Level 3 occurred due to reduced market liquidity.
- Subprime and Mortgage Exposure: Review the detailed breakdown of non-subprime, commercial, and U.S. subprime mortgage-related exposures, including net exposure figures and realized/unrealized losses.
- Capital Ratios: Confirm compliance with Basel II capital requirements. As of August 31, 2008, the Total Capital Ratio was 19.0% and the Tier 1 Capital Ratio was 12.7%.
- Liquidity Reserves: Assess the adequacy of liquidity reserves, which totaled $179 billion at August 31, 2008, including $77 billion at the parent company level.
- Legal Contingencies: Monitor the status of the ARS settlement and ongoing shareholder derivative lawsuits regarding ARS sales and subprime-related disclosures.