Morgan Stanley — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unaudited financial statements prepared under U.S. GAAP; the independent accountant’s interim review identified no material modifications needed. Morgan Stanley operates Institutional Securities, Wealth Management and Investment Management.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net revenues | $8.907bn | $7.956bn | $26.511bn | $24.648bn |
| Net income | $1.752bn | $1.018bn | $5.253bn | $3.440bn |
| Net income applicable to Morgan Stanley | $1.693bn | $906m | $5.097bn | $2.848bn |
| Common earnings per diluted share | $0.83 | $0.45 | $2.49 | $1.34 |
| Net interest income | $557m | $110m | $1.132bn | $496m |
| Non-interest expenses | $6.687bn | $6.591bn | $19.989bn | $19.888bn |
| Consolidated pre-tax margin | 25% | 17% | 25% | 19% |
Q3 net revenues rose about 12% and income applicable to Morgan Stanley rose about 87% year over year. Excluding debt valuation adjustment (DVA), management reported Q3 net revenues of $8.692bn and diluted continuing-operations EPS of $0.76, versus $8.127bn and $0.50 a year earlier. DVA added $215m to Q3 revenue in 2014, compared with a $171m reduction in 2013.
- Institutional Securities: Q3 net revenues were $4.516bn versus $3.710bn; pre-tax income was $1.226bn versus $397m. Investment banking improved, and sales and trading benefited from higher fixed-income and commodities results, including DVA. Nine-month net revenues were $13.440bn versus $12.176bn.
- Wealth Management: Q3 net revenues were $3.785bn versus $3.481bn; pre-tax income was $806m versus $668m. Higher fee-based revenues and lending balances helped, while transactional revenue declined. Client assets were $2.003tn; fee-based assets were $768bn, or 38% of client assets. Quarterly fee-based flows were $6.5bn, down from $15.0bn.
- Investment Management: Q3 net revenues were $655m versus $828m; pre-tax income was $188m versus $300m. Lower investment gains and nonrecurring carried interest outweighed higher management fees. Assets under management or supervision were $398bn, up from $360bn at September 2013.
Balance sheet at September 30: Total assets were $814.5bn, down from $832.7bn at December 31, 2013; total liabilities were $740.5bn and total equity $74.0bn. Cash and cash equivalents were $55.8bn, down from $59.9bn. Deposits increased to $124.4bn from $112.4bn. Long-term borrowings were $152.4bn, down from $153.6bn; $17.6bn of long-term borrowings were scheduled to mature over the next 12 months.
Cash flow, nine months: Operating activities provided $7.7bn, versus $16.8bn in 2013; investing activities used $23.8bn, versus $14.0bn used; financing activities provided $13.0bn, versus $8.8bn provided. Cash and cash equivalents declined $4.1bn. These amounts are influenced by substantial movements in trading and secured-financing balances.
Capital and liquidity: Common Equity Tier 1 ratio was 14.4%, Tier 1 capital ratio 16.2%, total capital ratio 18.8%, and Tier 1 leverage ratio 8.2%. Regulatory calculation methods changed, so comparisons with 2013 ratios are not directly like-for-like. The Global Liquidity Reserve was $190bn, compared with $202bn at year-end 2013; management stated it was sufficient under its liquidity stress tests. The company reported a preliminary pro forma supplementary leverage ratio estimate of 4.9% and expected to exceed 5% in 2015; these were estimates, not reported actual ratios.
Material changes, outlook and risks
- Revenue growth reflected stronger investment banking, higher Wealth Management fees and net interest income, and a favorable DVA comparison. Q3 investment revenue fell to $138m from $728m, reflecting lower investment gains.
- Reported effective tax rates were 20.9% for Q3 and 19.4% year to date. Results included a $237m discrete tax benefit in Q3 and $609m year to date. Excluding those benefits, management gave rates of 31.5% and 32.3%, respectively.
- Management’s stated goal is return on average common equity of at least 10%, excluding DVA, subject to successful execution of its strategy. It targeted a 22%–25% Wealth Management pre-tax margin by year-end 2015 and more than 10% return on equity for Fixed Income and Commodities. These are forward-looking goals, not guarantees.
- After quarter-end, a change in the tax status of Morgan Stanley Smith Barney Holdings was expected to produce an approximately $1.3bn discrete tax benefit in Q4 2014. The company also declared a $0.10 common dividend, payable November 14, 2014. Long-term borrowings increased about $1.0bn through October 31, including a $3.0bn senior-debt issuance.
- The proposed sale of the global oil merchanting business to Rosneft remained uncertain; required approvals were due by December 20, 2014, when the agreement would expire. Morgan Stanley completed the TransMontaigne sale in July and recorded a gain of about $101m.
- Other unusual items included a $141m gain on sale of retail property in September and an additional $30m prospectus-delivery rescission-offer accrual recorded after the October 17 earnings release. The latter reduced Q3 and year-to-date diluted EPS by $0.01.
- Legal and regulatory exposure remains significant. The filing describes ongoing mortgage-related litigation and investigations, and says potential losses in some matters cannot be reasonably estimated. Subsequent disclosures included a Virginia Attorney General lawsuit seeking treble damages and an Illinois Attorney General demand for approximately $88m.
- Key broader risks include market and economic conditions, trading volatility, credit and liquidity risks, litigation, tax examinations, cybersecurity, and evolving capital, liquidity and Volcker Rule requirements. The company noted the U.S. Liquidity Coverage Ratio requirements would phase in from 2015.
Most important facts for investors to verify
- How much of the earnings increase is recurring versus DVA, discrete tax benefits, asset-sale gains and other unusual items.
- Whether Wealth Management fee-based flows, client assets and lending growth continue, and how loan quality and funding costs evolve.
- The impact of upcoming capital and liquidity rules on required capital, the supplementary leverage ratio, balance-sheet capacity and capital returns.
- The status and potential financial range of significant mortgage-related litigation, regulatory investigations and the prospectus rescission offer.
- Whether the Rosneft transaction closes before its stated deadline and what options Morgan Stanley pursues if it does not.
- Whether the stated return and segment-margin goals are achieved; the filing cautions that actual results may differ materially.