MORGAN STANLEY annual report, FY2016

Morgan Stanley 2016 Form 10-K Summary

Business context and reporting period

Morgan Stanley is a global financial holding company operating through Institutional Securities, Wealth Management and Investment Management. This annual filing covers the year ended December 31, 2016; comparisons are primarily with 2015. The audited financial statements received an unqualified opinion, and management and the auditor reported effective internal control over financial reporting.

Financial performance and position

Metric	2016	2015
Net revenues	$34.631 billion	$35.155 billion
Income before tax	$8.848 billion	$8.495 billion
Net income applicable to Morgan Stanley	$5.979 billion	$6.127 billion
Diluted EPS	$2.92	$2.90
Non-interest expenses	$25.783 billion	$26.660 billion
Return on average common equity	8.0%	8.5%
Net cash provided by operating activities	$2.447 billion	$3.674 billion

Net interest income rose to $3.698 billion from $3.093 billion. Total non-interest revenue fell to $30.933 billion from $32.062 billion.
Net income excluding DVA and discrete tax benefits was $5.911 billion, or $2.88 per diluted share, versus $5.164 billion, or $2.41, in 2015. These are non-GAAP measures; 2016 and 2015 also differ in DVA accounting presentation.
Segment net revenues: Institutional Securities $17.459 billion, down 3%; Wealth Management $15.350 billion, up 2%; Investment Management $2.112 billion, down 9%. Segment income applicable to Morgan Stanley was $3.649 billion, $2.104 billion and $225 million, respectively.
Consolidated pre-tax margin was reported at 26% (non-GAAP), versus 24% in 2015. The expense efficiency ratio was 74.5%.
At year-end, total assets were $814.949 billion; deposits $155.863 billion; long-term borrowings $164.775 billion; common shareholders’ equity $68.530 billion; and loans, net of allowance, $94.248 billion. Cash and cash equivalents were $43.381 billion, down from $54.083 billion.
Global Liquidity Reserve was $202.297 billion, compared with $203.264 billion. Transitional regulatory capital ratios were CET1 16.9%, Tier 1 19.0%, total capital 22.0% and Tier 1 leverage 8.4%.
Cash flows were $2.447 billion from operations, negative $19.508 billion from investing and positive $7.424 billion from financing; cash and cash equivalents declined $10.702 billion. These flows reflect substantial balance-sheet and securities activity.

Material changes versus 2015

Net revenues decreased about 1.5%, while net income applicable to Morgan Stanley fell about 2.4%; diluted EPS edged up from $2.90 to $2.92 as average diluted shares declined.
Institutional Securities revenue weakness reflected lower investment banking and sales and trading revenues. Advisory revenue increased, but underwriting fell 26%. Fixed income sales and trading improved, particularly in credit, while equity sales and trading was slightly lower excluding 2015 DVA.
Wealth Management benefited from higher net interest income, up 19%, while transactional revenues declined 7%; client assets increased to $2.103 trillion from $1.985 trillion, and fee-based client assets rose to $877 billion from $795 billion.
Investment Management revenue fell 9%, mainly reflecting weaker investment performance and lower investment gains; management fees were relatively unchanged.
Non-interest expenses declined 3.3%, including lower legal and other non-compensation costs. Legal expenses were $263 million, down from $563 million; 2014’s $3.364 billion included major legacy mortgage and credit-crisis costs.
Discrete tax benefits were $68 million in 2016 versus $564 million in 2015. The 2015 comparison also included $618 million of positive DVA revenue; 2016 adopted accounting that records unrealized DVA in other comprehensive income.

Outlook, commentary, risks and unusual items

Management’s stated target was 9%–11% return on average common equity, excluding DVA, by 2017, subject to execution and external conditions. Supporting goals included a 23%–25% Wealth Management pre-tax margin and Project Streamline savings of $1 billion by 2017, excluding outsized litigation expense or penalties, assuming flat revenue. The 2016 expense ratio of 74.5% was above the stated 74% target.
Capital returns remain subject to regulatory approval. The 2016 capital plan contemplated up to $3.5 billion of share repurchases from July 2016 through June 2017; the Firm repurchased approximately $3.5 billion during 2016 and declared $0.70 per common share in dividends.
Management cited market volatility, interest rates, geopolitical events including the U.K.’s anticipated EU withdrawal, competition and pricing pressure, regulation, funding access, credit and operational risks, cybersecurity, and litigation as factors that could materially affect results. The filing does not provide conventional near-term revenue or earnings guidance.
Energy-related Institutional Securities loans and commitments totaled $11.8 billion; the Firm increased energy-related credit-loss allowances and warned that further deterioration in oil or commodity prices could cause additional lending losses.
A $70 million Wealth Management provision related to incorrect cost-basis tax reporting for certain brokerage accounts (tax years 2011–2016). The Firm said it was working with the IRS on client underpayments and planned to reimburse affected clients for identified overpayments; its review was ongoing.
Legacy mortgage and other proceedings remain significant and outcomes may be material to results or cash flows in a particular period. The filing identifies a possible loss of up to approximately $240 million in the CDIB dispute, as well as multiple mortgage matters with individually estimated exposures; some plaintiffs seek to expand claims. A proposed Italian claim related to derivatives asserted €2.879 billion (approximately $3 billion); Morgan Stanley disputed it. Land Salzburg sought €209 million plus interest and costs. The Firm said it could not predict outcomes across proceedings and investigations.
Regulatory developments include the fully phased-in U.S. liquidity coverage ratio requirement from January 2017, a proposed net stable funding ratio, and new TLAC and long-term debt requirements due by 2019. A December 2016 capital-plan resubmission addressed identified weaknesses; future capital distributions could be restricted if those weaknesses are not satisfactorily addressed.
Unusual accounting and measurement considerations include early adoption of DVA presentation changes, fair-value estimates involving unobservable inputs, and deferred tax assets. The filing also states that adoption of the 2018 revenue standard could delay recognition of carried-interest performance fees depending on the accounting approach ultimately applied.

Important facts for investors to verify

Reconcile GAAP and non-GAAP earnings, ROE and margins, including the different treatment of DVA and discrete tax benefits.
Assess whether Wealth Management growth, expense savings and the 9%–11% ROE target are achievable, and track performance against the disclosed deadlines and assumptions.
Review credit quality and reserve adequacy, especially energy exposures, growing Wealth Management lending and $98.4 billion of lending commitments.
Monitor the status, accrued reserves and potential outcomes of mortgage, foreign-exchange, Italy and Land Salzburg matters, including claims that are not reasonably estimable.
Confirm regulatory capital-plan approval, capital distribution capacity, TLAC readiness and compliance with evolving liquidity rules.
Evaluate funding maturities and rating sensitivity: $26.127 billion of long-term borrowings were due in 2017, and a one-notch downgrade could trigger $1.292 billion of incremental collateral or termination payments under the disclosed scenario.