Morgan Stanley — Q1 2019 Form 10-Q
Business context and period. Morgan Stanley is a global financial services firm operating through Institutional Securities, Wealth Management and Investment Management. This unaudited report covers the three months ended March 31, 2019; comparisons are primarily with Q1 2018. Balance-sheet comparisons are with December 31, 2018.
Financial results and key metrics
| Metric | Q1 2019 | Comparison |
|---|---|---|
| Net revenues | $10.286 billion | Down 7% from $11.077 billion |
| Net income applicable to Morgan Stanley | $2.429 billion | Down 9% from $2.668 billion |
| Diluted EPS | $1.39 | Down from $1.45 |
| Income before taxes | $2.955 billion | Down 14% from $3.420 billion |
| Total non-interest expenses | $7.331 billion | Down 4% from $7.657 billion |
| Net interest income | $1.014 billion | Up from $975 million |
| Operating cash flow | $17.041 billion | Compared with $12.648 billion in Q1 2018 |
| Investing / financing cash flow | $(7.227) billion / $(15.864) billion | Q1 2019 |
| Cash and cash equivalents | $80.682 billion | Down from $87.196 billion at year-end |
| Expense efficiency ratio | 71.3% | Up from 69.1%; higher indicates less revenue retained after expenses |
| ROE / ROTCE | 13.1% / 14.9% | Down from 14.9% / 17.2% |
The quarter’s GAAP effective tax rate was 16.5%, including a $101 million intermittent discrete tax benefit, principally from remeasurement of tax reserves and related interest following new information on multi-jurisdiction examinations. Excluding that benefit, the adjusted non-GAAP tax rate was 19.9%; adjusted diluted EPS was $1.33 versus reported EPS of $1.39.
Business segments
- Institutional Securities: Net revenues of $5.196 billion, down 15%; net income applicable to Morgan Stanley of $1.371 billion, down 16%. Lower investment banking revenues (down 24%) and sales and trading revenues (down 15%) drove the decline. Equity sales and trading fell 21%; fixed income fell 9%.
- Wealth Management: Net revenues of $4.389 billion were essentially unchanged; net income was $924 million, up 1%. Asset management revenues fell 5%, partly offset by 6% growth in net interest income and higher trading revenues. Client assets were $2.476 trillion, up from $2.303 trillion at year-end; fee-based assets were $1.116 trillion.
- Investment Management: Net revenues of $804 million, up 12%; net income applicable to Morgan Stanley of $136 million, up 7%. Higher investment gains, including carried interest in certain Asia funds, were partly offset by higher compensation expense.
Balance sheet, liquidity and capital
- Total assets were $875.964 billion, up from $853.531 billion at year-end, mainly reflecting higher securities borrowed and resale agreements in Institutional Securities.
- Loans, net of allowance, were $116.197 billion; deposits were $179.731 billion, down from $187.820 billion; borrowings were $190.691 billion, slightly above $189.662 billion at year-end.
- The global liquidity reserve was $233.148 billion, down from $249.735 billion. The average daily liquidity coverage ratio was 150%, versus 145% in the prior quarter, and the firm reported compliance with the 100% minimum.
- Common Equity Tier 1 ratio was 16.7%, Tier 1 capital ratio 19.0%, total capital ratio 21.6%, Tier 1 leverage ratio 8.4% and supplementary leverage ratio 6.5%. These remained above stated minimum requirements; CET1 was 16.9% at year-end.
- The firm repurchased $1.180 billion of common stock during the quarter and paid $0.30 per share in common dividends. A further $0.30 dividend was announced for payment in May 2019.
Material changes, outlook and notable items
- Revenue and earnings declined year over year, primarily because of weaker Institutional Securities results. Investment banking revenues decreased across advisory and underwriting, with lower fee realizations and issuance volumes. Wealth Management revenues were stable, while Investment Management benefited from higher investment gains.
- Compensation and benefits expense fell 5% to $4.651 billion, mainly due to lower incentive compensation, partly offset by higher salaries and changes in deferred-compensation investment values. Non-compensation expense fell 2% to $2.680 billion, reflecting lower litigation and volume-related costs, partly offset by technology investment.
- Management’s stated targets are ROE of 10%–13% and ROTCE of 11.5%–14.5%. These are forward-looking targets, not quarterly guidance, and depend on market conditions, business volumes, rates, regulation, legal expenses and capital levels. The filing provides no specific Q2 or full-year revenue or earnings guidance.
- The firm reported a $2.903 billion loss in trading revenues on borrowings carried under the fair value option, before related economic hedges; management says these amounts are not representative of net hedged economics. Net debt valuation adjustment reduced other comprehensive income by $620 million in the quarter.
- Leases accounting adopted January 1, 2019 added approximately $4 billion to both assets and liabilities at transition and resulted in a $63 million after-tax retained-earnings increase. CECL is scheduled to take effect January 1, 2020; preliminary estimates indicated no significant increase in credit-loss allowances, subject to economic conditions and portfolios at adoption.
- Risks include market, credit, liquidity, operational, model, legal and regulatory risks. The firm disclosed pending mortgage-related litigation and other proceedings, including estimated potential losses of up to approximately $240 million, $277 million and $126 million in certain matters, plus interest, fees and costs; some plaintiffs seek to expand claims. These are management estimates of potential exposure, not stated probable losses. A California RMBS-related matter was agreed to be settled on April 24, 2019.
- Other monitored developments included U.K. withdrawal from the E.U., replacement or reform of LIBOR and other benchmarks, proposed regulatory changes, and the Federal Reserve’s pending review of the 2019 capital plan. The filing noted potential downgrade-related collateral or termination payments, estimated at $452 million for a one-notch downgrade and $277 million for a two-notch downgrade under specified scenarios.
Important facts for investors to verify
- Whether Institutional Securities revenue weakness persists, especially in advisory, underwriting and equity trading, and how Wealth Management flows and fee-based assets develop.
- How much of reported earnings and the tax rate reflects discrete tax benefits, carried interest, deferred-compensation marks and fair-value-option movements.
- Trends in deposits, liquidity reserves, funding costs and capital ratios, including the effects of share repurchases and regulatory capital requirements.
- Updates to significant litigation, tax examinations and contingent exposures, including whether claim scope or estimated loss ranges change.
- Management’s progress toward ROE and ROTCE targets, the outcome of the 2019 capital plan review, and the eventual CECL adoption impact.
The independent accountant performed a review of the interim financial information, not a full audit, and reported no material modifications needed for U.S. GAAP conformity.