MORGAN STANLEY quarterly report, Q1 FY2010

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Morgan Stanley — Q1 2010 Form 10-Q Summary

Reporting period: Three months ended March 31, 2010. The interim financial statements are unaudited and were reviewed by the independent auditor, not audited. Dollar amounts are U.S. dollars.

Business context and results

Morgan Stanley is a global financial services firm with Institutional Securities, Global Wealth Management Group and Asset Management segments. Results include the company’s 51% interest in Morgan Stanley Smith Barney Holdings LLC (MSSB), consolidated since May 31, 2009; therefore, the prior-year comparison is not on a like-for-like basis.

  • Net revenues were $9.078 billion, versus $2.897 billion in Q1 2009. Non-interest revenues were $8.697 billion; net interest income was $381 million, compared with a $64 million net interest loss a year earlier.
  • Income from continuing operations before tax was $2.516 billion, versus a $630 million loss. Continuing-operations income was $2.080 billion; net income was $2.011 billion, compared with a $190 million net loss.
  • Net income applicable to Morgan Stanley was $1.776 billion, versus a $177 million loss. Diluted EPS was $0.99 ($1.03 from continuing operations), compared with a diluted loss of $0.57.
  • Non-interest expenses were $6.562 billion, up from $3.527 billion. Compensation and benefits were $4.418 billion, versus $1.978 billion, reflecting higher revenue and MSSB consolidation. Continuing-operations pre-tax margin was approximately 27.7%.

Segments and material changes

  • Institutional Securities: Net revenues of $5.344 billion and pre-tax income of $2.067 billion, versus $1.601 billion and a $464 million pre-tax loss. Fixed-income sales and trading revenues rose to $2.723 billion; equity sales and trading revenues were $1.419 billion. Investment-banking revenues were $887 million.
  • Global Wealth Management Group: Net revenues of $3.105 billion and pre-tax income of $278 million, versus $1.299 billion and $119 million. MSSB materially increased reported revenue, expenses, representatives and client assets. The segment recorded $100 million of MSSB integration costs and $6 million of deal-closing costs.
  • Asset Management: Net revenues of $653 million and pre-tax income of $173 million, versus $22 million and a $283 million loss. Merchant-banking investment gains were a key factor. Assets under management or supervision were $262 billion; the segment reported $27.9 billion of customer outflows, primarily from money market funds.
  • The comparison also reflects a major swing in fair-value changes on Morgan Stanley’s own debt: Q1 2010 included approximately $54 million of gains from wider credit spreads, versus $1.708 billion of losses in Q1 2009 from tighter spreads.
  • New consolidation guidance for variable interest entities took effect January 1, 2010. Management said adoption did not materially affect the balance sheet, but previously unconsolidated entities became subject to reassessment and the reported VIE population changed.

Cash flow, balance sheet, liquidity and capital

  • Operating cash flow was $21.094 billion, compared with a $32.521 billion outflow in Q1 2009; investing cash flow was a $18.812 billion outflow and financing cash flow was $1.585 billion in. Cash and cash equivalents increased $3.487 billion during the quarter to $35.478 billion.
  • Total assets were $819.719 billion at quarter-end, up from $771.462 billion at December 31, 2009. Total equity was $55.179 billion, including $48.264 billion of Morgan Stanley shareholders’ equity.
  • Long-term borrowings were $189.203 billion, down from $193.374 billion; short-term borrowings were $3.323 billion, up from $2.378 billion. The company issued approximately $8 billion of long-term notes and repaid approximately $10 billion. $23.8 billion of long-term debt remained outstanding under the FDIC Temporary Liquidity Guarantee Program.
  • Average total liquidity was $155 billion for the quarter; average parent-company liquidity was $65 billion. Management describes liquidity reserves and diversified secured and unsecured funding as central to its liquidity framework.
  • At March 31, the company reported Basel I Tier 1 capital of $50.122 billion and a 15.1% Tier 1 capital ratio; the total capital ratio was 16.1% and the Tier 1 leverage ratio was 6.1%. The Tier 1 common ratio was 8.3%.
  • Operating balance-sheet measures included $174.591 billion of repurchase-agreement liabilities and $138.633 billion of federal funds sold and securities purchased under resale agreements. These financing balances are not equivalent to unrestricted cash.

Outlook, risks and unusual items

  • The filing provides no specific earnings or revenue guidance. Management described recovering markets in Q1 2010 but noted continuing challenges in real estate and consumer spending, as well as economic and sovereign concerns in Europe.
  • Discontinued operations included a $932 million loss related to the planned sale of Revel, a development-stage Atlantic City property, and a $775 million gain from a settlement with Discover Financial Services. The company also reported Retail Asset Management as discontinued operations and expected its sale to Invesco to close in mid-2010, subject to approvals.
  • The quarter’s tax provision included a $382 million benefit from treating certain foreign earnings as indefinitely reinvested abroad. Excluding this discrete benefit, management reported an effective tax rate of 32.5%, versus 17.3% reported.
  • Monoline-related losses were $143 million. The filing cited approximately $202 million of net counterparty exposure, plus insured municipal securities and other exposures. Credit-rating downgrades could trigger additional collateral or termination payments; the filing estimated calls of approximately $1.610 billion for a one-notch downgrade and $2.983 billion for a two-notch downgrade under the agreements described in its liquidity discussion.
  • Off-balance-sheet and contingent exposures include $135.885 billion of commitments, including $53.605 billion of corporate lending commitments and $75.390 billion of forward-starting reverse repurchase agreements. These totals are not necessarily expected cash funding requirements. The company also disclosed VIE, securitization, derivative, guarantee and legal exposures.
  • Management said pending legal and regulatory matters were not expected to materially affect financial condition, but could materially affect results or cash flows in a particular future period. The filing does not quantify a clear aggregate range of potential legal losses.
  • Subsequent events: the board declared a $0.05 quarterly common dividend; new U.K. bonus payroll-tax legislation was expected to result in a Q2 2010 compensation charge, with the amount still under evaluation. A Japan securities joint venture with MUFG closed May 1, 2010.

Most important facts for investors to verify

  • How much of the year-over-year improvement reflects underlying business performance versus MSSB consolidation and the prior-year own-credit-spread valuation losses?
  • What is the recurring earnings and expense profile after excluding the $932 million Revel disposal loss, the $775 million Discover settlement gain and the $382 million tax benefit?
  • How will MSSB integration, Citi’s 49% economic interest and any remaining integration costs affect Wealth Management profitability?
  • What are the realizable values and liquidity implications of Level 3 assets, real-estate exposures, VIE interests, and commitments or guarantees?
  • How could credit-rating changes, legal and regulatory proceedings, the Invesco transaction, the U.K. bonus tax and the Japan joint venture affect capital, liquidity and future results?