MORGAN STANLEY quarterly report, Q3 FY2020

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Morgan Stanley Q3 2020 Form 10-Q Summary

Business context and reporting period

Morgan Stanley is a global financial services firm operating through Institutional Securities, Wealth Management and Investment Management. This unaudited quarterly report covers the three and nine months ended September 30, 2020; comparisons are with the corresponding 2019 periods unless otherwise noted.

Financial results and key metrics

  • Third quarter: Net revenues were $11.657 billion, up 16%; net income applicable to Morgan Stanley was $2.717 billion, up 25%; diluted EPS was $1.66 versus $1.27. Income before tax was $3.487 billion. Pre-tax margin was 29.9%, compared with 27.0%.
  • Nine months: Net revenues were $34.558 billion, up 13%; net income applicable to Morgan Stanley was $7.611 billion, up 12%; diluted EPS was $4.62 versus $3.89. Income before tax was $9.988 billion.
  • Returns and expenses: Q3 ROE was 13.2% and ROTCE was 15.0%; nine-month ROE was 12.6% and ROTCE was 14.3%. The expense efficiency ratio improved to 70.1% for Q3 from 73.0%. Compensation and benefits rose 15% in Q3 to $5.086 billion; total non-interest expenses increased 12% to $8.170 billion.
  • Segment performance, Q3: Institutional Securities revenue was $6.062 billion, up 21%, and segment net income was $1.647 billion. Wealth Management revenue was $4.657 billion, up 7%, with $1.120 billion pre-tax income and a 24% pre-tax margin; net income was $842 million. Investment Management revenue was $1.056 billion, up 38%, with $315 million pre-tax income and $225 million net income attributable to Morgan Stanley.
  • Cash flow, nine months: Operating activities provided $159 million, versus $40.909 billion in 2019; investing activities used $37.438 billion, versus $25.721 billion; financing activities provided $48.925 billion, versus $21.180 billion. Cash and cash equivalents ended at $94.772 billion. Management’s cash-flow statement reflects substantial balance-sheet movements in the firm’s financial activities.
  • Balance sheet and funding, September 30: Total assets were $955.940 billion, versus $895.429 billion at year-end 2019. Deposits were $239.253 billion, up from $190.356 billion; borrowings were $203.444 billion, up from $192.627 billion. Loans, net of allowance and including loans held for sale, were $146.237 billion. Common shareholders’ equity was $79.874 billion.
  • Liquidity and capital: Liquidity resources were $267.292 billion, compared with $215.868 billion at year-end. The standardized CET1 ratio was 17.4%, versus 16.4%; advanced CET1 was 16.9%. The LCR was 136%. The reported 7.4% SLR reflects temporary Federal Reserve relief excluding certain Treasury securities and central-bank deposits.
  • Credit losses: Q3 provision for credit losses on loans and lending commitments was $111 million; nine-month provision was $757 million. The allowance for credit losses on loans and lending commitments totaled $1.260 billion at quarter-end, compared with $590 million at year-end 2019, including the impact of CECL adoption and COVID-related estimates.

Material changes versus comparable periods

  • Institutional Securities was the main Q3 revenue growth driver: sales and trading revenue increased 20% to $4.154 billion, including fixed-income growth of 35%; equity underwriting contributed to higher investment banking revenue. Advisory revenue fell 35% amid fewer completed M&A transactions.
  • Wealth Management’s Q3 net interest revenue fell 15% to $889 million, principally due to lower rates, while positive fee-based flows and market appreciation supported asset-management revenue. Reported Q3 revenue growth also included gains on investments linked to employee deferred compensation plans.
  • Investment Management’s Q3 growth reflected higher average AUM and accrued carried interest and investment gains in an Asia private equity fund. Long-term net flows were $10.4 billion; quarter-end AUM was $715 billion.
  • Nine-month revenue growth reflected stronger trading and underwriting, partly offset by lower advisory revenue and a $628 million Institutional Securities “Other” net loss, primarily from mark-to-market losses on loans and lending commitments held for sale as credit spreads widened.
  • Deposits, loans and liquidity resources increased substantially from year-end 2019. Share repurchases were suspended; none were made under the repurchase program in Q3.

Outlook, risks, contingencies and unusual items

  • Management’s ROTCE target is 13%–15% over two years, set in January 2020. The filing says COVID-19 and the economic crisis make achievement within the original timeframe uncertain. It cautions that elevated trading and capital-markets activity may not recur and advisory activity may remain subdued.
  • COVID-19 continued to create uncertainty for markets, clients and borrowers. More than 85% of global employees were working from home at September 30. Low rates continued to pressure Wealth Management net interest margins. Management’s credit-loss base scenario assumed recovery through late 2020 and 2021, supported by fiscal and monetary measures; U.S. GDP was the most sensitive model input.
  • Borrower relief was granted in some cases. Approved principal and interest payment deferrals were less than $2 billion at September 30. Management said it did not believe modifications had materially changed the loan portfolio’s risk profile, while noting further requests could occur.
  • Strategic transactions after quarter-end: Morgan Stanley completed its E*TRADE acquisition on October 2, principally through approximately $11 billion of common shares, plus $0.7 billion of preferred shares. Preliminary purchase accounting anticipated approximately $77 billion of added assets, including about $5 billion of goodwill and $3 billion of intangible assets. On October 8, it agreed to acquire Eaton Vance in a cash-and-stock transaction valued at approximately $7 billion at announcement, expected to close in Q2 2021 subject to customary conditions.
  • Federal Reserve capital-action restrictions were extended through Q4 2020, limiting share repurchases and constraining dividends. Morgan Stanley announced a $0.35 common dividend per share payable November 13, 2020.
  • Material legal contingencies include the CDIB matter, for which the firm estimated possible loss of up to approximately $240 million plus interest, fees and costs, and two mortgage-related matters each with an estimated potential loss of up to approximately $277 million plus additional amounts. In one matter, plaintiffs may expand the loans at issue. These estimates are case-specific and should not be treated as a combined expected loss.
  • Other exposures include market, counterparty, credit, liquidity, legal and regulatory risks; ratings downgrades could trigger additional collateral or termination payments. The filing reports approximately $246 million and $315 million of potential collateral or termination payments under one-notch and two-notch downgrade scenarios, respectively.
  • Q3 included $113 million of intermittent net discrete tax benefits, primarily relating to tax examination developments. Nine-month intermittent benefits were $10 million. CECL was adopted January 1, 2020, increasing the opening allowance by $131 million and reducing retained earnings by $100 million net of tax.

Most important facts for investors to verify

  • Whether trading, underwriting and client activity remain strong if pandemic-era market volumes normalize, and how advisory revenue recovers.
  • Credit-quality trends, future provisioning and allowance adequacy as pandemic-related borrower relief ends and economic forecasts evolve.
  • Post-close E*TRADE integration, costs, revenue contribution and realized balance-sheet effects; progress and financing/integration assumptions for the proposed Eaton Vance acquisition.
  • Whether ROTCE remains within the stated target range, given the explicit uncertainty about the target’s timing.
  • Capital and liquidity ratios excluding temporary regulatory relief, and the effect of continuing dividend and repurchase restrictions.
  • Developments and potential exposure in the disclosed legal and tax matters; the filing does not establish that the stated maximum case estimates will be incurred.