Morgan Stanley 2019 Q2 Form 10-Q Summary
Business context and period. Morgan Stanley is a global financial services firm reporting three segments: Institutional Securities, Wealth Management and Investment Management. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods unless noted.
Financial results and key metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net revenues | $10.244B | $10.610B | $20.530B | $21.687B |
| Net income applicable to Morgan Stanley | $2.201B | $2.437B | $4.630B | $5.105B |
| Diluted EPS | $1.23 | $1.30 | $2.62 | $2.75 |
| Income before tax | $2.903B | $3.109B | $5.858B | $6.529B |
| Total non-interest expenses | $7.341B | $7.501B | $14.672B | $15.158B |
| Expense efficiency ratio | 71.7% | 70.7% | 71.5% | 69.9% |
| ROE / ROTCE | 11.2% / 12.8% | 13.0% / 14.9% | 12.1% / 13.8% | 13.9% / 16.0% |
Quarterly net revenues declined about 3%, while net income applicable to Morgan Stanley fell about 10%. For the first half, revenues declined about 5% and net income about 9%. Lower earnings and a higher expense efficiency ratio indicate reduced profitability versus the prior-year periods. The reported effective tax rate was 22.6% for Q2 and 19.5% for the first half; first-half results included a $101 million intermittent tax benefit.
Segment performance
| Q2 2019 | Net revenues | Net income applicable to Morgan Stanley | Revenue change vs. Q2 2018 |
|---|---|---|---|
| Institutional Securities | $5.113B | $1.121B | -11% |
| Wealth Management | $4.408B | $953M | +2% |
| Investment Management | $839M | $128M | +21% |
Institutional Securities weakness reflected lower trading and investment banking revenue amid macroeconomic uncertainty and softer market activity. Wealth Management grew modestly, with higher transactional revenue partly driven by gains on investments tied to certain employee deferred compensation plans. Investment Management benefited from higher investment gains, including carried interest and private-fund gains. First-half segment revenues were down 13% in Institutional Securities, up 1% in Wealth Management and up 17% in Investment Management.
Cash flow, balance sheet and capital
- First-half operating cash flow was $27.572B, versus $(81)M in 2018; investing cash flow was $(17.822)B and financing cash flow was $(17.261)B. Cash and cash equivalents fell $7.616B to $79.580B. Operating cash flow is affected by trading and collateral-related balance changes and should not be read as a simple earnings measure.
- At June 30, total assets were $891.959B, up from $853.531B at year-end 2018. Loans, as presented in selected metrics, were $120.901B versus $115.579B.
- Deposits declined to $176.593B from $187.820B, mainly due to lower brokerage sweep balances as clients redeployed cash and made seasonal tax payments. Borrowings increased to $197.848B from $189.662B; $26.621B of borrowings with original maturities over one year mature in the next 12 months.
- The Global Liquidity Reserve was $221.792B, down from $249.735B. The average quarterly LCR was 154%, above the 100% minimum; management said the Firm maintained sufficient liquidity under its stress tests.
- Common Equity Tier 1 was 16.3%, down from 16.9% at December 31, 2018; Tier 1 capital was 18.6%, total capital 21.0%, Tier 1 leverage 8.4% and SLR 6.5%. These ratios exceeded the applicable reported minimums.
- Common shareholders’ equity was $73.204B; tangible common shareholders’ equity was $63.771B. Book value per common share was $44.13 and tangible book value was $38.44.
Material changes and notable items
- Institutional Securities’ Q2 investment banking revenue fell 13%; trading revenue fell 18%. Lower advisory and fixed-income underwriting, reduced equity financing and execution results, and weaker global macro and commodities trading contributed. Credit products partly offset the decline.
- Q2 Wealth Management revenue rose 2%, but first-half fee-based asset flows were $24.6B versus $33.5B in the prior-year period. Period-end client assets rose to $2.570T from $2.303T at year-end 2018; fee-based client assets were $1.159T.
- Investment Management’s Q2 revenue rose 21%, largely on investment gains. Net cumulative unrealized carried interest at risk of reversal was $540M, compared with $434M at year-end 2018.
- Q2 consolidated net interest income increased to $1.029B from $906M, while first-half net interest income was $2.043B versus $1.881B. Interest income and expense both increased substantially, reflecting balances, rates and funding mix.
- Fair-value-option borrowings generated reported net revenue losses of $2.284B in Q2 and $5.280B in the first half, versus gains of $786M and $710M in the comparable 2018 periods. The filing says these figures exclude gains or losses on related economic hedges; investors should assess the combined effect.
- Common stock repurchases were $1.180B in Q2 and $2.360B in the first half. The Federal Reserve did not object to the 2019 Capital Plan, which permits up to $6.0B of repurchases from July 1, 2019 through June 30, 2020. The quarterly dividend was raised to $0.35 per share from $0.30, beginning with the dividend announced July 18, 2019.
- The Solium Capital acquisition was completed in the quarter; Morgan Stanley recorded approximately $469M of goodwill and $268M of intangible assets.
Outlook, risks and contingencies
- Management’s stated targets are ROE of 10%–13% and ROTCE of 11.5%–14.5%. These are targets, not specific quarterly earnings guidance, and may be affected by market conditions, trading and investment banking volumes, rates, regulation, legal costs, expenses and capital levels.
- Management said preliminary analysis indicated CECL adoption on January 1, 2020 would not significantly increase the allowance for credit losses; the ultimate impact depends on economic conditions, forecasts and portfolio composition.
- Key exposures include market, credit, liquidity, operational, model, legal and regulatory risks. A one-notch ratings downgrade could trigger an estimated $492M in incremental collateral or termination payments; a two-notch downgrade, $339M, under the disclosed contractual scenarios.
- The filing describes material legal and tax matters with potential losses, including a China Development Industrial Bank CDS case (up to about $240M plus interest and costs); mortgage-related claims with stated potential amounts up to about $240M, $126M and $277M in separate matters, with some plaintiffs seeking to expand claims; and a Dutch tax-credit dispute of about €124M (approximately $141M) plus interest. Outcomes and potential additional losses remain uncertain.
- Management discussed uncertainty surrounding the U.K.’s planned EU withdrawal and the transition from LIBOR and other benchmark rates. Morgan Stanley reported preparations for Brexit scenarios and a firm-wide benchmark-rate transition initiative. Regulation Best Interest and Form CRS compliance was expected by June 30, 2020.
- The interim financial statements received an independent accountant’s review, not an audit. The auditor reported no material modifications believed necessary for conformity with U.S. GAAP.
Important facts for investors to verify
- Whether Institutional Securities trading and investment banking recover, and whether Wealth Management flows and fee rates remain resilient.
- The full economic offset to fair-value-option borrowing losses from related hedges, and the persistence of investment and deferred-compensation-related gains.
- Deposit trends, borrowing maturities, liquidity-reserve levels and capital ratios against regulatory buffers as capital returns continue.
- Developments, accrued reserves and potential additional exposure in the listed legal and tax matters.
- The eventual CECL adoption effect, and progress and costs associated with LIBOR transition, Brexit readiness and new retail-investor rules.