Morgan Stanley — Q3 2017 Form 10-Q
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, 2017; comparisons are with the corresponding 2016 periods unless noted.
Financial performance and key metrics
| Metric | Q3 2017 | Q3 2016 | YTD 2017 | YTD 2016 |
|---|---|---|---|---|
| Net revenues | $9.197B | $8.909B | $28.445B | $25.610B |
| Net income attributable to Morgan Stanley | $1.781B | $1.597B | $5.468B | $4.313B |
| Diluted EPS | $0.93 | $0.81 | $2.79 | $2.11 |
| Income from continuing operations before tax | $2.482B | $2.381B | $7.932B | $6.602B |
| Net interest income | $783M | $1.003B | $2.305B | $2.815B |
| Non-interest expenses | $6.715B | $6.528B | $20.513B | $19.008B |
| Effective tax rate from continuing operations | 28.1% | 31.5% | 29.7% | 32.7% |
- Q3 revenue rose 3% and net income attributable to Morgan Stanley rose 12%; YTD revenue rose 11% and attributable net income rose 27%.
- Expense efficiency ratio improved to 73.0% in Q3 from 73.3%; YTD was 72.1% versus 74.2%. Annualized return on average common equity was 9.6% in Q3 and 9.8% YTD, versus 8.7% and 7.7%, respectively. Excluding the discrete tax provision and DVA, reported ROE was 9.0% for Q3 and 9.6% YTD.
- A discrete tax provision of $83M reduced Q3 attributable net income to $1.698B and diluted EPS to $0.88 on the company’s non-GAAP basis excluding that item. YTD, the corresponding figures were $5.403B and $2.76 per diluted share.
Business segments
- Institutional Securities: Q3 net revenues were $4.376B, down 4%; attributable net income was $973M, compared with $966M. Lower fixed-income trading results more than offset stronger underwriting and advisory revenues. YTD revenues were $14.290B, up 11%, and attributable net income was $3.179B, up 25%.
- Wealth Management: Q3 revenues were $4.220B, up 9%, and attributable net income was $698M, up 24%. Higher asset-management fees and net interest income supported growth. YTD revenues rose 9% to $12.429B and attributable net income rose 28% to $2.010B.
- Investment Management: Q3 revenues were $675M, up 22%, and attributable net income was $114M, versus $67M. Higher carried interest, investment gains and asset-management fees contributed. YTD revenues rose 21% to $1.949B and attributable net income rose 44% to $281M.
Balance sheet, cash flow and capital
- Total assets were $853.7B at September 30, 2017, up from $814.9B at year-end 2016, reflecting increased trading inventory and loan growth. Loans were $104.4B versus $94.2B; deposits were $154.6B versus $155.9B.
- Long-term borrowings increased to $191.7B from $164.8B; $25.8B was scheduled to mature over the next 12 months. Common shareholders’ equity was $70.5B, book value per share $38.87, and total equity $80.1B.
- For the first nine months, operating cash flow was negative $6.1B, versus positive $7.9B in 2016; investing cash flow was negative $8.8B versus negative $15.0B; financing cash flow was positive $17.5B versus negative $5.5B. Period-end cash and cash equivalents were $48.2B, up from $43.4B at December 31, 2016.
- Global Liquidity Reserve was $190.0B, down from $202.3B at year-end. The reported liquidity coverage ratio was 130%; the firm stated it met the 100% minimum and had sufficient liquidity under its stress tests.
- At September 30, regulatory capital ratios were 16.9% Common Equity Tier 1, 19.3% Tier 1 and 22.2% total capital. The pro forma supplementary leverage ratio was 6.5%. These ratios are subject to regulatory transition rules.
Material changes, outlook and risks
- Q3 net interest income fell to $783M from $1.003B, while interest expense more than doubled year over year. Institutional Securities reported negative net interest income of $242M in the quarter, compared with positive $117M a year earlier.
- Management had a 2017 ROE target of 9%–11%. Reported annualized ROE was 9.6% for Q3 and 9.8% YTD; the target calculation excludes DVA and discrete tax items. The filing provides no broader earnings or revenue forecast.
- The 2017 capital plan, which received Federal Reserve non-objection, authorized up to $5.0B of common-stock repurchases from July 2017 through June 2018 and raised the quarterly common dividend to $0.25 per share from $0.20. The firm repurchased $1.25B of common stock in Q3.
- Unusual item: The firm recorded an $86M YTD provision for potential U.K. VAT, interest and penalties related to VAT on intercompany services. Its review and discussions with U.K. tax authorities were ongoing.
- Legal and tax contingencies: The filing describes mortgage-related litigation and other claims with potentially material exposures, including several matters for which the firm estimated possible losses; outcomes and total exposure remain uncertain. It also disclosed a Dutch tax-authority challenge involving approximately €124M of withholding-tax credits, plus interest.
- Credit and market risks: Institutional Securities energy loans and commitments totaled $11.1B, including exposure to non-investment-grade exploration and production companies; management warned deterioration in oil and gas prices could result in lending losses. Trading revenues and investment performance remain sensitive to volatility, spreads, rates, market levels and client activity.
- Regulatory changes include forthcoming supplementary leverage and loss-absorbing-capacity requirements, a proposed U.S. net stable funding ratio, and the expected transition away from LIBOR. The firm said it expected to meet the applicable capital and TLAC requirements by their effective dates.
- The independent accountant performed an interim review, not an audit, and reported no material modifications needed to the interim statements. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether growth in Wealth Management fees and assets, and Investment Management performance fees, is sustained and supported by net flows rather than market appreciation alone.
- Whether the decline in Institutional Securities fixed-income results and consolidated net interest income persists, and how higher funding costs affect financing businesses.
- The eventual amount and timing of U.K. VAT exposure, and developments in the Dutch tax matter and material mortgage-related litigation.
- Loan growth, credit quality and energy-sector exposure, including any changes in allowances, charge-offs or lending commitments.
- Liquidity reserve levels, debt maturities and the firm’s ability to maintain capital buffers while executing planned dividends and repurchases.