Morgan Stanley — Form 10-Q Summary
Business context and reporting period
Morgan Stanley is a global financial services firm with Institutional Securities, Wealth Management and Investment Management businesses. This unaudited filing covers the quarter and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods unless noted. Deloitte performed an interim review, not a full audit.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net revenues | $9.743 billion | $8.608 billion | $19.650 billion | $17.604 billion |
| Income before tax, continuing operations | $2.727 billion | $1.932 billion | $5.582 billion | $4.302 billion |
| Net income applicable to Morgan Stanley | $1.807 billion | $1.899 billion | $4.201 billion | $3.404 billion |
| Diluted EPS | $0.85 | $0.92 | $2.03 | $1.66 |
| Net interest income | $698 million | $267 million | $1.294 billion | $575 million |
| Non-interest expenses | $7.016 billion | $6.676 billion | $14.068 billion | $13.302 billion |
- Q2 net revenues rose 13%; reported pre-tax margin was 28%, versus 22%. The six-month pre-tax margin was 28%, versus 24%.
- Q2 common shareholder earnings and diluted EPS declined year over year, despite higher revenue and pre-tax income. The 2014 quarter included a $609 million discrete tax benefit; Q2 2015 did not. Excluding DVA and that prior-year tax benefit, management reported Q2 2015 net income of $1.688 billion and diluted EPS of $0.79, versus $1.229 billion and $0.58.
- Six-month 2015 results included a $564 million discrete tax benefit, mainly from repatriating non-U.S. earnings at a lower-than-estimated tax cost following a U.K. entity restructuring. The 2014 six-month period included a $609 million discrete tax benefit related principally to tax-reserve remeasurement.
- Q2 revenue growth reflected Institutional Securities net revenues of $5.172 billion, up from $4.248 billion; Wealth Management of $3.875 billion, up from $3.702 billion; and Investment Management of $751 million, up from $705 million. Wealth Management benefited from higher asset-management fees and net interest income; Investment Management benefited from investment gains.
- Compensation and benefits were $4.405 billion in Q2, up from $4.200 billion; management attributed the increase primarily to higher revenue. Total expenses rose about 5% in the quarter.
- Q2 annualized return on average common equity was 9.9%, or 9.1% excluding DVA. For the first six months, it was 12.0%, or 11.3% excluding DVA and 9.6% excluding both DVA and the discrete tax benefit.
All dollar amounts below are in U.S. dollars. At June 30, 2015, total assets were $825.8 billion, up from $801.5 billion at year-end 2014; total liabilities were $749.7 billion and total equity was $76.1 billion. Cash and cash equivalents were $46.4 billion. The Global Liquidity Reserve was $188.2 billion, down from $193.2 billion at year-end.
Long-term borrowings were $158.1 billion, versus $152.8 billion at year-end; short-term borrowings were $3.1 billion, versus $2.3 billion. Deposits rose to $139.2 billion from $133.5 billion. Long-term borrowing maturities due within the next 12 months were $27.2 billion. The weighted average stated maturity of long-term borrowings was approximately 5.9 years.
For the first six months, operating cash flow was negative $8.453 billion, versus positive $5.827 billion in 2014; investing cash flow was negative $7.334 billion, versus negative $24.109 billion; financing cash flow was positive $15.704 billion, versus negative $843 million. Cash and cash equivalents decreased by $625 million to $46.359 billion. Operating cash flow was materially affected by changes in trading, securities-financing and other balance-sheet accounts.
Regulatory capital was strong: the transitional Advanced Approach Common Equity Tier 1 ratio was 14.0%, Tier 1 was 15.7%, total capital was 18.7%, and Tier 1 leverage was 7.9%. The supplementary leverage ratio was 5.6%; management estimated a fully phased-in ratio of approximately 5.3%. The company’s 2015 G-SIB surcharge was estimated at 3%, with phase-in beginning in 2016.
Material changes versus comparable periods
- Q2 trading revenue increased to $2.973 billion from $2.516 billion. Institutional Securities sales and trading net revenues increased 32% to $3.504 billion, with strong equity results and higher fixed-income interest-rate and foreign-exchange activity.
- Wealth Management net interest income increased to $737 million from $577 million. Its fee-based client assets rose to $813 billion from $785 billion at year-end, and total client assets reached $2.034 trillion. Fee-based flows were $13.9 billion for the quarter.
- Investment Management net revenues rose 7% in Q2, but six-month revenue fell to $1.420 billion from $1.457 billion, reflecting lower revenue from a minority investment in third-party managers.
- Loans, net of allowance, increased to $75.9 billion from $66.6 billion at year-end, driven by growth in corporate, consumer and residential real estate loans. Wealth Management lending and commitments increased, and management expected lending activity to continue growing.
- Common Equity Tier 1 increased to $58.7 billion from $57.3 billion at year-end, while risk-weighted assets decreased to $417.7 billion from $456.0 billion under the Advanced Approach transitional rules.
Outlook, risks and unusual items
- Management’s stated goal is a sustainable return on average common equity of at least 10% excluding DVA over time, subject to successful execution of strategic objectives; the filing gives no specific near-term earnings guidance.
- The company agreed to sell its global oil merchanting unit to Castleton Commodities International and recorded a $59 million impairment in Q2. The sale was expected to close in the second half of 2015 and was not classified as discontinued operations.
- The Federal Reserve did not object to the 2015 capital plan, which authorized up to $3.1 billion of common-stock repurchases through Q2 2016 and raised the quarterly common dividend to $0.15 per share. The company repurchased approximately $625 million of stock in Q2. A further $0.15 dividend was declared in July 2015.
- Market, credit, liquidity, operational, regulatory, cybersecurity, foreign-exchange and legal risks remain significant. The filing describes extensive OTC derivatives and collateralized financing activity. A one-notch or two-notch rating downgrade could trigger additional collateral or termination payments; the company estimated $1.269 billion and $1.232 billion, respectively, under specified derivative-contract scenarios.
- The company disclosed multiple mortgage-related lawsuits and foreign-exchange investigations. For several mortgage cases it estimated potential losses individually, including up to approximately $240 million, $149 million, $527 million, $173 million, $197 million and $292 million, generally before interest, fees and costs. Management cautioned that many legal matters cannot be reasonably estimated and that future litigation accruals may remain elevated.
- Unfunded lending commitments and other commitments were substantial: primary corporate lending commitments included $60.9 billion to investment-grade borrowers and $24.9 billion to non-investment-grade borrowers. Total commitments summarized in Note 11 were $156.3 billion; amounts may expire unused and do not necessarily represent future cash funding needs.
- Q2 fair-value gains on the company’s own debt from DVA added $182 million to revenue. Six-month DVA added $307 million. These valuation effects can fluctuate with Morgan Stanley’s credit spreads.
Important facts for investors to verify
- Reconcile reported Q2 earnings with the effects of DVA and the unusually large prior-year discrete tax benefit; assess the sustainability of earnings excluding these items.
- Review the cash-flow statement and balance-sheet movements, particularly securities financing and trading-related changes, rather than treating the negative operating cash flow as ordinary operating performance.
- Track Wealth Management loan growth, deposit levels, fee-based flows and asset balances, together with credit quality and allowance trends.
- Monitor regulatory capital and leverage requirements, including the G-SIB surcharge, supplementary leverage ratio phase-in and effects on capital distributions.
- Follow mortgage litigation, foreign-exchange investigations, downgrade-triggered collateral requirements and the oil merchanting sale; the filing does not provide a single clear aggregate estimate of potential legal losses.