Morgan Stanley — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; balance-sheet comparisons are with December 31, 2013 unless otherwise noted. Morgan Stanley is a global financial-services firm with Institutional Securities, Wealth Management and Investment Management businesses. The interim financial statements are unaudited; Deloitte reported that its review identified no material modifications needed for GAAP conformity.
Financial performance and position
- Revenue and earnings: Net revenues were $8.929 billion, up 9.6% from $8.150 billion. Net income was $1.584 billion versus $1.231 billion; net income attributable to Morgan Stanley was $1.505 billion versus $962 million. Common shareholders’ earnings were $1.449 billion versus $936 million.
- Per-share results: Diluted EPS was $0.74, including $0.72 from continuing operations, compared with $0.48 and $0.49, respectively. The common dividend declared for Q1 was $0.05 per share.
- Margins and returns: Pre-tax margin was 26%, versus 19%. Return on average common equity was 8.9%, versus 6.3%; return on average tangible common equity was 10.6%, versus 7.2%.
- Expenses and taxes: Non-interest expenses increased 1% to $6.622 billion. Compensation and benefits rose 2% to $4.305 billion; non-compensation expenses declined 2% to $2.317 billion. The continuing-operations effective tax rate was 33%, versus 21%; the 2013 rate included $142 million of discrete tax benefits.
- DVA: GAAP net revenues included a positive $126 million debt valuation adjustment, compared with a negative $317 million in Q1 2013. Excluding DVA, net revenues were $8.803 billion versus $8.467 billion, and diluted continuing-operations EPS was $0.68 versus $0.60. These are non-GAAP measures.
- Cash flow: Operating activities provided $5.327 billion, investing activities used $9.818 billion, and financing activities provided $519 million. Cash and cash equivalents decreased $4.459 billion to $55.424 billion. Operating cash flow included substantial changes in trading, securities-financing and customer balances; it should not be read as a simple measure of recurring free cash flow.
- Balance sheet and funding: Total assets were $831.381 billion and total liabilities $761.113 billion. Deposits were $116.648 billion; long-term borrowings were $153.374 billion, broadly unchanged from year-end. The filing separately reports $22.639 billion of long-term borrowings maturing in the next 12 months.
- Liquidity and equity: The Global Liquidity Reserve was $203 billion, and management said liquidity was sufficient under its stress tests. The reserve includes cash and unencumbered securities and is not the same as unrestricted cash; $43.651 billion was deposited with clearing organizations or segregated. Total equity was $70.268 billion; Morgan Stanley shareholders’ equity was $67.071 billion.
- Regulatory capital: Transitional U.S. Basel III ratios at March 31 were 14.1% Common Equity Tier 1, 15.6% Tier 1, 17.7% total capital and 7.6% Tier 1 leverage. The filing cautions that rule changes make period comparisons imperfect. Estimated fully phased-in Common Equity Tier 1 ratios were 11.6% under Advanced Approaches and 10.2% under the Standardized Approach.
Material changes and segment results
- Institutional Securities: Net revenues rose 13% to $4.609 billion; pre-tax income rose to $1.353 billion from $799 million. Investment banking revenue increased 20% to $1.136 billion. Excluding DVA, equity sales and trading rose 7% and fixed income and commodities sales and trading rose 9%; strength in commodities and client activity was partly offset by lower fixed-income volumes. Other sales and trading results included $244 million of losses, largely related to long-term-debt costs.
- Wealth Management: Net revenues increased 4% to $3.622 billion and pre-tax income to $691 million from $597 million. Higher asset-management fees and net interest outweighed weaker transactional revenue. Client assets reached $1.943 trillion; fee-based assets were $724 billion, or 37% of client assets. Fee-based flows were $19.0 billion versus $15.3 billion.
- Investment Management: Net revenues increased 15% to $740 million and pre-tax income to $263 million from $187 million, reflecting higher investment gains and fees. Assets under management or supervision rose to $382 billion from $341 billion a year earlier, with $6 billion of quarterly net inflows.
- Wealth Management ownership and deposits: Morgan Stanley owned 100% of the Wealth Management JV, versus 65% a year earlier; the 2013 comparison included Citi’s 35% noncontrolling interest. $5 billion of customer deposits transferred from Citi during the quarter, with approximately $24 billion more scheduled for transfer through June 2015.
- Disposals and portfolio changes: The Canadian terminal business CanTerm was sold on March 27 for approximately $110 million, generating a $45 million gain; its results are reported in discontinued operations. The global oil merchanting unit was held for sale under an agreement to sell to Rosneft, subject to approvals and other conditions, with closing expected in the second half of 2014. Strategic options for TransMontaigne were under review; no definitive decision had been reached.
Outlook, risks and contingencies
- Outlook and management commentary: No consolidated earnings or revenue guidance is provided. Management expected Wealth Management lending to continue growing and described the global economy as improving overall, while noting mixed investor sentiment, slow Eurozone growth, emerging-market volatility and geopolitical uncertainty, including Ukraine.
- Regulatory change: Basel III implementation and capital-ratio methods were changing; the Company expected to begin public reporting under Advanced Approaches in Q2 2014. Regulatory conditions on operational-risk modeling could reduce the pro forma Common Equity Tier 1 ratio estimate by about 50 basis points. The Volcker Rule’s compliance deadline was generally July 2015, and its full business impact remained uncertain.
- Liquidity and market risk: Stress tests assume, among other things, no access to equity or unsecured-debt markets, higher secured-funding haircuts, collateral calls and client withdrawals. A one- or two-notch ratings downgrade could trigger $1.558 billion plus an incremental $3.241 billion of collateral or termination payments under specified contracts. Management’s liquidity assessment is subject to these and other market risks.
- Legal and tax contingencies: Morgan Stanley said litigation accruals were expected to remain elevated and that some potential losses could not yet be reasonably estimated. Disclosed mortgage-related matters include a potential loss of up to approximately $240 million in the CDIB case and up to approximately $527 million in a mortgage-trust action, plus specified interest, fees or costs; outcomes remain uncertain and indemnification or offsets may apply in some matters. Unrecognized tax benefits were approximately $4.3 billion gross and $1.5 billion net; balances could decrease significantly within 12 months as an IRS examination is completed, but the income-statement effect was not estimable.
- Valuation and credit risks: Fair values for some assets rely on significant unobservable inputs. Level 3 trading assets were $18.658 billion before netting. Corporate lending exposure, including funded and unfunded commitments, was $95.453 billion; the company had $7.3 billion of related hedges. These exposures and reported fair values are not equivalent to expected losses.
Important facts for investors to verify
- Separate underlying earnings growth from the $443 million year-over-year swing in DVA, and assess the higher 2014 tax rate against the prior-year discrete tax benefits.
- Review segment drivers, especially Institutional Securities’ trading mix and Wealth Management’s fee-based flows, margins and deposit transfers from Citi.
- Track capital ratios as Basel III and Advanced Approaches calculations phase in; note that the filing’s pro forma capital estimates are preliminary and non-GAAP.
- Assess liquidity quality and accessibility, including the composition and legal-entity location of the $203 billion reserve, segregated cash, and upcoming debt maturities.
- Monitor the Rosneft sale, TransMontaigne review, legal proceedings and tax examinations for changes in timing, estimated exposure or reported results.
- Confirm the planned capital distributions: up to $1 billion of repurchases from Q2 2014 through Q1 2015 and a quarterly common dividend increase to $0.10 beginning with the Q2 2014 declaration.