Morgan Stanley — Form 10-Q Summary
Reporting period: Quarter ended September 30, 2013; nine-month results are compared with the periods ended September 30, 2012. Morgan Stanley is a global financial services firm with Institutional Securities, Wealth Management and Investment Management businesses. Amounts below are U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net revenues | $7,932 | $5,280 | $24,593 | $19,146 |
| Non-interest expenses | $6,593 | $6,763 | $19,897 | $19,490 |
| Income (loss) before tax, continuing operations | $1,339 | $(1,483) | $4,696 | $(344) |
| Net income (loss) applicable to Morgan Stanley | $906 | $(1,023) | $2,848 | $(526) |
| Diluted EPS | $0.45 | $(0.55) | $1.34 | $(0.32) |
| Net interest income (expense) | $111 | $(155) | $500 | $(374) |
Pre-tax margin on continuing operations was approximately 16.9% for Q3 and 19.1% for the first nine months of 2013; the comparable 2012 periods had pre-tax losses. Q3 net income included $112 million attributable to nonredeemable noncontrolling interests. The common dividend remained $0.05 per share for the quarter.
Segment results: Q3 net revenues were $3.686 billion for Institutional Securities, $3.481 billion for Wealth Management and $828 million for Investment Management. Continuing-operations pre-tax income was $371 million, $668 million and $300 million, respectively. Institutional Securities’ recovery from its prior-year loss and Wealth Management’s higher earnings were key contributors to the improvement.
Cash flow, balance sheet and capital: For the first nine months, operating cash flow was $16.820 billion, investing cash flow was $(13.989) billion and financing cash flow was $8.809 billion; cash and cash equivalents increased $10.877 billion to $57.781 billion. At September 30, total assets were $832.2 billion, total liabilities $764.0 billion and total equity $68.2 billion. Deposits rose to $104.8 billion from $83.3 billion at year-end 2012; net loans were $37.7 billion, up from $29.0 billion. Long-term borrowings were $157.8 billion, down from $169.6 billion; $24.2 billion was due within the next 12 months. The Global Liquidity Reserve was $198 billion, compared with $182 billion at December 31, 2012.
Under the then-applicable Basel I framework, the total capital ratio was 16.1%, Tier 1 capital ratio 15.3%, Tier 1 common ratio 12.6% and Tier 1 leverage ratio 7.3%. Risk-weighted assets increased to $385.7 billion from $306.7 billion at year-end; the filing cautions that the 2013 ratios reflect Basel 2.5 and prior-year ratios were not recalculated on that basis.
Material changes and unusual items
- Q3 reported revenue included negative debt valuation adjustments (DVA) of $171 million, versus negative $2.262 billion a year earlier. Excluding DVA, a non-GAAP measure, Q3 revenue was $8.103 billion versus $7.542 billion and diluted continuing-operations EPS was $0.50 versus $0.28. The large DVA comparison materially affects the reported year-over-year improvement.
- Institutional Securities’ Q3 equity sales and trading revenue excluding DVA increased 28%, while fixed income and commodities sales and trading revenue excluding DVA fell 43%, amid lower client activity and market volumes. Investment banking revenue rose 2% for the quarter, with underwriting gains partly offset by lower advisory revenue.
- Wealth Management revenue increased 8% to $3.481 billion in Q3. Fee-based client assets reached $652 billion, or 36% of client assets, and quarterly fee-based asset flows were $15.0 billion versus $6.8 billion. Investment Management revenue rose to $828 million, largely reflecting investment gains and carried interest.
- On June 28, Morgan Stanley acquired Citi’s remaining 35% interest in the Wealth Management joint venture for $4.725 billion, taking ownership to 100%. The transaction generated a $151 million after-tax retained-earnings adjustment that reduced nine-month EPS. Approximately $21 billion of Citi-held customer deposits transferred in Q3; about $35 billion remained scheduled for transfer through June 2015.
- Litigation accruals were approximately $265 million in Q3 and $549 million for the first nine months, versus $360 million and $381 million in the comparable 2012 periods. Management expects litigation accruals to remain elevated and fluctuate.
- The reported continuing-operations effective tax rates were 25.3% for Q3 and 26.1% year to date. Discrete tax benefits included $73 million related to foreign tax credit planning and, for the nine-month period, additional benefits of $81 million from the Relief Act and $61 million from reserve remeasurement. Excluding the identified benefits, management reported annualized rates of 30.8% for Q3 and 30.7% year to date.
Outlook, risks and contingencies
The filing provides no numerical earnings or revenue guidance. Management reported modest improvement in global markets but cited continuing uncertainty around U.S. monetary policy and fiscal issues, European sovereign debt and emerging-market growth. It expected Wealth Management loans and lending commitments to continue growing. Management also expects elevated, variable litigation accruals.
Key risks include market, credit, liquidity, funding, legal, tax and regulatory exposures. The filing reports $158.9 billion of commitments, including lending and forward-starting securities financing; these amounts may expire unused and do not represent expected cash funding. Mortgage-related litigation and investigations remain significant, and some potential losses cannot be reasonably estimated. Credit-rating downgrades could trigger additional collateral requirements; the filing estimates potential calls under specified rating scenarios, including $4.257 billion of OTC collateral at Baa3/BBB-. The Company also reported $95.2 billion of corporate lending exposure, including unfunded commitments, and substantial derivative notionals; notionals are not equivalent to expected loss.
U.S. Basel III requirements were scheduled to begin in 2014, with key elements phased in over subsequent years. Morgan Stanley estimated a pro forma Common Equity Tier 1 ratio of approximately 10.8% under the new rules, subject to regulatory model approvals and other assumptions. The estimate is preliminary and non-GAAP. The filing also describes proposed enhanced leverage and liquidity requirements whose ultimate effects were uncertain.
Important facts for investors to verify
- How much of the earnings rebound reflects reduced DVA losses versus underlying trading and business performance.
- Whether Wealth Management deposit transfers, fee-based flows and loan growth continue as planned, and how they affect funding costs and margins.
- Future litigation outcomes, accruals and possible losses beyond recorded reserves, particularly for mortgage-related matters.
- The effect of Basel III, proposed leverage and liquidity rules, and any regulatory model approvals on capital ratios and distributions.
- Liquidity and refinancing needs, including the $24.2 billion of long-term borrowings due within 12 months and potential downgrade-related collateral calls.