Morgan Stanley — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Morgan Stanley is a global financial services firm operating through Institutional Securities, Wealth Management, and Investment Management.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net revenues | $8.503B | $6.942B | $16.661B | $13.866B |
| Income before tax, continuing operations | $1.775B | $937M | $3.357B | $1.139B |
| Net income | $1.191B | $750M | $2.422B | $884M |
| Net income applicable to Morgan Stanley | $980M | $591M | $1.942B | $497M |
| Diluted EPS | $0.41 | $0.29 | $0.89 | $0.23 |
| Net interest | $204M | $(160)M | $389M | $(219)M |
| Non-interest expenses | $6.728B | $6.005B | $13.304B | $12.727B |
Q2 pretax margin was approximately 20.9%, compared with 13.5% a year earlier (calculated from reported continuing-operations pretax income and net revenues). Reported Q2 diluted EPS included a $151M, or about $0.08 per share, negative adjustment associated with buying Citi’s remaining Wealth Management JV interest. DVA contributed $175M of Q2 revenue, versus $350M in Q2 2012. Excluding DVA, management reported Q2 net revenues of $8.328B and continuing-operations diluted EPS of $0.37, versus $6.592B and $0.16, respectively.
- Institutional Securities: Q2 net revenues were $4.346B versus $3.332B; pretax income was $960M versus $488M. Investment banking revenues rose 22%; sales and trading benefited from stronger equity, foreign exchange and commodities activity. Higher litigation accruals and volume-driven expenses weighed on costs.
- Wealth Management: Q2 net revenues were $3.531B versus $3.196B; pretax income was $655M versus $410M. Client assets were $1.778T, fee-based assets $629B, and quarterly fee-based flows $10B.
- Investment Management: Q2 net revenues were $673M versus $456M; pretax income was $160M versus $43M, reflecting higher investment gains, including Merchant Banking, and higher management fees.
Balance sheet, cash flow, and capital
- At June 30, total assets were $802.7B, up from $781.0B at year-end 2012. Morgan Stanley shareholders’ equity was $63.2B and total equity was $66.1B.
- Cash and cash equivalents were $47.2B. The reported Global Liquidity Reserve was $181B, including cash and unencumbered highly liquid securities; management stated that liquidity stress tests showed sufficient liquidity for current and contingent obligations.
- Long-term borrowings were $161.1B, down from $169.6B at year-end; short-term borrowings were $2.4B. Deposits were $81.5B. The company issued approximately $22B of long-term notes and had approximately $23B mature or retire during the first half.
- First-half operating cash flow was $18.4B, investing cash flow was $(6.6)B, and financing cash flow was $(10.4)B. Cash increased by $295M. Financing included the $4.725B purchase of Citi’s remaining Wealth Management JV stake.
- Under the then-current Basel I framework, Tier 1 common, Tier 1 and total capital ratios were 11.8%, 14.1% and 14.9%; Tier 1 leverage was 7.1%. The company estimated a preliminary 9.9% pro forma Common Equity Tier 1 ratio under the U.S. Basel III final rule, subject to assumptions and regulatory model approvals.
Material changes, outlook, and risks
- On June 28, Morgan Stanley acquired Citi’s remaining 35% of the Wealth Management JV for $4.725B, taking ownership to 100%. The related deposit-sweep agreement ended; approximately $57B of customer deposits were to transfer to Morgan Stanley depositories over 24 months. About $17B transferred in July 2013.
- Q2 and first-half performance improved substantially year over year, but the filing provides no numerical earnings or revenue guidance. Management described global conditions as modestly improved while noting concerns about U.S. monetary-policy changes, rising rates and market volatility, European sovereign debt, U.S. fiscal issues, and slower emerging-market growth.
- Litigation accruals increased by approximately $199M in Q2 and $270M in the first half, versus $4M and $21M in the comparable 2012 periods. The filing describes significant mortgage-related litigation and other proceedings; some possible losses are not reasonably estimable. It also reports new mortgage repurchase and representation-and-warranty claims and a European Commission statement of objections concerning the credit default swap market.
- Rising interest rates caused $342M of Q2 after-tax unrealized losses on available-for-sale securities and contributed to a first-half $369M after-tax loss in accumulated other comprehensive income. Management said it did not intend or expect to be required to sell these securities before recovery.
- The first-half effective tax rate was 26.4%; results included $142M of discrete tax benefits. Excluding those benefits, management stated the annualized effective tax rate would have been 30.7% in its MD&A discussion.
- The U.S. Basel III final rule was issued in July 2013 and was scheduled to begin taking effect in 2014, with requirements phased in. The filing also describes proposed higher leverage requirements and possible restrictions on distributions if required capital buffers are not maintained.
Important facts for investors to verify
- Whether revenue and earnings momentum persists excluding DVA and other fair-value effects, and how expenses—particularly compensation and litigation—trend.
- Execution, costs and expected benefits of full Wealth Management JV ownership, including the timing and retention of the approximately $57B deposit transfers.
- Potential mortgage, representation-and-warranty, and CDS-market legal or regulatory losses, including matters for which the filing says losses cannot currently be estimated.
- How Basel III implementation, model approvals and proposed leverage rules affect capital ratios, capital distributions and the stated 9.9% preliminary pro forma CET1 estimate.
- Liquidity and funding resilience under stress, including rating-triggered collateral needs; the filing reports $181B of Global Liquidity Reserve and possible additional collateral calls under specified downgrade scenarios.