Morgan Stanley — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012. Dollar amounts are in millions unless stated otherwise. Morgan Stanley is a global financial-services holding company with Institutional Securities, Global Wealth Management Group and Asset Management segments. The interim financial statements were reviewed by Deloitte; they were not audited.
Financial results and position
| Metric | Q1 2012 | Q1 2011 / comparison |
|---|---|---|
| Net revenues | $6,935 | $7,574; down 8% |
| Income from continuing operations before tax | $203 | $901 |
| Consolidated net income | $134 | $1,130 |
| Net income attributable to Morgan Stanley | Loss of $94 | Income of $968 |
| Common shareholder earnings / diluted EPS | Loss of $119 / loss of $0.06 | Income of $736 / $0.50 |
| Net interest | Expense of $59 | Income of $6 |
| Non-interest expenses | $6,732 | $6,673 |
| Operating cash flow | Provided $7,431 | Used $1,322 |
Margins: Continuing-operations pre-tax income was approximately 2.9% of net revenues, versus 11.9% a year earlier. Net income attributable to Morgan Stanley was negative despite positive consolidated net income, principally because $228 million of consolidated income was attributable to noncontrolling interests.
Balance sheet at March 31: Total assets were $781.0 billion, up from $749.9 billion at December 31, 2011; total equity was $70.6 billion, compared with $70.1 billion. Long-term borrowings were $176.7 billion, down from $184.2 billion; senior indebtedness was approximately $166 billion. Cash and cash equivalents were $38.7 billion at quarter-end, down from $47.3 billion at the start of the quarter. Deposits were $66.4 billion and short-term borrowings $2.0 billion.
Liquidity and capital: The Global Liquidity Reserve was $179 billion at March 31; average total liquidity for the quarter was $178 billion, versus $172 billion in Q1 2011. Management said liquidity stress tests showed sufficient resources for modeled current and contingent obligations. Basel I Tier 1 common, Tier 1 and total capital ratios were 13.3%, 16.8% and 18.1%, respectively; the Tier 1 leverage ratio was 7.0%. Management estimated a preliminary Basel III Tier 1 common ratio of 8%–10% by year-end 2012, subject to change and not a firm projection.
Material changes and segment performance
- Major accounting-driven drag: GAAP net revenues included a $1.978 billion negative impact from tightening in Morgan Stanley’s own credit spreads on fair-value-accounted borrowings, compared with $189 million negative impact in Q1 2011. Excluding this item, management reported non-GAAP net revenues of $8.913 billion and continuing-operations diluted EPS of $0.71, versus $7.763 billion and $0.59. These adjusted figures are not GAAP results.
- Institutional Securities: Net revenues fell to $3.023 billion from $3.568 billion; continuing-operations pre-tax result shifted to a $312 million loss from $432 million income. Excluding the own-credit-spread impact, fixed income and commodities sales-and-trading revenue rose 34%, and equity sales-and-trading revenue rose 6%. Investment banking revenue declined 16% to $851 million. Segment expenses increased 6%, including severance expense.
- Global Wealth Management Group: Net revenues were broadly flat at $3.414 billion; pre-tax income increased to $387 million from $344 million. Client assets reached $1.744 trillion, but fee-based net inflows fell to $8.7 billion from $17.5 billion.
- Asset Management: Net revenues declined to $533 million from $622 million, while pre-tax income was $128 million versus $125 million. Assets under management or supervision increased to $304 billion from $276 billion, primarily reflecting market appreciation; net flows were approximately flat.
- Non-interest expenses were nearly flat overall. Compensation and benefits rose to $4.431 billion from $4.285 billion and included $138 million of severance expense; non-compensation expenses declined.
Outlook, commentary, risks and unusual items
- Management described global conditions as modestly improved from 2011 year-end, but still challenged by European sovereign-debt concerns, a muted U.S. recovery and slower emerging-market growth. No company earnings guidance was provided in the filing.
- The prior-year comparison benefited from a $447 million discrete tax benefit; Q1 2012 continuing-operations tax expense was $54 million, at a 26.5% effective rate. Q1 2011 had a 27.1% tax benefit, including that discrete item.
- Saxon’s asset sale was restructured, with its first phase completed in Q2 2012; remaining operations were expected to wind down during the year, with incremental costs anticipated. Quilter’s U.K. sale closed April 2, 2012. Both businesses were reported as discontinued operations.
- The company cited material exposure to litigation and regulatory matters, including mortgage-related claims. Disclosed matters included an appealed $269 million judgment in the Capmark case and estimated potential losses of up to approximately $240 million in the CDIB matter, plus interest, fees and costs. Some other potential losses could not be reasonably estimated. An April 2012 Federal Reserve consent order concerning Saxon mortgage servicing requires remediation, independent review and reporting; potential penalties or compensatory payments were not determined.
- Credit downgrades could trigger additional collateral or termination payments. The filing disclosed $34.7 billion fair value of OTC derivatives with credit-related contingent features in a net liability position and, under specified downgrade scenarios, material additional collateral or payment requirements. Ratings were split, and Moody’s had placed Morgan Stanley’s ratings on review for downgrade.
- Valuation and market risks remain significant: Level 3 assets were $29.7 billion before netting, and reported fair values depend in part on unobservable inputs. Other risks include credit exposure, funding-market disruption, regulatory changes (including Basel III, Dodd-Frank and the Volcker Rule), and tax examinations. Management reported no goodwill impairment in its March 2012 assessment.
- On April 19, 2012, the board declared a $0.05 quarterly common dividend. The Federal Reserve had not objected to the company’s 2012 capital plan, including current dividends and a potential additional 14% acquisition of MSSB.
Important facts for investors to verify
- Reconcile the $1.978 billion own-credit-spread charge and evaluate the adjusted, non-GAAP results separately from GAAP earnings.
- Track whether Institutional Securities trading and investment banking performance, and Wealth Management fee-based flows, persist beyond this quarter.
- Assess liquidity availability at the parent versus regulated subsidiaries, debt maturities, ratings-related collateral calls and the remaining TLGP-guaranteed debt.
- Monitor mortgage-related litigation, the Saxon consent-order remediation and wind-down costs, and the resolution of tax audits and unquantified contingencies.
- Review the assumptions behind Level 3 valuations, the preliminary Basel III capital estimate, and the effect of forthcoming regulatory requirements.