Morgan Stanley — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited interim statements; dollars in millions unless noted. Morgan Stanley operates Institutional Securities, Global Wealth Management Group, and Asset Management.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net revenues | $9,282 | $7,963 | $16,917 | $17,035 |
| Non-interest expenses | $7,338 | $6,260 | $14,101 | $12,817 |
| Income from continuing operations before tax | $1,944 | $1,703 | $2,816 | $4,218 |
| Net income | $1,406 | $1,984 | $2,536 | $3,995 |
| Net income applicable to Morgan Stanley | $1,193 | $1,960 | $2,161 | $3,736 |
| Common diluted EPS | $(0.38) | $1.09 | $0.13 | $2.08 |
Q2 revenue rose 17% year over year, while expenses rose 17%; six-month revenue was slightly lower and expenses were 10% higher. Q2 continuing-operations income applicable to Morgan Stanley was $1,189 million versus $1,439 million. Reported Q2 common EPS included a one-time, non-cash $1.7 billion, or approximately $1.02 per diluted share, charge from the MUFG preferred-stock conversion. Q2 net income therefore does not translate into positive common EPS.
- Revenue mix: Q2 investment banking revenue rose to $1,695 million from $1,080 million. Asset management, distribution and administration fees rose to $2,206 million from $1,974 million. Trading revenue was $3,485 million versus $3,353 million; investment gains were $402 million versus a $52 million loss.
- Net interest: Negative $72 million in Q2, compared with positive $141 million; negative $71 million for the six months, compared with positive $509 million. Interest expense growth outpaced interest income.
- Segment results: Q2 net revenue was $5,189 million for Institutional Securities, $3,476 million for Global Wealth Management, and $645 million for Asset Management. Pre-tax income was $1,457 million, $322 million, and $165 million, respectively. Institutional Securities’ six-month results included a $672 million loss from the Japanese securities joint venture.
- Cash flow: Six-month operating cash flow was a use of $5,174 million, versus a source of $29,393 million in 2010; investing cash flow was a source of $4,888 million and financing cash flow a source of $2,748 million. Cash and cash equivalents ended the period at $50,747 million, up $3,132 million from year-end.
Balance sheet, capital and liquidity
- Total assets were $830.7 billion at June 30, up from $807.7 billion at December 31, 2010; total equity was $68.1 billion, including $59.7 billion of Morgan Stanley shareholders’ equity.
- Long-term borrowings were $196.1 billion, up from $192.5 billion; deposits were $65.5 billion. Other secured financings rose to $22.5 billion from $10.5 billion, including a change in accounting for certain physical-commodities transactions that had no reported earnings impact.
- Regulatory capital ratios were 16.7% Tier 1 and 18.3% total capital, versus 16.1% and 16.5% at year-end. Tier 1 leverage was 6.0%, down from 6.6%. Management reported compliance with Basel I requirements and estimated a preliminary Basel III Tier 1 common ratio range of 8%–10% by end-2012.
- The Global Liquidity Reserve was $182 billion at quarter-end, including $82 billion at the parent and $100 billion at subsidiaries. Management stated it could be monetized within five business days under stress; subsidiary liquidity may not be available to the parent if legal, regulatory or tax constraints apply.
Material changes, outlook and risks
- MUFG conversion: On June 30, MUFG converted preferred stock with $7.8 billion face value into 385.5 million common shares. The conversion increased common equity but generated the non-cash EPS charge described above.
- Other unusual items: Six-month results included a $447 million tax benefit from remeasuring a deferred tax asset and reversing a valuation allowance related to the Revel disposal. Excluding it, management stated the six-month effective tax rate would have been 26.0%, versus a reported 10.2%. Q2 included $471 million of Monoline-related gains; the comparable 2010 quarter had $186 million of losses. Asset Management results also benefited from real-estate investment valuation gains.
- Legal contingencies: A court entered a $269 million judgment for Citibank in the Capmark dispute; Morgan Stanley appealed. The company estimated potential losses of up to approximately $240 million plus interest, fees and costs in the China Development Industrial Bank case, and up to approximately $223 million plus related amounts in the MBIA case. The filing also describes expanding residential-mortgage litigation; some exposures could not be reasonably estimated.
- Market and regulatory risks: Management cited slowing growth, European sovereign-debt concerns, U.S. debt-ceiling uncertainty, and continuing real-estate challenges. Dodd-Frank, Basel III and other regulatory changes could raise costs, capital or liquidity requirements, or restrict activities. The filing’s risk discussion also notes the August 5, 2011 U.S. sovereign downgrade, after quarter-end.
- Subsequent items: The board declared a $0.05 common dividend payable August 15, 2011. Long-term borrowings, net of repayments, increased approximately $1.5 billion through July 31. A newly enacted U.K. bank levy was expected to cost approximately $125 million for 2011, subject to change; accruals were to begin in Q3.
Most important facts for investors to verify
- How much of reported earnings and EPS reflects recurring operations versus the MUFG conversion charge, the Revel-related tax benefit, Monoline gains, and investment valuation gains?
- Whether MUMSS performance stabilizes after the $672 million six-month equity-method loss and the transfer of fixed-income trading risk.
- The status, accrued reserves and potential cash impact of the cited litigation and mortgage representations-and-warranties claims.
- Whether liquidity remains accessible across the parent and regulated subsidiaries under stress, and how funding costs respond to ratings or market changes.
- How final Basel III and Dodd-Frank rules affect capital ratios, business activities, costs and the preliminary 8%–10% Tier 1 common ratio estimate.