Morgan Stanley — 2017 Form 10-K
Business context and reporting period. This annual report covers the year ended December 31, 2017, with 2016 as the principal comparison. Morgan Stanley is a global financial services firm operating through Institutional Securities, Wealth Management and Investment Management. It reported 57,633 employees worldwide.
Financial performance
| Metric | FY 2017 | FY 2016 | Change |
|---|---|---|---|
| Net revenues | $37.945 billion | $34.631 billion | Up 10% |
| Income before tax | $10.403 billion | $8.848 billion | Up 18% |
| Net income applicable to Morgan Stanley | $6.111 billion | $5.979 billion | Up 2% |
| Diluted EPS | $3.07 | $2.92 | Up 5% |
| Net interest income | $3.300 billion | $3.698 billion | Down 11% |
| Total non-interest expenses | $27.542 billion | $25.783 billion | Up 7% |
Reported results include a $968 million intermittent net discrete tax provision, principally related to the Tax Act. Excluding intermittent discrete tax items, management presented non-GAAP net income of $7.079 billion and diluted EPS of $3.60, versus $5.911 billion and $2.88 in 2016. These adjusted figures are not GAAP measures.
- Margins and returns: Income before tax was 27% of net revenues, versus 26% in 2016. Reported ROE was 8.0% in both years; adjusted ROE was 9.4% in 2017 versus 7.9% in 2016. Reported ROTCE was 9.2% versus 9.3%; adjusted ROTCE was 10.8% versus 9.1%.
- Segments: Institutional Securities revenue rose 8% to $18.813 billion, with investment banking the main driver; net income applicable to Morgan Stanley was $3.536 billion, down 3%. Wealth Management revenue rose 10% to $16.836 billion and segment net income rose 11% to $2.325 billion. Investment Management revenue rose 22% to $2.586 billion and segment net income rose 9% to $246 million, helped by stronger investment and performance gains.
- Cash flow: Operating cash flow was negative $4.505 billion, investing cash flow was negative $12.391 billion and financing cash flow was positive $16.261 billion. Cash and cash equivalents ended the year at $80.395 billion, including $34.231 billion of restricted cash.
- Balance sheet and funding: Total assets were $851.733 billion, up from $814.949 billion. Loans were $104.126 billion; deposits were $159.436 billion; borrowings were $192.582 billion, up from $165.716 billion. Total liabilities were $773.267 billion and Morgan Stanley shareholders’ equity was $77.391 billion.
- Liquidity and capital: The Global Liquidity Reserve was $192.660 billion, down from $202.297 billion. The reported LCR was 128%, above the 100% minimum. Standardized CET1, Tier 1 and total capital ratios were 16.5%, 18.9% and 21.7%, respectively; the Tier 1 leverage ratio was 8.3%.
Material changes versus 2016
- Revenue growth was broad-based: Institutional Securities benefited from higher investment banking revenue; Wealth Management from asset-management revenue and net interest income; and Investment Management from investment gains and asset-management revenue.
- Net interest income fell as interest expense increased faster than interest income. Total expenses also rose, including compensation and benefits, up 8%, and non-compensation expenses, up 5%; management cited higher revenue-linked compensation, volume-related costs and litigation costs.
- Assets under management or supervision at Investment Management increased to $482 billion from $417 billion. Wealth Management client assets rose to $2.373 trillion from $2.103 trillion, with fee-based assets increasing to $1.045 trillion from $877 billion.
- Borrowings increased, while the Global Liquidity Reserve declined. The reported CET1 ratio was 16.5%, compared with 16.9% in 2016; the firm notes the comparison uses different transitional approaches in the two years.
Outlook, commentary, risks and unusual items
- Guidance: Management set a medium-term ROE target of 10%–13%, equivalent to ROTCE of 11.5%–14.5%. It expected a 2018 effective tax rate of approximately 22%–25%, subject to geographic earnings mix, share-based awards and evolving Tax Act interpretation.
- Tax Act: The filing describes an approximately $1.2 billion net discrete tax provision from enactment, primarily from remeasurement of deferred tax assets. The $968 million intermittent provision used in the reported-results comparison reflects the filing’s discrete-tax presentation and related offsets. A post-earnings estimate revision increased tax expense by $43 million.
- Legal and contingencies: The firm faces mortgage-related, trading, tax and other proceedings. It disclosed a potential loss of up to approximately $3.3 billion in an Italian claim concerning sovereign derivative transactions, plus interest; it contests liability. It also identified substantial potential exposures in several legacy RMBS matters. Management said it did not expect proceedings to materially adversely affect overall financial condition, but outcomes could materially affect results or cash flows in a particular period. Loss estimates are uncertain.
- Other notable items: The fourth quarter included a $53 million impairment of an Investment Management equity-method investment. The firm repurchased $3.75 billion of common stock in 2017 and declared $0.90 per common share in dividends for the year. Its 2017 capital plan authorized up to $5 billion in repurchases through June 30, 2018, subject to regulatory approval.
- Principal risks: Market, credit, liquidity, operational and cybersecurity risks; regulatory and capital changes; legal proceedings; competition and pricing pressure; valuation uncertainty; tax-law implementation; and international/geopolitical uncertainty, including Brexit. The firm also noted funding sensitivity to credit ratings and potential collateral calls following downgrades.
- Audit: Deloitte & Touche issued an unqualified opinion on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Reconcile reported earnings with the effect of the Tax Act and other discrete tax items; assess the assumptions behind the 2018 tax-rate outlook.
- Review the quarterly and segment results, especially the extent to which Investment Management gains and Wealth Management asset growth recur, and the effect of rising expenses and lower net interest income.
- Assess the quality and liquidity of assets, the growth and composition of loans and lending commitments, and the decline in the Global Liquidity Reserve.
- Examine capital requirements, forthcoming TLAC and leverage constraints, regulatory approval for capital returns, and the firm’s ability to meet its medium-term return targets.
- Track legal developments and reserves for the Italian derivative claim, legacy RMBS matters, Dutch tax-credit dispute and other investigations; potential outcomes and timing remain uncertain.