Morgan Stanley — Q2 2016 Form 10-Q
Business context and reporting period. Morgan Stanley is a global financial-services firm operating through Institutional Securities, Wealth Management and Investment Management. This unaudited filing covers the quarter and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods unless otherwise noted. Dollar amounts are in millions except per-share data.
Financial performance and condition
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net revenues | $8,909 | $9,743 | $16,701 | $19,650 |
| Net income applicable to Morgan Stanley | $1,582 | $1,807 | $2,716 | $4,201 |
| Earnings applicable to common shareholders | $1,425 | $1,665 | $2,481 | $3,979 |
| Diluted EPS | $0.75 | $0.85 | $1.30 | $2.03 |
| Net interest income | $913 | $698 | $1,812 | $1,294 |
| Non-interest expenses | $6,426 | $7,016 | $12,480 | $14,068 |
| Pre-tax margin | 28% | 28% | 25% | 28% |
- Q2 annualized return on average common equity was 8.3%, versus 9.9% in Q2 2015; the six-month returns were 7.2% and 12.0%, respectively. The prior-year six-month return was 9.6% excluding DVA and a discrete tax benefit.
- Six-month operating cash flow was $16,266, compared with cash used of $8,453 in 2015. Investing activities used $12,414 and financing activities used $2,516. Cash and cash equivalents increased $2,050 to $56,133.
- At June 30, total assets were $828,873 and total equity was $78,375. Long-term borrowings were $163,492, up from $153,768 at year-end 2015; deposits were $152,693, down from $156,034.
- The Global Liquidity Reserve was $207,455, up from $203,264 at December 31, 2015. The firm reported a 16.8% Common Equity Tier 1 ratio, an 18.8% Tier 1 ratio, a 22.4% total capital ratio and an 8.3% Tier 1 leverage ratio under the stated transitional approaches.
Material changes versus comparable periods
- Q2 net revenues declined about 9%; six-month net revenues declined 15%. Common earnings fell about 14% in Q2 and 38% for the six-month period.
- Institutional Securities: revenues were $4,578 in Q2, down 11%, and $8,292 for six months, down 22%. Lower underwriting and sales-and-trading results outweighed stronger M&A advisory. Q2 investment banking revenue fell 23%, as underwriting declined 40% while advisory rose 17%.
- Wealth Management: revenues were $3,811 in Q2, down 2%, and $7,479 for six months, down 3%. Lower transactional revenues were partly offset by stronger net interest income, which rose 12% in Q2 and 16% for six months.
- Investment Management: revenues were $583 in Q2, down 22%, and $1,060 for six months, down 25%, mainly reflecting lower investment gains and carried interest; management fees were broadly stable.
- Lower compensation and benefits and non-compensation costs partly cushioned revenue pressure. Compensation fell 9% in Q2 and 14% year to date; management cited lower incentive compensation and headcount. Non-compensation costs fell 8% and 7%, primarily due to lower litigation and selected operating expenses.
- Loan balances grew: total loans, net of allowance, were $93,165 versus $85,759 at year-end 2015. The allowance for loan losses increased to $323 from $225, reflecting, among other factors, specific reserves on energy exposures and other downgrades.
Outlook, commentary, risks and unusual items
- Management’s stated return-on-equity objective is to improve return on average common equity excluding DVA by 2017, subject to successful execution of its strategic objectives. The filing provides no specific quarterly or annual earnings guidance.
- The Federal Reserve gave a conditional non-objection to the 2016 capital plan, including up to $3.5 billion of share repurchases from July 2016 through June 2017 and a quarterly common dividend increase to $0.20. The Federal Reserve also required an additional capital plan by December 29, 2016 to address identified weaknesses in the firm’s capital-planning process; future distributions could be restricted if weaknesses are not satisfactorily addressed.
- The U.K. vote to leave the EU was identified as a source of uncertainty and potential short- and medium-term market volatility, with the eventual regulatory and operating consequences unclear.
- Energy lending is a credit risk: the firm stated that further deterioration in oil or commodity prices could produce additional lending losses. Institutional Securities had $13.5 billion of energy loans and commitments at quarter-end; about 59% was to investment-grade counterparties.
- Legal matters include mortgage-related litigation and other claims. Separately, an Italian public prosecutor invited the firm to respond to a proposed administrative claim of €2.879 billion concerning historical derivatives; the firm disputes the allegations. The filing says the proposed claim is not a final adjudicated liability.
- Unrealized debt valuation adjustments (DVA) moved to other comprehensive income following early adoption of an accounting provision effective January 1, 2016; 2015 results were not restated. This affects period-to-period comparability. The prior-year six-month period also included a $564 million discrete tax benefit, mainly related to repatriation of non-U.S. earnings.
- A $35 million loss was recognized in Q2 in connection with the sale of solar investments and impairment of remaining equity-method solar investments. The firm also reported a $131 million six-month provision for credit losses on lending activities.
- Subsequent events included $3.4 billion of net long-term borrowing increases through July 29, a July issuance of $3.0 billion of senior debt, and planned redemption of $2.8 billion of trust preferred securities.
Important facts for investors to verify
- Reconcile reported earnings and returns with the effects of the DVA accounting change and the prior-year discrete tax benefit.
- Track progress on the Federal Reserve’s capital-planning remediation requirement and the conditions governing planned buybacks and dividends.
- Review developments in the Italian proposed claim, mortgage-related proceedings and other contingencies, including any updated estimated loss ranges.
- Monitor energy-sector credit quality, loan-loss allowances, nonaccrual loans and potential effects of commodity prices.
- Assess liquidity and funding trends, including the Global Liquidity Reserve, secured funding, deposit balances, debt maturities and any rating-triggered collateral requirements.