Morgan Stanley 2011 Form 10-K Summary
Reporting period and business: This is Morgan Stanley’s annual report for the year ended December 31, 2011, not a standalone quarterly filing. The firm operates through Institutional Securities, Global Wealth Management Group and Asset Management. It reported 61,899 employees and $1.649 trillion in Global Wealth Management client assets at year-end.
Financial results and key metrics
Unless otherwise noted, amounts are in U.S. dollars; financial statement amounts are in millions.
| Metric | 2011 | 2010 |
|---|---|---|
| Net revenues | $32,403 | $31,387 |
| Non-interest expenses | $26,289 | $25,156 |
| Income from continuing operations before tax | $6,114 | $6,231 |
| Net income | $4,645 | $5,702 |
| Net income applicable to Morgan Stanley | $4,110 | $4,703 |
| Earnings applicable to common shareholders | $2,067 | $3,594 |
| Diluted EPS | $1.23 | $2.63 |
| Total assets at year-end | $749,898 | $807,698 |
| Long-term borrowings at year-end | $184,234 | $192,457 |
- Net revenue grew about 3%, while non-interest expenses rose about 5%. The resulting pre-tax margin was about 18.9%, versus about 19.9% in 2010; non-interest expenses were about 81.1% of net revenue.
- Net interest income fell to $357 million from $897 million. Cash and cash equivalents were $47.3 billion at year-end.
- Cash flow from operating activities was $6.684 billion, investing activities used $2.036 billion, and financing activities used $5.148 billion. Cash and cash equivalents decreased by $303 million during the year; operating cash flow was substantially below 2010’s $40.307 billion.
- Year-end deposits were $65.662 billion. The Global Liquidity Reserve was $182 billion; average liquidity during 2011 was $177 billion. Management said the reserve was designed to meet modeled stress needs and believed it could be monetized within five business days in a stressed environment.
- Regulatory capital ratios at year-end were 17.8% total capital, 16.6% Tier 1 capital, 13.0% Tier 1 common and 6.8% Tier 1 leverage. The filing notes a revised Federal Reserve definition reduced reported Tier 1 common capital by about $4.2 billion and the ratio by 132 basis points.
Fourth-quarter results
The annual report’s unaudited quarterly table reports fourth-quarter net revenues of $5.709 billion and a pre-tax loss from continuing operations of $457 million. Continuing-operations loss was $161 million; net loss was $184 million; net loss applicable to Morgan Stanley was $250 million; and loss applicable to common shareholders was $275 million, or $0.15 per diluted share. Fourth-quarter results included the MBIA settlement loss described below.
Business segment performance
| Segment | 2011 net revenue | 2011 pre-tax income | Change versus 2010 |
|---|---|---|---|
| Institutional Securities | $17.208 billion | $4.585 billion | Revenue rose about 6%; pre-tax income rose from $4.372 billion. |
| Global Wealth Management Group | $13.423 billion | $1.276 billion | Revenue rose about 6%; pre-tax income rose from $1.156 billion. |
| Asset Management | $1.887 billion | $253 million | Revenue fell from $2.685 billion and pre-tax income from $718 million. |
Material changes and unusual items
- Own-credit-spread accounting: Widening of Morgan Stanley’s credit spreads on borrowings carried at fair value added $3.681 billion to 2011 net revenue, compared with a $873 million reduction in 2010. This accounting effect materially affected reported revenue and is distinct from ordinary client-business performance.
- MBIA settlement: The December 2011 settlement resulted in an approximately $1.7 billion pre-tax loss, or $1.1 billion after tax, recorded in fixed income and commodities revenue. The settlement terminated specified CMBS credit protection and resolved litigation with MBIA. The firm said it reduced risk-weighted assets under the proposed Basel III framework.
- MUFG conversion and dilution: MUFG converted preferred stock with an $8.1 billion carrying value into 385.5 million Morgan Stanley common shares in June. The conversion generated a one-time, non-cash $1.7 billion reduction in the calculation of common EPS, approximately $0.98 per diluted share. Common shares outstanding increased to 1.927 billion from 1.512 billion.
- Japan joint venture: Morgan Stanley recorded a $783 million loss in 2011 from its 40% stake in Mitsubishi UFJ Morgan Stanley Securities (MUMSS), versus $62 million in 2010. MUFG provided capital to MUMSS; Morgan Stanley said it was not obligated to restore MUMSS capital for losses, though it could be required to contribute for certain regulatory-capital increases.
- Other notable effects: Restructuring certain derivatives reduced European peripheral exposure and generated about $600 million, primarily from releasing credit valuation adjustments. The firm also recorded $130 million in initial costs for its China securities joint venture, a $59 million U.K. bank levy charge and a $108 million fourth-quarter loss from applying the OIS curve to additional fixed-income products.
Outlook, risks and contingencies
- The filing does not provide a conventional revenue or earnings forecast. Management estimated a preliminary Basel III Tier 1 common ratio of 8% to 10% by year-end 2012, subject to regulatory rules and implementation assumptions. The firm planned to continue regulatory capital planning and stress testing.
- Management identified the European sovereign-debt crisis, market volatility, funding access and credit ratings, counterparty and credit risk, litigation, real estate exposures, competition, operational and cyber risks, and regulatory change as significant risks. At January 3, 2012, European peripheral exposure was approximately $5.044 billion before hedges and $3.056 billion after hedges; year-end overnight deposits with banks in those countries were about $448 million.
- Regulatory changes remained uncertain, including the Dodd-Frank Act, the Volcker Rule, derivatives regulation and Basel III. Morgan Stanley had announced plans to dispose of its Process-Driven Trading unit by the end of 2012; the unit did not materially affect 2011 financial condition, results or liquidity.
- Mortgage-related litigation and representations and warranties could lead to further losses. The filing describes numerous mortgage securities claims and investigations, and says some potential losses cannot be reasonably estimated. The maximum potential payout disclosed for securitization representations and warranties was $83.544 billion; this is a contractual exposure measure, not an estimate of expected loss. The firm had recorded $24 million for residential-mortgage representation and warranty payments owed at year-end.
- A court entered a $269 million judgment against the firm in the Citibank/Capmark matter; Morgan Stanley appealed. It also disclosed ongoing RMBS-related proceedings and investigations, and said it was cooperating with U.S. authorities concerning a previously identified China matter involving apparent Foreign Corrupt Practices Act violations.
- Total commitments disclosed were $115.612 billion, including lending commitments and forward-starting securities financing transactions; commitments may expire unused and do not necessarily represent future cash needs. Long-term borrowings due in 2012 were $35.082 billion.
- The common dividend was $0.05 per share each quarter in 2011, and a $0.05 quarterly dividend was declared in January 2012. Share repurchases under the authorized program were subject to regulatory approval; none were made under that program in 2011.
Most important facts for investors to verify
- How much of reported revenue and earnings depended on the $3.681 billion own-credit-spread benefit, and how underlying trading performance compares after that effect and other unusual items.
- The sources and sustainability of the sharp year-over-year decline in common-shareholder earnings, including the MBIA loss, MUMSS losses, tax items and the non-cash MUFG conversion adjustment.
- Capital adequacy under final Basel III rules, including the assumptions behind management’s preliminary 8%–10% estimate, and the impact of the enlarged common share count.
- Liquidity availability at the parent versus regulated subsidiaries, upcoming debt maturities, credit-rating downgrade collateral calls and the assumptions in liquidity stress tests.
- The status and potential financial impact of mortgage-related claims, representation-and-warranty obligations, the Capmark appeal and other material legal or regulatory matters.
- Whether the $182 billion liquidity reserve, corporate lending exposures and other contingent commitments remain comparable in later filings; cash flows and balance-sheet amounts can vary materially with trading and financing activity.
Audit and controls: Deloitte & Touche issued unqualified opinions on the 2011 consolidated financial statements and internal control over financial reporting. Management concluded disclosure controls were effective at year-end.