Morgan Stanley 10-Q Summary
Reporting period: Quarter ended March 31, 2017. Interim financial statements are unaudited; Deloitte conducted a review, not an audit. Morgan Stanley operates Institutional Securities, Wealth Management and Investment Management businesses.
Financial results
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Net revenues | $9.745 billion | $7.792 billion; up 25% |
| Net income applicable to Morgan Stanley | $1.930 billion | $1.134 billion; up 70% |
| Diluted EPS | $1.00 | $0.55 |
| Pre-tax income from continuing operations | $2.808 billion | $1.738 billion |
| Effective tax rate | 29.0% | 33.3% |
| Pre-tax profit margin | 29% | 22% |
| Expense efficiency ratio | 71.2% | 77.7% |
| Net interest income | $771 million | $899 million |
- Non-interest expenses rose 15% to $6.937 billion. Compensation and benefits increased 21% to $4.466 billion, mainly reflecting higher revenue-linked incentives and deferred compensation investment values. Non-compensation expense rose 4% to $2.471 billion, including higher litigation and volume-related costs.
- Q1 included a $112 million tax benefit from adopting new share-based payment accounting; the quarter’s net discrete tax benefit was $98 million. Management describes the share-based payment benefit as recurring-type, but its timing and amount may vary.
- ROE was 10.7%, versus 6.2% in Q1 2016. Management’s 2017 ROE target is 9%–11%; its target calculation excludes DVA and discrete tax items.
Business segments and period changes
- Institutional Securities: Net revenues rose 39% to $5.152 billion; net income applicable to Morgan Stanley was $1.214 billion, versus $591 million. Investment banking revenue increased 43% to $1.417 billion, led by underwriting; advisory revenue fell 16%. Sales and trading benefited from stronger fixed-income results and better market conditions, while equity financing faced higher funding costs.
- Wealth Management: Net revenues rose 11% to $4.058 billion and net income to $647 million, up 31%. Growth reflected higher net interest income, transactional revenue and asset-management fees. Fee-based client assets were $927 billion, up from $877 billion at year-end; quarterly net fee-based asset flows were $18.8 billion.
- Investment Management: Net revenues rose 28% to $609 million and net income applicable to Morgan Stanley was $67 million, versus $50 million. Private-equity and real-estate fund investment gains replaced prior-year losses; expenses increased 17%, mainly due to deferred compensation associated with carried interest. AUM or supervision ended at $421 billion, versus $417 billion at year-end.
Cash flow, balance sheet, debt and liquidity
- Operating cash flow was negative $1.611 billion, compared with positive $4.177 billion in Q1 2016. The filing attributes cash movements principally to changes in trading assets and liabilities and other working-capital balances. Investing cash outflow was $2.168 billion; financing cash inflow was $2.722 billion. Cash and cash equivalents ended at $42.854 billion, down $527 million from year-end.
- Total assets were $832.4 billion, up from $814.9 billion at December 31, 2016, primarily reflecting increased Institutional Securities trading inventory. Loans, net of allowance, were $96.0 billion.
- Long-term borrowings were $172.7 billion, up from $164.8 billion; deposits were $152.1 billion, down from $155.9 billion. Long-term debt weighted-average maturity was 6.4 years. About $23.2 billion of long-term borrowings matured within 12 months. Through April 28, long-term borrowings increased a further approximately $4.6 billion, net of maturities.
- The Global Liquidity Reserve was $197.6 billion, down from $202.3 billion at year-end. Management reported sufficient liquidity under its stress tests and compliance with the fully phased-in U.S. Liquidity Coverage Ratio minimum.
- Advanced Approach transitional capital ratios improved from year-end: CET1 17.4% (16.9%), Tier 1 19.9% (19.0%) and total capital 22.9% (22.0%). The transitional Tier 1 leverage ratio was 8.5% (8.4%). The pro forma supplementary leverage ratio was 6.5% (6.4%).
- The firm repurchased approximately $750 million of common stock in the quarter and issued preferred stock yielding approximately $994 million net proceeds. The Board declared a $0.20 common dividend per share, payable in May.
Outlook, risks and unusual items
- No quarterly earnings or revenue forecast is provided. Management’s stated 2017 ROE target is subject to market and macroeconomic conditions, interest rates, investment-banking and trading activity, legal expenses, regulation, capital levels and discrete tax items.
- Management said actions would be needed to meet the proposed U.S. Net Stable Funding Ratio, if adopted as proposed; it expects to meet the final requirement by its effective date. New capital, leverage, TLAC and long-term debt rules phase in over coming years and could constrain distributions if required buffers are not maintained.
- Market, credit, liquidity, operational, model, legal and regulatory risks remain significant. Average total Management VaR increased to $44 million from $39 million in Q4 2016; no daily trading loss exceeded the 95% one-day VaR in Q1. The filing identifies energy-sector lending exposure of $11.7 billion, including $1.1 billion of loans and $2.1 billion of commitments to oil and gas exploration and production companies; further losses could arise if commodity prices remain weak or decline.
- A one-notch credit downgrade could trigger approximately $1.373 billion of incremental collateral or termination payments under the firm’s broader contractual disclosures. The filing also describes substantial lending commitments, guarantees and off-balance-sheet exposures; stated commitment amounts may not become funded.
- Legal proceedings include legacy mortgage and securitization litigation. Morgan Stanley disclosed estimated potential losses for certain cases, generally excluding interest, fees and costs; plaintiffs may seek to expand claims, and the firm says some matters cannot be reasonably estimated. The aggregate exposure is not stated as a clear single value.
- Other relevant developments include the U.K.’s March 2017 invocation of Article 50, the delayed U.S. Department of Labor conflict-of-interest rule, and pending tax examinations. Management said resolution of identified tax matters could affect a future period’s income or tax rate, but the expected change in unrecognized tax benefits was not estimable.
Important facts for investors to verify
- How much of the earnings improvement reflects durable business performance versus favorable trading conditions, investment gains and the discrete tax benefit.
- Whether Wealth Management asset flows, fee-based assets and net interest income continue to grow, and whether higher rates or funding costs change segment profitability.
- Cash-flow drivers, liquidity-reserve composition and the effect of trading inventory, collateral requirements and debt maturities on funding needs.
- Credit quality and loss trends in corporate, energy, real-estate and securities-based lending, including changes to allowances and commitments.
- Updates to major mortgage/securitization litigation, tax matters, regulatory capital and liquidity rules, and the firm’s progress toward its ROE target.