Morgan Stanley — Q1 2018 Form 10-Q Summary
Business context and reporting period
Morgan Stanley is a global financial services firm operating through Institutional Securities, Wealth Management and Investment Management. This unaudited quarterly report covers the three months ended March 31, 2018; comparisons are with Q1 2017 unless otherwise stated.
Financial performance and key metrics
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Net revenues | $11.077 billion | $9.745 billion; up 14% |
| Net income applicable to Morgan Stanley | $2.668 billion | $1.930 billion; up 38% |
| Diluted EPS | $1.45 | $1.00 |
| Income from continuing operations before tax | $3.420 billion | $2.808 billion; up 22% |
| Total non-interest expenses | $7.657 billion | $6.937 billion; up 10% |
| Pre-tax profit margin | 31% | 29% |
| ROE / ROTCE | 14.9% / 17.2% | 10.7% / 12.3% |
| Net interest income | $975 million | $771 million |
| Cash from operating activities | $12.648 billion | $90 million |
Operating cash flow was strongly affected by changes in trading assets and liabilities; it should not be read as a simple measure of recurring cash earnings. The Q1 2018 effective tax rate was 20.9%, versus 29.0% a year earlier.
Segment results: Institutional Securities revenue was $6.100 billion, up 18%, and net income applicable to Morgan Stanley was $1.627 billion, up 34%. Wealth Management revenue was $4.374 billion, up 8%, and net income was $914 million, up 41%. Investment Management revenue was $718 million, up 18%, and net income was $127 million, up 90%.
At March 31, total assets were $858.5 billion, loans $109.1 billion, deposits $160.4 billion, borrowings $195.0 billion and common shareholders’ equity $69.5 billion. Cash and cash equivalents were $87.3 billion, including $35.3 billion of restricted cash. The Global Liquidity Reserve was $206.5 billion; the average quarterly Liquidity Coverage Ratio was 121%.
Regulatory capital ratios were 15.5% CET1, 17.7% Tier 1 and 20.3% total capital; the supplementary leverage ratio was 6.3%. These Q1 ratios use fully phased-in rules, while the December 2017 comparison used transitional rules. The average quarterly LCR fell from 128% at Q4 2017, primarily because lending commitments increased.
Material changes versus comparable periods
- Institutional Securities growth was led by sales and trading: equity sales and trading revenue rose 27% and fixed income rose 9%. Investment banking revenue increased 7%; advisory and equity underwriting improved, while fixed income underwriting declined.
- Wealth Management asset management revenue rose 14%, reflecting market appreciation and positive flows in average fee-based assets. Transactional revenue fell 9%, mainly because trading revenue declined.
- Investment Management asset management revenue grew 21%, reflecting higher average assets under management; investment gains fell 21%, primarily due to lower carried interest in certain private equity funds.
- Compensation and benefits increased 10% to $4.914 billion, reflecting higher discretionary incentives and Wealth Management payout linked to revenues. Non-compensation expenses rose 11% to $2.743 billion, partly reflecting higher activity and accounting presentation changes.
- Loans and lending commitments increased by about $25 billion during the quarter, mainly from Institutional Securities corporate commitments. Total assets increased by $6.8 billion from year-end.
Outlook, commentary, risks and unusual items
- Management’s medium-term targets, established in January 2018, are ROE of 10%–13% and ROTCE of 11.5%–14.5%. Management cautions that market conditions, regulation, trading and investment-banking volumes, expenses, capital and discrete tax items may affect results.
- The Firm expected a 2018 effective tax rate of approximately 22%–25%, subject to evolving interpretation and implementation of the Tax Act. Q1’s 20.9% rate included $147 million of tax benefits associated with employee share-based payments.
- Accounting changes adopted in Q1 included revenue recognition, hedge accounting and reclassification of certain Tax Act-related tax effects. The revenue standard increased reported revenue and expense through gross presentation; the filing reports a $79 million increase to both net revenues and non-compensation expenses from this presentation. Adoption of the revenue standard reduced retained earnings by $32 million, net of tax. The hedge-accounting adoption reduced retained earnings by $99 million; the AOCI tax reclassification increased retained earnings by $443 million.
- Credit exposure and commitments warrant attention: the allowance was $243 million for loans and $205 million for lending commitments. Most Institutional Securities and Wealth Management loans held for investment were current, but expanded lending commitments may increase future funding and credit exposure.
- Management reported sufficient liquidity under its stress tests and compliance with the minimum 100% LCR. It expected to meet the TLAC and long-term-debt requirements by January 2019. Proposed stress-buffer and supplementary-leverage-rule changes, and the proposed U.S. NSFR, could affect future capital, liquidity and distributions.
- Transition away from LIBOR after 2021 may affect valuations, trading markets, contracts, systems and processes. Other risks include market, credit, liquidity, legal, regulatory, operational and model risk; the filing also discusses uncertainty from Brexit.
- Legal contingencies include mortgage and credit-crisis litigation. The Firm disclosed potential losses of up to approximately $240 million in the CDIB matter and stated that potential losses in several mortgage-related cases could reach roughly $126 million to $277 million each, plus interest, fees or costs; some claims could expand. Separately, on April 26, 2018, an Amsterdam court dismissed the Dutch Tax Authority’s claims concerning approximately €124 million of withholding-tax credits; an appeal remained possible.
- The Firm repurchased $1.25 billion of common stock in Q1 and declared a $0.25-per-share dividend. It submitted its 2018 capital plan on April 5; the Federal Reserve response was expected by June 30, 2018. The independent accountant’s interim review found no material modifications needed; it was a review, not an audit.
Most important facts for investors to verify
- Whether the Q1 revenue and earnings growth persists, particularly the contribution from stronger trading activity and accounting presentation changes.
- How lending growth, including the increase in corporate commitments, affects credit quality, allowances, funding needs and regulatory capital.
- Whether the 2018 tax-rate outlook and medium-term ROE/ROTCE targets remain achievable as tax rules and market conditions evolve.
- The outcome and potential range of loss for material legal matters, and any appeal of the Dutch Tax Authority decision.
- How proposed regulatory capital and liquidity rules, LIBOR transition and the Federal Reserve’s 2018 capital-plan review may affect distributions and funding.
- The composition and usability of reported liquidity, including restricted cash, and the drivers of the unusually high operating cash flow in Q1.