Morgan Stanley — Q3 2015 Form 10-Q
Business context and period. Morgan Stanley is a global financial services firm with Institutional Securities, Wealth Management and Investment Management businesses. This unaudited quarterly filing covers the three and nine months ended September 30, 2015; balance-sheet comparisons are to December 31, 2014. Deloitte reviewed the interim statements but did not audit them.
Financial performance and position
Amounts are in U.S. dollars; income-statement and cash-flow figures are in millions unless stated otherwise.
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net revenues | $7,767 | $8,907 | $27,417 | $26,511 |
| Income from continuing operations before tax | $1,474 | $2,220 | $7,056 | $6,522 |
| Net income applicable to Morgan Stanley | $1,018 | $1,693 | $5,219 | $5,097 |
| Diluted EPS | $0.48 | $0.83 | $2.51 | $2.49 |
| Net interest income | $762 | $557 | $2,056 | $1,132 |
| Non-interest expenses | $6,293 | $6,687 | $20,361 | $19,989 |
| Consolidated pre-tax margin | 19% | 25% | 26% | 25% |
- Cash flow: Operating activities used $7,963 for the first nine months of 2015, compared with $7,691 provided in the prior-year period. Investing activities used $7,398 versus $23,763; financing activities provided $22,662 versus $12,954. Cash and cash equivalents were $53,518 at September 30, 2015, compared with $46,984 at year-end 2014.
- Balance sheet and funding: Total assets were $834.1 billion, liabilities $757.7 billion and total equity $76.4 billion, compared with $801.5 billion, $729.4 billion and $72.1 billion, respectively, at December 31, 2014. Deposits rose to $147.2 billion from $133.5 billion; long-term borrowings rose to $160.3 billion from $152.8 billion. Long-term borrowing maturities due in the next 12 months were $25.0 billion.
- Liquidity and capital: The Global Liquidity Reserve was $190.9 billion, down from $193.2 billion at year-end. Under transitional U.S. Basel III Advanced Approach rules, CET1 was 14.0%, Tier 1 capital 15.6%, total capital 18.6% and Tier 1 leverage 8.1%. These exceeded the stated minimum ratios. Book value per common share was $34.97; tangible book value per common share was $29.99.
Material changes and segment results
- Q3 net revenues declined 13% year over year and net income applicable to Morgan Stanley fell to $1.018 billion from $1.693 billion. Institutional Securities revenue decreased 14% to $3.904 billion, Wealth Management decreased 4% to $3.640 billion, and Investment Management decreased 59% to $274 million.
- Institutional Securities’ Q3 results reflected lower underwriting, fixed-income trading and other revenues. Equity sales and trading was broadly flat; fixed-income and commodities sales and trading fell 19% reported, and 42% excluding DVA.
- Wealth Management Q3 revenue declined chiefly on lower transactional and other revenues, partly offset by higher net interest income. Net interest revenue increased 25% to $751 million. Client assets were $1.925 trillion versus $2.025 trillion at year-end; fee-based assets were $770 billion versus $785 billion.
- Investment Management’s Q3 revenue and earnings were affected by reversal of previously accrued Asia private-equity carried interest, lower traditional asset-management results and investment losses. It reported a $38 million pre-tax loss from continuing operations for the quarter.
- For the first nine months, net revenues rose 3% and net income applicable to Morgan Stanley rose 2%. Institutional Securities revenue increased 8%, Wealth Management increased 2%, while Investment Management declined 20%.
- Net interest income increased substantially year over year, aided by lower interest expense overall and growth in Wealth Management deposits and lending. Total loans, net of allowance, grew to $78.2 billion from $66.6 billion at year-end.
Outlook, commentary, risks and unusual items
- Outlook: No specific near-term earnings or revenue guidance is provided. Management stated that Wealth Management lending activity had grown and expected that trend to continue. The stated longer-term goal is a sustainable return on average common equity of at least 10% excluding DVA; reported Q3 return was 3.9% excluding DVA, and nine-month return was 8.8% excluding DVA.
- Market conditions: Management described slower emerging-market growth and a sharp Q3 decline in global equity markets amid China-related concerns and uncertainty over U.S. rate increases. The filing identifies market, geopolitical, regulatory, legal, funding, cyber and operational risks as potential drivers of future results.
- DVA and taxes: Q3 net revenues included a positive $435 million DVA effect; nine-month revenues included $742 million. Excluding DVA, Q3 net revenues were $7.332 billion versus $8.692 billion. The 2015 nine-month effective tax rate included a $564 million discrete tax benefit; 2014 included $846 million of discrete benefits. The company’s non-GAAP comparisons excluding DVA and discrete tax benefits showed Q3 diluted EPS of $0.34 versus $0.64 and nine-month EPS of $1.98 versus $1.92.
- Expenses and one-offs: Q3 non-compensation expenses increased 15% overall, with legal expenses of $320 million versus $66 million a year earlier; nine-month legal expenses were $555 million versus $256 million. The Q3 increase included a reserve related to settlement of CDS antitrust litigation; the settlement was subject to court approval. The global oil merchanting unit generated a $69 million impairment charge in the first nine months; the sale closed November 1, 2015 and was not expected to materially affect financial results.
- Legal and contingencies: The company disclosed numerous mortgage-related claims and investigations, including cases with estimated potential losses of up to approximately $149 million, $170 million, $197 million, $240 million, $277 million, $292 million and $527 million, plus interest, fees and costs in certain matters. Plaintiffs may seek to expand some claims, and the company states it cannot estimate losses for certain other proceedings. It also faces foreign-exchange benchmark litigation in Canada. Total commitments were approximately $188.3 billion; these may expire unused and are not necessarily expected cash requirements.
- Capital actions: The Federal Reserve did not object to the 2015 capital plan, which authorized up to $3.1 billion of common-stock repurchases through Q2 2016 and increased the quarterly common dividend to $0.15 per share. The company repurchased approximately $1.5 billion of stock in the first nine months and declared a further $0.15 dividend in October.
- Regulatory developments: The filing discusses evolving Basel III capital requirements, a 3% G-SIB surcharge under the Federal Reserve’s final rule, and a proposed TLAC framework. Management was evaluating the proposal’s potential impact. Future capital ratio comparisons may also reflect changes in regulatory methods, not just changes in the company’s capital or risk profile.
Important facts for investors to verify
- Reconcile Q3 earnings and returns with the large DVA contribution and the prior-year discrete tax benefit; assess the company’s non-GAAP adjustments alongside GAAP results.
- Review the drivers and sustainability of lower Institutional Securities revenues and Investment Management’s carried-interest reversal and investment losses.
- Track the growth and credit quality of Wealth Management and corporate lending, including energy exposure and the allowance for loan and commitment losses.
- Assess legal contingencies, particularly mortgage-related claims, CDS antitrust settlement approval and the potential for claims to expand; compare disclosed possible losses with accrued amounts.
- Monitor liquidity reserve composition, debt maturities, rating-sensitive collateral requirements and the effects of proposed capital and TLAC rules on distributions and funding.