Form 10-Q
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

OR

☐    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

Commission File Number 1-11758

 

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(Exact Name of Registrant as specified in its charter)

 

       

Delaware

(State or other jurisdiction of

incorporation or organization)

  

1585 Broadway

New York, NY 10036

(Address of principal executive offices, including zip code)

 

  

36-3145972

(I.R.S. Employer Identification No.)

  

(212) 761-4000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes   ☒    No   ☐

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer  ☒

  

Accelerated Filer  ☐

Non-Accelerated Filer   ☐

  

Smaller reporting company  ☐

(Do not check if a smaller reporting company)

  

Emerging growth company  ☐

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.                ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of July 31, 2018, there were 1,744,789,709 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.


Table of Contents

QUARTERLY REPORT ON FORM 10-Q

For the quarter ended June 30, 2018

 

Table of Contents

     Part        Item        Page  

Financial Information

     I                 1  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     I        2        1  

Introduction

                       1  

Executive Summary

                       2  

Business Segments

                       7  

Supplemental Financial Information and Disclosures

                       18  

Accounting Development Updates

                       19  

Critical Accounting Policies

                       19  

Liquidity and Capital Resources

                       19  

Quantitative and Qualitative Disclosures about Market Risk

     I        3        32  

Report of Independent Registered Public Accounting Firm

                       41  

Financial Statements

     I        1        42  

Consolidated Financial Statements and Notes

                       42  

Consolidated Income Statements (Unaudited)

                       42  

Consolidated Comprehensive Income Statements (Unaudited)

                       43  

Consolidated Balance Sheets (Unaudited at June 30, 2018)

                       44  

Consolidated Statements of Changes in Total Equity (Unaudited)

                       45  

Consolidated Cash Flow Statements (Unaudited)

                       46  

Notes to Consolidated Financial Statements (Unaudited)

                       47  

1. Introduction and Basis of Presentation

                       47  

2. Significant Accounting Policies

                       48  

3. Fair Values

                       50  

4. Derivative Instruments and Hedging Activities

                       61  

5. Investment Securities

                       65  

6. Collateralized Transactions

                       68  

7. Loans, Lending Commitments and Allowance for Credit Losses

                       69  

8. Equity Method Investments

                       71  

9. Deposits

                       72  

10.Borrowings and Other Secured Financings

                       72  

11.Commitments, Guarantees and Contingencies

                       72  

12.Variable Interest Entities and Securitization Activities

                       76  

13.Regulatory Requirements

                       79  

14.Total Equity

                       81  

15.Earnings per Common Share

                       83  

16.Interest Income and Interest Expense

                       84  

17.Employee Benefit Plans

                       84  

18.Income Taxes

                       84  

19.Segment, Geographic and Revenue Information

                       85  

20.Subsequent Events

                       87  
Financial Data Supplement (Unaudited)                        88  
Glossary of Common Acronyms                        91  
Other Information      II                 93  
Legal Proceedings      II        1        93  
Unregistered Sales of Equity Securities and Use of Proceeds      II        2        94  
Controls and Procedures      I        4        95  
Exhibits      II        6        95  
Exhibit Index                        E-1  
Signatures                        S-1  

 

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Table of Contents

Available Information

We file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any document we file with the SEC at the SEC’s public reference room at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an internet site, www.sec.gov, that contains annual, quarterly and current reports, proxy and information statements and other information that issuers file electronically with the SEC. Our electronic SEC filings are available to the public at the SEC’s internet site.

Our internet site is www.morganstanley.com. You can access our Investor Relations webpage at www.morganstanley.com/about-us-ir. We make available free of charge, on or through our Investor Relations webpage, our Proxy Statements, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (“Exchange Act”), as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We also make available, through our Investor Relations webpage, via a link to the SEC’s internet site, statements of beneficial ownership of our equity securities filed by our directors, officers, 10% or greater shareholders and others under Section 16 of the Exchange Act.

You can access information about our corporate governance at www.morganstanley.com/about-us-governance. Our Corporate Governance webpage includes:

 

   

Amended and Restated Certificate of Incorporation;

   

Amended and Restated Bylaws;

   

Charters for our Audit Committee, Compensation, Management Development and Succession Committee, Nominating and Governance Committee, Operations and Technology Committee, and Risk Committee;

   

Corporate Governance Policies;

   

Policy Regarding Corporate Political Activities;

   

Policy Regarding Shareholder Rights Plan;

   

Equity Ownership Commitment;

   

Code of Ethics and Business Conduct;

   

Code of Conduct;

   

Integrity Hotline Information; and

   

Environmental and Social Policies.

Our Code of Ethics and Business Conduct applies to all directors, officers and employees, including our Chief Executive Officer, Chief Financial Officer and Deputy Chief Financial Officer. We will post any amendments to the Code of Ethics and Business Conduct and any waivers that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange LLC (“NYSE”) on our internet site. You can request a copy of these documents, excluding exhibits, at no cost, by contacting Investor Relations, 1585 Broadway, New York, NY 10036 (212-761-4000). The information on our internet site is not incorporated by reference into this report.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

 

Morgan Stanley is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Wealth Management and Investment Management. Morgan Stanley, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. Unless the context otherwise requires, the terms “Morgan Stanley,” “Firm,” “us,” “we” or “our” mean Morgan Stanley (the “Parent Company”) together with its consolidated subsidiaries. We define the following as part of our consolidated financial statements (“financial statements”): consolidated income statements (“income statements”), consolidated balance sheets (“balance sheets”), and consolidated cash flow statements (“cash flow statements”). See the “Glossary of Common Acronyms” for definitions of certain acronyms used throughout this Form 10-Q.

A description of the clients and principal products and services of each of our business segments is as follows:

Institutional Securities provides investment banking, sales and trading, lending and other services to corporations, governments, financial institutions, and high to ultra-high net worth clients. Investment banking services consist of capital raising and financial advisory services, including services relating to the underwriting of debt, equity and other securities, as well as advice on mergers and acquisitions, restructurings, real estate and project finance. Sales and trading services include sales, financing, prime brokerage and market-making activities in equity and fixed income products, including foreign exchange and commodities. Lending services include originating and/or purchasing corporate loans, commercial and residential mortgage lending, asset-backed lending and financing extended to equities and commodities customers and municipalities. Other activities include investments and research.

Wealth Management provides a comprehensive array of financial services and solutions to individual investors and small to medium-sized businesses and institutions covering brokerage and investment advisory services, financial and wealth planning services, annuity and insurance products, credit and other lending products, banking and retirement plan services.

Investment Management provides a broad range of investment strategies and products that span geographies, asset classes, and public and private markets to a diverse group of clients across institutional and intermediary channels. Strategies and products include equity, fixed income, liquidity and alternative/other products. Institutional clients include defined benefit/defined contribution plans, foundations, endowments, government entities, sovereign wealth funds, insurance companies, third-party fund sponsors and corporations. Individual clients are serviced through intermediaries, including affiliated and non-affiliated distributors.

The results of operations in the past have been, and in the future may continue to be, materially affected by competition; risk factors; and legislative, legal and regulatory developments; as well as other factors. These factors also may have an adverse impact on our ability to achieve our strategic objectives. Additionally, the discussion of our results of operations herein may contain forward-looking statements. These statements, which reflect management’s beliefs and expectations, are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of the risks and uncertainties that may affect our future results, see “Forward-Looking Statements,” “Business—Competition,” “Business—Supervision and Regulation” and “Risk Factors” in the 2017 Form 10-K, and “Liquidity and Capital Resources” herein.

 

 

   1    June 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Executive Summary

Overview of Financial Results

 

Consolidated Results

Net Revenues

($ in millions)

 

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Net Income Applicable to Morgan Stanley

($ in millions)

 

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Earnings per Common Share1

 

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1.

For the calculation of basic and diluted EPS, see Note 15 to the financial statements.

 

 

We reported net revenues of $10,610 million in the quarter ended June 30, 2018 (“current quarter,” or “2Q 2018”), compared with $9,503 million in the quarter ended June 30, 2017 (“prior year quarter,” or “2Q 2017”). For the current quarter, net income applicable to Morgan Stanley was $2,437 million, or $1.30 per diluted common share, compared with $1,757 million, or $0.87 per diluted common share, in the prior year quarter.

 

 

We reported net revenues of $21,687 million in the six months ended June 30, 2018 (“current year period,” or “YTD 2018”), compared with $19,248 million in the six months ended June 30, 2017 (“prior year period,” or “YTD 2017”). For the current year period, net income applicable to Morgan Stanley was $5,105 million, or $2.75 per diluted common share, compared with $3,687 million, or $1.87 per diluted common share, in the prior year period.

 

 

June 2018 Form 10-Q    2   


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Management’s Discussion and Analysis    LOGO

 

 

Non-interest Expenses1

($ in millions)

 

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1.

The percentages on the bars in the charts represent the contribution of compensation expense and non-compensation expense to the total.

 

Compensation and benefits expenses of $4,621 million in the current quarter and $9,535 million in the current year period each increased 9% from $4,252 million in the prior year quarter and $8,718 million in the prior year period. These results primarily reflected increases in discretionary incentive compensation mainly driven by higher revenues, as well as salaries, across all business segments, the formulaic payout to Wealth Management representatives, and amortization of deferred cash and equity awards. These increases were partially offset by a decrease in the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses were $2,880 million in the current quarter and $5,623 million in the current year period compared with $2,609 million in the prior year quarter and $5,080 million in the prior year period, representing a 10% and an 11% increase, respectively. These increases were primarily a result of higher volume-related expenses and the gross presentation of certain expenses due to the adoption of the accounting update Revenue from Contracts with Customers (see Notes 2 and 19 to the financial statements for further information).

Income Taxes

The current quarter and current year period included intermittent net discrete tax benefits of $88 million primarily associated with new information pertaining to the resolution of multi-jurisdiction tax examinations and other matters. The prior year quarter and prior year period included intermittent tax provisions of $4 million and $18 million, respectively. For further information, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

 

 

   3    June 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Selected Financial Information and Other Statistical Data

 

   

Three Months
Ended

June 30,

   

Six Months

Ended

June 30,

 
$ in millions   2018     2017     2018     2017  

Income from continuing operations applicable to Morgan Stanley

  $ 2,439     $ 1,762     $ 5,109     $ 3,714  

Income (loss) from discontinued operations applicable to Morgan Stanley

    (2     (5     (4     (27

Net income applicable to Morgan Stanley

    2,437       1,757       5,105       3,687  

Preferred stock dividends and other

    170       170       263       260  

Earnings applicable to Morgan Stanley common shareholders

  $ 2,267     $ 1,587     $ 4,842     $ 3,427  

Expense efficiency ratio1

    70.7%       72.2%       69.9%       71.7%  

ROE2

    13.0%       9.1%       13.9%       9.9%  

ROTCE2

    14.9%       10.4%       16.0%       11.4%  

 

in millions, except per share and
employee data
  At June 30,
2018
    At December 31,
2017
 

GLR3

  $ 226,322     $ 192,660  

Loans4

  $ 112,113     $ 104,126  

Total assets

  $ 875,875     $ 851,733  

Deposits

  $ 172,802     $ 159,436  

Borrowings

  $ 192,244     $ 192,582  

Common shareholders’ equity

  $ 70,589     $ 68,871  

Common shares outstanding

    1,750       1,788  

Book value per common share5

  $ 40.34     $ 38.52  

Worldwide employees

    58,010       57,633  

 

     At June 30,
2018
    At December 31,
2017
 

Capital ratios6

   

Common Equity Tier 1 capital ratio

    15.8%       16.5%  

Tier 1 capital ratio

    18.1%       18.9%  

Total capital ratio

    20.6%       21.7%  

Tier 1 leverage ratio

    8.2%       8.3%  

SLR7

    6.4%       6.5%  

 

1.

The expense efficiency ratio represents total non-interest expense as a percentage of net revenues.

2.

Represents a non-GAAP measure. See “Selected Non-GAAP Financial Information” herein.

3.

For a discussion of the GLR, see “Liquidity and Capital Resources—Liquidity Risk Management Framework—Global Liquidity Reserve” herein.

4.

Amounts include loans held for investment (net of allowance) and loans held for sale but exclude loans at fair value, which are included in Trading assets in the balance sheets (see Note 7 to the financial statements).

5.

Book value per common share equals common shareholders’ equity divided by common shares outstanding.

6.

Beginning in 2018, our risk based capital ratios are based on the Standardized Approach fully phased-in rules. At December 31, 2017, our risk based capital ratios were based on the Standardized Approach transitional rules. For a discussion of our regulatory capital ratios, see “Liquidity and Capital Resources—Regulatory Requirements” herein.

7.

The SLR became effective as a capital standard on January 1, 2018. For a discussion of the SLR, see “Liquidity and Capital Resources—Regulatory Requirements” herein.

Business Segment Results

Net Revenues by Segment1, 2 

($ in millions)

 

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June 2018 Form 10-Q    4   


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Management’s Discussion and Analysis    LOGO

 

Net Income Applicable to Morgan Stanley by Segment1, 3

($ in millions)

 

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1.

The percentages in the charts represent the contribution of each business segment to the total. Amounts do not necessarily total to 100% due to intersegment eliminations, where applicable.

2.

The total amount of Net Revenues by Segment also includes intersegment eliminations of $(120) million and $(75) million in the current quarter and prior year quarter, respectively, and $(235) million and $(149) million in the current year period and prior year period, respectively.

3.

The total amount of Net Income Applicable to Morgan Stanley by Segment also includes intersegment eliminations of $2 million in the prior year period.

 

 

Institutional Securities net revenues of $5,714 million in the current quarter and $11,814 million in the current year period increased 20% from the prior year quarter and 19% from the prior year period primarily reflecting higher sales and trading and Investment banking revenues.

 

 

Wealth Management net revenues of $4,325 million in the current quarter and $8,699 million in the current year period increased 4% from the prior year quarter and 6% from the prior year period primarily reflecting growth in Asset management revenues.

 

 

Investment Management net revenues of $691 million in the current quarter and $1,409 million in the current year period increased 4% from the prior year quarter and 11% from the prior year period primarily reflecting higher revenues from Asset management.

Net Revenues by Region1, 2

($ in millions)

 

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1.

For a discussion of how the geographic breakdown for net revenues is determined, see Note 19 to the financial statements.

2.

The percentages on the bars in the charts represent the contribution of each region to the total.

 

 

   5    June 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Selected Non-GAAP Financial Information

We prepare our financial statements using U.S. GAAP. From time to time, we may disclose certain “non-GAAP financial measures” in this document or in the course of our earnings releases, earnings and other conference calls, financial presentations, Definitive Proxy Statement and otherwise. A “non-GAAP financial measure” excludes, or includes, amounts from the most directly comparable measure calculated and presented in accordance with U.S. GAAP. We consider the non-GAAP financial measures we disclose to be useful to us, investors and analysts by providing further transparency about, or an alternate means of assessing, our financial condition, operating results, prospective regulatory capital requirements or capital adequacy. These measures are not in accordance with, or a substitute for, U.S. GAAP and may be different from or inconsistent with non-GAAP financial measures used by other companies. Whenever we refer to a non-GAAP financial measure, we will also generally define it or present the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP, along with a reconciliation of the differences between the U.S. GAAP financial measure and the non-GAAP financial measure.

The principal non-GAAP financial measures presented in this document are set forth below.

Reconciliations from U.S. GAAP to Non-GAAP Consolidated Financial Measures

 

$ in millions, except   Three Months Ended
June 30,
    Six Months Ended
June 30,
 
per share data       2018             2017             2018             2017      

Net income applicable to Morgan Stanley

  $ 2,437     $ 1,757     $ 5,105     $ 3,687  

Impact of adjustments

    (88     4       (88     18  

Adjusted net income applicable to Morgan Stanley—non-GAAP1

  $ 2,349       1,761     $ 5,017       3,705  

Earnings per diluted common share

  $ 1.30     $ 0.87     $ 2.75     $ 1.87  

Impact of adjustments

    (0.05           (0.05     0.01  

Adjusted earnings per diluted common share —non-GAAP1

  $ 1.25     $ 0.87     $ 2.70     $ 1.88  

Effective income tax rate

    20.6%       32.0%       20.7%       30.5%  

Impact of adjustments

    2.8%       (0.1)%       1.4%       (0.4)%  

Adjusted effective income tax rate—non-GAAP1

    23.4%       31.9%       22.1%       30.1%  
                Average Monthly Balance  
   

At
June 30,

2018

   

At
December 31,

2017

   

Three Months

Ended June 30,

   

Six Months

Ended June 30,

 
$ in millions   2018     2017     2018     2017  

Tangible Equity

           

U.S. GAAP

           

Morgan Stanley shareholders’ equity

  $ 79,109     $ 77,391     $ 78,432     $ 78,436     $ 77,960     $ 77,836  

Less: Goodwill and net intangible assets

    (9,022     (9,042     (9,076     (9,194     (9,049     (9,227

Morgan Stanley tangible shareholders’ equity—non-GAAP

  $ 70,087     $ 68,349     $ 69,356     $ 69,242     $ 68,911     $ 68,609  

U.S. GAAP

           

Common equity

  $ 70,589     $ 68,871     $ 69,912     $ 69,916     $ 69,440     $ 69,459  

Less: Goodwill and net intangible assets

    (9,022     (9,042     (9,076     (9,194     (9,049     (9,227

Tangible common equity—non-GAAP

  $   61,567     $ 59,829     $   60,836     $   60,722     $   60,391     $   60,232  

Consolidated Non-GAAP Financial Measures

 

    Three Months Ended
June 30,
     Six Months Ended
June 30,
 
$ in billions   2018      2017      2018      2017  

Average common equity

 

        

Unadjusted

  $ 69.9      $ 69.9      $ 69.4      $ 69.5  

Adjusted1

    69.9        69.9        69.4        69.5  

ROE2

 

        

Unadjusted

    13.0%        9.1%        13.9%        9.9%  

Adjusted1, 3

    12.5%        9.1%        13.7%        9.9%  

Average tangible common equity

 

        

Unadjusted

  $ 60.8      $ 60.7      $ 60.4      $ 60.2  

Adjusted1

    60.8        60.7        60.4        60.2  

ROTCE2

 

        

Unadjusted

    14.9%        10.4%        16.0%        11.4%  

Adjusted1, 3

    14.3%        10.5%        15.7%        11.4%  

 

     

At June 30,

2018

    

At December 31,

2017

 

Tangible book value per common share4

   $             35.19      $ 33.46  
 

 

June 2018 Form 10-Q    6   


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Management’s Discussion and Analysis    LOGO

 

Non-GAAP Financial Measures by Business Segment

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
$ in billions   2018     2017     2018     2017  

Pre-tax profit margin5

       

Institutional Securities

    32%       30%       33%       32%  

Wealth Management

    27%       25%       27%       25%  

Investment Management

    20%       21%       20%       19%  

Consolidated

    29%       28%       30%       28%  

Average common equity6

 

     

Institutional Securities

  $ 40.8     $ 40.2     $ 40.8     $ 40.2  

Wealth Management

    16.8       17.2       16.8       17.2  

Investment Management

    2.6       2.4       2.6       2.4  

Parent Company

    9.7       10.1       9.2       9.7  

Consolidated average common equity

  $ 69.9     $ 69.9     $ 69.4     $ 69.5  

Average tangible common equity6

 

     

Institutional Securities

  $ 40.1     $ 39.6     $ 40.1     $ 39.6  

Wealth Management

    9.2       9.3       9.2       9.3  

Investment Management

    1.7       1.6       1.7       1.6  

Parent Company

    9.8       10.2       9.4       9.7  

Consolidated average tangible common equity

  $ 60.8     $ 60.7     $ 60.4     $ 60.2  

ROE2, 7

 

     

Institutional Securities

    13.0%       8.5%       14.1%       9.9%  

Wealth Management

    20.0%       14.6%       20.7%       14.6%  

Investment Management

    15.7%       16.3%       17.5%       13.7%  

Consolidated

    13.0%       9.1%       13.9%       9.9%  

ROTCE2, 7

 

     

Institutional Securities

    13.2%       8.7%       14.3%       10.1%  

Wealth Management

    36.6%       27.0%       37.8%       27.0%  

Investment Management

    24.5%       24.1%       27.4%       20.2%  

Consolidated

    14.9%       10.4%       16.0%       11.4%  

 

1.

Adjusted amounts exclude intermittent net discrete tax provisions (benefits). Income tax consequences associated with employee share-based awards are recognized in Provision for income taxes in the income statements but are excluded from the intermittent net discrete tax provisions (benefits) adjustment as we anticipate conversion activity each quarter. For further information on the net discrete tax provisions (benefits), see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

2.

ROE and ROTCE equal annualized net income applicable to Morgan Stanley less preferred dividends as a percentage of average common equity and average tangible common equity, on a consolidated basis as indicated. When excluding intermittent net discrete tax provisions (benefits), both the numerator and denominator are adjusted.

3.

The calculations used in determining the Firm’s “ROE and ROTCE Targets” referred to below are the Adjusted ROE and Adjusted ROTCE amounts shown in this table.

4.

Tangible book value per common share equals tangible common equity divided by common shares outstanding.

5.

Pre-tax profit margin represents income from continuing operations before income taxes as a percentage of net revenues.

6.

Average common equity and average tangible common equity for each business segment are determined using our Required Capital framework (see “Liquidity and Capital Resources—Regulatory Requirements—Attribution of Average Common Equity According to the Required Capital Framework” herein).

7.

The calculation of the ROE and ROTCE by segment uses the annualized net income applicable to Morgan Stanley by segment less preferred dividends allocated to each segment as a percentage of average common equity and average tangible common equity, respectively, allocated to each segment.

Return on Equity and Tangible Common Equity Targets

In January 2018, we established an ROE Target of 10% to 13% for the medium term, which is equivalent to an ROTCE Target of 11.5% to 14.5%.

Our ROE and ROTCE Targets are forward-looking statements that may be materially affected by many factors, including, among other things: macroeconomic and market conditions; legislative and regulatory developments; industry trading and investment banking volumes; equity market levels; interest rate environment; outsize legal expenses or penalties and the ability to maintain a reduced level of expenses; and capital levels. For further information on our ROE and ROTCE Targets and related assumptions, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Executive Summary—Return on Equity and Tangible Common Equity Targets” in the 2017 Form 10-K.

Business Segments

Substantially all of our operating revenues and operating expenses are directly attributable to the business segments. Certain revenues and expenses have been allocated to each business segment, generally in proportion to its respective net revenues, non-interest expenses or other relevant measures.

As a result of treating certain intersegment transactions as transactions with external parties, we include an Intersegment Eliminations category to reconcile the business segment results to our consolidated results.

Net Revenues, Compensation Expense and Income Taxes

For an overview of the components of our net revenues, compensation expense and income taxes, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments” in the 2017 Form 10-K.

 

 

   7    June 2018 Form 10-Q


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Institutional Securities

Income Statement Information

 

    Three Months Ended
June 30,
       
$ in millions   2018     2017     % Change  

Revenues

     

Investment banking

  $       1,699     $       1,413       20%  

Trading

    3,128       2,725       15%  

Investments

    89       37       141%  

Commissions and fees

    674       630       7%  

Asset management

    102       89       15%  

Other

    168       126       33%  

Total non-interest revenues

    5,860       5,020       17%  

Interest income

    2,195       1,243       77%  

Interest expense

    2,341       1,501       56%  

Net interest

    (146     (258     43%  

Net revenues

    5,714       4,762       20%  

Compensation and benefits

    1,993       1,667       20%  

Non-compensation expenses

    1,909       1,652               16%  

Total non-interest expenses

    3,902       3,319       18%  

Income from continuing operations before income taxes

    1,812       1,443       26%  

Provision for income taxes

    323       413       (22)%  

Income from continuing operations

    1,489       1,030       45%  

Income (loss) from discontinued operations, net of income taxes

    (2     (5     60%  

Net income

    1,487       1,025       45%  

Net income applicable to noncontrolling interests

    30       33       (9)%  

Net income applicable to Morgan Stanley

  $ 1,457     $ 992       47%  

 

    Six Months Ended
June 30,
       
$ in millions   2018     2017     % Change  

Revenues

     

Investment banking

  $       3,212     $       2,830       13%  

Trading

    6,771       5,737       18%  

Investments

    138       103       34%  

Commissions and fees

    1,418       1,250       13%  

Asset management

    212       180       18%  

Other

    304       299       2%  

Total non-interest revenues

    12,055       10,399       16%  

Interest income

    3,999       2,367       69%  

Interest expense

    4,240       2,852       49%  

Net interest

    (241     (485     50%  

Net revenues

    11,814       9,914       19%  

Compensation and benefits

    4,153       3,537       17%  

Non-compensation expenses

    3,737       3,204               17%  

Total non-interest expenses

    7,890       6,741       17%  

Income from continuing operations before income taxes

    3,924       3,173       24%  

Provision for income taxes

    772       872       (11)%  

Income from continuing operations

    3,152       2,301       37%  

Income (loss) from discontinued operations, net of income taxes

    (4     (27     85%  

Net income

    3,148       2,274       38%  

Net income applicable to noncontrolling interests

    64       68       (6)%  

Net income applicable to Morgan Stanley

  $ 3,084     $ 2,206       40%  
 

 

June 2018 Form 10-Q    8   


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Investment Banking

Investment Banking Revenues

 

    Three Months Ended
June 30,
        
$ in millions   2018     2017      % Change  

Advisory

  $ 618     $ 504        23%  

Underwriting:

      

Equity

    541       405        34%  

Fixed income

    540       504        7%  

Total underwriting

    1,081       909        19%  

Total investment banking

  $ 1,699     $ 1,413        20%  

 

     Six Months Ended
June 30,
        
$ in millions    2018      2017      % Change  

Advisory

   $ 1,192      $ 1,000        19%  

Underwriting:

        

Equity

     962        795        21%  

Fixed income

     1,058        1,035        2%  

Total underwriting

     2,020        1,830        10%  

Total investment banking

   $ 3,212      $ 2,830        13%  

Investment Banking Volumes

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
$ in billions   2018     2017     2018     2017  

Completed mergers and acquisitions1

  $ 325     $ 212     $ 488     $ 375  

Equity and equity-related offerings2, 3

    16       20       37       30  

Fixed income offerings2, 4

    61       70       116       145  

Source: Thomson Reuters, data as of July 2, 2018. Transaction volumes may not be indicative of net revenues in a given period. In addition, transaction volumes for prior periods may vary from amounts previously reported due to the subsequent withdrawal or change in the value of a transaction.

 

1.

Amounts include transactions of $100 million or more. Completed mergers and acquisitions volumes are based on full credit to each of the advisors in a transaction.

2.

Equity and equity-related offerings and fixed income offerings are based on full credit for single book managers and equal credit for joint book managers.

3.

Amounts include Rule 144A issuances and registered public offerings of common stock and convertible securities and rights offerings.

4.

Amounts include non-convertible preferred stock, mortgage-backed and asset-backed securities, and taxable municipal debt. Amounts include publicly registered and Rule 144A issuances. Amounts exclude leveraged loans and self-led issuances.

Investment banking revenues are composed of fees from advisory services and revenues from the underwriting of securities offerings and syndication of loans, net of syndication expenses.

Investment banking revenues of $1,699 million in the current quarter and $3,212 million in the current year period increased 20% and 13% from the comparable prior year periods. The adoption of the accounting update Revenue from Contracts with Customers had the effect of increasing the revenues reported in investment banking by approximately $101 million in the current quarter and $161 million in the current year period compared with the prior year periods (see Notes 2 and 19 to the financial statements for further information). The drivers of the increase in our Investment banking revenues, other than the effect of the above accounting update, were:

 

 

Advisory revenues increased in the current quarter and current year period primarily reflecting higher volumes of completed M&A activity (see Investment Banking Volumes table), partially offset by lower fee realizations.

 

 

Equity underwriting revenues increased in the current quarter primarily as a result of higher fee realizations in initial public offerings and convertibles. In the current year period, equity underwriting revenues increased due to higher equity market volumes (see Investment Banking Volumes table).

 

 

Fixed income underwriting revenues increased in the current quarter primarily due to higher non-investment grade loan fees. Fixed income underwriting revenues in the current year period were relatively unchanged from the prior year period.

Sales and Trading Net Revenues

By Income Statement Line Item

 

     Three Months Ended
June 30,
        
$ in millions    2018      2017      % Change  

Trading

   $ 3,128      $ 2,725        15%  

Commissions and fees

     674        630        7%  

Asset management

     102        89        15%  

Net interest

     (146      (258      43%  

Total

   $ 3,758      $ 3,186        18%  

 

     Six Months Ended
June 30,
        
$ in millions    2018      2017      % Change  

Trading

   $ 6,771      $ 5,737        18%  

Commissions and fees

     1,418        1,250        13%  

Asset management

     212        180        18%  

Net interest

     (241      (485      50%  

Total

   $ 8,160      $ 6,682        22%  
 

 

   9    June 2018 Form 10-Q


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By Business

 

     Three Months Ended
June 30,
        
$ in millions    2018      2017      % Change  

Equity

   $ 2,470      $ 2,155        15%  

Fixed income

     1,389        1,239        12%  

Other

     (101      (208      51%  

Total

   $ 3,758      $ 3,186        18%  

 

     Six Months Ended
June 30,
        
$ in millions    2018      2017      % Change  

Equity

   $ 5,028      $ 4,171        21%  

Fixed income

     3,262        2,953        10%  

Other

     (130      (442      71%  

Total

   $ 8,160      $ 6,682        22%  

Sales and Trading Revenues—Equity and Fixed Income

 

    Three Months Ended
June 30, 2018
 
$ in millions   Trading     Fees1     Net
Interest2
    Total  

Financing

  $ 1,373     $ 89     $ (192   $ 1,270  

Execution services

    661       605       (66     1,200  

Total Equity

  $ 2,034     $ 694     $ (258   $ 2,470  

Total Fixed Income

  $ 1,299     $ 83     $ 7     $ 1,389  

 

    Three Months Ended
June 30, 2017
 
$ in millions   Trading     Fees1     Net
Interest2
    Total  

Financing

  $ 1,166     $ 88     $ (227   $ 1,027  

Execution services

    601       580       (53     1,128  

Total Equity

  $ 1,767     $ 668     $ (280   $ 2,155  

Total Fixed income

  $ 1,114     $ 48     $ 77     $ 1,239  

 

    Six Months Ended
June 30, 2018
 
$ in millions   Trading     Fees1     Net
Interest2
    Total  

Financing

  $ 2,607     $ 196     $ (338   $ 2,465  

Execution services

    1,452       1,269       (158     2,563  

Total Equity

  $ 4,059     $ 1,465     $ (496   $ 5,028  

Total Fixed Income

  $ 3,014     $ 166     $ 82     $ 3,262  

 

    Six Months Ended
June 30, 2017
 
$ in millions   Trading     Fees1     Net
Interest2
    Total  

Financing

  $ 2,097     $ 177     $ (415   $ 1,859  

Execution services

    1,265       1,148       (101     2,312  

Total Equity

  $ 3,362     $ 1,325     $ (516   $ 4,171  

Total Fixed income

  $ 2,712     $ 102     $ 139     $ 2,953  

 

1.

Includes Commissions and fees and Asset management revenues.

2.

Funding costs are allocated to the businesses based on funding usage and are included in Net interest.

As discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments—Net Revenues by Segment” in the 2017 Form 10-K, we manage each of the sales and trading businesses based on its aggregate net revenues. We provide qualitative commentary in the discussion of results that follow on the key drivers of period over period variances, as the quantitative impact of the various market dynamics typically cannot be disaggregated.

For additional information on total Trading revenues, see the table “Trading Revenues by Product Type” in Note 4 to the financial statements.

Sales and Trading Net Revenues during the Current Quarter

Equity

Equity sales and trading net revenues of $2,470 million in the current quarter increased 15% from the prior year quarter, reflecting higher results in both our financing businesses and execution services.

 

 

Financing revenues increased from the prior year quarter, primarily due to higher average client balances and changes in funding mix which resulted in increased Trading and Net interest revenues.

 

 

Execution services increased from the prior year quarter, primarily reflecting higher Trading revenues driven by effective inventory management in derivative products. In addition, Commissions and fees increased from higher client activity in cash equities products.

Fixed Income

Fixed income net revenues of $1,389 million in the current quarter were 12% higher than the prior year quarter, driven by higher results in commodities products and other and credit products, partially offset by lower results in global macro products.

 

 

Global macro products revenues decreased as higher client activity was more than offset by unfavorable inventory management results in foreign exchange and emerging markets products.

 

 

Credit products Trading and Net interest revenues increased primarily as a result of increased client activity in lending products, partially offset by the impact of credit spread widening on inventory.

 

 

Commodities products and Other increased primarily due to increased client trading activity across commodities products and higher Trading revenues principally from a reduction in counterparty credit risk.

 

 

June 2018 Form 10-Q    10   


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Other

Other sales and trading net losses of $101 million in the current quarter decreased from the prior year quarter, primarily reflecting higher revenues on economic hedges related to our long-term debt and corporate loan activity.

Sales and Trading Net Revenues during the Current Year Period

Equity

Equity sales and trading net revenues of $5,028 million in the current year period increased 21% from the prior year period, reflecting higher results in both our financing businesses and execution services.

 

 

Financing revenues increased from the prior year period, primarily due to higher average client balances and changes in funding mix which resulted in increased Trading and Net interest revenues.

 

 

Execution services increased from the prior year period, primarily reflecting higher Trading revenues driven by effective inventory management and higher client activity in derivative products. In addition, Commissions and fees increased from higher client activity in cash equities products.

Fixed Income

Fixed income net revenues of $3,262 million in the current year period were 10% higher than the prior year period, primarily driven by higher results in commodities products and other.

 

 

Global macro and Credit products revenues remained relatively unchanged from the prior year period.

 

 

Commodities products and Other increased primarily due to increased Commodities structured transactions and client flow and higher Trading revenues principally from a reduction in counterparty credit risk.

Other

Other sales and trading net losses of $130 million in the current year period decreased from the prior year period, primarily reflecting higher revenues on economic hedges related to our long-term debt and lower losses associated with corporate loan hedging activity.

Investments, Other Revenues, Non-interest Expenses and Income Tax Items

Investments

 

 

Net investment gains of $89 million in the current quarter and $138 million in the current year period increased from the prior year periods, primarily as a result of higher gains on business-related investments, partially offset by lower results from real estate limited partnership investments.

Other Revenues

 

 

Other revenues of $168 million in the current quarter and $304 million in the current year period increased from the prior year periods, reflecting the recovery of a previously charged off energy industry related loan and improved results from other equity method investments. These results were partially offset by losses associated with held-for-sale corporate loans compared with gains in the respective prior year periods.

Non-interest Expenses

Non-interest expenses of $3,902 million in the current quarter increased from the prior year quarter, reflecting a 20% increase in Compensation and benefits expenses and a 16% increase in Non-compensation expenses. Non-interest expenses of $7,890 million in the current year period increased from the prior year period reflecting a 17% increase in both Compensation and benefits expenses and Non-compensation expenses.

 

 

Compensation and benefits expenses increased in the current quarter and current year period, primarily due to increases in discretionary incentive compensation driven by higher revenues, as well as amortization of deferred cash and equity awards and salaries, partially offset by a decrease in the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses increased in the current quarter and current year period, primarily due to higher volume-related expenses and the gross presentation of certain expenses due to the adoption of the accounting update Revenue from Contracts with Customers (see Notes 2 and 19 to the financial statements for further information). In addition, in the current year period, the results were partially offset by the reversal of a portion of previously recorded provisions related to U.K. VAT matters.

 

 

   11    June 2018 Form 10-Q


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Income Tax Items

The effective tax rate in the current quarter and current year period is lower compared with the prior year periods primarily as a result of the enactment of the U.S. Tax Cuts and Jobs Act (“Tax Act”). For a discussion of the Tax Act, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

 

In both the current quarter and current year period, we recognized in Provision for income taxes an intermittent net discrete tax benefit of $97 million, primarily associated with new information pertaining to the resolution of multi-jurisdiction tax examinations and other matters.

 

 

June 2018 Form 10-Q    12   


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Wealth Management

Income Statement Information

 

    Three Months Ended
June 30,
       
$ in millions       2018             2017         % Change  

Revenues

     

Investment banking

  $ 114     $ 135       (16)%  

Trading

    135       207       (35)%  

Investments

    3       1       200%  

Commissions and fees

    442       424       4%  

Asset management

    2,514       2,302       9%  

Other

    74       73       1%  

Total non-interest revenues

    3,282       3,142       4%  

Interest income

    1,320       1,114       18%  

Interest expense

    277       105       164%  

Net interest

    1,043       1,009       3%  

Net revenues

    4,325       4,151       4%  

Compensation and benefits

    2,356       2,297       3%  

Non-compensation expenses

    812       797       2%  

Total non-interest expenses

    3,168       3,094       2%  

Income from continuing

operations before income taxes

    1,157       1,057       9%  

Provision for income taxes

    281       392       (28)%  

Net income applicable to Morgan Stanley

  $ 876     $ 665       32%  

 

    Six Months Ended
June 30,
       
$ in millions       2018             2017         % Change  

Revenues

     

Investment banking

  $ 254     $ 280       (9)%  

Trading

    244       445       (45)%  

Investments

    3       2       50%  

Commissions and fees

    940       864       9%  

Asset management

    5,009       4,486       12%  

Other

    137       129       6%  

Total non-interest revenues

    6,587       6,206       6%  

Interest income

    2,600       2,193       19%  

Interest expense

    488       190       157%  

Net interest

    2,112       2,003       5%  

Net revenues

    8,699       8,209       6%  

Compensation and benefits

    4,806       4,614       4%  

Non-compensation expenses

    1,576       1,565       1%  

Total non-interest expenses

    6,382       6,179       3%  

Income from continuing operations before income taxes

    2,317       2,030       14%  

Provision for income taxes

    527       718       (27)%  

Net income applicable to Morgan Stanley

  $ 1,790     $ 1,312       36%  

 

Financial Information and Statistical Data

 

$ in billions  

At

June 30,
        2018        

     At
December 31,
2017
 

Client assets

  $ 2,411      $ 2,373  

Fee-based client assets1

  $ 1,084      $ 1,045  

Fee-based client assets as a percentage of total client assets

    45%        44%  

Client liabilities2

  $ 82      $ 80  

Investment securities portfolio

  $ 59.7      $ 59.2  

Loans and lending commitments

  $ 80.7      $ 77.3  

Wealth Management representatives

    15,632        15,712  

 

     Three Months Ended
June 30,
 
          2018              2017      

Per representative:

     

Annualized revenues ($ in thousands)3

   $ 1,105      $ 1,052  

Client assets ($ in millions)4

   $ 154      $ 142  

Fee-based asset flows ($ in billions)5

   $ 15.3      $ 19.9  
     Six Months Ended
June 30,
 
      2018      2017  

Per representative:

     

Annualized revenues ($ in thousands)3

   $ 1,110      $ 1,041  

Client assets ($ in millions)4

   $ 154      $ 142  

Fee-based asset flows ($ in billions)5

   $ 33.5      $ 38.7  

 

1.

Fee-based client assets represent the amount of assets in client accounts where the basis of payment for services is a fee calculated on those assets.

2.

Client liabilities include securities-based and tailored lending, residential real estate loans and margin lending.

3.

Annualized revenues per representative equal Wealth Management’s annualized revenues divided by the average representative headcount.

4.

Client assets per representative equal total period-end client assets divided by period-end representative headcount.

5.

Fee-based asset flows include net new fee-based assets, net account transfers, dividends, interest and client fees and exclude institutional cash management-related activity.

 

 

   13    June 2018 Form 10-Q


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Transactional Revenues

 

     Three Months Ended
June 30,
        
$ in millions    2018      2017      % Change  

Investment banking

   $ 114      $ 135        (16)%  

Trading

     135        207        (35)%  

Commissions and fees

     442        424        4%  

Total

   $ 691      $ 766        (10)%  

Transactional revenues as a % of Net revenues

     16%        18%     

 

     Six Months Ended
June 30,
        
$ in millions    2018      2017      % Change  

Investment banking

   $ 254      $ 280        (9)%  

Trading

     244        445        (45)%  

Commissions and fees

     940        864        9%  

Total

   $ 1,438      $ 1,589        (10)%  

Transactional revenues as a % of Net revenues

     17%        19%     

Net Revenues

Transactional Revenues

Transactional revenues of $691 million in the current quarter and $1,438 million in the current year period decreased 10% from the respective prior year periods primarily as a result of lower Trading and Investment banking revenues, partially offset by higher Commissions and fees.

 

 

Investment banking revenues decreased in the current quarter and current year period primarily due to lower revenues from equity and structured products issuances.

 

 

Trading revenues decreased in the current quarter and current year period primarily as a result of lower gains related to investments associated with certain employee deferred compensation plans and lower fixed income revenue driven by product mix.

 

 

Commissions and fees increased in the current quarter and current year period primarily as a result of increased client transactions in alternative products, and options and futures.

Asset Management

Asset management revenues of $2,514 million in the current quarter and $5,009 million in the current year period increased 9% and 12%, respectively, primarily due to the effect of market appreciation and net positive flows on the respective beginning of period fee-based client assets balances on which billings are generally based.

See “Fee-Based Client Assets Rollforwards” herein.

Net Interest

Net interest of $1,043 million in the current quarter and $2,112 million in the current year period increased 3% and 5%, respectively, primarily as a result of higher Loan balances. In the current quarter and current year period, the effect of higher interest rates on Loans and Investment securities was essentially offset by higher average interest rates on Deposits, due to changes in our deposit mix.

Non-interest Expenses

Non-interest expenses of $3,168 million in the current quarter and $6,382 million in the current year period increased 2% and 3%, respectively, primarily as a result of higher Compensation and benefits expenses.

 

 

Compensation and benefits expenses increased in the current quarter and current year period primarily due to the formulaic payout to Wealth Management representatives linked to higher revenues and increases in salaries, partially offset by decreases in the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses were relatively unchanged in both the current quarter and current year period.

Income Tax Items

The effective tax rate in the current quarter and current year period is lower compared with the prior year periods primarily as a result of the enactment of the Tax Act. For a discussion of the Tax Act, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

 

 

June 2018 Form 10-Q    14   


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Management’s Discussion and Analysis    LOGO

 

Fee-Based Client Assets

For a description of fee-based client assets, including descriptions of the fee based client asset types and rollforward items in the following tables, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments—Wealth Management—Fee-Based Client Assets” in the 2017 Form 10-K.

Fee-Based Client Assets Rollforwards

 

$ in billions  

At

March 31,
2018

    Inflows     Outflows     Market
Impact
   

At

June 30,

2018

 

Separately managed1

  $ 260     $ 9     $ (5)     $ 3     $ 267  

Unified managed

    254       12       (8)       1       259  

Mutual fund advisory

    20             (1)       1       20  

Advisor

    147       8       (8)       2       149  

Portfolio manager

    356       20       (12)       3       367  

Subtotal

  $ 1,037     $ 49     $ (34)     $ 10     $ 1,062  

Cash management

    21       6       (5)           —       22  

Total fee-based client assets

  $ 1,058     $     55     $     (39)     $ 10     $     1,084  

 

$ in billions  

At

March 31,
2017

    Inflows     Outflows     Market
Impact
   

At

June 30,

2017

 

Separately managed1

  $ 230     $ 8     $ (7)     $ 6     $ 237  

Unified managed

    217       13       (7)       5       228  

Mutual fund advisory

    21             (1)       1       21  

Advisor

    133       10       (8)       3       138  

Portfolio manager

    305       23       (11)       4       321  

Subtotal

  $ 906     $     54     $     (34)     $     19     $     945  

Cash management

    21       2       (6)             17  

Total fee-based client assets

  $ 927     $ 56     $ (40)     $ 19     $ 962  
$ in billions  

At

December 31,
2017

    Inflows     Outflows     Market
Impact
   

At

June 30,

2018

 

Separately managed1

  $ 252     $ 18     $ (10)     $ 7     $ 267  

Unified managed

    250       25       (16)             259  

Mutual fund advisory

    21       1       (2)             20  

Advisor

    149       16       (16)             149  

Portfolio manager

    353       39       (22)       (3)       367  

Subtotal

  $ 1,025     $     99     $ (66)     $ 4     $ 1,062  

Cash management

    20       11       (9)           —       22  

Total fee-based client assets

  $ 1,045     $ 110     $     (75)     $ 4     $     1,084  

 

$ in billions  

At

December 31,
2016

    Inflows     Outflows     Market
Impact
   

At

June 30,

2017

 

Separately managed1

  $ 222     $ 16     $ (11)     $ 10     $ 237  

Unified managed

    204       25       (15)       14       228  

Mutual fund advisory

    21       1       (3)       2       21  

Advisor

    125       19       (14)       8       138  

Portfolio manager

    285           42       (21)       15       321  

Subtotal

  $ 857     $ 103     $     (64)     $     49     $     945  

Cash management

    20       5       (8)             17  

Total fee-based client assets

  $ 877     $ 108     $ (72)     $ 49     $ 962  

Average Fee Rates

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
Fee rate in bps       2018         2017             2018         2017      

Separately managed

    16       17       16       16  

Unified managed

    97       98       98       98  

Mutual fund advisory

    120       118       120       118  

Advisor

    84       84       85       85  

Portfolio manager

    96       96       96       97  

Subtotal

    77       77       76       76  

Cash management

    6       6       6       6  

Total fee-based client assets

    75       75       75       75  

 

1.

Includes non-custody account values reflecting prior quarter-end balances due to a lag in the reporting of asset values by third-party custodians.

 

 

   15    June 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Investment Management

Income Statement Information

 

    Three Months Ended
June 30,
       
$ in millions       2018             2017         % Change  

Revenues

     

Trading

  $ 16     $ (3     N/M  

Investments

    55       125       (56)%  

Asset management

    610       539       13%  

Other

    3       4       (25)%  

Total non-interest revenues

    684       665       3%  

Interest income

    17       1       N/M  

Interest expense

    10       1       N/M  

Net interest

    7             N/M  

Net revenues

    691       665       4%  

Compensation and benefits

    272       288       (6)%  

Non-compensation expenses

    279       235       19%  

Total non-interest expenses

    551       523       5%  

Income from continuing operations before income taxes

    140       142       (1)%  

Provision for income taxes

    36       41       (12)%  

Net income

    104       101       3%  

Net income (loss) applicable to noncontrolling interests

          1       N/M  

Net income applicable to Morgan Stanley

  $ 104     $ 100       4%  

 

    Six Months Ended
June 30,
       
$ in millions       2018             2017         % Change  

Revenues

     

Trading

  $ 21     $ (14     N/M  

Investments

    132       223       (41)%  

Asset management

    1,236       1,056       17%  

Other

    13       8       63%  

Total non-interest revenues

    1,402       1,273       10%  

Interest income

    18       2       N/M  

Interest expense

    11       1       N/M  

Net interest

    7       1       N/M  

Net revenues

    1,409       1,274       11%  

Compensation and benefits

    576       567       2%  

Non-compensation expenses

    545       462       18%  

Total non-interest expenses

    1,121       1,029       9%  

Income from continuing operations before income taxes

    288       245       18%  

Provision for income taxes

    55       71       (23)%  

Net income

    233       174       34%  

Net income (loss) applicable to noncontrolling interests

    2       7       (71)%  

Net income applicable to Morgan Stanley

  $ 231     $ 167       38%  

Net Revenues

Investments

Investments gains of $55 million in the current quarter and $132 million in the current year period compared with $125 million in the prior year quarter and $223 million in the prior year period, respectively. These decreases reflect the absence of realized investment gains in an infrastructure fund, as well as the reversal of previously accrued carried interest in certain Asia private equity funds, primarily due to losses associated with weakening Asia-Pacific currencies.

Asset Management

Asset management revenues of $610 million in the current quarter and $1,236 million in the current year period increased 13% and 17%, respectively, primarily as a result of higher average AUM across all asset classes. See “AUM Rollforwards” herein.

The adoption of the accounting update Revenue from Contracts with Customers had the effect of increasing Asset management revenues due to the gross presentation of distribution fees. This increase (approximately $44 million in the current year period) was partially offset by the delayed recognition of certain performance fees not in the form of carried interest until they are no longer probable of reversing. For 2018, the recognition of a greater portion of these revenues is expected to occur in the fourth quarter based on current fee arrangements. See Notes 2 and 19 to the financial statements for further details.

Non-interest Expenses

Non-interest expenses of $551 million in the current quarter and $1,121 million in the current year period increased 5% and 9%, respectively, primarily due to higher Non-compensation expenses.

 

 

Compensation and benefits expenses decreased in the current quarter due to decreases in deferred compensation associated with carried interest and the fair value of investments to which certain deferred compensation plans are referenced. Compensation and benefits expenses were relatively unchanged in the current year period.

 

 

Non-compensation expenses increased in the current quarter and current year period primarily as a result of the gross presentation of distribution fees due to the adoption of the accounting update Revenue from Contracts with Customers along with higher fee sharing on increased AUM balances. See “Asset Management” above.

 

 

June 2018 Form 10-Q    16   


Table of Contents
Management’s Discussion and Analysis    LOGO

 

Income Tax Items

The effective tax rate in the current quarter and current year period is lower compared with the prior year periods primarily as a result of the enactment of the Tax Act. For a discussion of the Tax Act, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

Assets Under Management or Supervision

For a description of the asset classes and rollforward items in the following tables, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments—Investment Management—Assets Under Management or Supervision” in the 2017 Form 10-K.

AUM Rollforwards

 

$ in billions  

At

March 31,
2018

    Inflows     Outflows     Market
Impact
    Other1    

At

June 30,

2018

 

Equity

  $ 109     $ 10     $ (7   $ 3     $ (1   $ 114  

Fixed income

    72       7       (7     (1     (2     69  

Alternative/Other

    131       6       (4     1       (2     132  

Long-term AUM subtotal

    312       23       (18     3       (5     315  

Liquidity

    157       375       (373     1       (1     159  

Total AUM

  $ 469     $ 398     $ (391   $ 4     $ (6   $ 474  

Shares of minority stake assets

    7                                       7  
$ in billions  

At

March 31,

2017

    Inflows     Outflows     Market
Impact
    Other1    

At

June 30,

2017

 

Equity

  $ 87     $ 6     $ (5   $ 5     $ 1     $ 94  

Fixed income

    62       8       (6     1       1       66  

Alternative/Other

    119       6       (6     3       (1     121  

Long-term AUM subtotal

    268       20       (17     9       1       281  

Liquidity

    153       308       (308           1       154  

Total AUM

  $ 421     $ 328     $ (325   $ 9     $ 2     $ 435  

Shares of minority stake assets

    7                                       8  
$ in billions  

At

December 31,
2017

    Inflows     Outflows     Market
Impact
    Other1    

At

June 30,

2018

 

Equity

  $ 105     $ 20     $ (14   $ 3     $     $ 114  

Fixed income

    73       14       (16     (1     (1     69  

Alternative/Other

    128       11       (9     1       1       132  

Long-term AUM subtotal

    306       45       (39     3             315  

Liquidity

    176       700       (717     1       (1     159  

Total AUM

  $ 482     $ 745     $ (756   $ 4     $ (1   $ 474  

Shares of minority stake assets

    7                                       7  
$ in billions  

At

December 31,
2016

    Inflows     Outflows     Market
Impact
    Other1    

At

June 30,

2017

 

Equity

  $ 79     $ 11     $ (10   $ 13     $ 1     $ 94  

Fixed income

    60       13       (11     2       2       66  

Alternative/Other

    115       13       (10     4       (1     121  

Long-term AUM subtotal

    254       37       (31     19       2       281  

Liquidity

    163       636       (646           1       154  

Total AUM

  $ 417     $ 673     $ (677   $ 19     $ 3     $ 435  

Shares of minority stake assets

    8                                       8  

 

1.

Includes distributions and foreign currency impact for all periods and the impact of the Mesa West Capital, LLC acquisition in the current year period.

Average AUM

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
$ in billions    2018      2017      2018      2017  

Equity

   $ 111      $ 91      $ 110      $ 87  

Fixed income

     71        64        72        63  

Alternative/Other

     131        120        130        119  

Long-term AUM subtotal

     313        275        312        269  

Liquidity

     161        153        163        155  

Total AUM

   $ 474      $ 428      $ 475      $ 424  

Shares of minority stake assets

     7        8        7        8  

Average Fee Rate

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
Fee rate in bps    2018      2017      2018      2017  

Equity

     77        73        76        74  

Fixed income

     33        33        34        33  

Alternative/Other

     67        70        67        70  

Long-term AUM

     63        62        63        63  

Liquidity

     18        17        18        18  

Total AUM

     47        46        47        46  
 

 

   17    June 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Supplemental Financial Information and Disclosures

Income Tax Matters

Effective Tax Rate from Continuing Operations

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
          2018              2017              2018              2017      

U.S. GAAP

     20.6%        32.0%        20.7%        30.5%  

Adjusted effective income tax rate—non-GAAP1

     23.4%        31.9%        22.1%        30.1%  

 

1.

Adjusted amounts exclude intermittent net discrete tax provisions (benefits). Income tax consequences associated with employee share-based awards are recognized in Provision for income taxes in the income statements but are excluded from the intermittent net discrete tax provisions (benefits) adjustment as we anticipate conversion activity each quarter. For further information on non-GAAP measures, see “Selected Non-GAAP Financial Information” herein.

Adjusted amounts exclude an intermittent net discrete tax benefit of $88 million in the current quarter and current year period, primarily associated with new information pertaining to the resolution of multi-jurisdiction tax examinations and other matters. Intermittent net discrete tax provisions were $4 million and $18 million in the prior year quarter and prior year period, respectively.

The effective tax rates include recurring-type discrete tax benefits associated with employee share-based payments of $17 million and $16 million in the current quarter and prior year quarter, respectively. The effective tax rates include recurring-type discrete tax benefits associated with employee share-based payments of $164 million and $128 million in the current year period and prior year period, respectively.

The effective tax rate reflects our current assumptions, estimates and interpretations related to the Tax Act and other factors. The Tax Act, enacted on December 22, 2017, significantly revised U.S. corporate income tax law by, among other things, reducing the corporate income tax rate to 21%, and implementing a modified territorial tax system that includes a one-time transition tax on deemed repatriated earnings of non-U.S. subsidiaries; imposes a minimum tax on global intangible low-taxed income (“GILTI”) and an alternative base erosion and anti-abuse tax (“BEAT”) on U.S. corporations that make deductible payments to non-U.S. related persons in excess of specified amounts; and broadens the tax base by partially or wholly eliminating tax deductions for certain historically deductible expenses.

Our income tax estimates may change as additional clarification and implementation guidance continue to be received from the U.S. Treasury Department and as the interpretation of the Tax Act evolves over time. Taking into account continuing developments related to provisions of the Tax Act

such as the modified territorial tax system and GILTI, we expect our effective tax rate from continuing operations for 2018 to be approximately 22% to 25% (see “Forward-Looking Statements” in the 2017 Form 10-K).

U.S. Bank Subsidiaries

Our U.S. bank subsidiaries, Morgan Stanley Bank N.A. (“MSBNA”) and Morgan Stanley Private Bank, National Association (“MSPBNA”) (collectively, “U.S. Bank Subsidiaries”) accept deposit accounts, provide loans to a variety of customers, from large corporate and institutional clients to high net worth individuals, and invest in securities. The lending activities in the Institutional Securities business segment primarily include loans and lending commitments to corporate clients. The lending activities in the Wealth Management business segment primarily include: securities-based lending, which allows clients to borrow money against the value of qualifying securities; and residential real estate loans.

We expect our lending activities to continue to grow through further market penetration of the client base. For a further discussion of our credit risks, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Credit Risk.” For further discussion about loans and lending commitments, see Notes 7 and 11 to the financial statements.

U.S. Bank Subsidiaries’ Supplemental Financial Information1

 

$ in billions   

At
    June 30,    

2018

     At
  December 31,  
2017
 

Assets

   $ 200.5      $ 185.3  

Investment securities portfolio:

     

Investment securities—AFS

     41.3        42.0  

Investment securities—HTM

     18.8        17.5  

Total investment securities

   $ 60.1      $ 59.5  

Deposits2

   $ 172.6      $ 159.1  

Wealth Management

 

Securities-based lending and other loans3

   $ 43.6      $ 41.2  

Residential real estate loans

     26.4        26.7  

Total

   $ 70.0      $ 67.9  

Institutional Securities

 

Corporate loans

   $ 26.7      $ 24.2  

Wholesale real estate loans

     14.5        12.2  

Total

   $ 41.2      $ 36.4  

 

1.

Amounts exclude transactions with the Parent Company and between the bank subsidiaries.

2.

For further information on deposits, see “Liquidity and Capital Resources—Funding Management—Unsecured Financing” herein.

3.

Other loans primarily include tailored lending.

 

 

June 2018 Form 10-Q    18   


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Management’s Discussion and Analysis    LOGO

 

Accounting Development Updates

The Financial Accounting Standards Board has issued certain accounting updates that apply to us. Accounting updates not listed below were assessed and determined to be either not applicable or are not expected to have a significant impact on our financial statements.

The following accounting updates are currently being evaluated to determine the potential impact of adoption:

 

Leases. This accounting update requires lessees to recognize in the balance sheet all leases with terms exceeding one year, which results in the recognition of a right of use asset and corresponding lease liability, including for those leases that we currently classify as operating leases. The accounting for leases where we are the lessor is largely unchanged.

 

  

The right of use asset and lease liability will initially be measured using the present value of the remaining rental payments. This change to the accounting for leases where we are lessee requires modifications to our lease accounting systems and determining the present value of the remaining rental payments. Key aspects of the latter include concluding upon the discount rate and determining whether to include non-lease components in rental payments. Currently, we plan to adopt this accounting update as of the effective date, January 1, 2019. Based upon our current population of leases, we expect the right of use asset and corresponding lease liability to be less than 1% of our total assets.

 

Financial Instruments–Credit Losses. This accounting update impacts the impairment model for certain financial assets measured at amortized cost by requiring a CECL methodology to estimate expected credit losses over the entire life of the financial asset, recorded at inception or purchase. CECL will replace the loss model currently applicable to loans held for investment, HTM securities and other receivables carried at amortized cost.

 

  

The update also eliminates the concept of other-than-temporary impairment for AFS securities. Impairments on AFS securities will be required to be recognized in earnings through an allowance, when the fair value is less than amortized cost and a credit loss exists or the securities are expected to be sold before recovery of amortized cost.

 

  

Under the update, there may be an ability to determine there are no expected credit losses in certain circumstances, e.g., based on collateral arrangements for lending and financing transactions or based on the credit quality of the borrower or issuer.

 

  

Overall, the amendments in this update are expected to accelerate the recognition of credit losses for portfolios

 

where the CECL models will be applied. This update is effective as of January 1, 2020 with early adoption permitted as of January 1, 2019.

Critical Accounting Policies

Our financial statements are prepared in accordance with U.S. GAAP, which requires us to make estimates and assumptions (see Note 1 to the financial statements). We believe that of our significant accounting policies (see Note 2 to the financial statements in the 2017 Form 10-K and Note 2 to the financial statements), the fair value, goodwill and intangible assets, legal and regulatory contingencies and income taxes policies involve a higher degree of judgment and complexity. For a further discussion about our critical accounting policies, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in the 2017 Form 10-K.

Liquidity and Capital Resources

Senior management, with oversight by the Asset and Liability Management Committee and the Board of Directors (“Board”), establishes and maintains our liquidity and capital policies. Through various risk and control committees, senior management reviews business performance relative to these policies, monitors the availability of alternative sources of financing, and oversees the liquidity, interest rate and currency sensitivity of our asset and liability position. The Treasury department, Firm Risk Committee, Asset and Liability Management Committee, and other committees and control groups assist in evaluating, monitoring and controlling the impact that our business activities have on our balance sheet, liquidity and capital structure. Liquidity and capital matters are reported regularly to the Board and the Risk Committee of the Board.

Balance Sheet

We monitor and evaluate the composition and size of our balance sheet on a regular basis. Our balance sheet management process includes quarterly planning, business-specific thresholds, monitoring of business-specific usage versus key performance metrics and new business impact assessments.

We establish balance sheet thresholds at the consolidated and business segment levels. We monitor balance sheet utilization and review variances resulting from business activity or market fluctuations. On a regular basis, we review current performance versus established thresholds and assess the need to re-allocate our balance sheet based on business unit needs. We also monitor key metrics, including asset and liability size and capital usage.

 

 

   19    June 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Total Assets by Business Segment

 

    At June 30, 2018  
$ in millions   IS     WM     IM     Total  

Assets

       

Cash and cash equivalents1

  $ 66,624     $ 14,891     $ 74     $ 81,589  

Trading assets at fair value

    262,743       78       3,617       266,438  

Investment securities

    22,204       59,744             81,948  

Securities purchased under agreements to resell

    79,509       14,419             93,928  

Securities borrowed

    153,062       186             153,248  

Customer and other receivables

    43,664       17,467       583       61,714  

Loans, net of allowance2

    42,071       70,037       5       112,113  

Other assets3

    14,011       9,227       1,659       24,897  

Total assets

  $   683,888     $   186,049     $   5,938     $   875,875  
    At December 31, 2017  
$ in millions   IS     WM     IM     Total  

Assets

       

Cash and cash equivalents1

  $ 63,597     $ 16,733     $ 65     $ 80,395  

Trading assets at fair value

    295,678       59       2,545       298,282  

Investment securities

    19,556       59,246             78,802  

Securities purchased under agreements to resell

    74,732       9,526             84,258  

Securities borrowed

    123,776       234             124,010  

Customer and other receivables

    36,803       18,763       621       56,187  

Loans, net of allowance2

    36,269       67,852       5       104,126  

Other assets3

    14,563       9,596       1,514       25,673  

Total assets

  $ 664,974     $ 182,009     $ 4,750     $ 851,733  

IS—Institutional Securities

WM—Wealth Management

IM—Investment Management

1.

Cash and cash equivalents includes Cash and due from banks, Interest bearing deposits with banks and Restricted cash.

2.

Amounts include loans held for investment (net of allowance) and loans held for sale but exclude loans at fair value, which are included in Trading assets in the balance sheets (see Note 7 to the financial statements).

3.

Other assets primarily includes Goodwill, Intangible assets, premises, equipment, software, other investments, and deferred tax assets.

A substantial portion of total assets consists of liquid marketable securities and short-term receivables arising principally from sales and trading activities in the Institutional Securities business segment. Total assets increased to $875.9 billion at June 30, 2018 from $851.7 billion at December 31, 2017, primarily driven by increases to support client activity in Securities borrowed in the Institutional Securities business segment and Loans across all segments. Trading assets within the Institutional Securities business segment declined due to reductions in Equities inventory to support increased demand and changes in client positioning. The decrease in Trading assets resulted in greater liquidity, as reflected by increases in GLR-eligible Securities purchased under agreements to resell, Investment securities and Cash and cash equivalents. For further information regarding our GLR, see “Global Liquidity Reserve” herein.

Collateralized Financing Transactions

 

$ in millions    At
June 30,
2018
     At
December 31,
2017
 

Securities purchased under agreements to resell and Securities borrowed

   $           247,176      $           208,268  

Securities sold under agreements to repurchase and Securities loaned

   $ 63,370      $ 70,016  

Securities received as collateral1

   $ 8,209      $ 13,749  
    

Average Daily Balance

Three Months Ended

 
$ in millions   

June 30,

2018

     December 31,
2017
 

Securities purchased under agreements to resell and Securities borrowed

   $ 227,527      $ 214,343  

Securities sold under agreements to repurchase and Securities loaned

   $ 64,404      $ 66,879  

 

1.

Included in Trading assets in the balance sheets.

See Note 2 to the financial statements in the 2017 Form 10-K and Note 6 to the financial statements for more details on collateralized financing transactions.

In addition to the collateralized financing transactions shown in the previous table, we also engage in financing transactions collateralized by customer-owned securities, which are segregated in accordance with regulatory requirements. Receivables under these financing transactions, primarily margin loans, are included in Customer and other receivables in the balance sheets, and payables under these financing transactions, primarily to prime brokerage customers, are included in Customer and other payables in the balance sheets. Our risk exposure on these transactions is mitigated by collateral maintenance policies that limit our credit exposure to customers and liquidity reserves held against this risk exposure.

Liquidity Risk Management Framework

The primary goal of our Liquidity Risk Management Framework is to ensure that we have access to adequate funding across a wide range of market conditions and time horizons. The framework is designed to enable us to fulfill our financial obligations and support the execution of our business strategies.

The core components of our Liquidity Risk Management Framework are the Required Liquidity Framework, Liquidity Stress Tests and the GLR, which support our target liquidity profile. For further discussion about the Firm’s Required Liquidity Framework and Liquidity Stress Tests, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Liquidity Risk Management Framework” in the 2017 Form 10-K.

 

 

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At June 30, 2018 and December 31, 2017, we maintained sufficient liquidity to meet current and contingent funding obligations as modeled in our Liquidity Stress Tests.

Global Liquidity Reserve

We maintain sufficient global liquidity reserves pursuant to our Required Liquidity Framework. For further discussion of our GLR, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Liquidity Risk Management Framework—Global Liquidity Reserve” in the 2017 Form 10-K.

GLR by Type of Investment

 

$ in millions    At
June 30,
2018
     At
December 31,
2017
 

Cash deposits with banks1

   $ 10,345      $ 7,167  

Cash deposits with central banks1

     33,948        33,791  

Unencumbered highly liquid securities:

     

U.S. government obligations

     88,979        73,422  

U.S. agency and agency mortgage-backed securities

     59,143        55,750  

Non-U.S. sovereign obligations2

     31,157        19,424  

Other investment grade securities

     2,750        3,106  

Total

   $         226,322      $         192,660  

 

1.

Primarily included in Cash and due from banks and Interest bearing deposits with banks in the balance sheets.

2.

Non-U.S. sovereign obligations are primarily composed of unencumbered Japanese, U.K., German, Brazilian and French government obligations.

GLR Managed by Bank and Non-Bank Legal Entities

 

   

At
June 30,

2018

   

At
December 31,

2017

    Average Daily
Balance
Three Months Ended
 
$ in millions   June 30, 2018  

Bank legal entities

                       

Domestic

  $ 76,667     $ 70,364     $ 70,962  

Foreign

    4,365       4,756       4,144  

Total Bank legal entities

    81,032       75,120       75,106  

Non-Bank legal entities

 

   

Domestic:

     

Parent Company

    63,401       41,642       55,887  

Non-Parent Company

    31,652       35,264       32,307  

Total Domestic

    95,053       76,906       88,194  

Foreign

    50,237       40,634       50,650  

Total Non-Bank legal entities

    145,290       117,540       138,844  

Total

  $     226,322     $     192,660     $     213,950  

Regulatory Liquidity Framework

Liquidity Coverage Ratio

We and our U.S. Bank Subsidiaries are subject to the LCR requirements including a requirement to calculate each entity’s LCR on each business day. The requirements are designed to ensure that banking organizations have sufficient HQLA to cover net cash outflows arising from significant stress over 30 calendar days, thus promoting the short-term resilience of the liquidity risk profile of banking organizations. Based on our daily calculations, we and our U.S. Bank Subsidiaries are compliant with the minimum required LCR of 100%.

The Firm’s calculations are based on our current understanding of the LCR and other factors, which may be subject to change as we receive additional clarification and implementation guidance from regulators relating to the LCR, and as the interpretation of the LCR evolves over time.

HQLA by Type of Asset and LCR

 

     Average Daily Balance
Three Months Ended
 
$ in millions        June 30, 2018            March 31, 2018  

HQLA

     

Cash deposits with central banks

   $ 38,456      $ 33,350  

Securities1

     128,268        125,015  

Total

   $ 166,724      $ 158,365  

LCR

     128%        121%  

 

1.

Primarily includes U.S. Treasuries; U.S. agency mortgage-backed securities; sovereign bonds; investment grade corporate bonds; and publicly traded common equities.

The increase in the LCR in the current quarter is due to increased HQLA resulting from changes in the composition of assets within the Institutional Securities business segment.

The regulatory definition of HQLA is substantially the same as our GLR. GLR includes cash placed at institutions other than central banks that is considered an inflow for LCR purposes. HQLA includes a portion of cash placed at central banks, certain unencumbered investment grade corporate bonds and publicly traded common equities, which do not meet the definition of our GLR.

Net Stable Funding Ratio

The objective of the NSFR is to reduce funding risk over a one-year horizon by requiring banking organizations to fund their activities with sufficiently stable sources of funding in order to mitigate the risk of future funding stress.

 

 

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The Basel Committee on Banking Supervision (“Basel Committee”) has previously finalized the NSFR framework. In May 2016, the U.S. banking agencies issued a proposal to implement the NSFR in the U.S., which would apply to us and our U.S. Bank Subsidiaries. Our preliminary estimates, based on the current proposal, indicate that actions will be necessary to meet the requirement, which we would expect to accomplish by the effective date of any final rule. Our preliminary estimates are subject to risks and uncertainties that may cause actual results based on the final rule to differ materially from estimates. For an additional discussion of the NSFR, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Liquidity Framework—Net Stable Funding Ratio” in the 2017 Form 10-K.

Funding Management

We manage our funding in a manner that reduces the risk of disruption to our operations. We pursue a strategy of diversification of secured and unsecured funding sources (by product, investor and region) and attempt to ensure that the tenor of our liabilities equals or exceeds the expected holding period of the assets being financed.

We fund our balance sheet on a global basis through diverse sources. These sources may include our equity capital, borrowings, securities sold under agreements to repurchase, securities lending, deposits, letters of credit and lines of credit. We have active financing programs for both standard and structured products targeting global investors and currencies.

Secured Financing

For a discussion of our secured financing activities, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Funding Management—Secured Financing” in the 2017 Form 10-K.

At June 30, 2018 and December 31, 2017, the weighted average maturity of our secured financing of less liquid assets was greater than 120 days.

Unsecured Financing

For a discussion of our unsecured financing activities, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Funding Management—Unsecured Financing” in the 2017 Form 10-K.

Deposits

 

$ in millions  

At

June 30,
2018

    At
December 31,
2017
 

Savings and demand deposits:

   

Brokerage sweep deposits1

  $ 130,698     $ 135,946  

Savings and other

    9,038       8,541  

Total Savings and demand deposits

    139,736       144,487  

Time deposits2

    33,066       14,949  

Total

  $         172,802     $         159,436  

 

1.

Represents balances swept from client brokerage accounts.

2.

Certain time deposit accounts are carried at fair value under the fair value option (see Note 3 to the financial statements).

Deposits are primarily sourced from our Wealth Management clients and are considered to have stable, low-cost funding characteristics. Total deposits at June 30, 2018 increased compared with December 31, 2017, primarily driven by increases in Time deposits and Savings and other deposits, partially offset by a reduction in Brokerage sweep deposits due to client deployment of cash into investments and typical seasonal client tax payments. In the current quarter we initiated a redesign of our Brokerage sweep deposit program, resulting in approximately $10 billion in incremental deposits in higher balance accounts, which partially offset the reductions noted since December 31, 2017. As we make additional adjustments in the third quarter of 2018, we anticipate a similar amount of incremental deposits.

Borrowings

We believe that accessing debt investors through multiple distribution channels helps provide consistent access to the unsecured markets. In addition, the issuance of borrowings with original maturities greater than one year allows us to reduce reliance on short-term credit sensitive instruments. Borrowings with original maturities greater than one year are generally managed to achieve staggered maturities, thereby mitigating refinancing risk, and to maximize investor diversification through sales to global institutional and retail clients across regions, currencies and product types.

The availability and cost of financing to us can vary depending on market conditions, the volume of certain trading and lending activities, our credit ratings and the overall availability of credit. We also engage in, and may continue to engage in, repurchases of our borrowings in the ordinary course of business.

 

 

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Borrowings by Remaining Maturity at June 30, 20181

 

$ in millions    Parent
Company
     Subsidiaries      Total  

Original maturities of one year or less

   $      $ 2,329      $ 2,329  

Original maturities greater than one year

 

  

2018

   $ 3,652      $ 2,436      $ 6,088  

2019

     21,497        4,095        25,592  

2020

     18,781        2,400        21,181  

2021

     21,294        2,984        24,278  

2022

     14,969        1,874        16,843  

Thereafter

     80,964        14,969        95,933  

Total

   $ 161,157      $ 28,758      $ 189,915  

Total Borrowings

   $       161,157      $       31,087      $       192,244  

Maturities over next 12 months2

 

   $ 17,330  

 

1.

Original maturity in the table is generally based on contractual final maturity. For borrowings with put options, remaining maturity represents the earliest put date.

2.

Includes only borrowings with original maturities greater than one year.

Borrowings of $192,244 million as of June 30, 2018 remained relatively unchanged compared with $192,582 million at December 31, 2017.

For further information on Borrowings, see Note 10 to the financial statements.

Credit Ratings

We rely on external sources to finance a significant portion of our daily operations. The cost and availability of financing generally are impacted by our credit ratings, among other things. In addition, our credit ratings can have an impact on certain trading revenues, particularly in those businesses where longer-term counterparty performance is a key consideration, such as OTC derivative transactions, including credit derivatives and interest rate swaps. When determining credit ratings, rating agencies consider company-specific factors, other industry factors such as regulatory or legislative changes, and the macroeconomic environment, among other things.

Our credit ratings do not include any uplift from perceived government support from any rating agency given the significant progress of U.S. financial reform legislation and regulations. Some rating agencies have stated that they currently incorporate various degrees of credit rating uplift from non-governmental third-party sources of potential support.

Parent Company and MSBNA Senior Unsecured Ratings at July 31, 2018

 

    Parent Company  
     Short-Term
Debt
  Long-Term
Debt
  Rating
Outlook
 

DBRS, Inc.

  R-1 (middle)   A (high)     Stable  

Fitch Ratings, Inc.

  F1   A     Stable  

Moody’s Investors Service, Inc.

  P-2   A3     Stable  

Rating and Investment Information, Inc.

  a-1   A-     Stable  

S&P Global Ratings

  A-2   BBB+     Stable  
    MSBNA  
     Short-Term
Debt
  Long-Term
Debt
  Rating
Outlook
 

Fitch Ratings, Inc.

  F1   A+     Stable  

Moody’s Investors Service, Inc.

  P-1   A1     Stable  

S&P Global Ratings

  A-1   A+     Stable  

In connection with certain OTC trading agreements and certain other agreements where we are a liquidity provider to certain financing vehicles associated with the Institutional Securities business segment, we may be required to provide additional collateral, immediately settle any outstanding liability balances with certain counterparties or pledge additional collateral to certain clearing organizations in the event of a future credit rating downgrade irrespective of whether we are in a net asset or net liability position.

The additional collateral or termination payments that may be called in the event of a future credit rating downgrade vary by contract and can be based on ratings by either or both of Moody’s Investors Service, Inc. (“Moody’s”) and S&P Global Ratings. The following table shows the future potential collateral amounts and termination payments that could be called or required by counterparties and clearing organizations in the event of one-notch or two-notch downgrade scenarios, from the lowest of Moody’s ratings or S&P Global Ratings, based on the relevant contractual downgrade triggers.

Incremental Collateral or Terminating Payments upon Potential Future Rating Downgrade

 

$ in millions   

At

June 30,
2018

     At
December 31,
2017
 

One-notch downgrade

   $                 828      $ 822  

Two-notch downgrade

     596        596  

While certain aspects of a credit rating downgrade are quantifiable pursuant to contractual provisions, the impact it would have on our business and results of operations in future periods is inherently uncertain and would depend on a number of interrelated factors, including, among others, the magnitude of the downgrade, the rating relative to peers, the

 

 

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rating assigned by the relevant agency pre-downgrade, individual client behavior and future mitigating actions we might take. The liquidity impact of additional collateral requirements is included in our Liquidity Stress Tests.

Capital Management

We view capital as an important source of financial strength and actively manage our consolidated capital position based upon, among other things, business opportunities, risks, capital availability and rates of return together with internal capital policies, regulatory requirements and rating agency guidelines and, therefore, in the future may expand or contract our capital base to address the changing needs of our businesses. We attempt to maintain total capital, on a consolidated basis, at least equal to the sum of our operating subsidiaries’ required equity.

Common Stock

 

   

Three Months

Ended June 30,

   

Six Months

Ended June 30,

 

$ in millions

    2018       2017       2018       2017  

Repurchases of common stock under our share repurchase program

  $     1,250     $ 500     $     2,500     $ 1,250  

From time to time we repurchase our outstanding common stock, including as part of our share repurchase program. On April 18, 2018, we entered into a sales plan with Mitsubishi UFJ Financial Group, Inc. (“MUFG”) whereby MUFG sells shares of the Firm’s common stock to us, as part of our share repurchase program. The sales plan, which began to be executed in the current quarter, is only intended to maintain MUFG’s ownership percentage below 24.9% in order to comply with MUFG’s passivity commitments to the Board of Governors of the Federal Reserve System (“Federal Reserve”) and will have no impact on the strategic alliance between MUFG and us, including the joint ventures in Japan. For a description of our share repurchase program, see “Unregistered Sales of Equity Securities and Use of Proceeds.”

For a description of our capital plan, see “Liquidity and Capital Resources—Regulatory Requirements—Capital Plans and Stress Tests.”

Common Stock Dividend Announcement

 

Announcement date

   July 18, 2018

Amount per share

   $0.30

Date to be paid

   August 15, 2018

Shareholders of record as of

   July 31, 2018

Preferred Stock

Preferred Stock Dividend Announcement

 

Announcement date

   June 15, 2018

Date paid

   July 16, 2018

Shareholders of record as of

   June 29, 2018

For additional information on common and preferred stock, see Note 14 to the financial statements.

Regulatory Requirements

Regulatory Capital Framework

We are a financial holding company (“FHC”) under the Bank Holding Company Act of 1956, as amended (“BHC Act”), and are subject to the regulation and oversight of the Federal Reserve. The Federal Reserve establishes capital requirements for us, including “well-capitalized” standards, and evaluates our compliance with such capital requirements. The OCC establishes similar capital requirements and standards for our U.S. Bank Subsidiaries. For us to remain an FHC, we must remain well-capitalized in accordance with standards established by the Federal Reserve and our U.S. Bank Subsidiaries must remain well-capitalized in accordance with standards established by the OCC. For additional information on regulatory capital requirements for our U.S. Bank Subsidiaries, see Note 13 to the financial statements.

Regulatory capital requirements established by the Federal Reserve are largely based on the Basel III capital standards established by the Basel Committee and also implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).

Regulatory Capital Requirements

We are required to maintain minimum risk-based and leverage-based capital ratios under the regulatory capital requirements. For more information on our regulatory capital requirements, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Capital Requirements” in the 2017 Form 10-K.

Risk-based Regulatory Capital.    Minimum risk-based capital ratio requirements apply to Common Equity Tier 1 capital, Tier 1 capital and Total capital (which includes Tier 2 capital). Certain adjustments to and deductions from capital are required for purposes of determining these ratios, such as goodwill, intangible assets, certain deferred tax assets, other amounts in AOCI and investments in the capital instruments of unconsolidated financial institutions.

 

 

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In addition to the minimum risk-based capital ratio requirements, by 2019 we will be subject to the following buffers:

 

 

A greater than 2.5% Common Equity Tier 1 capital conservation buffer;

 

 

The Common Equity Tier 1 G-SIB capital surcharge, currently at 3%; and

 

 

Up to a 2.5% Common Equity Tier 1 CCyB, currently set by U.S. banking agencies at zero.

In 2017 and 2018, each of the buffers is 50% and 75%, respectively, of the 2019 requirement noted above. Failure to maintain the buffers would result in restrictions on our ability to make capital distributions, including the payment of dividends and the repurchase of stock, and to pay discretionary bonuses to executive officers. For a further discussion of the G-SIB capital surcharge, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Requirements—G-SIB Capital Surcharge” in the 2017 Form 10-K.

Our risk-based capital ratios for purposes of determining regulatory compliance are the lower of the capital ratios computed under (i) the standardized approaches for calculating credit risk and market risk RWA (“Standardized Approach”) and (ii) the applicable advanced approaches for calculating credit risk, market risk and operational risk RWA (“Advanced Approach”). At June 30, 2018 and December 31, 2017, our ratios are based on the Standardized Approach rules.

Effective January 1, 2019, Common Equity Tier 1 capital, Tier 1 capital and Total capital requirements, inclusive of buffers, will increase to 10.0%, 11.5%, and 13.5%, respectively.

See “Total Loss-Absorbing Capacity, Long-Term Debt and Clean Holding Company Requirements” herein for additional capital requirements effective January 1, 2019.

Leverage-based Regulatory Capital. Minimum leverage-based capital requirements include a Tier 1 leverage ratio and an SLR. The SLR became effective as a capital standard on January 1, 2018. We are required to maintain a Tier 1 SLR of 3% as well as an enhanced SLR capital buffer of at least 2% (for a total of at least 5%) in order to avoid potential limitations on capital distributions, including dividends and stock repurchases, and discretionary bonus payments to executive officers.

Regulatory Capital Ratios

 

     At June 30, 2018  
            Fully Phased-In  
$ in millions    Required
Ratio
     Standardized      Advanced  

Risk-based capital

        

Common Equity Tier 1 capital

            $ 61,352      $ 61,352  

Tier 1 capital

              70,017        70,017  

Total capital

              79,681        79,425  

Total RWA

              387,414        369,383  

Common Equity Tier 1 capital

ratio

     8.6%        15.8%        16.6%  

Tier 1 capital ratio

     10.1%        18.1%        19.0%  

Total capital ratio

     12.1%        20.6%        21.5%  

Leverage-based capital

        

Adjusted average assets1

            $       852,726        N/A  

Tier 1 leverage ratio

     4.0%        8.2%        N/A  

Supplementary leverage exposure2

              N/A        1,096,953  

SLR

     5.0%        N/A        6.4%  

 

    At December 31, 2017  
          Transitional3     Pro Forma Fully
Phased-In
 
$ in millions   Required
Ratio
    Standardized     Advanced     Standardized     Advanced  

Risk-based capital

         

Common Equity

         

Tier 1 capital

          $ 61,134     $ 61,134     $ 60,564     $ 60,564  

Tier 1 capital

            69,938       69,938       69,120       69,120  

Total capital

            80,275       80,046       79,470       79,240  

Total RWA

            369,578       350,212       377,241       358,324  

Common Equity Tier 1 capital ratio

    7.3%       16.5%       17.5%       16.1%       16.9%  

Tier 1 capital ratio

    8.8%       18.9%       20.0%       18.3%       19.3%  

Total capital ratio

    10.8%       21.7%       22.9%       21.1%       22.1%  

Leverage-based capital

 

     

Adjusted average assets1

          $   842,270       N/A     $   841,756       N/A  

Tier 1 leverage ratio

    4.0%       8.3%       N/A       8.2%       N/A  

Supplementary leverage exposure2

            N/A       1,082,683       N/A       1,082,170  

Pro forma SLR

    5.0%       N/A       6.5%       N/A       6.4%  

 

1.

Adjusted average assets represents the denominator of the Tier 1 leverage ratio and is composed of the average daily balance of consolidated on-balance sheet assets under U.S. GAAP during the current quarter and the quarter ended December 31, 2017, adjusted for disallowed goodwill, intangible assets, certain deferred tax assets, certain investments in the capital instruments of unconsolidated financial institutions and other capital deductions.

2.

Supplementary leverage exposure is the sum of Adjusted average assets used in the Tier 1 leverage ratio and other adjustments, primarily (i) potential future exposure for derivative exposures, gross-up for cash collateral netting where qualifying criteria are not met, and the effective notional principal amount of sold credit protection offset by qualifying purchased credit protection; (ii) the counterparty credit risk for repo-style transactions; and (iii) the credit equivalent amount for off-balance sheet exposures.

3.

Regulatory compliance was determined based on capital ratios calculated under transitional rules until December 31, 2017.

At December 31, 2017, the pro forma fully phased-in estimated amounts and the pro forma estimated SLR utilized fully phased-in Tier 1 capital, including the fully phased-in Tier 1 capital deductions that applied beginning January 1, 2018. These pro forma fully phased-in estimates were

 

 

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non-GAAP financial measures as the related capital rules were not yet effective at December 31, 2017. These estimates were based on our understanding of the capital rules and other factors at the time.

Regulatory compliance was determined based on capital ratios including regulatory capital and RWA calculated under the transitional rules until December 31, 2017. The regulatory capital analyses in the following tables are presented using pro forma fully phased-in estimates as of December 31, 2017, which are equivalent to amounts calculated as of June 30, 2018.

Fully Phased-In Regulatory Capital

 

$ in millions  

At

June 30, 2018

   

At

December 31, 20171

 

Common Equity Tier 1 capital

   

Common stock and surplus

  $ 11,824     $ 14,354