10-Q 1 d10q.htm FORM 10-Q Form 10-Q
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

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  x    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  x    No  ¨

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

 

Large Accelerated Filer  x

   Accelerated Filer  ¨

Non-Accelerated Filer  ¨

   Smaller reporting company  ¨

(Do not check if a smaller reporting company)

  

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

As of July 31, 2011, there were 1,927,916,237 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.


Table of Contents

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QUARTERLY REPORT ON FORM 10-Q

For the quarter ended June 30, 2011

 

Table of Contents    Page  

Part I—Financial Information

  

Item 1.

  Financial Statements (unaudited)      1   
 

Condensed Consolidated Statements of Financial Condition—June 30, 2011 and December 31, 2010

     1   
 

Condensed Consolidated Statements of Income—Three and Six Months Ended June 30, 2011 and 2010

     3   
 

Condensed Consolidated Statements of Comprehensive Income—Three and Six Months Ended June  30, 2011 and 2010

     4   
 

Condensed Consolidated Statements of Cash Flows—Six Months Ended June 30, 2011 and 2010

     5   
 

Condensed Consolidated Statements of Changes in Total Equity—Six Months Ended June  30, 2011 and 2010

     6   
  Notes to Condensed Consolidated Financial Statements (unaudited)      8   
  Report of Independent Registered Public Accounting Firm      82   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      83   
 

Introduction

     83   
 

Executive Summary

     84   
 

Business Segments

     95   
 

Accounting Developments

     109   
 

Other Matters

     110   
 

Critical Accounting Policies

     114   
 

Liquidity and Capital Resources

     119   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      132   

Item 4.

  Controls and Procedures      143   
  Financial Data Supplement (Unaudited)      144   

Part II—Other Information

  

Item 1.

  Legal Proceedings      150   

Item 1A.

  Risk Factors      151   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      156   

Item 6.

  Exhibits      156   

 

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AVAILABLE INFORMATION

Morgan Stanley files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (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 that contains annual, quarterly and current reports, proxy and information statements and other information that issuers (including Morgan Stanley) file electronically with the SEC. Morgan Stanley’s electronic SEC filings are available to the public at the SEC’s internet site, www.sec.gov.

Morgan Stanley’s internet site is www.morganstanley.com. You can access Morgan Stanley’s Investor Relations webpage at www.morganstanley.com/about/ir. Morgan Stanley makes available free of charge, on or through its Investor Relations webpage, its 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 (the “Exchange Act”), as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. Morgan Stanley also makes available, through its Investor Relations webpage, via a link to the SEC’s internet site, statements of beneficial ownership of Morgan Stanley’s equity securities filed by its directors, officers, 10% or greater shareholders and others under Section 16 of the Exchange Act.

Morgan Stanley has a Corporate Governance webpage. You can access information about Morgan Stanley’s corporate governance at www.morganstanley.com/about/company/governance. Morgan Stanley posts the following on its Corporate Governance webpage:

 

   

Amended and Restated Certificate of Incorporation;

 

   

Amended and Restated Bylaws;

 

   

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

 

   

Corporate Governance Policies;

 

   

Policy Regarding Communication with the Board of Directors;

 

   

Policy Regarding Director Candidates Recommended by Shareholders;

 

   

Policy Regarding Corporate Political Contributions;

 

   

Policy Regarding Shareholder Rights Plan;

 

   

Code of Ethics and Business Conduct;

 

   

Code of Conduct; and

 

   

Integrity Hotline information.

Morgan Stanley’s Code of Ethics and Business Conduct applies to all directors, officers and employees, including its Chief Executive Officer, Chief Financial Officer and Deputy Chief Financial Officer. Morgan Stanley 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 its 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 Morgan Stanley’s internet site is not incorporated by reference into this report.

 

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Table of Contents

Part I—Financial Information.

 

Item 1. Financial Statements.

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(dollars in millions, except share data)

(unaudited)

 

     June 30,
2011
     December 31,
2010
 

Assets

     

Cash and due from banks ($254 and $297 at June 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities generally not available to the Company)

   $ 9,066       $ 7,341   

Interest bearing deposits with banks

     41,681         40,274   

Cash deposited with clearing organizations or segregated under federal and other regulations or requirements

     25,504         19,180   

Financial instruments owned, at fair value (approximately $122,209 and $129,969 were pledged to various parties at June 30, 2011 and December 31, 2010, respectively):

     

U.S. government and agency securities

     35,676         48,446   

Other sovereign government obligations

     39,172         33,908   

Corporate and other debt ($4,005 and $3,816 at June 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities, generally not available to the Company)

     89,159         88,154   

Corporate equities ($100 and $625 at June 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities, generally not available to the Company)

     66,053         68,416   

Derivative and other contracts

     46,167         51,292   

Investments ($2,012 and $1,873 at June 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities, generally not available to the Company)

     9,020         9,752   

Physical commodities

     9,551         6,778   
                 

Total financial instruments owned, at fair value

     294,798         306,746   

Securities available for sale, at fair value

     24,306         29,649   

Securities received as collateral, at fair value

     15,862         16,537   

Federal funds sold and securities purchased under agreements to resell

     180,990         148,253   

Securities borrowed

     132,092         138,730   

Receivables:

     

Customers

     39,142         35,258   

Brokers, dealers and clearing organizations

     9,439         9,102   

Fees, interest and other

     9,911         9,790   

Loans (net of allowances of $36 and $82 at June 30, 2011 and December 31, 2010, respectively)

     12,476         10,576   

Other investments

     4,831         5,412   

Premises, equipment and software costs (net of accumulated depreciation of $4,524 and $4,476 at June 30, 2011 and December 31, 2010, respectively) ($310 and $321 at June 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities, generally not available to the Company)

     6,399         6,154   

Goodwill

     6,744         6,739   

Intangible assets (net of accumulated amortization of $779 and $605 at June 30, 2011 and December 31, 2010, respectively) (includes $133 and $157 at fair value at June 30, 2011 and December 31, 2010, respectively)

     4,474         4,667   

Other assets ($371 and $118 at June 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities, generally not available to the Company)

     13,032         13,290   
                 

Total assets

   $ 830,747       $ 807,698   
                 

See Notes to Condensed Consolidated Financial Statements.

 

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MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION—(Continued)

(dollars in millions, except share data)

(unaudited)

 

     June 30,
2011
    December 31,
2010
 

Liabilities and Equity

    

Deposits (includes $2,830 and $3,027 at fair value at June 30, 2011 and December 31, 2010, respectively)

   $ 65,525      $ 63,812   

Commercial paper and other short-term borrowings (includes $1,710 and $1,799 at fair value at June 30, 2011 and December 31, 2010, respectively)

     3,566        3,256   

Financial instruments sold, not yet purchased, at fair value:

    

U.S. government and agency securities

     27,520        27,948   

Other sovereign government obligations

     22,479        22,250   

Corporate and other debt

     9,166        10,918   

Corporate equities

     27,618        19,838   

Derivative and other contracts

     41,113        47,802   
  

 

 

   

 

 

 

Total financial instruments sold, not yet purchased, at fair value

     127,896        128,756   

Obligation to return securities received as collateral, at fair value

     20,741        21,163   

Securities sold under agreements to repurchase (includes $358 and $849 at fair value at June 30, 2011 and December 31, 2010, respectively )

     133,707        147,598   

Securities loaned

     35,375        29,094   

Other secured financings (includes $16,632 and $8,490 at fair value at June 30, 2011 and December 31, 2010, respectively) ($3,157 and $2,656 at June 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities and are non-recourse to the Company)

     22,476        10,453   

Payables:

    

Customers

     133,372        123,249   

Brokers, dealers and clearing organizations

     5,178        3,363   

Interest and dividends

     3,066        2,572   

Other liabilities and accrued expenses ($132 and $117 at June 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities and are non-recourse to the Company)

     15,596        16,518   

Long-term borrowings (includes $43,434 and $42,709 at fair value at June 30, 2011 and December 31, 2010, respectively)

     196,106        192,457   
  

 

 

   

 

 

 
     762,604        742,291   
  

 

 

   

 

 

 

Commitments and contingent liabilities (see Note 11)

    

Equity

    

Morgan Stanley shareholders’ equity:

    

Preferred stock

     1,508        9,597   

Common stock, $0.01 par value;

    

Shares authorized: 3,500,000,000 at June 30, 2011 and December 31, 2010;

    

Shares issued: 1,989,377,171 at June 30, 2011 and 1,603,913,074 at December 31, 2010;

    

Shares outstanding: 1,929,032,583 at June 30, 2011 and 1,512,022,095 and December 31, 2010

     20        16   

Paid-in capital

     22,346        13,521   

Retained earnings

     38,637        38,603   

Employee stock trust

     3,385        3,465   

Accumulated other comprehensive loss

     (320     (467

Common stock held in treasury, at cost, $0.01 par value; 60,344,588 shares at June 30, 2011 and 91,890,979 shares at December 31, 2010

     (2,484     (4,059

Common stock issued to employee trust

     (3,385     (3,465
  

 

 

   

 

 

 

Total Morgan Stanley shareholders’ equity

     59,707        57,211   

Noncontrolling interests

     8,436        8,196   
  

 

 

   

 

 

 

Total equity

     68,143        65,407   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 830,747      $ 807,698   
  

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(dollars in millions, except share and per share data)

(unaudited)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2011     2010     2011     2010  

Revenues:

        

Investment banking

   $ 1,695      $ 1,080      $ 2,909      $ 2,140   

Principal transactions:

        

Trading

     3,485        3,353        6,462        7,111   

Investments

     402        (52     731        317   

Commissions

     1,291        1,308        2,740        2,568   

Asset management, distribution and administration fees

     2,206        1,974        4,315        3,937   

Other

     275        159        (169     453   
                                

Total non-interest revenues

     9,354        7,822        16,988        16,526   
                                

Interest income

     1,957        1,747        3,811        3,483   

Interest expense

     2,029        1,606        3,882        2,974   
                                

Net interest

     (72     141        (71     509   
                                

Net revenues

     9,282        7,963        16,917        17,035   
                                

Non-interest expenses:

        

Compensation and benefits

     4,675        3,886        9,008        8,302   

Occupancy and equipment

     401        401        803        791   

Brokerage, clearing and exchange fees

     416        371        821        719   

Information processing and communications

     448        416        893        811   

Marketing and business development

     154        153        301        287   

Professional services

     494        496        922        891   

Other

     750        537        1,353        1,016   
                                

Total non-interest expenses

     7,338        6,260        14,101        12,817   
                                

Income from continuing operations before income taxes

     1,944        1,703        2,816        4,218   

Provision for income taxes

     542        240        286        676   
                                

Income from continuing operations

     1,402        1,463        2,530        3,542   
                                

Discontinued operations:

        

Gain from discontinued operations

     5        866        6        767   

Provision for income taxes

     1        345        —          314   
                                

Net gain from discontinued operations

     4        521        6        453   
                                

Net income

   $ 1,406      $ 1,984      $ 2,536      $ 3,995   

Net income applicable to noncontrolling interests

     213        24        375        259   
                                

Net income applicable to Morgan Stanley

   $ 1,193      $ 1,960      $ 2,161      $ 3,736   
                                

Earnings (loss) applicable to Morgan Stanley common shareholders

   $ (558   $ 1,578      $ 188      $ 2,990   
                                

Amounts applicable to Morgan Stanley:

        

Income from continuing operations

   $ 1,189      $ 1,439      $ 2,155      $ 3,283   

Net gain from discontinued operations

     4        521        6        453   
                                

Net income applicable to Morgan Stanley

   $ 1,193      $ 1,960      $ 2,161      $ 3,736   
                                

Earnings (loss) per basic common share:

        

Income (loss) from continuing operations

   $ (0.38   $ 0.84      $ 0.12      $ 1.96   

Net gain from discontinued operations

     —          0.36        0.01        0.31   
                                

Earnings (loss) per basic common share

   $ (0.38   $ 1.20      $ 0.13      $ 2.27   
                                

Earnings (loss) per diluted common share:

        

Income (loss) from continuing operations

   $ (0.38   $ 0.80      $ 0.12      $ 1.82   

Net gain from discontinued operations

     —          0.29        0.01        0.26   
                                

Earnings (loss) per diluted common share

   $ (0.38   $ 1.09      $ 0.13      $ 2.08   
                                

Average common shares outstanding:

        

Basic

     1,464,295,984        1,317,686,493        1,460,155,981        1,316,147,257   
                                

Diluted

     1,464,295,984        1,748,208,948        1,477,572,132        1,687,528,753   
                                

See Notes to Condensed Consolidated Financial Statements.

 

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MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in millions)

(unaudited)

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
         2011              2010          2011      2010  

Net income

   $ 1,406       $ 1,984       $ 2,536       $ 3,995   

Other comprehensive income, net of tax:

           

Foreign currency translation adjustments(1)

     94         35         131         37   

Amortization of cash flow hedges(2)

     3         2         4         5   

Net unrealized gain on Securities available for sale(3)

     50         107         14         87   

Pension, postretirement and other related adjustments(4)

     2         105         7         109   
  

 

 

    

 

 

    

 

 

    

 

 

 

Comprehensive income

   $ 1,555       $ 2,233       $ 2,692       $ 4,233   

Net income applicable to noncontrolling interests

     213         24         375         259   

Other comprehensive income applicable to noncontrolling interests

     43         44         9         32   
  

 

 

    

 

 

    

 

 

    

 

 

 

Comprehensive income applicable to Morgan Stanley

   $ 1,299       $ 2,165       $ 2,308       $ 3,942   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Amounts are net of provision for (benefit from) income taxes of $(68) million and $(19) million for the quarters ended June 30, 2011 and 2010, respectively, and $(136) million and $70 million for the six months ended June 30, 2011 and 2010, respectively.
(2) Amounts are net of provision for income taxes of $2 million for the quarter ended June 30, 2010, and $2 million and $3 million for the six months ended June 30, 2011 and 2010, respectively.
(3) Amounts are net of provision for income taxes of $34 million and $90 million for the quarters ended June 30, 2011 and 2010, respectively, and $10 million and $76 million for the six months ended June 30, 2011 and 2010, respectively.
(4) Amounts are net of provision for income taxes of $4 million and $66 million for the quarters ended June 30, 2011 and 2010, respectively, and $68 million for the six months ended June 30, 2010.

See Notes to Condensed Consolidated Financial Statements.

 

 

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MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in millions)

(unaudited)

 

     Six Months Ended
June 30,
 
         2011             2010      

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income

   $ 2,536      $ 3,995   

Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities:

    

(Gain) loss on equity method investees

     725        (78

Compensation payable in common stock and options

     728        671   

Depreciation and amortization

     759        1,191   

Gain on business dispositions

     —          (514

Gain on sale of securities available for sale

     (94     —     

Loss on repurchase of long-term debt

     31        —     

Insurance reimbursement

     —          (88

Loss on assets held for sale

     —          951   

Impairment charges and other-than-temporary impairment charges

     3        27   

Changes in assets and liabilities:

    

Cash deposited with clearing organizations or segregated under federal and other regulations or requirements

     (6,324     1,782   

Financial instruments owned, net of financial instruments sold, not yet purchased

     22,984        7,242   

Securities borrowed

     6,638        (11,358

Securities loaned

     6,281        278   

Receivables, loans and other assets

     (6,271     343   

Payables and other liabilities

     13,458        872   

Federal funds sold and securities purchased under agreements to resell

     (32,737     (1,654

Securities sold under agreements to repurchase

     (13,891     25,733   
  

 

 

   

 

 

 

Net cash provided by (used for) operating activities

     (5,174     29,393   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Net proceeds from (payments for):

    

Premises, equipment and software costs

     (725     (436

Business acquisitions, net of cash acquired

     —          (1,028

Business dispositions, net of cash disposed

     —          800   

Japanese securities joint venture with MUFG

     —          283   

Purchases of securities available for sale

     (8,632     (19,233

Sales and redemptions of securities available for sale

     14,245        —     
  

 

 

   

 

 

 

Net cash provided by (used for) investing activities

     4,888        (19,614
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Net proceeds from (payments for):

    

Commercial paper and other short-term borrowings

     310        1,457   

Dividends related to noncontrolling interests

     (153     (14

Derivatives financing activities

     146        (64

Other secured financings

     3,176        (367

Deposits

     1,713        (847

Net proceeds from:

    

Excess tax benefits associated with stock-based awards

     29        3   

Public offerings and other issuances of common stock

     —          2   

Issuance of long-term borrowings

     22,596        13,757   

Payments for:

    

Long-term borrowings

     (24,192     (17,570

Repurchases of common stock for employee tax withholding

     (283     (275

Cash dividends

     (594     (582
  

 

 

   

 

 

 

Net cash provided by (used for) financing activities

     2,748        (4,500
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     416        (923
  

 

 

   

 

 

 

Effect of cash and cash equivalents related to variable interest entities

     254        —     
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     3,132        4,356   

Cash and cash equivalents, at beginning of period

     47,615        31,991   
  

 

 

   

 

 

 

Cash and cash equivalents, at end of period

   $ 50,747      $ 36,347   
  

 

 

   

 

 

 

Cash and cash equivalents include:

    

Cash and due from banks

   $ 9,066      $ 8,770   

Interest bearing deposits with banks

     41,681        27,577   
  

 

 

   

 

 

 

Cash and cash equivalents, at end of period

   $ 50,747      $ 36,347   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash payments for interest were $3,144 million and $3,302 million for the six months ended June 30, 2011 and 2010, respectively.

Cash payments for income taxes were $530 million and $236 million for the six months ended June 30, 2011 and 2010, respectively.

See Notes to Condensed Consolidated Financial Statements.

 

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MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY

Six Months Ended June 30, 2011

(dollars in millions)

(unaudited)

 

    Preferred
Stock
    Common
Stock
    Paid-in
Capital
    Retained
Earnings
    Employee
Stock
Trust
    Accumulated
Other
Comprehensive
Income (Loss)
    Common
Stock
Held in
Treasury
at Cost
    Common
Stock
Issued to
Employee
Trust
    Non-
controlling
Interests
    Total
Equity
 

BALANCE AT

DECEMBER 31, 2010

  $ 9,597      $ 16      $ 13,521      $ 38,603      $ 3,465      $ (467   $ (4,059   $ (3,465   $ 8,196      $ 65,407   

Net income

    —          —          —          2,161        —          —          —          —          375        2,536   

Dividends

    —          —          —          (401     —          —          —          —          —          (401

Shares issued under employee plans and related tax effects

    —          —          (1,072     —          (80     —          1,858        80        —          786   

Repurchases of common stock

    —          —          —          —          —          —          (283     —          —          (283

Net change in cash flow hedges

    —          —          —          —          —          4        —          —          —          4   

Pension, postretirement and other related adjustments

    —          —          —          —          —          7        —          —          —          7   

Foreign currency translation adjustments

    —          —          —          —          —          122        —          —          9        131   

Change in net unrealized gains on securities available for sale

    —          —          —          —          —          14        —          —          —          14   

Other increase in equity method investments

    —          —          86        —          —          —          —          —          —          86   

MUFG stock conversion

    (8,089     4        9,811        (1,726     —          —          —          —          —          —     

Decrease in noncontrolling interests related to dividends of noncontrolling interests

    —          —          —          —          —          —          —          —          (153     (153

Other increases in noncontrolling interests

    —          —          —          —          —          —          —          —          9        9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT JUNE 30, 2011

  $ 1,508      $ 20      $ 22,346      $ 38,637      $ 3,385      $ (320   $ (2,484   $ (3,385   $ 8,436      $ 68,143   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY—(Continued)

Six Months Ended June 30, 2010

(dollars in millions)

(unaudited)

 

    Preferred
Stock
    Common
Stock
    Paid-in
Capital
    Retained
Earnings
    Employee
Stock
Trust
    Accumulated
Other
Comprehensive
Income (Loss)
    Common
Stock
Held in
Treasury
at Cost
    Common
Stock
Issued to
Employee
Trust
    Non-
controlling
Interests
    Total
Equity
 

BALANCE AT DECEMBER 31, 2009

  $ 9,597      $ 15      $ 8,619      $ 35,056      $ 4,064      $ (560   $ (6,039   $ (4,064   $ 6,092      $ 52,780   

Net income

    —          —          —          3,736        —          —          —          —          259        3,995   

Dividends

    —          —          —          (582     —          —          —          —          —          (582

Shares issued under employee plans and related tax effects

    —          —          (1,687     —          (398     —          2,210        398        —          523   

Repurchases of common stock

    —          —          —          —          —          —          (275     —          —          (275

Net change in cash flow hedges

    —          —          —          —          —          5        —          —          —          5   

Pension and postretirement adjustments

    —          —          —          —          —          109        —          —          —          109   

Foreign currency translation adjustments

    —          —          —          —          —          5        —          —          32        37   

Gain on Japanese securities joint venture with MUFG

    —          —          717        —          —          —          —          —          —          717   

Change in net unrealized gains on securities available for sale

    —          —          —          —          —          87        —          —          —          87   

Increase in noncontrolling interests related to Japanese securities joint venture with MUFG

    —          —          —          —          —          —          —          —          1,130        1,130   

Increase in noncontrolling interests related to the consolidation of certain real estate partnerships sponsored by the Company

    —          —          —          —          —          —          —          —          468        468   

Decrease in noncontrolling interests related to dividends of noncontrolling interests

    —          —          —          —          —          —          —          —          (14     (14

Other increases in noncontrolling interests

    —          —          —          —          —          —          —          —          179        179   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT JUNE 30, 2010

  $ 9,597      $ 15      $ 7,649      $ 38,210      $ 3,666      $ (354   $ (4,104   $ (3,666   $ 8,146      $ 59,159   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. Introduction and Basis of Presentation.

The Company.    Morgan Stanley, a financial holding company, is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Global Wealth Management Group and Asset Management. Unless the context otherwise requires, the terms “Morgan Stanley” and the “Company” mean Morgan Stanley and its consolidated subsidiaries.

A summary of the activities of each of the Company’s business segments is as follows:

Institutional Securities provides capital raising; financial advisory services, including advice on mergers and acquisitions, restructurings, real estate and project finance; corporate lending; sales, trading, financing and market-making activities in equity and fixed income securities and related products, including foreign exchange and commodities; and investment activities.

Global Wealth Management Group, which includes the Company’s 51% interest in Morgan Stanley Smith Barney Holdings LLC (“MSSB”), provides brokerage and investment advisory services to individual investors and small-to-medium sized businesses and institutions covering various investment alternatives; financial and wealth planning services; annuity and other insurance products; credit and other lending products; cash management services; retirement services; and trust and fiduciary services and engages in fixed income principal trading, which primarily facilitates clients’ trading or investments in such securities.

Asset Management provides a broad array of investment strategies that span the risk/return spectrum across geographies, asset classes and public and private markets to a diverse group of clients across the institutional and intermediary channels as well as high net worth clients (see “Discontinued Operations—Retail Asset Management Business” herein).

Discontinued Operations.

Retail Asset Management Business.    On June 1, 2010, the Company completed the sale of substantially all of its retail asset management business (“Retail Asset Management”), including Van Kampen Investments, Inc., to Invesco Ltd. (“Invesco”). The Company received $800 million in cash and approximately 30.9 million shares of Invesco stock upon the sale. The results of Retail Asset Management are reported as discontinued operations within the Asset Management business segment for all periods presented through the date of sale. The Company recorded the 30.9 million shares as securities available for sale. In the fourth quarter of 2010, the Company sold its investment in Invesco.

Revel Entertainment Group, LLC.    On March 31, 2010, the Board of Directors authorized a plan of disposal by sale for Revel Entertainment Group, LLC (“Revel”), a development stage enterprise and subsidiary of the Company that was primarily associated with a development property in Atlantic City, New Jersey. On February 17, 2011, the Company completed the sale of Revel to a group of investors led by Revel’s chief executive officer. The Company did not retain any stake or ongoing involvement. The sale price approximated the carrying value of Revel and, accordingly, the Company did not recognize any pre-tax gain or loss on the sale. Total assets of Revel included in the Company’s condensed consolidated statement of financial condition at December 31, 2010 approximated $28 million. The results of Revel are reported as discontinued operations within the Institutional Securities business segment for all periods presented through the date of sale. The three and six months ended June 30, 2010 included losses of approximately $19 million and $951 million, respectively, in connection with such planned disposition. See Note 17 for additional information about an income tax benefit related to Revel.

CityMortgage Bank.    In the third quarter of 2010, the Company completed the disposal of CityMortgage Bank (“CMB”), a Moscow-based mortgage bank. The results of CMB are reported as discontinued operations for all periods presented through the date of disposal within the Institutional Securities business segment.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Other.    In the third quarter of 2010, the Company completed a disposal of a real estate property within the Asset Management business segment. The results of operations are reported as discontinued operations for all periods presented through the date of disposal.

Discover.    On June 30, 2007, the Company completed the spin-off of its business segment Discover Financial Services (“DFS”) to its shareholders. On February 11, 2010, DFS paid the Company $775 million in complete satisfaction of its obligations to the Company regarding the sharing of proceeds from a lawsuit against Visa and MasterCard. The payment was recorded as a gain in discontinued operations for the six months ended June 30, 2010.

Prior period amounts have been recast for discontinued operations. See Note 20 for additional information on discontinued operations.

Basis of Financial Information.    The condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”), which require the Company to make estimates and assumptions regarding the valuations of certain financial instruments, the valuation of goodwill, compensation, deferred tax assets, the outcome of litigation and tax matters, and other matters that affect the condensed consolidated financial statements and related disclosures. The Company believes that the estimates utilized in the preparation of the condensed consolidated financial statements are prudent and reasonable. Actual results could differ materially from these estimates.

At June 30, 2011, the Company recorded approximately $5.6 billion in Financial instruments owned—Corporate and other debt, $3.4 billion of physical commodities within Financial instruments owned—Physical commodities, and $9.0 billion of financing obligations within Other secured financing in the condensed consolidated statements of financial condition in connection with certain physical commodities swap transactions. Prior to June 30, 2011, the Company accounted for these types of transfers of assets as sales and purchases instead of financings. There was no impact on the Company’s results of operations in any period presented as a result of this change. The Company did not restate the balances in connection with such transactions at December 31, 2010 as amounts did not materially affect the Company’s condensed consolidated statement of financial condition.

Material intercompany balances and transactions have been eliminated.

The condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 (the “Form 10-K”). The condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for the fair presentation of the results for the interim period. The results of operations for interim periods are not necessarily indicative of results for the entire year.

Consolidation.    The condensed consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and other entities in which the Company has a controlling financial interest, including certain variable interest entities (“VIE”) (see Note 6). For consolidated subsidiaries that are less than wholly owned, the third-party holdings of equity interests are referred to as noncontrolling interests. The portion of net income attributable to noncontrolling interests for such subsidiaries is presented as Net income (loss) applicable to noncontrolling interests in the condensed consolidated statements of income, and the portion of the shareholders’ equity of such subsidiaries is presented as Noncontrolling interests in the condensed consolidated statements of financial condition and condensed consolidated statements of changes in total equity.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

For entities where (1) the total equity investment at risk is sufficient to enable the entity to finance its activities without additional support and (2) the equity holders bear the economic residual risks and returns of the entity and have the power to direct the activities of the entity that most significantly affect its economic performance, the Company consolidates those entities it controls either through a majority voting interest or otherwise. For entities that do not meet these criteria, commonly known as VIEs, the Company consolidates those entities where the Company has the power to make the decisions that most significantly affect the economic performance of the VIE and has the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE, except for certain VIEs that are money market funds, investment companies or are entities qualifying for accounting purposes as investment companies. Generally, the Company consolidates those entities when it absorbs a majority of the expected losses or a majority of the expected residual returns, or both, of the entities.

For investments in entities in which the Company does not have a controlling financial interest but has significant influence over operating and financial decisions, the Company generally applies the equity method of accounting with net gains and losses recorded within Other revenues. Where the Company has elected to measure certain eligible investments at fair value in accordance with the fair value option, net gains and losses are recorded within Principal transactions—Investments (see Note 3).

Equity and partnership interests held by entities qualifying for accounting purposes as investment companies are carried at fair value.

The Company’s significant regulated U.S. and international subsidiaries include Morgan Stanley & Co. LLC (“MS&Co.”), Morgan Stanley Smith Barney LLC, Morgan Stanley & Co. International plc (“MSIP”), Morgan Stanley MUFG Securities, Co., Ltd. (“MSMS”), Morgan Stanley Bank, N.A., Morgan Stanley Private Bank, National Association and Morgan Stanley Investment Advisors Inc.

Income Statement Presentation.    The Company, 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. In connection with the delivery of the various products and services to clients, the Company manages its revenues and related expenses in the aggregate. As such, when assessing the performance of its businesses, primarily in its Institutional Securities business segment, the Company considers its principal trading, investment banking, commissions and interest income, along with the associated interest expense, as one integrated activity.

 

2. Significant Accounting Policies.

For a detailed discussion about the Company’s significant accounting policies, see Note 2 to the consolidated financial statements for the year ended December 31, 2010 included in the Form 10-K.

During the six months ended June 30, 2011, other than the following, no other updates were made to the Company’s significant accounting policies.

Financial Instruments and Fair Value.

Fair value for many cash instruments and OTC derivative contracts is derived using pricing models. Pricing models take into account the contract terms (including maturity) as well as multiple inputs, including, where applicable, commodity prices, equity prices, interest rate yield curves, credit curves, correlation, creditworthinness of the counterparty, creditworthiness of the Company, option volatility and currency rates. Where appropriate, valuation adjustments are made to account for various factors such as liquidity risk (bid-ask adjustments), credit quality, model uncertainty and concentration risk. Adjustments for liquidity risk adjust

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

model derived mid-market levels of Level 2 and Level 3 financial instruments for the bid-mid or mid-ask spread required to properly reflect the exit price of a risk position. Bid-mid and mid-ask spreads are marked to levels observed in trade activity, broker quotes or other external third-party data. Where these spreads are unobservable for the particular position in question, spreads are derived from observable levels of similar positions. The Company applies credit-related valuation adjustments to its short-term and long-term borrowings (primarily structured notes) for which the fair value option was elected and to OTC derivatives. The Company considers the impact of changes in its own credit spreads based upon observations of the Company’s secondary bond market spreads when measuring the fair value for short-term and long-term borrowings. For OTC derivatives, the impact of changes in both the Company’s and the counterparty’s credit standing is considered when measuring fair value. In determining the expected exposure, the Company simulates the distribution of the future exposure to a counterparty, then applies market-based default probabilities to the future exposure, leveraging external third-party credit default swap (“CDS”) spread data. Where CDS spread data are unavailable for a specific counterparty, bond market spreads, CDS spread data based on the counterparty’s credit rating or CDS spread data that reference a comparable counterparty may be utilized. The Company also considers collateral held and legally enforceable master netting agreements that mitigate the Company’s exposure to each counterparty. Adjustments for model uncertainty are taken for positions whose underlying models are reliant on significant inputs that are neither directly nor indirectly observable, hence requiring reliance on established theoretical concepts in their derivation. These adjustments are derived by making assessments of the possible degree of variability using statistical approaches and market-based information where possible. The Company generally subjects all valuations and models to a review process initially and on a periodic basis thereafter. The Company may apply a concentration adjustment to certain of its OTC derivatives portfolios to reflect the additional cost of closing out a particularly large risk position. Where possible, these adjustments are based on observable market information but in many instances significant judgment is required to estimate the costs of closing out concentrated risk positions due to the lack of liquidity in the marketplace.

Allowance for Loan Losses.

The Company places loans on nonaccrual status if principal or interest is past due for a period of 90 days or more or payment of principal or interest is in doubt unless the obligation is well secured and in the process of collection. Payments received on nonaccrual loans held for investment are applied to principal if there is doubt regarding the ultimate collectability of principal (cost recovery method). If collection of the principal of nonaccrual loans held for investment is not in doubt, interest income is recognized on a cash basis. If neither principal nor interest collection is in doubt, loans are on accrual status and interest income is recognized using the effective interest method.

Condensed Consolidated Statements of Cash Flows.

For purposes of the condensed consolidated statements of cash flows, cash and cash equivalents consist of Cash and due from banks and Interest bearing deposits with banks, which are highly liquid investments with original maturities of three months or less and readily convertible to known amounts of cash, and are held for investment purposes. At June 30, 2011, Mitsubishi UFJ Financial Group, Inc. (“MUFG”) and the Company converted MUFG’s outstanding Series B Non-Cumulative Non-Voting Perpetual Convertible Preferred Stock (“Series B Preferred Stock”) in the Company with a face value of $7.8 billion (carrying value $8.1 billion) into the Company’s common stock. As a result of the adjustment to the conversion ratio, pursuant to the transaction agreement, the Company incurred a one-time, non-cash negative adjustment of approximately $1.7 billion in its calculation of basic and diluted earnings per share during the quarter and six months ended June 30, 2011 (see Note 13). In addition, in the six months ended June 30, 2010, the Company’s significant non-cash activities include assets acquired of approximately $0.4 billion and assumed liabilities of approximately $0.1 billion in connection with a business acquisition and approximately $0.6 billion of equity securities received in connection with the sale of Retail Asset Management.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Accounting Developments.

Goodwill Impairment Test.

In December 2010, the Financial Accounting Standards Board (the “FASB”) issued accounting guidance that modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity shall consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance. This guidance became effective for the Company on January 1, 2011. The adoption of this accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.

3. Fair Value Disclosures.

Fair Value Measurements.

A description of the valuation techniques applied to the Company’s major categories of assets and liabilities measured at fair value on a recurring basis follows.

Financial Instruments Owned and Financial Instruments Sold, Not Yet Purchased.

U.S. Government and Agency Securities.

 

   

U.S. Treasury Securities.    U.S. Treasury securities are valued using quoted market prices. Valuation adjustments are not applied. Accordingly, U.S. Treasury securities are generally categorized in Level 1 of the fair value hierarchy.

 

   

U.S. Agency Securities.    U.S. agency securities are composed of three main categories consisting of agency-issued debt, agency mortgage pass-through pool securities and collateralized mortgage obligations. Non-callable agency-issued debt securities are generally valued using quoted market prices. Callable agency-issued debt securities are valued by benchmarking model-derived prices to quoted market prices and trade data for identical or comparable securities. The fair value of agency mortgage pass-through pool securities is model-driven based on spreads of the comparable To-be-announced (“TBA”) security. Collateralized mortgage obligations are valued using indices, quoted market prices and trade data for identical or comparable securities. Actively traded non-callable agency-issued debt securities are generally categorized in Level 1 of the fair value hierarchy. Callable agency-issued debt securities, agency mortgage pass-through pool securities and collateralized mortgage obligations are generally categorized in Level 2 of the fair value hierarchy.

Other Sovereign Government Obligations.

 

   

Foreign sovereign government obligations are valued using quoted prices in active markets when available. To the extent quoted prices are not available, fair value is determined based on a valuation model that has as inputs interest rate yield curves, cross-currency basis index spreads, and country credit spreads for structures similar to the bond in terms of issuer, maturity and seniority. These bonds are generally categorized in Level 1 or Level 2 of the fair value hierarchy.

Corporate and Other Debt.

 

   

State and Municipal Securities.    The fair value of state and municipal securities is determined using recently executed transactions, market price quotations and pricing models that factor in, where applicable, interest rates, bond or credit default swap spreads and volatility. These bonds are generally categorized in Level 2 of the fair value hierarchy.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

   

Residential Mortgage-Backed Securities (“RMBS”), Commercial Mortgage-Backed Securities (“CMBS”) and other Asset-Backed Securities (“ABS”).    RMBS, CMBS and other ABS may be valued based on price or spread data obtained from observed transactions or independent external parties such as vendors or brokers. When position-specific external price data are not observable, the fair value determination may require benchmarking to similar instruments and/or analyzing expected credit losses, default and recovery rates. In evaluating the fair value of each security, the Company considers security collateral-specific attributes, including payment priority, credit enhancement levels, type of collateral, delinquency rates and loss severity. In addition, for RMBS borrowers, Fair Isaac Corporation (“FICO”) scores and the level of documentation for the loan are also considered. Market standard models, such as Intex, Trepp or others, may be deployed to model the specific collateral composition and cash flow structure of each transaction. Key inputs to these models are market spreads, forecasted credit losses, default and prepayment rates for each asset category. Valuation levels of RMBS and CMBS indices are also used as an additional data point for benchmarking purposes or to price outright index positions.

RMBS, CMBS and other ABS are generally categorized in Level 2 of the fair value hierarchy. If external prices or significant spread inputs are unobservable or if the comparability assessment involves significant subjectivity related to property type differences, cash flows, performance and other inputs, then RMBS, CMBS and other ABS are categorized in Level 3 of the fair value hierarchy.

 

   

Corporate Bonds.    The fair value of corporate bonds is determined using recently executed transactions, market price quotations (where observable), bond spreads or credit default swap spreads obtained from independent external parties such as vendors and brokers adjusted for any basis difference between cash and derivative instruments. The spread data used are for the same maturity as the bond. If the spread data do not reference the issuer, then data that reference a comparable issuer are used. When observable price quotations are not available, fair value is determined based on cash flow models with yield curves, bond or single name credit default swap spreads and recovery rates as significant inputs. Corporate bonds are generally categorized in Level 2 of the fair value hierarchy; in instances where prices, spreads or any of the other aforementioned key inputs are unobservable, they are categorized in Level 3 of the fair value hierarchy.

 

   

Collateralized Debt Obligations (“CDO”).    The Company holds cash CDOs that typically reference a tranche of an underlying synthetic portfolio of single name credit default swaps. The collateral is usually ABS or other corporate bonds. Credit correlation, a primary input used to determine the fair value of a cash CDO, is usually unobservable and derived using a benchmarking technique. The other model inputs such as credit spreads, including collateral spreads, and interest rates are typically observable. CDOs are categorized in Level 2 of the fair value hierarchy when the credit correlation input is insignificant. In instances where the credit correlation input is deemed to be significant, these instruments are categorized in Level 3 of the fair value hierarchy.

 

   

Corporate Loans and Lending Commitments.    The fair value of corporate loans is determined using recently executed transactions, market price quotations (where observable), implied yields from comparable debt, and market observable credit default swap spread levels obtained from independent external parties such as vendors and brokers adjusted for any basis difference between cash and derivative instruments, along with proprietary valuation models and default recovery analysis where such transactions and quotations are unobservable. The fair value of contingent corporate lending commitments is determined by using executed transactions on comparable loans and the anticipated market price based on pricing indications from syndicate banks and customers. The valuation of loans and lending commitments also takes into account fee income that is considered an attribute of the contract. Corporate loans and lending commitments are categorized in Level 2 of the fair value hierarchy except in instances where prices or significant spread inputs are unobservable, in which case they are categorized in Level 3 of the fair value hierarchy.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

   

Mortgage Loans.    Mortgage loans are valued using observable prices based on transactional data or third party pricing for identical or comparable instruments, when available. Where observable prices are not available, the Company estimates fair value based on benchmarking to prices and rates observed in the primary market for similar loan or borrower types or based on the present value of expected future cash flows using its best estimates of the key assumptions, including forecasted credit losses, prepayment rates, forward yield curves and discount rates commensurate with the risks involved or a methodology that utilizes the capital structure and credit spreads of recent comparable securitization transactions. Mortgage loans valued based on observable market data for identical or comparable instruments are categorized in Level 2 of the fair value hierarchy. Where observable prices are not available, due to the subjectivity involved in the comparability assessment related to mortgage loan vintage, geographical concentration, prepayment speed and projected loss assumptions, mortgage loans are categorized in Level 3 of the fair value hierarchy.

 

   

Auction Rate Securities (“ARS”).    The Company primarily holds investments in Student Loan Auction Rate Securities (“SLARS”) and Municipal Auction Rate Securities (“MARS”) with interest rates that are reset through periodic auctions. SLARS are ABS backed by pools of student loans. MARS are municipal bonds often wrapped by municipal bond insurance. ARS were historically traded and valued as floating rate notes, priced at par due to the auction mechanism. Beginning in fiscal 2008, uncertainties in the credit markets have resulted in auctions failing for certain types of ARS. Once the auctions failed, ARS could no longer be valued using observations of auction market prices. Accordingly, the fair value of ARS is determined using independent external market data where available and an internally developed methodology to discount for the lack of liquidity and non-performance risk.

Inputs that impact the valuation of SLARS are independent external market data, the underlying collateral types, level of seniority in the capital structure, amount of leverage in each structure, credit rating and liquidity considerations. Inputs that impact the valuation of MARS are independent external market data when available, the maximum rate, quality of underlying issuers/insurers and evidence of issuer calls. ARS are generally categorized in Level 2 of the fair value hierarchy as the valuation technique relies on observable external data.

Corporate Equities.

 

   

Exchange-Traded Equity Securities.    Exchange-traded equity securities are generally valued based on quoted prices from the exchange. To the extent these securities are actively traded, valuation adjustments are not applied, and they are categorized in Level 1 of the fair value hierarchy; otherwise, they are categorized in Level 2 or Level 3 of the fair value hierarchy.

Derivative and Other Contracts.

 

   

Listed Derivative Contracts.    Listed derivatives that are actively traded are valued based on quoted prices from the exchange and are categorized in Level 1 of the fair value hierarchy. Listed derivatives that are not actively traded are valued using the same approaches as those applied to OTC derivatives; they are generally categorized in Level 2 of the fair value hierarchy.

 

   

OTC Derivative Contracts.    OTC derivative contracts include forward, swap and option contracts related to interest rates, foreign currencies, credit standing of reference entities, equity prices or commodity prices.

Depending on the product and the terms of the transaction, the fair value of OTC derivative products can be either observed or modeled using a series of techniques and model inputs from comparable benchmarks, including closed-form analytic formulas, such as the Black-Scholes option-pricing model,

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

and simulation models or a combination thereof. Many pricing models do not entail material subjectivity because the methodologies employed do not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets, as is the case for generic interest rate swaps, certain option contracts and certain credit default swaps. In the case of more established derivative products, the pricing models used by the Company are widely accepted by the financial services industry. A substantial majority of OTC derivative products valued by the Company using pricing models fall into this category and are categorized in Level 2 of the fair value hierarchy.

Other derivative products, including complex products that have become illiquid, require more judgment in the implementation of the valuation technique applied due to the complexity of the valuation assumptions and the reduced observability of inputs. This includes derivative interests in certain mortgage-related CDO securities, certain types of ABS credit default swaps, basket credit default swaps and CDO-squared positions (a CDO-squared position is a special purpose vehicle that issues interests, or tranches, that are backed by tranches issued by other CDOs) where direct trading activity or quotes are unobservable. These instruments involve significant unobservable inputs and are categorized in Level 3 of the fair value hierarchy.

Derivative interests in complex mortgage-related CDOs and ABS credit default swaps, for which observability of external price data is extremely limited, are valued based on an evaluation of the market and model input parameters sourced from similar positions as indicated by primary and secondary market activity. Each position is evaluated independently taking into consideration the underlying collateral performance and pricing, behavior of the tranche under various cumulative loss and prepayment scenarios, deal structures (e.g., non-amortizing reference obligations, call features, etc.) and liquidity. While these factors may be supported by historical and actual external observations, the determination of their value as it relates to specific positions nevertheless requires significant judgment.

For basket credit default swaps and CDO-squared positions, the correlation input between reference credits is unobservable for each specific swap or position and is benchmarked to standardized proxy baskets for which correlation data are available. The other model inputs such as credit spread, interest rates and recovery rates are observable. In instances where the correlation input is deemed to be significant, these instruments are categorized in Level 3 of the fair value hierarchy; otherwise, these instruments are categorized in Level 2 of the fair value hierarchy.

The Company trades various derivative structures with commodity underlyings. Depending on the type of structure, the model inputs generally include interest rate yield curves, commodity underlier price curves, implied volatility of the underlying commodities and, in some cases, the implied correlation between these inputs. The fair value of these products is determined using executed trades and broker and consensus data to provide values for the aforementioned inputs. Where these inputs are unobservable, relationships to observable commodities and data points, based on historic and/or implied observations, are employed as a technique to estimate the model input values. Commodity derivatives are generally categorized in Level 2 of the fair value hierarchy; in instances where significant inputs are unobservable, they are categorized in Level 3 of the fair value hierarchy.

For further information on derivative instruments and hedging activities, see Note 10.

Investments.

 

   

The Company’s investments include investments in private equity funds, real estate funds and hedge funds (which include investments made in connection with certain employee deferred compensation plans) as well as direct investments in equity securities. Direct investments are presented in the fair value hierarchy table as Principal investments and Other. Initially, the transaction price is generally considered by the Company as the exit price and is the Company’s best estimate of fair value.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

After initial recognition, in determining the fair value of internally and externally managed funds, the Company generally considers the net asset value of the fund provided by the fund manager to be the best estimate of fair value. For non-exchange-traded investments either held directly or held within internally managed funds, fair value after initial recognition is based on an assessment of each underlying investment, considering rounds of financing and third-party transactions, discounted cash flow analyses and market-based information, including comparable company transactions, trading multiples and changes in market outlook, among other factors. Exchange-traded direct equity investments are generally valued based on quoted prices from the exchange.

Exchange-traded direct equity investments that are actively traded are categorized in Level 1 of the fair value hierarchy. Non-exchange-traded direct equity investments and investments in private equity and real estate funds are generally categorized in Level 3 of the fair value hierarchy. Investments in hedge funds that are redeemable at the measurement date or in the near future are categorized in Level 2 of the fair value hierarchy; otherwise, they are categorized in Level 3 of the fair value hierarchy.

Physical Commodities.

 

   

The Company trades various physical commodities, including crude oil and refined products, natural gas, base and precious metals and agricultural products. Fair value for physical commodities is determined using observable inputs, including broker quotations and published indices. Physical commodities are generally categorized in Level 2 of the fair value hierarchy; in instances where significant inputs are unobservable, they are categorized in Level 3 of the fair value hierarchy.

Securities Available for Sale.

 

   

Securities available for sale are composed of U.S. government and agency securities, including U.S. Treasury securities, agency-issued debt, agency mortgage pass-through securities and collateralized mortgage obligations. Actively traded U.S. Treasury securities and non-callable agency-issued debt securities are generally categorized in Level 1 of the fair value hierarchy. Callable agency-issued debt securities, agency mortgage pass-through securities and collateralized mortgage obligations are generally categorized in Level 2 of the fair value hierarchy. For further information on securities available for sale, see Note 4.

Deposits.

 

   

Time Deposits.    The fair value of certificates of deposit is determined using third-party quotations. These deposits are generally categorized in Level 2 of the fair value hierarchy.

Commercial Paper and Other Short-term Borrowings/Long-term Borrowings.

 

   

Structured Notes.    The Company issues structured notes that have coupon or repayment terms linked to the performance of debt or equity securities, indices, currencies or commodities. Fair value of structured notes is determined using valuation models for the derivative and debt portions of the notes. These models incorporate observable inputs referencing identical or comparable securities, including prices that the notes are linked to, interest rate yield curves, option volatility and currency, commodity or equity rates. Independent, external and traded prices for the notes are also considered. The impact of the Company’s own credit spreads is also included based on the Company’s observed secondary bond market spreads. Most structured notes are categorized in Level 2 of the fair value hierarchy.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Securities Sold under Agreements to Repurchase.

 

   

In 2010, the fair value option was elected for certain securities sold under agreements to repurchase. The fair value of a repurchase agreement is computed using a standard cash flow discounting methodology. The inputs to the valuation include contractual cash flows and collateral funding spreads, which are estimated using various benchmarks, interest rate yield curves and option volatilities. In instances where the unobservable inputs are deemed significant, repurchase agreements are categorized in Level 3 of the fair value hierarchy; otherwise, they are categorized in Level 2 of the fair value hierarchy.

The following fair value hierarchy tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis at June 30, 2011 and December 31, 2010.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis at June 30, 2011

 

    Quoted
Prices in
Active

Markets
for
Identical
Assets
(Level 1)
    Significant
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs

(Level 3)
    Counterparty
and Cash
Collateral
Netting
    Balance at
June 30,
2011
 
    (dollars in millions)  

Assets

         

Financial instruments owned:

         

U.S. government and agency securities:

         

U.S. Treasury securities

  $ 13,062      $ 21      $ —        $ —        $ 13,083   

U.S. agency securities

    2,499        20,092        2        —          22,593   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

    15,561        20,113        2        —          35,676   

Other sovereign government obligations

    30,743        8,297        132        —          39,172   

Corporate and other debt:

         

State and municipal securities

    —          3,166        —          —          3,166   

Residential mortgage-backed securities

    —          3,025        509        —          3,534   

Commercial mortgage-backed securities

    —          2,586        136        —          2,722   

Asset-backed securities

    —          1,639        298        —          1,937   

Corporate bonds

    —          36,972        1,179        —          38,151   

Collateralized debt obligations

    —          1,932        1,650        —          3,582   

Loans and lending commitments

    —          17,055        10,420        —          27,475   

Other debt

    —          8,429        163        —          8,592   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    —          74,804        14,355        —          89,159   

Corporate equities(1)

    62,535        3,057        461        —          66,053   

Derivative and other contracts:

         

Interest rate contracts

    1,660        578,414        4,919        —          584,993   

Credit contracts

    —          96,664        15,622        —          112,286   

Foreign exchange contracts

    —          55,956        517        —          56,473   

Equity contracts

    1,900        38,839        1,240        —          41,979   

Commodity contracts

    5,638        42,934        1,297        —          49,869   

Other

    —          233        312        —          545   

Netting(2)

    (8,020     (720,762     (11,253     (59,943     (799,978
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

    1,178        92,278        12,654        (59,943     46,167   

Investments:

         

Private equity funds

    —          —          2,160        —          2,160   

Real estate funds

    —          7        1,290        —          1,297   

Hedge funds

    —          436        827        —          1,263   

Principal investments

    213        228        3,120        —          3,561   

Other

    188        26        525        —          739   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

    401        697        7,922        —          9,020   

Physical commodities

    —          8,878        673        —          9,551   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial instruments owned

    110,418        208,124        36,199        (59,943     294,798   

Securities available for sale:

         

U.S. government and agency securities

    9,378        14,928        —          —          24,306   

Securities received as collateral

    15,778        84        —          —          15,862   

Intangible assets(3)

    —          —          133        —          133   

Liabilities

         

Deposits

  $ —        $ 2,830      $ —        $ —        $ 2,830   

Commercial paper and other short-term borrowings

    —          1,687        23        —          1,710   

Financial instruments sold, not yet purchased:

         

U.S. government and agency securities:

         

U.S. Treasury securities

    25,315        —          —          —          25,315   

U.S. agency securities

    2,191        14        —          —          2,205   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

    27,506        14        —          —          27,520   

Other sovereign government obligations

    19,903        2,576        —          —          22,479   

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

    Quoted
Prices in
Active

Markets
for
Identical
Assets
(Level 1)
    Significant
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs

(Level 3)
    Counterparty
and Cash
Collateral
Netting
    Balance at
June 30,
2011
 
    (dollars in millions)  

Corporate and other debt:

         

State and municipal securities

    —          4        —          —          4   

Residential mortgage-backed securities

    —          —          41        —          41   

Commercial mortgage-backed securities

    —          18        —          —          18   

Corporate bonds

    —          7,962        35        —          7,997   

Unfunded lending commitments

    —          669        240        —          909   

Other debt

    —          19        178        —          197   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    —          8,672        494        —          9,166   

Corporate equities(1)

    26,563        1,054        1        —          27,618   

Derivative and other contracts:

         

Interest rate contracts

    1,560        551,231        4,602        —          557,393   

Credit contracts

    —          93,508        8,230        —          101,738   

Foreign exchange contracts

    —          57,275        473        —          57,748   

Equity contracts

    1,758        43,459        2,901        —          48,118   

Commodity contracts

    6,196        43,852        981        —          51,029   

Other

    —          612        709        —          1,321   

Netting(2)

    (8,020     (720,762     (11,253     (36,199     (776,234
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

    1,494        69,175        6,643        (36,199     41,113   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial instruments sold, not yet purchased

    75,466        81,491        7,138        (36,199     127,896   

Obligation to return securities received as collateral

    20,657        84        —          —          20,741   

Securities sold under agreements to repurchase

    —          —          358        —          358   

Other secured financings

    —          15,890        742        —          16,632   

Long-term borrowings

    12        42,171        1,251        —          43,434   

 

(1) The Company holds or sells short for trading purposes equity securities issued by entities in diverse industries and of varying size.
(2) For positions with the same counterparty that cross over the levels of the fair value hierarchy, both counterparty netting and cash collateral netting are included in the column titled “Counterparty and Cash Collateral Netting.” For contracts with the same counterparty, counterparty netting among positions classified within the same level is included within that level. For further information on derivative instruments and hedging activities, see Note 10.
(3) Amount represents mortgage servicing rights (“MSR”) accounted for at fair value. See Note 6 for further information on MSRs.

Transfers Between Level 1 and Level 2 During the Quarter Ended June 30, 2011.

Financial instruments owned—Derivative and other contracts and Financial instruments sold, not yet purchased—Derivative and other contracts.    During the quarter ended June 30, 2011, the Company reclassified approximately $0.9 billion of derivative assets and approximately $1.3 billion of derivative liabilities from Level 2 to Level 1 as these listed derivatives became actively traded and were valued based on quoted prices from the exchange.

Transfers Between Level 1 and Level 2 During the Six Months Ended June 30, 2011.

Financial instruments owned—Derivative and other contracts and Financial instruments sold, not yet purchased—Derivative and other contracts.    During the six months ended June 30, 2011, the Company reclassified approximately $1.1 billion of derivative assets and approximately $0.9 billion of derivative liabilities from Level 2 to Level 1 as these listed derivatives became actively traded and were valued based on quoted prices from the exchange.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2010

 

    Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
    Significant
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
    Counterparty
and Cash
Collateral
Netting
    Balance at
December 31,
2010
 
    (dollars in millions)  

Assets

         

Financial instruments owned:

         

U.S. government and agency securities:

         

U.S. Treasury securities

  $ 19,226      $ —        $ —        $ —        $ 19,226   

U.S. agency securities

    3,827        25,380        13        —          29,220   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

    23,053        25,380        13        —          48,446   

Other sovereign government obligations

    25,334        8,501        73        —          33,908   

Corporate and other debt:

         

State and municipal securities

    —          3,229        110        —          3,339   

Residential mortgage-backed securities

    —          3,690        319        —          4,009   

Commercial mortgage-backed securities

    —          2,692        188        —          2,880   

Asset-backed securities

    —          2,322        13        —          2,335   

Corporate bonds

    —          39,569        1,368        —          40,937   

Collateralized debt obligations

    —          2,305        1,659        —          3,964   

Loans and lending commitments

    —          15,308        11,666        —          26,974   

Other debt

    —          3,523        193        —          3,716   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    —          72,638        15,516        —          88,154   

Corporate equities(1)

    65,009        2,923        484        —          68,416   

Derivative and other contracts:

         

Interest rate contracts

    3,985        616,016        966        —          620,967   

Credit contracts

    —          95,818        14,316        —          110,134   

Foreign exchange contracts

    1        61,556        431        —          61,988   

Equity contracts

    2,176        36,612        1,058        —          39,846   

Commodity contracts

    5,464        57,528        1,160        —          64,152   

Other

    —          108        135        —          243   

Netting(2)

    (8,551     (761,939     (7,168     (68,380     (846,038
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

    3,075        105,699        10,898        (68,380     51,292   

Investments:

         

Private equity funds

    —          —          1,986        —          1,986   

Real estate funds

    —          8        1,176        —          1,184   

Hedge funds

    —          736        901        —          1,637   

Principal investments

    286        486        3,131        —          3,903   

Other(3)

    403        79        560        —          1,042   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

    689        1,309        7,754        —          9,752   

Physical commodities

    —          6,778        —          —          6,778   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial instruments owned

    117,160        223,228        34,738        (68,380     306,746   

Securities available for sale:

         

U.S. government and agency securities

    20,792        8,857        —          —          29,649   

Securities received as collateral

    15,646        890        1        —          16,537   

Intangible assets(4)

    —          —          157        —          157   

Liabilities

         

Deposits

  $ —        $ 3,011      $ 16      $ —        $ 3,027   

Commercial paper and other short-term borrowings

    —          1,797        2        —          1,799   

Financial instruments sold, not yet purchased:

         

U.S. government and agency securities:

         

U.S. Treasury securities

    25,225        —          —          —          25,225   

U.S. agency securities

    2,656        67        —          —          2,723   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

    27,881        67        —          —          27,948   

Other sovereign government obligations

    19,708        2,542        —          —          22,250   

Corporate and other debt:

         

State and municipal securities

    —          11        —          —          11   

Asset-backed securities

    —          12        —          —          12   

Corporate bonds

    —          9,100        44        —          9,144   

Collateralized debt obligations

    —          2        —          —          2   

Unfunded lending commitments

    —          464        263        —          727   

Other debt

    —          828        194        —          1,022   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    —          10,417        501        —          10,918   

 

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Table of Contents

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

    Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
    Significant
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
    Counterparty
and Cash
Collateral
Netting
    Balance at
December 31,
2010
 
    (dollars in millions)  

Corporate equities(1)

    19,696        127        15        —          19,838   

Derivative and other contracts:

         

Interest rate contracts

    3,883        591,378        542        —          595,803   

Credit contracts

    —          87,904        7,722        —          95,626   

Foreign exchange contracts

    2        64,301        385        —          64,688   

Equity contracts

    2,098        42,242        1,820        —          46,160   

Commodity contracts

    5,871        58,885        972        —          65,728   

Other

    —          520        1,048        —          1,568   

Netting(2)

    (8,551     (761,939     (7,168     (44,113     (821,771
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

    3,303        83,291        5,321        (44,113     47,802   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial instruments sold, not yet purchased

    70,588        96,444        5,837        (44,113     128,756   

Obligation to return securities received as collateral

    20,272        890        1        —          21,163   

Securities sold under agreements to repurchase

    —          498        351        —          849   

Other secured financings

    —          7,474        1,016        —          8,490   

Long-term borrowings

    —          41,393        1,316        —          42,709   

 

(1) The Company holds or sells short for trading purposes equity securities issued by entities in diverse industries and of varying size.
(2) For positions with the same counterparty that cross over the levels of the fair value hierarchy, both counterparty netting and cash collateral netting are included in the column titled “Counterparty and Cash Collateral Netting.” For contracts with the same counterparty, counterparty netting among positions classified within the same level is included within that level. For further information on derivative instruments and hedging activities, see Note 10.
(3) In June 2010, the Company voluntarily contributed $25 million to certain other investments in funds that it manages in connection with upcoming rule changes regarding net asset value disclosures for money market funds. Based on current liquidity and fund performance, the Company does not expect to provide additional voluntary support to non-consolidated funds that it manages.
(4) Amount represents MSRs accounted for at fair value. See Note 6 for further information on MSRs.

Transfers Between Level 1 and Level 2 during the Quarter Ended June 30, 2010.

Financial instruments owned—Derivative and other contracts and Financial instruments sold, not yet purchased—Derivative and other contracts.    During the quarter ended June 30, 2010, the Company reclassified approximately $1.5 billion of derivative assets and approximately $1.5 billion of derivative liabilities from Level 2 to Level 1 as these listed derivatives became actively traded and were valued based on quoted prices from the exchange.

Financial instruments owned—Corporate equities.    During the quarter ended June 30, 2010, the Company reclassified approximately $0.5 billion of certain Corporate equities from Level 2 to Level 1 as transactions in these securities occurred with sufficient frequency and volume to constitute an active market. During the quarter ended June 30, 2010, the Company reclassified approximately $1.0 billion of certain Corporate equities from Level 1 to Level 2 as transactions in these securities did not occur with sufficient frequency and volume to constitute an active market.

Transfers Between Level 1 and Level 2 During the Six Months Ended June 30, 2010.

Financial instruments owned—Derivative and other contracts and Financial instruments sold, not yet purchased—Derivative and other contracts.    During the six months ended June 30, 2010, the Company reclassified approximately $1.8 billion of derivative assets and approximately $1.9 billion of derivative liabilities from Level 2 to Level 1 as these listed derivatives became actively traded and were valued based on quoted prices from the exchange.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Financial instruments owned—Corporate equities.    During the six months ended June 30, 2010, the Company reclassified approximately $1.1 billion of certain Corporate equities from Level 2 to Level 1 as transactions in these securities occurred with sufficient frequency and volume to constitute an active market.

Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis.

The following tables present additional information about Level 3 assets and liabilities measured at fair value on a recurring basis for the quarter and six months ended June 30, 2011 and for the quarter and six months ended June 30, 2010, respectively. Level 3 instruments may be hedged with instruments classified in Level 1 and Level 2. As a result, the realized and unrealized gains (losses) for assets and liabilities within the Level 3 category presented in the tables below do not reflect the related realized and unrealized gains (losses) on hedging instruments that have been classified by the Company within the Level 1 and/or Level 2 categories.

Additionally, both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the unrealized gains (losses) during the period for assets and liabilities within the Level 3 category presented in the tables below may include changes in fair value during the period that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.

For assets and liabilities that were transferred into Level 3 during the period, gains (losses) are presented as if the assets or liabilities had been transferred into Level 3 at the beginning of the period; similarly, for assets and liabilities that were transferred out of Level 3 during the period, gains (losses) are presented as if the assets or liabilities had been transferred out at the beginning of the period.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Three Months Ended June 30, 2011

 

    Beginning
Balance at
March 31,
2011
    Total
Realized and
Unrealized
Gains
(Losses)(1)
    Purchases     Sales     Issuances     Settlements     Net Transfers     Ending
Balance at
June 30,
2011
    Unrealized
Gains
(Losses) for
Level 3 Assets/
Liabilities
Outstanding at
June 30,
2011(2)
 
    (dollars in millions)  

Assets

                 

Financial instruments owned:

                 

U.S. agency securities

  $ 57      $ 1      $ 29      $ (72   $ —        $ —        $ (13   $ 2      $ —     

Other sovereign government obligations

    126        9        —          (4     —          —          1        132        9   

Corporate and other debt:

                 

State and municipal securities

    4        —          21        (25     —          —          —          —          —     

Residential mortgage-backed securities

    361        (10     101        (54     —          —          111        509        —     

Commercial mortgage-backed securities

    132        (21     81        (10     —          —          (46     136        (1

Asset-backed securities

    —          259        4        —          —          —          35        298        259   

Corporate bonds

    1,366        (93     216        (353     —          —          43        1,179        (57

Collateralized debt obligations

    1,593        17        357        (352     —          (19     54        1,650        14   

Loans and lending commitments

    11,218        (168     1,898        (676     —          (1,285     (567     10,420        (236

Other debt

    165        5        6        (13     —          —          —          163        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    14,839        (11     2,684        (1,483     —          (1,304     (370     14,355        (20

Corporate equities

    502        11        127        (144     —          —          (35     461        24   

Net derivative and other contracts(3):

                 

Interest rate contracts

    (58     472        22        —          (45     (62     (12     317        376   

Credit contracts

    6,079        1,002        1,089        —          (109     (737     68        7,392        958   

Foreign exchange contracts

    46        (34     2        —          —          30        —          44        (39

Equity contracts

    (645     58        77        (7     (1,163     52        (33     (1,661     60   

Commodity contracts

    330        (129     330        —          (146     (99     30        316        (139

Other

    (508     (74     2        —          (112     296        (1     (397     (81
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net derivative and other contracts

    5,244        1,295        1,522        (7     (1,575     (520     52        6,011        1,135   

Investments:

                 

Private equity funds

    2,006        153        91        (90     —          —          —          2,160        129   

Real estate funds

    1,251        81        17        (59     —          —          —          1,290        148   

Hedge funds

    871        (17     20        (120     —          —          73        827        (17

Principal investments

    3,057        182        75        (108     —          —          (86     3,120        (15

Other

    398        2        2        (3     —          —          126        525        (2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

    7,583        401        205        (380     —          —          113        7,922        243   

Physical commodities

    —          (48     721        —          —          —          —          673        (48

Intangible assets

    144        (11     1        —          —          (1     —          133        (11

Liabilities

                 

Commercial paper and other short-term borrowings

  $ 4      $ 7      $ —        $ —        $ 29      $ (3   $ —        $ 23      $ 7   

Financial instruments sold, not yet purchased:

                 

Corporate and other debt:

                 

Residential mortgage-backed securities

    —          (13     (13     41        —          —          —          41        (13

Corporate bonds

    150        49        (324     336        —          —          (78     35        60   

Collateralized debt obligations

    2        —          (1     —          —          —          (1     —          —     

Unfunded lending commitments

    171        (69     —          —          —          —          —          240        (69

Other debt

    180        13        —          13        —          —          (2     178        13   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    503        (20     (338     390        —          —          (81     494        (9

Corporate equities

    9        13        (8     12        —          —          1        1        3   

Securities sold under agreements to repurchase

    352        (5     —          —          1        —          —          358        (5

Other secured financings

    605        (9     —          —          145        (17     —          742        (9

Long-term borrowings

    1,374        38        —          —          215        (175     (125     1,251        20   

 

(1) Total realized and unrealized gains (losses) are primarily included in Principal transactions—Trading in the condensed consolidated statements of income except for $401 million related to Financial instruments owned—Investments, which is included in Principal transactions—Investments.
(2) Amounts represent unrealized gains (losses) for the quarter ended June 30, 2011 related to assets and liabilities still outstanding at June 30, 2011.
(3) Net derivative and other contracts represent Financial instruments owned—Derivative and other contracts net of Financial instruments sold, not yet purchased—Derivative and other contracts. For further information on Derivative instruments and hedging activities, see Note 10.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Financial instruments owned—Corporate and other debt.    During the quarter ended June 30, 2011, the Company reclassified approximately $1.2 billion of certain Corporate and other debt, primarily corporate loans, from Level 3 to Level 2. The Company reclassified the corporate loans as external prices and/or spread inputs for these instruments became observable.

The Company also reclassified approximately $0.8 billion of certain Corporate and other debt from Level 2 to Level 3. The reclassifications were primarily related to corporate loans and were generally due to a reduction in market price quotations for these or comparable instruments, or a lack of available broker quotes, such that unobservable inputs had to be utilized for the fair value measurement of these instruments.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Six Months Ended June 30, 2011

 

    Beginning
Balance at
December 31,
2010
    Total
Realized
and
Unrealized
Gains
(Losses)(1)
    Purchases     Sales     Issuances     Settlements     Net
Transfers
    Ending
Balance at
June 30,
2011
    Unrealized
Gains
(Losses) for
Level 3 Assets/
Liabilities
Outstanding at
June 30,
2011(2)
 
    (dollars in millions)  

Assets

                 

Financial instruments owned:

                 

U.S. agency securities

  $ 13      $ —        $ 34      $ (40   $ —        $ —        $ (5   $ 2      $ —     

Other sovereign government obligations

    73        8        56        —          —          —          (5     132        8   

Corporate and other debt:

                 

State and municipal securities

    110        (1     —          (96     —          —          (13     —          —     

Residential mortgage-backed securities

    319        (62     279        (193     —          (1     167        509        (71

Commercial mortgage-backed securities

    188        (19     96        (30     —          —          (99     136        (18

Asset-backed securities

    13        259        13        (17     —          —          30        298        258   

Corporate bonds

    1,368        (26     273        (409     —          34        (61     1,179        42   

Collateralized debt obligations

    1,659        273        641        (862     —          (55     (6     1,650        70   

Loans and lending commitments

    11,666        213        2,321        (537     —          (2,038     (1,205     10,420        212   

Other debt

    193        —          5        (33     —          —          (2     163        (9
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    15,516        637        3,628        (2,177     —          (2,060     (1,189     14,355        484   

Corporate equities

    484        (207     219        (176     —          —          141        461        1   

Net derivative and other contracts(3):

                 

Interest rate contracts

    424        702        19        —          (704     (192     68        317        600   

Credit contracts

    6,594        388        1,148        —          (197     (614     73        7,392        772   

Foreign exchange contracts

    46        (159     1        —          —          159        (3     44        (130

Equity contracts

    (762     105        119        —          (1,236     98        15        (1,661     96   

Commodity contracts

    188        165        455        —          (321     (281     110        316        153   

Other

    (913     117        2        —          (116     428        85        (397     110   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net derivative and other contracts

    5,577        1,318        1,744        —          (2,574     (402     348        6,011        1,601   

Investments:

                 

Private equity funds

    1,986        260        88        (245     —          —          71        2,160        209   

Real estate funds

    1,176        145        31        (62     —          —          —          1,290        255   

Hedge funds

    901        (25     15        (172     —          —          108        827        (25

Principal investments

    3,131        242        (26     (195     —          —          (32     3,120        (105

Other

    560        51        (4     (11     —          —          (71     525        41   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

    7,754        673        104        (685     —          —          76        7,922        375   

Physical commodities

    —          (48     721        —          —          —          —          673        (48

Securities received as collateral

    1        —          —          (1     —          —          —          —          —     

Intangible assets

    157        (26     5        (1     (1     (1     —          133        (26

Liabilities

                 

Deposits

  $ 16      $ 2      $ —        $ —        $ —        $ (14   $ —        $ —        $ —     

Commercial paper and other short-term borrowings

    2        7        —          —