10-Q 1 d231401d10q.htm FORM 10-Q Form 10-Q
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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 September 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 October 31, 2011, there were 1,927,402,132 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.


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QUARTERLY REPORT ON FORM 10-Q

For the quarter ended September 30, 2011

 

Table of Contents    Page  

Part I—Financial Information

  

Item 1.

  Financial Statements (unaudited)      1   
 

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

     1   
 

Condensed Consolidated Statements of Income—Three and Nine Months Ended September  30, 2011 and 2010

     3   
 

Condensed Consolidated Statements of Comprehensive Income—Three and Nine Months Ended September 30, 2011 and 2010

     4   
 

Condensed Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2011 and 2010

     5   
 

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

     6   
  Notes to Condensed Consolidated Financial Statements (unaudited)      8   
  Report of Independent Registered Public Accounting Firm      84   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      85   
 

Introduction

     85   
 

Executive Summary

     86   
 

Business Segments

     97   
 

Accounting Developments

Other Matters

    

 

111

112

  

  

 

Critical Accounting Policies

     116   
 

Liquidity and Capital Resources

     121   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      134   

Item 4.

  Controls and Procedures      147   
  Financial Data Supplement (Unaudited)      148   

Part II—Other Information

  

Item 1.

  Legal Proceedings      154   

Item 1A.

  Risk Factors      157   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      159   

Item 6.

  Exhibits      159   

 

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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)

 

    September 30,
2011
    December 31,
2010
 

Assets

   

Cash and due from banks ($362 and $297 at September 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities generally not available to the Company)

  $ 12,255      $ 7,341   

Interest bearing deposits with banks

    41,652        40,274   

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

    30,864        19,180   

Financial instruments owned, at fair value (approximately $132,554 and $129,969 were pledged to various parties at September 30, 2011 and December 31, 2010, respectively):

   

U.S. government and agency securities

    43,104        48,446   

Other sovereign government obligations

    34,779        33,908   

Corporate and other debt ($3,440 and $3,816 at September 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities, generally not available to the Company)

    76,143        88,154   

Corporate equities ($0 and $625 at September 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities, generally not available to the Company)

    47,194        68,416   

Derivative and other contracts

    54,412        51,292   

Investments ($1,814 and $1,873 at September 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities, generally not available to the Company)

    8,323        9,752   

Physical commodities

    10,296        6,778   
 

 

 

   

 

 

 

Total financial instruments owned, at fair value

    274,251        306,746   

Securities available for sale, at fair value

    27,697        29,649   

Securities received as collateral, at fair value

    10,899        16,537   

Federal funds sold and securities purchased under agreements to resell

    169,824        148,253   

Securities borrowed

    123,904        138,730   

Receivables:

   

Customers

    34,175        35,258   

Brokers, dealers and clearing organizations

    11,063        9,102   

Fees, interest and other

    9,392        9,790   

Loans (net of allowances of $18 and $82 at September 30, 2011 and December 31, 2010, respectively)

    13,453        10,576   

Other investments

    4,811        5,412   

Premises, equipment and software costs (net of accumulated depreciation of $4,722 and $4,476 at September 30, 2011 and December 31, 2010, respectively) ($324 and $321 at September 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities, generally not available to the Company)

    6,511        6,154   

Goodwill

    6,709        6,739   

Intangible assets (net of accumulated amortization of $865 and $605 at September 30, 2011 and December 31, 2010, respectively) (includes $133 and $157 at fair value at September 30, 2011 and December 31, 2010, respectively)

    4,370        4,667   

Other assets ($346 and $118 at September 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities, generally not available to the Company)

    13,109        13,290   
 

 

 

   

 

 

 

Total assets

  $ 794,939      $ 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)

 

    September 30,
2011
    December 31,
2010
 

Liabilities and Equity

   

Deposits (includes $2,796 and $3,027 at fair value at September 30, 2011 and December 31, 2010, respectively)

  $ 66,184      $ 63,812   

Commercial paper and other short-term borrowings (includes $1,139 and $1,799 at fair value at September 30, 2011 and December 31, 2010, respectively)

    2,881        3,256   

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

   

U.S. government and agency securities

    19,334        27,948   

Other sovereign government obligations

    18,089        22,250   

Corporate and other debt

    9,978        10,918   

Corporate equities

    26,483        19,838   

Derivative and other contracts

    48,064        47,802   

Physical commodities

    16        —     
 

 

 

   

 

 

 

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

    121,964        128,756   

Obligation to return securities received as collateral, at fair value

    15,035        21,163   

Securities sold under agreements to repurchase (includes $354 and $849 at fair value at September 30, 2011 and December 31, 2010, respectively )

    110,053        147,598   

Securities loaned

    27,785        29,094   

Other secured financings (includes $15,940 and $8,490 at fair value at September 30, 2011 and December 31, 2010, respectively) ($2,681 and $2,656 at September 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities and are non-recourse to the Company)

    22,156        10,453   

Payables:

   

Customers

    143,717        123,249   

Brokers, dealers and clearing organizations

    5,891        3,363   

Interest and dividends

    2,788        2,572   

Other liabilities and accrued expenses ($142 and $117 at September 30, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities and are non-recourse to the Company)

    17,298        16,518   

Long-term borrowings (includes $39,687 and $42,709 at fair value at September 30, 2011 and December 31, 2010, respectively)

    189,093        192,457   
 

 

 

   

 

 

 
    724,845        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 September 30, 2011 and December 31, 2010;

   

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

   

Shares outstanding: 1,927,539,703 at September 30, 2011 and 1,512,022,095 at December 31, 2010

    20        16   

Paid-in capital

    22,501        13,521   

Retained earnings

    40,710        38,603   

Employee stock trust

    3,216        3,465   

Accumulated other comprehensive loss

    (413     (467

Common stock held in treasury, at cost, $0.01 par value; 61,837,468 shares at September 30, 2011 and 91,890,979 shares at December 31, 2010

    (2,498     (4,059

Common stock issued to employee trust

    (3,216     (3,465
 

 

 

   

 

 

 

Total Morgan Stanley shareholders’ equity

    61,828        57,211   

Noncontrolling interests

    8,266        8,196   
 

 

 

   

 

 

 

Total equity

    70,094        65,407   
 

 

 

   

 

 

 

Total liabilities and equity

  $ 794,939      $ 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
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Revenues:

        

Investment banking

   $ 1,031      $ 1,221      $ 3,940      $ 3,361   

Principal transactions:

        

Trading

     4,961        1,441        11,423        8,552   

Investments

     (298     820        433        1,137   

Commissions and fees

     1,484        1,068        4,224        3,636   

Asset management, distribution and administration fees

     2,184        1,940        6,499        5,877   

Other

     390        187        221        640   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest revenues

     9,752        6,677        26,740        23,203   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     1,749        1,851        5,560        5,334   

Interest expense

     1,609        1,748        5,491        4,722   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest

     140        103        69        612   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net revenues

     9,892        6,780        26,809        23,815   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expenses:

        

Compensation and benefits

     3,685        3,685        12,693        11,987   

Occupancy and equipment

     386        399        1,189        1,190   

Brokerage, clearing and exchange fees

     447        332        1,268        1,051   

Information processing and communications

     460        412        1,353        1,223   

Marketing and business development

     145        134        446        421   

Professional services

     462        460        1,384        1,351   

Other

     629        557        1,982        1,573   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expenses

     6,214        5,979        20,315        18,796   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     3,678        801        6,494        5,019   

Provision for (benefit from) income taxes

     1,410        (23     1,696        653   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     2,268        824        4,798        4,366   
  

 

 

   

 

 

   

 

 

   

 

 

 

Discontinued operations:

        

Gain (loss) from discontinued operations

     1        (148     7        619   

Provision for (benefit from) income taxes

     (24     35        (24     349   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net gain (loss) from discontinued operations

     25        (183     31        270   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 2,293      $ 641      $ 4,829      $ 4,636   

Net income applicable to noncontrolling interests

     94        510        469        769   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income applicable to Morgan Stanley

   $ 2,199      $ 131      $ 4,360      $ 3,867   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) applicable to Morgan Stanley common shareholders

   $ 2,153      $ (91   $ 2,335      $ 2,971   
  

 

 

   

 

 

   

 

 

   

 

 

 

Amounts applicable to Morgan Stanley:

        

Income from continuing operations

   $ 2,174      $ 314      $ 4,329      $ 3,597   

Net gain (loss) from discontinued operations

     25        (183     31        270   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income applicable to Morgan Stanley

   $ 2,199      $ 131      $ 4,360      $ 3,867   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per basic common share:

        

Income from continuing operations

   $ 1.15      $ 0.07      $ 1.45      $ 2.04   

Net gain (loss) from discontinued operations

     0.01        (0.14     0.02        0.18   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per basic common share

   $ 1.16      $ (0.07   $ 1.47      $ 2.22   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per diluted common share:

        

Income from continuing operations

   $ 1.14      $ 0.05      $ 1.43      $ 1.98   

Net gain (loss) from discontinued operations

     0.01        (0.12     0.02        0.17   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per diluted common share

   $ 1.15      $ (0.07   $ 1.45      $ 2.15   
  

 

 

   

 

 

   

 

 

   

 

 

 

Average common shares outstanding:

        

Basic

     1,848,246,471        1,377,230,354        1,589,519,478        1,336,508,289   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     1,868,743,943        1,443,100,524        1,607,962,757        1,709,544,142   
  

 

 

   

 

 

   

 

 

   

 

 

 

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
September 30,
     Nine Months Ended
September 30,
 
         2011             2010              2011              2010      

Net income

   $ 2,293      $ 641       $ 4,829       $ 4,636   

Other comprehensive income, net of tax:

          

Foreign currency translation adjustments(1)

     (108     178         23         215   

Amortization of cash flow hedges(2)

     1        2         5         7   

Net unrealized gain on Securities available for sale(3)

     76        145         90         232   

Pension, postretirement and other related adjustments(4)

     1        4         8         113   
  

 

 

   

 

 

    

 

 

    

 

 

 

Comprehensive income

   $ 2,263      $ 970       $ 4,955       $ 5,203   

Net income applicable to noncontrolling interests

     94        510         469         769   

Other comprehensive income applicable to noncontrolling interests

     63        91         72         123   
  

 

 

   

 

 

    

 

 

    

 

 

 

Comprehensive income applicable to Morgan Stanley

   $ 2,106      $ 369       $ 4,414       $ 4,311   
  

 

 

   

 

 

    

 

 

    

 

 

 

  

 

(1) Amounts are net of provision for (benefit from) income taxes of $239 million and $(219) million for the quarters ended September 30, 2011 and 2010, respectively, and $103 million and $(149) million for the nine months ended September 30, 2011 and 2010, respectively.
(2) Amounts are net of provision for income taxes of $2 million and $1 million for the quarters ended September 30, 2011 and 2010, respectively, and $4 million and $5 million for the nine months ended September 30, 2011 and 2010, respectively.
(3) Amounts are net of provision for income taxes of $52 million and $78 million for the quarters ended September 30, 2011 and 2010, respectively, and $62 million and $154 million for the nine months ended September 30, 2011 and 2010, respectively.
(4) Amounts are net of provision for income taxes of $1 million and $2 million for the quarters ended September 30, 2011 and 2010, respectively, and $1 million and $70 million for the nine months ended September 30, 2011 and 2010, respectively.

 

See Notes to Condensed Consolidated Financial Statements.

 

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MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in millions)

(unaudited)

 

     Nine Months  Ended
September 30,
 
         2011             2010      

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income

   $ 4,829      $ 4,636   

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

    

(Gain) loss on equity method investees

     788        (4

Compensation payable in common stock and options

     1,006        977   

Depreciation and amortization

     1,187        1,837   

Gain on business dispositions

     (24     (514

Gain on sale of securities available for sale

     (130     —     

Gain on retirement of long-term debt

     (46     —     

Insurance reimbursement

     —          (88

Loss on assets held for sale

     —          1,158   

Impairment charges and other-than-temporary impairment charges

     57        66   

Changes in assets and liabilities:

    

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

     (11,684     3,439   

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

     34,742        4,421   

Securities borrowed

     14,826        5,067   

Securities loaned

     (1,309     4,877   

Receivables, loans and other assets

     (3,989     (6,081

Payables and other liabilities

     22,501        2,495   

Federal funds sold and securities purchased under agreements to resell

     (21,571     (10,744

Securities sold under agreements to repurchase

     (37,545     7,710   
  

 

 

   

 

 

 

Net cash provided by (used for) operating activities

     3,638        19,252   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Net proceeds from (payments for):

    

Premises, equipment and software costs

     (1,088     (800

Business acquisitions, net of cash acquired

     —          (1,028

Business dispositions, net of cash disposed

     —          800   

Japanese securities joint venture with MUFG

     —          247   

Purchases of securities available for sale

     (13,968     (23,374

Sales, maturities and redemptions of securities available for sale

     16,809        31   
  

 

 

   

 

 

 

Net cash provided by (used for) investing activities

     1,753        (24,124
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Net proceeds from (payments for):

    

Commercial paper and other short-term borrowings

     (375     2,271   

Distributions related to noncontrolling interests

     (489     (20

Derivatives financing activities

     54        (76

Other secured financings

     1,705        (409

Deposits

     2,372        (1,013

Net proceeds from:

    

Excess tax benefits associated with stock-based awards

     30        4   

Public offerings and other issuances of common stock

     —          5,581   

Issuance of long-term borrowings

     30,063        26,648   

Payments for:

    

Long-term borrowings

     (31,936     (20,662

Redemption of junior subordinated debentures related to CIC

     —          (5,579

Repurchases of common stock for employee tax withholding

     (311     (298

Cash dividends

     (714     (867
  

 

 

   

 

 

 

Net cash provided by (used for) financing activities

     399        5,580   
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     140        171   
  

 

 

   

 

 

 

Effect of cash and cash equivalents related to variable interest entities

     362        245   
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     6,292        1,124   

Cash and cash equivalents, at beginning of period

     47,615        31,991   
  

 

 

   

 

 

 

Cash and cash equivalents, at end of period

   $ 53,907      $ 33,115   
  

 

 

   

 

 

 

Cash and cash equivalents include:

    

Cash and due from banks

   $ 12,255      $ 6,936   

Interest bearing deposits with banks

     41,652        26,179   
  

 

 

   

 

 

 

Cash and cash equivalents, at end of period

   $ 53,907      $ 33,115   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash payments for interest were $4,832 million and $4,066 million for the nine months ended September 30, 2011 and 2010, respectively.

Cash payments for income taxes were $791 million and $378 million for the nine months ended September 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

Nine Months Ended September 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

    —          —          —          4,360        —          —          —          —          469        4,829   

Dividends

    —          —          —          (527     —          —          —          —          —          (527

Shares issued under employee plans and related tax effects

    —          —          (917     —          (249     —          1,873        249        —          956   

Repurchases of common stock

    —          —          —          —          —          —          (312     —          —          (312

Net change in cash flow hedges

    —          —          —          —          —          5        —          —          —          5   

Pension, postretirement and other related adjustments

    —          —          —          —          —          8        —          —          —          8   

Foreign currency translation adjustments

    —          —          —          —          —          (49     —          —          72        23   

Change in net unrealized gains on securities available for sale

    —          —          —          —          —          90        —          —          —          90   

Other increase in equity method investments

    —          —          86        —          —          —          —          —          —          86   

MUFG stock conversion

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

Decrease in noncontrolling interests related to distributions to noncontrolling interests

    —          —          —          —          —          —          —          —          (489     (489

Other increases in noncontrolling interests

    —          —          —          —          —          —          —          —          18        18   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT SEPTEMBER 30, 2011

  $ 1,508      $ 20      $ 22,501      $ 40,710      $ 3,216      $ (413   $ (2,498   $ (3,216   $ 8,266      $ 70,094   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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MORGAN STANLEY

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

Nine Months Ended September 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

    —          —          —          3,867        —          —          —          —          769        4,636   

Dividends

    —          —          —          (867     —          —          —          —          —          (867

Shares issued under employee plans and related tax effects

    —          —          (1,539     —          (515     —          2,271        515        —          732   

Repurchases of common stock

    —          —          —          —          —          —          (298     —          —          (298

Net change in cash flow hedges

    —          —          —          —          —          7        —          —          —          7   

Pension and postretirement adjustments

    —          —          —          —          —          113        —          —          —          113   

Foreign currency translation adjustments

    —          —          —          —          —          92        —          —          123        215   

Gain on Japanese securities joint venture with MUFG

    —          —          731        —          —          —          —          —          —          731   

Change in net unrealized gains on securities available for sale

    —          —          —          —          —          232        —          —          —          232   

Redemption of CIC equity units and issuance of common stock

    —          1        5,578        —          —          —          —          —          —          5,579   

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 distributions to noncontrolling interests

    —          —          —          —          —          —          —          —          (20     (20

Other increases in noncontrolling interests

    —          —          —          —          —          —          —          —          144        144   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT SEPTEMBER 30, 2010

  $ 9,597      $ 16      $ 13,389      $ 38,056      $ 3,549      $ (116   $ (4,066   $ (3,549   $ 8,706      $ 65,582   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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 nine months ended September 30, 2010 included losses of approximately $229 million and approximately $1.2 billion, respectively, in connection with such 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 nine months ended September 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 September 30, 2011, the Company had approximately $5.6 billion in Financial instruments owned—Corporate and other debt, $4.2 billion of physical commodities within Financial instruments owned—Physical commodities, and $9.8 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. and Morgan Stanley Private Bank, National Association.

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 fees 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 nine months ended September 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 model derived mid-market levels of Level 2 and Level 3 financial instruments for the bid-mid or mid-ask spread

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 nine months ended September 30, 2011 (see Note 13). In addition, in the nine months ended September 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 quoted market prices and trade data adjusted by subsequent changes in related indices 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.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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.

 

   

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

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

 

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.

 

   

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.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

   

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, 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.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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.

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 (e.g., U.S. Treasury securities, agency-issued debt, agency mortgage pass-through securities and collateralized mortgage obligations) and Federal Family Education Loan Program (“FFELP”) student loan asset-backed securities. 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, collateralized mortgage obligations and FFELP student loan asset-backed securities 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

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

 

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.

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 September 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 September 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
September 30,
2011
 
     (dollars in millions)  

Assets

          

Financial instruments owned:

          

U.S. government and agency securities:

          

U.S. Treasury securities

   $ 19,329      $ 21      $ —        $ —        $ 19,350   

U.S. agency securities

     3,913        19,831        10        —          23,754   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

     23,242        19,852        10        —          43,104   

Other sovereign government obligations

     26,069        8,592        118        —          34,779   

Corporate and other debt:

          

State and municipal securities

     —          2,446        —          —          2,446   

Residential mortgage-backed securities

     —          2,042        386        —          2,428   

Commercial mortgage-backed securities

     —          1,815        146        —          1,961   

Asset-backed securities

     —          884        6        —          890   

Corporate bonds

     —          29,642        1,004        —          30,646   

Collateralized debt obligations

     —          2,368        1,249        —          3,617   

Loans and lending commitments

     —          14,239        11,307        —          25,546   

Other debt

     —          8,472        137        —          8,609   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

     —          61,908        14,235        —          76,143   

Corporate equities(1)

     43,504        3,309        381        —          47,194   

Derivative and other contracts:

          

Interest rate contracts

     1,657        906,548        5,636        —          913,841   

Credit contracts

     —          150,394        19,468        —          169,862   

Foreign exchange contracts

     10        89,880        629        —          90,519   

Equity contracts

     2,696        58,167        955        —          61,818   

Commodity contracts

     5,896        35,382        2,585        —          43,863   

Other

     —          932        326        —          1,258   

Netting(2)

     (8,880     (1,122,162     (11,501     (84,206     (1,226,749
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

     1,379        119,141        18,098        (84,206     54,412   

Investments:

          

Private equity funds

     —          —          2,040        —          2,040   

Real estate funds

     —          5        1,254        —          1,259   

Hedge funds

     —          377        791        —          1,168   

Principal investments

     161        —          3,074        —          3,235   

Other

     91        49        481        —          621   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

     252        431        7,640        —          8,323   

Physical commodities

     —          10,296        —          —          10,296   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial instruments owned

     94,446        223,529        40,482        (84,206     274,251   

Securities available for sale

     11,491        16,206        —          —          27,697   

Securities received as collateral

     10,806        93        —          —          10,899   

Intangible assets(3)

     —          —          133        —          133   

Liabilities

          

Deposits

   $ —        $ 2,796      $ —        $ —        $ 2,796   

Commercial paper and other short-term borrowings

     —          1,137        2        —          1,139   

Financial instruments sold, not yet purchased:

          

U.S. government and agency securities:

          

U.S. Treasury securities

     17,264        1        —          —          17,265   

U.S. agency securities

     1,602        467        —          —          2,069   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

     18,866        468        —          —          19,334   

Other sovereign government obligations

     14,348        3,741        —          —          18,089   

Corporate and other debt:

          

State and municipal securities

     —          6        —          —          6   

 

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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
September 30,
2011
 
     (dollars in millions)  

Residential mortgage-backed securities

     —          8        93        —          101   

Commercial mortgage-backed securities

     —          14        —          —          14   

Corporate bonds

     —          7,811        70        —          7,881   

Unfunded lending commitments

     —          1,411        206        —          1,617   

Other debt

     —          289        70        —          359   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

     —          9,539        439        —          9,978   

Corporate equities(1)

     26,234        247        2        —          26,483   

Derivative and other contracts:

          

Interest rate contracts

     1,713        877,542        4,924        —          884,179   

Credit contracts

     —          149,071        8,935        —          158,006   

Foreign exchange contracts

     11        91,673        570        —          92,254   

Equity contracts

     2,697        59,919        2,174        —          64,790   

Commodity contracts

     6,686        33,284        2,043        —          42,013   

Other

     —          1,022        1,424        —          2,446   

Netting(2)

     (8,880     (1,122,162     (11,501     (53,081     (1,195,624
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

     2,227        90,349        8,569        (53,081     48,064   

Physical commodities

     —          16        —          —          16   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial instruments sold, not yet purchased

     61,675        104,360        9,010        (53,081     121,964   

Obligation to return securities received as collateral

     14,938        97        —          —          15,035   

Securities sold under agreements to repurchase

     —          8        346        —          354   

Other secured financings

     —          15,350        590        —          15,940   

Long-term borrowings

     30        38,371        1,286        —          39,687   

 

(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 September 30, 2011.

Financial instruments owned—Derivative and other contracts and Financial instruments sold, not yet purchased—Derivative and other contracts.    During the quarter ended September 30, 2011, the Company reclassified approximately $1.0 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.

Financial instruments owned—Other sovereign government obligations.    During the quarter ended September 30, 2011, the Company reclassified approximately $1.8 billion of other sovereign government obligations assets and approximately $2.1 billion of other sovereign government obligations liabilities from Level 1 to Level 2. These reclassifications primarily related to European peripheral government bonds 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 Nine Months Ended September 30, 2011.

Financial instruments owned—Derivative and other contracts and Financial instruments sold, not yet purchased—Derivative and other contracts.    During the nine months ended September 30, 2011, the Company

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

reclassified approximately $0.8 billion of derivative assets and approximately $1.2 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—Other sovereign government obligations.    During the nine months ended September 30, 2011, the Company reclassified approximately $1.8 billion of other sovereign government obligations assets and approximately $2.1 billion of other sovereign government obligations liabilities from Level 1 to Level 2. These reclassifications primarily related to European peripheral government bonds as transactions in these securities did not occur with sufficient frequency and volume to constitute an active market.

 

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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   

 

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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 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   

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 September 30, 2010.

Financial instruments owned—Derivative and other contracts and Financial instruments sold, not yet purchased—Derivative and other contracts.    During the quarter ended September 30, 2010, the Company reclassified approximately $1.6 billion of derivative assets and approximately $1.6 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 Nine Months Ended September 30, 2010.

Financial instruments owned—Derivative and other contracts and Financial instruments sold, not yet purchased—Derivative and other contracts.    During the nine months ended September 30, 2010, the Company reclassified approximately $2.2 billion of derivative assets and approximately $2.3 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.

 

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Table of Contents

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Financial instruments owned—Corporate equities.    During the nine months ended September 30, 2010, the Company reclassified approximately $1.2 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 nine months ended September 30, 2011 and for the quarter and nine months ended September 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.

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

 

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Table of Contents

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

    Beginning
Balance at
June 30,
2011
    Total
Realized and
Unrealized
Gains
(Losses)(1)
    Purchases     Sales     Issuances     Settlements     Net Transfers     Ending
Balance at
September 30,
2011
    Unrealized
Gains
(Losses) for
Level 3 Assets/

Liabilities
Outstanding at
September 30,
2011(2)
 
    (dollars in millions)  

Assets

                 

Financial instruments owned:

                 

U.S. agency securities

  $ 2      $ —        $ 18      $ (10   $ —        $ —        $ —        $ 10      $ —     

Other sovereign government obligations

    132        (13     —          —          —          —          (1     118        (13

Corporate and other debt:

                 

Residential mortgage-backed securities

    509        (28     147        (193     —          —          (49     386        (16

Commercial mortgage-backed securities

    136        (3     7        (49     —          —          55        146        (6

Asset-backed securities

    298        3        1        (297     —          —          1        6        2   

Corporate bonds

    1,179        (119     309        (385     —          —          20        1,004        (151

Collateralized debt obligations

    1,650        (115     189        (303     —          (24     (148     1,249        (119

Loans and lending commitments

    10,420        (166     1,525        (968     —          (957     1,453        11,307        (184

Other debt

    163        40        10        (34     —          (13     (29     137        24   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    14,355        (388     2,188        (2,229     —          (994     1,303        14,235        (450

Corporate equities

    461        (46     90        (137     —          —          13        381        (62

Net derivative and other contracts(3):

                 

Interest rate contracts

    317        274        17        —          (112     200        16        712        294   

Credit contracts

    7,392        3,375        107        —          (383     (51     93        10,533        3,277   

Foreign exchange contracts

    44        62        —          —          —          (47     —          59        52   

Equity contracts

    (1,661     532        80        (41     (156     57        (30     (1,219     511   

Commodity contracts

    316        245        —          —          —          (19     —          542        330   

Other

    (397     (710     —          —          (5     16        (2     (1,098     (701
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net derivative and other contracts

    6,011        3,778        204        (41     (656     156        77        9,529        3,763   

Investments:

                 

Private equity funds

    2,160        (104     66        (82     —          —          —          2,040        (126

Real estate funds

    1,290        (15     7        (28     —          —          —          1,254        3   

Hedge funds

    827        (4     31        (65     —          —          2        791        (4

Principal investments

    3,120        (50     41        (153     —          —          116        3,074        (72

Other

    525        (34     1        (8     —          —          (3     481        (37
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

    7,922        (207     146        (336     —          —          115        7,640        (236

Physical commodities

    673        —          —          —          —          (673     —          —          —     

Intangible assets

    133        (1     1        —          —          —          —          133        (1

Liabilities

                 

Commercial paper and other short-term borrowings

  $ 23      $ 1      $ —        $ —        $ 1      $ (19   $ (2   $ 2      $ 1   

Other sovereign government obligations

    —          —          (31     —          —          —          31        —          —     

Financial instruments sold, not yet purchased:

                 

Corporate and other debt:

                 

Residential mortgage-backed securities

    41        1        (37     115        —          —          (25     93        —     

Corporate bonds

    35        122        (34     168        —          —          23        70        39   

Unfunded lending commitments

    240        (66     —          —          —          (100     —          206        (66

Other debt

    178        98        (7     9        —          (2     (10     70        97   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    494        155        (78     292        —          (102     (12     439        70   

Corporate equities

    1        6        (16     17        —          —          6        2        —     

Securities sold under agreements to repurchase

    358        12        —          —          —          —          —          346        12   

Other secured financings

    742        33        —          —          27        (146     —          590        33   

Long-term borrowings

    1,251        76        —          —          239        (133     5        1,286        58   

 

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Table of Contents

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

 

(1) Total realized and unrealized gains (losses) are primarily included in Principal transactions—Trading in the condensed consolidated statements of income except for $(207) million related to Financial instruments owned—Investments, which is included in Principal transactions—Investments.
(2) Amounts represent unrealized gains (losses) for the quarter ended September 30, 2011 related to assets and liabilities still outstanding at September 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.

Financial instruments owned—Corporate and other debt.    During the quarter ended September 30, 2011, the Company reclassified approximately $0.8 billion of certain Corporate and other debt, primarily corporate loans, residential mortgage-backed securities, and collateralized debt obligations, 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 $2.1 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.

Financial instruments owned—Net derivative and other contracts.    The net gains in Net derivative and other contracts were primarily driven by widening of credit spreads on underlying reference entities of certain basket default swaps where the Company was long protection.

 

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Table of Contents

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 Nine Months Ended September 30, 2011

 

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

Assets

                 

Financial instruments owned:

                 

U.S. agency securities

  $ 13      $ 1      $ 54      $ (56   $ —        $ —        $ (2   $ 10      $ 1   

Other sovereign government obligations

    73        (5     56        —          —          —          (6     118        (3

Corporate and other debt:

                 

State and municipal securities

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

Residential mortgage-backed securities

    319        (50     347        (329     —          (1     100        386        (57

Commercial mortgage-backed securities

    188        10        61        (68     —          —          (45     146        (9

Asset-backed securities

    13        5        16        (48     —          —          20        6        1   

Corporate bonds

    1,368        (147     492        (651     —          —          (58     1,004        (76

Collateralized debt obligations

    1,659        135        749        (1,191     —          (55     (48     1,249        (102

Loans and lending commitments

    11,666        (179     3,504        (1,182     —          (2,285     (217     11,307        (203

Other debt

    193        43        10        (64     —          (11     (34     137        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    15,516        (184     5,179        (3,629     —          (2,352     (295     14,235        (446

Corporate equities

    484        2        295        (324     —          —          (76     381        (23

Net derivative and other contracts(3):

                 

Interest rate contracts

    424        1,255        36        —          (809     (239     45        712        1,152   

Credit contracts

    6,594        3,860        1,176        —          (478     (707     88        10,533        4,195   

Foreign exchange contracts

    46        (95     2        —          —          100        6        59        (73

Equity contracts

    (762     664        187        (130     (1,373     67        128        (1,219     636   

Commodity contracts

    188        422        457        —          (321     (299     95        542        490   

Other

    (913     (571     1        —          (120     424        81        (1,098     (565
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net derivative and other contracts

    5,577        5,535        1,859        (130     (3,101     (654     443        9,529        5,835   

Investments:

                 

Private equity funds

    1,986        156        189        (362     —          —          71        2,040        84   

Real estate funds

    1,176        128        40        (90     —          —          —          1,254        181   

Hedge funds

    901        (30     172        (361     —          —          109        791        (32

Principal investments

    3,131        192        285        (618     —          —          84        3,074        (8

Other

    560        16        4        (25     —          —          (74     481        4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

    7,754        462        690        (1,456     —          —          190        7,640        229   

Physical commodities

    —          (48     721        —          —          (673     —          —          —     

Securities received as collateral

    1        —          —          (1     —          —          —          —          —