10-Q 1 d432415d10q.htm FORM 10-Q Form 10-Q
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

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, 2012, there were 1,974,320,133 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.


Table of Contents

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QUARTERLY REPORT ON FORM 10-Q

For the quarter ended September 30, 2012

 

Table of Contents    Page  

Part I—Financial Information

  

Item 1.

  Financial Statements (unaudited)      1   
 

Condensed Consolidated Statements of Financial Condition—September 30, 2012 and December  31, 2011

     1   
 

Condensed Consolidated Statements of Income—Three and Nine Months Ended
September 30, 2012 and 2011

     3   
 

Condensed Consolidated Statements of Comprehensive Income—Three and Nine Months Ended September 30, 2012 and 2011

     4   
 

Condensed Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2012 and 2011

     5   
 

Condensed Consolidated Statements of Changes in Total Equity—Nine Months Ended September 30, 2012 and 2011

     6   
 

Notes to Condensed Consolidated Financial Statements (unaudited)

     8   
 

Report of Independent Registered Public Accounting Firm

     91   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      92   
 

Introduction

     92   
 

Executive Summary

     93   
 

Business Segments

     104   
 

Accounting Developments

     120   
 

Other Matters

     121   
 

Critical Accounting Policies

     123   
 

Liquidity and Capital Resources

     128   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      144   

Item 4.

  Controls and Procedures      160   

Financial Data Supplement (Unaudited)

     161   

Part II—Other Information

  

Item 1.

  Legal Proceedings      167   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      172   

Item 6.

  Exhibits      172   

 

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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; Operations and Technology Committee; Compensation, Management Development and Succession Committee; Nominating and Governance 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,
2012
     December 31,
2011
 

Assets

     

Cash and due from banks ($487 and $511 at September 30, 2012 and December 31, 2011, respectively, related to consolidated variable interest entities generally not available to the Company)

   $ 18,239       $ 13,165   

Interest bearing deposits with banks

     18,347         34,147   

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

     28,847         29,454   

Financial instruments owned, at fair value (approximately $133,773 and $140,749 were pledged to various parties at September 30, 2012 and December 31, 2011, respectively):

     

U.S. government and agency securities

     52,134         63,449   

Other sovereign government obligations

     37,171         29,059   

Corporate and other debt ($2,261 and $3,007 at September 30, 2012 and December 31, 2011, respectively, related to consolidated variable interest entities, generally not available to the Company)

     55,439         68,923   

Corporate equities

     55,575         47,966   

Derivative and other contracts

     34,568         48,064   

Investments ($1,855 and $1,666 at September 30, 2012 and December 31, 2011, respectively, related to consolidated variable interest entities, generally not available to the Company)

     8,501         8,195   

Physical commodities

     7,920         9,697   
  

 

 

    

 

 

 

Total financial instruments owned, at fair value

     251,308         275,353   

Securities available for sale, at fair value

     40,498         30,495   

Securities received as collateral, at fair value

     12,811         11,651   

Federal funds sold and securities purchased under agreements to resell (includes $625 and $112 at fair value at September 30, 2012 and December 31, 2011, respectively)

     136,282         130,155   

Securities borrowed

     138,545         127,074   

Receivables:

     

Customers

     45,506         33,977   

Brokers, dealers and clearing organizations

     7,673         5,248   

Fees, interest and other

     10,399         9,444   

Loans (net of allowances of $101 and $17 at September 30, 2012 and December 31, 2011, respectively)

     24,344         15,369   

Other investments

     4,749         4,832   

Premises, equipment and software costs (net of accumulated depreciation of $5,350 and $4,852 at September 30, 2012 and December 31, 2011, respectively) ($227 and $234 at September 30, 2012 and December 31, 2011, respectively, related to consolidated variable interest entities, generally not available to the Company)

     6,083         6,457   

Goodwill

     6,622         6,686   

Intangible assets (net of accumulated amortization of $1,162 and $910 at September 30, 2012 and December 31, 2011, respectively) (includes $6 and $133 at fair value at September 30, 2012 and December 31, 2011, respectively)

     3,905         4,285   

Other assets ($327 and $446 at September 30, 2012 and December 31, 2011, respectively, related to consolidated variable interest entities, generally not available to the Company)

     10,827         12,106   
  

 

 

    

 

 

 

Total assets

   $ 764,985       $ 749,898   
  

 

 

    

 

 

 

 

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,
2012
    December 31,
2011
 

Liabilities

    

Deposits (includes $1,942 and $2,101 at fair value at September 30, 2012 and December 31, 2011, respectively)

   $ 70,757      $ 65,662   

Commercial paper and other short-term borrowings (includes $697 and $1,339 at fair value at September 30, 2012 and December 31, 2011, respectively)

     2,123        2,843   

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

    

U.S. government and agency securities

     26,651        19,630   

Other sovereign government obligations

     27,528        17,141   

Corporate and other debt

     7,649        8,410   

Corporate equities

     28,026        24,497   

Derivative and other contracts

     35,033        46,453   

Physical commodities

     —          16   
  

 

 

   

 

 

 

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

     124,887        116,147   

Obligation to return securities received as collateral, at fair value

     16,441        15,394   

Securities sold under agreements to repurchase (includes $287 and $348 at fair value at September 30, 2012 and December 31, 2011, respectively )

     116,220        104,800   

Securities loaned

     35,920        30,462   

Other secured financings (includes $9,674 and $14,594 at fair value at September 30, 2012 and December 31, 2011, respectively) ($1,176 and $2,316 at September 30, 2012 and December 31, 2011, respectively, related to consolidated variable interest entities and are non-recourse to the Company)

     18,173        20,719   

Payables:

    

Customers

     117,193        117,241   

Brokers, dealers and clearing organizations

     7,447        4,082   

Interest and dividends

     3,347        2,292   

Other liabilities and accrued expenses ($119 and $121 at September 30, 2012 and December 31, 2011, respectively, related to consolidated variable interest entities and are non-recourse to the Company)

     14,561        15,944   

Long-term borrowings (includes $45,756 and $39,663 at fair value at September 30, 2012 and December 31, 2011, respectively)

     168,444        184,234   
  

 

 

   

 

 

 
     695,513        679,820   
  

 

 

   

 

 

 

Commitments and contingent liabilities (see Note 12)

    

Redeemable noncontrolling interests (see Notes 2, 3 and 14)

     4,302        —     

Equity

    

Morgan Stanley shareholders’ equity:

    

Preferred stock

     1,508        1,508   

Common stock, $0.01 par value;

    

Shares authorized: 3,500,000,000 at September 30, 2012 and December 31, 2011;

    

Shares issued: 2,038,893,979 at September 30, 2012 and 1,989,377,171 at December 31, 2011; Shares outstanding: 1,975,040,372 at September 30, 2012 and 1,926,986,130 at December 31, 2011

     20        20   

Paid-in capital

     23,202        22,836   

Retained earnings

     39,441        40,341   

Employee stock trust

     2,979        3,166   

Accumulated other comprehensive loss

     (146     (157

Common stock held in treasury, at cost, $0.01 par value; 63,853,607 shares at September 30, 2012 and 62,391,041 shares at December 31, 2011

     (2,226     (2,499

Common stock issued to employee trust

     (2,979     (3,166
  

 

 

   

 

 

 

Total Morgan Stanley shareholders’ equity

     61,799        62,049   

Nonredeemable noncontrolling interests

     3,371        8,029   
  

 

 

   

 

 

 

Total equity

     65,170        70,078   
  

 

 

   

 

 

 

Total liabilities, redeemable noncontrolling interests and equity

   $ 764,985      $ 749,898   
  

 

 

   

 

 

 

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,
 
    2012     2011     2012     2011  

Revenues:

       

Investment banking

  $ 1,152      $ 1,031      $ 3,319      $ 3,940   

Principal transactions:

       

Trading

    607        4,960        5,483        11,421   

Investments

    290        (298     438        433   

Commissions and fees

    988        1,476        3,205        4,198   

Asset management, distribution and administration fees

    2,257        2,149        6,677        6,406   

Other

    152        347        432        110   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest revenues

    5,446        9,665        19,554        26,508   
 

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

    1,379        1,753        4,244        5,573   

Interest expense

    1,536        1,608        4,621        5,490   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net interest

    (157     145        (377     83   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net revenues

    5,289        9,810        19,177        26,591   
 

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expenses:

       

Compensation and benefits

    3,929        3,638        11,993        12,545   

Occupancy and equipment

    388        382        1,160        1,174   

Brokerage, clearing and exchange fees

    359        443        1,167        1,254   

Information processing and communications

    493        456        1,439        1,340   

Marketing and business development

    138        143        440        436   

Professional services

    477        440        1,367        1,310   

Other

    985        623        1,948        1,976   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expenses

    6,769        6,125        19,514        20,035   
 

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

    (1,480     3,685        (337     6,556   

Provision for (benefit from) income taxes

    (524     1,415        (244     1,709   
 

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

    (956     2,270        (93     4,847   
 

 

 

   

 

 

   

 

 

   

 

 

 

Discontinued operations:

       

Gain (loss) from discontinued operations

    (15     (5     61        (55

Provision for (benefit from) income taxes

    (15     (28     40        (37
 

 

 

   

 

 

   

 

 

   

 

 

 

Net gain (loss) from discontinued operations

    —          23        21        (18
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (956   $ 2,293      $ (72   $ 4,829   

Net income applicable to redeemable noncontrolling interests

    8        —          8        —     

Net income applicable to nonredeemable noncontrolling interests

    59        94        446        469   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) applicable to Morgan Stanley

  $ (1,023   $ 2,199      $ (526   $ 4,360   
 

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) applicable to Morgan Stanley common shareholders

  $ (1,047   $ 2,153      $ (599   $ 2,335   
 

 

 

   

 

 

   

 

 

   

 

 

 

Amounts applicable to Morgan Stanley:

       

Income (loss) from continuing operations

  $ (1,007   $ 2,178      $ (522   $ 4,383   

Net gain (loss) from discontinued operations

    (16     21        (4     (23
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) applicable to Morgan Stanley

  $ (1,023   $ 2,199      $ (526   $ 4,360   
 

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per basic common share:

       

Income (loss) from continuing operations

  $ (0.55   $ 1.15      $ (0.32   $ 1.48   

Net gain (loss) from discontinued operations

    —          0.01        —          (0.01
 

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per basic common share

  $ (0.55   $ 1.16      $ (0.32   $ 1.47   
 

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per diluted common share:

       

Income (loss) from continuing operations

  $ (0.55   $ 1.14      $ (0.32   $ 1.47   

Net gain (loss) from discontinued operations

    —          0.01        —          (0.02
 

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per diluted common share

  $ (0.55   $ 1.15      $ (0.32   $ 1.45   
 

 

 

   

 

 

   

 

 

   

 

 

 

Average common shares outstanding:

       

Basic

    1,889,300,631        1,848,246,471        1,883,813,883        1,589,519,478   
 

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

    1,889,300,631        1,868,743,943        1,883,813,883        1,607,962,757   
 

 

 

   

 

 

   

 

 

   

 

 

 

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,
 
         2012             2011             2012             2011      

Net income (loss)

   $ (956   $ 2,293      $ (72   $ 4,829   

Other comprehensive income (loss), net of tax:

        

Foreign currency translation adjustments(1)

   $ 43      $ (108   $ (88   $ 23   

Amortization of cash flow hedges(2)

     2        1        5        5   

Net unrealized gains on Securities available for sale(3)

     62        76        84        90   

Pension, postretirement and other related adjustments(4)

     (4     1        15        8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income (loss)

   $ 103      $ (30   $ 16      $ 126   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ (853   $ 2,263      $ (56   $ 4,955   

Net income applicable to redeemable noncontrolling interests

     8        —          8        —     

Net income applicable to nonredeemable noncontrolling interests

     59        94        446        469   

Other comprehensive income (loss) applicable to redeemable noncontrolling interests

     (1     —          (1     —     

Other comprehensive income applicable to nonredeemable noncontrolling interests

     29        63        5        72   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss) applicable to Morgan Stanley

   $ (948   $ 2,106      $ (514   $ 4,414   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Amounts are net of provision for (benefit from) income taxes of $(150) million and $239 million for the quarters ended September 30, 2012 and 2011, respectively, and $26 million and $103 million for the nine months ended September 30, 2012 and 2011, respectively.
(2) Amounts are net of provision for income taxes of $1 million and $2 million for the quarters ended September 30, 2012 and 2011, respectively and $3 million and $4 million for the nine months ended September 30, 2012 and 2011, respectively.
(3) Amounts are net of provision for income taxes of $46 million and $52 million for the quarters ended September 30, 2012 and 2011, respectively, and $63 million and $62 million for the nine months ended September 30, 2012 and 2011, respectively.
(4) Amounts are net of provision for income taxes of $8 million and $1 million for the quarters ended September 30, 2012 and 2011, respectively, and $18 million and $1 million for the nine months ended September 30, 2012 and 2011, 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,
 
     2012     2011  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income (loss)

   $ (72   $ 4,829   

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

    

Loss on equity method investees

     24        788   

Compensation payable in common stock and options

     898        1,006   

Depreciation and amortization

     1,218        1,187   

Gain on business dispositions

     (108     (24

Gain on sale of securities available for sale

     (53     (130

Gain on retirement of long-term debt

     (29     (46

Impairment charges and other-than-temporary impairment charges

     224        57   

Changes in assets and liabilities:

    

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

     607        (11,684

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

     31,556        34,742   

Securities borrowed

     (11,471     14,826   

Securities loaned

     5,458        (1,309

Receivables and other assets

     (23,625     3,263   

Payables and other liabilities

     9,807        22,501   

Federal funds sold and securities purchased under agreements to resell

     (6,127     (21,571

Securities sold under agreements to repurchase

     14,465        (37,545
  

 

 

   

 

 

 

Net cash provided by operating activities

     22,772        10,890   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Net proceeds from (payments for):

    

Premises, equipment and software costs

     (865     (1,088

Business dispositions, net of cash disposed

     1,536        —     

Loans

     (1,739     (7,252

Purchases of securities available for sale

     (17,492     (13,968

Sales, maturities and redemptions of securities available for sale

     8,200        16,809   
  

 

 

   

 

 

 

Net cash used for investing activities

     (10,360     (5,499
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Net proceeds from (payments for):

    

Commercial paper and other short-term borrowings

     (720     (375

Distributions related to nonredeemable noncontrolling interests

     (186     (489

Derivatives financing activities

     102        54   

Other secured financings

     (4,291     1,705   

Deposits

     5,095        2,372   

Net proceeds from:

    

Excess tax benefits associated with stock-based awards

     42        30   

Issuance of long-term borrowings

     16,196        30,063   

Payments for:

    

Long-term borrowings

     (36,386     (31,936

Repurchases of common stock for employee tax withholding

     (222     (311

Purchase of additional stake in the Wealth Management Joint Venture from Citi

     (1,890     —     

Cash dividends

     (349     (714
  

 

 

   

 

 

 

Net cash provided by (used for) financing activities

     (22,609     399   
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     (42     140   
  

 

 

   

 

 

 

Effect of cash and cash equivalents related to variable interest entities

     (487     362   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     (10,726     6,292   

Cash and cash equivalents, at beginning of period

     47,312        47,615   
  

 

 

   

 

 

 

Cash and cash equivalents, at end of period

   $ 36,586      $ 53,907   
  

 

 

   

 

 

 

Cash and cash equivalents include:

    

Cash and due from banks

   $ 18,239      $ 12,255   

Interest bearing deposits with banks

     18,347        41,652   
  

 

 

   

 

 

 

Cash and cash equivalents, at end of period

   $ 36,586      $ 53,907   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash payments for interest were $3,423 million and $4,832 million for the nine months ended September 30, 2012 and 2011, respectively.

Cash payments for income taxes were $330 million and $791 million for the nine months ended September 30, 2012 and 2011, 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, 2012

(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-
Redeemable
Non-
controlling
Interests
    Total
Equity
 

BALANCE AT DECEMBER 31, 2011

  $ 1,508      $ 20      $ 22,836      $ 40,341      $ 3,166      $ (157   $ (2,499   $ (3,166   $ 8,029      $ 70,078   

Net loss applicable to Morgan Stanley

    —          —          —          (526     —          —          —          —          —          (526

Net income applicable to nonredeemable noncontrolling interests

    —          —          —          —          —          —          —          —          446        446   

Dividends

    —          —          —          (374     —          —          —          —          —          (374

Shares issued under employee plans and related tax effects

    —          —          473        —          (187     —          495        187        —          968   

Repurchases of common stock

    —          —          —          —          —          —          (222     —          —          (222

Net change in cash flow hedges

    —          —          —          —          —          5        —          —          —          5   

Pension, postretirement and other related adjustments

    —          —          —          —          —          10        —          —          5        15   

Foreign currency translation adjustments

    —          —          —          —          —          (88     —          —          —          (88

Change in net unrealized gains on securities available for sale

    —          —          —          —          —          84        —          —          —          84   

Purchase of additional stake in the Wealth Management Joint Venture

    —          —          (107     —          —          —          —          —          (1,718     (1,825

Reclassification to redeemable noncontrolling interests

    —          —          —          —          —          —          —          —          (4,296     (4,296

Other net increases in nonredeemable noncontrolling interests

    —          —          —          —          —          —          —          —          905        905   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT SEPTEMBER 30, 2012

  $ 1,508      $ 20      $ 23,202      $ 39,441      $ 2,979      $ (146   $ (2,226   $ (2,979   $ 3,371      $ 65,170   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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, 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-
Redeemable
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 loss applicable to Morgan Stanley

    —          —          —          4,360        —          —          —          —          —          4,360   

Net income applicable to nonredeemable noncontrolling interests

    —          —          —          —          —          —          —          —          469        469   

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     —          —          —          —          —          —     

Other net decreases in nonredeemable noncontrolling interests

    —          —          —          —          —          —          —          —          (471     (471
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

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 and the term “Parent” means the parent company, Morgan Stanley.

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 65% interest in Morgan Stanley Smith Barney Holdings LLC (the “Wealth Management Joint Venture” or “Wealth Management JV”), 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.

Discontinued Operations.

Saxon.    On October 24, 2011, the Company announced that it had reached an agreement to sell Saxon, a provider of servicing and subservicing of residential mortgage loans, to Ocwen Financial Corporation. The transaction, which was restructured as a sale of Saxon’s assets during the first quarter of 2012, was substantially completed in the second quarter of 2012. The remaining operations of Saxon are expected to be wound down within the year. The Company expects to incur incremental wind-down costs in future periods. The results of Saxon are reported as discontinued operations within the Institutional Securities business segment for all periods presented.

Quilter.    On April 2, 2012, the Company completed the sale of Quilter & Co. Ltd. (“Quilter”), its retail wealth management business in the United Kingdom (“U.K.”). The results of Quilter are reported as discontinued operations within the Global Wealth Management Group business segment for all periods presented.

Prior period amounts have been recast for discontinued operations. See Note 21 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 and intangible assets, 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.

Intercompany balances and transactions have been eliminated.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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, 2011 (the “Form 10-K”). The condensed consolidated financial statements reflect all adjustments of a normal recurring nature 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 7). For condensed 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 either Net income (loss) applicable to redeemable noncontrolling interests or Net income (loss) applicable to nonredeemable noncontrolling interests in the condensed consolidated statements of income. The portion of the shareholders’ equity of such subsidiaries that is redeemable is presented as Redeemable noncontrolling interests outside of the equity section in the condensed statements of financial condition. The portion of the shareholders’ equity of such subsidiaries that is nonredeemable is presented as Nonredeemable noncontrolling interests in the condensed consolidated statements of financial condition.

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 VIEs (i.e., entities that do not meet these criteria), 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 4).

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

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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, 2011 included in the Form 10-K.

During the nine months ended September 30, 2012, other than the following, no other updates were made to the Company’s significant accounting policies.

Noncontrolling Interests.

For consolidated subsidiaries that are less than wholly owned, the third-party holdings of equity interests are referred to as noncontrolling interests.

As a result of the modifications to the purchase agreement regarding the Wealth Management JV, the Company now classifies Citigroup, Inc.’s (“Citi’s”) interest in the Wealth Management JV as redeemable noncontrolling interests, as the interest is redeemable at both the option of the Company and upon the occurrence of an event that is not solely within the Company’s control. This interest is classified outside of the equity section in Redeemable noncontrolling interests in the condensed consolidated statements of financial condition. Noncontrolling interests that do not contain such redemption features are presented as nonredeemable noncontrolling interests within the equity section of the condensed consolidated statements of financial condition.

Financial Instruments and Fair Value—Valuation Process.

The Valuation Review Group (“VRG”) within the Financial Control Group (“FCG”) is responsible for the Company’s fair value valuation policies, processes and procedures. VRG is independent of the business units and reports to the Chief Financial Officer (“CFO”), who has final authority over the valuation of the Company’s financial instruments. VRG implements valuation control processes to validate the fair value of the Company’s financial instruments measured at fair value including those derived from pricing models. These control processes are designed to assure that the values used for financial reporting are based on observable inputs wherever possible. In the event that observable inputs are not available, the control processes are designed to assure that the valuation approach utilized is appropriate and consistently applied and the assumptions are reasonable.

The Company’s control processes apply to financial instruments categorized in Level 1, Level 2 or Level 3 of the fair value hierarchy, unless otherwise noted. These control processes include:

Model Review.    VRG, in conjunction with the Market Risk Department (“MRD”) and, where appropriate, the Credit Risk Management Department, both of which report to the Chief Risk Officer, independently review the valuation model’s theoretical soundness, the appropriateness of the valuation methodology and calibration techniques developed by the business units using observable inputs. Where inputs are not observable, VRG reviews the appropriateness of the proposed valuation methodology to ensure it is consistent with how a market participant would arrive at the unobservable input. The valuation methodologies utilized in the absence of observable inputs may include extrapolation techniques and the use of comparable observable inputs. As part of the review, VRG develops a methodology to independently verify the fair value generated by the business unit’s valuation model. Before trades are executed using new valuation models, those models are required to be independently reviewed. All of the Company’s valuation models are subject to an independent annual VRG review.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Independent Price Verification.    The business units are responsible for determining the fair value of financial instruments using approved valuation models and valuation methodologies. Generally on a monthly basis, VRG independently validates the fair values of financial instruments determined using valuation models by determining the appropriateness of the inputs used by the business units and testing compliance with the documented valuation methodologies approved in the model review process described above.

VRG uses recently executed transactions, other observable market data such as exchange data, broker/dealer quotes, third-party pricing vendors and aggregation services for validating the fair values of financial instruments generated using valuation models. VRG assesses the external sources and their valuation methodologies to determine if the external providers meet the minimum standards expected of a third-party pricing source. Pricing data provided by approved external sources is evaluated using a number of approaches; for example, by corroborating the external sources’ prices to executed trades, analyzing the methodology and assumptions used by the external source to generate a price and/or by evaluating how active the third-party pricing source (or originating sources used by the third-party pricing source) is in the market. Based on this analysis, VRG generates a ranking of the observable market data to ensure that the highest-ranked market data source is used to validate the business unit’s fair value of financial instruments.

For financial instruments categorized within Level 3 of the fair value hierarchy, VRG reviews the business unit’s valuation techniques to ensure these are consistent with market participant assumptions.

The results of this independent price verification and any adjustments made by VRG to the fair value generated by the business units are presented to management of the three business segments (i.e., Institutional Securities, Global Wealth Management Group and Asset Management), the CFO and the Chief Risk Officer on a regular basis.

Review of New Level 3 Transactions.    VRG reviews the model and valuation methodology used to price all new material Level 3 transactions and both FCG and MRD management must approve the fair value of the trade that is initially recognized.

Securities Available for Sale—Other-than-temporary Impairment.

For available for sale (“AFS”) debt securities, a credit loss exists if the present value of cash flows expected to be collected is less than the amortized cost basis of the security. When determining if a credit loss exists, the Company considers all relevant information including the length of time and the extent to which the fair value has been less than the amortized cost basis; adverse conditions specifically related to the security, an industry, or geographic area; changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, changes in the financial condition of the underlying loan obligors; the historical and implied volatility of the fair value of the security; the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future; failure of the issuer of the security to make scheduled interest or principal payments; any changes to the rating of the security by a rating agency and recoveries or additional declines in fair value after the balance sheet date. When estimating the present value of expected cash flows, information includes the remaining payment terms of the security, prepayment speeds, financial condition of the issuer(s), expected defaults and the value of any underlying collateral.

For AFS equity securities, the Company considers various factors including the intent and ability to hold the equity security for a period of time sufficient to allow for any anticipated recovery in market value in evaluating whether an other-than-temporary impairment (“OTTI”) exists. If the equity security is considered other-than-temporarily impaired, the security will be written down to fair value, with the full difference between fair value and cost recognized in earnings.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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. In the nine months ended September 30, 2012, the Company’s significant non-cash activities include approximately $2.4 billion and $1.0 billion, respectively of assets and liabilities disposed of, in connection with business dispositions. 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 15).

During the third quarter of 2012, the Company identified that activities related to certain loans had been reported as cash flows from operating activities and should have been presented as investing activities. The Company corrected the previously presented cash flows for these loans and in doing so, for the nine months ended September 30, 2011, the condensed consolidated statement of cash flows were adjusted to increase net cash flows from operating activities by $7.3 billion with a corresponding decrease in net cash flows from investing activities. The Company has evaluated the effect of the incorrect presentation, both qualitatively and quantitatively, and concluded that it did not have a material impact on, nor require amendment of, any previously filed annual or quarterly consolidated financial statements.

Accounting Developments.

Reconsideration of Effective Control for Repurchase Agreements.

In April 2011, the Financial Accounting Standards Board (the “FASB”) issued accounting guidance that modified the criteria that must be satisfied for a transfer of financial assets to be accounted for as a sale. If the transferor maintains effective control over the transferred assets, the transaction is to be accounted for as a financing. This guidance eliminated from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. This guidance became effective for transfers occurring on and after January 1, 2012. The adoption of this accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.

Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.

In May 2011, the FASB issued an accounting update that clarified existing fair value measurement guidance and changed certain principles or requirements for measuring fair value or disclosing information about fair value measurements. This update resulted in common principles and requirements for measuring fair value and for disclosing information about fair value measurement in accordance with U.S. GAAP and International Financial Reporting Standards (“IFRS”). The guidance became effective for the Company beginning on January 1, 2012. See Note 4 for additional disclosures as required by this accounting guidance.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Goodwill and Intangible Assets.

In September 2011, the FASB issued accounting guidance that simplified how entities test goodwill for impairment. This guidance allows entities an option to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under that option, an entity no longer would be required to calculate the fair value of a reporting unit unless the entity determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This guidance became effective for the Company beginning on January 1, 2012. The adoption of this accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.

During the third quarter ended September 30, 2012, the Company changed the brand name of the U.S. Wealth Management business from Morgan Stanley Smith Barney to Morgan Stanley Wealth Management. The Smith Barney tradename will continue to be legally protected by the Company and will continue to be used as stipulated by our regulators as the legal entity name for the retail broker dealer (“Morgan Stanley Smith Barney LLC”). As a result of the change in intended use of this tradename, the Company determined that the tradename should be reclassified from an indefinite–lived to a finite–lived intangible asset. This change required the Company to test the intangible asset for impairment. Based on a comparison of the fair value to the carrying value of the tradename as of the date of the name change, no impairment was identified. The carrying value of the tradename will be amortized over its remaining estimated useful life.

 

3. Wealth Management Joint Venture.

On May 31, 2009, the Company and Citi consummated the combination of the Company’s Global Wealth Management Group and the businesses of Citi’s Smith Barney in the U.S., Quilter Holdings Ltd. in the U.K. and Smith Barney Australia (collectively, “Smith Barney”). The combined businesses operate as Morgan Stanley Wealth Management. Prior to September 2012, the Company owned 51% and Citi owned 49% of the Wealth Management JV.

In September 2012, the Company reached an agreement with Citi for the Company to purchase from Citi an additional 14% stake in the Wealth Management JV at an implied 100% valuation for the Wealth Management JV of $13.5 billion, and receive a transfer of approximately $5.4 billion of deposits at no premium from Citi.

In addition, subject to obtaining the required regulatory approvals, Morgan Stanley and Citi have reached an agreement with respect to the purchase of Citi’s remaining 35% stake in the Wealth Management JV at the same implied $13.5 billion valuation, and receive a transfer of deposits of approximately $54 billion at no premium from Citi, no later than June 1, 2015. The Company also agreed to purchase the next 15% stake in the Wealth Management JV by June 1, 2013, subject to regulatory approvals.

The Company completed the purchase of the additional 14% stake in the Wealth Management JV from Citi on September 17, 2012 for $1.89 billion. The related $5.4 billion of deposits were transferred at no premium in October of 2012. At September 30, 2012, the Company holds a 65% stake in the Wealth Management JV. The Company must use reasonable best efforts to obtain regulatory approvals required to purchase the remaining 35% stake in the Wealth Management JV by June 1, 2015, and, subject to receipt of such approvals, the Company must consummate such acquisition by that date at a purchase price of $4.725 billion (or a pro rata portion of such amount if less than 35% of the total outstanding stake are being purchased).

The change in the terms of the Wealth Management JV’s noncontrolling interests resulted in a reclassification of approximately $4.3 billion from nonredeemable noncontrolling interests to redeemable noncontrolling interests

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

on the condensed consolidated statements of financial condition. At September 30, 2012, the redeemable noncontrolling interest is not reflected as a liability at its redemption amount because it is not deemed probable that the noncontrolling interest will become redeemable due to the fact that regulatory approvals are required.

 

4. 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. These bonds are generally categorized in Level 1 of the fair value hierarchy. If the market is less active or prices are dispersed, these bonds are categorized in Level 2 of the fair value hierarchy.

Corporate and Other Debt.

 

   

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

 

   

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

 

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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 position-specific external price data are not observable, fair value is determined based on either benchmarking to similar instruments or 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 collateralized by corporate bonds (“credit-linked notes”) or cash portfolio of asset-backed securities (“asset-backed CDOs”). Credit correlation, a primary input used to determine the fair value of credit-linked notes, is usually unobservable and derived using a benchmarking technique. The other credit-linked note model inputs such as credit spreads, including collateral spreads, and interest rates are typically observable. Asset-backed CDOs 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 asset-backed CDO position is evaluated independently taking into consideration available comparable market levels, underlying collateral performance and pricing, deal structures, as well as liquidity. Cash CDOs are categorized in Level 2 of the fair value hierarchy when either the credit correlation input is insignificant or comparable market transactions are observable. In instances where the credit correlation input is deemed to be significant or comparable market transactions are unobservable, cash CDOs are categorized in Level 3 of the fair value hierarchy.

 

   

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

 

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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 position-specific external prices are not observable, 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. Mortgage loans are presented within Loans and lending commitments in the fair value hierarchy table.

 

   

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 recently executed transactions, the maximum rate, quality of underlying issuers/insurers and evidence of issuer calls/prepayment. ARS are generally categorized in Level 2 of the fair value hierarchy as the valuation technique relies on observable external data. SLARS and MARS are presented within Asset-backed securities and State and municipal securities, respectively, in the fair value hierarchy table.

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.

 

   

Unlisted Equity Securities.    Unlisted equity securities are valued based on an assessment of each underlying security, 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. These securities are generally categorized in Level 3 of the fair value hierarchy.

 

   

Fund Units.    Listed fund units are generally marked to the exchange-traded price or net asset value (“NAV”) and are categorized in Level 1 of the fair value hierarchy if actively traded on an exchange or in Level 2 of the fair value hierarchy if trading is not active. Unlisted fund units are generally marked to NAV and categorized as Level 2; however, positions which are not redeemable at the measurement date or in the near future are categorized in Level 3 of the fair value hierarchy.

 

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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 over-the-counter (“OTC”) derivatives; they are generally categorized in Level 2 of the fair value hierarchy.

 

   

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

Depending on the product and the terms of the transaction, the fair value of OTC derivative products can be either observed or modeled using a series of techniques and model inputs from comparable benchmarks, including closed-form analytic formulas, such as the Black-Scholes option-pricing model, 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 certain types of interest rate derivatives with both volatility and correlation exposure and credit derivatives including credit default swaps on certain mortgage-backed or asset-backed securities, 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 credit default swaps on certain mortgage-backed or asset-backed securities, for which observability of external price data is 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 available comparable market levels as well as cash-synthetic basis, or 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

 

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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 11.

Investments.

 

   

The Company’s investments include direct investments in equity securities as well as investments in private equity funds, real estate funds and hedge funds, which include investments made in connection with certain employee deferred compensation plans. 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 non-exchange-traded internally and externally managed funds, the Company generally considers the NAV 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 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), Federal Family Education Loan Program (“FFELP”) student loan asset-backed securities, auto loan asset-backed securities, corporate bonds and equity securities. Actively traded U.S. Treasury securities, non-callable agency-issued debt securities and equity 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, auto loan asset-backed securities and corporate bonds are generally categorized in Level 2 of the fair value hierarchy. For further information on securities available for sale, see Note 5.

 

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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 fixed income or equity securities, indices, currencies or commodities. Fair value of structured notes is determined using valuation models for the derivative and debt portions of the notes. These models incorporate observable inputs referencing identical or comparable securities, including prices that the notes are linked to, interest rate yield curves, option volatility and currency, commodity or equity prices. 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 Purchased under Agreements to Resell, and Securities Sold under Agreements to Repurchase.

 

   

The fair value of a reverse repurchase agreement or 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, reverse repurchase agreements and 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, 2012 and December 31, 2011.

 

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Assets and Liabilities Measured at Fair Value on a Recurring Basis at September 30, 2012.

 

     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,
2012
 
     (dollars in millions)  

Assets at Fair Value

          

Financial instruments owned:

          

U.S. government and agency securities:

          

U.S. Treasury securities

   $ 25,532      $ —        $ —        $ —        $ 25,532   

U.S. agency securities

     1,593        25,009        —          —          26,602   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

     27,125        25,009        —          —          52,134   

Other sovereign government obligations

     31,178        5,990        3        —          37,171   

Corporate and other debt:

          

State and municipal securities

     —          1,952        2        —          1,954   

Residential mortgage-backed securities

     —          1,446        20        —          1,466   

Commercial mortgage-backed securities

     —          1,602        126        —          1,728   

Asset-backed securities

     —          1,130        10        —          1,140   

Corporate bonds

     —          16,569        757        —          17,326   

Collateralized debt obligations

     —          566        2,031        —          2,597   

Loans and lending commitments

     —          11,605        7,825        —          19,430   

Other debt

     —          9,787        11        —          9,798   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

     —          44,657        10,782        —          55,439   

Corporate equities(1)

     53,263        1,941        371        —          55,575   

Derivative and other contracts:

          

Interest rate contracts

     1,590        874,089        4,164        —          879,843   

Credit contracts

     —          73,612        6,621        —          80,233   

Foreign exchange contracts

     6        47,326        126        —          47,458   

Equity contracts

     1,493        43,321        747        —          45,561   

Commodity contracts

     4,408        21,757        2,248        —          28,413   

Other

     —          146        —          —          146   

Netting(2)

     (6,694     (959,322     (8,620     (72,450     (1,047,086
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

     803        100,929        5,286        (72,450     34,568   

Investments:

          

Private equity funds

     —          5        2,246        —          2,251   

Real estate funds

     —          6        1,354        —          1,360   

Hedge funds

     —          375        564        —          939   

Principal investments

     155        2        3,026        —          3,183   

Other

     160        132        476        —          768   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

     315        520        7,666        —          8,501   

Physical commodities

     —          7,920        —          —          7,920   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial instruments owned

     112,684        186,966        24,108        (72,450     251,308   

Securities available for sale

     17,756        22,742        —          —          40,498   

Securities received as collateral

     12,766        41        4        —          12,811   

Federal funds sold and securities purchased under agreements to resell

     —          625        —          —          625   

Intangible assets(3)

     —          —          6        —          6   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets measured at fair value

   $ 143,206      $ 210,374      $ 24,118      $ (72,450   $ 305,248   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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     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,
2012
 
     (dollars in millions)  

Liabilities at Fair Value

          

Deposits

   $ —        $ 1,942      $ —        $ —        $ 1,942   

Commercial paper and other short-term borrowings

     —          683        14        —          697   

Financial instruments sold, not yet purchased:

          

U.S. government and agency securities:

          

U.S. Treasury securities

     25,194        —          —          —          25,194   

U.S. agency securities

     1,318        139        —          —          1,457   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

     26,512        139        —          —          26,651   

Other sovereign government obligations

     25,548        1,980        —          —          27,528   

Corporate and other debt:

          

State and municipal securities

     —          100        —          —          100   

Residential mortgage-backed securities

     —          —          4        —          4   

Corporate bonds

     —          6,222        91        —          6,313   

Collateralized debt obligations

     —          347        1        —          348   

Unfunded lending commitments

     —          552        62        —          614   

Other debt

     —          215        55        —          270   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

     —          7,436        213        —          7,649   

Corporate equities(1)

     27,049        965        12        —          28,026   

Derivative and other contracts:

          

Interest rate contracts

     1,842        844,049        4,263        —          850,154   

Credit contracts

     —          71,299        3,998        —          75,297   

Foreign exchange contracts

     10        52,619        537        —          53,166   

Equity contracts

     1,529        47,179        2,082        —          50,790   

Commodity contracts

     5,129        23,590        1,480        —          30,199   

Other

     —          58        3        —          61   

Netting(2)

     (6,694     (959,322     (8,620     (49,998     (1,024,634
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

     1,816        79,472        3,743        (49,998     35,033   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial instruments sold, not yet purchased

     80,925        89,992        3,968        (49,998     124,887   

Obligation to return securities received as collateral

     16,378        43        20        —          16,441   

Securities sold under agreements to repurchase

     —          89        198        —          287   

Other secured financings

     —          9,258        416        —          9,674   

Long-term borrowings

     —          43,302        2,454        —          45,756   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities measured at fair value

   $ 97,303      $ 145,309      $ 7,070      $ (49,998   $ 199,684   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(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 11.
(3) Amount represents mortgage servicing rights (“MSR”) accounted for at fair value. See Note 7 for further information on MSRs.

Transfers Between Level 1 and Level 2 During the Quarter Ended September 30, 2012.

For assets and liabilities that were transferred between Level 1 and Level 2 during the period, fair values are ascribed as if the assets or liabilities had been transferred as of the beginning of the period.

Financial instruments owned—Derivative and other contracts and Financial instruments sold, not yet purchased—Derivative and other contracts.    During the quarter ended September 30, 2012, the Company reclassified approximately $1.2 billion of derivative assets and approximately $1.5 billion of derivative liabilities from Level 2 to Level 1 as these listed derivatives became actively traded and were valued based on quoted

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

prices from the exchange. Also during the quarter ended September 30, 2012, the Company reclassified approximately $0.5 billion of derivative assets and approximately $0.5 billion of derivative liabilities from Level 1 to Level 2 as transactions in these contracts 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, 2012.

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, 2012, the Company reclassified approximately $2.7 billion of derivative assets and approximately $2.6 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. Also during the nine months ended September 30, 2012, the Company reclassified approximately $0.3 billion of derivative assets and approximately $0.3 billion of derivative liabilities from Level 1 to Level 2 as transactions in these contracts did not occur with sufficient frequency and volume to constitute an active market.

 

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Table of Contents

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 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
December 31,
2011
 
     (dollars in millions)  

Assets at Fair Value

          

Financial instruments owned:

          

U.S. government and agency securities:

          

U.S. Treasury securities

   $ 38,769      $ 1      $ —        $ —        $ 38,770   

U.S. agency securities

     4,332        20,339        8        —          24,679   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

     43,101        20,340        8        —          63,449   

Other sovereign government obligations

     22,650        6,290        119        —          29,059   

Corporate and other debt:

          

State and municipal securities

     —          2,261        —          —          2,261   

Residential mortgage-backed securities

     —          1,304        494        —          1,798   

Commercial mortgage-backed securities

     —          1,686        134        —          1,820   

Asset-backed securities

     —          937        31        —          968   

Corporate bonds

     —          25,873        675        —          26,548   

Collateralized debt obligations

     —          1,711        980        —          2,691   

Loans and lending commitments

     —          14,854        9,590        —          24,444   

Other debt

     —          8,265        128        —          8,393   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

     —          56,891        12,032        —          68,923   

Corporate equities(1)

     45,173        2,376        417        —          47,966   

Derivative and other contracts:

          

Interest rate contracts

     1,493        906,082        5,301        —          912,876   

Credit contracts

     —          123,689        15,102        —          138,791   

Foreign exchange contracts

     —          61,770        573        —          62,343   

Equity contracts

     929        44,558        800        —          46,287   

Commodity contracts

     6,356        31,246        2,176        —          39,778   

Other

     —          292        306        —          598   

Netting(2)

     (7,596     (1,045,912     (11,837     (87,264     (1,152,609
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

     1,182        121,725        12,421        (87,264     48,064   

Investments:

          

Private equity funds

     —          7        1,936        —          1,943   

Real estate funds

     —          5        1,213        —          1,218   

Hedge funds

     —          473        696        —          1,169   

Principal investments

     161        104        2,937        —          3,202   

Other

     141        21        501        —          663   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

     302        610        7,283        —          8,195   

Physical commodities

     —          9,651        46        —          9,697   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial instruments owned

     112,408        217,883        32,326        (87,264     275,353   

Securities available for sale

     13,437        17,058        —          —          30,495   

Securities received as collateral

     11,530        121        —          —          11,651   

Federal funds sold and securities purchased under agreements to resell

     —          112        —          —          112   

Intangible assets(3)

     —          —          133        —          133   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets measured at fair value

   $ 137,375      $ 235,174      $ 32,459      $ (87,264   $ 317,744   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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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,
2011
 
     (dollars in millions)  

Liabilities at Fair Value

          

Deposits

   $ —        $ 2,101      $ —        $ —        $ 2,101   

Commercial paper and other short-term borrowings

     —          1,337        2        —          1,339   

Financial instruments sold, not yet purchased:

          

U.S. government and agency securities:

          

U.S. Treasury securities

     17,776        —          —          —          17,776   

U.S. agency securities

     1,748        106        —          —          1,854   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

     19,524        106        —          —          19,630   

Other sovereign government obligations

     14,981        2,152        8        —          17,141   

Corporate and other debt:

          

State and municipal securities

     —          3        —          —          3   

Residential mortgage-backed securities

     —          —          355        —          355   

Commercial mortgage-backed securities

     —          14        —          —          14   

Corporate bonds

     —          6,217        219        —          6,436   

Collateralized debt obligations

     —          3        —          —          3   

Unfunded lending commitments

     —          1,284        85        —          1,369   

Other debt

     —          157        73        —          230   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

     —          7,678        732        —          8,410   

Corporate equities(1)

     24,347        149        1        —          24,497   

Derivative and other contracts:

          

Interest rate contracts

     1,680        873,466        4,881        —          880,027   

Credit contracts

     —          121,438        9,288        —          130,726   

Foreign exchange contracts

     —          64,218        530        —          64,748   

Equity contracts

     877        45,375        2,034        —          48,286   

Commodity contracts

     7,144        31,248        1,606        —          39,998   

Other

     —          879        1,396        —          2,275   

Netting(2)

     (7,596     (1,045,912     (11,837     (54,262     (1,119,607
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

     2,105        90,712        7,898        (54,262     46,453   

Physical commodities

     —          16        —          —          16   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial instruments sold, not yet purchased

     60,957        100,813        8,639        (54,262     116,147   

Obligation to return securities received as collateral

     15,267        127        —          —          15,394   

Securities sold under agreements to repurchase

     —          8        340        —          348   

Other secured financings

     —          14,024        570        —          14,594   

Long-term borrowings

     10        38,050        1,603        —          39,663   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities measured at fair value

   $ 76,234      $ 156,460      $ 11,154      $ (54,262   $ 189,586   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(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 11.
(3) Amount represents MSRs accounted for at fair value. See Note 7 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.

 

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Table of Contents

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 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.

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, 2012 and 2011, respectively. Level 3 instruments may be hedged with instruments classified in Level 1 and Level 2. As a result, the realized and unrealized gains (losses) for assets and liabilities within the Level 3 category presented in the tables below do not reflect the related realized and unrealized gains (losses) on hedging instruments that have been classified by the Company within the Level 1 and/or Level 2 categories.

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

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

 

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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 Quarter Ended September 30, 2012.

 

    Beginning
Balance at
June 30,
2012
    Total
Realized and
Unrealized
Gains
(Losses)(1)
    Purchases     Sales     Issuances     Settlements     Net
Transfers
    Ending
Balance at
September 30,
2012
    Unrealized
Gains

(Losses) for
Level 3

Assets/
Liabilities
Outstanding at
September 30,
2012(2)
 
    (dollars in millions)  

Assets at Fair Value

                 

Financial instruments owned:

                 

Other sovereign government obligations

  $ 1      $ —        $ 1        —        $ —        $ —        $ 1      $ 3      $ —     

Corporate and other debt:

                 

State and municipal securities

    3        1        —          (2     —          —          —          2        —     

Residential mortgage-backed securities

    24        1        1        (4     —          —          (2     20        (1

Commercial mortgage-backed securities

    256        13        7        (54     —          (99     3        126        8   

Asset-backed securities

    9        1        —          —          —          —          —          10        1   

Corporate bonds

    745        50        86        (157     —          —          33        757        51   

Collateralized debt obligations

    1,457        92        569        (200     —          —          113        2,031        127   

Loans and lending commitments

    7,794        183        1,098        (366     —          (674     (210     7,825        148   

Other debt

    13        —          12        (2     —          —          (12     11        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    10,301        341        1,773        (785     —          (773     (75     10,782        334   

Corporate equities

    482        9        48        (95     —          —          (73     371        9   

Net derivative and other contracts(3):

                 

Interest rate contracts

    (172     (282     5        —          (10     187        173        (99     (76

Credit contracts

    3,842        (791     22        —          (17     (266     (167     2,623        (870

Foreign exchange contracts

    (224     (101     —          —          —          (12     (74     (411     (102

Equity contracts

    (1,173     (2     126        (12     (57     32        (249     (1,335     (8

Commodity contracts

    937        (84     11        —          (3     (5     (88     768        (28

Other

    (27     —          —          —          —          6        18        (3     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net derivative and other contracts

    3,183        (1,260     164        (12     (87     (58     (387     1,543        (1,084

Investments:

                 

Private equity funds

    2,005        162        127        (48     —          —          —          2,246        153   

Real estate funds

    1,326        44        20        (36     —          —          —          1,354        30   

Hedge funds

    533        19        42        (46     —          —          16        564        14   

Principal investments

    3,047        1        33        (50     —          —          (5     3,026        3   

Other

    543        4        11        (9     —          —          (73     476        5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

    7,454        230        233        (189     —          —          (62     7,666        205   

Securities received as collateral

    —          —          —          —          —          —          4        4        —     

Intangible assets

    8        —          —          —          —          (2     —          6        —     

Liabilities at Fair Value

                 

Commercial paper and other short-term borrowings

  $ 2      $ —        $ —        $ —        $ —        $ —        $ 12      $ 14      $ —     

Financial instruments sold, not yet purchased:

                 

Corporate and other debt:

                 

Residential mortgage-backed securities

    4        —          —          —          —          —          —          4        —     

Corporate bonds

    127        (26     (116     56        —          —          (2     91        (45

Collateralized debt obligations

    1        —          —          1        —          —          (1     1        —     

Unfunded lending commitments

    51        (11     —          —          —          —          —          62        (11

Other debt

    63        2        (6     —          —          —          —          55        2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    246        (35     (122     57        —          —          (3     213        (54

Corporate equities

    47        26        (21     —          —          —          12        12        (3

Obligation to return securities received as collateral

    —          —          —          —          —          —          20        20        —     

Securities sold under agreements to repurchase

    185        (13     —          —          —          —          —          198        (13

Other secured financings

    470        (22     —          —          —          (76     —          416        (22

Long-term borrowings

    2,210        (215     —          —          259        (223     (7     2,454        (231

 

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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 $230 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, 2012 related to assets and liabilities still outstanding at September 30, 2012.
(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 11.

Financial instruments owned—Net derivative and other contracts.    The net loss in Net derivative and other contracts was primarily driven by tightening of credit spreads on underlying reference entities of basket credit default swaps.

 

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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, 2012.

 

    Beginning
Balance at
December 31,
2011
    Total
Realized
and
Unrealized
Gains
(Losses)(1)
    Purchases     Sales     Issuances     Settlements     Net
Transfers
    Ending
Balance at
September 30,
2012
    Unrealized
Gains (Losses)
for Level 3
Assets/
Liabilities
Outstanding at
September 30,
2012(2)
 
    (dollars in millions)  

Assets at Fair Value

                 

Financial instruments owned:

                 

U.S. agency securities

  $ 8      $ —        $ —        $ (7   $ —        $ —        $ (1   $ —        $ —     

Other sovereign government obligations

    119        —          2        (118     —          —          —          3        —     

Corporate and other debt:

                 

State and municipal securities

    —          2        —          (3     —          —          3        2        —     

Residential mortgage-backed securities

    494        (24     4        (267     —          —          (187     20        (36

Commercial mortgage-backed securities

    134        36        123        (65     —          (100     (2     126        28   

Asset-backed securities

    31        1        9        (31     —          —          —          10        —     

Corporate bonds

    675        8        367        (314     —          —          21        757        (1

Collateralized debt obligations

    980        193        1,215        (321     —          —          (36     2,031        147   

Loans and lending commitments

    9,590        54        2,592        (2,205     —          (2,019     (187     7,825        (144

Other debt

    128        15        8        (140     —          —          —          11        9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    12,032        285        4,318        (3,346     —          (2,119     (388     10,782        3   

Corporate equities

    417        (2     153        (184     —          —          (13     371        3   

Net derivative and other contracts(3):

                 

Interest rate contracts

    420        (338     98        —          (15     7        (271     (99     (85

Credit contracts

    5,814        (1,733     46        —          (421     (533     (550     2,623        (2,048

Foreign exchange contracts

    43        (163     —          —          —          (142     (149     (411     (221

Equity contracts

    (1,234     156        272        (5     (122     (205     (197     (1,335     143   

Commodity contracts

    570        152        17        —          (8     29        8        768        145   

Other

    (1,090     59        —          —          —          238        790        (3     56