10-Q 1 d521750d10q.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 March 31, 2013

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 April 30, 2013, there were 1,960,115,045 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 March 31, 2013

 

Table of Contents    Page  

Part I—Financial Information

  

Item 1.

  Financial Statements (unaudited)   
 

Condensed Consolidated Statements of Financial Condition—March 31, 2013 and December 31, 2012

     1   
 

Condensed Consolidated Statements of Income—Three Months Ended March 31, 2013 and 2012

     2   
 

Condensed Consolidated Statements of Comprehensive Income—Three Months Ended March 31, 2013 and 2012

     3   
 

Condensed Consolidated Statements of Cash Flows—Three Months Ended March 31, 2013 and 2012

     4   
 

Condensed Consolidated Statements of Changes in Total Equity—Three Months Ended March 31, 2013 and 2012

     5   
 

Notes to Condensed Consolidated Financial Statements (unaudited)

     7   
 

Report of Independent Registered Public Accounting Firm

     89   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      90   
 

Introduction

     90   
 

Executive Summary

     91   
 

Business Segments

     100   
 

Accounting Developments

     114   
 

Other Matters

     115   
 

Critical Accounting Policies

     117   
 

Liquidity and Capital Resources

     121   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      136   

Item 4.

  Controls and Procedures      151   

Financial Data Supplement (unaudited)

     152   

Part II—Other Information

  

Item 1.

  Legal Proceedings      155   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      158   

Item 6.

  Exhibits      158   

 

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Table of Contents

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)

 

    March 31,
2013
    December 31,
2012
 

Assets

   

Cash and due from banks ($584 and $526 at March 31, 2013 and December 31, 2012, respectively, related to consolidated variable interest entities generally not available to the Company)

  $ 17,773     $ 20,878   

Interest bearing deposits with banks

    25,129       26,026   

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

    31,313       30,970   

Trading assets, at fair value (approximately $138,143 and $147,348 were pledged to various parties at March 31, 2013 and December 31, 2012, respectively; $3,343 and $3,490 related to consolidated variable interest entities, generally not available to the Company at March 31, 2013 and December 31, 2012, respectively)

    267,236       267,603   

Securities available for sale, at fair value

    41,454       39,869   

Securities received as collateral, at fair value

    17,971       14,278   

Federal funds sold and securities purchased under agreements to resell (includes $873 and $621 at fair value at March 31, 2013 and December 31, 2012, respectively)

    140,415       134,412   

Securities borrowed

    135,727       121,701   

Customer and other receivables

    62,271       64,288   

Loans (net of allowances of $129 and $106 at March 31, 2013 and December 31, 2012, respectively)

    30,615       29,046   

Other investments

    4,940       4,999   

Premises, equipment and software costs (net of accumulated depreciation of $5,750 and $5,525 at March 31, 2013 and December 31, 2012, respectively) ($222 and $224 at March 31, 2013 and December 31, 2012, respectively, related to consolidated variable interest entities, generally not available to the Company)

    5,928       5,946   

Goodwill

    6,633       6,650   

Intangible assets (net of accumulated amortization of $1,336 and $1,250 at March 31,2013 and December 31, 2012, respectively) (includes $8 and $7 at fair value at March 31, 2013 and December 31, 2012, respectively)

    3,694       3,783   

Other assets ($577 and $593 at March 31, 2013 and December 31, 2012, respectively, related to consolidated variable interest entities, generally not available to the Company)

    10,284       10,511   
 

 

 

   

 

 

 

Total assets

  $ 801,383     $ 780,960   
 

 

 

   

 

 

 

Liabilities

   

Deposits (includes $1,442 and $1,485 at fair value at March 31, 2013 and December 31, 2012, respectively)

  $ 80,623      $ 83,266  

Commercial paper and other short-term borrowings (includes $1,262 and $725 at fair value at March 31, 2013 and December 31, 2012, respectively)

    2,475        2,138  

Trading liabilities, at fair value

    132,472        120,122  

Obligation to return securities received as collateral, at fair value

    23,510        18,226  

Securities sold under agreements to repurchase (includes $565 and $363 at fair value at March 31, 2013 and December 31, 2012, respectively)

    119,270        122,674  

Securities loaned

    40,351        36,849  

Other secured financings (includes $9,624 and $9,466 at fair value at March 31, 2013 and December 31, 2012, respectively) ($739 and $976 at March 31, 2013 and December 31, 2012, respectively, related to consolidated variable entities and are non-recourse to the Company)

    16,294        15,727  

Customer and other payables

    137,127        127,722  

Other liabilities and accrued expenses ($116 and $117 at March 31, 2013 and December 31, 2012, respectively related to consolidated variable interest entities and are non-recourse to the Company)

    13,622        14,928  

Long-term borrowings (includes $42,510 and $44,044 at fair value at March 31, 2013 and December 31, 2012, respectively)

    165,142        169,571  
 

 

 

   

 

 

 
    730,886        711,223  
 

 

 

   

 

 

 

Commitments and contingent liabilities (see Note 12)

   

Redeemable noncontrolling interests (see Notes 3 and 14)

    4,425        4,309  

Equity

   

Morgan Stanley shareholders’ equity:

   

Preferred stock

    1,508        1,508  

Common stock, $0.01 par value:

   

Shares authorized: 3,500,000,000 at March 31, 2013 and December 31, 2012;

   

Shares issued: 2,038,893,979 at December 31, 2012 and March 31,2013;

   

Shares outstanding: 1,960,582,868 at March 31, 2013 and 1,974,042,123 at December 31, 2012

    20        20  

Additional Paid-in capital

    23,661        23,426  

Retained earnings

    40,750        39,912  

Employee stock trust

    1,872        2,932  

Accumulated other comprehensive loss

    (694     (516

Common stock held in treasury, at cost, $0.01 par value; 78,311,111 shares at March 31, 2013 and 64,851,856 shares at December 31, 2012

    (2,541     (2,241

Common stock issued to employee trust

    (1,872     (2,932
 

 

 

   

 

 

 

Total Morgan Stanley shareholders’ equity

    62,704        62,109  

Nonredeemable noncontrolling interests

    3,368        3,319  
 

 

 

   

 

 

 

Total equity

    66,072        65,428  
 

 

 

   

 

 

 

Total liabilities, redeemable noncontrolling interests and equity

  $ 801,383      $ 780,960  
 

 

 

   

 

 

 

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
March 31,
 
     2013     2012  

Revenues:

    

Investment banking

   $ 1,224     $ 1,063  

Trading

     2,694       2,402  

Investments

     338       85  

Commissions and fees

     1,168       1,177  

Asset management, distribution and administration fees

     2,346       2,152  

Other

     203       104  
  

 

 

   

 

 

 

Total non-interest revenues

     7,973       6,983  
  

 

 

   

 

 

 

Interest income

     1,398       1,542  

Interest expense

     1,213       1,601  
  

 

 

   

 

 

 

Net interest

     185       (59
  

 

 

   

 

 

 

Net revenues

     8,158       6,924  
  

 

 

   

 

 

 

Non-interest expenses:

    

Compensation and benefits

     4,216       4,430  

Occupancy and equipment

     379       388  

Brokerage, clearing and exchange fees

     428       403  

Information processing and communications

     448       459  

Marketing and business development

     134       146  

Professional services

     440       412  

Other

     531       484  
  

 

 

   

 

 

 

Total non-interest expenses

     6,576       6,722  
  

 

 

   

 

 

 

Income from continuing operations before income taxes

     1,582       202  

Provision for income taxes

     332       54  
  

 

 

   

 

 

 

Income from continuing operations

     1,250       148  
  

 

 

   

 

 

 

Discontinued operations:

    

Gain (loss) from discontinued operations

     (30     28  

Provision for (benefit from) income taxes

     (11     42  
  

 

 

   

 

 

 

Net gain (loss) from discontinued operations

     (19     (14
  

 

 

   

 

 

 

Net income

   $ 1,231     $ 134  

Net income applicable to redeemable noncontrolling interests

     122       —    

Net income applicable to nonredeemable noncontrolling interests

     147       228  
  

 

 

   

 

 

 

Net income (loss) applicable to Morgan Stanley

   $ 962     $ (94
  

 

 

   

 

 

 

Earnings (loss) applicable to Morgan Stanley common shareholders

   $ 936     $ (119
  

 

 

   

 

 

 

Amounts applicable to Morgan Stanley:

    

Income (loss) from continuing operations

   $ 981     $ (79

Net gain (loss) from discontinued operations

     (19     (15
  

 

 

   

 

 

 

Net income (loss) applicable to Morgan Stanley

   $ 962     $ (94
  

 

 

   

 

 

 

Earnings (loss) per basic common share:

    

Income (loss) from continuing operations

   $ 0.50     $ (0.05

Net gain (loss) from discontinued operations

     (0.01     (0.01
  

 

 

   

 

 

 

Earnings (loss) per basic common share

   $ 0.49     $ (0.06
  

 

 

   

 

 

 

Earnings (loss) per diluted common share:

    

Income (loss) from continuing operations

   $ 0.49     $ (0.05

Net gain (loss) from discontinued operations

     (0.01     (0.01
  

 

 

   

 

 

 

Earnings (loss) per diluted common share

   $ 0.48     $ (0.06
  

 

 

   

 

 

 

Dividends declared per common share

   $ 0.05     $ 0.05  

Average common shares outstanding:

    

Basic

     1,901,204,729       1,876,961,836  
  

 

 

   

 

 

 

Diluted

     1,940,264,085       1,876,961,836  
  

 

 

   

 

 

 

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
March 31,
 
         2013             2012      

Net income

   $ 1,231     $ 134  

Other comprehensive income (loss), net of tax:

    

Foreign currency translation adjustments(1)

   $ (245   $ 20  

Amortization of cash flow hedges(2)

     1       2  

Change in net unrealized losses on securities available for sale(3)

     (27     (19

Pension, postretirement and other related adjustments(4)

     1       2  
  

 

 

   

 

 

 

Total other comprehensive income (loss)

   $ (270   $ 5  
  

 

 

   

 

 

 

Comprehensive income

   $ 961     $ 139  

Net income applicable to redeemable noncontrolling interests

     122       —    

Net income applicable to nonredeemable noncontrolling interests

     147       228  

Other comprehensive income applicable to redeemable noncontrolling interests

     —         —    

Other comprehensive income (loss) applicable to nonredeemable noncontrolling interests

     (92     (92
  

 

 

   

 

 

 

Comprehensive income applicable to Morgan Stanley

   $ 784     $ 3  
  

 

 

   

 

 

 

  

 

(1) Amounts are net of provision for income taxes of $165 million and $4 million for the quarters ended March 31, 2013 and 2012, respectively.
(2) Amounts are net of provision for income taxes of $1 million and $1 million for the quarters ended March 31, 2013 and 2012, respectively.
(3) Amounts are net of provision for (benefit from) income taxes of $(19) million and $(13) million for the quarters ended March 31, 2013 and 2012, respectively.
(4) Amounts are net of provision for income taxes of $5 million and $2 million for the quarters ended March 31, 2013 and 2012, respectively.

 

See Notes to Condensed Consolidated Financial Statements.

 

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MORGAN STANLEY

Condensed Consolidated Statements of Cash Flows

(dollars in millions)

(unaudited)

 

     Three Months Ended
March 31,
 
         2013             2012      

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income

   $ 1,231     $ 134  

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

    

(Income) loss on equity method investees

     (64     32  

Compensation payable in common stock and options

     265       372  

Depreciation and amortization

     360       375  

Loss on business dispositions

     5       —     

Gain on sale of securities available for sale

     (3     (1

(Gain) loss on retirement of long-term debt

     —          (14

Impairment charges and other-than-temporary impairment charges

     29       12  

Provision for credit losses on lending activities

     (39     (2

Changes in assets and liabilities:

    

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

     (343     (698

Trading assets, net of Trading liabilities

     13,284       13,690  

Securities borrowed

     (14,026     (14,536

Securities loaned

     3,502       3,969  

Customer and other receivables and other assets

     2,830       (5,179

Customer and other payables and other liabilities

     6,976       10,567  

Federal funds sold and securities purchased under agreements to resell

     (6,003     (6,296

Securities sold under agreements to repurchase

     (3,404     5,575  
  

 

 

   

 

 

 

Net cash provided by operating activities

     4,600       8,000  
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Proceeds from (payments for):

    

Premises, equipment and software costs, net

     (263     (212

Business dispositions, net of cash disposed

     481       —     

Loans, net

     (2,168     (569

Purchases of securities available for sale

     (4,674     (3,487

Sales, maturities and redemptions of securities available for sale

     3,380       1,003  
  

 

 

   

 

 

 

Net cash used for investing activities

     (3,244     (3,265
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Net proceeds from (payments for):

    

Commercial paper and other short-term borrowings

     337       (826

Distributions related to noncontrolling interests

     (8     (7

Derivatives financing activities

     36       (169

Other secured financings

     501       (1,674

Deposits

     (2,643     779  

Net proceeds from:

    

Excess tax benefits associated with stock-based awards

     12       34  

Issuance of long-term borrowings

     10,046       5,320  

Payments for:

    

Long-term borrowings

     (12,018     (16,043

Repurchases of common stock for employee tax withholding

     (306     (183

Cash dividends

     (119     (112
  

 

 

   

 

 

 

Net cash used for financing activities

     (4,162     (12,881
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     (612     93  
  

 

 

   

 

 

 

Effect of cash and cash equivalents related to variable interest entities

     (584     (534
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (4,002     (8,587

Cash and cash equivalents, at beginning of period

     46,904       47,312  
  

 

 

   

 

 

 

Cash and cash equivalents, at end of period

   $ 42,902     $ 38,725  
  

 

 

   

 

 

 

Cash and cash equivalents include:

    

Cash and due from banks

   $ 17,773     $ 10,133  

Interest bearing deposits with banks

     25,129       28,592  
  

 

 

   

 

 

 

Cash and cash equivalents, at end of period

   $ 42,902     $ 38,725  
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash payments for interest were $728 million and $1,169 million for the quarters ended March 31, 2013 and 2012, respectively.

Cash payments for income taxes were $139 million and $145 million for the quarters ended March 31, 2013 and 2012, respectively.

See Notes to Condensed Consolidated Financial Statements.

 

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MORGAN STANLEY

Condensed Consolidated Statements of Changes in Total Equity

Three Months Ended March 31, 2013

(dollars in millions)

(unaudited)

 

    Preferred
Stock
    Common
Stock
    Additional
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, 2012

  $ 1,508     $ 20     $ 23,426     $ 39,912     $ 2,932     $ (516   $ (2,241   $ (2,932   $ 3,319     $ 65,428  

Net income applicable to Morgan Stanley

    —          —          —          962       —          —          —          —          —          962  

Net income applicable to nonredeemable noncontrolling interests

    —          —          —          —          —          —          —          —          147       147  

Dividends

    —          —          —          (124     —          —          —          —          —          (124

Shares issued under employee plans and related tax effects

    —          —          235       —          (1,060     —          6       1,060       —          241  

Repurchases of common stock

    —          —          —          —          —          —          (306     —          —          (306

Foreign currency translation adjustments

    —          —          —          —          —          (153     —          —          (92     (245

Net change in cash flow hedges

    —          —          —          —          —          1       —          —          —          1  

Change in net unrealized losses on securities available for sale

    —          —          —          —          —          (27     —          —          —          (27

Pension, postretirement and other related adjustments

    —          —          —          —          —          1       —          —          —          1  

Other net decreases

    —          —          —          —          —          —          —          —          (6     (6
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT MARCH 31, 2013

  $ 1,508     $ 20     $ 23,661     $ 40,750     $ 1,872     $ (694   $ (2,541   $ (1,872   $ 3,368     $ 66,072  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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MORGAN STANLEY

Condensed Consolidated Statements of Changes in Total Equity—(Continued)

Three Months Ended March 31, 2012

(dollars in millions)

(unaudited)

 

 

    Preferred
Stock
    Common
Stock
    Additional
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

    —          —          —          (94     —          —          —          —          —          (94

Net income applicable to nonredeemable noncontrolling interests

    —          —          —          —          —          —          —          —          228       228  

Dividends

    —          —          —          (129     —          —          —          —          —          (129

Shares issued under employee plans and related tax effects

    —          —          94       —          86       —          490       (86     —          584  

Repurchases of common stock

    —          —          —          —          —          —          (183     —          —          (183

Foreign currency translation adjustments

    —          —          —          —          —          112       —          —          (92     20  

Net change in cash flow hedges

    —          —          —          —          —          2       —          —          —          2  

Change in net unrealized losses on securities available for sale

    —          —          —          —          —          (19     —          —          —          (19

Pension, postretirement and other related adjustments

    —          —          —          —          —          2       —          —          —          2  

Other net increases

    —          —          —          —          —          —          —          —          103       103  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT MARCH 31, 2012

  $ 1,508     $ 20     $ 22,930     $ 40,118     $ 3,252     $ (60   $ (2,192   $ (3,252   $ 8,268     $ 70,592  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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. 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. Unless the context otherwise requires, the terms “Morgan Stanley” or the “Company” mean Morgan Stanley (the “Parent”) together with its consolidated subsidiaries.

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

Institutional Securities provides financial advisory and capital raising 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”) (see Note 3), 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 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.

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.

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 results of Saxon are reported as discontinued operations within the Institutional Securities 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.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Intercompany balances and transactions have been eliminated.

In the quarter ended March 31, 2013, the Company renamed “Principal transactions—Trading” revenues as “Trading” revenues and “Principal transactions—Investments” revenues as “Investments” revenues in the condensed consolidated statements of income, and “Financial instruments owned” as “Trading assets,” “Financial instruments sold, not yet purchased” as “Trading liabilities,” “Receivables” as “Customer and other receivables” and “Payables” as “Customer and other payables” in the condensed consolidated statements of financial condition.

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, 2012 (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 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 consolidated statements of financial condition. The portion of the shareholders’ equity of such subsidiaries that is nonredeemable is presented as Nonredeemable noncontrolling interests, a component of total equity, 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 Investments revenues (see Note 4).

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

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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

Income Statement Presentation.    The Company, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. In connection with the delivery of the various products and services to clients, the Company manages its revenues and related expenses in the aggregate. As such, when assessing the performance of its businesses, primarily in its Institutional Securities business segment, the Company considers its 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, 2012 included in the Form 10-K.

During the quarter ended March 31, 2013, other than the following, no updates were made to the Company’s significant accounting policies.

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, held for investment purposes, and readily convertible to known amounts of cash.

In the quarter ended March 31, 2012, the Company’s significant non-cash activities included approximately $0.1 billion of net assets received from Citigroup, Inc. (“Citi”) related to Citi’s required equity contribution in connection with the Morgan Stanley Wealth Management platform integration (see Notes 3 and 14).

During the third quarter of 2012, the Company identified that activities related to certain loans had been reported as cash flows from operating activities that should have been presented as investing activities. The Company corrected the previously presented cash flows for these loans and in doing so, the condensed consolidated statements of cash flows for the quarter ended March 31, 2012 has been adjusted to increase net cash flows from operating activities by $0.6 billion, with the corresponding decreases 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.

Disclosures about Offsetting Assets and Liabilities. In January 2013, the Financial Accounting Standards Board (the “FASB”) issued an accounting update that clarified the intended scope of the new balance sheet offsetting disclosures to derivatives, repurchase agreements, and securities lending transactions to the extent that they are either offset in the financial statements or subject to an enforceable master netting arrangement or similar agreement. These disclosure requirements became effective for the Company beginning on January 1, 2013. Since these amended principles require only additional disclosures concerning offsetting and related arrangements, adoption has not affected the Company’s condensed consolidated statements of income or financial condition (see Notes 6 and 11).

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. In February 2013, the FASB issued an accounting update that created new disclosure requirements requiring entities to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (“GAAP”) to be reclassified in its entirety to net income. The disclosure requirements became effective for the Company beginning on January 1, 2013. Since these amended principles require only additional disclosures concerning amounts reclassified out of accumulated other comprehensive income, adoption has not affected the Company’s condensed consolidated statements of comprehensive income or notes to the condensed consolidated financial statements (see Note 14).

 

3. Wealth Management Joint Venture.

On May 31, 2009, the Company and Citi consummated the combination of the Company’s Global Wealth Management Group business segment and the businesses of Citi’s Smith Barney in the U.S., Quilter Holdings Ltd. (see Note 21) 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 to purchase an additional 14% stake in the Wealth Management JV, and a transfer of approximately $5.4 billion of deposits at no premium from Citi. In addition, the agreement specifies that the Company must use reasonable best efforts to obtain the 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 is being purchased) and receive a transfer of deposits currently estimated to be $57 billion at no premium from Citi, no later than June 1, 2015.

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 March 31, 2013, the Company held a 65% stake in the Wealth Management JV.

The change in the terms of the Wealth Management JV’s agreement to acquire the remaining noncontrolling interest resulted in a reclassification of approximately $4.3 billion from nonredeemable noncontrolling interests to redeemable noncontrolling interests. At December 31, 2012 and March 31, 2013, 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 required regulatory approvals.

 

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.

Trading Assets and Trading Liabilities.

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.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

   

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 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

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

 

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 Obligation (“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, and 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.

 

   

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

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

 

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.

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

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 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.

 

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MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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), CMBS, 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, CMBS, 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.

Deposits.

 

   

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

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

 

   

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

 

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Table of Contents

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 March 31, 2013 and December 31, 2012.

 

LOGO   16  


Table of Contents

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis at March 31, 2013.

 

     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
March 31,
2013
 
     (dollars in millions)  

Assets at Fair Value

          

Trading assets:

          

U.S. government and agency securities:

          

U.S. Treasury securities

   $ 24,411     $ —       $ —       $ —       $ 24,411  

U.S. agency securities

     2,040       22,796       —         —         24,836  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

     26,451       22,796       —         —         49,247  

Other sovereign government obligations

     29,893       8,577       3       —         38,473  

Corporate and other debt:

          

State and municipal securities

     —         2,228       —         —         2,228  

Residential mortgage-backed securities

     —         1,684       19       —         1,703  

Commercial mortgage-backed securities

     —         1,122       174       —         1,296  

Asset-backed securities

     —         1,040       11       —         1,051  

Corporate bonds

     —         18,453       888       —         19,341  

Collateralized debt obligations

     —         442       1,666       —         2,108  

Loans and lending commitments

     —         11,175       5,284       —         16,459  

Other debt

     —         9,104       1       —         9,105  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

     —         45,248       8,043       —         53,291  

Corporate equities(1)

     74,280       923       270       —         75,473  

Derivative and other contracts:

          

Interest rate contracts

     711       708,732       3,640       —         713,083  

Credit contracts

     —         58,131       4,134       —         62,265  

Foreign exchange contracts

     24       50,395       5       —         50,424  

Equity contracts

     965       42,508       1,044       —         44,517  

Commodity contracts

     3,674       15,559       2,332       —         21,565  

Other

     —         90       —         —         90  

Netting(2)

     (4,892     (774,480     (6,543     (70,200     (856,115
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

     482       100,935       4,612       (70,200     35,829  

Investments:

          

Private equity funds

     —         —         2,291       —         2,291  

Real estate funds

     —         7       1,370       —         1,377  

Hedge funds

     —         370       545       —         915  

Principal investments

     20       2       2,855       —         2,877  

Other

     190       77       496       —         763  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

     210       456       7,557       —         8,223  

Physical commodities

     —         6,700       —         —         6,700  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total trading assets

     131,316       185,635       20,485       (70,200     267,236  

Securities available for sale

     14,049       27,405       —         —         41,454  

Securities received as collateral

     17,920       51       —         —         17,971  

Federal funds sold and securities purchased under agreements to resell

     —         873       —         —         873  

Intangible assets(3)

     —         —         8       —         8  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets measured at fair value

   $ 163,285     $ 213,964     $ 20,493     $ (70,200   $ 327,542  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities at Fair Value

          

Deposits

   $ —       $ 1,442     $ —       $ —       $ 1,442  

Commercial paper and other short-term borrowings

     —         1,257       5       —         1,262  

Trading liabilities:

          

U.S. government and agency securities:

          

U.S. Treasury securities

     21,303       —         —         —         21,303  

U.S. agency securities

     1,765       96       —         —         1,861  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

     23,068       96       —         —         23,164  

Other sovereign government obligations

     26,928       3,325       —         —         30,253  

 

  17   LOGO


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
March 31,
2013
 
     (dollars in millions)  

Corporate and other debt:

          

State and municipal securities

     —         47       —         —         47  

Residential mortgage-backed securities

     —         —         4       —         4  

Asset-backed securities

     —         1       —         —         1  

Corporate bonds

     —         6,979       424       —         7,403  

Collateralized debt obligations

     —         317       —         —         317  

Unfunded lending commitments

     —         252       25       —         277  

Other debt

     —         87       11       —         98  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

     —         7,683       464       —         8,147  

Corporate equities(1)

     28,705       1,547       4       —         30,256  

Derivative and other contracts:

          

Interest rate contracts

     747       681,975       3,662       —         686,384  

Credit contracts

     —         56,326       2,731       —         59,057  

Foreign exchange contracts

     3       51,466       240       —         51,709  

Equity contracts

     891       47,321       2,384       —         50,596  

Commodity contracts

     4,164       15,027       1,629       —         20,820  

Other

     —         30       3       —         33  

Netting(2)

     (4,892     (774,480     (6,543     (42,032     (827,947
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

     913       77,665       4,106       (42,032     40,652  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total trading liabilities

     79,614       90,316       4,574       (42,032     132,472  

Obligation to return securities received as collateral

     23,452       58       —         —         23,510  

Securities sold under agreements to repurchase

     —         410       155       —         565  

Other secured financings

     —         9,349       275       —         9,624  

Long-term borrowings

     —         39,726       2,784       —         42,510  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities measured at fair value

   $ 103,066     $ 142,558     $ 7,793     $ (42,032   $ 211,385  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(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 March 31, 2013.

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.

In the quarter ended March 31, 2013, there were no material transfers between Level 1 and Level 2.

 

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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, 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
December 31,
2012
 
     (dollars in millions)  

Assets at Fair Value

          

Trading assets:

          

U.S. government and agency securities:

          

U.S. Treasury securities

   $ 24,662     $ 14     $ —       $ —       $ 24,676  

U.S. agency securities

     1,451       27,888       —         —         29,339  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

     26,113       27,902       —         —         54,015  

Other sovereign government obligations

     37,669       5,487       6       —         43,162  

Corporate and other debt:

          

State and municipal securities

     —         1,558       —         —         1,558  

Residential mortgage-backed securities

     —         1,439       45       —         1,484  

Commercial mortgage-backed securities

     —         1,347       232       —         1,579  

Asset-backed securities

     —         915       109       —         1,024  

Corporate bonds

     —         18,403       660       —         19,063  

Collateralized debt obligations

     —         685       1,951       —         2,636  

Loans and lending commitments

     —         12,617       4,694       —         17,311  

Other debt

     —         4,457       45       —         4,502  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

     —         41,421       7,736       —         49,157  

Corporate equities(1)

     68,072       1,067       288       —         69,427  

Derivative and other contracts:

          

Interest rate contracts

     446       819,581       3,774       —         823,801  

Credit contracts

     —         63,234       5,033       —         68,267  

Foreign exchange contracts

     34       52,729       31       —         52,794  

Equity contracts

     760       37,074       766       —         38,600  

Commodity contracts

     4,082       14,256       2,308       —         20,646  

Other

     —         143       —         —         143  

Netting(2)

     (4,740     (883,733     (6,947     (72,634     (968,054
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

     582       103,284       4,965       (72,634     36,197  

Investments:

          

Private equity funds

     —         —         2,179       —         2,179  

Real estate funds

     —         6       1,370       —         1,376  

Hedge funds

     —         382       552       —         934  

Principal investments

     185       83       2,833       —         3,101  

Other

     199       71       486       —         756  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

     384       542       7,420       —         8,346  

Physical commodities

     —         7,299       —         —         7,299  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total trading assets

     132,820       187,002       20,415       (72,634     267,603  

Securities available for sale

     14,466       25,403       —         —         39,869  

Securities received as collateral

     14,232       46       —         —         14,278  

Federal funds sold and securities purchased underagreements to resell

     —         621       —         —         621  

Intangible assets(3)

     —         —         7       —         7  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets measured at fair value

   $ 161,518     $ 213,072     $ 20,422     $ (72,634   $ 322,378  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities at Fair Value

          

Deposits

   $ —       $ 1,485     $ —       $ —       $ 1,485  

Commercial paper and other short-term borrowings

     —         706       19       —         725  

Trading liabilities:

          

U.S. government and agency securities:

          

U.S. Treasury securities

     20,098       21       —         —         20,119  

U.S. agency securities

     1,394       107       —         —         1,501  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. government and agency securities

     21,492       128       —         —         21,620  

Other sovereign government obligations

     27,583       2,031       —         —         29,614  

 

  19   LOGO


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,
2012
 
     (dollars in millions)  

Corporate and other debt:

          

State and municipal securities

     —         47       —         —         47  

Residential mortgage-backed securities

     —         —         4       —         4  

Corporate bonds

     —         3,942       177       —         4,119  

Collateralized debt obligations

     —         328       —         —         328  

Unfunded lending commitments

     —         305       46       —         351  

Other debt

     —         156       49       —         205  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

     —         4,778       276       —         5,054  

Corporate equities(1)

     25,216       1,655       5       —         26,876  

Derivative and other contracts:

          

Interest rate contracts

     533       789,715       3,856       —         794,104  

Credit contracts

     —         61,283       3,211       —         64,494  

Foreign exchange contracts

     2       56,021       390       —         56,413  

Equity contracts

     748       39,212       1,910       —         41,870  

Commodity contracts

     4,530       15,702       1,599       —         21,831  

Other

     —         54       7       —         61  

Netting(2)

     (4,740     (883,733     (6,947     (46,395     (941,815
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative and other contracts

     1,073       78,254       4,026       (46,395     36,958  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total trading liabilities

     75,364       86,846       4,307       (46,395     120,122  

Obligation to return securities received as collateral

     18,179       47       —         —         18,226  

Securities sold under agreements to repurchase

     —         212       151       —         363  

Other secured financings

     —         9,060       406       —         9,466  

Long-term borrowings

     —         41,255       2,789       —         44,044  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities measured at fair value

   $ 93,543     $ 139,611     $ 7,672     $ (46,395   $ 194,431  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(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 March 31, 2012.

Trading assets—Derivative and other contracts and Trading liabilities—Derivative and other contracts.    During the quarter ended March 31, 2012, the Company reclassified approximately $1.1 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. Also during the quarter ended March 31, 2012, the Company reclassified approximately $0.3 billion of derivative assets and approximately $0.4 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.

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 quarters ended March 31, 2013 and 2012, 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

 

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Table of Contents

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 March 31, 2013.

 

    Beginning
Balance at
December 31,
2012
    Total
Realized and
Unrealized
Gains
(Losses) (1)
    Purchases     Sales     Issuances     Settlements     Net
Transfers
    Ending
Balance at
March 31,
2013
    Unrealized
Gains

(Losses) for
Level 3
Assets/
Liabilities
Outstanding

at March 31,
2013(2)
 
    (dollars in millions)  

Assets at Fair Value

                 

Trading assets:

                 

Other sovereign government obligations

  $ 6     $ —       $ 1     $ (3   $ —       $ —       $ (1   $ 3     $ —    

Corporate and other debt:

                 

Residential mortgage-backed securities

    45       26       15       (42     —         —         (25     19       9  

Commercial mortgage-backed securities

    232       15       6       (80     —         —         1       174       7  

Asset-backed securities

    109       —         1       (99     —         —         —         11       —    

Corporate bonds

    660       62       437       (247     —         (12     (12     888       5  

Collateralized debt obligations

    1,951       191       314       (695     —         (95     —         1,666       63  

Loans and lending commitments

    4,694       20       944       (149     —         (738     513       5,284       1  

Other debt

    45       (8     14       (49     —         —         (1     1       (1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    7,736       306       1,731       (1,361     —         (845     476       8,043       84  

Corporate equities

    288       (22     85       (61     —         —         (20     270       5  

Net derivative and other contracts(3):

                 

Interest rate contracts

    (82     (106     1       —         (1     192       (26     (22     18  

Credit contracts

    1,822       (452     42       —         (15     (4     10       1,403       (418

Foreign exchange contracts

    (359     8       —         —         —         109       7       (235     (2

Equity contracts

    (1,144     (140     85       (1     (93     (76     29       (1,340     (125

Commodity contracts

    709       (10     9       —         (4     (8     7       703       (30

Other

    (7     (2     —         —         —         6       —         (3     (2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net derivative and other contracts

    939       (702     137       (1     (113     219       27       506       (559

Investments:

                 

Private equity funds

    2,179       114       70       (72     —         —         —         2,291       104  

Real estate funds

    1,370       80       3       (83     —         —         —         1,370       90  

Hedge funds

    552       2       31       (34     —         —         (6     545       (3

Principal investments

    2,833       63       35       (85     —         —         9       2,855       78  

Other

    486       17       11       (17     —         —         (1     496       16  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

    7,420       276       150       (291     —         —         2       7,557       285  

Intangible assets

    7       4       —         —         —         (3     —         8       2  

Liabilities at Fair Value

                 

Commercial paper and other short-term borrowings

  $ 19     $ —       $ —       $ —       $ 1     $ (1   $ (14   $ 5     $ —    

Trading liabilities:

                 

Corporate and other debt:

                 

Residential mortgage-backed securities

    4       —         —         —         —         —         —         4       —    

Corporate bonds

    177       —         (131     371       —         —         7       424       3  

Unfunded lending commitments

    46       21       —         —         —         —         —         25       20  

Other debt

    49       11       (37     10       —         —         —         11       10  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    276       32       (168     381       —         —         7       464       33  

Corporate equities

    5       —         (3     1       —         —         1       4       1  

Securities sold under agreements to repurchase

    151       (4     —         —         —         —         —         155       (4

Other secured financings

    406       12       —         —         13       (132     —         275       5  

Long-term borrowings

    2,789       (17     —         —         543       (188     (377     2,784       (17

 

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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 Trading in the condensed consolidated statements of income except for $276 million related to Trading assets—Investments, which is included in Investments revenues.
(2) Amounts represent unrealized gains (losses) for the quarter ended March 31, 2013 related to assets and liabilities still outstanding at March 31, 2013.
(3) Net derivative and other contracts represent Trading assets—Derivative and other contracts net of Trading liabilities—Derivative and other contracts. For further information on derivative instruments and hedging activities, see Note 11.

 

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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 Quarter Ended March 31, 2012.

 

    Beginning
Balance at
December 31,
2011
    Total
Realized
and
Unrealized
Gains
(Losses)(1)
    Purchases     Sales     Issuances     Settlements     Net
Transfers
    Ending
Balance at
March 31,
2012
    Unrealized
Gains

(Losses) for
Level 3

Assets/
Liabilities
Outstanding at
March 31,
2012(2)
 
    (dollars in millions)  

Assets at Fair Value

                 

Trading assets:

                 

U.S. agency securities

  $ 8     $ —       $ 42     $ (26   $ —       $ —       $ (1   $ 23     $ —    

Other sovereign government obligations

    119       (1     8       (118     —         —         —         8       —    

Corporate and other debt:

                 

State and municipal securities

    —         —         —         —         —         —         3       3       —    

Residential mortgage-backed securities

    494       (21     6       (245     —         —         (191     43       (18

Commercial mortgage-backed securities

    134       23       5       (21     —         (1     (13     127       16  

Asset-backed securities

    31       1       —         (28     —         —         (1     3       1  

Corporate bonds

    675       45       426       (225     —         —         (22     899       39  

Collateralized debt obligations

    980       123       296       (161     —         —         (73     1,165       82  

Loans and lending commitments

    9,590       (20     496       (1,018     —         (421     (30     8,597       (35

Other debt

    128       2       27       (123     —         —         23       57       —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    12,032       153       1,256       (1,821     —         (422     (304     10,894       85  

Corporate equities

    417       (45     901       (758     —         —         39       554       (9

Net derivative and other contracts(3):

                 

Interest rate contracts

    420       170       6       —         (5     (139     (430     22       179  

Credit contracts

    5,814       (1,381     63       —         (10     (47     (58     4,381       (1,786

Foreign exchange contracts

    43       (99     —         —         —         162       (40     66       (83

Equity contracts

    (1,234     (99     199       (58     (50     (250     50       (1,442     (161

Commodity contracts

    570       199       4       —         (4     37       (3     803       101  

Other

    (1,090     58       —         —         —         269       740       (23     56  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net derivative and other contracts

    4,523       (1,152     272       (58     (69     32       259       3,807       (1,694

Investments:

                 

Private equity funds

    1,936       (7     101       (36     —         —         —         1,994       1  

Real estate funds

    1,213       52       87       (14     —         —         —         1,338       5  

Hedge funds

    696       25       22       (33     —         —         (87     623       23  

Principal investments

    2,937       38       180       (65     —         —         104       3,194       57  

Other

    501       (33     34       (3     —         —         28       527       (41
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

    7,283       75       424       (151     —         —         45       7,676       45  

Physical commodities

    46       —         —         —         —         (46     —         —         —    

Intangible assets

    133       (34     —         —         —         —         —         99       (34

 

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Table of Contents

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

    Beginning
Balance at
December 31,
2011
    Total
Realized
and
Unrealized
Gains
(Losses) (1)
    Purchases     Sales     Issuances     Settlements     Net
Transfers
    Ending
Balance at
March 31,
2012
    Unrealized
Gains

(Losses) for
Level 3

Assets/
Liabilities
Outstanding at
March 31,
2012(2)
 
    (dollars in millions)  

Liabilities at Fair Value

                 

Commercial paper and other short-term borrowings

  $ 2     $ —       $ —       $ —       $ 13     $ —       $  —       $ 15     $ —    

Trading liabilities:

                 

Other sovereign government obligations

    8       —         (7     —         —         —         —         1       —    

Corporate and other debt:

                 

Residential mortgage-backed securities

    355       —         (294     —         —         —         —         61       (61

Corporate bonds

    219       (59     (186     126       —         —         (25     193       (74

Unfunded lending commitments

    85       25       —         —         —         —         —         60       25  

Other debt

    73       1       —         —         —         (55     16       33       3  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total corporate and other debt

    732       (33     (480     126       —         (55     (9     347       (107

Corporate equities

    1       (2     (2     10       —         —         (9     2       —    

Securities sold under agreements to repurchase

    340       1       —         —         —         —         (153     186       3  

Other secured financings

    570       (44     —         —         12       (32     —         594       (44

Long-term borrowings

    1,603       (173     —         —         262       (78     183       2,143       (171

 

(1) Total realized and unrealized gains (losses) are primarily included in Trading in the condensed consolidated statements of income except for $75 million related to Trading assets—Investments, which is included in Investments revenues.
(2) Amounts represent unrealized gains (losses) for the quarter ended March 31, 2012 related to assets and liabilities still outstanding at March 31, 2012.
(3) Net derivative and other contracts represent Trading assets—Derivative and other contracts net of Trading liabilities—Derivative and other contracts. For further information on derivative instruments and hedging activities, see Note 11.

 

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Table of Contents

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Quantitative Information about and Sensitivity of Significant Unobservable Inputs Used in Recurring Level 3 Fair Value Measurements at March 31, 2013 and December 31, 2012.

The disclosures below provide information on the valuation techniques, significant unobservable inputs and their ranges and averages for each major category of assets and liabilities measured at fair value on a recurring basis with a significant Level 3 balance. The level of aggregation and breadth of products cause the range of inputs to be wide and not evenly distributed across the inventory. Further, the range of unobservable inputs may differ across firms in the financial services industry because of diversity in the types of products included in each firm’s inventory. The disclosures below also include qualitative information on the sensitivity of the fair value measurements to changes in the significant unobservable inputs.

At March 31, 2013.

 

    Balance at
March 31,
2013
(dollars in
millions)
   

Valuation Technique(s)

 

Significant Unobservable Input(s) /

Sensitivity of the Fair Value to Changes in the
Unobservable Inputs

 

Range(1)

 

Averages(2)

Assets

         

Trading assets:

         

Corporate and other debt:

                       

Commercial mortgage-backed securities

  $ 174     Comparable pricing   Comparable bond price /(A)   57 to 101 points   81 points

Corporate bonds

    888     Comparable pricing   Comparable bond price / (A)   4 to 145 points   92 points

Collateralized debt obligations

    1,666     Comparable pricing(6)   Comparable bond price / (A)   16 to 95 points   63 points
            Correlation model   Credit correlation / (B)   23 to 54 %   41%

Loans and lending commitments

    5,284     Corporate loan model   Credit spread / (C)   44 to 1,045 basis points   245 basis points
    Comparable pricing   Comparable bond price / (A)   80 to 120 points   100 points
            Comparable pricing(6)   Comparable loan price / (A)   30 to 103 points   86 points

Corporate equities(3)

    270     Net asset value(6)   Discount to net asset value / (C)   0 to 51 %   20%
    Comparable pricing   Comparable equity price / (A)   0 to 100 %   50%
    Comparable pricing   Comparable price / (A)   43 to 74 points   52 points
            Market approach   EBITDA multiple / (A)   8 to 10 times   9 times

Net derivative and other contracts:

         

Interest rate contracts

    (22   Option model   Interest rate volatility concentration liquidity multiple / (C)(D)   0 to 10 times   0 times / 0 times (4)
      Comparable bond price / (A)(D)   5 to 98 points   52 points / 52 points (4)
      Interest rate - Foreign exchange correlation /(A)(D)   2 to 63 %   35% / 43%(4)
      Interest rate volatility skew / (A)(D)   9 to 117 %   53% / 48%(4)
      Interest rate quanto correlation / (A)(D)   -53 to 37 %   8% / -1%(4)
      Interest rate curve correlation / (A)(D)   42 to 98 %   78% / 82%(4)
                Inflation volatility / (A)(D)   60 to 83 %   70% / 66%(4)

Credit contracts

    1,403     Comparable pricing   Cash synthetic basis / (C)(D)   1 to 10 points   3 points
      Comparable bond price / (C)(D)   0 to 83 points   27 points
            Correlation model(6)   Credit correlation / (B)   20 to 94 %   47%

Foreign exchange contracts(5)

    (235   Option model   Comparable bond price / (A)(D)   5 to 98 points   52 points / 52 points (4)
      Interest rate quanto correlation / (A)(D)   -53 to 37 %   8% / -1%(4)
      Interest rate - Credit spread correlation /(A)(D)   -59 to 60 %   -5% / -3%(4)
      Interest rate - Foreign exchange correlation /(A)(D)   2 to 63 %   35% / 43%(4)
                Interest rate volatility skew / (A)(D)   9 to 117 %   53% / 48%(4)

Equity contracts(5)

    (1,340   Option model   At the money volatility / (C)(D)   14 to 44 %   30%
      Volatility skew / (C)(D)   -2 to 0 %   -1%
      Equity - Equity correlation / (C)(D)   40 to 99 %   71%
      Equity - Foreign exchange correlation / (C)(D)   -60 to 38 %   -15%
                Equity - Interest rate correlation / (C)(D)   1 to 66 %   42% /40%(4)

Commodity contracts

    703     Option model   Forward power price / (C)(D)   $18 to $110 per Megawatt hour   $42 per Megawatt hour
      Commodity volatility / (A)(D)   12 to 31 %   13%
                Cross commodity correlation / (C)(D)   43 to 97 %   91%

Investments(3):

         

Principal investments

    2,855     Discounted cash flow