10-Q 1 d372076d10q.htm FORM 10-Q Form 10-Q
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2017

OR

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

EXCHANGE ACT OF 1934

Commission File Number 1-11758

 

 

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(Exact Name of Registrant as specified in its charter)

 

 

 

Delaware

(State or other jurisdiction of

incorporation or organization)

 

1585 Broadway

New York, NY 10036

(Address of principal executive offices, including zip code)

 

36-3145972

(I.R.S. Employer Identification No.)

    

(212) 761-4000

(Registrant’s telephone number, including area code)

 

 

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

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

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

 

Large Accelerated Filer  ☒

 

Accelerated Filer  ☐

Non-Accelerated Filer  ☐

 

Smaller reporting company  ☐

(Do not check if a smaller reporting company)

 

Emerging growth company  ☐

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

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

As of May 1, 2017, there were 1,849,782,135 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, 2017

 

Table of Contents   Part     Item      Page  

Financial Information

    I                1  

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

            2        1  

Introduction

                     1  

Executive Summary

                     2  

Business Segments

                     6  

Supplemental Financial Information and Disclosures

                     15  

Accounting Development Updates

                     15  

Critical Accounting Policies

                     16  

Liquidity and Capital Resources

                     17  

Quantitative and Qualitative Disclosures about Market Risk

            3        29  

Controls and Procedures

            4        39  

Report of Independent Registered Public Accounting Firm

                     40  

Financial Statements

            1        41  

Consolidated Financial Statements and Notes

                     41  

Consolidated Income Statements (Unaudited)

                     41  

Consolidated Comprehensive Income Statements (Unaudited)

                     42  

Consolidated Balance Sheets (Unaudited at March 31, 2017)

                     43  

Consolidated Statements of Changes in Total Equity (Unaudited)

                     44  

Consolidated Cash Flow Statements (Unaudited)

                     45  

Notes to Consolidated Financial Statements (Unaudited)

                     46  

   1. Introduction and Basis of Presentation

                     46  

   2. Significant Accounting Policies

                     47  

  3. Fair Values

                     48  

   4. Derivative Instruments and Hedging Activities

                     58  

  5. Investment Securities

                     64  

  6. Collateralized Transactions

                     68  

   7. Loans and Allowance for Credit Losses

                     70  

  8. Equity Method Investments

                     73  

  9. Deposits

                     73  

10. Long-Term Borrowings and Other Secured Financings

                     73  

11. Commitments, Guarantees and Contingencies

                     74  

12. Variable Interest Entities and Securitization Activities

                     79  

13. Regulatory Requirements

                     82  

14. Total Equity

                     84  

15. Earnings per Common Share

                     86  

16. Interest Income and Interest Expense

                     86  

17. Employee Benefit Plans

                     86  

18. Income Taxes

                     87  

19. Segment and Geographic Information

                     87  

20. Subsequent Events

                     88  

Financial Data Supplement (Unaudited)

                     89  

Other Information

    II                91  

Legal Proceedings

            1        91  

Unregistered Sales of Equity Securities and Use of Proceeds

            2        92  

Exhibits

            6        92  

Signatures

                     S-1  

Exhibit Index

                     E-1  

 

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Available Information

We file annual, quarterly and current reports, proxy statements and other information with the U.S. 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 us) file electronically with the SEC. Our electronic SEC filings are available to the public at the SEC’s internet site, www.sec.gov.

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

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

 

   

Amended and Restated Certificate of Incorporation;

   

Amended and Restated Bylaws;

   

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

   

Corporate Governance Policies;

   

Policy Regarding Communication with the Board of Directors;

   

Policy Regarding Director Candidates Recommended by Shareholders;

   

Policy Regarding Corporate Political Activities;

   

Policy Regarding Shareholder Rights Plan;

   

Equity Ownership Commitment;

   

Code of Ethics and Business Conduct;

   

Code of Conduct;

   

Integrity Hotline Information; and

   

Environmental and Social Policies.

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

 

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Financial Information

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

Introduction

 

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, Wealth Management and Investment Management. Morgan Stanley, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. Unless the context otherwise requires, the terms “Morgan Stanley,” “Firm,” “us,” “we,” or “our” mean Morgan Stanley (the “Parent Company”) together with its consolidated subsidiaries.

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

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

Wealth Management provides a comprehensive array of financial services and solutions to individual investors and small to medium-sized businesses and institutions covering

brokerage and investment advisory services, financial and wealth planning services, annuity and insurance products, credit and other lending products, banking and retirement plan services.

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

The results of operations in the past have been, and in the future may continue to be, materially affected by competition; risk factors; and legislative, legal and regulatory developments; as well as other factors. These factors also may have an adverse impact on our ability to achieve our strategic objectives. Additionally, the discussion of our results of operations herein may contain forward-looking statements. These statements, which reflect management’s beliefs and expectations, are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of the risks and uncertainties that may affect our future results, see “Forward-Looking Statements” immediately preceding Part I, Item 1, “Business—Competition” and “Business—Supervision and Regulation” in Part I, Item 1, “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”) and “Liquidity and Capital Resources—Regulatory Requirements” herein.

 

 

  1   March 2017 Form 10-Q


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Management’s Discussion and Analysis   LOGO

 

Executive Summary

Overview of Financial Results

Consolidated Results

Net Revenues

($ in millions)

 

 

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Net Income Applicable to Morgan Stanley

($ in millions)

 

 

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Earnings per Common Share1

 

 

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1.

For the calculation of basic and diluted earnings per common share, see Note 15 to the consolidated financial statements.

 

We reported net revenues of $9,745 million in the quarter ended March 31, 2017 (“current quarter,” or “1Q 2017”), compared with $7,792 million in the quarter ended March 31, 2016 (“prior year quarter,” or “1Q 2016”). For the current quarter, net income applicable to Morgan Stanley was $1,930 million, or $1.00 per diluted common share, compared with $1,134 million, or $0.55 per diluted common share, in the prior year quarter.

 

 

Results for the current quarter included a recurring-type of discrete tax benefit of $112 million associated with the accounting update related to employee share-based payments.

Non-interest Expenses

($ in millions)

 

 

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Compensation and benefits expenses of $4,466 million in the current quarter increased 21% from $3,683 million in the prior year quarter, primarily due to increases in discretionary incentive compensation driven mainly by higher revenues and increases in the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses were $2,471 million in the current quarter compared with $2,371 million in the prior year quarter, representing a 4% increase, primarily as a result of higher litigation costs and volume-driven expenses.

 

 

March 2017 Form 10-Q   2  


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Management’s Discussion and Analysis   LOGO

 

Return on Average Common Equity

 

 

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The annualized return on average common equity (“ROE”) was 10.7% in the current quarter compared with 6.2% in the prior year quarter (see “Selected Non-Generally Accepted Accounting Principles (“Non-GAAP”) Financial Information” herein).

Business Segment Results

Net Revenues by Segment1, 2

($ in millions)

 

 

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Net Income Applicable to Morgan Stanley by Segment2, 3

($ in millions)

 

 

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1.

The total amount of Net Revenues by Segment also includes intersegment eliminations of $(74) million and $(67) million in the current quarter and prior year quarter, respectively.

2.

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

3.

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

 

 

Institutional Securities net revenues of $5,152 million in the current quarter increased 39% compared with $3,714 million in the prior year quarter, primarily as a result of higher sales and trading and Investment banking revenues.

 

 

Wealth Management net revenues of $4,058 million in the current quarter increased 11% from $3,668 million in the prior year quarter, primarily as a result of growth in Net interest income and higher transactional and asset management fee revenues.

 

 

Investment Management net revenues of $609 million in the current quarter increased 28% from $477 million in the prior year quarter, primarily driven by investment gains in certain private equity and real estate funds compared with losses in the prior year quarter.

Net Revenues by Region1

($ in millions)

 

 

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EMEA—Europe, Middle East and Africa

1.

For a discussion of how the geographic breakdown for net revenues is determined, see Note 21 to the consolidated financial statements in Item 8 of the 2016 Form 10-K.

 

 

  3   March 2017 Form 10-Q


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Management’s Discussion and Analysis   LOGO

 

Selected Financial Information and Other Statistical Data

 

     Three Months Ended
March 31,
 
$ in millions    2017     2016  

Income from continuing operations applicable to Morgan Stanley

   $ 1,952     $ 1,137  

Income (loss) from discontinued operations applicable to Morgan Stanley

     (22 )       (3

Net income applicable to Morgan Stanley

     1,930       1,134  

Preferred stock dividends and other

     90       79  

Earnings applicable to Morgan Stanley common shareholders

   $ 1,840     $ 1,055  

Effective income tax rate from continuing operations

     29.0     33.3

 

     At March 31,
2017
    At December 31,
2016
 

Capital ratios (Transitional—Advanced)1

 

Common Equity Tier 1 capital ratio

    17.4     16.9

Tier 1 capital ratio

    19.9     19.0

Total capital ratio

    22.9     22.0

Capital ratios (Transitional—Standardized)1

 

Tier 1 leverage ratio2

    8.5     8.4

 

in millions, except per share amounts    At March 31,
2017
     At December 31,
2016
 

Loans3

   $ 95,953      $ 94,248  

Total assets

   $ 832,391      $ 814,949  

Global Liquidity Reserve4

   $ 197,647      $ 202,297  

Deposits

   $ 152,109      $ 155,863  

Long-term borrowings

   $ 172,688      $ 164,775  

Common shareholders’ equity

   $ 69,404      $ 68,530  

Common shares outstanding

     1,852        1,852  

Book value per common share5

   $ 37.48      $ 36.99  

Worldwide employees

     55,607        55,311  

 

1.

For a discussion of our regulatory capital ratios, see “Liquidity and Capital Resources—Regulatory Requirements” herein.

2.

See Note 13 to the consolidated financial statements for information on the Tier 1 leverage ratio.

3.

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

4.

For a discussion of Global Liquidity Reserve, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Liquidity Risk Management Framework—Global Liquidity Reserve” in Part II, Item 7 of the 2016 Form 10-K.

5.

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

Selected Non-Generally Accepted Accounting Principles (“Non-GAAP”) Financial Information

We prepare our consolidated financial statements using accounting principles generally accepted in the United States of America (“U.S. GAAP”). From time to time, we may disclose certain “non-GAAP financial measures” in this document, or in the course of our earnings releases, earnings and other conference calls, financial presentations, definitive proxy statement and otherwise. A “non-GAAP financial measure” excludes, or includes, amounts from the most directly comparable measure calculated and presented in accordance with U.S. GAAP. Non-GAAP financial measures disclosed by us are provided as additional information to investors and analysts in order to provide them with further transparency about, or as an alternative method for assessing, our financial condition, operating results or prospective regulatory capital requirements. These measures are not in accordance with, or a substitute for, U.S. GAAP and may be different from or inconsistent with non-GAAP financial measures used by other companies. Whenever we refer to a non-GAAP financial measure, we will also generally define it or present the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP, along with a reconciliation of the differences between the U.S. GAAP financial measure and the non-GAAP financial measure.

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

Non-GAAP Financial Measures by Business Segment

 

     Three Months Ended
March 31,
 
$ in billions    2017     2016  

Pre-tax profit margin1

 

    

Institutional Securities

     34     24

Wealth Management

     24     21

Investment Management

     17     9

Consolidated

     29     22

Average common equity2

 

    

Institutional Securities

   $     40.2     $     43.2  

Wealth Management

     17.2       15.3  

Investment Management

     2.4       2.8  

Parent Company

     9.2       6.9  

Consolidated average common equity

   $ 69.0     $ 68.2  

Return on average common equity2

 

    

Institutional Securities

     11.4     4.9

Wealth Management

     14.6     12.6

Investment Management

     11.1     6.9

Consolidated

     10.7     6.2
 

 

March 2017 Form 10-Q   4  


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Management’s Discussion and Analysis   LOGO

 

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

 

     Three Months Ended
March 31,
 
$ in millions, except per share data    2017     2016  

Net income applicable to Morgan Stanley

 

 

 

U.S. GAAP

   $ 1,930     $ 1,134  

Impact of discrete tax provision3

     14        

Net income applicable to Morgan Stanley, excluding discrete tax provision—non-GAAP4

   $ 1,944     $ 1,134  

Earnings per diluted common share

 

 

 

U.S. GAAP

   $ 1.00     $ 0.55  

Impact of discrete tax provision3

     0.01        

Earnings per diluted common share, excluding discrete tax provision—non-GAAP4

   $ 1.01     $ 0.55  

Effective income tax rate

 

    

U.S. GAAP

     29.0     33.3

Impact of discrete tax provision3

     (0.5 )%       

Effective income tax rate from continuing operations, excluding discrete tax provision—non-GAAP4

     28.5     33.3

 

1.

Pre-tax profit margin is a non-GAAP financial measure that we consider to be a useful measure to us, investors and analysts to assess operating performance and represents income from continuing operations before income taxes as a percentage of net revenues.

2.

Average common equity and return on average common equity are non-GAAP financial measures we consider to be useful measures to us, investors and analysts to assess capital adequacy and to allow better comparability of period-to-period operating performance. Average common equity for each business segment is determined at the beginning of each year using our Required Capital framework, an internal capital adequacy measure (see “Liquidity and Capital Resources—Regulatory Requirements—Attribution of Average Common Equity According to the Required Capital Framework” herein) and will remain fixed throughout the year until the next annual reset. Each business segment’s return on average common equity equals annualized net income applicable to Morgan Stanley less an allocation of preferred dividends as a percentage of average common equity for that segment. Consolidated return on average common equity equals annualized consolidated net income applicable to Morgan Stanley less preferred dividends as a percentage of average common equity.

3.

Beginning in 2017, with the adoption of the accounting update Improvements to Employee Share-Based Payment Accounting, the income tax consequences related to share-based payments are required to be recognized in Provision for income taxes in the consolidated income statements, and treated as a discrete item, upon the conversion of employee share-based awards. The impact of the income tax consequences upon conversion of the awards may be either a benefit or a provision. Conversion of employee share-based awards to Firm shares will primarily occur in the first quarter of each year. The above exclusion calculations for net income applicable to Morgan Stanley, earnings per diluted common share and effective income tax rate have not been adjusted for these income tax consequences as we anticipate conversion activity each quarter. See Note 2 to the consolidated financial statements for information on the adoption of the accounting update Improvements to Employee Share-Based Payment Accounting. For further information on the discrete tax provision, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

4.

Net income applicable to Morgan Stanley, excluding discrete tax provision, earnings per diluted common share, excluding discrete tax provision and effective income tax rate from continuing operations, excluding discrete tax provision, are non-GAAP financial measures we consider to be useful measures to us, investors and analysts to allow better comparability of period-to-period operating performance.

Consolidated Non-GAAP Financial Measures

 

     Three Months Ended
March 31,
 
$ in billions    2017     2016  

Average common equity1, 3, 4, 5

 

    

Unadjusted

   $     69.0     $     68.2  

Excluding DVA

     69.6       68.3  

Excluding DVA and discrete tax provision

     69.6       68.3  

Return on average common equity1, 2, 3, 4

 

 

 

Unadjusted

     10.7     6.2

Excluding DVA

     10.6     6.2

Excluding DVA and discrete tax provision

     10.7     6.2

Average tangible common equity1, 3, 4, 5

 

 

 

Unadjusted

   $ 59.7     $ 58.7  

Excluding DVA

     60.3       58.8  

Excluding DVA and discrete tax provision

     60.3       58.8  

Return on average tangible common equity1, 2, 3, 4

 

 

Unadjusted

     12.3     7.2

Excluding DVA

     12.2     7.2

Excluding DVA and discrete tax provision

     12.3     7.2

Expense efficiency ratio1, 6

     71.2     77.7

 

     At March 31,
2017
     At December 31,
2016
 

Tangible book value per common share1, 7

  $ 32.49      $ 31.98  

DVA—Debt valuation adjustment represents the change in the fair value resulting from fluctuations in our credit spreads and other credit factors related to liabilities carried at fair value under the fair value option, primarily certain Long-term and Short-term borrowings.

 

1.

The average common equity, return on average common equity, average tangible common equity, return on average tangible common equity, the expense efficiency ratio and the tangible book value per common share measures set forth in this table are all non-GAAP financial measures we consider to be useful measures to us, investors and analysts to assess capital adequacy and to allow better comparability of period-to-period operating performance. For a discussion of tangible common equity, see “Liquidity and Capital Resources—Tangible Equity” herein.

2.

Return on average common equity equals annualized consolidated net income applicable to Morgan Stanley less preferred dividends as a percentage of average common equity. Return on average tangible common equity equals annualized net income applicable to Morgan Stanley less preferred dividends as a percentage of average tangible common equity.

3.

When excluding DVA, it is only excluded from the denominator. When excluding the discrete tax provision, both the numerator and denominator are adjusted to exclude that item.

4.

The calculation used in determining the Firm’s “ROE Target” is return on average common equity excluding DVA and discrete tax items as set forth above. Beginning in 2017, with the adoption of the accounting update Improvements to Employee Share-Based Payment Accounting, the income tax consequences related to share-based payments are required to be recognized in Provision for income taxes in the consolidated income statements, and treated as a discrete item, upon the conversion of employee share-based awards. The impact of the income tax consequences upon conversion of the awards may be either a benefit or a provision. Conversion of employee share-based awards to Firm shares will primarily occur in the first quarter of each year. The above exclusion calculations for returns on average common equity and tangible common equity have not been adjusted for these income tax consequences as we anticipate conversion activity each quarter. See Note 2 to the consolidated financial statements for information on the adoption of the accounting update Improvements to Employee Share-Based Payment Accounting.

5.

The impact of DVA on average common equity and average tangible common equity was approximately $(584) million and $(144) million in the current quarter and prior year quarter, respectively.

6.

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

7. Tangible book value per common share equals tangible common equity of $60,175 million at March 31, 2017 and $59,234 million at December 31, 2016 divided by common shares outstanding of 1,852 million at both March 31, 2017 and December 31, 2016.

 

 

  5   March 2017 Form 10-Q


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Management’s Discussion and Analysis   LOGO

 

Return on Equity Target

We have an ROE Target of 9% to 11% to be achieved by 2017. Our ROE Target and the related strategies and goals are forward-looking statements that may be materially affected by many factors, including, among other things: macroeconomic and market conditions; legislative and regulatory developments; industry trading and investment banking volumes; equity market levels; interest rate environment; legal expenses and the ability to reduce expenses in general; capital levels; and discrete tax items. For further information on our ROE Target and related assumptions, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Executive Summary—Return on Equity Target” in Part II, Item 7 of the 2016 Form 10-K.

Business Segments

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

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

Net Revenues, Compensation Expense and Income Taxes

For discussions of our net revenues, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments—Net Revenues” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments—Net Revenues by Segment” in Part II, Item 7 of the 2016 Form 10-K. For a discussion of our compensation expense, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments—Compensation Expense” in Part II, Item 7 of the 2016 Form 10-K. For a discussion of our Income Tax expense, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments—Income Taxes” in Part II, Item 7 of the 2016 Form 10-K.

 

 

March 2017 Form 10-Q   6  


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Management’s Discussion and Analysis   LOGO

 

Institutional Securities

Income Statement Information

 

     Three Months Ended
March 31,
       
$ in millions        2017             2016         % Change  

Revenues

      

Investment banking

   $ 1,417     $ 990       43

Trading

     3,012       1,891       59

Investments

     66       32       106

Commissions and fees

     620       655       (5 )% 

Asset management, distribution and administration fees

     91       73       25

Other

     173       4       N/

Total non-interest revenues

     5,379       3,645       48

Interest income

     1,124       1,053       7

Interest expense

     1,351       984       37

Net interest

     (227     69       N/

Net revenues

     5,152       3,714       39

Compensation and benefits

     1,870       1,382       35

Non-compensation expenses

     1,552       1,424       9

Total non-interest expenses

     3,422       2,806       22

Income from continuing operations before income taxes

     1,730       908       91

Provision for income taxes

     459       275       67

Income from continuing operations

     1,271       633       101

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

     (22     (3     N/

Net income

     1,249       630       98

Net income applicable to noncontrolling interests

     35       39       (10 )% 

Net income applicable to Morgan Stanley

   $ 1,214     $ 591       105

N/M—Not Meaningful

Investment Banking

Investment Banking Revenues

 

     Three Months Ended
March 31,
        
$ in millions    2017      2016      % Change  

Advisory

   $ 496      $ 591        (16)%  

Underwriting revenues:

                          

Equity

     390        160        144%  

Fixed income

     531        239        122%  

Total underwriting

     921        399        131%  

Total investment banking

   $ 1,417      $ 990        43%  

Investment Banking Volumes

 

     Three Months Ended
March 31,
 
$ in billions    20171      20161  

Completed mergers and acquisitions2

   $ 150      $ 297  

Equity and equity-related offerings3

     10        7  

Fixed income offerings4

     71        51  

 

1.

Source: Thomson Reuters, data at April 3, 2017. Completed mergers and acquisitions volumes are based on full credit to each of the advisors in a transaction. Equity and equity-related offerings and fixed income offerings are based on full credit for single book managers and equal credit for joint book managers. Transaction volumes may not be indicative of net revenues in a given period. In addition, transaction volumes for prior periods may vary from amounts previously reported due to the subsequent withdrawal or change in the value of a transaction.

2.

Amounts include transactions of $100 million or more.

3.

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

4.

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

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

Investment banking revenues of $1,417 million in the current quarter increased 43% from the prior year quarter due to higher underwriting revenues, partially offset by a decrease in advisory revenues in the current quarter.

 

 

Advisory revenues decreased reflecting the lower levels of global completed merger, acquisition and restructuring transactions (“M&A”) activity (see Investment Banking Volumes table), partially offset by higher fee realization.

 

 

Equity underwriting revenues increased as a result of higher global market volumes in both initial public offerings and follow-on offerings (see Investment Banking Volumes table), as well as higher fee realization. Fixed income underwriting revenues increased in the current quarter, primarily due to higher bond and non-investment grade loan fees.

Sales and Trading Net Revenues

By Income Statement Line Item

 

     Three Months Ended
March 31,
        
$ in millions    2017     2016      % Change  

Trading

   $ 3,012     $ 1,891        59

Commissions and fees

     620       655        (5 )% 

Asset management, distribution and administration fees

     91       73        25

Net interest

     (227     69        N/

Total

   $ 3,496     $ 2,688        30

N/M—Not Meaningful

 

 

  7   March 2017 Form 10-Q


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Management’s Discussion and Analysis   LOGO

 

By Business

 

     Three Months Ended
March 31,
 
$ in millions      2017         2016    

Equity

   $ 2,016     $ 2,056  

Fixed income

     1,714       873  

Other

     (234     (241

Total

   $ 3,496     $ 2,688  

Sales and Trading ActivitiesEquity and Fixed Income

Following is a description of the sales and trading activities within our equities and fixed income businesses as well as how their results impact the income statement line items, followed by a presentation and explanation of results.

Equities—Financing. We provide financing and prime brokerage services to our clients active in the equity markets through a variety of products including margin lending, securities lending and swaps. Results from this business are largely driven by the difference between financing income earned and financing costs incurred, which are reflected in Net interest for securities and equity lending products and in Trading revenues for derivative products.

Equities—Execution services. We make markets for our clients in equity-related securities and derivative products, including providing liquidity and hedging products. A significant portion of the results for this business is generated by commissions and fees from executing and clearing client transactions on major stock and derivative exchanges as well as from over-the-counter (“OTC”) transactions. Market-making also generates gains and losses on inventory, which are reflected in Trading revenues.

Fixed income—Within fixed income we make markets in order to facilitate client activity as part of the following products and services.

 

 

Global macro products.    We make markets for our clients in interest rate, foreign exchange and emerging market products, including exchange-traded and OTC securities, loans and derivative instruments. The results of this market-making activity are primarily driven by gains and losses from buying and selling positions to stand ready for and satisfy client demand and are recorded in Trading revenues.

 

 

Credit products.    We make markets in credit-sensitive products, such as corporate bonds and mortgage securities and other securitized products, and related derivative instruments. The values of positions in this business are sensitive to changes in credit spreads and interest rates, which result in gains and losses reflected in Trading revenues. Due to the amount and type of the interest-bearing securities and loans

   

making up this business, a significant portion of the results is also reflected in Net interest revenues.

 

 

Commodities products.    We make markets in various commodity products related primarily to electricity, natural gas, oil, and precious metals, with the results primarily reflected in Trading revenues.

Sales and Trading Net Revenues—Equity and Fixed Income

 

     Three Months Ended
March 31, 2017
 
$ in millions    Trading      Fees1      Net
Interest2
    Total  

Financing

   $ 931      $ 89      $ (188   $ 832  

Execution services

     664        568        (48     1,184  

Total Equity

   $ 1,595      $ 657      $ (236   $ 2,016  

Total Fixed Income

   $ 1,598      $ 54      $ 62     $ 1,714  

 

     Three Months Ended  
     March 31, 2016  
$ in millions    Trading      Fees1      Net
Interest2
    Total  

Financing

   $ 886      $ 86      $ 40     $ 1,012  

Execution services

     509        600        (65     1,044  

Total Equity

   $ 1,395      $ 686      $ (25   $ 2,056  

Total Fixed Income

   $ 555      $ 40      $ 278     $ 873  

 

1.

Includes Commissions and fees and Asset management, distribution and administration fees.

2.

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

We manage each of the sales and trading businesses based on its aggregate net revenues, which are comprised of the consolidated income statement line items quantified in the previous table. Trading revenues are affected by a variety of market dynamics, including volumes, bid-offer spreads, and inventory prices, as well as impacts from hedging activity, which are interrelated. We provide qualitative commentary in the discussion of results that follow on the key drivers of period over period variances, as the quantitative impact of the various market dynamics typically cannot be disaggregated.

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

Equity

Equity sales and trading net revenues of $2,016 million in the current quarter were lower than the prior year quarter, reflecting lower results in our financing businesses driven by higher funding costs, partially offset by strong results in our execution services revenues.

 

 

Financing revenues decreased 18% from the prior year quarter as Net interest revenues declined from higher net

 

 

March 2017 Form 10-Q   8  


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Management’s Discussion and Analysis   LOGO

 

   

interest costs, reflecting increased liquidity requirements, and an increased proportion of lower spread transactions.

 

 

Execution services increased 13% from the prior year quarter, primarily reflecting improved results in Trading revenues due to a lower volatility environment compared with the prior year quarter when increased volatility resulted in inventory losses. This was partially offset by lower fees in cash products driven by reduced market volumes.

Fixed Income

Fixed income net revenues of $1,714 million in the current quarter were 96% higher than the prior year quarter, driven by an increase in Trading revenues reflecting strong performance across products and regions on improved market conditions.

 

 

Credit products increased due to a more favorable credit environment in the current quarter compared with the widening spread environment in the prior year quarter that resulted in inventory losses. This was partially offset by a lower level of interest realized in securitized products in the current quarter.

 

 

Global macro products increased due to a more favorable environment across products compared with the prior year quarter when results were impacted by inventory losses. This was partially offset by higher interest costs in the current quarter which were impacted by interest products inventory management.

 

 

Commodities products increased due to increased structured transactions and customer flow in electricity and natural gas products and an improved credit environment.

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

Investments

 

 

Net investment gains of $66 million in the current quarter increased from the prior year quarter, primarily as a result of gains on investments associated with our compensation plans compared with losses in the prior year quarter.

Other

 

 

Other revenues of $173 million in the current quarter increased from the prior year quarter, primarily reflecting mark-to-market gains on loans held for sale in the current quarter compared with mark-to-market losses in the prior year quarter and a decrease in the provision on loans held for investment.

Non-interest Expenses

Non-interest expenses of $3,422 million in the current quarter increased from the prior year quarter, primarily reflecting a 35% increase in Compensation and benefits expenses and a 9% increase in Non-compensation expenses in the current quarter.

 

 

Compensation and benefits expenses increased in the current quarter, primarily due to increases in discretionary incentive compensation driven mainly by higher revenues and the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses increased in the current quarter, primarily due to higher litigation costs and Brokerage, clearing and exchange fees expense due to higher volumes.

 

 

  9   March 2017 Form 10-Q


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Wealth Management

Income Statement Information

 

    Three Months Ended
March 31,
   

% Change

 
$ in millions   2017     20161    

Revenues

     

Investment banking

  $ 145     $ 121       20%  

Trading

    238       194       23%  

Investments

    1       (2     150%  

Commissions and fees

    440       412       7%  

Asset management, distribution and administration fees

    2,184       2,054       6%  

Other

    56       58       (3)%  

Total non-interest revenues

    3,064       2,837       8%  

Interest income

    1,079       914       18%  

Interest expense

    85       83       2%  

Net interest

    994       831       20%  

Net revenues

    4,058       3,668       11%  

Compensation and benefits

    2,317       2,088       11%  

Non-compensation expenses

    768       794       (3)%  

Total non-interest expenses

    3,085       2,882       7%  

Income from continuing operations before income taxes

    973       786       24%  

Provision for income taxes

    326       293       11%  

Net income applicable to Morgan Stanley

  $ 647     $ 493       31%  

 

1.

Effective July 1, 2016, the Institutional Securities and Wealth Management business segments entered into an agreement, whereby Institutional Securities assumed management of Wealth Management’s fixed income client-driven trading activities and employees. Institutional Securities now pays fees to Wealth Management based on distribution activity (collectively, the “Fixed Income Integration”). Prior periods have not been recast for this new intersegment agreement due to immateriality.

Statistical Data

Financial Information and Statistical Data

 

$ in billions    At
March 31,
2017
     At
December 31,
2016
 

Client assets

   $ 2,187      $ 2,103  

Fee-based client assets1

   $ 927      $ 877  

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

     42%        42%  

Client liabilities2

   $ 74      $ 73  

Bank deposit program

   $ 149      $ 153  

Investment securities portfolio

   $ 62.6      $ 63.9  

Loans and lending commitments

   $ 70.3      $ 68.7  

Wealth Management representatives

     15,777        15,763  

 

     Three Months Ended
March 31,
 
        2017            2016      

Annualized revenues per representative

     

(dollars in thousands)3

   $ 1,029      $ 923  

Client assets per representative

     

(dollars in millions)4

   $ 139      $ 126  

Fee-based asset flows5

     

(dollars in billions)

   $ 18.8      $ 5.9  

 

1.

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

2.

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

3.

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

4.

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

5.

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

Transactional Revenues

 

     Three Months Ended
March 31,
    

% Change

 
$ in millions        2017              2016         

Investment banking

   $ 145      $ 121        20%  

Trading

     238        194        23%  

Commissions and fees

     440        412        7%  

Total

   $ 823      $ 727        13%  
 

 

March 2017 Form 10-Q   10  


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Net Revenues

Transactional Revenues

Transactional revenues of $823 million in the current quarter increased 13% from the prior year quarter primarily reflecting higher revenues related to investments associated with certain employee deferred compensation plans.

 

 

Investment banking revenues increased in the current quarter due to higher revenues from the distribution of structured products and equities, partially offset by lower preferred stock underwriting activity.

 

 

Trading revenues increased in the current quarter primarily due to gains related to investments associated with certain employee deferred compensation plans, partially offset by decreases from the Fixed Income Integration.

 

 

Commissions and fees increased in the current quarter primarily related to the Fixed Income Integration and to higher equities activity, partially offset by lower annuity product revenues.

Asset Management

 

 

Asset management, distribution and administration fees of $2,184 million in the current quarter increased 6% from the prior year quarter primarily due to market appreciation and positive flows, partially offset by lower average client fee rates. See “Fee-Based Client Assets Activity and Average Fee Rate by Account Type” herein.

Net Interest

 

 

Net interest of $994 million in the current quarter increased 20% from the prior year quarter primarily due to higher loan balances and higher interest rates.

Non-interest Expenses

Non-interest expenses of $3,085 million in the current quarter increased 7% from the prior year quarter.

 

 

Compensation and benefits expenses increased in the current quarter primarily due to higher revenues and increases in the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses decreased in the current quarter primarily due to lower professional service costs.

 

 

Fee-Based Client Assets Activity and Average Fee Rate by Account Type

For a description of fee-based client assets, including descriptions for the fee based client asset types and rollforward items in the following tables, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments—Wealth Management—Fee-Based Client Assets Activity and Average Fee Rate by Account Type” in Part II, Item 7 of the 2016 Form 10-K.

 

   

At

December 31,

2016

   

Inflows

   

Outflows

   

Market

Impact

   

At

March 31,

2017

    Average for the
Three Months Ended
March 31, 2017
$ in billions, Fee Rate in bps             Fee Rate1
                                             

Separately managed accounts2,3

  $ 222     $ 9     $ (5   $ 4     $ 230     16

Unified managed accounts3

    204       13       (9     9       217     100

Mutual fund advisory

    21             (1     1       21     120

Representative as advisor

    125       10       (7     5       133     86

Representative as portfolio manager

    285       20       (11     11       305     98

Subtotal

  $ 857     $ 52     $ (33   $ 30     $ 906     77

Cash management

    20       3       (2           21     6

Total fee-based client assets

  $ 877     $ 55     $ (35   $ 30     $ 927     75

 

  11   March 2017 Form 10-Q


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At

December 31,

2015

    

Inflows

    

Outflows

   

Market

Impact

   

At

March 31,

2016

     Average for the
Three Months Ended
March 31, 2016
$ in billions, Fee Rate in bps                 Fee Rate1
                                                 

Separately managed accounts2

   $ 283      $ 9      $ (10   $ (4   $ 278      37

Unified managed accounts

     105        10        (5     2       112      109

Mutual fund advisory

     25               (1           24      121

Representative as advisor

     115        6        (7           114      87

Representative as portfolio manager

     252        15        (11     (1     255      102

Subtotal

   $ 780      $ 40      $ (34   $ (3   $ 783      78

Cash management

     15        2        (2           15      6

Total fee-based client assets

   $ 795      $ 42      $ (36   $ (3   $ 798      77

bps—Basis points

1.

 Certain data enhancements during the current quarter resulted in a modification to the “Fee Rate” calculations. Prior periods have been restated to reflect the  revised calculations.

2.

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

3.

 A shift in client assets of approximately $66 billion in the fourth quarter of 2016 from separately managed accounts to unified managed accounts resulted in a  lower average fee rate for those platforms but did not impact the average fee rate for total fee-based client assets.

 

March 2017 Form 10-Q   12  


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Investment Management

 

     Three Months Ended
March 31,
        
$ in millions    2017     2016     % Change  

Revenues

      

Investment banking

   $     $ 1       (100 )% 

Trading

     (11     (10     (10 )% 

Investments

     98       (64     N /M 

Commissions and fees

           3       (100 )% 

Asset management, distribution and administration fees

     517       526       (2 )% 

Other

     4       22       (82 )% 

Total non-interest revenues

     608       478       27

Interest income

     1       1        

Interest expense

           2       (100 )% 

Net interest

     1       (1     200

Net revenues

     609       477       28

Compensation and benefits

     279       213       31

Non-compensation expenses

     227       220       3

Total non-interest expenses

     506       433       17

Income from continuing operations before income taxes

     103       44       134

Provision for income taxes

     30       10       200

Net income

     73       34       115

Net income (loss) applicable to noncontrolling interests

     6       (16     138

Net income applicable to Morgan Stanley

   $ 67     $ 50       34

N/M—Not Meaningful

Net Revenues

Investments

 

 

Investments gains of $98 million in the current quarter increased from the prior year quarter primarily driven by

   

gains in certain private equity and real estate funds compared with losses in the prior year quarter.

Asset Management, Distribution and Administration Fees

 

 

Asset management, distribution and administration fees of $517 million in the current quarter decreased 2% from the prior year quarter primarily reflecting higher management fees in the prior year quarter from the completion of certain fund raisings in alternative/other products. This decrease was partially offset by higher fee rates and higher average assets under management or supervision (“AUM”) for the other product areas in the current quarter (see “AUM and Average Fee Rate by Asset Class” herein).

Non-interest Expenses

Non-interest expenses of $506 million in the current quarter increased 17% from the prior year quarter, primarily due to higher Compensation and benefits expenses.

 

 

Compensation and benefits expenses increased in the current quarter primarily due to an increase in deferred compensation associated with carried interest.

 

 

Non-compensation expenses increased, primarily due to higher brokerage clearing and exchange fees, partially offset by lower professional service fees.

Assets Under Management or Supervision

Effective in the second quarter of 2016, the presentation of AUM for Investment Management has been revised to better align asset classes with its present organizational structure. All prior period information has been recast in the new format.

 

 

  13   March 2017 Form 10-Q


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AUM and Average Fee Rate by Asset Class

For a description of the rollforward items in the following tables, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments—Investment Management—Assets Under Management or Supervision” in Part II, Item 7 of the 2016 Form 10-K.

 

   

At

December 31,
2016

    Inflows     Outflows     Market
Impact
    Other1    

At

March 31,
2017

   

Average for the

Three Months Ended

March 31, 2017

 
$ in billions, Fee Rate in bps              

Total

AUM

   

Fee

Rate

 
                                                                 

Equity

  $ 79     $ 5     $ (5   $ 8     $     $ 87     $ 83       74  

Fixed income

    60       5       (5     1       1       62       62       33  

Liquidity

    163       328       (338                 153       157       18  

Alternative / Other products

    115       7       (4     1             119       117       71  

Total assets under management or supervision

  $ 417     $ 345     $ (352   $ 10     $ 1     $ 421     $ 419       46  

Shares of minority stake assets

    8                                       7       7          

 

   

At

December 31,
2015

    Inflows     Outflows     Market
Impact
    Other1    

At

March 31,
2016

   

Average for the

Three Months Ended

March 31, 2016

 
$ in billions, Fee Rate in bps              

Total

AUM

   

Fee

Rate

 
                                                                 

Equity

  $ 83     $ 5     $ (6   $ (1         $ 81     $ 79       71  

Fixed income

    60       5       (6     2       1       62       60       32  

Liquidity

    149       336       (338     (1           146       149       17  

Alternative / Other products

    114       5       (4           1       116       115       81  

Total assets under management or supervision

  $ 406     $ 351     $ (354   $       2     $ 405     $ 403       48  

Shares of minority stake assets

    8                                       8       8          

bps—Basis points

1.

 Includes distributions and foreign currency impact.

 

March 2017 Form 10-Q   14  


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Supplemental Financial Information and Disclosures

U.S. Bank Subsidiaries

We provide loans to a variety of customers, from large corporate and institutional clients to high net worth individuals, primarily through our U.S. bank subsidiaries, Morgan Stanley Bank, N.A. (“MSBNA”) and Morgan Stanley Private Bank, National Association (“MSPBNA”) (collectively, “U.S. Bank Subsidiaries”). The lending activities in the Institutional Securities business segment primarily include loans or lending commitments to corporate clients. The lending activities in the Wealth Management business segment primarily include securities-based lending that allows clients to borrow money against the value of qualifying securities and also include residential real estate loans. We expect our lending activities to continue to grow through further market penetration of the Wealth Management business segment’s client base. For a further discussion of our credit risks, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Credit Risk.” For further discussion about loans and lending commitments, see Notes 7 and 11 to the consolidated financial statements.

U.S. Bank Subsidiaries’ Supplemental Financial Information Excluding Transactions with the Parent Company

 

$ in billions   

At

March 31,
2017

    

At

December 31,
2016

 

U.S. Bank Subsidiaries assets

   $ 179.4      $ 180.7  

U.S. Bank Subsidiaries investment securities portfolio:

     

Investment securities—AFS

     48.5        50.3  

Investment securities—HTM

     14.1        13.6  

Total

   $ 62.6      $ 63.9  

Wealth Management U.S. Bank Subsidiaries data

 

Securities-based lending and other loans1

   $ 36.6      $ 36.0  

Residential real estate loans

     25.0        24.4  

Total

   $ 61.6      $ 60.4  

Institutional Securities U.S. Bank Subsidiaries data

 

Corporate loans

   $ 19.2      $ 20.3  

Wholesale real estate loans

     10.3        9.9  

Total

   $ 29.5      $ 30.2  

AFS—Available for sale

HTM—Held to maturity

1.

Other loans primarily include tailored lending.

Income Tax Matters

Effective Tax Rate

 

     Three Months Ended  
      March 31, 2017     March 31, 2016  

From continuing operations

     29.0     33.3

The effective tax rate for the current quarter includes a net discrete tax benefit of $98 million, primarily resulting from a $112 million recurring-type benefit associated with the adoption of new accounting guidance related to employee share-based payments. See Note 2 to the consolidated financial statements for information on the adoption of the accounting update Improvements to Employee Share-Based Payment Accounting.

Accounting Development Updates

The Financial Accounting Standards Board issued the following accounting updates that apply to us.

Accounting updates not listed below were assessed and determined to be either not applicable or are not expected to have a significant impact on our consolidated financial statements.

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

 

 

Revenue from Contracts with Customers.    This accounting update aims to clarify the principles of revenue recognition, to develop a common revenue recognition standard across all industries for U.S. GAAP and International Financial Reporting Standards, and to provide enhanced disclosures for users of the financial statements. The core principle of this guidance is that an entity should recognize revenues to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We will adopt the guidance on January 1, 2018 and are currently evaluating the method of adoption.

We expect this accounting update to potentially change the timing and presentation of certain revenues, as well as the timing and presentation of certain related costs, for Investment banking fees and Asset management, distribution and administration fees. Outside of Investment Management performance fees in the form of carried interest, discussed further in the following paragraph, these changes are not expected to be significant.

Regarding the recognition of performance fees from fund management activities in the form of carried interest that are subject to reversal, we are currently assessing the alternative accounting approaches available for these arrangements. If we consider the equity method of accounting

 

 

  15   March 2017 Form 10-Q


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principles to apply to carried interest, the current recognition of such fees would remain essentially unchanged. If the fees are deemed in the scope of the new revenue guidance, we would defer recognition until such fees are no longer subject to reversal, which would cause a significant delay in the recognition of these fees as revenue.

We will continue to assess the impact of the new rule as we progress through the implementation of the new standard; therefore, additional impacts may be identified prior to adoption.

 

 

Gains and Losses from the Derecognition of Nonfinancial Assets.    This accounting update clarifies the guidance on how to account for the derecognition of nonfinancial assets and in substance nonfinancial assets and also provides guidance on the accounting for partial sales of nonfinancial assets. This update is effective as of January 1, 2018.

 

 

Leases.    This accounting update requires lessees to recognize on the balance sheet all leases with terms exceeding one year, which results in the recognition of a right of use asset and corresponding lease liability, including for those leases that we currently classify as operating leases. The right of use asset and lease liability will initially be measured using the present value of the remaining rental payments. The accounting for leases where we are the lessor is largely unchanged. This update is effective as of January 1, 2019.

 

Financial Instruments—Credit Losses.    This accounting update impacts the impairment model for certain financial assets measured at amortized cost such as loans held for investment and HTM securities. The amendments in this update will accelerate the recognition of credit losses by replacing the incurred loss impairment methodology with a current expected credit loss (“CECL”) methodology that requires an estimate of expected credit losses over the entire life of the financial asset. Additionally, although the CECL methodology will not apply to AFS debt securities, the update will require establishment of an allowance to reflect impairment of these securities, thereby eliminating the concept of a permanent write-down. This update is effective as of January 1, 2020.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with U.S. GAAP, which require us to make estimates and assumptions (see Note 1 to the consolidated financial statements). We believe that of our significant accounting policies (see Note 2 to the consolidated financial statements in Item 8 of the 2016 Form 10-K and Note 2 to the consolidated financial statements), the fair value, goodwill and intangible assets, legal and regulatory contingencies and income taxes policies involve a higher degree of judgment and complexity. For a further discussion about our critical accounting policies, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in Part II, Item 7 of the 2016 Form 10-K.

 

 

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Liquidity and Capital Resources

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

The Balance Sheet

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

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

Total Assets by Business Segment

 

    At March 31, 2017  
$ in millions   Institutional
Securities
    Wealth
Management
    Investment
Management
    Total  

Assets

       

Cash and cash equivalents1

  $ 26,254     $ 16,537     $ 63     $ 42,854  

Trading assets at fair value

    281,804       74       2,463       284,341  

Investment securities

    18,544       62,595             81,139  

Securities purchased under agreements to resell

    98,988       5,835             104,823  

Securities borrowed

    111,499       304             111,803  

Customer and other receivables

    29,621       18,180       543       48,344  

Loans, net of allowance

    34,312       61,636       5       95,953  

Other assets2

    48,744       12,859       1,531       63,134  

Total assets

  $ 649,766     $ 178,020     $ 4,605     $ 832,391  
    At December 31, 2016  
$ in millions   Institutional
Securities
    Wealth
Management
    Investment
Management
    Total  

Assets

       

Cash and cash equivalents1

  $ 25,291     $ 18,022     $ 68     $ 43,381  

Trading assets at fair value

    259,680       64       2,410       262,154  

Investment securities

    16,222       63,870             80,092  

Securities purchased under agreements to resell

    96,735       5,220             101,955  

Securities borrowed

    124,840       396             125,236  

Customer and other receivables

    26,624       19,268       568       46,460  

Loans, net of allowance

    33,816       60,427       5       94,248  

Other assets2

    45,941       13,868       1,614       61,423  

Total assets

  $ 629,149     $ 181,135     $ 4,665     $ 814,949  

 

1.

Cash and cash equivalents include cash and due from banks and interest bearing deposits with banks.

2.

Other assets primarily includes Cash deposited with clearing organizations or segregated under federal and other regulations or requirements; Other investments; Premises, equipment and software costs; Goodwill; Intangible assets and deferred tax assets.

A substantial portion of total assets consists of liquid marketable securities and short-term receivables arising principally from sales and trading activities in the Institutional Securities business segment. Total assets increased to $832.4 billion at March 31, 2017 from $814.9 billion at December 31, 2016, primarily driven by an increase in trading inventory within Institutional Securities. The increase reflects higher market values for corporate equities compared with December 31, 2016, along with increased trading activity across fixed income in U.S. government and agency securities and Other sovereign government obligations.

Securities Repurchase Agreements and Securities Lending

Securities borrowed or securities purchased under agreements to resell and securities loaned or securities sold under agreements to repurchase are treated as collateralized financings (see Note 2 to the consolidated financial statements in the 2016 Form 10-K and Note 6 to the consolidated financial statements).

Collateralized Financing Transactions

 

$ in millions    At
March 31,
2017
     At
December 31,
2016
 

Securities purchased under agreements to resell and Securities borrowed

   $ 216,626      $ 227,191  

Securities sold under agreements to repurchase and Securities loaned

   $ 75,459      $ 70,472  

Securities received as collateral1

   $ 13,339      $ 13,737  

 

    

Daily Average Balance

Three Months Ended

 
$ in millions    March 31,
2017
     December 31,
2016
 

Securities purchased under agreements to resell and Securities borrowed

   $ 222,224      $ 224,355  

Securities sold under agreements to repurchase and Securities loaned

   $ 73,674      $ 68,908  

 

1.

Included in Trading assets in the consolidated balance sheets.

 

 

  17   March 2017 Form 10-Q


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At March 31, 2017 and December 31, 2016, differences between period end balances and average balances in the previous table were not significant.

Customer Securities Financing

The customer receivable portion of the securities financing transactions primarily includes customer margin loans, collateralized by customer-owned securities, which are segregated in accordance with regulatory requirements. The customer payable portion of the securities financing transactions primarily includes payables to our prime brokerage customers. Our risk exposure on these transactions is mitigated by collateral maintenance policies that limit our credit exposure to customers and liquidity reserves held against this risk exposure.

Liquidity Risk Management Framework

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

The following principles guide our Liquidity Risk Management Framework:

 

 

Sufficient liquid assets should be maintained to cover maturing liabilities and other planned and contingent outflows;

 

 

Maturity profile of assets and liabilities should be aligned, with limited reliance on short-term funding;

 

 

Source, counterparty, currency, region and term of funding should be diversified; and

 

 

Liquidity Stress Tests should anticipate, and account for, periods of limited access to funding.

The core components of our Liquidity Risk Management Framework are the Required Liquidity Framework, Liquidity Stress Tests and the Global Liquidity Reserve, which support our target liquidity profile. For further discussion about the Firm’s Required Liquidity Framework and Liquidity Stress Tests, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Liquidity Risk Management Framework—Global Liquidity Reserve” in Part II, Item 7 of the 2016 Form 10-K.

At March 31, 2017 and December 31, 2016, we maintained sufficient liquidity to meet current and contingent funding obligations as modeled in our Liquidity Stress Tests.

Global Liquidity Reserve

We maintain sufficient global liquidity reserves pursuant to our Required Liquidity Framework. For further discussion of our Global Liquidity Reserve, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Liquidity Risk Management Framework—Global Liquidity Reserve” in Part II, Item 7 of the 2016 Form 10-K.

Global Liquidity Reserve by Type of Investment

 

$ in millions   

At

March 31,
2017

    

At

December 31,
2016

 

Cash deposits with banks

   $ 10,336      $ 8,679  

Cash deposits with central banks

     27,896        30,568  

Unencumbered highly liquid securities:

     

U.S. government obligations

     83,133        78,615  

U.S. agency and agency mortgage-backed securities

     51,892        46,360  

Non-U.S. sovereign obligations1

     17,997        30,884  

Other investment grade securities

     6,393        7,191  

Global Liquidity Reserve

   $ 197,647      $ 202,297  

 

1.

Non-U.S. sovereign obligations are primarily composed of unencumbered German, French, Dutch, United Kingdom (“U.K.”) and Japanese government obligations.

Global Liquidity Reserve Managed by Bank and Non-Bank Legal Entities

 

                  

Daily Average
Balance

Three Months
Ended

 
$ in millions   

At

March 31,
2017

    

At

December 31,
2016

     March 31,
2017
 

Bank legal entities

        

Domestic

   $ 71,520      $ 74,411      $ 72,477  

Foreign

     3,678        4,238        4,126  

Total Bank legal entities

     75,198        78,649        76,603  

Non-Bank legal entities

        

Domestic:

        

Parent Company

     60,375        66,514        64,436  

Non-Parent Company

     21,035        18,801        21,178  

Total Domestic

     81,410        85,315        85,614  

Foreign

     41,039        38,333        41,932  

Total Non-Bank legal entities

     122,449        123,648        127,546  

Total

   $ 197,647      $ 202,297      $ 204,149  

Regulatory Liquidity Framework

Liquidity Coverage Ratio

The Basel Committee on Banking Supervision’s (“Basel Committee”) Liquidity Coverage Ratio (“LCR”) standard is designed to ensure that banking organizations have sufficient high-quality liquid assets to cover net cash outflows arising from significant stress over 30 calendar days. The standard’s objective is to promote the short-term resilience of the liquidity risk profile of banking organizations.

 

 

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We and our U.S. Bank Subsidiaries are subject to the LCR requirements issued by U.S. banking regulators (“U.S. LCR”), which are based on the Basel Committee’s LCR, including a requirement to calculate each entity’s U.S. LCR on each business day. As of January 1, 2017, we and our U.S. Bank Subsidiaries are required to maintain a minimum of 100% of the fully phased-in U.S. LCR. We and our U.S. Bank Subsidiaries are compliant with the minimum required U.S. LCR based on current interpretations. In addition, effective April 1, 2017, we are required to disclose certain quantitative and qualitative information related to our U.S. LCR calculation after each calendar quarter.

Net Stable Funding Ratio

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

The Basel Committee finalized the NSFR framework in 2014. In May 2016, the U.S. banking regulators issued a proposal to implement the NSFR in the U.S. If adopted as proposed, the requirements would apply to us and our U.S. Bank Subsidiaries beginning January 1, 2018. We continue to evaluate the potential impact of the proposal, which is subject to further rulemaking procedures following the closing of the public comment period. Our preliminary estimates, based on the current proposal, indicate that actions will be necessary to meet the requirement, which we expect to accomplish by the effective date of the final rule. For an additional discussion of NSFR, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Liquidity Framework—Net Stable Funding Ratio” in Part II, Item 7 of the 2016 Form 10-K.

Funding Management

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

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

Secured Financing

For a discussion of our secured financing activities, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Funding Management—Secured Financing” in Part II, Item 7 of the 2016 Form 10-K.

At March 31, 2017 and December 31, 2016, the weighted average maturity of our secured financing of less liquid assets was greater than 120 days.

Unsecured Financing

For a discussion of our unsecured financing activities, see “Management’s Discussion and Analysis of Financing Condition and Results of Operations—Liquidity and Capital Resources—Funding Management—Unsecured Financing” in Part II, Item 7 of the 2016 Form 10-K and see Note 4 to the consolidated financial statements.

Deposits

Available funding sources to our U.S. Bank Subsidiaries include demand deposit accounts, money market deposit accounts, time deposits, repurchase agreements, federal funds purchased and Federal Home Loan Bank advances. The vast majority of deposits in our U.S. Bank Subsidiaries are sourced from our retail brokerage accounts and are considered to have stable, low-cost funding characteristics. At March 31, 2017 and December 31, 2016, deposits were $152,109 million and $155,863 million, respectively (see Note 9 to the consolidated financial statements).

Short-Term Borrowings

Our unsecured short-term borrowings may primarily consist of structured notes, bank loans and bank notes with original maturities of 12 months or less. At March 31, 2017 and December 31, 2016, we had approximately $1,122 million and $941 million, respectively, in short-term borrowings.

Long-Term Borrowings

We believe that accessing debt investors through multiple distribution channels helps provide consistent access to the unsecured markets. In addition, the issuance of long-term borrowings allows us to reduce reliance on short-term credit sensitive instruments. Long-term borrowings are generally managed to achieve staggered maturities, thereby mitigating refinancing risk, and to maximize investor diversification through sales to global institutional and retail clients across regions, currencies and product types. Availability and cost of financing to us can vary depending on market conditions, the volume of certain trading and lending activities, our credit ratings and the overall availability of credit.

 

 

  19   March 2017 Form 10-Q


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We may engage in various transactions in the credit markets (including, for example, debt retirements) that we believe are in our investors’ best interests.

Long-term Borrowings by Maturity at March 31, 2017

 

$ in millions    Parent
Company
     Subsidiaries      Total  

2017

   $     12,491      $ 4,187      $     16,678  

2018

     18,238        2,008        20,246  

2019

     21,335        1,144        22,479  

2020

     19,266        1,456        20,722  

2021

     15,667        1,202        16,869  

Thereafter

     69,414        6,280        75,694  

Total

   $ 156,411      $ 16,277      $ 172,688  

Maturities of long-term borrowings outstanding over the next 12 months were $23,239 million at March 31, 2017.

Subsequent to March 31, 2017 and through April 28, 2017, long-term borrowings increased by approximately $4.6 billion, net of maturities. This amount includes the issuances of senior debt; $1.8 billion on April 24, 2017 and $3.8 billion on April 27, 2017.

For further information on long-term borrowings, see Note 10 to the consolidated financial statements.

Credit Ratings

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

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

Parent Company and MSBNA’s Senior Unsecured Ratings at April 28, 2017

 

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

DBRS, Inc.

  R-1 (middle)   A (high)   Stable

Fitch Ratings, Inc.

  F1   A   Stable

Moody’s Investors Service, Inc.

  P-2   A3   Stable

Rating and Investment Information, Inc.

  a-1   A-   Stable

Standard & Poor’s Global Ratings

  A-2   BBB+   Stable

 

    Morgan Stanley Bank, N.A.
     Short-Term
Debt
  Long-Term
Debt
  Rating
Outlook

Fitch Ratings, Inc.

  F1   A+   Stable

Moody’s Investors Service, Inc.

  P-1   A1   Stable

Standard & Poor’s Global Ratings

  A-1   A+   Stable

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

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

Incremental Collateral or Terminating Payments upon Potential Future Rating Downgrade

 

$ in millions   

At

March 31,
2017

    

At

December 31,
2016

 

One-notch downgrade

   $ 1,373      $ 1,292  

Two-notch downgrade

     676        875  

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

 

 

March 2017 Form 10-Q   20  


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client behavior and future mitigating actions we might take. The liquidity impact of additional collateral requirements is included in our Liquidity Stress Tests.

Capital Management

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

Common Stock

We repurchased approximately $750 million of our outstanding common stock as part of our share repurchase program during the current quarter and $625 million during the prior year quarter (see Note 14 to the consolidated financial statements).

For a description of our share repurchase program, see “Unregistered Sales of Equity Securities and Use of Proceeds.”

The Board determines the declaration and payment of dividends on a quarterly basis. On April 19, 2017, we announced that the Board declared a quarterly dividend per common share of $0.20. The dividend is payable on May 15, 2017 to common shareholders of record on May 1, 2017.

Preferred Stock

On March 15, 2017, we announced that the Board declared quarterly dividends for preferred stock shareholders of record on March 31, 2017 that were paid on April 17, 2017.

Series K Preferred Stock. The Series K Preferred Stock offering (net of related issuance costs) resulted in proceeds of approximately $994 million. On March 15, 2017, we announced that the Board declared a quarterly dividend of $304.69 per share of Series K Preferred Stock.

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

Tangible Equity

 

                Monthly Average
Balance
Three Months Ended
 
$ in millions   At March 31,
2017
    At December 31,
2016
   

March 31,

2017

 

Common equity

  $ 69,404     $ 68,530     $ 68,989  

Preferred equity

    8,520       7,520       8,270  

Morgan Stanley shareholders’ equity

    77,924       76,050       77,259  

Less: Goodwill and net intangible assets

    (9,229     (9,296     (9,262

Tangible Morgan Stanley shareholder’s equity1

  $         68,695     $ 66,754     $         67,997  

Common equity

  $ 69,404     $ 68,530     $ 68,989  

Less: Goodwill and net intangible assets

    (9,229     (9,296     (9,262

Tangible common equity1

  $ 60,175     $ 59,234     $ 59,727  

 

1.

Tangible Morgan Stanley shareholders’ equity and tangible common equity are non-GAAP financial measures that we and investors consider to be a useful measure to assess capital adequacy.

Regulatory Requirements

Regulatory Capital Framework

We are a financial holding company (“FHC”) under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and are subject to the regulation and oversight of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Federal Reserve establishes capital requirements for us, including well-capitalized standards, and evaluates our compliance with such capital requirements. The Office of the Comptroller of the Currency (“OCC”) establishes similar capital requirements and standards for our U.S. Bank Subsidiaries. The regulatory capital requirements are largely based on the Basel III capital standards established by the Basel Committee and also implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).

The Basel Committee has recently published revisions to certain standards in its capital framework, and is actively considering potential revisions to other capital standards, that, if adopted by the U.S. banking agencies, could substantially change the U.S. regulatory capital framework. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Requirements—Regulatory Capital Framework” in Part II, Item 7 of the 2016 Form 10-K.

 

 

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Regulatory Capital Requirements

We are required to maintain minimum risk-based and leverage capital ratios under the regulatory capital requirements. A summary of the calculations of regulatory capital, risk-weighted assets (“RWAs”) and transition provisions follows.

Regulatory Capital. Minimum risk-based capital ratio requirements apply to Common Equity Tier 1 capital, Tier 1 capital and Total capital. Certain adjustments to and deductions from capital are required for purposes of determining these ratios, such as goodwill, intangible assets, certain deferred tax assets, other amounts in Accumulated other comprehensive income (loss) (“AOCI”) and investments in the capital instruments of unconsolidated financial institutions. Certain of these adjustments and deductions are also subject to transitional provisions.

In addition to the minimum risk-based capital ratio requirements, on a fully phased-in basis by 2019, we will be subject to:

 

 

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

 

 

The Common Equity Tier 1 global systemically important bank (“G-SIB”) capital surcharge, currently at 3%; and

 

 

Up to a 2.5% Common Equity Tier 1 countercyclical capital buffer (“CCyB”), currently set by banking regulators at zero (collectively, the “buffers”).

In 2017, the phase-in amount for each of the buffers is 50% of the fully phased-in buffer requirement. Failure to maintain the buffers would result in restrictions on our ability to make capital distributions, including the payment of dividends and the repurchase of stock, and to pay discretionary bonuses to executive officers. For a further discussion of the G-SIB capital surcharge, see “Management’s Discussion and Analysis of Financial Condition and Results of

Operations—Liquidity and Capital Resources—Regulatory Requirements—G-SIB Capital Surcharge” in Part II, Item 7 of the 2016 Form 10-K.

Risk-Weighted Assets. RWAs reflect both our on- and off-balance sheet risk as well as capital charges attributable to the risk of loss arising from the following:

 

 

Credit risk: The failure of a borrower, counterparty or issuer to meet its financial obligations to us;

 

 

Market risk: Adverse changes in the level of one or more market prices, rates, indices, implied volatilities, correlations or other market factors, such as market liquidity; and

 

 

Operational risk: Inadequate or failed processes or systems, human factors or from external events (e.g., fraud, theft, legal and compliance risks, cyber attacks or damage to physical assets).

For a further discussion of our market, credit and operational risks, see “Quantitative and Qualitative Disclosures about Market Risk.”

Our binding risk-based capital ratios for regulatory purposes are the lower of the capital ratios computed under (i) the standardized approaches for calculating credit risk and market risk RWAs (the “Standardized Approach”) and (ii) the applicable advanced approaches for calculating credit risk, market risk and operational risk RWAs (the “Advanced Approach”). At March 31, 2017, our binding ratios are based on the Advanced Approach transitional rules.

The methods for calculating each of our risk-based capital ratios will change through January 1, 2022 as aspects of the capital rules are phased in. These changes may result in differences in our reported capital ratios from one reporting period to the next that are independent of changes to our capital base, asset composition, off-balance sheet exposures or risk profile.

 

 

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Minimum Risk-Based Capital Ratios: Transitional Provisions

 

 

LOGO

 

1.

 These ratios assume the requirements for the G-SIB capital surcharge (3.0%) and CCyB (zero) remain at current levels. See “Total Loss-Absorbing Capacity,  Long-Term Debt and Clean Holding Company Requirements” herein for additional capital requirements effective  January 1, 2019.

 

Transitional and Fully Phased-In Regulatory Capital Ratios

 

    At March 31, 2017  
    Transitional     Pro Forma Fully Phased-In  
$ in millions   Standardized     Advanced     Standardized         Advanced      

Risk-based capital

       

Common Equity Tier 1 capital

  $ 60,414     $ 60,414     $ 59,554     $ 59,554  

Tier 1 capital

    69,136       69,136       68,297       68,297  

Total capital

    79,957       79,675       79,130       78,848  

Total RWAs

    345,131       347,472       355,668       358,642  

Common Equity Tier 1 capital ratio

    17.5     17.4     16.7     16.6

Tier 1 capital ratio

    20.0     19.9     19.2     19.0

Total capital ratio

    23.2     22.9     22.2     22.0

Leverage-based capital

       

Adjusted average assets1

  $ 816,077       N/A     $ 815,537       N/A  

Tier 1 leverage ratio2

    8.5     N/A       8.4     N/A  
    At December 31, 2016  
    Transitional     Pro Forma Fully Phased-In  
$ in millions   Standardized     Advanced     Standardized         Advanced      

Risk-based capital

       

Common Equity Tier 1 capital

  $ 60,398     $ 60,398     $ 58,616     $ 58,616  

Tier 1 capital

    68,097       68,097       66,315       66,315  

Total capital

    78,917       78,642       77,155       76,881  

Total RWAs

    340,191       358,141       351,101       369,709  

Common Equity Tier 1 capital ratio

    17.8     16.9     16.7     15.9

Tier 1 capital ratio

    20.0     19.0     18.9     17.9

Total capital ratio

    23.2     22.0     22.0     20.8

Leverage-based capital

       

Adjusted average assets1

  $ 811,402       N/A     $ 810,288       N/A  

Tier 1 leverage ratio2

    8.4     N/A       8.2     N/A  

N/A—Not Applicable

1.

Adjusted average assets represent the denominator of the Tier 1 leverage ratio and are composed of the average daily balance of consolidated on-balance sheet assets under U.S. GAAP during the calendar quarter ended March 31, 2017 and December 31, 2016 adjusted for disallowed goodwill, transitional intangible assets, certain deferred tax assets, certain investments in the capital instruments of unconsolidated financial institutions and other adjustments.

2.

The minimum Tier 1 leverage ratio requirement is 4.0%.

 

 

  23   March 2017 Form 10-Q


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The fully phased-in pro forma estimates in the previous tables are based on our current understanding of the capital rules and other factors, which may be subject to change as we receive additional clarification and implementation guidance from the Federal Reserve and as the interpretation of the regulations evolves over time. These fully phased-in pro forma estimates are non-GAAP financial measures that we consider to be useful measures for us, investors and analysts in evaluating compliance with new regulatory capital requirements that were not yet effective at March 31, 2017. These preliminary estimates are subject to risks and uncertainties that may cause actual results to differ materially and should not be taken as a projection of what our capital, capital ratios, RWAs, earnings or other results will actually be at future dates. For a discussion of risks and uncertainties that may affect our future results, see “Risk Factors” in Part I, Item 1A of the 2016 Form 10-K.

Well-Capitalized Minimum Regulatory Capital Ratios for U.S. Bank Subsidiaries

 

      At March 31, 2017  

Common Equity Tier 1 risk-based capital ratio

     6.5%  

Tier 1 risk-based capital ratio

     8.0%  

Total risk-based capital ratio

     10.0%  

Tier 1 leverage ratio

     5.0%  

For us to remain a FHC, our U.S. Bank Subsidiaries must qualify as well-capitalized by maintaining the minimum ratio requirements set forth in the previous table. The Federal Reserve has not yet revised the well-capitalized standard for financial holding companies to reflect the higher capital standards required for us under the capital rules. Assuming that the Federal Reserve would apply the same or very similar well-capitalized standards to financial holding companies, each of our risk-based capital ratios and Tier 1 leverage ratio at March 31, 2017 would have exceeded the revised well-capitalized standard. The Federal Reserve may require us to maintain risk- and leverage-based capital ratios substantially in excess of mandated minimum levels, depending upon general economic conditions and a financial holding company’s particular condition, risk profile and growth plans.

Regulatory Capital Calculated under Advanced Approach

Transitional Rules

 

$ in millions   

At

March 31,
2017

   

At

December 31,

2016

 

Common Equity Tier 1 capital

    

Common stock and surplus

   $               16,745     $               17,494  

Retained earnings

     55,109       53,679  

AOCI

     (2,450     (2,643

Regulatory adjustments and deductions:

    

Net goodwill

     (6,538     (6,526

Net intangible assets (other than goodwill and mortgage servicing assets)

     (2,113     (1,631

Credit spread premium over risk-free rate for derivative liabilities

     (324     (271

Net deferred tax assets

     (449     (304

Net after-tax DVA

     473       357  

Adjustments related to AOCI

     194       422  

Other adjustments and deductions

     (233     (179

Total Common Equity Tier 1 capital

   $ 60,414     $ 60,398  

Additional Tier 1 capital

    

Preferred stock

   $ 8,520     $ 7,520  

Noncontrolling interests

     490       613  

Regulatory adjustments and deductions:

    

Credit spread premium over risk-free rate for derivative liabilities

     (81     (181

Net deferred tax assets

     (112     (202

Net after-tax DVA

     118       238  

Other adjustments and deductions

     (52     (101

Additional Tier 1 capital

   $ 8,883     $ 7,887  

Deduction for investments in covered funds

     (161     (188

Total Tier 1 capital

   $ 69,136     $ 68,097  

Tier 2 capital

    

Subordinated debt

   $ 10,255     $ 10,303  

Noncontrolling interests

     79       62  

Eligible allowance for credit losses

     208       189  

Regulatory adjustments and deductions

     (3     (9

Total Tier 2 capital

   $ 10,539     $ 10,545  

Total capital

   $ 79,675     $ 78,642  
 

 

March 2017 Form 10-Q   24  


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Rollforward of Regulatory Capital Calculated under Advanced Approach Transitional Rules

 

$ in millions   

Three Months
Ended

March 31,

2017

 

Common Equity Tier 1 capital

  

Common Equity Tier 1 capital at December 31, 2016

   $ 60,398  

Change related to the following items:

  

Value of shareholders’ common equity

     874  

Net goodwill

     (12

Net intangible assets (other than goodwill and mortgage servicing assets)

     (482

Credit spread premium over risk-free rate for derivative liabilities

     (53

Net deferred tax assets

     (145

Net after-tax DVA

     116  

Adjustments related to AOCI

     (228

Other deductions and adjustments

     (54

Common Equity Tier 1 capital at March 31, 2017

   $ 60,414  

Additional Tier 1 capital

  

Additional Tier 1 capital at December 31, 2016

   $ 7,887  

New issuance of qualifying preferred stock

     1,000  

Change related to the following items:

  

Noncontrolling interests

     (123

Credit spread premium over risk-free rate for derivative liabilities

     100  

Net deferred tax assets

     90  

Net after-tax DVA

     (120

Other adjustments and deductions

     49  

Additional Tier 1 capital at March 31, 2017

     8,883  

Deduction for investments in covered funds at December 31, 2016

     (188

Deduction for investments in covered funds

     27  

Deduction for investments in covered funds at March 31, 2017

     (161

Tier 1 capital at March 31, 2017

   $ 69,136  

Tier 2 capital

  

Tier 2 capital at December 31, 2016

   $ 10,545  

Change related to the following items:

  

Subordinated debt

     (48

Noncontrolling interests

     17  

Eligible allowance for credit losses

     19  

Other adjustments and deductions

     6  

Tier 2 capital at March 31, 2017

   $ 10,539  

Total capital at March 31, 2017

   $ 79,675  

Rollforward of RWAs Calculated under Advanced Approach Transitional Rules

 

 

$ in millions   

Three Months
Ended
March 31,

20171

 

Credit risk RWAs

  

Balance at December 31, 2016

   $ 169,231  

Change related to the following items:

  

Derivatives

     (302

Securities financing transactions

     1,413  

Securitizations

     912  

Credit valuation adjustment

     (1,269

Investment securities

     (18

Loans

     (3,396

Cash

     343  

Equity investments

     (2

Other credit risk2

     (202

Total change in credit risk RWAs

   $ (2,521

Balance at March 31, 2017

   $ 166,710  

Market risk RWAs

  

Balance at December 31, 2016

   $ 60,872  

Change related to the following items:

  

Regulatory VaR

     848  

Regulatory stressed VaR

     330  

Incremental risk charge

     1,018  

Comprehensive risk measure

     (1,314

Specific risk:

  

Non-securitizations

     2,425  

Securitizations

     728  

Total change in market risk RWAs

   $ 4,035  

Balance at March 31, 2017

   $ 64,907  

Operational risk RWAs

  

Balance at December 31, 2016

   $ 128,038  

Change in operational risk RWAs3

     (12,183

Balance at March 31, 2017

   $ 115,855  

Total RWAs

   $ 347,472  

VaR—Value-at-Risk

1.

The RWAs for each category in the table reflect both on- and off-balance sheet exposures, where appropriate.

2.

Amount reflects assets not in a defined category, non-material portfolios of exposures and unsettled transactions.

3.

Amount reflects a reduction in the internal loss data related to litigation utilized in the operational risk capital model.

Supplementary Leverage Ratio

We and our U.S. Bank Subsidiaries are required to publicly disclose our supplementary leverage ratios, which will become effective as a capital standard on January 1, 2018. By January 1, 2018, we must also maintain a Tier 1 supplementary leverage capital buffer of at least 2% in addition to the 3% minimum supplementary leverage ratio (for a total of at

 

 

  25   March 2017 Form 10-Q


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least 5%), in order to avoid limitations on capital distributions, including dividends and stock repurchases, and discretionary bonus payments to executive officers. In addition, beginning in 2018, our U.S. Bank Subsidiaries must maintain a supplementary leverage ratio of 6% to be considered well-capitalized.

Pro Forma Supplementary Leverage Exposure and Ratio on a Transitional Basis

 

$ in millions    At
March 31,
2017
     At
December 31,
2016
 

Average total assets1

   $ 825,739      $ 820,536  

Adjustments2, 3

     241,734        242,113  

Pro forma supplementary leverage exposure

   $ 1,067,473      $ 1,062,649  

Pro forma supplementary leverage ratio

     6.5%        6.4%  

 

1.

Computed as the average daily balance of consolidated total assets under U.S. GAAP during the calendar quarter ended March 31, 2017 and December 31, 2016.

2.

Computed as the arithmetic mean of the month-end balances over the calendar quarter ended March 31, 2017 and December 31, 2016.

3.

Adjustments are to: (i) incorporate derivative exposures, including adding the related potential future exposure (including for derivatives cleared for clients), grossing up cash collateral netting where qualifying criteria are not met and adding the effective notional principal amount of sold credit protection offset by qualifying purchased credit protection; (ii) reflect the counterparty credit risk for repo-style transactions; (iii) add the credit equivalent amount for off-balance sheet exposures; and (iv) apply other adjustments to Tier 1 capital, including disallowed goodwill, transitional intangible assets, certain deferred tax assets and certain investments in the capital instruments of unconsolidated financial institutions.

Based on our current understanding of the rules and other factors, we estimate our pro forma fully phased-in supplementary leverage ratio to be approximately 6.4% at March 31, 2017 and 6.2% at December 31, 2016. These estimates utilize a fully phased-in Tier 1 capital numerator and a fully phased-in denominator of approximately $1,066.9 billion at March 31, 2017 and $1,061.5 billion at December 31, 2016, which takes into consideration the Tier 1 capital deductions that would be applicable in 2018 after the phase-in period has ended.

U.S. Subsidiary Banks’ Pro Forma Supplementary Leverage Ratios on a Transitional Basis

 

      At March 31, 2017     At December 31, 2016  

MSBNA

     8.1     7.7%  

MSPBNA

     10.4     10.2%  

The pro forma supplementary leverage exposures and pro forma supplementary leverage ratios, both on transitional and fully phased-in bases, are non-GAAP financial measures that we consider to be useful measures for us, investors and analysts in evaluating prospective compliance with new regulatory capital requirements that have not yet become effective. Our estimates are subject to risks and uncertainties that may cause actual results to differ materially from estimates based on these regulations. Further, these expectations should not be taken as projections of what our supplementary leverage ratios, earnings, assets or exposures will actually be

at future dates. For a discussion of risks and uncertainties that may affect our future results, see “Risk Factors” in Part I, Item 1A of the 2016 Form 10-K.

Total Loss-Absorbing Capacity, Long-Term Debt and Clean Holding Company Requirements

On December 15, 2016, the Federal Reserve adopted a final rule for top-tier bank holding companies of U.S. G-SIBs (“covered BHCs”), including the Parent Company, that establishes external TLAC, long-term debt (“LTD”) and clean holding company requirements. The final rule contains various definitions and restrictions, such as requiring eligible LTD to be issued by the covered BHC and be unsecured, have a maturity of one year or more from the date of issuance and not have certain derivative-linked features typically associated with certain types of structured notes. Covered BHCs must comply with all requirements under the rule by January 1, 2019, which we expect to comply with.

For a further discussion of TLAC and LTD requirements, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Requirements—Total Loss-Absorbing Capacity, Long-Term Debt and Clean Holding Company Requirements” in Part II, Item 7 of the 2016 Form 10-K. For discussions about the interaction between the single point of entry (“SPOE”) resolution strategy and the TLAC and LTD requirements, see “Business—Supervision and Regulation—Financial Holding Company—Resolution and Recovery Planning” in Part I, Item 1 and “Risk Factors—Legal, Regulatory and Compliance Risk” in Part I, Item 1A of the 2016 Form 10-K.

Capital Plans and Stress Tests

Pursuant to the Dodd-Frank Act, the Federal Reserve has adopted capital planning and stress test requirements for large bank holding companies, including us, which form part of the Federal Reserve’s annual Comprehensive Capital Analysis and Review (“CCAR”) framework.

In March 2017, we received a non-objection from the Federal Reserve to our resubmitted 2016 capital plan.

We submitted our 2017 capital plan and company-run stress test results to the Federal Reserve on April 5, 2017. We expect that the Federal Reserve will provide its response to our 2017 capital plan by June 30, 2017. The Federal Reserve is expected to publish summary results of the CCAR and Dodd-Frank Act supervisory stress tests of each large bank holding company, including us, by June 30, 2017. We must disclose a summary of the results of our company-run stress tests within 15 days of the date the Federal Reserve discloses the results of the supervisory stress tests. In addition, we must

 

 

March 2017 Form 10-Q   26  


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submit the results of our mid-cycle company-run stress test to the Federal Reserve by October 5, 2017 and disclose a summary of the results between October 5, 2017 and November 4, 2017.

The Dodd-Frank Act also requires each of our U.S. Bank Subsidiaries to conduct an annual stress test. MSBNA and MSPBNA submitted their 2017 annual company-run stress tests to the OCC on April 5, 2017 and must publish a summary of their stress test results between June 15, 2017 and July 15, 2017.

For a further discussion of our capital plans and stress tests, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Requirements—Capital Plans and Stress Tests” in Part II, Item 7 of the 2016 Form 10-K.

Attribution of Average Common Equity According to the Required Capital Framework

Our required capital (“Required Capital”) estimation is based on the Required Capital framework, an internal capital adequacy measure. Common equity attribution to the business segments is based on capital usage calculated by the Required Capital framework, as well as each business segment’s relative contribution to our total Required Capital. Required Capital is assessed for each business segment and further attributed to product lines. This process is intended to align capital with the risks in each business segment in order to allow senior management to evaluate returns on a risk-adjusted basis.

The Required Capital framework is a risk-based and leverage use-of-capital measure, which is compared with our regulatory capital to ensure that we maintain an amount of going concern capital after absorbing potential losses from stress events, where applicable, at a point in time. We define the difference between our total average common equity and the sum of the average common equity amounts allocated to our business segments as Parent Company equity. We generally hold Parent Company equity for prospective regulatory requirements, organic growth, acquisitions and other capital needs.

Common equity estimation and attribution to the business segments are based on our pro forma fully phased-in regulatory capital estimates, including supplementary leverage, and incorporates our internal stress tests. The amount of capital allocated to the business segments are set at the beginning of each year and will remain fixed throughout the year until the next annual reset. Differences between available and Required Capital will be attributed to Parent Company equity during the year.

The Required Capital framework is expected to evolve over time in response to changes in the business and regulatory environment, for example, to incorporate enhancements in modeling techniques. We will continue to evaluate the framework with respect to the impact of future regulatory requirements, as appropriate.

Average Common Equity Attribution

 

     Three Months Ended  
     March 31,  
$ in billions    2017      2016  

Institutional Securities

   $ 40.2      $ 43.2  

Wealth Management

     17.2        15.3  

Investment Management

     2.4        2.8  

Parent Company

     9.2        6.9  

Total1

   $ 69.0      $ 68.2  

 

1.

Average common equity is a non-GAAP financial measure that we consider to be a useful measure for us, investors and analysts to assess capital adequacy.

Regulatory Developments

Resolution and Recovery Planning

Pursuant to the Dodd-Frank Act, we are required to submit to the Federal Reserve and the Federal Deposit Insurance Corporation (“FDIC”) an annual resolution plan that describes our strategy for a rapid and orderly resolution under the U.S. Bankruptcy Code in the event of our material financial distress or failure.

Our preferred resolution strategy, which is set out in our 2015 resolution plan, is an SPOE strategy. On September 30, 2016, we submitted a status report to the Federal Reserve and the FDIC in respect of certain shortcomings identified in our 2015 resolution plan. As indicated in our status report, the Parent Company will amend and restate its support agreement with its material subsidiaries. Under the amended and restated support agreement, upon the occurrence of a resolution scenario, the Parent Company will be obligated to contribute or loan on a subordinated basis all of its material assets, other than shares in subsidiaries of the Parent Company and certain intercompany receivables, to provide capital and liquidity, as applicable, to our material subsidiaries. The obligations of the Parent Company under the amended and restated support agreement will be secured on a senior basis by the assets of the Parent Company (other than shares in subsidiaries of the Parent Company). As a result, claims of our material subsidiaries against the assets of the Parent Company (other than shares in subsidiaries of the Parent Company) will be effectively senior to unsecured obligations of the Parent Company. Due to a filing extension

 

 

  27   March 2017 Form 10-Q


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issued by the Federal Reserve and the FDIC in 2016, our next full resolution plan submission will be on July 1, 2017.

In September 2016, the OCC issued final guidelines that establish enforceable standards for recovery planning by national banks and certain other institutions with total consolidated assets of $50 billion or more, calculated on a rolling four-quarter average basis, including MSBNA and MSPBNA. The guidelines were effective on January 1, 2017; MSBNA must be in compliance by January 1, 2018 and MSPBNA must be in compliance by October 1, 2018.

For more information about resolution and recovery planning requirements and our activities in these areas, including the implications of such activities in a resolution scenario, see “Business—Supervision and Regulation—Financial Holding Company—Resolution and Recovery Planning” in Part I, Item 1, “Risk Factors—Legal, Regulatory and Compliance Risk” in Part I, Item 1A and “Management’s Discussion and Analysis of Financial Condition and Results of Operations— Liquidity and Capital Resources—Regulatory Developments—Resolution and Recovery Planning” in Part II, Item 7 of the 2016 Form 10-K.

Legacy Covered Funds under the Volcker Rule

The Volcker Rule prohibits “banking entities,” including us and our affiliates, from engaging in certain “proprietary trading” activities, as defined in the Volcker Rule, subject to exemptions for underwriting, market-making-related activities, risk-mitigating hedging and certain other activities. The Volcker Rule also prohibits certain investments and relationships by banking entities with “covered funds,” with a number of exemptions and exclusions.

For more information about Volcker Rule requirements and our activities in these areas, including the conformance periods applicable to certain covered funds and our application for a statutory extension, see “Business—Supervision and Regulation—Financial Holding Company—Activities Restrictions under the Volcker Rule” in Part I, Item 1 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Developments—Legacy Covered Funds under the Volcker Rule” in Part II, Item 7 of the 2016 Form 10-K.

U.S. Department of Labor Conflict of Interest Rule

In April 2017, the U.S. Department of Labor published a final Conflict of Interest Rule, which delayed the applicability date

from April 10, 2017 to June 9, 2017, with certain aspects subject to phased-in compliance, and with full compliance required by January 1, 2018, assuming no further delays. For a discussion of the U.S. Department of Labor Conflict of Interest Rule, see “Business—Supervision and Regulation— Institutional Securities and Wealth Management” in Part I, Item 1 of the 2016 Form 10-K.

U.K. Referendum

Following the U.K. electorate vote to leave the European Union, the U.K. invoked Article 50 of the Lisbon Treaty on March 29, 2017. For further discussion of U.K. referendum’s potential impact on our operations, see “Risk Factors—International Risk” in Part I, Item 1A of the 2016 Form 10-K. For further information regarding our exposure to the U.K., see also “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Credit Risk—Country Risk Exposure.”

Off-Balance Sheet Arrangements

We enter into various off-balance sheet arrangements, including through unconsolidated special purpose entities (“SPEs”) and lending-related financial instruments (e.g., guarantees and commitments), primarily in connection with the Institutional Securities and Investment Management business segments.

We utilize SPEs primarily in connection with securitization activities. For information on our securitization activities, see Note 12 to the consolidated financial statements.

For information on our commitments, obligations under certain guarantee arrangements and indemnities, see Note 11 to the consolidated financial statements. For further information on our lending commitments, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Credit Risk—Lending Activities.”

Effects of Inflation and Changes in Interest and Foreign Exchange Rates

For a discussion of the effects of inflation and changes in interest and foreign exchange rates on our business and financial results and strategies to mitigate potential exposures, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Effects of Inflation and Changes in Interest and Foreign Exchange Rates” in Part II, Item 7 of the 2016 Form 10-K.

 

 

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Risk Management

Management believes effective risk management is vital to the success of our business activities. For a discussion of our risk management functions, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management” in Part II, Item 7A of the 2016 Form 10-K.

Market Risk

Market risk refers to the risk that a change in the level of one or more market prices, rates, indices, implied volatilities (the price volatility of the underlying instrument imputed from option prices), correlations or other market factors, such as market liquidity, will result in losses for a position or portfolio. Generally, we incur market risk as a result of trading, investing and client facilitation activities, principally within the Institutional Securities business segment where the substantial majority of our Value-at-Risk (“VaR”) for market risk exposures is generated. In addition, we incur market risk within the Wealth Management and Investment Management business segments. The Wealth Management business segment primarily incurs non-trading market risk from lending and deposit-taking activities. The Investment Management business segment primarily incurs non-trading market risk from capital investments in real estate funds and investments in private equity vehicles. For a further discussion of market risk, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Market Risk” in Part II, Item 7A of the 2016 Form 10-K.

VaR

We use the statistical technique known as VaR as one of the tools used to measure, monitor and review the market risk exposures of our trading portfolios. The Market Risk Department calculates and distributes daily VaR-based risk measures to various levels of management.

VaR Methodology, Assumptions and Limitations.    For information regarding our VaR methodology, assumptions and limitations, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Market Risk—Sales and Trading and Related Activities—VaR Methodology, Assumptions and Limitations” in Part II, Item 7A of the 2016 Form 10-K.

We utilize the same VaR model for risk management purposes as well as for regulatory capital calculations. Our VaR model has been approved by our regulators for use in regulatory calculations.

The portfolio of positions used for our VaR for risk management purposes (“Management VaR”) differs from that used

for regulatory capital requirements (“Regulatory VaR”). Management VaR contains certain positions that are excluded from Regulatory VaR. Examples include counterparty credit valuation adjustment (“CVA”) and related hedges, as well as loans that are carried at fair value and associated hedges.

The following table presents the Management VaR for the Trading portfolio, on a period-end, quarterly average and quarterly high and low basis. To further enhance the transparency of the traded market risk, the Credit Portfolio VaR has been disclosed as a separate category from the Primary Risk Categories. The Credit Portfolio includes counterparty CVA and related hedges, as well as loans that are carried at fair value and associated hedges.

Trading Risks

95%/One-Day Management VaR

 

     95%/One-Day VaR for the  
     Quarter Ended  
     March 31, 2017  
$ in millions   

Period

End

    Average     High      Low  

Interest rate and credit spread

   $ 40     $ 30     $ 40      $ 23  

Equity price

     19       15       26        12  

Foreign exchange rate

     11       11       18        7  

Commodity price

     8       8       11        7  

Less: Diversification benefit1, 2

     (26     (25     N/A        N/A  

Primary Risk Categories

   $ 52     $ 39     $ 52      $ 28  

Credit Portfolio

     14       15       17        14  

Less: Diversification benefit1, 2

     (9     (10     N/A        N/A  

Total Management VaR

   $ 57     $ 44     $ 57      $ 33  
    

 

95%/One-Day VaR for the

 
     Quarter Ended  
     December 31, 2016  
$ in millions   

Period

End

    Average     High      Low  

Interest rate and credit spread

   $ 24     $ 25     $ 30      $ 22  

Equity price

     12       14       28        11  

Foreign exchange rate

     7       9       12        6  

Commodity price

     8       8       10        7  

Less: Diversification benefit1, 2

     (21     (24     N/A        N/A  

Primary Risk Categories

   $ 30     $ 32     $ 46      $ 29  

Credit Portfolio

     15       17       19        15  

Less: Diversification benefit1, 2

     (11     (10     N/A        N/A  

Total Management VaR

   $ 34     $ 39     $ 54      $ 34  

N/A—Not Applicable

1.

Diversification benefit equals the difference between the total Management VaR and the sum of the component VaRs. This benefit arises because the simulated one-day losses for each of the components occur on different days; similar diversification benefits also are taken into account within each component.

2.

The high and low VaR values for the total Management VaR and each of the component VaRs might have occurred on different days during the quarter, and therefore, the diversification benefit is not an applicable measure.

 

 

  29   March 2017 Form 10-Q


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The average total Management VaR for the quarter ended March 31, 2017 (“current quarter”) was $44 million compared with $39 million for the quarter ended December 31, 2016 (“last quarter”). The average Management VaR for the Primary Risk Categories for the current quarter was $39 million compared with $32 million for the last quarter. These increases were driven by strong client demand within our sales and trading businesses and areas of volatility across several fixed income asset classes.

Distribution of VaR Statistics and Net Revenues for the Current Quarter.    One method of evaluating the reasonableness of our VaR model as a measure of our potential volatility of net revenues is to compare VaR with actual trading revenues. Assuming no intraday trading, for a 95%/one-day VaR, the expected number of times that trading losses should exceed VaR during the year is 13, and, in general, if trading losses were to exceed VaR more than 21 times in a year, the adequacy of the VaR model would be questioned. We evaluate the reasonableness of our VaR model by comparing the potential declines in portfolio values generated by the model with actual trading results for the Firm, as well as individual business units. For days where losses exceed the VaR statistic, we examine the drivers of trading losses to evaluate the VaR model’s accuracy relative to realized trading results.

The distribution of VaR Statistics and Net Revenues is presented in the following histograms for the Total Trading populations.

Total Trading.    As shown in the 95%/One-Day Management VaR table on the preceding page, the average 95%/one-day total Management VaR for the current quarter was $44 million. The following histogram presents the distribution of the daily 95%/one-day total Management VaR for the current quarter, which was in a range between $35 million and $55 million for approximately 95% of trading days during the current quarter.

 

 

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The following histogram shows the distribution for the current quarter of daily net trading revenues, including profits and losses from Interest rate and credit spread, Equity price,

Foreign exchange rate, Commodity price, and Credit Portfolio positions and intraday trading activities, for our Trading businesses. Daily net trading revenues also include intraday trading activities but exclude certain items not captured in the VaR model, such as fees, commissions and net interest income. Daily net trading revenues differ from the definition of revenues required for Regulatory VaR backtesting, which further excludes intraday trading. During the current quarter, we experienced net trading losses on 3 days, of which no day was in excess of the 95%/one-day Total Management VaR.

 

 

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Non-Trading Risks

We believe that sensitivity analysis is an appropriate representation of our non-trading risks. Reflected below is this analysis covering substantially all of the non-trading risk in our portfolio.

Counterparty Exposure Related to Our Own Credit Spread.    The credit spread risk sensitivity of the counterparty exposure related to our own credit spread corresponded to an increase in value of approximately $6 million for each 1 basis point widening in our credit spread level at both March 31, 2017 and December 31, 2016.

Funding Liabilities.    The credit spread risk sensitivity of our mark-to-market funding liabilities corresponded to an increase in value of approximately $19 million and $17 million for each 1 basis point widening in our credit spread level at March 31, 2017 and December 31, 2016, respectively.

Interest Rate Risk Sensitivity.    The following table presents an analysis of selected instantaneous upward and downward parallel interest rate shocks on net interest income over the next 12 months for our U.S. Bank Subsidiaries. These shocks are applied to our 12-month forecast for our U.S. Bank Subsidiaries, which incorporates market expectations of interest rates and our forecasted business activity, including our deposit deployment strategy and asset-liability management hedges.

 

 

March 2017 Form 10-Q   30  


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U.S. Bank Subsidiaries’ Net Interest Income Sensitivity Analysis

 

$ in millions    At March 31, 2017     At December 31, 2016  

Basis point change

    

+200

   $ 537     $ 550  

+100

     332       262  

-100

     (569     (655)  

We do not manage to any single rate scenario but rather manage net interest income in our U.S. Bank Subsidiaries to optimize across a range of possible outcomes. The sensitivity analysis assumes that we take no action in response to these scenarios, assumes there are no changes in other macroeconomic variables normally correlated with changes in interest rates, and includes subjective assumptions regarding customer and market re-pricing behavior and other factors.

Investments. We have exposure to public and private companies through direct investments, as well as through funds that invest in these assets. These investments are predominantly equity positions with long investment horizons, a portion of which are for business facilitation purposes. The market risk related to these investments is measured by estimating the potential reduction in net income associated with a 10% decline in investment values and related impact on performance fees.

Investments Sensitivity, Including Related Performance Fees

 

     10% Sensitivity  
$ in millions   

At

March 31,

2017

    

At

December 31,

2016

 

Investments related to Investment Management activities

   $ 337      $ 332  

Other investments:

     

Mitsubishi UFJ Morgan Stanley Securities Co., Ltd.

     171        158  

Other Firm investments

     151        130  

Equity Market Sensitivity.    In the Wealth Management and Investment Management business segments, certain fee-based revenue streams are driven by the value of clients’ equity holdings. The overall level of revenues for these streams also depends on multiple additional factors that include, but are not limited to, the level and duration of the equity market decline, price volatility, the geographic and industry mix of client assets, the rate and magnitude of client investments and redemptions, and the impact of such market decline and price volatility on client behavior. Therefore, overall revenues do not correlate completely with changes in the equity markets.

Credit Risk

Credit risk refers to the risk of loss arising when a borrower, counterparty or issuer does not meet its financial obligations to us. We primarily incur credit risk exposure to institutions and individuals through our Institutional Securities and Wealth Management business segments. For a further discussion of our credit risks, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Credit Risk” in Part II, Item 7A of the 2016 Form 10-K. Also, see Notes 7 and 11 to the consolidated financial statements for additional information about our loans and lending commitments, respectively.

Lending Activities

We provide loans and lending commitments to a variety of customers, from large corporate and institutional clients to high net worth individuals. In addition, we purchase loans in the secondary market. In the consolidated balance sheets, these loans and lending commitments are carried at either fair value with changes in fair value recorded in earnings; held for investment, which are recorded at amortized cost; or held for sale, which are recorded at the lower of cost or fair value. Loans held for investment and loans held for sale are classified in Loans, and loans held at fair value are classified in Trading assets in the consolidated balance sheets. See Notes 3, 7 and 11 to the consolidated financial statements for further information.

Loan and Lending Commitment Portfolio by Business Segment

 

    At March 31, 2017  
$ in millions   Institutional
Securities
    Wealth
Management
    Investment
Management1
    Total  

Corporate loans

  $ 13,671     $ 11,553     $ 5     $ 25,229  

Consumer loans

          25,042             25,042  

Residential real estate loans

          25,036             25,036  

Wholesale real estate loans

    8,292                   8,292  

Loans held for investment, gross of allowance

    21,963       61,631       5       83,599  

Allowance for loan losses

    (260     (37           (297)  

Loans held for investment, net of allowance

    21,703       61,594       5       83,302  

Corporate loans

    11,216                   11,216  

Residential real estate loans

    11       42             53  

Wholesale real estate loans

    1,382                   1,382  

Loans held for sale

    12,609       42             12,651  

Corporate loans

    6,225             19       6,244  

Residential real estate loans

    857                   857  

Wholesale real estate loans

    1,197                   1,197  

Loans held at fair value

    8,279             19       8,298  

Total loans2

    42,591       61,636       24       104,251  

Lending commitments3,4

    88,721       8,659             97,380  

Total loans and lending commitments2,3,4

  $ 131,312     $ 70,295     $ 24     $ 201,631  
 

 

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    At December 31, 2016  
$ in millions   Institutional
Securities
    Wealth
Management
    Investment
Management1
    Total  

Corporate loans

  $ 13,858     $ 11,162     $ 5     $ 25,025  

Consumer loans

          24,866             24,866  

Residential real estate loans

          24,385             24,385  

Wholesale real estate loans

    7,702                   7,702  

Loans held for investment, gross of allowance

    21,560       60,413       5       81,978  

Allowance for loan losses

    (238     (36           (274)  

Loans held for investment, net of allowance

    21,322       60,377       5       81,704  

Corporate loans

    10,710                   10,710  

Residential real estate loans

    11       50             61  

Wholesale real estate loans

    1,773                   1,773  

Loans held for sale

    12,494       50             12,544  

Corporate loans

    7,199             18       7,217  

Residential real estate loans

    966                   966  

Wholesale real estate loans

    519                   519  

Loans held at fair value

    8,684             18       8,702  

Total loans2

    42,500       60,427       23       102,950  

Lending commitments3,4

    90,143       8,299             98,442  

Total loans and lending commitments2,3,4

  $      132,643     $        68,726     $ 23     $      201,392  

 

1.

Loans in the Investment Management business segment are entered into in conjunction with certain investment advisory activities.

2.

Amounts exclude $26.2 billion and $24.4 billion related to margin loans and $4.3 billion and $4.7 billion related to employee loans at March 31, 2017 and December 31, 2016, respectively. See Notes 6 and 7 to the consolidated financial statements for further information.

3.

Lending commitments represent the notional amount of legally binding obligations to provide funding to clients for all lending transactions. Since commitments associated with these business activities may expire unused or may not be utilized to full capacity, they do not necessarily reflect the actual future cash funding requirements.

4.

For syndications led by us, the lending commitments accepted by the borrower but not yet closed are net of the amounts agreed to by counterparties that will participate in the syndication. For syndications that we participate in and do not lead, lending commitments accepted by the borrower but not yet closed include only the amount that we expect will be allocated from the lead, syndicate bank. Due to the nature of our obligations under the commitments, these amounts include certain commitments participated to third parties.

Our credit exposure from our loans and lending commitments is measured in accordance with our internal risk management standards. Risk factors considered in determining the aggregate allowance for loan and commitment losses include the borrower’s financial strength, seniority of the loan, collateral type, volatility of collateral value, debt cushion, loan-to-value ratio, debt service ratio, covenants and counterparty type. Qualitative and environmental factors such as economic and business conditions, nature and volume of the portfolio and lending terms, and volume and severity of past due loans may also be considered.

At March 31, 2017 and December 31, 2016, the allowance for loan losses related to loans that were accounted for as held for investment was $297 million and $274 million, respectively,

and the allowance for commitment losses related to lending commitments that were accounted for as held for investment was $193 million and $190 million, respectively. The aggregate allowance for loan and commitment losses increased during the current quarter primarily due to updates to model parameters used in determining the inherent allowance. See Note 7 to the consolidated financial statements for further information.

Institutional Securities Lending Activities.    In connection with certain of our Institutional Securities business segment activities, we provide loans and lending commitments to a diverse group of corporate and other institutional clients. These activities include originating and purchasing corporate loans, commercial and residential mortgage lending, asset-backed lending, financing extended to equities and commodities customers, and loans to municipalities. These loans and lending commitments may have varying terms; may be senior or subordinated; may be secured or unsecured; are generally contingent upon representations, warranties and contractual conditions applicable to the borrower; and may be syndicated, traded or hedged by us.

We also participate in securitization activities whereby we extend short-term or long-term funding to clients through loans and lending commitments that are secured by the assets of the borrower and generally provide for over-collateralization, including commercial real estate loans, loans secured by loan pools, commercial company loans, and secured lines of revolving credit. Credit risk with respect to these loans and lending commitments arises from the failure of a borrower to perform according to the terms of the loan agreement or a decline in the underlying collateral value. See Note 12 to the consolidated financial statements for information about our securitization activities. In addition, a collateral management group monitors collateral levels against requirements and oversees the administration of the collateral function. See Note 6 to the consolidated financial statements for additional information about our collateralized transactions.

Institutional Securities loans and lending commitments are mainly related to relationship-based and event-driven lending to select corporate clients. Relationship-based loans and lending commitments are used for general corporate purposes, working capital and liquidity purposes by our investment banking clients and typically consist of revolving lines of credit, letter of credit facilities and term loans. In connection with the relationship-based lending activities, we had hedges (which included single-name, sector and index hedges) with a notional amount of $14.4 billion and $20.2 billion at March 31, 2017 and December 31, 2016, respectively. Event-driven loans and lending commitments are associated with a particular event or transaction, such as to support client merger, acquisition, recapitalization and

 

 

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project finance activities. Event-driven loans and lending commitments typically consist of revolving lines of credit, term loans and bridge loans.

Institutional Securities Loans and Lending Commitments by Credit Rating1

 

    At March 31, 2017  
    Years to Maturity        
$ in millions   Less than 1     1-3     3-5     Over 5     Total  

AAA

  $     $ 165     $     $     $ 165  

AA

    3,810       325       3,792       106       8,033  

A

    3,812       6,296       12,979       1,096       24,183  

BBB

    6,350       14,913       20,318       1,289       42,870  

Investment grade

    13,972       21,699       37,089       2,491       75,251  

Non-investment grade

    7,680       21,329       19,913       5,278       54,200  

Unrated2

    520       60       124       1,157       1,861  

Total

  $     22,172     $     43,088     $     57,126     $     8,926     $     131,312  

 

    At December 31, 2016  
    Years to Maturity        
$ in millions   Less than 1     1-3     3-5     Over 5     Total  

AAA

  $ 50     $ 105     $ 50     $     $ 205  

AA

    3,724       451       4,027             8,202  

A

    2,229       5,385       12,526       944       21,084  

BBB

    7,970       15,479       20,916       2,015       46,380  

Investment grade

    13,973       21,420       37,519       2,959       75,871  

Non-investment grade

    7,506       21,048       19,896       5,722       54,172  

Unrated2

    806       132       175       1,487       2,600  

Total

  $     22,285     $     42,600     $     57,590     $   10,168     $     132,643  

 

1.

Obligor credit ratings are determined by the Credit Risk Management Department.

2.

Unrated loans and lending commitments are primarily trading positions that are measured at fair value and risk managed as a component of Market Risk. For a further discussion of our Market Risk, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Market Risk” herein.

Institutional Securities Loans by Credit Grade

 

$ in millions   

At

March 31,
2017

     At
December 31,
2016
 

Investment grade

   $ 15,400      $ 15,303  

Non-investment grade

     25,395        24,714  

Unrated

     1,796        2,483  

Total1

   $ 42,591      $ 42,500  

 

1.

At March 31, 2017 and December 31, 2016, approximately 99% of loans held for investment were current, while approximately 1% were on nonaccrual status because the loans were past due for a period of 90 days or more or payment of principal or interest was in doubt.

Event-Driven Loans and Lending Commitments

 

$ in millions    At
March 31,
2017
     At
December 31,
2016
 

Loans

   $ 6,392      $ 5,097  

Lending commitments

     12,542        16,252  

Total

   $ 18,934      $ 21,349  

Loans and lending commitments to non-investment grade borrowers

   $ 13,876      $ 15,339  

Maturity Profile of Event-Driven Loans and Lending Commitments

 

      At
March 31,
2017
     At
December 31,
2016
 

Less than 1 year

     31%        34%  

1-3 years

     18%        14%  

3-5 years

     29%        28%  

Over 5 years

     22%        24%  

Institutional Securities Credit Exposure from Loans and Lending Commitments by Industry

 

$ in millions    At
March 31,
2017
     At
December 31,
2016
 

Industry1

     

Real estate

   $ 21,952      $ 19,807  

Consumer discretionary

     11,825        12,059  

Industrials

     11,791        11,465  

Energy

     11,654        11,757  

Funds, exchanges and other financial services2

     10,517        11,481