10-Q 1 d421308d10q.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 June 30, 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 July 31, 2017, there were 1,836,580,691 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.


Table of Contents

QUARTERLY REPORT ON FORM 10-Q

For the quarter ended June 30, 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

                     7  

Supplemental Financial Information and Disclosures

                     18  

Accounting Development Updates

                     18  

Critical Accounting Policies

                     19  

Liquidity and Capital Resources

                     19  

Quantitative and Qualitative Disclosures about Market Risk

            3        31  

Controls and Procedures

            4        41  

Report of Independent Registered Public Accounting Firm

                     42  

Financial Statements

            1        43  

Consolidated Financial Statements and Notes

                     43  

Consolidated Income Statements (Unaudited)

                     43  

Consolidated Comprehensive Income Statements (Unaudited)

                     44  

Consolidated Balance Sheets (Unaudited at June 30, 2017)

                     45  

Consolidated Statements of Changes in Total Equity (Unaudited)

                     46  

Consolidated Cash Flow Statements (Unaudited)

                     47  

Notes to Consolidated Financial Statements (Unaudited)

                     48  

   1. Introduction and Basis of Presentation

                     48  

   2. Significant Accounting Policies

                     49  

  3. Fair Values

                     50  

   4. Derivative Instruments and Hedging Activities

                     62  

  5. Investment Securities

                     67  

  6. Collateralized Transactions

                     71  

   7. Loans and Allowance for Credit Losses

                     73  

  8. Equity Method Investments

                     76  

  9. Deposits

                     76  

10. Long-Term Borrowings and Other Secured Financings

                     77  

11. Commitments, Guarantees and Contingencies

                     77  

12. Variable Interest Entities and Securitization Activities

                     82  

13. Regulatory Requirements

                     85  

14. Total Equity

                     87  

15. Earnings per Common Share

                     89  

16. Interest Income and Interest Expense

                     90  

17. Employee Benefit Plans

                     90  

18. Income Taxes

                     90  

19. Segment and Geographic Information

                     91  

20. Subsequent Events

                     92  

Financial Data Supplement (Unaudited)

                     93  

Other Information

    II                96  

Legal Proceedings

            1        96  

Unregistered Sales of Equity Securities and Use of Proceeds

            2        98  

Exhibits

            6        98  

Signatures

                     99  

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, www.sec.gov, that contains annual, quarterly and current reports, proxy and information statements and other information that issuers file electronically with the SEC. Our electronic SEC filings are available to the public at the SEC’s internet site.

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/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   June 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 $9,503 million in the three months ended June 30, 2017 (“current quarter,” or “2Q 2017”), compared with $8,909 million in the three months ended June 30, 2016 (“prior year quarter,” or “2Q 2016”). For the current quarter, net income applicable to Morgan Stanley was $1,757 million, or $0.87 per diluted common share, compared with $1,582 million, or $0.75 per diluted common share, in the prior year quarter.

 

 

We reported net revenues of $19,248 million in the six months ended June 30, 2017 (“current year period,” or “YTD 2017”), compared with $16,701 million in the six months ended June 30, 2016 (“prior year period,” or “YTD 2016”). For the current year period, net income applicable to Morgan Stanley was $3,687 million, or $1.87 per diluted common share, compared with income of $2,716 million, or $1.30 per diluted common share in the prior year period.

Non-interest Expenses

($ in millions)

 

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Compensation and benefits expenses of $4,252 million in the current quarter and $8,718 million in the current year period increased 6% and 13%, respectively, from $4,015 million in the prior year quarter and $7,698 million in the prior year period, primarily due to increases in incentive compensation driven mainly by higher revenues and

 

 

June 2017 Form 10-Q   2  


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Management’s Discussion and Analysis   LOGO

 

   

the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses were $2,609 million in the current quarter and $5,080 million in the current year period compared with $2,411 million in the prior year quarter and $4,782 million in the prior year period, representing an 8% and a 6% increase, respectively. These increases were primarily as a result of higher Brokerage, clearing and exchange fees expense and other volume-driven expenses and a provision related to a United Kingdom (“U.K.”) indirect tax (i.e. value-added tax or “VAT”) matter. In addition to these drivers, non-compensation expenses increased in the current year period due to higher litigation costs. For further discussion of the U.K. VAT matter, see “Institutional Securities—Investments, Other Revenues, Non-interest Expenses and Other Items—Other Items” herein.

Expense Efficiency Ratio

 

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The expense efficiency ratio was 72.2% in the current quarter and 71.7% in the current year period. The expense efficiency ratio was 72.1% in the prior year quarter and 74.7% in the prior year period (see “Selected Non-Generally Accepted Accounting Principles (“Non-GAAP”) Financial Information” herein).

Return on Average Common Equity

 

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The annualized return on average common equity (“ROE”) was 9.1% in the current quarter and 9.9% in the current

   

year period. The annualized ROE was 8.3% in the prior year quarter and 7.2% in the prior year period (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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  3   June 2017 Form 10-Q


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Management’s Discussion and Analysis   LOGO

 

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 $(75) million and $(63) million in the current quarter and prior year quarter, respectively, and $(149) million and $(130) million in the current year period and prior year period, 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 year period.

 

 

Institutional Securities net revenues of $4,762 million in the current quarter and $9,914 million in the current year period increased 4% from the prior year quarter and increased 20% from the prior year period. The current quarter results primarily reflected higher revenues from underwriting and strength in equity sales and trading. The current year period results primarily reflected higher revenues from fixed income sales and trading and underwriting.

 

 

Wealth Management net revenues of $4,151 million in the current quarter and $8,209 million in the current year period increased 9% from the prior year quarter and increased 10% from the prior year period. The current

   

quarter and the current year period results reflected growth in asset management fee revenues and Net interest income. In addition to these drivers, the current year period results reflected higher transactional revenues.

 

 

Investment Management net revenues of $665 million in the current quarter and $1,274 million in the current year period increased 14% from the prior year quarter and increased 20% from the prior year period. The current quarter results primarily reflected higher investment gains and carried interest and growth in asset management fee revenues. Current year period results primarily reflected investment gains compared with losses in the prior year period and positive carried interest in the current year period.

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.

 

 

June 2017 Form 10-Q   4  


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Management’s Discussion and Analysis   LOGO

 

Selected Financial Information and Other Statistical Data

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
$ in millions   2017     2016     2017     2016  

Income from continuing operations applicable to Morgan Stanley

  $ 1,762     $ 1,586     $ 3,714     $ 2,723  

Income (loss) from discontinued operations applicable to Morgan Stanley

    (5     (4     (27     (7

Net income applicable to Morgan Stanley

    1,757       1,582       3,687       2,716  

Preferred stock dividends and other

    170       157       260       235  

Earnings applicable to Morgan Stanley common shareholders

  $ 1,587     $ 1,425     $ 3,427     $ 2,481  

Effective income tax rate from continuing operations

    32.0     33.5     30.5     33.4

 

    

At June 30,

2017

   

At December 31,

2016

 

Capital ratios (Transitional-Advanced)1

 

Common Equity Tier 1 capital ratio

    16.6     16.9

Tier 1 capital ratio

    19.0     19.0

Total capital ratio

    21.9     22.0

Capital ratios (Transitional-Standardized)1

 

Tier 1 leverage ratio2

    8.5     8.4

 

in millions, except per share and
employee data
   At June 30,
2017
     At December 31,
2016
 

Loans3

   $ 97,639      $ 94,248  

Total assets

   $ 841,016      $ 814,949  

Global Liquidity Reserve4

   $ 188,296      $ 202,297  

Deposits

   $ 144,913      $ 155,863  

Long-term borrowings

   $ 184,112      $ 164,775  

Common shareholders’ equity

   $ 70,306      $ 68,530  

Common shares outstanding

     1,840        1,852  

Book value per common share5

   $ 38.22      $ 36.99  

Worldwide employees

     56,187        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. We consider the non-GAAP financial measures we disclose to be useful to us, investors and analysts by providing further transparency about, or an alternate means of assessing, our financial condition, operating results, prospective regulatory capital requirements, or capital adequacy. 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
June 30,
    Six Months Ended
June 30,
 
$ in billions    2017     2016     2017     2016  

Pre-tax profit margin1

        

Institutional Securities

     30     33     32     29

Wealth Management

     25     23     25     22

Investment Management

     21     20     19     15

Consolidated

     28     28     28     25

Average common equity2

 

   

Institutional Securities

   $ 40.2     $ 43.2     $ 40.2     $ 43.2  

Wealth Management

     17.2       15.3       17.2       15.3  

Investment Management

     2.4       2.8       2.4       2.8  

Parent Company

     10.1       7.7       9.7       7.3  

Consolidated average common equity

   $ 69.9     $ 69.0     $ 69.5     $ 68.6  

Return on average common equity2

 

   

Institutional Securities

     8.5     8.0     9.9     6.4

Wealth Management

     14.6     12.9     14.6     12.7

Investment Management

     16.3     10.6     13.7     8.8

Consolidated

     9.1     8.3     9.9     7.2
 

 

  5   June 2017 Form 10-Q


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Management’s Discussion and Analysis   LOGO

 

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

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 

$ in millions, except per

share data

   2017     2016     2017     2016  

Net income applicable to Morgan Stanley

 

 

 

U.S. GAAP

   $ 1,757     $ 1,582     $ 3,687     $ 2,716  

Impact of discrete tax provision3

     4             18        

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

   $ 1,761     $ 1,582     $ 3,705     $ 2,716  

Earnings per diluted common share

 

 

 

U.S. GAAP

   $ 0.87     $ 0.75     $ 1.87     $ 1.30  

Impact of discrete tax provision3

                 0.01        

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

   $ 0.87     $ 0.75     $ 1.88     $ 1.30  

Effective income tax rate

 

        

U.S. GAAP

     32.0     33.5     30.5     33.4

Impact of discrete tax provision3

     (0.1 )%            (0.4 )%       

Effective income tax rate from continuing

 

     

operations, excluding discrete

tax provision—non-GAAP

     31.9     33.5     30.1     33.4

 

1.

Pre-tax profit margin represents income from continuing operations before income taxes as a percentage of net revenues.

2.

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 upon the conversion of employee share-based awards, which primarily occur in the first quarter of each year. The impact of the income tax consequences upon conversion of the awards may be either a benefit or a provision and is treated as a discrete item. The non-GAAP financial measures for net income applicable to Morgan Stanley, earnings per diluted common share and effective income tax rate above exclude discrete tax provisions other than income tax consequences arising from conversion activity 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.

Consolidated Non-GAAP Financial Measures

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
$ in billions   2017     2016     2017     2016  

Average common equity1, 2, 3

 

 

     

Unadjusted

  $ 69.9     $ 69.0     $ 69.5     $ 68.6  

Excluding DVA

    70.5       69.1       70.1       68.7  

Excluding DVA and discrete tax provision (benefit)

    70.5       69.1       70.1       68.7  

Return on average common equity1, 2, 4, 5

 

 

   

Unadjusted

    9.1     8.3     9.9     7.2

Excluding DVA

    9.0     8.3     9.8     7.2

Excluding DVA and discrete tax provision (benefit)

    9.0     8.3     9.8     7.2

Average tangible common equity1, 2, 3, 6

 

 

   

Unadjusted

  $ 60.7     $ 59.5     $ 60.2     $ 59.1  

Excluding DVA

    61.3       59.6       60.8       59.2  

Excluding DVA and discrete tax provision (benefit)

    61.3       59.6       60.8       59.2  

Return on average tangible common equity1, 2, 5

 

 

 

Unadjusted

    10.4     9.6     11.4     8.4

Excluding DVA

    10.3     9.6     11.3     8.4

Excluding DVA and discrete tax provision (benefit)

    10.4     9.6     11.3     8.4

Expense efficiency ratio7

    72.2     72.1     71.7     74.7

 

     At June 30,
2017
     At December 31,
2016
 

Tangible book value per common share6

  $ 33.24      $ 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.

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

2.

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 upon the conversion of employee share-based awards, which primarily occur in the first quarter of each year. The impact of the income tax consequences upon conversion of the awards may be either a benefit or a provision and is treated as a discrete item. When excluding discrete tax provision (benefit) from average common equity, return on average common equity, average tangible common equity and return on average tangible common equity above only discrete tax provisions (benefits) other than income tax consequences arising from conversion activity are excluded 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.

3.

The impact of DVA on average common equity and average tangible common equity was approximately $(612) million and $(106) million in the current quarter and prior year quarter, respectively. The impact of DVA on average common equity and average tangible common equity was approximately $(599) million and $(128) million in the current year period and prior year period, respectively.

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.

5.

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.

 

 

June 2017 Form 10-Q   6  


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6.

For a discussion of tangible common equity, see “Liquidity and Capital Resources—Tangible Equity” herein. Tangible book value per common share equals tangible common equity divided by common shares outstanding.

7.

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

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.

 

 

  7   June 2017 Form 10-Q


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Management’s Discussion and Analysis   LOGO

 

Institutional Securities

Income Statement Information

 

     Three Months Ended
June 30,
       
$ in millions        2017             2016         % Change  

Revenues

      

Investment banking

   $ 1,413     $ 1,108       28%  

Trading

     2,725       2,498       9%  

Investments

     37       76       (51)%  

Commissions and fees

     630       607       4%  

Asset management, distribution and administration fees

     89       69       29%  

Other

     126       138       (9)%  

Total non-interest revenues

     5,020       4,496       12%  

Interest income

     1,243       966       29%  

Interest expense

     1,501       884       70%  

Net interest

     (258     82       N/M  

Net revenues

     4,762       4,578       4%  

Compensation and benefits

     1,667       1,625       3%  

Non-compensation expenses

     1,652       1,447       14%  

Total non-interest expenses

     3,319       3,072       8%  

Income from continuing operations before income taxes

     1,443       1,506       (4)%  

Provision for income taxes

     413       453       (9)%  

Income from continuing operations

     1,030       1,053       (2)%  

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

     (5     (4     (25)%  

Net income

     1,025       1,049       (2)%  

Net income applicable to noncontrolling interests

     33       61       (46)%  

Net income applicable to Morgan Stanley

   $ 992       988       —%  

 

 

     Six Months Ended
June 30,
       
$ in millions        2017             2016         % Change  

Revenues

      

Investment banking

   $ 2,830     $ 2,098       35%  

Trading

     5,737       4,389       31%  

Investments

     103       108       (5)%  

Commissions and fees

     1,250       1,262       (1)%  

Asset management, distribution and administration fees

     180       142       27%  

Other

     299       142       111%  

Total non-interest revenues

     10,399       8,141       28%  

Interest income

     2,367       2,019       17%  

Interest expense

     2,852       1,868       53%  

Net interest

     (485     151       N/M  

Net revenues

     9,914       8,292       20%  

Compensation and benefits

     3,537       3,007       18%  

Non-compensation expenses

     3,204       2,871       12%  

Total non-interest expenses

     6,741       5,878       15%  

Income from continuing operations before income taxes

     3,173       2,414       31%  

Provision for income taxes

     872       728       20%  

Income from continuing operations

     2,301       1,686       36%  

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

     (27     (7     N/M  

Net income

     2,274       1,679       35%  

Net income applicable to noncontrolling interests

     68       100       (32)%  

Net income applicable to Morgan Stanley

   $ 2,206     $ 1,579       40%  

N/M—Not Meaningful

 

 

June 2017 Form 10-Q   8  


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Management’s Discussion and Analysis   LOGO

 

Investment Banking

Investment Banking Revenues

 

     Three Months Ended
June 30,
        
$ in millions    2017      2016      % Change  

Advisory

   $ 504      $ 497        1%  

Underwriting revenues:

        

Equity

     405        266        52%  

Fixed income

     504        345        46%  

Total underwriting

     909        611        49%  

Total investment banking

   $ 1,413      $ 1,108        28%  

 

 

 

     Six Months Ended
June 30,
        
$ in millions    2017      2016      % Change  

Advisory

   $ 1,000      $ 1,088        (8)%  

Underwriting revenues:

        

Equity

     795        426        87%  

Fixed income

     1,035        584        77%  

Total underwriting

     1,830        1,010        81%  

Total investment banking

   $ 2,830      $ 2,098        35%  

Investment Banking Volumes

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
$ in billions   20171     20161     20171     20161  

Completed mergers and acquisitions2

  $   205     $   241     $   356     $   538  

Equity and equity-related offerings3

    20       14       30       21  

Fixed income offerings4

    67       62       142       113  

 

1.

Source: Thomson Reuters, data at July 12, 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 issuances. 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 $1,413 million in the current quarter and $2,830 million in the current year period increased 28% and 35% from the comparable prior year periods. The increase in the current quarter primarily reflected higher underwriting revenues. The increase in the current year period was due to higher underwriting revenues, partially offset by lower advisory revenues.

 

Advisory revenues were relatively unchanged in the current quarter and decreased in the current year period reflecting the lower volumes of completed merger, acquisition and restructuring transactions (see Investment Banking Volumes table), offset by the positive impact of higher fee realizations.

 

 

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

Sales and Trading Net Revenues

By Income Statement Line Item

 

     Three Months Ended
June 30,
      
$ in millions    2017     2016      % Change

Trading

   $   2,725     $   2,498      9%

Commissions and fees

     630       607      4%

Asset management, distribution and administration fees

     89       69      29%

Net interest

     (258     82      N/M

Total

   $ 3,186     $ 3,256      (2)%

 

     Six Months Ended
June 30,
      
$ in millions    2017     2016      % Change

Trading

   $   5,737     $   4,389      31%

Commissions and fees

     1,250       1,262      (1)%

Asset management, distribution and administration fees

     180       142      27%

Net interest

     (485     151      N/M

Total

   $ 6,682     $ 5,944      12%

N/M—Not Meaningful

 

 

  9   June 2017 Form 10-Q


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Management’s Discussion and Analysis   LOGO

 

By Business

 

     Three Months Ended
June 30,
     
$ in millions      2017         2016       % Change

Equity

   $ 2,155     $ 2,145     —%

Fixed income

     1,239       1,297     (4)%

Other

     (208     (186   (12)%

Total

   $ 3,186     $ 3,256     (2)%

 

     Six Months Ended
June 30,
     
$ in millions      2017         2016       % Change

Equity

   $ 4,171     $ 4,201     (1)%

Fixed income

     2,953       2,170     36%

Other

     (442     (427   (4)%

Total

   $ 6,682     $ 5,944     12%

Sales and Trading Activities—Equity 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 and Other. 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. Other activities include the results from the centralized management of our fixed income derivative counterparty exposures, which are primarily recorded in Trading revenues.

Sales and Trading Net Revenues—Equity and Fixed Income

 

     Three Months Ended
June 30, 2017
 
$ in millions    Trading      Fees1      Net
Interest2
    Total  

Financing

   $ 1,166      $ 88      $ (227   $ 1,027  

Execution services

     601        580        (53     1,128  

Total Equity

   $ 1,767      $ 668      $ (280   $ 2,155  

Total Fixed Income

   $ 1,114      $ 48      $ 77     $ 1,239  

 

     Three Months Ended
June 30, 2016
 
$ in millions    Trading      Fees1      Net
Interest2
    Total  

Financing

   $ 1,039      $ 90      $ (82   $ 1,047  

Execution services

     576        549        (27     1,098  

Total Equity

   $ 1,615      $ 639      $ (109   $ 2,145  

Total Fixed Income

   $ 1,018      $ 37      $ 242     $ 1,297  

 

     Six Months Ended
June 30, 2017
 
$ in millions    Trading      Fees1      Net
Interest2
    Total  

Financing

   $ 2,097      $ 177      $ (415   $ 1,859  

Execution services

     1,265        1,148        (101     2,312  

Total Equity

   $ 3,362      $ 1,325      $ (516   $ 4,171  

Total Fixed Income

   $ 2,712      $ 102      $ 139     $ 2,953  

 

     Six Months Ended
June 30, 2016
 
$ in millions    Trading      Fees1      Net
Interest2
    Total  

Financing

   $ 1,925      $ 176      $ (42   $ 2,059  

Execution services

     1,085        1,149        (92     2,142  

Total Equity

   $ 3,010      $ 1,325      $ (134   $ 4,201  

Total Fixed Income

   $ 1,573      $ 77      $ 520     $ 2,170  

 

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.

 

 

June 2017 Form 10-Q   10  


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Management’s Discussion and Analysis   LOGO

 

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.

Sales and Trading Net Revenues during the Current Quarter

Equity

Equity sales and trading net revenues of $2,155 million in the current quarter were relatively unchanged from the prior year quarter, reflecting higher results in execution services, offset by lower results in our financing business.

 

 

Financing revenues decreased 2% from the prior year quarter as Net interest revenues declined from higher net interest costs, reflecting increased liquidity requirements and an increased proportion of lower spread transactions, partially offset by higher client activity in equity swaps reflected in Trading.

 

 

Execution services increased 3% from the prior year quarter primarily reflecting higher revenues from derivative products and improved commissions and fees driven by increased client activity, partially offset by higher net interest costs.

Fixed Income

Fixed income net revenues of $1,239 million in the current quarter were 4% lower than the prior year quarter, driven by a decrease in Net interest revenues across all three product areas, partially offset by an increase in Trading revenues.

 

 

Credit products decreased due to a lower level of interest realized in securitized products and tighter bid-offer spreads in the current quarter.

 

 

Global macro products decreased due to higher interest costs in the current quarter which resulted from interest rate products inventory management. This was partially offset by improved performance in foreign exchange and emerging markets trading activity principally due to specific market events.

 

Commodities products and Other increased due to the absence of losses from counterparty risk management incurred in the prior year quarter, partially offset by a decrease in Commodities structured transactions.

Sales and Trading Net Revenues during the Current Year Period

Equity

Equity sales and trading net revenues of $4,171 million in the current year period were relatively unchanged from the prior year period, reflecting lower results in our financing business, offset by higher results in execution services.

 

 

Financing revenues decreased 10% from the prior year period as Net interest revenues declined from higher net interest costs, reflecting increased liquidity requirements and an increased proportion of lower spread transactions, partially offset by higher client activity in equity swaps reflected in Trading.

 

 

Execution services increased 8% from the prior year period primarily reflecting improved results in Trading revenues compared with the prior year period when increased volatility resulted in inventory losses.

Fixed Income

Fixed income net revenues of $2,953 million in the current year period were 36% higher than the prior year period, driven by an increase in Trading revenues, partially offset by a decline in Net interest revenues.

 

 

Credit products increased due to the absence of inventory losses driven by a widening spread environment in the prior year period. This was partially offset by a lower level of interest realized in securitized products in the current year period.

 

 

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

 

 

Commodities products and Other increased due to improved energy trading and the absence of losses from counterparty risk management incurred in the prior year period.

 

 

  11   June 2017 Form 10-Q


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

Investments

 

 

Net investment gains of $37 million in the current quarter decreased from the prior year quarter primarily as a result of lower gains on equities business related investments.

 

 

Net investment gains of $103 million in the current year period decreased from the prior year period primarily reflecting lower gains on business related investments, partially offset by gains on investments associated with our compensation plans compared with losses in the prior year period.

Other

 

 

Other revenues of $126 million in the current quarter were relatively unchanged from the prior year quarter. Other revenues of $299 million in the current year period increased from the prior year period primarily reflecting mark-to-market gains on loans held for sale in the current year period compared with mark-to-market losses in the prior year period and a decrease in the provision on loans held for investment.

Non-interest Expenses

Non-interest expenses of $3,319 million in the current quarter increased from the comparable prior year period primarily reflecting a 3% increase in Compensation and benefits expenses and a 14% increase in Non-compensation expenses. Non-interest expenses of $6,741 million in the current year period reflect an 18% increase in Compensation and benefits expenses and a 12% increase in Non-compensation expenses.

 

 

Compensation and benefits expenses increased in the current quarter and current year period 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 and current year period primarily due to higher Brokerage, clearing and exchange fees expense and other volume-driven expenses and a provision related to the U.K. VAT matter (see Other Items below). In addition to these drivers, non-compensation expenses increased in the current year period due to higher litigation costs.

Other Items

The Firm self-identified an issue regarding VAT on intercompany services provided by certain overseas affiliates to our U.K. Group. The Firm is reviewing the reporting of U.K. VAT as additional support service centers were added to our operations over the years, and the focus and nature of their intended services shifted among geographic locations. During the current quarter, we have recorded a provision of $86 million that incorporates potential additional VAT, interest and penalties for this exposure. We are actively working with Her Majesty’s Revenue and Customs to resolve this matter. The provision reflected is based on currently available information and analyses, and our review of this matter is continuing.

 

 

June 2017 Form 10-Q   12  


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Management’s Discussion and Analysis   LOGO

 

Wealth Management

Income Statement Information

 

    Three Months Ended
June 30,
   

% Change

 
$ in millions   2017     20161    

Revenues

     

Investment banking

  $ 135     $ 123       10%  

Trading

    207       252       (18)%  

Investments

    1       —         N/M  

Commissions and fees

    424       423       —%  

Asset management, distribution and administration fees

    2,302       2,082       11%  

Other

    73       102       (28)%  

Total non-interest revenues

    3,142       2,982       5%  

Interest income

    1,114       920       21%  

Interest expense

    105       91       15%  

Net interest

    1,009       829       22%  

Net revenues

    4,151       3,811       9%  

Compensation and benefits

    2,297       2,152       7%  

Non-compensation expenses

    797       800       —%  

Total non-interest expenses

    3,094       2,952       5%  

Income from continuing operations before income taxes

    1,057       859       23%  

Provision for income taxes

    392       343       14%  

Net income applicable to Morgan Stanley

  $ 665     $ 516       29%  
    Six Months Ended
June 30,
   

% Change

 
$ in millions   2017     20161    

Revenues

     

Investment banking

  $ 280     $ 244       15%  

Trading

    445       446       —%  

Investments

    2       (2     200%  

Commissions and fees

    864       835       3%  

Asset management, distribution and administration fees

    4,486       4,136       8%  

Other

    129       160       (19)%  

Total non-interest revenues

    6,206       5,819       7%  

Interest income

    2,193       1,834       20%  

Interest expense

    190       174       9%  

Net interest

    2,003       1,660       21%  

Net revenues

    8,209       7,479       10%  

Compensation and benefits

    4,614       4,240       9%  

Non-compensation expenses

    1,565       1,594       (2)%  

Total non-interest expenses

    6,179       5,834       6%  

Income from continuing operations before income taxes

    2,030       1,645       23%  

Provision for income taxes

    718       636       13%  

Net income applicable to Morgan Stanley

  $ 1,312     $ 1,009       30%  

N/M – Not Meaningful

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
June 30,
2017
     At
December 31,
2016
 

Client assets

   $ 2,239      $ 2,103  

Fee-based client assets1

   $ 962      $ 877  

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

     43%        42%  

Client liabilities2

   $ 77      $ 73  

Bank deposit program

   $ 139      $ 153  

Investment securities portfolio

   $ 53.5      $ 63.9  

Loans and lending commitments

   $ 74.2      $ 68.7  

Wealth Management representatives

     15,777        15,763  

 

     Three Months Ended
June 30,
 
        2017            2016      

Annualized revenues per representative

     

(dollars in thousands)3

   $ 1,052      $ 959  

Client assets per representative

     

(dollars in millions)4

   $ 142      $ 128  

Fee-based asset flows5

     

(dollars in billions)

   $ 19.9      $ 12.0  
     Six Months Ended
June 30,
 
      2017      2016  

Annualized revenues per representative

     

(dollars in thousands)3

   $ 1,041      $ 941  

Client assets per representative

     

(dollars in millions)4

   $ 142      $ 128  

Fee-based asset flows5

     

(dollars in billions)

   $ 38.7      $ 17.9  

 

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.

 

 

  13   June 2017 Form 10-Q


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Management’s Discussion and Analysis   LOGO

 

Transactional Revenues

 

    Three Months Ended
June 30,
   

% Change

 
$ in millions   2017     2016    

Investment banking

  $ 135     $ 123       10%  

Trading

    207       252       (18)%  

Commissions and fees

    424       423       —%  

Total

  $ 766     $ 798       (4)%  
    Six Months Ended
June 30,
   

% Change

 
$ in millions   2017     2016    

Investment banking

  $ 280     $ 244       15%  

Trading

    445       446       —%  

Commissions and fees

    864       835       3%  

Total

  $ 1,589     $ 1,525       4%  

Net Revenues

Transactional Revenues

Transactional revenues of $766 million in the current quarter decreased 4% from the prior year quarter primarily reflecting lower Trading revenues, partially offset by higher Investment banking revenues.

Transactional revenues of $1,589 million in the current year period increased 4% from the prior year period primarily reflecting higher revenues in Investment banking and Commissions and fees.

 

 

Investment banking revenues increased in the current quarter primarily due to higher revenues from structured products and equity syndicate activities, partially offset by lower fixed income revenues as a result of the Fixed Income Integration and lower preferred stock underwriting activity. The increase in the current year period was due to higher revenues from structured products and equity syndicate activities, partially offset by lower preferred stock underwriting activity.

 

 

Trading revenues decreased in the current quarter primarily due to the Fixed Income Integration, partially offset by gains related to investments associated with certain employee deferred compensation plans. Trading revenues in the current year period were relatively unchanged as lower revenues related to the Fixed Income Integration were largely offset by gains related to investments associated with certain employee deferred compensation plans.

 

Commissions and fees were relatively unchanged in the current quarter. Commissions and fees increased in the current year period primarily due 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 $2,302 million in the current quarter and $4,486 million in the current year period increased 11% from the prior year quarter and increased 8% from the prior year period. The increase in each respective period is primarily due to market appreciation and net 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 $1,009 million in the current quarter and $2,003 million in the current year period increased 22% and 21%, respectively, from the comparable prior year periods primarily due to higher interest rates and higher loan balances, partially offset by lower investment portfolio balances.

Other

 

 

Other revenues of $73 million in the current quarter and $129 million in the current year period decreased 28% and 19%, respectively, from the comparable prior year periods, due to lower realized gains from the available for sale (“AFS”) securities portfolio.

Non-interest Expenses

Non-interest expenses of $3,094 million in the current quarter and $6,179 million in the current year period increased 5% and 6%, respectively, from the comparable prior year periods.

 

 

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

 

 

Non-compensation expenses were relatively unchanged in the current quarter. Non-compensation expenses decreased in the current year period primarily due to lower litigation and information processing costs, partially offset by higher deposit insurance expenses.

 

 

June 2017 Form 10-Q   14  


Table of Contents
Management’s Discussion and Analysis   LOGO

 

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
March 31,

2017

    Inflows     Outflows    

Market

Impact

   

At
June 30,

2017

    Average for the
Three Months Ended
June 30, 2017
$ in billions, Fee Rate in bps             Fee Rate1
                                             

Separately managed accounts2, 3

  $ 230     $ 8     $ (7   $ 6     $ 237     17

Unified managed accounts3

    217       13       (7     5       228     98

Mutual fund advisory

    21             (1     1       21     118

Representative as advisor

    133       10       (8     3       138     84

Representative as portfolio manager

    305       23       (11     4       321     96

Subtotal

  $ 906     $ 54     $ (34   $ 19     $ 945     77

Cash management

    21       2       (6           17     6

Total fee-based client assets

  $ 927     $ 56     $ (40   $ 19     $ 962     75
   

At
March 31,

2016

   

Inflows

   

Outflows

   

Market

Impact

   

At
June 30,

2016

    Average for the
Three Months Ended
June 30, 2016
$ in billions, Fee Rate in bps             Fee Rate1
                                             

Separately managed accounts2

  $ 278     $ 9     $ (7   $ (1   $ 279     37

Unified managed accounts

    112       11       (5     2       120     106

Mutual fund advisory

    24             (1           23     119

Representative as advisor

    114       8       (8     3       117     85

Representative as portfolio manager

    255       17       (12     5       265     99

Subtotal

  $ 783     $ 45     $ (33   $ 9     $ 804     78

Cash management

    15       4       (3           16     6

Total fee-based client assets

  $ 798     $ 49     $ (36   $ 9     $ 820     76
   

At
December 31,

2016

   

Inflows

   

Outflows

   

Market

Impact

   

At
June 30,

2017

    Average for the
Six Months Ended
June 30, 2017
$ in billions, fee rate in bps             Fee Rate1
                                             

Separately managed accounts2, 3

  $ 222     $ 16     $ (11   $ 10     $ 237     16

Unified managed accounts3

    204       25       (15     14       228     98

Mutual fund advisory

    21       1       (3     2       21     118

Representative as advisor

    125       19       (14     8       138     85

Representative as portfolio manager

    285       42       (21     15       321     97

Subtotal

  $ 857     $ 103     $ (64   $ 49     $ 945     76

Cash management

    20       5       (8           17     6

Total fee-based client assets

  $ 877     $ 108     $ (72   $ 49     $ 962     75
   

At
December 31,

2015

   

Inflows

   

Outflows

   

Market

Impact

   

At
June 30,

2016

    Average for the
Six Months Ended
June 30, 2016
$ in billions, Fee Rate in bps             Fee Rate1
                                             

Separately managed accounts2

  $ 283     $ 17     $ (17   $ (4   $ 279     37

Unified managed accounts

    105       21       (9     3       120     107

Mutual fund advisory

    25       1       (3           23     119

Representative as advisor

    115       13       (14     3       117     86

Representative as portfolio manager

    252       31       (22     4       265     100

Subtotal

  $ 780     $ 83     $ (65   $ 6     $ 804     77

Cash management

    15       7       (6           16     6

Total fee-based client assets

  $ 795     $ 90     $ (71   $ 6     $ 820     76

bps—Basis points

1.

Certain data enhancements made in the first quarter of 2017 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.

 

  15   June 2017 Form 10-Q


Table of Contents
Management’s Discussion and Analysis   LOGO

 

Investment Management

Income Statement Information

 

    Three Months Ended
June 30,
        
$ in millions   2017     2016     % Change  

Revenues

     

Trading

  $ (3   $ 5       (160 )% 

Investments

    125       50       150

Asset management, distribution and administration fees

    539       517       4

Other

    4       9       (56 )% 

Total non-interest revenues

    665       581       14

Interest income

    1       3       (67 )% 

Interest expense

    1       1      

Net interest

          2       (100 )% 

Net revenues

    665       583       14

Compensation and benefits

    288       238       21

Non-compensation expenses

    235       227       4

Total non-interest expenses

    523       465       12

Income from continuing operations before income taxes

    142       118       20

Provision for income taxes

    41       37       11

Net income

    101       81       25

Net income applicable to noncontrolling interests

    1       3       (67 )% 

Net income applicable to Morgan Stanley

  $ 100     $ 78       28
    Six Months Ended
June 30,
        
$ in millions   2017     2016     % Change  

Revenues

     

Investment banking

  $     $ 1       (100 )% 

Trading

    (14     (5     (180 )% 

Investments

    223       (14     N/M  

Commissions and fees

          3       (100 )% 

Asset management, distribution and administration fees

    1,056       1,043       1

Other

    8       31       (74 )% 

Total non-interest revenues

    1,273       1,059       20

Interest income

    2       4       (50 )% 

Interest expense

    1       3       (67 )% 

Net interest

    1       1      

Net revenues

    1,274       1,060       20

Compensation and benefits

    567       451       26

Non-compensation expenses

    462       447       3

Total non-interest expenses

    1,029       898       15

Income from continuing operations before income taxes

    245       162       51

Provision for income taxes

    71       47       51

Net income

    174       115       51

Net income (loss) applicable to noncontrolling interests

    7       (13     (154 )% 

Net income applicable to Morgan Stanley

  $ 167     $ 128       30

N/M – Not Meaningful

Net Revenues

Investments    

 

 

Investments gains of $125 million in the current quarter compared with Investment gains of $50 million in the prior quarter reflected higher realized gains and higher carried interest in Infrastructure and Private Equity investments.

 

 

Investments gains of $223 million in the current year period reflected gains and positive carried interest in all Alternative/Other products. Investments losses in the prior year period reflected losses and the reversal of previously accrued carried interest in certain Private Equity and Real Estate investments.

Asset Management, Distribution and Administration Fees    

 

 

Asset management, distribution and administration fees of $539 million increased 4% in the current quarter compared to the prior year quarter primarily as a result of higher average assets under management or supervision (“AUM”) in Equity and Fixed income products, with higher performance fees, partially offset by lower fee rates in Liquidity products and Alternative/Other products.

 

 

Asset management, distribution and administration fees of $1,056 million were relatively unchanged in the current year period, reflecting higher average AUM in Equity and Fixed income products, essentially offset by lower fee rates in Alternative/Other products.

See “AUM and Average Fee Rate by Asset Class” herein.

Non-interest Expenses

Non-interest expenses of $523 million in the current quarter and $1,029 million in the current year period increased 12% and 15% from the comparable periods primarily due to higher Compensation and benefit expenses.

 

 

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

 

 

Non-compensation expenses increased in the current quarter and current year period primarily due to higher brokerage, clearing and exchange fees, partially offset by lower professional service fees.

 

 

June 2017 Form 10-Q   16  


Table of Contents
Management’s Discussion and Analysis   LOGO

 

Assets Under Management or Supervision

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

March 31,
2017

     Inflows      Outflows    

Market

Impact

     Other1    

At

June 30,
2017

   

Average for the

Three Months Ended

June 30, 2017

 
$ in billions, Fee Rate in bps                 

Total

AUM

   

Fee

Rate

 
                                                                    

Equity

  $ 87      $ 6      $ (5   $ 5      $ 1     $ 94     $ 91       73  

Fixed income

    62        8        (6     1        1       66       64       33  

Liquidity

    153        308        (308     —          1       154       153       17  

Alternative / Other products

    119        6        (6     3        (1     121       120       70  

Total assets under management or supervision

  $ 421      $ 328      $ (325   $ 9      $ 2     $ 435     $ 428       46  

Shares of minority stake assets

    7                                          8       8          
   

At

March 31,

2016

     Inflows      Outflows     Market
Impact
     Other1    

At

June 30,
2016

   

Average for the

Three Months Ended

June 30, 2016

 
$ in billions, Fee Rate in bps                 

Total

AUM

   

Fee

Rate

 
                                                                    

Equity

  $ 81      $ 5      $ (6   $ 1      $     $ 81     $ 81       74  

Fixed income

    62        7        (8                  61       61       32  

Liquidity

    146        291        (289     1              149       146       19  

Alternative / Other products

    116        9        (10     1        (1     115       116       74  

Total assets under management or supervision

  $ 405      $ 312      $ (313   $ 3      $ (1   $ 406     $ 404       48  

Shares of minority stake assets

    8                                          8       8          
   

At

December 31,
2016

     Inflows      Outflows     Market
Impact
     Other1    

At

June 30,
2017

   

Average for the

Six Months Ended

June 30, 2017

 

$ in billions, Fee Rate in bps

                

Total

AUM

   

Fee

Rate

 
                                                                    

Equity

  $ 79      $ 11      $ (10   $ 13      $ 1     $ 94     $ 87       74  

Fixed income

    60        13        (11     2        2       66       63       33  

Liquidity

    163        636        (646            1       154       155       18  

Alternative / Other products

    115        13        (10     4        (1     121       119       70  

Total assets under management or supervision

  $ 417      $ 673      $ (677   $ 19      $ 3     $ 435     $ 424       46  

Shares of minority stake assets

    8                                          8       8          
   

At

December 31,
2015

     Inflows      Outflows     Market
Impact
     Other1    

At

June 30,
2016

   

Average for the

Six Months Ended

June 30, 2016

 

$ in billions, Fee Rate in bps

                

Total

AUM

   

Fee

Rate

 
                                                                    

Equity

  $ 83      $ 10      $ (12   $            $ 81     $ 80       73  

Fixed income

    60        12        (14     2        1       61       60       32  

Liquidity

    149        627        (627                  149       148       18  

Alternative / Other products

    114        14        (14     1              115       115       77  

Total assets under management or supervision

  $ 406      $ 663      $ (667   $ 3        1     $ 406     $ 403       48  

Shares of minority stake assets

    8                                          8       8          

bps—Basis points

1.

Includes distributions and foreign currency impact.

 

  17   June 2017 Form 10-Q


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Management’s Discussion and Analysis   LOGO

 

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
June 30,

2017

     At
December 31,
2016
 

U.S. Bank Subsidiaries assets

   $ 175.4      $ 180.7  

U.S. Bank Subsidiaries investment securities portfolio:

     

Investment securities—AFS

     38.3        50.3  

Investment securities—HTM

     15.3        13.6  

Total

   $ 53.6      $ 63.9  

Wealth Management U.S. Bank Subsidiaries data

 

Securities-based lending and other loans1

   $ 39.4      $ 36.0  

Residential real estate loans

     25.7        24.4  

Total

   $ 65.1      $ 60.4  

Institutional Securities U.S. Bank Subsidiaries data

 

Corporate loans

   $ 20.0      $ 20.3  

Wholesale real estate loans

     10.7        9.9  

Total

   $ 30.7      $ 30.2  

AFS—Available for sale

HTM—Held to maturity

1.

Other loans primarily include tailored lending.

AFS Investment securities in our U.S. Bank Subsidiaries decreased as of June 30, 2017 as compared with December 31, 2016 primarily as a result of sales of securities to fund changes in our liquidity profile including deposit outflows, growth in loans and growth in HTM securities.

Income Tax Matters

Effective Tax Rate

 

     Three Months Ended
June 30,
       Six Months Ended
June 30,
 
       2017       2016          2017        2016  

From continuing operations

     32.0     33.5        30.5      33.4

The effective tax rate for the current year period includes net discrete tax benefits of $110 million, primarily resulting from a $128 million recurring-type benefit in the current year period 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 accounting updates that apply to us but are not yet effective for the Firm.

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 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 expect to apply the modified retrospective 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. Subject to the resolution of certain industry interpretations, these changes are not expected to be significant.

The recognition of performance fees from fund management activities in the form of carried interest that are subject to reversal is expected to remain essentially unchanged. We expect to apply the equity method of accounting to such carried interest, thus excluding them from the scope of this standard.

 

 

June 2017 Form 10-Q   18  


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Management’s Discussion and Analysis   LOGO

 

We will continue to assess the impact of the new standard as we progress through the implementation process and as industry interpretations are resolved; therefore, additional impacts may be identified prior to adoption.

 

 

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 requires 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.

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 of Directors (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 and business segment 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 June 30, 2017  

$ in millions

  Institutional
Securities
    Wealth
Management
    Investment
Management
    Total  

Assets

       

Cash and cash equivalents1

  $ 30,203     $ 14,391     $ 65     $ 44,659  

Trading assets at fair value

    288,255       77       2,470       290,802  

Investment securities

    18,077       53,499             71,576  

Securities purchased under agreements to resell

    90,490       6,918             97,408  

Securities borrowed

    126,428       294             126,722  

Customer and other receivables

    35,954       18,380       583       54,917  

Loans, net of allowance

    32,528       65,106       5       97,639  

Other assets2

    43,668       12,070       1,555       57,293  

Total assets

  $ 665,603     $ 170,735     $ 4,678     $ 841,016  
 

 

  19   June 2017 Form 10-Q


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Management’s Discussion and Analysis   LOGO

 

    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 $841.0 billion at June 30, 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 products including 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
June 30,
2017
     At
December 31,
2016
 

Securities purchased under agreements to resell and Securities borrowed1

   $ 224,130      $ 227,191  

Securities sold under agreements to repurchase and Securities loaned1

   $ 67,559      $ 70,472  

Securities received as collateral2

   $ 14,408      $ 13,737  

 

    

Daily Average Balance

Three Months Ended

 

$ in millions

   June 30,
2017
     December 31,
2016
 

Securities purchased under agreements to resell and Securities borrowed1

   $ 220,045      $ 224,355  

Securities sold under agreements to repurchase and Securities loaned1

   $ 72,040      $ 68,908  
1.

Differences between period end balances and average balances were not significant.

2.

Included in Trading assets in the consolidated balance sheets.

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 core components of our Liquidity Risk Management Framework are the Required Liquidity Framework, Liquidity Stress Tests and the Global Liquidity Reserve (“GLR”), 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” in Part II, Item 7 of the 2016 Form 10-K.

At June 30, 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 GLR, 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.

 

 

June 2017 Form 10-Q   20  


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GLR by Type of Investment

 

$ in millions

  

At

June 30,

2017

    

At

December 31,
2016

 

Cash deposits with banks

   $ 10,057      $ 8,679  

Cash deposits with central banks

     29,427        30,568  

Unencumbered highly liquid securities:

     

U.S. government obligations

     71,336        78,615  

U.S. agency and agency mortgage-backed securities

     52,967        46,360  

Non-U.S. sovereign obligations1

     21,290        30,884  

Other investment grade securities

     3,219        7,191  

Total

   $ 188,296      $ 202,297  

 

1.

Non-U.S. sovereign obligations are primarily composed of unencumbered German, French, Dutch, U.K. and Japanese government obligations.

GLR Managed by Bank and Non-Bank Legal Entities

 

    

At

June 30,
2017

    

At

December 31,
2016

     Daily Average
Balance
Three Months
Ended
 
$ in millions          June 30,
2017
 

Bank legal entities

        

Domestic

   $ 62,897      $ 74,411      $ 65,976  

Foreign

     4,145        4,238        3,949  

Total Bank legal entities

     67,042        78,649        69,925  

Non-Bank legal entities

        

Domestic:

        

Parent Company

     48,987        66,514        56,070  

Non-Parent Company

     32,953        18,801        31,557  

Total Domestic

     81,940        85,315        87,627  

Foreign

     39,314        38,333        42,620  

Total Non-Bank legal entities

     121,254        123,648        130,247  

Total

   $ 188,296      $ 202,297      $ 200,172  

The reduction in total GLR as of June 30, 2017 compared with December 31, 2016, reflecting the decrease in our AFS Investment securities, was primarily related to the reduction in our deposits balance and growth in loans.

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 (“HQLA”) 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. 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.

HQLA by Type of Asset

 

$ in millions    At
June 30,
2017
     At
December 31,
2016
 

Cash1

   $ 29,608      $ 30,569  

Securities2

     138,666        129,524  

Total3

   $ 168,274      $ 160,093  

 

1.

Cash on deposit with central banks.

2.

Primarily includes U.S. Treasuries; U.S. agency mortgage-backed securities; sovereign bonds; investment-grade corporate bonds; and publicly traded common equities.

3.

Excludes excess HQLA held at U.S. Bank Subsidiaries.

The regulatory definition of HQLA is substantially the same as our GLR. Differences include cash placed at institutions other than central banks, which is included in our GLR but considered an inflow for LCR purposes, and certain unencumbered investment grade corporate bonds and publicly traded common equities, which are includable in HQLA but do not meet the definition of GLR.

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.

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 in August 2016. 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.

 

 

  21   June 2017 Form 10-Q


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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 June 30, 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

 

$ in millions    At June 30, 2017      At December 31, 2016  

Deposits

   $ 144,913      $ 155,863  

The 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. 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 reduction in Deposits as of June 30, 2017 compared with December 31, 2016 was primarily due to client deployment of cash into the markets and typical seasonal client tax payments.

Short-Term Borrowings

 

$ in millions   

At

June 30, 2017

    

At

December 31, 2016

 

Short-term borrowings

   $ 916      $ 941  

Our unsecured short-term borrowings primarily consist of structured notes, bank loans and bank notes with original maturities of 12 months or less.

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.

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 June 30, 2017

 

$ in millions    Parent
Company
     Subsidiaries      Total  

2017

   $ 8,742      $ 4,079      $ 12,821  

2018

     18,532        2,044        20,576  

2019

     21,738        1,567        23,305  

2020

     19,238        1,860        21,098  

2021

     15,826        1,350        17,176  

Thereafter

     80,485        8,651        89,136  

Total

   $ 164,561      $ 19,551      $ 184,112  

Maturities over next 12 months

 

            $ 28,823  

Approximate net increase in long-term borrowings June 30, 2017 through July 28, 2017

 

   $ 7,518  

Includes:

 

  

Senior debt issuance on July 24, 2017

 

     7,000  

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

 

 

June 2017 Form 10-Q   22  


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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 July 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, 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

June 30, 2017

    

At

December 31, 2016

 

One-notch downgrade

   $ 950      $ 1,292  

Two-notch downgrade

     720        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 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 $500 million of our outstanding common stock as part of our share repurchase program during the current quarter and $1,250 million during the current year period. We repurchased approximately $625 million during the prior year quarter and $1,250 million in the prior year period (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.”

For a description of our 2017 capital plan, see “Liquidity and Capital Resources—Regulatory Requirements—Capital Plans and Stress Tests.”

 

 

  23   June 2017 Form 10-Q


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Preferred Stock

On June 15, 2017, we announced that the Board declared quarterly dividends for preferred stock shareholders of record on June 30, 2017 that were paid on July 17, 2017.

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

Tangible Equity

 

    

At
June 30,
2017

   

At
December 31,
2016

    Monthly Average
Balance
Three Months Ended
 
$ in millions        June 30, 2017  

Common equity

   $ 70,306     $ 68,530     $ 69,916  

Preferred equity

     8,520       7,520       8,520  

Morgan Stanley shareholders’ equity

     78,826       76,050       78,436  

Less: Goodwill and net intangible assets

     (9,156     (9,296     (9,194

Morgan Stanley tangible shareholders’ equity1

   $ 69,670     $ 66,754     $ 69,242  

Common equity

   $ 70,306     $ 68,530     $ 69,916  

Less: Goodwill and net intangible assets

     (9,156     (9,296     (9,194

Tangible common equity1

   $ 61,150     $ 59,234     $ 60,722  

 

1.

Morgan Stanley tangible shareholders’ equity and tangible common equity are non-GAAP financial measures.

Regulatory Requirements

Regulatory Capital Framework

We are a financial holding company 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. For additional discussion of 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.

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 (which includes Tier 2 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 U.S. 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.

See “Total Loss-Absorbing Capacity, Long-Term Debt and Clean Holding Company Requirements” herein for additional capital requirements effective January 1, 2019.

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;

 

 

June 2017 Form 10-Q   24  


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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”). The credit risk RWA calculations between the two approaches differ in that the Standardized Approach requires calculation of RWAs using prescribed risk weights, whereas the Advanced Approach utilizes models to calculate exposure amounts and risk weights. At June 30, 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.

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 June 30, 2017  
     Transitional     Pro Forma Fully Phased-In  
$ in millions    Standardized     Advanced     Standardized     Advanced  

Risk-based capital

        

Common Equity Tier 1 capital

   $ 61,604     $ 61,604     $ 60,862     $ 60,862  

Tier 1 capital

     70,380       70,380       69,603       69,603  

Total capital

     81,302       81,025       80,537       80,261  

Total RWAs

     368,963       370,679       379,191       381,520  

Common Equity Tier 1 capital ratio

     16.7     16.6     16.1     16.0

Tier 1 capital ratio

     19.1     19.0     18.4     18.2

Total capital ratio

     22.0     21.9     21.2     21.0

Leverage-based capital

        

Adjusted average assets1

   $ 828,365       N/A     $ 827,842       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 June 30, 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%.

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 because they were not yet effective at June 30, 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.

 

 

  25   June 2017 Form 10-Q


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

 

      At June 30, 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 financial holding company, 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 June 30, 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 Transitional Rules

 

$ in millions   

At

June 30, 2017

   

At

December 31,

2016

 

Common Equity Tier 1 capital

    

Common stock and surplus

   $               16,469     $               17,494  

Retained earnings

     56,325       53,679  

AOCI

     (2,488     (2,643

Regulatory adjustments and deductions:

    

Net goodwill

     (6,532     (6,526

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

     (2,051     (1,631

Other adjustments and deductions1

     (119     25  

Total Common Equity Tier 1 capital

   $ 61,604     $ 60,398  

Additional Tier 1 capital

    

Preferred stock

   $ 8,520     $ 7,520  

Noncontrolling interests

     489       613  

Other adjustments and deductions2

     (66     (246

Additional Tier 1 capital

   $ 8,943     $ 7,887  

Deduction for investments in covered funds

     (167     (188

Total Tier 1 capital

   $ 70,380     $ 68,097  

Standardized Tier 2 capital

    

Subordinated debt

   $ 10,351     $ 10,303  

Noncontrolling interests

     80       62  

Eligible allowance for credit losses

     493       464  

Other adjustments and deductions

     (2     (9

Total Standardized Tier 2 capital

   $ 10,922     $ 10,820  

Total Standardized capital

   $ 81,302     $ 78,917  

Advanced Tier 2 capital

    

Subordinated debt

   $ 10,351     $ 10,303  

Noncontrolling interests

     80       62  

Eligible credit reserves

     216       189  

Other adjustments and deductions

     (2     (9

Total Advanced Tier 2 capital

   $ 10,645     $ 10,545  

Total Advanced capital

   $ 81,025     $ 78,642  
 

 

June 2017 Form 10-Q   26  


Table of Contents
Management’s Discussion and Analysis   LOGO

 

Regulatory Capital Rollforward Calculated under Transitional Rules

 

$ in millions   Six Months Ended
June 30, 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

    1,776  

Net goodwill

    (6

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

    (420

Other adjustments and deductions1

    (144

Common Equity Tier 1 capital at June 30, 2017

  $ 61,604  

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

    (124

Other adjustments and deductions2

    180  

Additional Tier 1 capital at June 30, 2017

    8,943