Form 10-Q
Table of Contents

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

 

LOGO

(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  

 

i


Table of Contents

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.

 

ii


Table of Contents
  LOGO

 

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


Table of Contents
Management’s Discussion and Analysis   LOGO

 

Executive Summary

Overview of Financial Results

Consolidated Results

Net Revenues

($ in millions)

 

LOGO

Net Income Applicable to Morgan Stanley

($ in millions)

 

LOGO

Earnings per Common Share1

 

LOGO

 

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)

 

LOGO

 

LOGO

 

 

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  


Table of Contents
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

 

LOGO

 

 

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

 

LOGO

 

 

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)

 

LOGO

 

LOGO

 

 

  3   June 2017 Form 10-Q


Table of Contents
Management’s Discussion and Analysis   LOGO

 

Net Income Applicable to Morgan Stanley by Segment2, 3

($ in millions)

 

LOGO

 

LOGO

 

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)

 

LOGO

 

LOGO

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  


Table of Contents
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


Table of Contents
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  


Table of Contents
Management’s Discussion and Analysis   LOGO

 

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


Table of Contents
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  


Table of Contents
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


Table of Contents
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  


Table of Contents
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


Table of Contents
Management’s Discussion and Analysis   LOGO

 

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  


Table of Contents
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


Table of Contents
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


Table of Contents
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  


Table of Contents
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


Table of Contents
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  


Table of Contents
Management’s Discussion and Analysis   LOGO

 

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


Table of Contents
Management’s Discussion and Analysis   LOGO

 

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  


Table of Contents
Management’s Discussion and Analysis   LOGO

 

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


Table of Contents
Management’s Discussion and Analysis   LOGO

 

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  


Table of Contents
Management’s Discussion and Analysis   LOGO

 

 

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


Table of Contents
Management’s Discussion and Analysis   LOGO

 

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  

Deduction for investments in covered funds at December 31, 2016

    (188

Change in deduction for investments in covered funds

    21  

Deduction for investments in covered funds at June 30, 2017

    (167

Tier 1 capital at June 30, 2017

  $ 70,380  

Standardized Tier 2 capital

 

Tier 2 capital at December 31, 2016

  $ 10,820  

Change related to the following items:

 

Eligible allowance for credit losses

    29  

Other changes, adjustments and deductions3

    73  

Standardized Tier 2 capital at June 30, 2017

  $ 10,922  

Total Standardized capital at June 30, 2017

  $ 81,302  

Advanced Tier 2 capital

 

Tier 2 capital at December 31, 2016

  $ 10,545  

Change related to the following items:

 

Eligible credit reserves

    27  

Other changes, adjustments and deductions3

    73  

Advanced Tier 2 capital at June 30, 2017

  $ 10,645  

Total Advanced capital at June 30, 2017

  $ 81,025  

 

1.

Other adjustments and deductions used in the calculation of Common Equity Tier 1 capital include credit spread premium over risk-free rate for derivative liabilities, net deferred tax assets, net after-tax DVA and adjustments related to AOCI.

2.

Other adjustments and deductions used in the calculation of Additional Tier 1 capital include credit spread premium over risk-free rate for derivatives liabilities, net deferred tax assets and net after-tax DVA.

3.

Other changes, adjustments and deductions used in the calculations of Standardized and Advanced Tier 2 capital include changes in subordinated debt and noncontrolling interests.

RWAs Rollforward Calculated under Transitional Rules

 

    

Six Months Ended

June 30, 20171

 
$ in millions    Standardized     Advanced  

Credit risk RWAs

    

Balance at December 31, 2016

   $ 278,874     $ 169,231  

Change related to the following items:

    

Derivatives

     3,799       1,896  

Securities financing transactions

     4,406       1,719  

Securitizations

     1,362       992  

Investment securities

     (3,025     (1,593

Commitments, guarantees and loans

     40       228  

Cash

     (452     (520

Equity investments

     (933     (991

Other credit risk2

     1,141       622  

Total change in credit risk RWAs

   $ 6,338     $ 2,353  

Balance at June 30, 2017

   $ 285,212     $ 171,584  

Market risk RWAs

    

Balance at December 31, 2016

   $ 61,317     $ 60,872  

Change related to the following items:

    

Regulatory VaR

     2,366       2,366  

Regulatory stressed VaR

     14,279       14,279  

Incremental risk charge

     2,448       2,448  

Comprehensive risk measure

     (1,935     (1,670

Specific risk:

    

Non-securitizations

     2,138       2,138  

Securitizations

     3,138       3,175  

Total change in market risk RWAs

   $ 22,434     $ 22,736  

Balance at June 30, 2017

   $ 83,751     $ 83,608  

Operational risk RWAs

    

Balance at December 31, 2016

   $ N/A     $ 128,038  

Change in operational risk RWAs3

     N/A       (12,551

Balance at June 30, 2017

   $ N/A     $ 115,487  

Total RWAs

   $ 368,963     $ 370,679  

VaR—Value-at-Risk

N/A—Not Applicable

1.

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

2.

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

3.

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

Regulatory stressed VaR increased $14,279 million in the current year period under both the Standardized and the Advanced approaches. These increases were primarily driven by increases in trading inventory across the equities, global macro, and credit businesses within Institutional Securities, in response to client demand.

 

 

  27   June 2017 Form 10-Q


Table of Contents
Management’s Discussion and Analysis   LOGO

 

Supplementary Leverage Ratio

We and our U.S. Bank Subsidiaries are required to publicly disclose our supplementary leverage ratios, which will become effective as a capital standard on January 1, 2018. By January 1, 2018, we must also maintain a Tier 1 supplementary leverage capital buffer of at least 2% in addition to the 3% minimum supplementary leverage ratio (for a total of at least 5%), in order to avoid limitations on capital distributions, including dividends and stock repurchases, and discretionary bonus payments to executive officers. In addition, beginning in 2018, our U.S. Bank Subsidiaries must maintain a supplementary leverage ratio of 6% to be considered well-capitalized.

Pro Forma Supplementary Leverage Exposure and Ratio

 

    At June 30, 2017     At December 31, 2016  

$ in millions

  Transitional
basis
    Fully
phased-in1
    Transitional
basis
    Fully
phased-in1
 

Average total assets2

  $ 837,875     $ 837,875     $ 820,536     $ 820,536  

Adjustments3, 4

    241,726       241,203       242,113       240,999  

Pro forma supplementary leverage exposure

  $ 1,079,601     $ 1,079,078     $ 1,062,649     $ 1,061,535  

Pro forma supplementary leverage ratio

    6.5%       6.5%       6.4%       6.2%  

 

1.

Estimated amounts utilize fully phased-in Tier 1 capital and take into consideration the Tier 1 capital deduction that would be applicable in 2018 after the phase-in period has ended.

2.

Computed as the average daily balance of consolidated total assets under U.S. GAAP during the calendar quarter ended June 30, 2017 and December 31, 2016.

3.

Computed as the arithmetic mean of the month-end balances over the calendar quarter ended June 30, 2017 and December 31, 2016.

4.

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

Pro forma fully phased-in supplementary leverage exposure and ratio are based on our current understanding of rules and other factors.

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

 

      At June 30, 2017     At December 31, 2016  

MSBNA

     8.8     7.7%  

MSPBNA

     9.9     10.2%  

The pro forma supplementary leverage exposures and pro forma supplementary leverage ratios, both on transitional and fully phased-in bases, are non-GAAP financial measures because they have not yet become effective. Our estimates are subject to risks and uncertainties that may cause actual results to differ materially from estimates based on these regulations. Further, these expectations should not be taken as projections of what our supplementary leverage ratios, earnings, assets or exposures will actually be at future dates. For a

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

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

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

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

Capital Plans and Stress Tests

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

We submitted our 2017 capital plan and company-run stress test results to the Federal Reserve on April 5, 2017. On June 22, 2017, the Federal Reserve published summary results of the Dodd-Frank Act supervisory stress tests of each large bank holding company, including us. On June 28, 2017, the Federal Reserve published summary results of CCAR and announced that they did not object to our 2017 Capital Plan (“Capital Plan”). The Capital Plan includes the repurchase of up to $5.0 billion of outstanding common stock for the period beginning July 1, 2017 through June 30, 2018, an increase from $3.5 billion in the 2016 Capital Plan. Additionally, the Capital Plan includes an increase in our quarterly common

 

 

June 2017 Form 10-Q   28  


Table of Contents
Management’s Discussion and Analysis   LOGO

 

stock dividend to $0.25 per share from $0.20 per share, beginning with the common stock dividend declared on July 19, 2017. We disclosed a summary of the results of our company-run stress tests on June 23, 2017 on our Investor Relations website. In addition, we must submit the results of our mid-cycle company-run stress test to the Federal Reserve by October 5, 2017 and disclose a summary of the results between October 5, 2017 and November 4, 2017.

The Dodd-Frank Act also requires each of our U.S. Bank Subsidiaries to conduct an annual stress test. MSBNA and MSPBNA submitted their 2017 annual company-run stress tests to the OCC on April 5, 2017 and published a summary of their stress test results on June 23, 2017 on our Investor Relations website.

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

Attribution of Average Common Equity According to the Required Capital Framework

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

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

Common equity estimation and attribution to the business segments are based on our pro forma fully phased-in regulatory capital estimates, including supplementary leverage, and incorporates our internal stress tests. The amount of capital allocated to the business segments is set at the beginning of each year and remains fixed throughout the year until the next

annual reset. Differences between available and Required Capital are attributed to Parent Company equity during the year.

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

Average Common Equity Attribution

 

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

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  

Total1

   $ 69.9      $ 69.0      $ 69.5      $ 68.6  

 

1.

Average common equity is a non-GAAP financial measure.

Regulatory Developments

Resolution and Recovery Planning

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

Our preferred resolution strategy, which is set out in our 2017 resolution plan, is a single point of entry strategy. We submitted our full 2017 resolution plan on June 30, 2017. We previously submitted a status report in respect of certain shortcomings identified in our 2015 resolution plan on September 30, 2016. As indicated in our 2017 resolution plan and anticipated in our 2016 status report, the Parent Company has amended and restated its support agreement with its material subsidiaries. Under the amended and restated support agreement, upon the occurrence of a resolution scenario, the Parent Company would be obligated to contribute or loan on a subordinated basis all of its material assets, other than shares in subsidiaries of the Parent Company and certain intercompany receivables, to provide capital and liquidity, as applicable, to our material subsidiaries. The obligations of the Parent Company under the amended and restated support agreement are secured on a senior basis by the assets of the Parent Company (other than shares in subsidiaries of the Parent Company). As a result, claims of our material subsidiaries against the assets of the Parent Company (other than shares in subsidiaries of the

 

 

  29   June 2017 Form 10-Q


Table of Contents
Management’s Discussion and Analysis   LOGO

 

Parent Company) are effectively senior to unsecured obligations of the Parent Company.

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

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

Legacy Covered Funds under the Volcker Rule

The Volcker Rule prohibits “banking entities,” including us and our affiliates, from engaging in certain “proprietary trading” activities, as defined in the Volcker Rule, subject to exemptions for underwriting, market-making-related activities, risk-mitigating hedging and certain other activities. The Volcker Rule also prohibits certain investments and relationships by banking entities with “covered funds,” with a number of exemptions and exclusions. In June 2017, we received approval from the Federal Reserve of our application for a five-year extension of the transition period to conform investments in certain legacy Volcker covered funds that are also illiquid funds. The approval covers essentially all of our non-conforming investments in, and relationships with, legacy covered funds subject to the Volcker Rule.

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

U.S. Department of Labor Conflict of Interest Rule

The U.S. Department of Labor’s final Conflict of Interest Rule went into effect on June 9, 2017, with certain aspects subject to phased-in compliance, and full compliance required by January 1, 2018. The U.S. Department of Labor is undertaking an examination of the rule which may result in changes to the rule or related exemptions or a change in the January 1, 2018 full compliance date. For a discussion of the U.S. Department of Labor Conflict of Interest Rule, see “Business—Supervision and Regulation—Institutional Securities and Wealth Management” in Part I, Item 1 of the 2016 Form 10-K.

U.K. Referendum

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

Off-Balance Sheet Arrangements

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

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

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

Effects of Inflation and Changes in Interest and Foreign Exchange Rates

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

 

 

June 2017 Form 10-Q   30  


Table of Contents
Quantitative and Qualitative Disclosures about Market Risk   LOGO

 

Risk Management

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

Market Risk

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

VaR

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

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

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

The portfolio of positions used for our VaR for risk management purposes (“Management VaR”) differs from that used for regulatory capital requirements (“Regulatory VaR”).

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

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

Trading Risks

95%/One-Day Management VaR

 

     95%/One-Day VaR for the  
     Three Months Ended  
     June 30, 2017  

$ in millions

  

Period

End

    Average     High      Low  

Interest rate and credit spread

   $ 35     $ 35     $ 44      $ 27  

Equity price

     15       18       26        15  

Foreign exchange rate

     10       11       15        8  

Commodity price

     9       9       10        8  

Less: Diversification benefit1, 2

     (27     (27     N/A        N/A  

Primary Risk Categories

   $ 42     $ 46     $ 60      $ 36  

Credit Portfolio

     11       12       14        11  

Less: Diversification benefit1, 2

     (7     (7     N/A        N/A  

Total Management VaR

   $ 46     $ 51     $ 64      $ 41  
    

 

95%/One-Day VaR for the

 
     Three Months Ended  
     March 31, 2017  

$ in millions

  

Period

End

    Average     High      Low  

Interest rate and credit spread

   $ 40     $ 30     $ 40      $ 23  

Equity price

     19       15       26        12  

Foreign exchange rate

     11       11       18        7  

Commodity price

     8       8       11        7  

Less: Diversification benefit1, 2

     (26     (25     N/A        N/A  

Primary Risk Categories

   $ 52     $ 39     $ 52      $ 28  

Credit Portfolio

     14       15       17        14  

Less: Diversification benefit1, 2

     (9     (10     N/A        N/A  

Total Management VaR

   $ 57     $ 44     $ 57      $ 33  

N/A—Not Applicable

1.

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

2.

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

 

 

  31   June 2017 Form 10-Q


Table of Contents
Risk Disclosures   LOGO

 

The average total Management VaR for the three months ended June 30, 2017 (“current quarter”) was $51 million compared with $44 million for the three months ended March 31, 2017 (“last quarter”). The average Management VaR for the Primary Risk Categories for the current quarter was $46 million compared with $39 million for the last quarter. These increases were primarily driven by increases in trading inventory across the equities, global macro, and credit businesses within Institutional Securities, in response to client demand.

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

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

Total Trading.    As shown in the 95%/One-Day Management VaR table on the preceding page, the average 95%/one-day total Management VaR for the current quarter was $51 million. The following histogram presents the distribution of the daily 95%/one-day total Management VaR for the current quarter, which was in a range between $40 million and $60 million for approximately 95% of trading days during the current quarter.

 

LOGO

The following histogram shows the distribution for the current quarter of daily net trading revenues, including profits and losses from Interest rate and credit spread, Equity price, Foreign exchange rate, Commodity price, and Credit Portfolio positions and intraday trading activities, for our Trading businesses. Daily net trading revenues also include intraday trading activities but exclude certain items not captured in the VaR model, such as fees, commissions and net interest income. Daily net trading revenues differ from the definition of revenues required for Regulatory VaR backtesting, which further excludes intraday trading. During the current quarter, we experienced net trading losses on one day, which was not in excess of the 95%/one-day Total Management VaR.

 

LOGO

Non-Trading Risks

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

Counterparty Exposure Related to Our Own Credit Spread.    The credit spread risk sensitivity of the counterparty exposure related to our own credit spread corresponded to an increase in value of approximately $6 million for each 1 basis point widening in our credit spread level at both June 30, 2017 and March 31, 2017.

Funding Liabilities.    The credit spread risk sensitivity of our mark-to-market funding liabilities corresponded to an increase in value of approximately $26 million and $19 million for each 1 basis point widening in our credit spread level at June 30, 2017 and March 31, 2017, respectively.

Interest Rate Risk Sensitivity.    The following table presents an analysis of selected instantaneous upward and downward parallel interest rate shocks on net interest income over the next 12 months for our U.S. Bank Subsidiaries. These shocks

 

 

June 2017 Form 10-Q   32  


Table of Contents
Risk Disclosures   LOGO

 

are applied to our 12-month forecast for our U.S. Bank Subsidiaries, which incorporates market expectations of interest rates and our forecasted business activity, including our deposit deployment strategy and asset-liability management hedges.

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

 

$ in millions    At June 30, 2017     At March 31, 2017  

Basis point change

    

+200

   $ 716     $ 537  

+100

     413       332  

-100

     (577     (569)  

We do not manage to any single rate scenario but rather manage net interest income in our U.S. Bank Subsidiaries to optimize across a range of possible outcomes. The sensitivity analysis assumes that we take no action in response to these scenarios, assumes there are no changes in other macroeconomic variables normally correlated with changes in interest rates, and includes subjective assumptions regarding customer and market re-pricing behavior and other factors. The increase in positive sensitivity to interest rates arising in the +200 and +100 basis points scenarios between March 31, 2017 and June 30, 2017 is related to overall changes in our asset-liability positioning, primarily lower holdings of fixed-rate AFS Investment securities.

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

Investments Sensitivity, Including Related Performance Fees

 

     10% Sensitivity  
$ in millions   

At

June 30,

2017

    

At

March 31,

2017

 

Investments related to Investment Management activities

   $ 326      $ 337  

Other investments:

     

Mitsubishi UFJ Morgan Stanley Securities Co., Ltd.

     171        171  

Other Firm investments

     151        151  

Equity Market Sensitivity.    In the Wealth Management and Investment Management business segments, certain fee-based revenue streams are driven by the value of clients’ equity holdings. The overall level of revenues for these streams also depends on multiple additional factors that include, but are not limited to, the level and duration of the equity market increase or decline, price volatility, the geographic and

industry mix of client assets, the rate and magnitude of client investments and redemptions, and the impact of such market increase or decline and price volatility on client behavior. Therefore, overall revenues do not correlate completely with changes in the equity markets.

Credit Risk

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

Lending Activities

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

Loan and Lending Commitment Portfolio by Business Segment

 

    At June 30, 2017  

$ in millions

  Institutional
Securities
    Wealth
Management
    Investment
Management1
    Total  

Corporate loans

  $ 13,730     $ 13,096     $ 5             $ 26,831  

Consumer loans

          26,354       —               26,354  

Residential real estate loans

          25,646       —               25,646  

Wholesale real estate loans

    8,482             —               8,482  

Loans held for investment, gross of allowance

    22,212       65,096       5               87,313  

Allowance for loan losses

    (266     (40     —               (306)  

Loans held for investment, net of allowance

    21,946       65,056       5               87,007  

Corporate loans

    9,394             —               9,394  

Residential real estate loans

    10       50       —               60  

Wholesale real estate loans

    1,178             —               1,178  

Loans held for sale

    10,582       50       —               10,632  

Corporate loans

    6,755             20               6,775  

Residential real estate loans

    662             —               662  

Wholesale real estate loans

    1,788             —               1,788  

Loans held at fair value

    9,205             20               9,225  

Total loans2

    41,733       65,106       25               106,864  

Lending commitments3,4

    88,739       9,110       —               97,849  

Total loans and lending commitments2,3,4

  $ 130,472     $ 74,216     $ 25             $ 204,713  
 

 

  33   June 2017 Form 10-Q


Table of Contents
Risk Disclosures   LOGO

 

    At December 31, 2016  

$ in millions

  Institutional
Securities
    Wealth
Management
    Investment
Management1
    Total  

Corporate loans

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

Consumer loans

          24,866       —               24,866  

Residential real estate loans

          24,385       —               24,385  

Wholesale real estate loans

    7,702             —               7,702  

Loans held for investment, gross of allowance

    21,560       60,413       5               81,978  

Allowance for loan losses

    (238     (36     —               (274)  

Loans held for investment, net of allowance

    21,322       60,377       5               81,704  

Corporate loans

    10,710             —               10,710  

Residential real estate loans

    11       50       —               61  

Wholesale real estate loans

    1,773             —               1,773  

Loans held for sale

    12,494       50       —               12,544  

Corporate loans

    7,199             18               7,217  

Residential real estate loans

    966             —               966  

Wholesale real estate loans

    519             —               519  

Loans held at fair value

    8,684             18               8,702  

Total loans2

    42,500       60,427       23               102,950  

Lending commitments3,4

    90,143       8,299       —               98,442  

Total loans and lending commitments2,3,4

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

 

1.

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

2.

Amounts exclude $27.7 billion and $24.4 billion related to margin loans and $4.2 billion and $4.7 billion related to employee loans at June 30, 2017 and December 31, 2016, respectively. See Notes 6 and 7 to the consolidated financial statements for further information.

3.

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

4.

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

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

At June 30, 2017 and December 31, 2016, the allowance for loan losses related to loans that were accounted for as held for

investment was $306 million and $274 million, respectively, and the allowance for commitment losses related to lending commitments that were accounted for as held for investment was $186 million and $190 million, respectively. The aggregate allowance for loan and commitment losses increased during the current year period primarily due to updates to model parameters used in determining the inherent allowance. See Note 7 to the consolidated financial statements for further information.

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

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

Institutional Securities loans and lending commitments are mainly related to relationship-based and event-driven lending to select corporate clients. Relationship-based loans and lending commitments are used for general corporate purposes, working capital and liquidity purposes by our investment banking clients and typically consist of revolving lines of credit, letter of credit facilities and term loans. In connection with the relationship-based lending activities, we had hedges (which included single-name, sector and index hedges) with a notional amount of $15.2 billion and $20.2 billion at June 30, 2017 and December 31, 2016,

 

 

June 2017 Form 10-Q   34  


Table of Contents
Risk Disclosures   LOGO

 

respectively. Event-driven loans and lending commitments are associated with a particular event or transaction, such as to support client merger, acquisition, recapitalization and project finance activities. Event-driven loans and lending commitments typically consist of revolving lines of credit, term loans and bridge loans.

Institutional Securities Loans and Lending Commitments by Credit Rating1

 

    At June 30, 2017  
    Years to Maturity        
$ in millions   Less than 1     1-3     3-5     Over 5     Total  

Loans

         

AAA

  $     $     $     $     $  

AA

                34       187       221  

A

    800       2,018       860       781       4,459  

BBB

    2,213       4,505       2,737       590       10,045  

NIG

    5,314       13,016       4,275       2,246       24,851  

Unrated2

    320       129       430       1,278       2,157  

Total Loans3

    8,647       19,668       8,336       5,082       41,733  

Lending Commitments

         

AAA

          165                   165  

AA

    3,885       614       3,620       4       8,123  

A

    2,976       4,704       11,749       759       20,188  

BBB

    2,680       10,216       17,070       208       30,174  

NIG

    3,677       11,065       12,378       2,855       29,975  

Unrated2

    41       46       4       23       114  

Total Lending Commitments

    13,259       26,810       44,821       3,849       88,739  

Total Exposure

  $     21,906     $     46,478     $     53,157     $     8,931     $     130,472  

 

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

Loans

         

AAA

  $     $     $     $     $  

AA

                38             38  

A

    235       775       1,391       552       2,953  

BBB

    1,709       6,473       2,768       1,362       12,312  

NIG

    4,667       12,114       5,629       2,304       24,714  

Unrated2

    699       126       175       1,483       2,483  

Total Loans3

    7,310       19,488       10,001       5,701       42,500  

Lending Commitments

         

AAA

    50       105       50             205  

AA

    3,724       451       3,989             8,164  

A

    1,994       4,610       11,135       392       18,131  

BBB

    6,261       9,006       18,148       653       34,068  

NIG

    2,839       8,934       14,267       3,418       29,458  

Unrated2

    107       6             4       117  

Total Lending Commitments

    14,975       23,112       47,589       4,467       90,143  

Total Exposure

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

 

1.

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

2.

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

3.

At June 30, 2017 and December 31, 2016, approximately 99% of loans held for investment were current, while approximately 1% were on nonaccrual status because the loans were past due for a period of 90 days or more or payment of principal or interest was in doubt.

Event-Driven Loans and Lending Commitments

 

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

Loans

   $ 4,777      $ 5,097  

Lending commitments

     9,685        16,252  

Total

   $ 14,462      $ 21,349  

Loans and lending commitments to non-investment grade borrowers

   $ 11,550      $ 15,339  

 

Maturity Profile of Event-Driven Loans and Lending Commitments

 

 

      At
June 30,
2017
     At
December 31,
2016
 

Less than 1 year

     22%        34%  

1-3 years

     34%        14%  

3-5 years

     21%        28%  

Over 5 years

     23%        24%  

Institutional Securities Credit Exposure from Loans and Lending Commitments by Industry

 

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

Industry1

     

Real estate

   $ 23,794      $ 19,807  

Consumer discretionary

     13,171        12,059  

Funds, exchanges and other financial services2

     12,382        11,481  

Energy

     11,572        11,757  

Industrials

     11,049        11,465  

Utilities

     9,515        9,216  

Healthcare

     9,185        11,534  

Information technology

     8,138        8,602  

Consumer staples

     7,707        7,329  

Mortgage finance

     5,553        6,296  

Materials

     5,283        7,630  

Telecommunications services

     4,437        6,156  

Insurance

     3,510        4,190  

Consumer finance

     2,572        2,847  

Other

     2,604        2,274  

Total

   $ 130,472      $ 132,643  

 

1.

Industry categories are based on the Global Industry Classification Standard®.

2.

Includes mutual funds, pension funds, private equity and real estate funds, exchanges and clearinghouses, and diversified financial services.

 

 

  35   June 2017 Form 10-Q


Table of Contents
Risk Disclosures   LOGO

 

Institutional Securities Lending Exposures Related to the Energy Industry. At June 30, 2017, Institutional Securities’ loans and lending commitments related to the energy industry were $11.6 billion, of which approximately 67% are accounted for as held for investment and 33% are accounted for as either held for sale or at fair value. Additionally, approximately 56% of the total energy industry loans and lending commitments were to investment grade counterparties.

At June 30, 2017, the energy industry portfolio included $1.1 billion in loans and $2.1 billion in lending commitments to Oil and Gas Exploration and Production (“E&P”) companies. The E&P loans were to non-investment grade counterparties, which are generally subject to periodic borrowing base reassessments based on the value of the underlying oil and gas reserves pledged as collateral. In limited situations, we may extend the period related to borrowing base reassessments typically in conjunction with taking certain risk mitigating actions with the borrower. Approximately 52% of the E&P lending commitments were to investment grade counterparties. To the extent oil and natural gas prices remain at quarter-end levels, or deteriorate further, we may incur additional lending losses.

Institutional Securities Margin Lending.    In addition to the activities noted above, Institutional Securities provides margin lending, which allows the client to borrow against the value of qualifying securities. At June 30, 2017 and December 31, 2016, the amounts related to margin lending were $15.4 billion and $11.9 billion, respectively, which were classified within Customer and other receivables in the consolidated balance sheets.

Wealth Management Lending Activities.    The principal Wealth Management lending activities include securities-based lending and residential real estate loans.

Securities-based lending provided to our retail clients is primarily conducted through our Portfolio Loan Account (“PLA”) and Liquidity Access Line (“LAL”) platforms, which had an outstanding loan balance of $31.6 billion and $29.7 billion at June 30, 2017 and December 31, 2016, respectively. For more information about our securities-based lending and residential real estate loans, see “Quantitative and Qualitative Disclosures about Market Risk–Risk Management–Credit Risk–Lending Activities” in Part II, Item 7A of the 2016 Form 10-K.

For the current quarter, loans and lending commitments associated with the Wealth Management business segment lending activities increased by approximately 6%, mainly due to growth in securities-based lending and other loans.

Wealth Management Lending Activities by Remaining Contractual Maturity

 

    At June 30, 2017  
    Years to Maturity        
$ in millions   Less than 1     1-3     3-5     Over 5     Total  

Securities-based lending and other loans

  $ 34,048     $ 3,208     $ 1,196     $ 979     $ 39,431  

Residential real estate loans

          9       35       25,631       25,675  

Total1

  $ 34,048     $ 3,217     $ 1,231     $ 26,610     $ 65,106  

Lending commitments

    6,484       1,903       458       265       9,110  

Total loans and lending commitments

  $     40,532     $     5,120     $     1,689     $     26,875     $     74,216  

 

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

Securities-based lending and other loans

  $ 30,547     $ 2,983      $ 1,304     $ 1,179     $ 36,013  

Residential real estate loans

                 45       24,369       24,414  

Total1

  $ 30,547     $ 2,983      $ 1,349     $ 25,548     $ 60,427  

Lending commitments

    6,372       1,413        268       246       8,299  

Total loans and lending commitments

  $     36,919     $     4,396      $     1,617     $     25,794     $     68,726  

 

1.

At June 30, 2017 and December 31, 2016, greater than 99% of the Wealth Management business segment loans held for investment were current, while less than 1% were on nonaccrual status because the loans were past due for a period of 90 days or more or payment of principal or interest was in doubt.

Wealth Management Loans included in Customer and Other Receivables

 

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

Net customer receivables representing margin loans

   $ 12,328     $ 12,483  

Employee loans1:

    

Balance

   $ 4,323     $ 4,804  

Allowance for loan losses

     (83     (89

Balance, net

   $ 4,240     $ 4,715  

 

1.

Granted in conjunction with programs established by us to retain and recruit certain employees. These loans are full recourse and generally require periodic payments. At June 30, 2017, these loans have repayment terms ranging from 1 to 20 years. We establish an allowance for loan amounts to terminated employees that we do not consider recoverable, which is recorded in Compensation and benefits expense.

Credit Exposure—Derivatives

We incur credit risk as a dealer in OTC derivatives. Credit risk with respect to derivative instruments arises from the possibility that a counterparty may fail to perform according to the terms of the contract. In connection with our OTC derivative activities, we generally enter into master netting agreements and collateral arrangements with counterparties. These agreements provide us with the ability to demand

 

 

June 2017 Form 10-Q   36  


Table of Contents
Risk Disclosures   LOGO

 

collateral, as well as to liquidate collateral and offset receivables and payables covered under the same master netting agreement in the event of counterparty default.

We manage our trading positions by employing a variety of risk mitigation strategies. These strategies include diversification of risk exposures and hedging. Hedging activities consist of the purchase or sale of positions in related securities and financial instruments, including a variety of derivative products (e.g., futures, forwards, swaps and options). For credit exposure information on our OTC derivative products, see Note 4 to the consolidated financial statements. For a discussion of our credit exposure and related credit derivative contracts, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Credit Risk—Credit Exposure—Derivatives” in Part II, Item 7A of the 2016 Form 10-K.

Credit Derivative Portfolio by Counterparty Type

 

     At June 30, 2017  
     Fair Values1     Notionals  
$ in millions    Receivable      Payable      Net     Protection
Purchased
     Protection
Sold
 

Banks and securities firms

   $ 5,870      $ 6,293      $ (423   $ 222,828      $ 195,023  

Insurance and other financial institutions

     3,563        4,022        (459     156,758        154,604  

Non-financial entities

     39        90        (51     3,586        1,189  

Total

   $ 9,472      $ 10,405      $ (933   $ 383,172      $ 350,816  

 

     At December 31, 2016  
     Fair Values1     Notionals  
$ in millions    Receivable      Payable      Net     Protection
Purchased
     Protection
Sold
 

Banks and securities firms

   $ 8,516      $ 9,397      $ (881   $ 319,830      $ 273,462  

Insurance and other financial institutions

     3,619        3,901        (282     144,527        151,999  

Non-financial entities

     94        127        (33     5,832        4,269  

Total

   $ 12,229      $ 13,425      $ (1,196   $ 470,189      $ 429,730  

 

1.

Our Credit Default Swaps (“CDS”) are classified in either Level 2 or Level 3 of the fair value hierarchy. Approximately 4% of receivable fair values, and 6% and 7%, respectively, of payable fair values represented Level 3 amounts at June 30, 2017 and December 31, 2016 (see Note 3 to the consolidated financial statements).

The fair values shown in the previous table are before the application of contractual netting or collateral. For additional credit exposure information on our credit derivative portfolio, see Note 4 to the consolidated financial statements.

OTC Derivative Products at Fair Value, Net of Collateral, by Industry

 

$ in millions    At June 30,
2017
     At December 31,
20161
 

Industry2

  

Utilities

   $ 4,052      $ 4,184  

Funds, exchanges and other financial services3

     3,145        2,756  

Industrials

     1,269        1,644  

Regional governments

     1,144        1,352  

Sovereign governments

     1,104        709  

Banks and securities firms

     949        1,485  

Healthcare

     930        1,103  

Not-for-profit organizations

     730        830  

Hedge funds

     542        233  

Consumer discretionary

     392        590  

Information technology

     366        267  

Materials

     348        235  

Insurance

     279        570  

Energy

     267        533  

Consumer staples

     243        567  

Special purpose vehicles

     229        821  

Other

     166        256  

Total4

   $ 16,155      $ 18,135  

 

1.

The amounts included in the December 31, 2016 industry categories have been revised due to previous misclassifications. The total remains unchanged.

2.

Industry categories are based on the Global Industry Classification Standard®.

3.

Amounts include mutual funds, pension funds, private equity and real estate funds, exchanges and clearinghouses, consumer finance, mortgage finance and other diversified financial services.

4.

For further information on derivative instruments and hedging activities, see Note 4 to the consolidated financial statements.

 

 

  37   June 2017 Form 10-Q


Table of Contents
Risk Disclosures   LOGO

 

Country Risk Exposure

Country risk exposure is the risk that events in, or that affect, a foreign country (any country other than the U.S.) might adversely affect us. We actively manage country risk exposure through a comprehensive risk management framework that combines credit and market fundamentals and allows us to effectively identify, monitor and limit country risk. Country risk exposure before and after hedging is monitored and managed. For a further discussion of our country risk exposure see, “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Country Risk Exposure” in Part II, Item 7A of the 2016 Form 10-K.

Our sovereign exposures consist of financial instruments entered into with sovereign and local governments. Our non-sovereign exposures consist of exposures to primarily corporations and financial institutions. The following table shows our 10 largest non-U.S. country risk net exposures at June 30, 2017. Index credit derivatives are included in the country risk exposure table. Each reference entity within an index is allocated to that reference entity’s country of risk. Index exposures are allocated to the underlying reference entities in proportion to the notional weighting of each reference entity in the index, adjusted for any fair value receivable/payable for that reference entity. Where credit risk crosses multiple jurisdictions, for example, a CDS purchased from an issuer in a specific country that references bonds issued by an entity in a different country, the fair value of the CDS is reflected in the Net Counterparty Exposure column based on the country of the CDS issuer. Further, the notional amount of the CDS adjusted for the fair value of the receivable/payable is reflected in the Net Inventory column based on the country of the underlying reference entity.

 

 

June 2017 Form 10-Q   38  


Table of Contents
Risk Disclosures   LOGO

 

Top Ten Country Exposures at June 30, 20171

 

$ in millions    Net Inventory2    

Net

Counterparty

Exposure3,4

     Loans      Lending
Commitments
     Exposure
Before Hedges
     Hedges5     Net Exposure  

Country

                  

United Kingdom:

                  

Sovereigns

   $ 1,444     $ 92      $             —        $            —      $ 1,536      $             (254)     $ 1,282  

Non-sovereigns

     595       9,995        2,050        5,630        18,270        (1,824     16,446  

Total

   $ 2,039     $ 10,087      $ 2,050      $ 5,630      $ 19,806      $ (2,078   $ 17,728  

Japan:

                  

Sovereigns

   $ 2,205     $             76      $      $      $ 2,281      $ (82   $ 2,199  

Non-sovereigns

     512       3,161        95               3,768        (144     3,624  

Total

   $ 2,717     $ 3,237      $ 95      $      $ 6,049      $ (226   $ 5,823  

Brazil:

                  

Sovereigns

   $ 4,088     $      $      $      $ 4,088      $ (12   $ 4,076  

Non-sovereigns

     52       568        955        68        1,643        (511     1,132  

Total

   $ 4,140     $ 568      $ 955      $ 68      $ 5,731      $ (523   $ 5,208  

Germany:

                  

Sovereigns

   $ 1,237     $ 772      $      $      $ 2,009      $ (908   $ 1,101  

Non-sovereigns

     144       1,359        526        3,256        5,285        (1,370     3,915  

Total

   $ 1,381     $ 2,131      $ 526      $ 3,256      $ 7,294      $ (2,278   $ 5,016  

Canada:

                  

Sovereigns

   $ 182     $ 100      $      $      $ 282      $     $ 282  

Non-sovereigns

     276       1,619        155        1,465        3,515        (356     3,159  

Total

   $ 458     $ 1,719      $ 155      $ 1,465      $ 3,797      $ (356   $ 3,441  

United Arab Emirates:

                  

Sovereigns

   $ (25   $ 831      $      $      $ 806      $ (24   $ 782  

Non-sovereigns

     5       191        28        1,983        2,207        (15     2,192  

Total

   $ (20   $ 1,022      $ 28      $ 1,983      $ 3,013      $ (39   $ 2,974  

China:

                  

Sovereigns

   $ (45   $ 213      $      $      $ 168      $ (249   $ (81

Non-sovereigns

     1,032       157        759        515        2,463        (10     2,453  

Total

   $ 987     $ 370      $ 759      $ 515      $ 2,631      $ (259   $ 2,372  

India:

                  

Sovereigns

   $ 1,157     $      $      $      $ 1,157      $     $ 1,157  

Non-sovereigns

     562       507                      1,069              1,069  

Total

   $             1,719     $ 507      $      $      $ 2,226      $     $ 2,226  

Ireland:

                  

Sovereigns

   $ 13     $ 5      $      $      $ 18      $ (82   $ (64

Non-sovereigns

     122       399        1,671        74        2,266              2,266  

Total

   $ 135     $ 404      $ 1,671      $ 74      $ 2,284      $ (82   $ 2,202  

Singapore:

                  

Sovereigns

   $ 1,482     $ 149      $      $      $ 1,631      $     $ 1,631  

Non-sovereigns

     50       228        29        117        424              424  

Total

   $ 1,532     $ 377      $ 29      $ 117      $ 2,055      $     $             2,055  

 

1.

At June 30, 2017, we had exposure to these countries for overnight deposits with banks of approximately $14.6 billion.

2.

Net inventory represents exposure to both long and short single-name and index positions (i.e., bonds and equities at fair value and CDS based on a notional amount assuming zero recovery adjusted for any fair value receivable or payable). As a market maker, we may transact in these CDS positions to facilitate client trading. At June 30, 2017, gross purchased protection, gross written protection, and net exposures related to single-name and index credit derivatives for those countries shown in the previous table were $(55.7) billion, $53.5 billion and $(2.2) billion, respectively.

3.

Net counterparty exposure (i.e., repurchase transactions, securities lending and OTC derivatives) takes into consideration legally enforceable master netting agreements and collateral.

4.

At June 30, 2017, the benefit of collateral received against counterparty credit exposure was $7.9 billion in the U.K. with 96% of collateral consisting of cash and government obligations of the U.K., the U.S. and France, and $9.3 billion in Germany, with 95% of collateral consisting of cash and government obligations of France, Belgium and Germany. The benefit of collateral received against counterparty credit exposure in the other countries totaled approximately $7.2 billion, with collateral primarily consisting of cash and government obligations of Japan. These amounts do not include collateral received on secured financing transactions.

5.

Amounts represent CDS hedges (purchased and sold) on net counterparty exposure and lending executed by trading desks responsible for hedging counterparty and lending credit risk exposures for us. Amounts are based on the CDS notional amount assuming zero recovery adjusted for any fair value receivable or payable. For a further description of the contractual terms for purchased credit protection and whether they may limit the effectiveness of our hedges, see “Credit Exposure—Derivatives” herein.

 

  39   June 2017 Form 10-Q


Table of Contents
Risk Disclosures   LOGO

 

Country Risk Exposures Related to the United Kingdom.    At June 30, 2017, our country risk exposures in the U.K. included net exposures of $17,728 million as shown in the previous table, and overnight deposits of $6,657 million. The $16,446 million of exposures to non-sovereigns were diversified across both names and sectors. Of this exposure $14,162 million was to investment grade counterparties, with the largest single component ($5,334 million) to exchanges and clearing houses.

Country Risk Exposures Related to Brazil.    At June 30, 2017, our country risk exposures in Brazil included net exposures of $5,208 million as shown in the previous table. Our sovereign net exposures in Brazil were principally in the form of local currency government bonds held onshore to support client activity. The $1,132 million of exposures to non-sovereigns were diversified across both names and sectors.

Operational Risk

Operational risk refers to the risk of loss, or of damage to our reputation, resulting from 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). We may incur operational risk across the full scope of our business activities, including revenue-generating activities (e.g., sales and trading) and support and control groups (e.g., information technology and trade processing). For a further discussion about our operational risk, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Operational Risk” in Part II, Item 7A of the 2016 Form 10-K.

Model Risk

Model risk refers to the potential for adverse consequences from decisions based on incorrect or misused model outputs. Model risk can lead to financial loss, poor business and strategic decision making, or damage to the Firm’s reputation. The risk inherent in a model is a function of the materiality,

complexity and uncertainty around inputs and assumptions. Model risk is generated from the use of models impacting financial statements, regulatory filings, capital adequacy assessments and the formulation of business strategies. For a further discussion about our model risk, see “Quantitative and Qualitative Disclosures about Market Risk–Risk Management–Model Risk” in Part II, Item 7A of the 2016 Form 10-K.

Liquidity Risk

Liquidity risk refers to the risk that we will be unable to finance our operations due to a loss of access to the capital markets or difficulty in liquidating our assets. Liquidity risk also encompasses our ability (or perceived ability) to meet our financial obligations without experiencing significant business disruption or reputational damage that may threaten our viability as a going concern. For a further discussion about our liquidity risk, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Liquidity Risk” in Part II, Item 7A of the 2016 Form 10-K and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” in Part I, Item 2.

Legal and Compliance Risk

Legal and compliance risk includes the risk of legal or regulatory sanctions, material financial loss, including fines, penalties, judgments, damages and/or settlements, or loss to reputation that we may suffer as a result of failure to comply with laws, regulations, rules, related self-regulatory organization standards and codes of conduct applicable to our business activities. This risk also includes contractual and commercial risk, such as the risk that a counterparty’s performance obligations will be unenforceable. It also includes compliance with anti-money laundering and terrorist financing rules and regulations. For a further discussion about our legal and compliance risk, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Legal and Compliance Risk” in Part II, Item 7A of the 2016 Form 10-K.

 

 

June 2017 Form 10-Q   40  


Table of Contents
  LOGO

 

Controls and Procedures

Under the supervision and with the participation of the Firm’s management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the Firm’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

No change in the Firm’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) occurred during the period covered by this report that materially affected, or is reasonably likely to materially affect, the Firm’s internal control over financial reporting.

 

 

  41   June 2017 Form 10-Q


Table of Contents
 

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of Morgan Stanley:

We have reviewed the accompanying condensed consolidated balance sheet of Morgan Stanley and subsidiaries (the “Firm”) as of June 30, 2017, and the related condensed consolidated income statements and comprehensive income statements for the three-month and six-month periods ended June 30, 2017 and 2016, and the cash flow statements and statements of changes in total equity for the six-month periods ended June 30, 2017 and 2016. These interim condensed consolidated financial statements are the responsibility of the management of the Firm.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding

the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed interim consolidated financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Firm as of December 31, 2016, and the consolidated income statement, comprehensive income statement, cash flow statement and statement of changes in total equity for the year then ended (not presented herein) included in the Firm’s Annual Report on Form 10-K; and in our report dated February 27, 2017, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2016 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

 

/s/ Deloitte & Touche LLP

New York, New York

August 3, 2017

 

June 2017 Form 10-Q   42  


Table of Contents

Financial Statements

 

Consolidated Financial Statements and Notes

  LOGO

 

Consolidated Income Statements

(Unaudited)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
in millions, except per share data          2017                 2016                 2017                 2016        

Revenues

        

Investment banking

   $ 1,530     $ 1,224     $ 3,075     $ 2,331  

Trading

     2,931       2,746       6,166       4,811  

Investments

     163       126       328       92  

Commissions and fees

     1,027       1,020       2,060       2,075  

Asset management, distribution and administration fees

     2,902       2,637       5,669       5,257  

Other

     199       243       428       323  

Total non-interest revenues

     8,752       7,996       17,726       14,889  

Interest income

     2,106       1,667       4,071       3,414  

Interest expense

     1,355       754       2,549       1,602  

Net interest

     751       913       1,522       1,812  

Net revenues

     9,503       8,909       19,248       16,701  

Non-interest expenses

        

Compensation and benefits

     4,252       4,015       8,718       7,698  

Occupancy and equipment

     333       329       660       658  

Brokerage, clearing and exchange fees

     525       484       1,034       949  

Information processing and communications

     433       429       861       871  

Marketing and business development

     155       154       291       288  

Professional services

     561       547       1,088       1,061  

Other

     602       468       1,146       955  

Total non-interest expenses

     6,861       6,426       13,798       12,480  

Income from continuing operations before income taxes

     2,642       2,483       5,450       4,221  

Provision for income taxes

     846       833       1,661       1,411  

Income from continuing operations

     1,796       1,650       3,789       2,810  

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

     (5     (4     (27     (7

Net income

   $ 1,791     $ 1,646     $ 3,762     $ 2,803  

Net income applicable to noncontrolling interests

     34       64       75       87  

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  

Earnings per basic common share

        

Income from continuing operations

   $ 0.89     $ 0.77     $ 1.92     $ 1.33  

Income (loss) from discontinued operations

           (0.01     (0.01     (0.01

Earnings per basic common share

   $ 0.89     $ 0.76     $ 1.91     $ 1.32  

Earnings per diluted common share

        

Income from continuing operations

   $ 0.87     $ 0.75     $ 1.88     $ 1.30  

Income (loss) from discontinued operations

                 (0.01      

Earnings per diluted common share

   $ 0.87     $ 0.75     $ 1.87     $ 1.30  

Dividends declared per common share

   $ 0.20     $ 0.15     $ 0.40     $ 0.30  

Average common shares outstanding

        

Basic

     1,791       1,866       1,796       1,875  

Diluted

     1,830       1,899       1,836       1,907  

 

See Notes to Consolidated Financial Statements   43   June 2017 Form 10-Q


Table of Contents
Consolidated Comprehensive Income Statements (Unaudited)   LOGO

 

    

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
$ in millions        2017             2016             2017             2016      

Net income

   $ 1,791     $ 1,646     $ 3,762     $ 2,803  

Other comprehensive income (loss), net of tax:

        

Foreign currency translation adjustments

   $ 12     $ 131       162       317  

Change in net unrealized gains on available-for-sale securities

     108       143       192       538  

Pension, postretirement and other

     4       (5     4       (4

Change in net debt valuation adjustment

     (183     145       (174     348  

Total other comprehensive income (loss)

   $ (59   $ 414     $ 184     $ 1,199  

Comprehensive income

   $ 1,732     $ 2,060     $ 3,946     $ 4,002  

Net income applicable to noncontrolling interests

     34       64       75       87  

Other comprehensive income (loss) applicable to noncontrolling interests

     (21     81       29       136  

Comprehensive income applicable to Morgan Stanley

   $ 1,719     $ 1,915     $ 3,842     $ 3,779  

 

June 2017 Form 10-Q   44   See Notes to Consolidated Financial Statements


Table of Contents
Consolidated Balance Sheets   LOGO

 

     (Unaudited)        
$ in millions, except share data   

At

June 30,
2017

   

At

December 31,
2016

 

Assets

    

Cash and due from banks

   $ 25,008     $ 22,017  

Interest bearing deposits with banks

     19,651       21,364  

Trading assets at fair value ($163,689 and $152,548 were pledged to various parties)

     290,802       262,154  

Investment securities (includes $50,488 and $63,170 at fair value)

     71,576       80,092  

Securities purchased under agreements to resell (includes $102 and $302 at fair value)

     97,408       101,955  

Securities borrowed

     126,722       125,236  

Customer and other receivables

     54,917       46,460  

Loans:

 

    

Held for investment (net of allowance of $306 and $274)

     87,007       81,704  

Held for sale

     10,632       12,544  

Goodwill

     6,591       6,577  

Intangible assets (net of accumulated amortization of $2,575 and $2,421)

     2,567       2,721  

Other assets

     48,135       52,125  

Total assets

   $ 841,016     $ 814,949  

Liabilities

    

Deposits (includes $130 and $63 at fair value)

   $ 144,913     $ 155,863  

Short-term borrowings (includes $582 and $406 at fair value)

     916       941  

Trading liabilities at fair value

     134,810       128,194  

Securities sold under agreements to repurchase (includes $738 and $729 at fair value)

     50,697       54,628  

Securities loaned

     16,862       15,844  

Other secured financings (includes $5,731 and $5,041 at fair value)

     16,642       11,118  

Customer and other payables

     197,055       190,513  

Other liabilities and accrued expenses

     15,042       15,896  

Long-term borrowings (includes $43,226 and $38,736 at fair value)

     184,112       164,775  

Total liabilities

     761,049       737,772  

Commitments and contingent liabilities (see Note 11)

    

Equity

    

Morgan Stanley shareholders’ equity:

    

Preferred stock

     8,520       7,520  

Common stock, $0.01 par value:

    

Shares authorized: 3,500,000,000; Shares issued: 2,038,893,979; Shares outstanding: 1,839,578,174 and 1,852,481,601

     20       20  

Additional paid-in capital

     23,140       23,271  

Retained earnings

     56,325       53,679  

Employee stock trusts

     2,945       2,851  

Accumulated other comprehensive income (loss)

     (2,488     (2,643

Common stock held in treasury at cost, $0.01 par value (199,315,805 and 186,412,378 shares)

     (6,691     (5,797

Common stock issued to employee stock trusts

     (2,945     (2,851

Total Morgan Stanley shareholders’ equity

     78,826       76,050  

Noncontrolling interests

     1,141       1,127  

Total equity

     79,967       77,177  

Total liabilities and equity

   $ 841,016     $ 814,949  

 

See Notes to Consolidated Financial Statements   45   June 2017 Form 10-Q


Table of Contents
Consolidated Statements of Changes in Total Equity (Unaudited)   LOGO

 

 

$ in millions

 

Preferred

Stock

   

Common

Stock

   

Additional

Paid-in

Capital

   

Retained

Earnings

   

Employee

Stock

Trusts

   

Accumulated

Other

Comprehensive

Income (Loss)

   

Common

Stock

Held in

Treasury

at Cost

   

Common

Stock

Issued to

Employee

Stock

Trusts

   

Non-

controlling

Interests

   

Total

Equity

 

Balance at December 31, 2016

  $ 7,520     $ 20     $ 23,271     $ 53,679     $ 2,851     $ (2,643   $ (5,797   $ (2,851   $ 1,127     $ 77,177  

Cumulative adjustment for accounting changes1

                45       (35                                   10  

Net income applicable to Morgan Stanley

                      3,687                                     3,687  

Net income applicable to noncontrolling interests

                                                    75       75  

Dividends

                      (1,006                                   (1,006

Shares issued under employee plans

                (170           94             815       (94           645  

Repurchases of common stock and employee tax withholdings

                                        (1,709                 (1,709

Net change in Accumulated other comprehensive income (loss)

                                  155                   29       184  

Issuance of preferred stock

    1,000             (6                                         994  

Other net decreases

                                                    (90     (90

Balance at June 30, 2017

  $ 8,520     $ 20     $ 23,140     $ 56,325     $ 2,945     $ (2,488   $ (6,691   $ (2,945   $ 1,141     $ 79,967  

Balance at December 31, 2015

  $ 7,520     $ 20     $ 24,153     $ 49,204     $ 2,409     $ (1,656   $ (4,059   $ (2,409   $ 1,002     $ 76,184  

Cumulative adjustment for accounting change related to DVA2

                      312             (312                        

Net adjustment for accounting change related to consolidation3

                                                    106       106  

Net income applicable to Morgan Stanley

                      2,716                                     2,716  

Net income applicable to noncontrolling interests

                                                    87       87  

Dividends

                      (822                                   (822

Shares issued under employee plans and related tax effects

                (1,456           464             2,062       (464           606  

Repurchases of common stock and employee tax withholdings

                                        (1,629                 (1,629

Net change in Accumulated other comprehensive income (loss)

                                  1,063                   136       1,199  

Other net decreases

                                                    (72     (72

Balance at June 30, 2016

  $ 7,520     $ 20     $ 22,697     $ 51,410     $ 2,873     $ (905)     $ (3,626)     $ (2,873)     $ 1,259     $ 78,375  

 

1.

The cumulative adjustment relates to the adoption of the following accounting updates on January 1, 2017: Improvements to Employee Share-Based Payment Accounting, for which the Firm recorded a cumulative catch-up adjustment to reflect its election to account for forfeitures as they occur (see Note 2 for further information); and Intra-Entity Transfers of Assets Other Than Inventory, for which the Firm recorded a cumulative catch-up adjustment to reflect the tax impact from an intercompany sale of assets.

2.

Debt valuation adjustment (“DVA”) represents the change in the fair value resulting from fluctuations in the Firm’s credit spreads and other credit factors related to liabilities carried at fair value under the fair value option, primarily related to certain Long-term and Short-term borrowings. In accordance with the early adoption of a provision of the accounting update Recognition and Measurement of Financial Assets and Financial Liabilities, a cumulative catch-up adjustment was recorded as of January 1, 2016 to move the cumulative unrealized DVA amount, net of noncontrolling interests and tax, related to outstanding liabilities under the fair value option election from Retained earnings into Accumulated other comprehensive income (loss) (“AOCI”). See Note 2 to the consolidated financial statements in the Firm’s Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”) and Note 14 for further information.

3.

In accordance with the accounting update Amendments to the Consolidation Analysis, a net adjustment was recorded as of January 1, 2016 to both consolidate and deconsolidate certain entities under the new guidance. See Note 2 to the consolidated financial statements in the 2016 Form 10-K for further information.

 

June 2017 Form 10-Q   46   See Notes to Consolidated Financial Statements


Table of Contents

Consolidated Cash Flow Statements

(Unaudited)

  LOGO

 

 

    

Six Months Ended

June 30,

 
$ in millions            2017                     2016          

Cash flows from operating activities

    

Net income

   $ 3,762     $ 2,803  

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

    

(Income) loss from equity method investments

           (1

Compensation payable in common stock and options

     518       492  

Depreciation and amortization

     889       879  

Net gain on sale of available-for-sale securities

     (16     (82

Impairment charges

     6       67  

Provision for credit losses on lending activities

     25       131  

Other operating adjustments

     (148     218  

Changes in assets and liabilities:

    

Trading assets, net of Trading liabilities

     (18,050     (333

Securities borrowed

     (1,486     11,135  

Securities loaned

     1,018       (2,117

Customer and other receivables and other assets

     (2,336     (10,537

Customer and other payables and other liabilities

     5,732       9,949  

Securities purchased under agreements to resell

     4,547       (9,932

Securities sold under agreements to repurchase

     (3,931     13,636  

Net cash provided by (used for) operating activities

     (9,470     16,308  

Cash flows from investing activities

    

Proceeds from (payments for):

    

Other assets—Premises, equipment and software, net

     (723     (645

Changes in loans, net

     (5,326     (4,724

Investment securities:

    

Purchases

     (8,418     (30,700

Proceeds from sales

     13,533       20,274  

Proceeds from paydowns and maturities

     3,668       3,507  

Other investing activities

     (39     (126

Net cash provided by (used for) investing activities

     2,695       (12,414

Cash flows from financing activities

    

Net proceeds from (payments for):

    

Short-term borrowings

     (25     (1,293

Noncontrolling interests

     (35     (43

Other secured financings

     4,272       (69

Deposits

     (10,950     (3,341

Proceeds from:

    

Derivatives financing activities

     73        

Issuance of preferred stock, net of issuance costs

     994        

Issuance of long-term borrowings

     33,522       20,628  

Payments for:

    

Long-term borrowings

     (17,796     (15,900

Derivatives financing activities

     (48     (120

Repurchases of common stock and employee tax withholdings

     (1,709     (1,629

Cash dividends

     (954     (791

Other financing activities

     21        

Net cash provided by (used for) financing activities

     7,365       (2,558

Effect of exchange rate changes on cash and cash equivalents

     688       714  

Net increase in cash and cash equivalents

     1,278       2,050  

Cash and cash equivalents, at beginning of period

     43,381       54,083  

Cash and cash equivalents, at end of period

   $ 44,659     $ 56,133  

Cash and cash equivalents include:

    

Cash and due from banks

   $ 25,008     $ 27,597  

Interest bearing deposits with banks

     19,651       28,536  

Cash and cash equivalents, at end of period

   $ 44,659     $ 56,133  

Supplemental Disclosure of Cash Flow Information

Cash payments for interest were $1,922 million and $1,082 million.

Cash payments for income taxes, net of refunds, were $732 million and $340 million

 

See Notes to Consolidated Financial Statements   47   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

1. Introduction and Basis of Presentation

The Firm

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” or the “Firm” mean Morgan Stanley (the “Parent Company”) together with its consolidated subsidiaries.

A description of the clients and principal products and services of each of the Firm’s 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, founda-

tions, 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.

Basis of Financial Information

The unaudited consolidated financial statements (“consolidated financial statements”) are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), which require the Firm to make estimates and assumptions regarding the valuations of certain financial instruments, the valuation of goodwill and intangible assets, compensation, deferred tax assets, the outcome of legal and tax matters, allowance for credit losses and other matters that affect its consolidated financial statements and related disclosures. The Firm believes that the estimates utilized in the preparation of its consolidated financial statements are prudent and reasonable. Actual results could differ materially from these estimates. Intercompany balances and transactions have been eliminated. Certain reclassifications have been made to prior periods to conform to the current presentation.

The accompanying consolidated financial statements should be read in conjunction with the Firm’s consolidated financial statements and notes thereto included in the 2016 Form 10-K. Certain footnote disclosures included in the 2016 Form 10-K have been condensed or omitted from these consolidated financial statements as they are not required for interim reporting under U.S. GAAP. The consolidated financial statements reflect all adjustments of a normal, recurring nature that are, in the opinion of management, necessary for the fair presentation of the results for the interim period. The results of operations for interim periods are not necessarily indicative of results for the entire year.

Consolidation

The consolidated financial statements include the accounts of the Firm, its wholly owned subsidiaries and other entities in which the Firm has a controlling financial interest, including certain variable interest entities (“VIE”) (see Note 12). For consolidated subsidiaries that are less than wholly owned, the third-party holdings of equity interests are referred to as noncontrolling interests. The net income attributable to noncontrolling interests for such subsidiaries is presented as Net income applicable to noncontrolling interests in the consolidated income statements. The portion of shareholders’ equity that is attributable to noncontrolling interests for such subsidiaries is presented as noncontrolling interests, a component of total equity, in the consolidated balance sheets.

 

 

June 2017 Form 10-Q   48  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

For a discussion of the Firm’s involvement with VIEs and its significant regulated U.S. and international subsidiaries, see Notes 1 and 2 to the consolidated financial statements in the 2016 Form 10-K.

2. Significant Accounting Policies

For a detailed discussion about the Firm’s significant accounting policies, see Note 2 to the consolidated financial statements in the 2016 Form 10-K.

During the six months ended June 30, 2017 (“current year period”), other than the following, there were no significant updates made to the Firm’s significant accounting policies.

Accounting Standards Adopted

The Firm adopted the following accounting update on January 1, 2017.

 

 

Improvements to Employee Share-Based Payment Accounting. This accounting update simplifies the accounting for employee share-based payments, including the recognition of forfeitures, the classification of income tax consequences, and the classification within the consolidated cash flow statements.

Beginning in 2017, 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 instead of additional paid-in capital. The impact of the income tax consequences upon conversion of the awards may be either a benefit or a provision. Conversion of employee share-based awards to Firm shares will primarily occur in the first quarter of each year. The impact of recognizing excess tax benefits upon conversion of awards in the quarter in which the accounting update was adopted (three months ended March 31, 2017) was a $112 million benefit to Provision for income taxes. The classification of cash flows from excess tax benefits was moved from the financing section to the operating section of the consolidated cash flow statements, and was applied on a retrospective basis.

In addition, this accounting update permits an entity to elect whether to continue to estimate the total forfeitures, or to account for forfeitures on an actual basis as they occur. The Firm has elected to account for forfeitures on an actual basis as they occur. This change is required to be applied using a modified retrospective approach, and upon adoption, the Firm recorded a cumulative catch-up adjustment, decreasing Retained earnings by approximately $30 million net of tax, increasing Additional paid-in capital by approximately $45 million and increasing deferred tax assets by approximately $15 million.

 

 

  49   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

3. Fair Values

Fair Value Measurement

Assets and Liabilities Measured at Fair Value on a Recurring

Basis

 

    At June 30, 2017  
$ in millions   Level 1     Level 2     Level 3     Netting4     Total  

Assets at Fair Value

         

Trading assets:

         

U.S. government and agency securities:

         

U.S. Treasury securities

  $ 27,473     $     $     $     $ 27,473  

U.S. agency securities

    2,148       25,832                   27,980  

Total U.S. government and agency securities

    29,621       25,832                   55,453  

Other sovereign government obligations1

    19,553       5,382       100             25,035  

Corporate and other debt:

         

State and municipal securities

          2,572       9             2,581  

Residential mortgage-, commercial mortgage- and asset-backed securities

          2,564       264             2,828  

Corporate bonds

          15,338       449             15,787  

Collateralized debt and loan obligations

          305       58             363  

Loans and lending commitments2

          4,361       4,864             9,225  

Other debt

          2,269       186             2,455  

Total corporate and other debt

          27,409       5,830             33,239  

Corporate equities3

    127,252       394       500             128,146  

Securities received as collateral

    14,402       6                   14,408  

Derivative and other contracts:

         

Interest rate

    623       254,677       1,850             257,150  

Credit

          9,049       423             9,472  

Foreign exchange

    100       54,895       62             55,057  

Equity

    803       41,506       3,073             45,382  

Commodity and other

    1,647       6,705       4,071             12,423  

Netting4

    (2,976     (297,356     (2,360     (46,652     (349,344

Total derivative and other contracts

    197       69,476       7,119       (46,652     30,140  

Investments5

    305       243       946             1,494  

Physical commodities

          134                   134  

Total trading assets5

    191,330       128,876       14,495       (46,652     288,049  

Investment securities—AFS

    22,018       28,470                   50,488  

Securities purchased under agreements to resell

          102                   102  

Intangible assets

          3                   3  

Total assets at fair value6

  $ 213,348     $ 157,451     $ 14,495     $ (46,652   $ 338,642  
    At June 30, 2017  
$ in millions   Level 1     Level 2     Level 3     Netting4     Total  

Liabilities at Fair Value

         

Deposits

  $     $ 51     $ 79     $     $ 130  

Short-term borrowings

          582                   582  

Trading liabilities:

         

U.S. government and agency securities:

         

U.S. Treasury securities

    16,142                         16,142  

U.S. agency securities

    439       84                   523  

Total U.S. government and agency securities

    16,581       84                   16,665  

Other sovereign government obligations1

    25,411       1,118                   26,529  

Corporate and other debt:

         

Corporate bonds

          6,653       13             6,666  

Other debt

          316       2             318  

Total corporate and other debt

          6,969       15             6,984  

Corporate equities3

    36,338       81       27             36,446  

Obligation to return securities received as collateral

    21,471       9       1             21,481  

Derivative and other contracts:

         

Interest rate

    551       233,943       880             235,374  

Credit

          9,677       728             10,405  

Foreign exchange

    35       58,070       60             58,165  

Equity

    699       44,996       1,980             47,675  

Commodity and other

    1,847       6,757       2,562             11,166  

Netting4

    (2,976     (297,356     (2,360     (33,388     (336,080

Total derivative and other contracts

    156       56,087       3,850       (33,388     26,705  

Total trading liabilities

    99,957       64,348       3,893       (33,388     134,810  

Securities sold under agreements to repurchase

          590       148             738  

Other secured financings

          5,487       244             5,731  

Long-term borrowings

    67       40,513       2,646             43,226  

Total liabilities at fair value6

  $ 100,024     $ 111,571     $ 7,010     $ (33,388   $ 185,217  
 

 

June 2017 Form 10-Q   50  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

    At December 31, 2016  
$ in millions   Level 1     Level 2     Level 3     Netting4     Total  

Assets at Fair Value

         

Trading assets:

         

U.S. government and agency securities:

         

U.S. Treasury securities

  $ 25,457     $     $     $     $ 25,457  

U.S. agency securities

    2,122       20,392       74             22,588  

Total U.S. government and agency securities

    27,579       20,392       74             48,045  

Other sovereign government obligations

    14,005       5,497       6             19,508  

Corporate and other debt:

         

State and municipal securities

          2,355       250             2,605  

Residential mortgage-, commercial mortgage- and asset-backed securities

          1,691       217             1,908  

Corporate bonds

          11,051       232             11,283  

Collateralized debt and loan obligations

          602       63             665  

Loans and lending commitments2

          3,580       5,122             8,702  

Other debt

          1,360       180             1,540  

Total corporate and other debt

          20,639       6,064             26,703  

Corporate equities3

    117,857       333       445             118,635  

Securities received as collateral

    13,717       19       1             13,737  

Derivative and other contracts:

         

Interest rate

    1,131       300,406       1,373             302,910  

Credit

          11,727       502             12,229  

Foreign exchange

    231       74,921       13             75,165  

Equity

    1,185       35,736       1,708             38,629  

Commodity and other

    2,808       6,734       3,977             13,519  

Netting4

    (4,378     (353,543     (1,944     (51,381     (411,246

Total derivative and other contracts

    977       75,981       5,629       (51,381     31,206  

Investments5

    237       197       958             1,392  

Physical commodities

          112                   112  

Total trading assets5

    174,372       123,170       13,177       (51,381     259,338  

Investment securities—AFS

    29,120       34,050                   63,170  

Securities purchased under agreements to resell

          302                   302  

Intangible assets

          3                   3  

Total assets at fair value6

  $ 203,492     $ 157,525     $ 13,177     $ (51,381   $ 322,813  
    At December 31, 2016  
$ in millions   Level 1     Level 2     Level 3     Netting4     Total  

Liabilities at Fair Value

         

Deposits

  $     $ 21     $ 42     $     $ 63  

Short-term borrowings

          404       2             406  

Trading liabilities:

         

U.S. government and agency securities:

         

U.S. Treasury securities

    10,745                         10,745  

U.S. agency securities

    891       61                   952  

Total U.S. government and agency securities

    11,636       61                   11,697  

Other sovereign government obligations

    20,658       2,430                   23,088  

Corporate and other debt:

         

Corporate bonds

          5,572       34             5,606  

Other debt

          549       2             551  

Total corporate and other debt

          6,121       36             6,157  

Corporate equities3

    37,611       29       34             37,674  

Obligation to return securities received as collateral

    20,236       25       1             20,262  

Derivative and other contracts:

         

Interest rate

    1,244       285,379       953             287,576  

Credit

          12,550       875             13,425  

Foreign exchange

    17       75,510       56             75,583  

Equity

    1,162       37,828       1,524             40,514  

Commodity and other

    2,663       6,845       2,377             11,885  

Netting4

    (4,378     (353,543     (1,944     (39,803     (399,668

Total derivative and other contracts

    708       64,569       3,841       (39,803     29,315  

Physical commodities

          1                   1  

Total trading liabilities

    90,849       73,236       3,912       (39,803     128,194  

Securities sold under agreements to repurchase

          580       149             729  

Other secured financings

          4,607       434             5,041  

Long-term borrowings

    47       36,677       2,012             38,736  

Total liabilities at fair value6

  $ 90,896     $ 115,525     $ 6,551     $ (39,803   $ 173,169  

AFS—Available for sale

1.

At June 30, 2017, the Firm transferred from Level 2 to Level 1 $1.3 billion and $1.8 billion of Trading assets-Other sovereign government obligations and Trading liabilities-Other sovereign government obligations, respectively, due to increased market activity in these instruments.

2.

At June 30, 2017, loans held at fair value consisted of $6,775 million of corporate loans, $662 million of residential real estate loans and $1,788 million of wholesale real estate loans. At December 31, 2016, loans held at fair value consisted of $7,217 million of corporate loans, $966 million of residential real estate loans and $519 million of wholesale real estate loans.

3.

For trading purposes, the Firm holds or sells short equity securities issued by entities in diverse industries and of varying sizes.

4.

For positions with the same counterparty that cross over the levels of the fair value hierarchy, both counterparty netting and cash collateral netting are included in the column titled “Netting.” For contracts with the same counterparty, counterparty netting among positions classified within the same level is included within that shared level. For further information on derivative instruments and hedging activities, see Note 4.

5.

Amounts exclude certain investments that are measured at fair value using the net asset value (“NAV”) per share, which are not classified in the fair value hierarchy. For additional disclosure about such investments, see “Fair Value of Investments Measured at NAV” herein.

6.

Amounts exclude the unsettled fair value on long futures contracts of $852 million at June 30, 2017 and $784 million at December 31, 2016 included in Customer and other receivables in the consolidated balance sheets and unsettled fair value of short futures contracts of $425 million at June 30, 2017 and $174 million at December 31, 2016 in Customer and other payables in the consolidated balance sheets. These contracts are primarily: classified as Level 1 in the fair value hierarchy, actively traded, and valued based on quoted prices from the exchange.

 

 

  51   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

For a description of the valuation techniques applied to the Firm’s major categories of assets and liabilities measured at fair value on a recurring basis, see Note 3 to the consolidated financial statements in the 2016 Form 10-K. During the current quarter there were no significant updates made to the Firm’s valuation techniques.

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables present additional information about Level 3 assets and liabilities measured at fair value on a recurring basis for the three months ended June 30, 2017 (“current quarter”), the three months ended June 30, 2016 (“prior year quarter”), the current year period and the six months ended June 30, 2016 (“prior year period”). Level 3 instruments may be hedged with instruments classified in Level 1 and Level 2. As a result, the realized and unrealized gains (losses) for assets and liabilities within the Level 3 category presented in the following tables do not reflect the related realized and unrealized gains (losses) on hedging instruments that have been classified by the Firm within the Level 1 and/or Level 2 categories.

Additionally, both observable and unobservable inputs may be used to determine the fair value of positions that the Firm has classified within the Level 3 category. As a result, the unrealized gains (losses) during the period for assets and liabilities within the Level 3 category presented in the following tables herein may include changes in fair value during the period that were attributable to both observable and unobservable inputs. Total realized and unrealized gains (losses) are primarily included in Trading revenues in the consolidated income statements.

Roll-forward of Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis

 


$ in millions
   Beginning
Balance at
March 31,
2017
    Realized
and
Unrealized
Gains
(Losses)
    Purchases1     Sales and
Issuances2
    Settlements1     Net
Transfers
    Ending
Balance at
June 30,
2017
    Unrealized
Gains
(Losses) at
June 30,
2017
 

Assets at Fair Value

                

Trading assets:

                

U.S. agency securities

   $ 42     $     $     $     $     $ (42   $     $  

Other sovereign government obligations

     65             87       (52                 100        

Corporate and other debt:

                

State and municipal securities

     55                     3                     3       (52                 9        

Residential mortgage-, commercial mortgage- and asset backed securities

     216       36       32       (44     (5     29       264       8  

Corporate bonds

     445       2       144       (161           19       449       (2

Collateralized debt and loan obligations

     78       (2     5       (23     (1     1       58       (2

Loans and lending commitments

     4,479       27       1,242       (417     (581     114       4,864       11  

Other debt

     194       33       57       (108           10       186       30  

Total corporate and other debt

     5,467       99       1,483       (805     (587     173       5,830       45  

Corporate equities

     309       8       101       (59           141       500       9  

Securities received as collateral

     1                   (1                     —               —                       —                   —  

Net derivative and other contracts3:

                

Interest rate

     298       35       28       (27     637       (1     970       58  

Credit

     (351     28                             —       16       2       (305     24  

Foreign exchange

     (71     53       1       (1     22       (2     2       64  

Equity

     217       185       677       (171     80       105       1,093       189  

Commodity and other

     1,503       154       3             (108     (43     1,509       79  

Total net derivative and other contracts

     1,596       455       709       (199     647       61       3,269       414  

Investments

     961       11       20       (25     4       (25     946       7  

Liabilities at Fair Value

                

Deposits

   $ 56     $     $     $ 23     $     $     $ 79     $  

Trading liabilities:

                

Corporate and other debt:

                

Corporate bonds

     34             (135     124             (10     13       (1

Other debt

     2                                     2        

Total corporate and other debt

     36             (135     124             (10     15       (1

Corporate equities

           (12     (34     44             5       27       (11

Obligation to return securities received as collateral

     2             (2     1                   1        

Securities sold under agreements to repurchase

     148                                     148        

Other secured financings

     203       (4           38       (1           244       (4

Long-term borrowings

     2,092       (45           694       (145     (40     2,646       (49

 

June 2017 Form 10-Q   52  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

$ in millions    Beginning
Balance at
March 31,
2016
    Realized
and
Unrealized
Gains
(Losses)
    Purchases1     Sales and
Issuances2
    Settlements1     Net
Transfers
    Ending
Balance at
June 30,
2016
    Unrealized
Gains
(Losses) at
June 30,
2016
 

Assets at Fair Value

                

Trading assets:

                

U.S. agency securities

   $ 8     $     $     $ (18   $                 —     $ 30     $ 20     $  

Other sovereign government obligations

     8                     —                     —       (3           (3     2                   —  

Corporate and other debt:

                

State and municipal securities

                   5       1       4                     —                           —       10       2  

Residential mortgage-, commercial mortgage- and asset backed securities

     355       (4     7       (87           84       355       (14

Corporate bonds

     224       17       116       (35           (46     276       17  

Collateralized debt and loan obligations

     348       18       3       (178           (82     109       18  

Loans and lending commitments

     6,185       (46     360       (484     (596     (1     5,418       (55

Other debt

     527       4       13       (19           3       528       2  

Total corporate and other debt

     7,644       (10     503       (803     (596     (42     6,696       (30

Corporate equities

     430       (63     273       (82           14       572       (63

Net derivative and other contracts3:

                                                                

Interest rate

     169       (159     2       (7     42       (282     (235     (157

Credit

     (723     65       1             93       (550     (1,114     53  

Foreign exchange

     126       (58                 (94     25       (1     (47

Equity

     (1,832     168       50       (140     263       18       (1,473     (106

Commodity and other

     1,200       211       5       (4     (88     (37     1,287       130  

Total net derivative and other contracts

     (1,060     227       58       (151     216       (826     (1,536     (127

Investments

     922       5       58       (11                 974       7  

Intangible assets

     4                               (4                   —        

Liabilities at Fair Value

                

Deposits

   $ 23     $ (1   $     $ 8     $     $ (2   $ 30     $ (1

Trading liabilities:

                

Corporate and other debt:

                

Corporate bonds

     6       (1     (5     29             (25     6       (1

Other debt

     5       1       (1                       3        

Total corporate and other debt

     11             (6     29             (25     9       (1

Corporate equities

     31       (28     (33     5             (5     26        

Obligation to return securities received as collateral

     1             (1                              

Securities sold under agreements to repurchase

     151       1                               150       1  

Other secured financings

     454       (14           23       (22     (28     441       (14

Long-term borrowings

     1,798       21             164       (131     119       1,929       26  

 

  53   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

$ in millions   Beginning
Balance at
December 31,
2016
    Realized
and
Unrealized
Gains
(Losses)
    Purchases1     Sales and
Issuances2
    Settlements1     Net
Transfers
    Ending
Balance at
June 30,
2017
    Unrealized
Gains
(Losses) at
June 30,
2017
 

Assets at Fair Value

               

Trading assets:

               

U.S. agency securities

  $ 74     $ (1   $     $ (240   $                 —     $ 167     $                 —     $                 —  

Other sovereign government obligations

    6                     —       98       (4                 100        

Corporate and other debt:

               

State and municipal securities

                  250       3       3       (77           (170     9        

Residential mortgage-, commercial mortgage- and asset backed securities

    217       44       78       (83     (16     24       264       27  

Corporate bonds

    232       (2     241       (98           76       449       (1

Collateralized debt and loan obligations

    63       (3     11       (12     (2     1       58       (3

Loans and lending commitments

    5,122       89       1,596       (1,002     (1,146     205       4,864       41  

Other debt

    180       36       38       (115           47       186       34  

Total corporate and other debt

    6,064       167       1,967       (1,387     (1,164     183       5,830       98  

Corporate equities

    445       10       97       (158           106       500       15  

Securities received as collateral

    1                   (1                        

Net derivative and other contracts3:

               

Interest rate

    420       (66     47       (27     652       (56     970       (55

Credit

    (373     1                   62       5       (305     (13

Foreign exchange

    (43     23       1       (1     8       14       2       43  

Equity

    184       118       758       (158     121       70       1,093       200  

Commodity and other

    1,600       104       9       (19     (188     3       1,509       (76

Total net derivative and other contracts

    1,788       180       815       (205     655       36       3,269       99  

Investments

    958       19       82       (28     (63     (22     946       11  

Liabilities at Fair Value

               

Deposits

  $ 42     $ (1   $     $ 36     $     $     $ 79     $ (1

Short-term borrowings

    2                           —                     —       (2                  

Trading liabilities:

               

Corporate and other debt:

               

Corporate bonds

    34             (164     129             14       13        

Other debt

    2                                     2        

Total corporate and other debt

    36             (164     129             14       15        

Corporate equities

    34             (63     5             51       27        

Obligation to return securities received as collateral

    1                                     1        

Securities sold under agreements to repurchase

    149       1                               148       1  

Other secured financings

    434       (23           52       (221     (44     244       (16

Long-term borrowings

    2,012       (104           981       (286     (165     2,646       (95

 

June 2017 Form 10-Q   54  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

$ in millions   Beginning
Balance at
December 31,
2015
    Realized
and
Unrealized
Gains
(Losses)
    Purchases1     Sales and
Issuances2
    Settlements1     Net
Transfers
    Ending
Balance at
June 30,
2016
    Unrealized
Gains
(Losses) at
June 30,
2016
 

Assets at Fair Value

               

Trading assets:

               

U.S. agency securities

  $                 —     $ 1     $                 —     $ (19   $                 —     $ 38     $ 20     $ 1  

Other sovereign government obligations

    4                     —             (5           3       2       1  

Corporate and other debt:

               

State and municipal securities

    19       1       4       (15           1       10       1  

Residential mortgage-, commercial mortgage- and asset backed securities

    438       (36     26       (170           97       355       (33

Corporate bonds

    267       62       113       (128           (38     276       61  

Collateralized debt and loan obligations

    430       5       22       (224           (124     109       17  

Loans and lending commitments

    5,936       (111     970       (720     (672     15       5,418       (121

Other debt

    448       (2     133       (63           12       528       (2

Total corporate and other debt

    7,538       (81     1,268       (1,320     (672     (37     6,696       (77

Corporate equities

    433       (45     296       (119           7       572       (64

Securities received as collateral

    1                   (1                         —                     —                     —  

Net derivative and other contracts3:

               

Interest rate

    260       305       3       (21     (60     (722     (235     205  

Credit

    (844     (343     1             153       (81     (1,114     (360

Foreign exchange

    141       (109                 (201     168       (1     (82

Equity

    (2,031     (321     71       (184     1,121       (129     (1,473     (434

Commodity and other

    1,050       297       7       (4     (176     113       1,287       210  

Total net derivative and other contracts

    (1,424     (171     82       (209     837       (651     (1,536     (461

Investments

    707       (56     404       (40     (41           974       (53

Intangible assets

    5                               (5            

Liabilities at Fair Value

               

Deposits

  $ 19     $ (2   $     $ 13     $     $ (4   $ 30     $ (2

Short-term borrowings

    1                         (1                  

Trading liabilities:

               

Corporate and other debt:

               

Corporate bonds

          (5     (7     10             (2     6       (5

Other debt

    4       2       (3     4                   3       2  

Total corporate and other debt

    4       (3     (10     14             (2     9       (3

Corporate equities

    17       (3     (22     18             10       26       (3

Obligation to return securities received as collateral

    1             (1                              

Securities sold under agreements to repurchase

    151       1                               150       1  

Other secured financings

    461       (32           69       (43     (78     441       (32

Long-term borrowings

    1,987       (12           276       (167     (179     1,929       (6

 

1.

Loan originations and consolidations of VIEs are included in purchases and deconsolidations of VIEs are included in settlements.

2.

Amounts related to entering into Net derivatives and other contracts, Deposits, Short-term borrowings, Other secured financings and Long-term borrowings primarily represent issuances. Amounts for other line items primarily represent sales.

3.

Net derivative and other contracts represent Trading assets—Derivative and other contracts, net of Trading liabilities—Derivative and other contracts.

 

  55   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Significant Unobservable Inputs Used in Recurring and Nonrecurring Level 3 Fair Value Measurements

The following disclosures provide information on the valuation techniques, significant unobservable inputs, and their ranges and averages for each major category of assets and liabilities measured at fair value on a recurring and nonrecurring basis with a significant Level 3 balance. The level of aggregation and breadth of products cause the range of inputs to be wide and not evenly distributed across the inventory. Further, the range of unobservable inputs may differ across firms in the financial services industry because of diversity in the types of products included in each firm’s inventory. For qualitative information on the sensitivity of the fair value measurements to changes in the significant unobservable inputs, see Note 3 to the consolidated financial statements in the 2016 Form 10-K. There are no predictable relationships between multiple significant unobservable inputs attributable to a given valuation technique. A single amount is disclosed when there is no significant difference between the minimum, maximum and average (weighted average or simple average / median).

Valuation Techniques and Sensitivity of Unobservable Inputs Used in Recurring and Nonrecurring Level 3 Fair Value Measurements

 

     Predominant Valuation Techniques/Significant
Unobservable Inputs
   Range (Weighted Averages or Simple Averages/Median)1
$ in millions       At June 30, 2017    At December 31, 2016

Recurring Fair Value Measurement

     

Assets at Fair Value

     

U.S. agency securities ($- and $74)

     

Comparable pricing:

   Comparable bond price    N/A    96 to 105 points (102 points)

Other sovereign government obligations ($100 and $6)

     

Comparable pricing:

   Comparable bond price    92 to 99 points (96 points)    N/M

State and municipal securities ($9 and $250)

     

Comparable pricing:

   Comparable bond price    N/M    53 to 100 points (91 points)

Residential mortgage-, commercial mortgage- and asset-backed securities ($264 and $217)

  

Comparable pricing:

   Comparable bond price    0 to 95 points (24 points)    0 to 86 points (27 points)

Corporate bonds ($449 and $232)

     

Comparable pricing:

   Comparable bond price    2 to 133 points (87 points)    3 to 130 points (70 points)

Option model:

   At the money volatility    15% to 34% (24%)    23% to 33% (30%)

Collateralized debt and loan obligations ($58 and $63)

     

Comparable pricing:

   Comparable bond price    0 to 65 points (35 points)    0 to 103 points (50 points)

Correlation model:

   Credit correlation    42% to 49% (44%)    N/M

Loans and lending commitments ($4,864 and $5,122)

     

Corporate loan model:

   Credit spread    N/M    402 to 672 bps (557 bps)

Expected recovery:

   Asset coverage    36% to 100% (85%)    43% to 100% (83%)

Option model:

   Volatility skew    -1%    N/M

Margin loan model:

   Discount rate    1% to 5% (2%)    2% to 8% (3%)
     Volatility skew    10% to 32% (18%)    21% to 63% (33%)

Comparable pricing:

   Comparable loan price    55 to 104 points (95 points)    45 to 100 points (84 points)

Discounted cash flow:

   Implied weighted average cost of capital    N/M    5%
     Capitalization rate    N/M    4% to 10% (4%)

Other debt ($186 and $180)

     

Option model:

   At the money volatility    17% to 52% (44%)    16% to 52% (52%)

Discounted cash flow:

   Discount rate    9% to 12% (11%)    7% to 12% (11%)

Comparable pricing:

   Comparable loan price    N/M    1 to 74 points (23 points)

Corporate equities ($500 and $445)

     

Comparable pricing:

   Comparable equity price    100%    100%

Net derivative and other contracts2:

     

Interest rate ($970 and $420)

     

Option model:

   Interest rate - Foreign exchange correlation   

N/M

   28% to 58% (44% / 43%)
     Interest rate volatility skew   

26% to 94% (42% / 41%)

   19% to 117% (55% / 56%)
     Interest rate quanto correlation    N/M    -17% to 31% (1% / -5%)
     Interest rate curve correlation    N/M    28% to 96% (68% / 72%)
     Inflation volatility    24% to 63% (44% / 41%)    23% to 55% (40% / 39%)
     Interest rate - inflation correlation    -48% to -27% (-36% / -34%)    N/M
     Interest rate curve    1%    N/M

 

June 2017 Form 10-Q   56  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

     Predominant Valuation Techniques/Significant
Unobservable Inputs
   Range (Weighted Averages or Simple Averages/Median)1
$ in millions       At June 30, 2017    At December 31, 2016

Credit ($(305) and $(373))

     

Comparable pricing:

   Cash synthetic basis    4 to 6 points (5 points)    5 to 12 points (11 points)
     Comparable bond price    N/M    0 to 70 points (23 points)

Correlation model:

   Credit correlation    37% to 78% (48%)    32% to 70% (45%)

Foreign exchange3 ($2 and $(43))

     

Option model:

   Interest rate - Foreign exchange correlation    27% to 54% (44% / 44%)    28% to 58% (44% / 43%)
     Interest rate volatility skew    29% to 102% (47% / 46%)    34% to 117% (55% / 56%)
     Interest rate quanto correlation   

N/M

   -17% to 31% (1% / -5%)

Equity3 ($1,093 and $184)

     

Option model:

   At the money volatility    6% to 57% (33%)    7% to 66% (33%)
     Volatility skew    -3% to 1% (-1%)    -4% to 0% (-1%)
     Equity - Equity correlation    5% to 99% (78%)    25% to 99% (73%)
     Equity - Foreign exchange correlation    -70% to 9% (-30%)    -63% to 30% (-43%)
     Equity - Interest rate correlation    -7% to 52% (23% / 24%)    -8% to 52% (12% / 4%)

Commodity and other($1,509 and $1,600)

     

Option model:

   Forward power price    $6 to $87 ($30) per MWh    $7 to $90 ($32) per MWh
     Commodity volatility    6% to 62% (17%)    6% to 130% (18%)
     Cross-commodity correlation    5% to 99% (92%)    5% to 99% (92%)

Investments ($946 and $958)

     

Discounted cash flow:

   Implied weighted average cost of capital    N/M    10%
     Exit multiple    10 times    10 to 24 times (11 times)

Market approach:

   EBITDA multiple    8 to 24 times (13 times)    6 to 24 times (12 times)

Comparable pricing:

   Comparable equity price    75% to 100% (90%)    75% to 100% (93%)

Liabilities at Fair Value

     

Deposits ($79 and $42)

     

Option model:

   At the money volatility    15% to 50% (24%)    N/M
     Volatility skew    -1% to 0% (-1%)    N/M

Securities sold under agreements to repurchase ($148 and $149)

     

Discounted cash flow:

   Funding spread    131 to 145 bps (136 bps)    118 to 127 bps (121 bps)

Other secured financings ($244 and $434)

     

Discounted cash flow:

   Funding spread    48 to 80 bps (64 bps)    63 to 92 bps (78 bps)

Option model:

   Volatility skew    -1%    -1%
     At the money volatility    10% to 40% (26%)    N/M

Discounted cash flow:

   Discount rate    N/M    4%

Long-term borrowings ($2,646 and $2,012)

     

Option model:

   At the money volatility    6% to 42% (26%)    7% to 42% (30%)
     Volatility skew    -3% to 1% (-1%)    -2% to 0% (-1%)
     Equity - Equity correlation    36% to 98% (71%)    35% to 99% (84%)
     Equity - Foreign exchange correlation    -72% to 13% (-29%)    -63% to 13% (-40%)

Option model:

   Interest rate volatility skew    26% to 94% (42% / 41%)    25%
     Equity volatility discount    9% to 12% (10% / 11%)    7% to 11% (10% / 10%)

Comparable pricing:

   Comparable equity price    100%    N/M
Nonrecurring Fair Value Measurement          
Assets at Fair Value          
Loans ($1,277 and $2,443)      

Corporate loan model:

   Credit spread    90 to 563 bps (273 bps)    90 to 487 bps (208 bps)

Expected recovery:

   Asset coverage    73% to 95% (84%)    73% to 99% (97%)

bps—Basis points. One basis point equals 1/100th of 1%.

Points—Percentage of par

MWh—Megawatt hours

EBITDA—Earnings before interest, taxes, depreciation and amortization

N/A—Not Applicable

N/M—Not Meaningful

1.

Amounts represent weighted averages except where simple averages and the median of the inputs are provided when more relevant.

2.

Credit valuation adjustment (“CVA”) and funding valuation adjustments (“FVA”) are included in the balance but excluded from the Valuation Technique(s) and Significant Unobservable Inputs in the previous table. CVA is a Level 3 input when the underlying counterparty credit curve is unobservable. FVA is a Level 3 input in its entirety given the lack of observability of funding spreads in the principal market.

3.

Includes derivative contracts with multiple risks (i.e., hybrid products).

 

  57   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

For a description of the Firm’s significant unobservable inputs for all major categories of assets and liabilities, see Note 3 to the consolidated financial statements in the 2016 Form 10-K. During the current quarter there were no significant updates made to the Firm’s significant unobservable inputs.

Fair Value of Investments Measured at NAV

For a description of the Firm’s investments in private equity funds, real estate funds and hedge funds measured at fair value based on NAV, see Note 3 to the consolidated financial statements in the 2016 Form 10-K.

Investments in Certain Funds Measured at NAV per Share

 

    At June 30, 2017     At December 31, 2016  
$ in millions   Fair Value     Commitment     Fair Value     Commitment  

Private equity funds

  $           1,588     $                 388     $         1,566     $                 335  

Real estate funds

    1,050       157       1,103       136  

Hedge funds

    115       18       147       4  

Total

  $ 2,753     $ 563     $ 2,816     $ 475  

Nonredeemable Funds by Contractual Maturity

 

     Fair Value at June 30, 2017  
$ in millions    Private Equity      Real Estate  

Less than 5 years

   $                              297      $                              80  

5-10 years

     745        644  

Over 10 years

     546        326  

Total

   $ 1,588      $ 1,050  

Restrictions

Investments in hedge funds may be subject to initial period lock-up or gate provisions. A lock-up provision is a provision that provides that during a certain initial period an investor may not make a withdrawal from the fund. A gate provision restricts the amount of redemption that an investor can demand on any redemption date.

Hedge Funds Redemption Frequency

 

      Fair Value At
June 30, 2017

Quarterly

   57%

Every six months

   —%

Greater than six months

   21%

Subject to lock-up provisions1

   22%

Percentage of hedge fund investments that cannot be redeemed due to a gate provision2

   23%

 

1.

Remaining restriction period for these investments was primarily over three years.

2.

Gate provision has been imposed by the hedge fund manager primarily for indefinite periods.

The redemption notice periods for hedge funds were primarily greater than six months.

Fair Value Option

The Firm elected the fair value option for certain eligible instruments that are risk managed on a fair value basis to mitigate income statement volatility caused by measurement basis differences between the elected instruments and their associated risk management transactions or to eliminate complexities of applying certain accounting models.

Earnings Impact of Instruments under the Fair Value Option

 

$ in millions    Trading
Revenues
    Interest
Income
(Expense)
   Net
Revenues
 

Three Months Ended June 30, 2017

       

Securities purchased under agreements to resell

   $ (1   $        1    $  

Deposits1

               

Short-term borrowings1

     6     (1)      5  

Securities sold under agreements to repurchase1

     (3   (4)      (7)  

Long-term borrowings1

     (901   (111)      (1,012)  

Three Months Ended June 30, 2016

       

Securities purchased under agreements to resell

   $ (1   $        2    $ 1  

Deposits1

     (1   (1)      (2)  

Short-term borrowings1

     (9        (9)  

Securities sold under agreements to repurchase1

     (3   (3)      (6)  

Long-term borrowings1

     (1,289   (130)      (1,419)  

Six Months Ended June 30, 2017

       

Securities purchased under agreements to resell

   $ (1   $        2    $ 1  

Deposits1

     (1        (1)  

Short-term borrowings1

     (9   (1)      (10)  

Securities sold under agreements to repurchase1

     (1   (8)      (9)  

Long-term borrowings1

     (2,511   (230)      (2,741)  

Six Months Ended June 30, 2016

       

Securities purchased under agreements to resell

   $ (1   $        4    $ 3  

Deposits1

     (3   (1)      (4)  

Short-term borrowings1

     36          36  

Securities sold under agreements to repurchase1

     (12   (5)      (17)  

Long-term borrowings1

     (2,254   (269)      (2,523)  

 

1.

Gains (losses) in all periods are mainly attributable to changes in foreign currency rates or interest rates or movements in the reference price or index for short-term and long-term borrowings before the impact of related hedges.

The amounts in the previous table are included within Net revenues and do not reflect any gains or losses on related hedging instruments. In addition to the amounts in the

 

 

June 2017 Form 10-Q   58  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

previous table, as discussed in Note 2 to the consolidated financial statements in the 2016 Form 10-K, instruments within Trading assets or Trading liabilities are measured at fair value.

Gains (Losses) Due to Changes in Instrument-Specific Credit Risk

 

     Three Months Ended June 30,  
     2017     2016  
$ in millions    Trading
Revenues
    OCI     Trading
Revenues
    OCI  

Short-term and long-term borrowings1

   $ (4     $    (281)     $     $     226  

Securities sold under agreements to repurchase1

                       (1

Loans and other debt2

     48             (14      

Lending commitments3

                 2        
     Six Months Ended June 30,  
     2017     2016  
$ in millions    Trading
Revenues
    OCI     Trading
Revenues
    OCI  

Short-term and long-term borrowings1

   $ (8   $ (267   $ 41     $ 545  

Securities sold under agreements to repurchase1

           (3           3  

Loans and other debt2

     45             (114      

Lending commitments3

                 3        

 

$ in millions    June 30,
2017
     December 31,
2016
 

Cumulative pre-tax DVA gain (loss)
recognized in AOCI

     $    (1,191)      $ (921

OCI—Other comprehensive income (loss)

1.

Unrealized DVA gains (losses) are recorded in OCI and when such gains (losses) are realized they are recorded in Trading revenues. See Note 2 to the consolidated financial statements in the 2016 Form 10-K and Note 14 for further information.

2.

Loans and other debt instrument-specific credit gains (losses) were determined by excluding the non-credit components of gains and losses, such as those due to changes in interest rates.

3.

Gains (losses) on lending commitments were generally determined based on the difference between estimated expected client yields and contractual yields at each respective period-end.

Short-Term and Long-Term Borrowings Measured at Fair Value on a Recurring Basis

 

$ in millions

  

At

June 30,

2017

    

At

December 31,
2016

 
Business Unit Responsible for Risk Management      

Equity

   $             23,605      $ 21,066  

Interest rates

     18,502        16,051  

Foreign exchange

     760        1,114  

Credit

     709        647  

Commodities

     232        264  

Total

   $ 43,808      $ 39,142  

Net Difference of Contractual Principal Amount Over Fair Value

 

$ in millions   

At

June 30,

2017

     At
December 31,
2016
 

Loans and other debt1

   $             12,986      $ 13,495  

Loans 90 or more days past due and/or on nonaccrual status1

     11,337        11,502  

Short-term and long-term borrowings2

     621        720  

 

1.

The majority of the difference between principal and fair value amounts for loans and other debt relates to distressed debt positions purchased at amounts well below par.

2.

Short-term and long-term borrowings do not include structured notes where the repayment of the initial principal amount fluctuates based on changes in a reference price or index.

Fair Value Loans on Nonaccrual Status

 

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

Nonaccrual loans

   $ 1,326      $ 1,536  

Nonaccrual loans 90 or more days past due

   $ 796      $ 787  

The previous tables exclude non-recourse debt from consolidated VIEs, liabilities related to failed sales of financial assets, pledged commodities and other liabilities that have specified assets attributable to them.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Current Quarter Gains (Losses)

 

     Three Months
Ended June 30,
 
$ in millions    20171     20161  

Assets

    

Loans2

   $ 20     $ (34

Other Assets—Other investments3

           (38

Other assets—Premises, equipment and software costs4

     (1     (22

Total

   $ 19     $ (94

Liabilities

    

Other liabilities and accrued expenses2

    

Lending commitments

   $ 21     $ 13  

Total

   $ 21     $ 13  
 

 

  59   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Current Year Period Gains (Losses)

 

     Six Months Ended
June 30,
 
$ in millions    20171     20161  

Assets

    

Loans2

   $ 44     $ (131

Other Assets—Other investments3

           (40

Other assets—Premises, equipment and software costs4

     (6     (27

Total

   $ 38     $ (198

Liabilities

    

Other liabilities and accrued expenses2

    

Lending commitments

   $ 48     $ 24  

Total

   $ 48     $ 24  

 

1.

Gains and losses for Loans and Other assets—Other investments are classified in Other revenues. For other items, gains and losses are recorded in Other revenues if the item is held for sale, otherwise Other expenses.

2.

Non-recurring changes in the fair value of loans and lending commitments were calculated as follows: for the held for investment category, based on the value of the underlying collateral; and for the held for sale category, based on recently executed transactions, market price quotations, valuation models that incorporate market observable inputs where possible, such as comparable loan or debt prices and credit default swap spread levels adjusted for any basis difference between cash and derivative instruments, or default recovery analysis where such transactions and quotations are unobservable.

3.

Losses related to Other assets—Other investments were determined using techniques that included discounted cash flow models, methodologies that incorporate multiples of certain comparable companies and recently executed transactions.

4.

Losses related to Other assets—Premises, equipment and software costs were determined using techniques that included a default recovery analysis and recently executed transactions.

Carrying and Fair Values

 

     At June 30, 2017  
              Fair Value by Level  
$ in millions    Total      Level 2      Level 31  

Assets

                          

Loans

   $     2,632      $ 1,355      $ 1,277  

Total assets

   $ 2,632      $ 1,355      $ 1,277  

Liabilities

        

Other liabilities and accrued expenses—Lending commitments

   $ 212      $ 164      $ 48  

Total liabilities

   $ 212      $ 164      $ 48  
     At December 31, 2016  
              Fair Value by Level  
$ in millions    Total      Level 2      Level 31  

Assets

                          

Loans

   $     4,913      $ 2,470      $ 2,443  

Other assets—Other investments

     123               123  

Other assets—Premises, equipment and software costs

     25        22        3  

Total assets

   $ 5,061      $ 2,492      $ 2,569  

Liabilities

        

Other liabilities and accrued expenses—Lending commitments

   $ 226      $ 166      $ 60  

Total liabilities

   $ 226      $ 166      $ 60  

 

1.

Refer to “Significant Unobservable Inputs Used in Recurring and Nonrecurring Level 3 Fair Value Measurements” section herein for details of the significant unobservable inputs used for nonrecurring fair value measurement.

Financial Instruments Not Measured at Fair Value

 

    At June 30, 2017  
    Carrying     Fair Value  
$ in millions   Value     Level 1     Level 2     Level 3     Total  

Financial Assets

 

       

Cash and due
from banks

  $ 25,008     $ 25,008     $     $     $ 25,008  

Interest bearing
deposits with
banks

    19,651       19,651                   19,651  

Investment securities—HTM

    21,088       8,255       12,319       123       20,697  

Securities purchased under agreements
to resell

    97,306             92,537       4,718       97,255  

Securities borrowed

    126,722             126,722       1       126,723  

Customer and other receivables1

    49,292             45,052       4,110       49,162  

Loans2

    97,639             20,319       78,579       98,898  

Other assets3

    30,171       30,171                   30,171  

Financial Liabilities

 

       

Deposits

  $ 144,783     $     $ 144,783     $     $ 144,783  

Short-term
borrowings

    334             334             334  

Securities sold
under agreements
to repurchase

    49,959             46,452       3,488       49,940  

Securities loaned

    16,862             16,477       401       16,878  

Other secured financings

    10,911             9,961       956       10,917  

Customer and
other payables1

    192,973             192,973             192,973  

Long-term
borrowings

    140,886             145,544       51       145,595  
 

 

June 2017 Form 10-Q   60  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

    At December 31, 2016  
    Carrying     Fair Value  
$ in millions   Value     Level 1     Level 2     Level 3     Total  

Financial Assets

                                       

Cash and due
from banks

  $ 22,017     $ 22,017     $     $     $ 22,017  

Interest bearing
deposits with
banks

    21,364       21,364                   21,364  

Investment securities—HTM

    16,922       5,557       10,896             16,453  

Securities purchased under agreements
to resell

    101,653             97,825       3,830       101,655  

Securities borrowed

    125,236             125,093       147       125,240  

Customer and other receivables1

    41,679             36,962       4,575       41,537  

Loans2

    94,248             20,906       74,121       95,027  

Other assets3

    33,979       33,979                   33,979  

Financial Liabilities

         

Deposits

  $ 155,800     $     $ 155,800     $     $ 155,800  

Short-term
borrowings

    535             535             535  

Securities sold
under agreements
to repurchase

    53,899             50,941       2,972       53,913  

Securities loaned

    15,844             15,853             15,853  

Other secured financings

    6,077             4,792       1,290       6,082  

Customer and
other payables1

    187,497             187,497             187,497  

Long-term
borrowings

    126,039             129,826       51       129,877  

 

HTM—Held

to maturity

1.

Accrued interest, fees, and dividend receivables and payables where carrying value approximates fair value have been excluded.

2.

Amounts include loans measured at fair value on a non-recurring basis.

3.

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

Lending commitments—Held for investment and Held for sale

 

     Commitment      Fair Value  
$ in millions    amount1      Total      Level 2      Level 3  

June 30, 2017

   $ 95,090      $ 917      $ 706      $ 211  

December 31, 2016

     97,409        1,241        973        268  

 

1.

For further discussion on lending commitments, see Note 11.

The previous tables exclude certain financial instruments such as equity method investments and all non-financial assets and liabilities such as the value of the long-term relationships with the Firm’s deposit customers. For further discussion of the contents and valuation techniques of financial instruments not measured at fair value, see Note 3 to the consolidated financial statements in the 2016 Form 10-K. During the current quarter there were no significant updates made to the Firm’s valuation techniques for financial instruments not measured at fair value.

 

 

  61   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

4. Derivative Instruments and Hedging Activities

Derivative Fair Values

 

At June 30, 2017      
    Assets  

$ in millions

  Bilateral
OTC
    Cleared
OTC1
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

Interest rate contracts

  $ 1,547     $ 937     $     $ 2,484  

Foreign exchange contracts

    48       8             56  

Total

    1,595       945             2,540  

Not designated as accounting hedges2

 

Interest rate contracts

    182,333       72,140       193       254,666  

Credit contracts

    7,282       2,190             9,472  

Foreign exchange contracts

    54,357       544       100       55,001  

Equity contracts

    24,832             20,550       45,382  

Commodity and other contracts

    10,197             2,226       12,423  

Total

    279,001       74,874       23,069       376,944  

Total gross derivatives

  $ 280,596     $ 75,819     $ 23,069     $ 379,484  

Amounts offset

       

Counterparty netting

    (215,065     (71,178     (20,307     (306,550

Cash collateral netting

    (38,973     (3,821           (42,794

Total in Trading assets

  $ 26,558     $ 820     $ 2,762     $ 30,140  

Amounts not offset3

       

Financial instruments collateral

    (11,213                 (11,213

Other cash collateral

    (10                 (10

Net amounts4

  $ 15,335     $ 820     $ 2,762     $ 18,917  
    Liabilities  

$ in millions

  Bilateral
OTC
    Cleared
OTC1
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

Interest rate contracts

  $ 60     $ 757     $     $ 817  

Foreign exchange contracts

    138       40             178  

Total

    198       797             995  

Not designated as accounting hedges2

 

Interest rate contracts

    166,210       68,206       141       234,557  

Credit contracts

    8,132       2,273             10,405  

Foreign exchange contracts

    57,314       625       48       57,987  

Equity contracts

    27,653             20,022       47,675  

Commodity and other contracts

    8,881             2,285       11,166  

Total

    268,190       71,104       22,496       361,790  

Total gross derivatives

  $ 268,388     $ 71,901     $ 22,496     $ 362,785  

Amounts offset

       

Counterparty netting

    (215,065     (71,178     (20,307     (306,550

Cash collateral netting

    (29,136     (394           (29,530

Total in Trading liabilities

  $ 24,187     $ 329     $ 2,189     $ 26,705  

Amounts not offset3

       

Financial instruments collateral

    (6,276           (168     (6,444

Other cash collateral

    (26     (58           (84

Net amounts4

  $ 17,885     $ 271     $ 2,021     $ 20,177  
At December 31, 2016      
    Assets  

$ in millions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

Interest rate contracts

  $ 1,924     $ 1,049     $     $ 2,973  

Foreign exchange contracts

    249       18             267  

Total

    2,173       1,067             3,240  

Not designated as accounting hedges5

 

Interest rate contracts

    200,336       99,217       384       299,937  

Credit contracts

    9,837       2,392             12,229  

Foreign exchange contracts

    73,645       1,022       231       74,898  

Equity contracts

    20,710             17,919       38,629  

Commodity and other contracts

    9,792             3,727       13,519  

Total

    314,320       102,631       22,261       439,212  

Total gross derivatives

  $ 316,493     $ 103,698     $ 22,261     $ 442,452  

Amounts offset

       

Counterparty netting

    (243,488     (100,477     (19,607     (363,572

Cash collateral netting

    (45,875     (1,799           (47,674

Total in Trading assets

  $ 27,130     $ 1,422     $ 2,654     $ 31,206  

Amounts not offset3

       

Financial instruments collateral

    (10,293                 (10,293

Other cash collateral

    (124                 (124

Net amounts4

  $ 16,713     $ 1,422     $ 2,654     $ 20,789  
    Liabilities  

$ in millions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

Interest rate contracts

  $ 77     $ 647     $     $ 724  

Foreign exchange contracts

    15       25             40  

Total

    92       672             764  

Not designated as accounting hedges5

 

Interest rate contracts

    183,063       103,392       397       286,852  

Credit contracts

    11,024       2,401             13,425  

Foreign exchange contracts

    74,575       952       16       75,543  

Equity contracts

    22,531             17,983       40,514  

Commodity and other contracts

    8,303             3,582       11,885  

Total

    299,496       106,745       21,978       428,219  

Total gross derivatives

  $ 299,588     $ 107,417     $ 21,978     $ 428,983  

Amounts offset

       

Counterparty netting

    (243,488     (100,477     (19,607     (363,572

Cash collateral netting

    (30,405     (5,691           (36,096

Total in Trading liabilities

  $ 25,695     $ 1,249     $ 2,371     $ 29,315  

Amounts not offset3

       

Financial instruments collateral

    (7,638           (585     (8,223

Other cash collateral

    (10     (1           (11

Net amounts4

  $ 18,047     $ 1,248     $ 1,786     $ 21,081  
 

 

June 2017 Form 10-Q   62  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Derivative Notionals

At June 30, 2017

 

    Assets  

$ in billions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

Interest rate contracts

  $ 25     $ 36     $     $ 61  

Foreign exchange contracts

    4                   4  

Total

    29       36             65  

Not designated as accounting hedges2

 

Interest rate contracts

    3,928       7,275       3,184       14,387  

Credit contracts

    255       105             360  

Foreign exchange contracts

    1,779       60       10       1,849  

Equity contracts

    388             291       679  

Commodity and other contracts

    69             84       153  

Total

    6,419       7,440       3,569       17,428  

Total gross derivatives

  $ 6,448     $ 7,476     $ 3,569     $ 17,493  
    Liabilities  

$ in billions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

Interest rate contracts

  $ 2     $ 95     $     $ 97  

Foreign exchange contracts

    5       1             6  

Total

    7       96             103  

Not designated as accounting hedges2

 

Interest rate contracts

    3,671       5,901       1,236       10,808  

Credit contracts

    287       87             374  

Foreign exchange contracts

    1,869       62       23       1,954  

Equity contracts

    378             347       725  

Commodity and other contracts

    76             69       145  

Total

    6,281       6,050       1,675       14,006  

Total gross derivatives

  $ 6,288     $ 6,146     $ 1,675     $     14,109  

 

At December 31, 2016

 

    Assets  

$ in billions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

Interest rate contracts

  $ 30     $ 38     $     $ 68  

Foreign exchange contracts

    6                   6  

Total

    36       38             74  

Not designated as accounting hedges5

 

Interest rate contracts

    3,586       6,224       2,586       12,396  

Credit contracts

    333       112             445  

Foreign exchange contracts

    1,580       52       13       1,645  

Equity contracts

    338             242       580  

Commodity and other contracts

    67             79       146  

Total

    5,904       6,388       2,920       15,212  

Total gross derivatives

  $ 5,940     $ 6,426     $ 2,920     $ 15,286  
    Liabilities  

$ in billions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

Interest rate contracts

  $ 2     $ 52     $     $ 54  

Foreign exchange contracts

    1       1             2  

Total

    3       53             56  

Not designated as accounting hedges5

 

Interest rate contracts

    3,462       6,087       897       10,446  

Credit contracts

    359       96             455  

Foreign exchange contracts

    1,557       48       14       1,619  

Equity contracts

    321             273       594  

Commodity and other contracts

    78             59       137  

Total

    5,777       6,231       1,243       13,251  

Total gross derivatives

  $ 5,780     $ 6,284     $ 1,243     $     13,307  

OTC—Over–the-counter

1.

Effective in the first quarter of 2017, the Chicago Mercantile Exchange (“CME”) amended its rulebook for cleared OTC derivatives, resulting in the characterization of variation margin transfers as settlement payments as opposed to cash posted as collateral. In the quarter of adoption, the cleared OTC gross derivative assets and liabilities, and related counterparty and cash collateral netting amounts in total decreased by approximately $13 billion and $20 billion, respectively.

2.

Notional amounts include gross notionals related to open long and short futures contracts of $2,765 billion and $732 billion, respectively. The unsettled fair value on these futures contracts (excluded from this table) of $852 million and $425 million is included in Customer and other receivables and Customer and other payables, respectively, in the consolidated balance sheets.

3.

Amounts relate to master netting agreements and collateral agreements that have been determined by the Firm to be legally enforceable in the event of default but where certain other criteria are not met in accordance with applicable offsetting accounting guidance.

 

 

  63   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

4.

Amounts include transactions that are either not subject to master netting agreements or collateral agreements or are subject to such agreements but the Firm has not determined the agreements to be legally enforceable as follows: $3.3 billion of derivative assets and $3.5 billion of derivative liabilities at June 30, 2017 and $3.7 billion of derivative assets and $3.5 billion of derivative liabilities at December 31, 2016.

5.

Notional amounts include gross notionals related to open long and short futures contracts of $2,088 billion and $332 billion, respectively. The unsettled fair value on these futures contracts (excluded from this table) of $784 million and $174 million is included in Customer and other receivables and Customer and other payables, respectively, in the consolidated balance sheets.

For information related to offsetting of certain collateralized transactions, see Note 6. For a discussion of the Firm’s derivative instruments and hedging activities, see Note 4 to the consolidated financial statements in the 2016 Form 10-K.

Gains (Losses) on Fair Value Hedges

 

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

Derivatives

    $   138       $   969       $  (660)     $   3,119   

Borrowings

    (213     (993     495       (3,282)  

Total

  $ (75   $ (24     $  (165)     $ (163)  

Gains (Losses) on Net Investment Hedges

 

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

Foreign exchange contracts

 

   

Effective portion—OCI

    $    (47)     $ (112     $  (251)       $  (336)  

Forward points excluded from hedge effectiveness testing—Interest income

    $      (9)     $ (19     $    (19)       $    (39)  

Trading Revenues by Product Type

 

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

Interest rate contracts

  $ 451     $ 320     $   1,045     $ 626   

Foreign exchange contracts

    197       362       432       599   

Equity security and index contracts1

      1,818         1,615         3,459         2,945   

Commodity and other contracts

    110       20       299       (124)  

Credit contracts

    355       429       931       765   

Total

  $   2,931     $   2,746     $ 6,166     $ 4,811   

 

1.

Dividend income is included within equity security and index contracts.

The previous table summarizes gains and losses included in Trading revenues in the consolidated income statements from trading activities. These activities include revenues related to derivative and non-derivative financial instruments. The Firm generally utilizes financial instruments across a variety of product types in connection with its market-making and related risk management strategies. Accordingly, the trading revenues presented in the previous table are not representative of the manner in which the Firm manages its business activities and are prepared in a manner similar to the presentation of trading revenues for regulatory reporting purposes.

OTC Derivative Products—Trading Assets

Counterparty Credit Rating and Remaining Maturity of OTC Derivative Assets

 

    Fair Value at June 30, 20171  
    Contractual Years to Maturity     Total
Derivative
Assets
 
$ in millions   Less than 1     1-3     3-5     Over 5    

Credit Rating2

 

AAA

  $ 232     $ 308     $ 406     $ 3,168     $ 4,114  

AA

    1,357       1,913       2,336       10,841       16,447  

A

    6,487       5,123       4,342       18,625       34,577  

BBB

    3,417       2,685       2,001       12,737       20,840  

Non-investment grade

    2,753       2,104       3,070       2,247       10,174  

Total

  $ 14,246     $   12,133     $   12,155     $   47,618     $ 86,152  

 

    Fair Value at June 30, 20171  
$ in millions   Total
Derivative
Assets
   

Cross-Maturity

and Cash

Collateral

Netting3

   

Net Amounts

Post-cash

Collateral

   

Net Amounts

Post-
collateral4

 

Credit Rating2

 

AAA

  $ 4,114     $ (3,091   $ 1,023     $ 952  

AA

    16,447       (10,935     5,512       2,756  

A

    34,577       (25,571     9,006       5,118  

BBB

    20,840       (14,301     6,539       4,908  

Non-investment grade

    10,174       (4,886     5,288       2,421  

Total

  $ 86,152     $ (58,784   $ 27,368     $ 16,155  

 

    Fair Value at December 31, 20161  
    Contractual Years to Maturity     Total
Derivative
Assets
 
$ in millions   Less than 1     1-3     3-5     Over 5    

Credit Rating2

 

AAA

  $ 150     $ 428     $ 918     $ 2,931     $ 4,427  

AA

    3,177       2,383       2,942       10,194       18,696  

A

    9,244       6,676       5,495       21,322       42,737  

BBB

    4,423       3,085       2,434       13,023       22,965  

Non-investment grade

    2,283       1,702       1,722       1,794       7,501  

Total

  $ 19,277     $   14,274     $   13,511     $   49,264     $ 96,326  
 

 

June 2017 Form 10-Q   64  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

    Fair Value at December 31, 20161  
$ in millions   Total
Derivative
Assets
   

Cross-Maturity

and Cash

Collateral
Netting3

    Net Amounts
Post-cash
Collateral
    Net Amounts
Post-
collateral4
 

Credit Rating2

 

AAA

  $ 4,427     $ (3,900   $ 527     $ 485  

AA

    18,696       (11,813     6,883       4,114  

A

    42,737       (31,425     11,312       6,769  

BBB

    22,965       (16,629     6,336       4,852  

Non-investment grade

    7,501       (4,131     3,370       1,915  

Total

  $ 96,326     $ (67,898   $ 28,428     $ 18,135  

 

1.

Fair values shown represent the Firm’s net exposure to counterparties related to its OTC derivative products.

2.

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

3.

Amounts represent the netting of receivable balances with payable balances for the same counterparty across maturity categories. Receivable and payable balances with the same counterparty in the same maturity category are netted within such maturity category, where appropriate. Cash collateral received is netted on a counterparty basis, provided legal right of offset exists.

4.

Fair value is shown net of collateral received (primarily cash and U.S. government and agency securities).

Credit Risk-Related Contingencies

In connection with certain OTC trading agreements, the Firm may be required to provide additional collateral or immediately settle any outstanding liability balances with certain counterparties in the event of a credit rating downgrade of the Firm.

The following table presents the aggregate fair value of certain derivative contracts that contain credit risk-related contingent features that are in a net liability position for which the Firm has posted collateral in the normal course of business.

Net Derivative Liabilities and Collateral Posted

 

$ in millions

   At June 30,
2017
     At December 31,
2016
 

Net derivative liabilities with credit risk-related contingent features

   $ 19,335      $ 22,939  

Collateral posted

     14,672        17,040  

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 exchange and clearing organizations in the event of one-notch or two-notch downgrade scenarios based on the relevant contractual downgrade triggers.

Incremental Collateral or Termination Payments upon Potential Future Ratings Downgrade

 

$ in millions    At June 30, 20171

One-notch downgrade

   $                        1,042

Two-notch downgrade

   401

 

1.

Amounts include $1,187 million related to bilateral arrangements between the Firm and other parties where upon the downgrade of one party, the downgraded party must deliver collateral to the other party. These bilateral downgrade arrangements are used by the Firm to manage the risk of counterparty downgrades.

Credit Derivatives and Other Credit Contracts

The Firm enters into credit derivatives, principally through credit default swaps, under which it receives or provides protection against the risk of default on a set of debt obligations issued by a specified reference entity or entities. A majority of the Firm’s counterparties for these derivatives are banks, broker-dealers, and insurance and other financial institutions.

For further information on credit derivatives and other credit contracts, see Note 4 to the consolidated financial statements in the 2016 Form 10-K.

Protection Sold and Purchased with Credit Default Swaps

 

    At June 30, 2017  
    Protection Sold     Protection Purchased  

$ in millions

  Notional    

Fair Value
(Asset)/

Liability

    Notional    

Fair Value
(Asset)/

Liability

 

Credit default swaps

 

     

Single name

  $  195,821     $ (1,274    $  207,973     $ 1,613  

Index and basket

    131,476       (48     126,594       (113

Tranched index and basket

    23,519       (408     48,605       1,163  

Total

  $ 350,816     $ (1,730    $ 383,172     $ 2,663  

Single name and non-tranched index and basket with identical underlying reference obligations

  $ 323,765           $ 330,349        

 

    At December 31, 2016  
    Protection Sold     Protection Purchased  

$ in millions

  Notional    

Fair Value
(Asset)/

Liability

    Notional    

Fair Value
(Asset)/

Liability

 

Credit default swaps

 

     

Single name

  $  266,918       $ (753    $  269,623      $ 826  

Index and basket

    130,383       374       122,061       (481

Tranched index and basket

    32,429       (670     78,505       1,900  

Total

  $  429,730       $ (1,049    $ 470,189      $ 2,245  

Single name and non-tranched index and basket with identical underlying reference obligations

  $ 395,536           $ 389,221        
 

 

 

  65   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Credit Ratings of Reference Obligation and Maturities of Credit Protection Sold

 

     At June 30, 2017  
     Maximum Potential Payout/Notional     

Fair Value

(Asset)/

Liability1

 
     Years to Maturity     
$ in millions    Less than 1      1-3      3-5      Over 5      Total     

Single name credit default swaps2

                 

Investment grade

   $ 57,174      $     52,949      $     26,353      $ 9,523      $     145,999      $ (1,397

Non-investment grade

     22,379        18,958        7,465        1,020        49,822        123  

Total single name credit default swaps

     79,553        71,907        33,818        10,543        195,821        (1,274

Index and basket credit default swaps2

                 

Investment grade

     26,972        14,044        48,806        7,914        97,736        (999

Non-investment grade

     27,129        7,037        13,807        9,286        57,259        543  

Total index and basket credit default swaps

     54,101        21,081        62,613        17,200        154,995        (456

Total credit default swaps sold

   $ 133,654      $ 92,988      $ 96,431      $     27,743      $ 350,816      $ (1,730

Other credit contracts

     27               13        129        169        4  

Total credit derivatives and other credit contracts

   $ 133,681      $ 92,988      $ 96,444      $ 27,872      $ 350,985      $ (1,726

 

     At December 31, 2016  
     Maximum Potential Payout/Notional     

Fair Value

(Asset)/

Liability1

 
     Years to Maturity     
$ in millions    Less than 1      1-3      3-5      Over 5      Total     

Single name credit default swaps2

                 

Investment grade

   $ 79,449      $ 70,796      $ 34,529      $ 10,293      $ 195,067      $ (1,060

Non-investment grade

     34,571        25,820        10,436        1,024        71,851        307  

Total single name credit default swaps

   $ 114,020      $ 96,616      $ 44,965      $ 11,317      $ 266,918      $ (753

Index and basket credit default swaps2

                 

Investment grade

   $ 26,530      $ 21,388      $ 35,060      $ 9,096      $ 92,074      $ (846

Non-investment grade

     26,135        22,983        11,759        9,861        70,738        550  

Total index and basket credit default swaps

   $ 52,665      $ 44,371      $ 46,819      $ 18,957      $ 162,812      $ (296

Total credit default swaps sold

   $ 166,685      $     140,987      $     91,784      $     30,274      $     429,730      $ (1,049

Other credit contracts

     49        6               215        270         

Total credit derivatives and other credit contracts

   $ 166,734      $ 140,993      $ 91,784      $ 30,489      $ 430,000      $ (1,049

 

1.

Fair value amounts are shown on a gross basis prior to cash collateral or counterparty netting.

2.

In order to provide an indication of the current payment status or performance risk of the CDS, a breakdown of CDS based on the Firm’s internal credit ratings by investment grade and non-investment grade is provided. Internal credit ratings serve as the Credit Risk Management Department’s assessment of credit risk and the basis for a comprehensive credit limits framework used to control credit risk. The Firm uses quantitative models and judgment to estimate the various risk parameters related to each obligor.

 

June 2017 Form 10-Q   66  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

5. Investment Securities

The following tables present information about the Firm’s AFS securities, which are carried at fair value, and HTM securities, which are carried at amortized cost. The net unrealized gains or losses on AFS securities are reported on an after-tax basis as a component of AOCI.

AFS and HTM Securities

 

    

At June 30, 2017

 
$ in millions    Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

AFS debt securities

           

U.S. government and agency securities:

           

U.S. Treasury securities

   $ 21,580      $      $ 417      $ 21,163  

U.S. agency securities1

     21,714        36        200        21,550  

Total U.S. government and agency securities

     43,294        36        617        42,713  

Corporate and other debt:

           

Commercial mortgage-backed securities:

           

Agency

     1,536        2        42        1,496  

Non-agency

     1,578        11        9        1,580  

Corporate bonds

     1,586        13        8        1,591  

Collateralized loan obligations

     560        1               561  

FFELP student loan asset-backed securities2

     2,549        7        15        2,541  
Total corporate and other debt      7,809        34        74        7,769  

Total AFS debt securities

     51,103        70        691        50,482  

AFS equity securities

     15               9        6  

Total AFS securities

     51,118        70        700        50,488  

HTM securities

           

U.S. government securities:

           

U.S. Treasury securities

     8,463        9        216        8,256  

U.S. agency securities1

     12,501        10        193        12,318  

Total U.S. government and agency securities

     20,964        19        409        20,574  

Corporate and other debt:

           

Commercial mortgage-backed securities:

           

Non-agency

     124               1        123  

Total corporate and other debt

     124               1        123  

Total HTM securities

     21,088        19        410        20,697  

Total Investment securities

   $ 72,206      $ 89      $ 1,110      $ 71,185  
     At December 31, 2016  
$ in millions    Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value  

AFS debt securities

           

U.S. government and agency securities:

           

U.S. Treasury securities

   $ 28,371      $ 1      $ 545      $     27,827  

U.S. agency securities1

     22,348        14        278        22,084  

Total U.S. government and agency securities

     50,719        15        823        49,911  

Corporate and other debt:

           

Commercial mortgage-backed securities:

           

Agency

     1,850        2        44        1,808  

Non-agency

     2,250        11        16        2,245  

Auto loan asset-backed securities

     1,509        1        1        1,509  

Corporate bonds

     3,836        7        22        3,821  

Collateralized loan obligations

     540               1        539  

FFELP student loan asset-backed securities2

     3,387        5        61        3,331  

Total corporate and other debt

     13,372        26        145        13,253  

Total AFS debt securities

     64,091        41        968        63,164  

AFS equity securities

     15               9        6  

Total AFS securities

     64,106        41        977        63,170  

HTM securities

           

U.S. government securities:

           

U.S. Treasury securities

     5,839        1        283        5,557  

U.S. agency securities1

     11,083        1        188        10,896  

Total HTM securities

     16,922        2        471        16,453  

Total Investment securities

   $ 81,028      $ 43      $ 1,448      $ 79,623  

 

1.

U.S. agency securities consist mainly of agency-issued debt, agency mortgage pass-through pool securities and collateralized mortgage obligations.

2.

FFELP—Federal Family Education Loan Program. Amounts are backed by a guarantee from the U.S. Department of Education of at least 95% of the principal balance and interest on such loans.

 

 

  67   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Investment Securities in an Unrealized Loss Position

 

     At June 30, 2017  
     Less than 12 Months      12 Months or Longer      Total  
$ in millions    Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 

AFS debt securities

                 

U.S. government and agency securities:

                 

U.S. Treasury securities

   $ 21,163      $ 417      $      $      $ 21,163      $ 417  

U.S. agency securities

     11,890        199        99        1        11,989        200  

Total U.S. government and agency securities

     33,053        616        99        1        33,152        617  

Corporate and other debt:

                 

Commercial mortgage-backed securities:

                 

Agency

     1,063        42                      1,063        42  

Non-agency

     370        6        406        3        776        9  

Corporate bonds

     592        8                      592        8  

FFELP student loan asset-backed securities

     1,580        15                      1,580        15  

Total corporate and other debt

     3,605        71        406        3        4,011        74  

Total AFS debt securities

     36,658        687        505        4        37,163        691  

AFS equity securities

                   6        9        6        9  

Total AFS securities

     36,658        687        511        13        37,169        700  

HTM securities

                 

U.S. government and agency securities:

                 

U.S. Treasury securities

     7,043        216                      7,043        216  

U.S. agency securities

     10,573        193                      10,573        193  

Total U.S. government and agency securities

     17,616        409                      17,616        409  

Corporate and other debt:

                 

Non-agency

     91        1                      91        1  

Total corporate and other debt

     91        1                      91        1  

Total HTM securities

     17,707        410                      17,707        410  

Total Investment securities

   $ 54,365      $ 1,097      $ 511      $ 13      $ 54,876      $ 1,110  

 

June 2017 Form 10-Q   68  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

     At December 31, 2016  
     Less than 12 Months      12 Months or Longer      Total  
$ in millions    Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 

AFS debt securities

                 

U.S. government and agency securities:

                 

U.S. Treasury securities

   $ 25,323      $ 545      $      $      $ 25,323      $ 545  

U.S. agency securities

     16,760        278        125               16,885        278  

Total U.S. government and agency securities

     42,083        823        125               42,208        823  

Corporate and other debt:

                 

Commercial mortgage-backed securities:

                 

Agency

     1,245        44                      1,245        44  

Non-agency

     763        11        594        5        1,357        16  

Auto loan asset-backed securities

     659        1        123               782        1  

Corporate bonds

     2,050        21        142        1        2,192        22  

Collateralized loan obligations

     178               239        1        417        1  

FFELP student loan asset-backed securities

     2,612        61                      2,612        61  

Total corporate and other debt

     7,507        138        1,098        7        8,605        145  

Total AFS debt securities

     49,590        961        1,223        7        50,813        968  

AFS equity securities

     6        9                      6        9  

Total AFS securities

     49,596        970        1,223        7        50,819        977  

HTM securities

                 

U.S. government and agency securities:

                 

U.S. Treasury securities

     5,057        283                      5,057        283  

U.S. agency securities

     10,612        188                      10,612        188  

Total HTM securities

     15,669        471                      15,669        471  

Total Investment securities

   $ 65,265      $ 1,441      $ 1,223      $ 7      $ 66,488      $ 1,448  

 

  69   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

As discussed in Note 2 to the consolidated financial statements in the 2016 Form 10-K, AFS and HTM securities with a current fair value less than their amortized cost are analyzed as part of the Firm’s ongoing assessment of temporarily versus other-than-temporarily impaired at the individual security level.

The Firm believes there are no securities in an unrealized loss position that are other-than-temporarily-impaired at June 30, 2017 and December 31, 2016 for the reasons discussed herein.

For AFS debt securities, the Firm does not intend to sell the securities and is not likely to be required to sell the securities prior to recovery of amortized cost basis. For AFS and HTM debt securities, the securities have not experienced credit losses as the net unrealized losses reported in the previous table are primarily due to higher interest rates since those securities were purchased.

Additionally, the Firm does not expect to experience a credit loss based on consideration of the relevant information (as discussed in Note 2 to the consolidated financial statements in the 2016 Form 10-K), including for U.S. government and agency securities, the existence of an explicit and implicit guarantee provided by the U.S. government. The risk of credit loss on securities in an unrealized loss position is considered minimal because the Firm’s U.S. government and agency securities, as well as asset-backed securities (“ABS”), commercial mortgage-backed securities (“CMBS”) and collateralized loan obligations (“CLOs”), are highly rated and because corporate bonds are all investment grade.

For AFS equity securities, the Firm has the intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in market value.

See Note 12 for additional information on securities issued by VIEs, including U.S. agency mortgage-backed securities, non-agency CMBS, auto loan ABS, CLO and FFELP student loan ABS.

Investment Securities by Contractual Maturity

 

    At June 30, 2017  

$ in millions

  Amortized
Cost
    Fair Value     Annualized
Average
Yield
 

AFS debt securities

     

U.S. government and agency securities:

 

U.S. Treasury securities:

     

Due within 1 year

  $           3,798     $           3,786       0.9%  

After 1 year through 5 years

    13,090       12,923       1.2%  

After 5 years through 10 years

    4,692       4,454       1.4%  

Total

    21,580       21,163          
    At June 30, 2017  

$ in millions

  Amortized
Cost
    Fair Value     Annualized
Average
Yield
 

U.S. agency securities:

     

Due within 1 year

  $ 539     $ 539       0.3%  

After 1 year through 5 years

    3,696       3,693       0.7%  

After 5 years through 10 years

    760       762       2.0%  

After 10 years

    16,719       16,556       1.8%  

Total

    21,714       21,550          

Total U.S. government and agency securities

    43,294       42,713       1.4%  

Corporate and other debt:

     

Commercial mortgage-backed securities:

 

Agency:

     

Due within 1 year

    49       49       1.1%  

After 1 year through 5 years

    241       240       1.5%  

After 5 years through 10 years

    383       385       1.2%  

After 10 years

    863       822       1.6%  

Total

    1,536       1,496          

Non-agency:

     

After 5 years through 10 years

    36       35       2.5%  

After 10 years

    1,542       1,545       2.1%  

Total

    1,578       1,580          

Corporate bonds:

     

Due within 1 year

    36       36       1.2%  

After 1 year through 5 years

    1,219       1,225       2.4%  

After 5 years through 10 years

    331       330       2.4%  

Total

    1,586       1,591          

Collateralized loan obligations:

     

After 5 years through 10 years

    362       362       1.5%  

After 10 years

    198       199       2.4%  

Total

    560       561          

FFELP student loan asset-backed securities:

     

After 1 year through 5 years

    57       56       0.8%  

After 5 years through 10 years

    536       532       0.8%  

After 10 years

    1,956       1,953       1.1%  

Total

    2,549       2,541          

Total corporate and other debt

    7,809       7,769       1.6%  

Total AFS debt securities

    51,103       50,482       1.4%  

AFS equity securities

    15       6       — %  

Total AFS securities

    51,118       50,488       1.4%  

HTM securities

     

U.S. government securities:

     

U.S. Treasury securities:

     

Due within 1 year

    300       300       0.7%  

After 1 year through 5 years

    4,837       4,831       1.5%  

After 5 years through 10 years

    2,599       2,472       1.6%  

After 10 years

    727       653       2.3%  

Total

    8,463       8,256          

U.S. agency securities:

     

After 10 years

    12,501       12,318       2.4%  

Total

    12,501       12,318          

Corporate and other debt:

     

Commercial mortgage-backed securities:

 

Non-agency:

     

After 1 year through 5 years

    41       41       3.7%  

After 5 years through 10 years

    83       82       3.8%  

Total

    124       123          

Total HTM securities

    21,088       20,697       2.1%  

Total Investment securities

  $ 72,206     $ 71,185       1.6%  
 

 

June 2017 Form 10-Q   70  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Gross Realized Gains and Losses on Sales of AFS Securities

 

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

Gross realized gains

   $ 23     $ 71     $ 27     $ 85  

Gross realized (losses)

     (9     (1     (11     (3

Total

   $ 14     $ 70     $ 16     $ 82  

Gross realized gains and losses are recognized in Other revenues in the consolidated income statements.

6. Collateralized Transactions

The Firm enters into securities purchased under agreements to resell, securities sold under agreements to repurchase, securities borrowed and securities loaned transactions to, among other things, acquire securities to cover short positions and settle other securities obligations, to accommodate customers’ needs and to finance its inventory positions. For further discussion of the Firm’s collateralized transactions, see Note 6 to the consolidated financial statements in the 2016 Form 10-K.

Offsetting of Certain Collateralized Transactions

 

    At June 30, 2017  

$ in millions

  Gross
Amounts
   

Amounts

Offset

    Net
Amounts
Presented
    Amounts
Not Offset1
    Net
Amounts
 

Assets

         

Securities purchased under agreements to resell

  $ 161,364     $ (63,956   $ 97,408     $ (89,731   $ 7,677  

Securities borrowed

    140,136       (13,414     126,722       (121,668     5,054  

Liabilities

         

Securities sold under agreements to repurchase

  $   114,653     $ (63,956   $ 50,697     $ (44,980   $ 5,717  

Securities loaned

    30,276       (13,414     16,862       (16,632     230  

Not subject to legally enforceable master netting agreements2

 

Securities purchased under agreements to resell

 

  $ 7,010  

Securities borrowed

                                    1,224  

Securities sold under agreements to repurchase

 

    5,222  

Securities loaned

                                    183  
    At December 31, 2016  

$ in millions

  Gross
Amounts
   

Amounts

Offset

    Net
Amounts
Presented
    Amounts
Not Offset1
    Net
Amounts
 

Assets

         

Securities purchased under agreements to resell

  $   182,888     $     (80,933   $ 101,955     $ (93,365   $ 8,590  

Securities borrowed

    129,934       (4,698     125,236       (118,974     6,262  

Liabilities

         

Securities sold under agreements to repurchase

  $ 135,561     $ (80,933   $ 54,628     $ (47,933   $ 6,695  

Securities loaned

    20,542       (4,698     15,844       (15,670     174  

Not subject to legally enforceable master netting agreements2

 

Securities purchased under agreements to resell

 

  $ 7,765  

Securities borrowed

                                    2,591  

Securities sold under agreements to repurchase

 

    6,500  

Securities loaned

                                    154  

 

1.

Amounts relate to master netting agreements that have been determined by the Firm to be legally enforceable in the event of default but where certain other criteria are not met in accordance with applicable offsetting accounting guidance.

2.

Represents amounts within Net Amounts related to transactions that are either not subject to master netting agreements or are subject to such agreements but the Firm has not determined the agreements to be legally enforceable.

For information related to offsetting of derivatives, see Note 4.

Maturities and Collateral Pledged

Gross Secured Financing Balances by Remaining Contractual Maturity

 

    At June 30, 2017  

$ in millions

 

Overnight

and
Open

   

Less
than

30 Days

    30-90
Days
   

Over

90 Days

    Total  

Securities sold under agreements to repurchase1

  $   29,403     $   26,884     $   18,896     $   39,470     $   114,653  

Securities loaned1

    16,447       1,656       1,833       10,340       30,276  

Gross amount of secured financing included in the offsetting disclosure

  $ 45,850     $ 28,540     $ 20,729     $ 49,810     $ 144,929  

Trading liabilities— Obligation to return securities received as collateral

    21,481                         21,481  

Total

  $ 67,331     $ 28,540     $ 20,729     $ 49,810     $ 166,410  
 

 

  71   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

    At December 31, 2016  

$ in millions

 

Overnight

and
Open

   

Less
than

30 Days

    30-90
Days
   

Over

90 Days

    Total  

Securities sold under agreements to repurchase1

  $ 41,549     $   36,703     $   24,648     $   32,661     $   135,561  

Securities loaned1

    9,487       851       2,863       7,341       20,542  

Gross amount of secured financing included in the offsetting disclosure

  $ 51,036     $ 37,554     $ 27,511     $ 40,002     $ 156,103  

Trading liabilities— Obligation to return securities received as collateral

    20,262                         20,262  

Total

  $ 71,298     $ 37,554     $ 27,511     $ 40,002     $ 176,365  

 

1.

Amounts are presented on a gross basis, prior to netting in the consolidated balance sheets.

Gross Secured Financing Balances by Class of Collateral Pledged

 

$ in millions   

At

June 30,

2017

    

At

December 31,
2016

 

Securities sold under agreements to repurchase1

 

U.S. government and agency securities

   $ 28,512      $ 56,372  

State and municipal securities

     157        1,363  

Other sovereign government obligations

     51,498        42,790  

Asset-backed securities

     1,549        1,918  

Corporate and other debt

     5,083        9,086  

Corporate equities

     26,599        23,152  

Other

     1,255        880  

Total securities sold under agreements to repurchase

   $ 114,653      $ 135,561  

Securities loaned1

     

Other sovereign government obligations

     13,599        4,762  

Corporate and other debt

     124        73  

Corporate equities

     16,375        15,693  

Other

     178        14  

Total securities loaned

   $ 30,276      $ 20,542  

Gross amount of secured financing included in the offsetting disclosure

   $ 144,929      $ 156,103  

Trading liabilities—Obligation to return securities received as collateral

 

Corporate equities

     21,472        20,247  

Other

     9        15  

Total Trading liabilities—Obligation to return securities received as collateral

   $ 21,481      $ 20,262  

Total

   $           166,410      $           176,365  

 

1.

Amounts are presented on a gross basis, prior to netting in the consolidated balance sheets.

Assets Pledged

 

$ in millions   

At

June 30,

2017

    

At

December 31,

2016

 

Carrying value of trading assets loaned or pledged1

   $ 42,053      $ 41,358  

Carrying value of loans pledged (gross of allowance for loan losses)1

     3,876        —    

Total

   $             45,929      $             41,358  

 

1.

Counterparties do not have the right to sell or repledge the collateral.

The Firm pledges its trading assets and loans to collateralize securities sold under agreements to repurchase, securities loaned, other secured financings and derivatives. Counterparties may or may not have the right to sell or repledge the collateral.

Pledged financial instruments that can be sold or repledged by the secured party are identified as Trading assets (pledged to various parties) in the consolidated balance sheets. Pledged financial instruments that cannot be sold or repledged by the secured party are shown in the previous table.

Collateral Received

The Firm receives collateral in the form of securities in connection with securities purchased under agreements to resell, securities borrowed, derivative transactions, customer margin loans and securities-based lending. In many cases, the Firm is permitted to sell or repledge these securities held as collateral and use the securities to secure securities sold under agreements to repurchase, to enter into securities lending and derivative transactions or for delivery to counterparties to cover short positions.

The Firm also receives securities as collateral in connection with certain securities-for-securities transactions. In instances where the Firm is the lender and permitted to sell or repledge these securities, it reports the fair value of the collateral received and the related obligation to return the collateral included in Trading assets and Trading liabilities, respectively, in its consolidated balance sheets.

Fair Value of Collateral Received with Right to Sell or Repledge

 

$ in millions   

At

June 30,

2017

    

At

December 31,

2016

 

Collateral received with right to sell or repledge

   $ 556,203      $ 561,239  

Collateral that was sold or repledged

               429,029                  430,911  
 

 

June 2017 Form 10-Q   72  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Customer Margin Lending and Other

 

$ in millions   

At

June 30,

2017

    

At

December 31,

2016

 

Net customer receivables representing margin loans

   $ 27,744      $ 24,359  

The Firm engages in margin lending to clients that allows the client to borrow against the value of qualifying securities. Margin loans are included within Customer and other receivables in the consolidated balance sheets. Under these agreements and transactions, the Firm receives collateral, including U.S. government and agency securities, other sovereign government obligations, corporate and other debt, and corporate equities. Customer receivables generated from margin lending activities are collateralized by customer-owned securities held by the Firm. The Firm monitors required margin levels and established credit terms daily and, pursuant to such guidelines, requires customers to deposit additional collateral, or reduce positions, when necessary.

For a further discussion of the Firm’s margin lending activities, see Note 6 to the consolidated financial statements in the 2016 Form 10-K.

The Firm has additional secured liabilities. For a further discussion of other secured financings, see Note 10.

Cash and Securities Deposited with Clearing Organizations or Segregated

 

$ in millions   

At

June 30,

2017

    

At

December 31,

2016

 

Segregated securities1

   $ 20,351      $ 23,756  

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

     30,171        33,979  

Total

   $           50,522      $           57,735  

 

1.

Securities segregated under federal regulations for the Firm’s U.S. broker-dealers are sourced from Securities purchased under agreements to resell and Trading assets in the consolidated balance sheets.

7. Loans and Allowance for Credit Losses

Loans

The Firm’s loans held for investment are recorded at amortized cost, and its loans held for sale are recorded at the lower of cost or fair value in the consolidated balance sheets. For a further description of these loans, refer to Note 7 to the consolidated financial statements in the 2016 Form 10-K. See Note 3 for further information regarding Loans and lending commitments held at fair value.

 

Loans Held for Investment and Held for Sale by Loan Type

 

     At June 30, 2017  
$ in millions    Loans
Held for
Investment
    Loans
Held for
Sale
     Total
Loans
 

Corporate loans

   $ 26,831     $ 9,394      $ 36,225  

Consumer loans

     26,354              26,354  

Residential real estate loans

     25,646       60        25,706  

Wholesale real estate loans

     8,482       1,178        9,660  

Total loans, gross

     87,313       10,632        97,945  

Allowance for loan losses

     (306            (306

Total loans, net

   $ 87,007     $ 10,632      $ 97,639  

 

     At December 31, 2016  
$ in millions    Loans
Held for
Investment
    Loans
Held for
Sale
     Total
Loans
 

Corporate loans

   $ 25,025     $ 10,710      $ 35,735  

Consumer loans

     24,866              24,866  

Residential real estate loans

     24,385       61        24,446  

Wholesale real estate loans

     7,702       1,773        9,475  

Total loans, gross

     81,978       12,544        94,522  

Allowance for loan losses

     (274            (274

Total loans, net

   $ 81,704     $ 12,544      $ 94,248  

Loans to Non-U.S. Borrowers

 

$ in millions   

At
June 30,

2017

     At
December 31,
2016
 

Loans, net of allowance

   $ 8,725      $ 9,388  

Loans by Interest Rate Type

 

$ in millions   

At
June 30,

2017

     At
December 31,
2016
 

Fixed

   $ 12,696      $ 11,895  

Floating or adjustable

   $ 84,943      $ 82,353  

Credit Quality

For a further discussion about the Firm’s evaluation of credit transactions and monitoring and credit quality indicators, see Note 7 to the consolidated financial statements in the 2016 Form 10-K.

 

 

  73   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Loans Held for Investment before Allowance by Credit Quality

 

    At June 30, 2017  

$ in millions

  Corporate     Consumer    

Residential

Real
Estate

   

Wholesale

Real
Estate

    Total  

Pass

  $ 25,321     $ 26,351     $ 25,598     $ 7,975     $ 85,245  

Special mention

    416       3             192       611  

Substandard

    1,025             48       315       1,388  

Doubtful

    69                         69  

Loss

                             

Total

  $ 26,831     $ 26,354     $ 25,646     $ 8,482     $ 87,313  

 

    At December 31, 2016  
$ in millions   Corporate     Consumer    

Residential

Real
Estate

   

Wholesale

Real
Estate

    Total  

Pass

  $ 23,409     $ 24,853     $ 24,345     $ 7,294     $ 79,901  

Special mention

    288       13             218       519  

Substandard

    1,259             40       190       1,489  

Doubtful

    69                         69  

Loss

                             

Total

  $ 25,025     $ 24,866     $ 24,385     $ 7,702     $ 81,978  

Allowance for Credit Losses and Impaired Loans

For factors considered by the Firm in determining the allowance for loan losses and impairments, see Notes 2 and 7 to the consolidated financial statements in the 2016 Form 10-K.

Impaired Loans Before Allowance by Product Type

 

     At June 30, 2017  
$ in millions    Corporate     

Residential

Real
Estate

     Total  

With allowance

   $ 141      $      $ 141  

Without allowance1

     122        35        157  

Unpaid principal balance2

     273        36        309  
     At December 31, 2016  
$ in millions    Corporate     

Residential

Real
Estate

     Total  

With allowance

   $ 104      $      $ 104  

Without allowance1

     206        35        241  

Unpaid principal balance2

     316        38        354  

 

1.

At June 30, 2017 and December 31, 2016, no allowance was recorded for these loans as the present value of the expected future cash flows (or, alternatively, the observable market price of the loan or the fair value of the collateral held) equaled or exceeded the carrying value.

2.

The impaired loans unpaid principal balance differs from the aggregate amount of impaired loan balances with and without allowance due to various factors, including charge-offs and net deferred loan fees or costs.

Select Loan Information by Region

 

     At June 30, 2017  
$ in millions    Americas      EMEA      Asia-
Pacific
     Total  

Impaired loans

   $ 279      $ 9      $ 10      $ 298  

Allowance for loan losses

     274        30        2        306  
     At December 31, 2016  
$ in millions    Americas      EMEA      Asia-
Pacific
     Total  

Impaired loans

   $ 320      $ 9      $ 16      $ 345  

Allowance for loan losses

     245        28        1        274  

EMEA—Europe, Middle East and Africa

Allowance for Credit Losses on Lending Activities

Loans—Current Year Period

Allowance for Loan Losses Rollforward

 

$ in millions  

Corporate

    Consumer    

Residential

Real
Estate

    Wholesale
Real
Estate
    Total  

December 31, 2016

  $ 195     $ 4     $ 20     $ 55     $ 274  

Recoveries

    1                         1  

Provision for (release of) loan losses1

    14             1       14       29  

Other

    1                   1       2  

June 30, 2017

  $ 211     $ 4     $ 21     $ 70     $ 306  

Loan Loss Allowance by Impairment Methodology

 

     At June 30, 2017  
$ in
millions
   Corporate      Consumer     

Residential

Real
Estate

     Wholesale
Real
Estate
     Total  

Inherent

   $ 142      $ 4      $ 21      $ 70      $ 237  

Specific

     69                             69  

Total

   $ 211      $ 4      $ 21      $ 70      $ 306  

Loans by Impairment Methodology2

 

    At June 30, 2017  
$ in millions   Corporate     Consumer    

Residential

Real
Estate

    Wholesale
Real
Estate
    Total  

Inherent

  $ 26,568     $ 26,354     $ 25,611     $ 8,482     $ 87,015  

Specific

    263             35             298  

Total

  $ 26,831     $ 26,354     $ 25,646     $ 8,482     $ 87,313  

 

1.

The Firm recorded provisions of $7 million for loan losses for the current quarter.

2.

Loan balances are gross of the allowance for loan losses.

 

 

June 2017 Form 10-Q   74  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Loans—Prior Year Period

Allowance for Loan Losses Rollforward

 

$ in millions  

Corporate

    Consumer    

Residential

Real
Estate

    Wholesale
Real
Estate
    Total  

December 31, 2015

  $ 166     $ 5     $ 17     $ 37     $ 225  

Provision for (release of) loan losses1

    116       (1     1       12       128  

Other2

    (30                       (30

June 30, 2016

  $ 252     $ 4     $ 18     $ 49     $ 323  

Loan Loss Allowance by Impairment Methodology

 

    At June 30, 2016  
$ in millions   Corporate     Consumer    

Residential

Real
Estate

    Wholesale
Real
Estate
    Total  

Inherent

  $ 147     $ 4     $ 18     $ 49     $ 218  

Specific

    105                         105  

Total

  $ 252     $ 4     $ 18     $ 49     $ 323  

Loans by Impairment Methodology3

 

    At June 30, 2016  
$ in millions   Corporate     Consumer    

Residential

Real
Estate

    Wholesale
Real
Estate
    Total  

Inherent

  $ 23,604     $ 23,337     $ 22,638     $ 7,415     $ 76,994  

Specific

    582             30             612  

June 30, 2016

  $ 24,186     $ 23,337     $ 22,668     $ 7,415     $ 77,606  

 

1.

The Firm recorded provisions of $16 million for loan losses for the prior year quarter.

2.

Amount includes the impact related to the transfer to loans held for sale and foreign currency translation adjustments.

3.

Loan balances are gross of the allowance for loan losses.

Commitments—Current Year Period

Allowance for Lending Commitments Rollforward

 

$ in millions   Corporate     Consumer    

Residential

Real
Estate

    Wholesale
Real
Estate
    Total  

December 31, 2016

  $ 185     $ 1     $     $ 4     $ 190  

Provision for (release of) lending commitments1

    (3                 (1     (4

June 30, 2017

  $ 182     $ 1     $     $ 3     $ 186  

Lending Commitments Allowance by Impairment Methodology

 

    At June 30, 2017  
$ in millions   Corporate     Consumer    

Residential

Real
Estate

    Wholesale
Real
Estate
    Total  

Inherent

  $ 179     $ 1     $     $ 3     $ 183  

Specific

    3                         3  

Total

  $ 182     $ 1     $     $ 3     $ 186  

Lending Commitments by Impairment Methodology2

 

    At June 30, 2017  
$ in millions   Corporate     Consumer    

Residential

Real
Estate

    Wholesale
Real
Estate
    Total  

Inherent

  $ 62,339     $ 6,005     $ 346     $ 409     $ 69,099  

Specific

    229                         229  

Total

  $ 62,568     $ 6,005     $ 346     $ 409     $ 69,328  

 

1.

The Firm recorded a release of $7 million for commitments for the current quarter.

2.

Lending commitments are gross of the allowance for lending commitments.

Commitments—Prior Year Period

Allowance for Lending Commitments Rollforward

 

$ in millions   Corporate     Consumer    

Residential

Real
Estate

    Wholesale
Real
Estate
    Total  

December 31, 2015

  $ 180     $ 1     $     $ 4     $ 185  

Provision for lending commitments1

    1                   2       3  

Other

          (1                 (1

June 30, 2016

  $ 181     $     $     $ 6     $ 187  

Lending Commitments Allowance by Impairment Methodology

 

    At June 30, 2016  
$ in millions   Corporate     Consumer    

Residential

Real
Estate

    Wholesale
Real
Estate
    Total  

Inherent

  $ 173     $     $     $ 6     $ 179  

Specific

    8                         8  

Total

  $ 181     $     $     $ 6     $ 187  
 

 

  75   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Lending Commitments by Impairment Methodology2

 

    At June 30, 2016  
$ in millions   Corporate     Consumer    

Residential

Real
Estate

    Wholesale
Real
Estate
    Total  

Inherent

  $ 63,120     $ 5,264     $ 327     $ 496     $ 69,207  

Specific

    64                         64  

Total

  $ 63,184     $ 5,264     $ 327     $ 496     $ 69,271  

 

1.

The Firm recorded a release of $13 million for commitments for the prior year quarter.

2.

Lending commitments are gross of the allowance for lending commitments.

Troubled Debt Restructurings    

Impaired loans and lending commitments classified as held for investment within corporate loans include troubled debt restructurings as shown in the following table.

Troubled Debt Restructurings

 

$ in millions   

At June 30,

2017

     At December 31,
2016
 

Loans

   $ 58      $ 67  

Lending commitments

     21        14  

Allowance for loan losses

     8         

These restructurings typically include modifications of interest rates, collateral requirements, other loan covenants and payment extensions.

Employee Loans

Employee loans are granted in conjunction with a program established in the Wealth Management business segment to retain and recruit certain employees. These loans are recorded in Customer and other receivables in the consolidated balance sheets. These loans are full recourse, generally require periodic payments and have repayment terms ranging from 1 to 20 years. The Firm establishes an allowance for loan amounts it does not consider recoverable, and the related provision is recorded in Compensation and benefits expense.

Employee Loans

 

$ in millions   

At June 30,

2017

    At December 31,
2016
 

Balance

   $ 4,323     $ 4,804  

Allowance for loan losses

     (83     (89

Balance, net

   $ 4,240     $ 4,715  

8. Equity Method Investments

Overview

The Firm’s investments accounted for under the equity method of accounting (see Note 1 to the consolidated financial statements in the 2016 Form 10-K) are included in Other assets—Other investments in the consolidated balance sheets. Income (loss) from equity method investments is included in Other revenues in the consolidated income statements.

Equity Method Investment Balances

 

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

Investments

   $ 2,760      $ 2,837  

 

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

Income (loss)

  $ (9   $ (14   $     $ 1  

Japanese Securities Joint Venture

Included in the equity method investments is the Firm’s 40% voting interest (“40% interest”) in Mitsubishi UFJ Morgan Stanley Securities Co., Ltd. (“MUMSS”). Mitsubishi UFJ Financial Group, Inc. (“MUFG”) holds a 60% voting interest. The Firm accounts for its equity method investment in MUMSS within the Institutional Securities business segment. The Firm records income from its 40% interest in MUMSS within Other revenues in the consolidated income statements.

 

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

Income from investment in MUMSS

  $ 23     $ 23     $ 71     $ 57  

In addition to MUMSS, the Firm held other equity method investments that were not individually significant.

9. Deposits

Deposits

 

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

Savings and demand deposits

   $ 141,087      $ 154,559  

Time deposits1

     3,826        1,304  

Total2

   $ 144,913      $ 155,863  

Deposits subject to FDIC insurance

   $ 120,991      $ 127,992  

Time deposits that equal or exceed the FDIC insurance limit

   $ 2      $ 46  
 

 

June 2017 Form 10-Q   76  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Interest Bearing Deposit Maturities at June 30, 2017

 

$ in millions    Savings and
Demand Deposits
     Time
Deposits1
 

Demand

   $ 141,047      $  

2017

            2,925  

2018

            672  

2019

            105  

2021

            8  

Thereafter

            116  

 

FDIC—Federal

Deposit Insurance Corporation

1.

Certain time deposit accounts are carried at fair value under the fair value option (see Note 3).

2.

Deposits were primarily held in the U.S.

The vast majority of deposits in Morgan Stanley Bank, N.A. (“MSBNA”) and Morgan Stanley Private Bank, National Association (“MSPBNA”) (collectively, “U.S. Bank Subsidiaries”) are sourced from Wealth Management customer accounts.

10. Long-Term Borrowings and Other Secured Financings

Long-Term Borrowings

 

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

Senior

   $ 173,761      $ 154,472  

Subordinated

     10,351        10,303  

Total

   $ 184,112      $ 164,775  

Weighted average stated maturity, in years

     6.5        5.9  

During the current year period and prior year period, the Firm issued notes with a principal amount of approximately $33.5 billion and $20.6 billion, respectively, and approximately $17.8 billion and $15.9 billion, respectively, in aggregate long-term borrowings matured or were retired.

Other Secured Financings

Other secured financings include the liabilities related to transfers of financial assets that are accounted for as financings rather than sales, consolidated VIEs where the Firm is deemed to be the primary beneficiary, pledged commodities, certain equity-linked notes and other secured borrowings. These liabilities are generally payable from the cash flows of the related assets accounted for as Trading assets. See Note 12 for further information on Other secured financings related to VIEs and securitization activities.

Other Secured Financings by Original Maturity and Type

 

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

Secured Financings

     

Original maturities:

     

Greater than one year

   $ 11,005      $ 9,404  

One year or less

     4,996        1,429  

Failed sales1

     641        285  

Total

   $ 16,642      $ 11,118  

 

1.

For more information on failed sales, see Note 12.

11. Commitments, Guarantees and Contingencies

Commitments

The Firm’s commitments are summarized in the following table by years to maturity. Since commitments associated with these instruments may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.

 

     Years to Maturity at June 30, 2017         
$ in millions    Less
than 1
     1-3      3-5      Over 5      Total  

Lending:

              

Corporate1

   $ 13,478      $ 28,417      $ 45,187      $ 3,806      $ 90,888  

Consumer

     5,998        4               4        6,006  

Residential real estate

     35        25        84        238        382  

Wholesale real estate

     232        266        8        67        573  

Forward-starting secured financing receivables2

     70,023                             70,023  

Underwriting

     1,024                             1,024  

Investment activities

     569        197        22        259        1,047  

Letters of credit and other financial guarantees

     156        1        1        41        199  

Total

   $ 91,515      $ 28,910      $ 45,302      $ 4,415      $ 170,142  

 

1.

Due to the nature of the Firm’s obligations under the commitments, these amounts include certain commitments participated to third parties of $6.2 billion.

2.

Represents forward-starting securities purchased under agreements to resell and securities borrowed agreements, of which $59.8 billion settled within three business days.

For a further description of these commitments, refer to Note 12 to the consolidated financial statements in the 2016 Form 10-K.

 

 

  77   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Guarantees

Obligations under Guarantee Arrangements at June 30, 2017

 

    Maximum Potential Payout/Notional  
    Years to Maturity        
$ in millions   Less
than 1
    1-3     3-5     Over 5     Total  

Credit derivatives

  $ 133,654     $ 92,988     $ 96,431     $ 27,743     $ 350,816  

Other credit contracts

    27             13       129       169  

Non-credit derivatives

    1,560,514       918,800       331,073       572,502       3,382,889  

Standby letters of credit and other financial guarantees issued1

    779       856       1,147       5,153       7,935  

Market value guarantees

    39       65       70             174  

Liquidity facilities

    3,229                         3,229  

Whole loan sales guarantees

                2       23,278       23,280  

Securitization representations and warranties

                      57,547       57,547  

General partner guarantees

    34       44       313       13       404  

 

$ in millions    Carrying
Amount
(Asset)/
Liability
    Collateral/
Recourse
 

Credit derivatives2

   $ (1,730   $  

Other credit contracts

     4        

Non-credit derivatives2

     45,076        

Standby letters of credit and other financial guarantees issued1

     (186     6,560  

Market value guarantees

     1       4  

Liquidity facilities

     (5     5,503  

Whole loan sales guarantees

     8        

Securitization representations and warranties

     90        

General partner guarantees

     44        

 

1.

These amounts include certain issued standby letters of credit participated to third parties, totaling $0.7 billion of notional and collateral/recourse, due to the nature of the Firm’s obligations under these arrangements.

2.

Carrying amounts of derivative contracts are shown on a gross basis prior to cash collateral or counterparty netting. For further information on derivative contracts, see Note 4.

The Firm also has obligations under certain guarantee arrangements, including contracts and indemnification agreements, that contingently require the Firm to make payments to the guaranteed party based on changes in an underlying measure (such as an interest or foreign exchange rate, security or commodity price, an index, or the occurrence or non-occurrence of a specified event) related to an asset, liability or equity security of a guaranteed party. Also included as guarantees are contracts that contingently require the Firm to make payments to the guaranteed party based on another entity’s failure to perform under an agreement, as well as indirect guarantees of the indebtedness of others.

For more information on the nature of the obligation and related business activity for market value guarantees, liquidity facilities, whole loan sales guarantees and general partner guarantees related to certain investment management funds, as well as the other products in the previous table, see Note 12 to the consolidated financial statements in the 2016 Form 10-K.

Other Guarantees and Indemnities

In the normal course of business, the Firm provides guarantees and indemnifications in a variety of transactions. These provisions generally are standard contractual terms. Certain of these guarantees and indemnifications related to indemnities, exchange/clearinghouse member guarantees and merger and acquisition guarantees are described in Note 12 to the consolidated financial statements in the 2016 Form 10-K.

In addition, in the ordinary course of business, the Firm guarantees the debt and/or certain trading obligations (including obligations associated with derivatives, foreign exchange contracts and the settlement of physical commodities) of certain subsidiaries. These guarantees generally are entity or product specific and are required by investors or trading counterparties. The activities of the Firm’s subsidiaries covered by these guarantees (including any related debt or trading obligations) are included in the consolidated financial statements.

Finance Subsidiary

The Parent Company fully and unconditionally guarantees the securities issued by Morgan Stanley Finance LLC, a 100%-owned finance subsidiary.

Contingencies

Legal.    In the normal course of business, the Firm has been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litiga-

 

 

June 2017 Form 10-Q   78  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

tion, arising in connection with its activities as a global diversified financial services institution. Certain of the actual or threatened legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. In some cases, the entities that would otherwise be the primary defendants in such cases are bankrupt or are in financial distress. These actions have included, but are not limited to, residential mortgage and credit-crisis related matters.

Over the last several years, the level of litigation and investigatory activity (both formal and informal) by governmental and self-regulatory agencies has increased materially in the financial services industry. As a result, the Firm expects that it will continue to be the subject of elevated claims for damages and other relief and, while the Firm has identified below any individual proceedings where the Firm believes a material loss to be reasonably possible and reasonably estimable, there can be no assurance that material losses will not be incurred from claims that have not yet been asserted or are not yet determined to be probable or possible and reasonably estimable losses.

The Firm contests liability and/or the amount of damages as appropriate in each pending matter. Where available information indicates that it is probable a liability had been incurred at the date of the consolidated financial statements and the Firm can reasonably estimate the amount of that loss, the Firm accrues the estimated loss by a charge to income.

In many proceedings and investigations, however, it is inherently difficult to determine whether any loss is probable or even possible or to estimate the amount of any loss. In addition, even where a loss is possible or an exposure to loss exists in excess of the liability already accrued with respect to a previously recognized loss contingency, it is not always possible to reasonably estimate the size of the possible loss or range of loss.

For certain legal proceedings and investigations, the Firm cannot reasonably estimate such losses, particularly for proceedings and investigations where the factual record is being developed or contested or where plaintiffs or governmental entities seek substantial or indeterminate damages, restitution, disgorgement or penalties. Numerous issues may need to be resolved, including through potentially lengthy discovery and determination of important factual matters, determination of issues related to class certification and the calculation of damages or other relief, and by addressing novel or unsettled legal questions relevant to the proceedings or investigations in question, before a loss or additional loss or range of loss or additional range of loss can be reasonably estimated for a proceeding or investigation.

For certain other legal proceedings and investigations, the Firm can estimate reasonably possible losses, additional losses, ranges of loss or ranges of additional loss in excess of amounts accrued, but does not believe, based on current knowledge and after consultation with counsel, that such losses will have a material adverse effect on the Firm’s consolidated financial statements as a whole, other than the matters referred to in the following paragraphs.

On July 15, 2010, China Development Industrial Bank (“CDIB”) filed a complaint against the Firm, styled China Development Industrial Bank v. Morgan Stanley & Co. Incorporated et al., which is pending in the Supreme Court of the State of New York, New York County (“Supreme Court of NY”). The complaint relates to a $275 million credit default swap referencing the super senior portion of the STACK 2006-1 CDO. The complaint asserts claims for common law fraud, fraudulent inducement and fraudulent concealment and alleges that the Firm misrepresented the risks of the STACK 2006-1 CDO to CDIB, and that the Firm knew that the assets backing the CDO were of poor quality when it entered into the credit default swap with CDIB. The complaint seeks compensatory damages related to the approximately $228 million that CDIB alleges it has already lost under the credit default swap, rescission of CDIB’s obligation to pay an additional $12 million, punitive damages, equitable relief, fees and costs. On February 28, 2011, the court denied the Firm’s motion to dismiss the complaint. Based on currently available information, the Firm believes it could incur a loss in this action of up to approximately $240 million plus pre- and post-judgment interest, fees and costs.

On August 8, 2012, U.S. Bank, in its capacity as trustee, filed a complaint on behalf of Morgan Stanley Mortgage Loan Trust 2006-14SL, Mortgage Pass-Through Certificates, Series 2006-14SL, Morgan Stanley Mortgage Loan Trust 2007-4SL and Mortgage Pass-Through Certificates, Series 2007-4SL against the Firm styled Morgan Stanley Mortgage Loan Trust 2006-14SL, et al. v. Morgan Stanley Mortgage Capital Holdings LLC, as successor in interest to Morgan Stanley Mortgage Capital Inc., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trusts, which had original principal balances of approximately $354 million and $305 million respectively, breached various representations and warranties. The complaint seeks, among other relief, rescission of the mortgage loan purchase agreements underlying the transactions, specific performance and unspecified damages and interest. On August 16, 2013, the court granted in part and denied in part the Firm’s motion to dismiss the complaint. On August 16, 2016, the Firm moved for summary judgment and the plaintiffs moved for partial summary judgment. Based on currently available informa-

 

 

  79   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

tion, the Firm believes that it could incur a loss in this action of up to approximately $527 million, the total original unpaid balance of the mortgage loans for which the Firm received repurchase demands that it did not repurchase, plus pre- and post-judgment interest, fees and costs, but plaintiff is seeking to expand the number of loans at issue and the possible range of loss could increase.

On May 3, 2013, plaintiffs in Deutsche Zentral-Genossenschaftsbank AG et al. v. Morgan Stanley et al. filed a complaint against the Firm, certain affiliates, and other defendants in the Supreme Court of NY. The complaint alleges that defendants made material misrepresentations and omissions in the sale to plaintiffs of certain mortgage pass-through certificates backed by securitization trusts containing residential mortgage loans. The total amount of certificates allegedly sponsored, underwritten and/or sold by the Firm to plaintiff was approximately $644 million. The complaint alleges causes of action against the Firm for common law fraud, fraudulent concealment, aiding and abetting fraud, negligent misrepresentation, and rescission and seeks, among other things, compensatory and punitive damages. On June 10, 2014, the court granted in part and denied in part the Firm’s motion to dismiss the complaint. On June 20, 2017 the Appellate Division, First Department, affirmed the lower court’s June 10, 2014 order. On July 28, 2017, the Firm filed a motion for leave to appeal that decision to the New York Court of Appeals. At March 25, 2017, the current unpaid balance of the mortgage pass-through certificates at issue in this action was approximately $237 million, and the certificates had incurred actual losses of approximately $87 million. Based on currently available information, the Firm believes it could incur a loss in this action up to the difference between the $237 million unpaid balance of these certificates (plus any losses incurred) and their fair market value at the time of a judgment against the Firm, or upon sale, plus pre- and post-judgment interest, fees and costs. The Firm may be entitled to be indemnified for some of these losses.

On July 8, 2013, U.S. Bank National Association, in its capacity as trustee, filed a complaint against the Firm styled U.S. Bank National Association, solely in its capacity as Trustee of the Morgan Stanley Mortgage Loan Trust 2007-2AX (MSM 2007-2AX) v. Morgan Stanley Mortgage Capital Holdings LLC, as Successor-by-Merger to Morgan Stanley Mortgage Capital Inc. and GreenPoint Mortgage Funding, Inc., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $650 million, breached various representations and warranties. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, unspecified damages and interest. On August 22,

2013, the Firm filed a motion to dismiss the complaint, which was granted in part and denied in part on November 24, 2014. Based on currently available information, the Firm believes that it could incur a loss in this action of up to approximately $240 million, the total original unpaid balance of the mortgage loans for which the Firm received repurchase demands that it did not repurchase, plus pre- and post-judgment interest, fees and costs, but plaintiff is seeking to expand the number of loans at issue and the possible range of loss could increase.

On December 30, 2013, Wilmington Trust Company, in its capacity as trustee for Morgan Stanley Mortgage Loan Trust 2007-12, filed a complaint against the Firm styled Wilmington Trust Company v. Morgan Stanley Mortgage Capital Holdings LLC et al., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $516 million, breached various representations and warranties. The complaint seeks, among other relief, unspecified damages, attorneys’ fees, interest and costs. On February 28, 2014, the defendants filed a motion to dismiss the complaint, which was granted in part and denied in part on June 14, 2016. The plaintiff filed a notice of appeal of that order on August 17, 2016, and the appeal was fully briefed on May 5, 2017. On July 11, 2017, the Appellate Division, First Department affirmed in part and reversed in part the trial court’s order that granted in part the Firm’s motion to dismiss. Based on currently available information, the Firm believes that it could incur a loss in this action of up to approximately $152 million, the total original unpaid balance of the mortgage loans for which the Firm received repurchase demands that it did not repurchase, plus attorney’s fees, costs and interest, but plaintiff is seeking to expand the number of loans at issue and the possible range of loss could increase.

On April 28, 2014, Deutsche Bank National Trust Company, in its capacity as trustee for Morgan Stanley Structured Trust I 2007-1, filed a complaint against the Firm styled Deutsche Bank National Trust Company v. Morgan Stanley Mortgage Capital Holdings LLC, pending in the United States District Court for the Southern District of New York. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $735 million, breached various representations and warranties. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, unspecified compensatory and/or rescissory damages, interest and costs. On April 3, 2015, the court granted in part and denied in part the Firm’s motion to dismiss the complaint. On May 8, 2017, the Firm moved for summary judgment. Based on currently available

 

 

June 2017 Form 10-Q   80  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

information, the Firm believes that it could incur a loss in this action of up to approximately $292 million, the total original unpaid balance of the mortgage loans for which the Firm received repurchase demands that it did not repurchase, plus pre- and post-judgment interest, fees and costs, but plaintiff is seeking to expand the number of loans at issue and the possible range of loss could increase.

On September 19, 2014, Financial Guaranty Insurance Company (“FGIC”) filed a complaint against the Firm in the Supreme Court of NY, styled Financial Guaranty Insurance Company v. Morgan Stanley ABS Capital I Inc. et al. relating to a securitization issued by Basket of Aggregated Residential NIMS 2007-1 Ltd. The complaint asserts claims for breach of contract and alleges, among other things, that the net interest margin securities (“NIMS”) in the trust breached various representations and warranties. FGIC issued a financial guaranty policy with respect to certain notes that had an original balance of approximately $475 million. The complaint seeks, among other relief, specific performance of the NIMS breach remedy procedures in the transaction documents, unspecified damages, reimbursement of certain payments made pursuant to the transaction documents, attorneys’ fees and interest. On November 24, 2014, the Firm filed a motion to dismiss the complaint, which the court denied on January 19, 2017. On February 24, 2017, the Firm filed a notice of appeal of the court’s order. Based on currently available information, the Firm believes that it could incur a loss in this action of up to approximately $126 million, the unpaid balance of these notes, plus pre- and post-judgment interest, fees and costs, as well as claim payments that FGIC has made and will make in the future.

On September 23, 2014, FGIC filed a complaint against the Firm in the Supreme Court of NY styled Financial Guaranty Insurance Company v. Morgan Stanley ABS Capital I Inc. et al. relating to the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4. The complaint asserts claims for breach of contract and fraudulent inducement and alleges, among other things, that the loans in the trust breached various representations and warranties and defendants made untrue statements and material omissions to induce FGIC to issue a financial guaranty policy on certain classes of certificates that had an original balance of approximately $876 million. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, compensatory, consequential and punitive damages, attorneys’ fees and interest. On January 23, 2017, the court denied the Firm’s motion to dismiss the complaint. On February 24, 2017, the Firm filed a notice of appeal of the court’s order. Based on currently available information, the Firm believes that it could incur a loss in this action of up to approximately $277 million, the total original unpaid balance of the mortgage loans for which the Firm received repurchase

demands from a certificate holder and FGIC that the Firm did not repurchase, plus pre- and post-judgment interest, fees and costs, as well as claim payments that FGIC has made and will make in the future. In addition, plaintiff is seeking to expand the number of loans at issue and the possible range of loss could increase.

On January 23, 2015, Deutsche Bank National Trust Company, in its capacity as trustee, filed a complaint against the Firm styled Deutsche Bank National Trust Company solely in its capacity as Trustee of the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4 v. Morgan Stanley Mortgage Capital Holdings LLC as Successor-by-Merger to Morgan Stanley Mortgage Capital Inc., and Morgan Stanley ABS Capital I Inc., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $1.05 billion, breached various representations and warranties. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, compensatory, consequential, rescissory, equitable and punitive damages, attorneys’ fees, costs and other related expenses, and interest. On December 11, 2015, the court granted in part and denied in part the Firm’s motion to dismiss the complaint. On February 11, 2016, plaintiff filed a notice of appeal of that order, and the appeal was fully briefed on August 19, 2016. Based on currently available information, the Firm believes that it could incur a loss in this action of up to approximately $277 million, the total original unpaid balance of the mortgage loans for which the Firm received repurchase demands from a certificate holder and a monoline insurer that the Firm did not repurchase, plus pre- and post-judgment interest, fees and costs, but plaintiff is seeking to expand the number of loans at issue and the possible range of loss could increase.

In matters styled Case number 15/3637 and Case number 15/4353, the Dutch Tax Authority (“Dutch Authority”) is challenging in the Dutch Tax Tribunal in Amsterdam the prior set-off by the Firm of approximately €124 million (plus accrued interest) of withholding tax credits against the Firm’s corporation tax liabilities for the tax years 2007 to 2013. The Dutch Authority alleges that the Firm was not entitled to receive the withholding tax credits on the basis, inter alia, that a Firm subsidiary did not hold legal title to certain securities subject to withholding tax on the relevant dates. The Dutch Authority has also alleged that the Firm failed to provide certain information to the Dutch Authority and keep adequate books and records. The Firm does not agree with these allegations. A hearing regarding this matter has been scheduled on September 19, 2017. Based on currently available information, the Firm believes that it could incur a loss in this action of up to approximately €124 million (plus accrued interest).

 

 

  81   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

12. Variable Interest Entities and Securitization Activities

Overview

For a discussion of the Firm’s VIEs, the determination and structure of VIEs and securitization activities, see Note 13 to the consolidated financial statements in the 2016 Form 10-K.

Consolidated VIEs

Assets and Liabilities by Type of Activity

 

     At June 30, 2017      At December 31, 2016  

$ in millions

  

VIE

Assets

     VIE
Liabilities
    

VIE

Assets

     VIE
Liabilities
 

Credit-linked notes

   $ 200      $      $ 501      $  

Other structured financings

     426        5        602        10  

Asset-backed securitizations1

     34        22        397        283  

Other2

     1,164        258        910        25  

Total

   $ 1,824      $ 285      $ 2,410      $ 318  

 

1.

Asset-backed securitizations include transactions backed by residential mortgage loans, commercial mortgage loans and other types of assets, including consumer or commercial assets. The value of assets is determined based on the fair value of the liabilities and the interests owned by the Firm in such VIEs because the fair values for the liabilities and interests owned are more observable.

2.

Other primarily includes certain operating entities, investment funds and structured transactions.

Assets and Liabilities by Balance Sheet Caption

 

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

Assets

     

Cash and due from banks

   $ 87      $ 74  

Trading assets at fair value

     785        1,295  

Customer and other receivables

     12        13  

Goodwill

     18        18  

Intangible assets

     166        177  

Other assets

     756        833  

Total

   $ 1,824      $ 2,410  

Liabilities

     

Other secured financings at fair value

   $ 249      $ 289  

Other liabilities and accrued expenses

     36        29  

Total

   $ 285      $ 318  

Consolidated VIE assets and liabilities are presented in the previous tables after intercompany eliminations. The assets owned by many consolidated VIEs cannot be removed unilaterally by the Firm and are not generally available to the Firm. The related liabilities issued by many consolidated VIEs are

non-recourse to the Firm. In certain other consolidated VIEs, the Firm either has the unilateral right to remove assets or provides additional recourse through derivatives such as total return swaps, guarantees or other forms of involvement.

In general, the Firm’s exposure to loss in consolidated VIEs is limited to losses that would be absorbed on the VIE’s net assets recognized in its financial statements, net of amounts absorbed by third-party variable interest holders.

Noncontrolling Interests and Additional Maximum Exposure to Losses Related to Consolidated VIEs

 

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

Noncontrolling interests

   $ 206      $ 228  

Maximum exposure to losses1

            78  

 

1.

Primarily related to certain derivatives, commitments, guarantees and other forms of involvement not recognized in the consolidated financial statements.

Non-consolidated VIEs

The following tables include all VIEs in which the Firm has determined that its maximum exposure to loss is greater than specific thresholds or meets certain other criteria and exclude exposure to loss from liabilities due to immateriality. Most of the VIEs included in the following tables are sponsored by unrelated parties; the Firm’s involvement generally is the result of its secondary market-making activities, securities held in its Investment securities portfolio (see Note 5) and certain investments in funds.

Non-consolidated VIE Assets, Maximum and Carrying Value of Exposure to Loss

 

    At June 30, 2017  
$ in millions   MABS     CDO     MTOB     OSF     Other  

VIE assets (unpaid principal balance)

  $ 78,818     $ 8,598     $ 5,337     $ 3,526     $ 34,823  

Maximum exposure to loss

 

   

Debt and equity interests

  $ 8,482     $ 1,703     $ 52     $ 1,503     $ 5,528  

Derivative and other contracts

                3,229             25  

Commitments, guarantees and other

    805       1,468             174       337  

Total

  $ 9,287     $ 3,171     $ 3,281     $ 1,677     $ 5,890  

Carrying value of exposure to loss—Assets

 

   

Debt and equity interests

  $ 8,482     $ 1,703     $ 52     $ 1,098     $ 5,528  

Derivative and other contracts

                5             52  

Total

  $ 8,482     $ 1,703     $ 57     $ 1,098     $ 5,580  
 

 

June 2017 Form 10-Q   82  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

    At December 31, 2016  
$ in millions   MABS     CDO     MTOB     OSF     Other  

VIE assets (unpaid principal balance)

  $ 101,916     $ 11,341     $ 4,857     $ 4,293     $ 39,077  

Maximum exposure to loss

 

   

Debt and equity interests

  $ 11,243     $ 1,245     $ 50     $ 1,570     $ 4,877  

Derivative and other contracts

                2,812             45  

Commitments, guarantees and other

    684       99             187       228  

Total

  $ 11,927     $ 1,344     $ 2,862     $ 1,757     $ 5,150  

Carrying value of exposure to loss—Assets

 

   

Debt and equity interests

  $ 11,243     $ 1,245     $ 49     $ 1,183     $ 4,877  

Derivative and other contracts

                5             18  

Total

  $ 11,243     $ 1,245     $ 54     $ 1,183     $ 4,895  

MABS—Mortgage- and asset-backed securitizations

CDO—Collateralized debt obligations, including collateralized loan obligations

MTOB—Municipal tender option bonds

OSF—Other structured financings

Non-consolidated VIE Mortgage- and Asset-Backed Securitization Assets

 

    At June 30, 2017     At December 31, 2016  
$ in millions   Unpaid
Principal
Balance
    Debt and
Equity
Interests
    Unpaid
Principal
Balance
    Debt and
Equity
Interests
 

Residential mortgages

  $ 9,106     $ 524     $ 4,775     $ 458  

Commercial mortgages

    49,504       2,614       54,021       2,656  

U.S. agency collateralized mortgage obligations

    13,243       2,745       14,796       2,758  

Other consumer or commercial loans

    6,965       2,599       28,324       5,371  

Total

  $     78,818     $      8,482     $     101,916     $      11,243  

The Firm’s maximum exposure to loss presented above often differs from the carrying value of the variable interests held by the Firm. The maximum exposure to loss presented above is dependent on the nature of the Firm’s variable interest in the VIEs and is limited to the notional amounts of certain liquidity facilities, other credit support, total return swaps, written put options, and the fair value of certain other derivatives and investments the Firm has made in the VIEs. Liabilities issued by VIEs generally are non-recourse to the Firm. Where notional amounts are utilized in quantifying the maximum exposure related to derivatives, such amounts do not reflect fair value write-downs already recorded by the Firm.

The Firm’s maximum exposure to loss presented above does not include the offsetting benefit of any financial instruments that the Firm may utilize to hedge these risks associated with its variable interests. In addition, the Firm’s maximum exposure to loss presented above is not reduced by the amount of collateral held as part of a transaction with the VIE or any party to the VIE directly against a specific exposure to loss.

Securitization transactions generally involve VIEs. Primarily as a result of its secondary market-making activities, the Firm owned additional VIE assets mainly issued by securitization SPEs for which the maximum exposure to loss is less than specific thresholds. These additional assets totaled $11.9 billion and $11.7 billion at June 30, 2017 and December 31, 2016, respectively.

These assets were either retained in connection with transfers of assets by the Firm, acquired in connection with secondary market-making activities, held as AFS securities in its Investment securities portfolio (see Note 5), or held as investments in funds. At June 30, 2017 and December 31, 2016, these assets consisted of securities backed by residential mortgage loans, commercial mortgage loans or other consumer loans, such as credit card receivables, automobile loans and student loans, CDOs or CLOs, and investment funds.

The Firm’s primary risk exposure is to the securities issued by the SPE owned by the Firm, with the highest risk on the most subordinate class of beneficial interests. These assets generally are included in Trading assets—Corporate and other debt, Trading assets—Investments or AFS securities within its Investment securities portfolio and are measured at fair value (see Note 3). The Firm does not provide additional support in these transactions through contractual facilities, such as liquidity facilities, guarantees or similar derivatives. The Firm’s maximum exposure to loss generally equals the fair value of the assets owned.

 

 

  83   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Transactions with SPEs in which the Firm, acting as principal, transferred financial assets with continuing involvement and received sales treatment are shown in the following tables.

Transfers of Assets with Continuing Involvement

 

    At June 30, 2017  
$ in millions  

Residential
Mortgage
Loans

    Commercial
Mortgage
Loans
    U.S. Agency
Collateralized
Mortgage
Obligations
   

Credit-
Linked
Notes and

Other1

 

SPE assets (unpaid principal balance)2

  $ 17,692     $ 53,764     $ 12,337     $ 11,831  

Retained interests

 

Investment grade3

  $     $ 140     $ 710     $ 5  

Non-investment grade (fair value)

    3       86             643  

Total

  $ 3     $ 226     $ 710     $ 648  

Interests purchased in the secondary market (fair value)

 

Investment grade

  $ 4     $ 92     $ 66     $  

Non-investment grade

    17       71              

Total

  $ 21     $ 163     $ 66     $  

Derivative assets (fair value)

  $ 1     $     $     $ 32  

Derivative liabilities (fair value)

                      307  

 

    At December 31, 2016  
$ in millions  

Residential
Mortgage
Loans

    Commercial
Mortgage
Loans
    U.S. Agency
Collateralized
Mortgage
Obligations
   

Credit-
Linked
Notes and

Other1

 

SPE assets (unpaid principal balance)2

  $ 19,381     $ 43,104     $ 11,092     $ 11,613  

Retained interests (fair value)

 

Investment grade

  $     $ 22     $ 375     $  

Non-investment grade

    4       79             826  

Total

  $ 4     $ 101     $ 375     $ 826  

Interests purchased in the secondary market (fair value)

 

Investment grade

  $     $ 30     $ 26     $  

Non-investment grade

    23       75              

Total

  $ 23     $ 105     $ 26     $  

Derivative assets (fair value)

  $     $ 261     $     $ 89  

Derivative liabilities (fair value)

                      459  

 

1.

Amounts include CLO transactions managed by unrelated third parties.

2.

Amounts include assets transferred by unrelated transferors.

3.

Amounts include $734 million of investment grade retained interests at fair value.

     At June 30, 2017  
$ in millions    Level 2      Level 3      Total  

Retained interests (fair value)

        

Investment grade

   $ 729      $ 5      $ 734  

Non-investment grade

     4        728        732  

Total

   $ 733      $         733      $     1,466  

Interests purchased in the secondary market (fair value)

 

Investment grade

   $ 155      $ 7      $ 162  

Non-investment grade

     75        13        88  

Total

   $         230      $ 20      $ 250  

Derivative assets (fair value)

   $ 33      $      $ 33  

Derivative liabilities (fair value)

     131        176        307  
     At December 31, 2016  
$ in millions    Level 2      Level 3      Total  

Retained interests (fair value)

        

Investment grade

   $ 385      $ 12      $ 397  

Non-investment grade

     14        895        909  

Total

   $ 399      $ 907      $ 1,306  

Interests purchased in the secondary market (fair value)

 

Investment grade

   $ 56      $      $ 56  

Non-investment grade

     84        14        98  

Total

   $ 140      $ 14      $ 154  

Derivative assets (fair value)

   $ 348      $ 2      $ 350  

Derivative liabilities (fair value)

     98        361        459  

Transferred assets are carried at fair value prior to securitization, and any changes in fair value are recognized in the consolidated income statements. The Firm may act as underwriter of the beneficial interests issued by these securitization vehicles. Investment banking underwriting net revenues are recognized in connection with these transactions. The Firm may retain interests in the securitized financial assets as one or more tranches of the securitization. These retained interests are generally carried at fair value in the consolidated balance sheets with changes in fair value recognized in the consolidated income statements.

Proceeds from New Securitization Transactions and Sales of Loans

 

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

New transactions1

   $     4,750      $     4,163      $     10,747      $     6,876  

Retained interests

     529        502        959        1,133  

Sales of corporate loans to CLO SPEs1,2

     239               418        31  

 

1.

Net gains on new transactions and sales of corporate loans to CLO entities at the time of the sale were not material for all periods presented.

2.

Sponsored by non-affiliates.

The Firm has provided, or otherwise agreed to be responsible for, representations and warranties regarding certain assets transferred in securitization transactions sponsored by the Firm (see Note 11).

 

 

June 2017 Form 10-Q   84  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

The Firm also enters into transactions in which it sells equity securities and contemporaneously enters into bilateral OTC equity derivatives with the purchasers of the securities, through which it retains the exposure to the securities as shown in the following table.

Carrying and Fair Value of Assets Sold and Retained Interest Exposure

 

$ in millions   

At June 30,

2017

     At December 31,
2016
 

Carrying value of assets derecognized at the time of sale and gross cash proceeds

   $ 14,817      $ 11,209  

Fair value

     

Assets sold

     14,710        11,301  

Derivative assets recognized in the consolidated balance sheets

     33        128  

Derivative liabilities recognized in the consolidated balance sheets

     140        36  

Failed Sales

For transfers that fail to meet the accounting criteria for a sale, the Firm continues to recognize the assets in Trading assets at fair value, and the Firm recognizes the associated liabilities in Other secured financings at fair value in the consolidated balance sheets (see Note 10).

The assets transferred to certain unconsolidated VIEs in transactions accounted for as failed sales cannot be removed unilaterally by the Firm and are not generally available to the Firm. The related liabilities are also non-recourse to the Firm. In certain other failed sale transactions, the Firm has the right to remove assets or provides additional recourse through derivatives such as total return swaps, guarantees or other forms of involvement.

Carrying Value of Assets and Liabilities Related to Failed Sales

 

    

At June 30,

2017

     At December 31,
2016
 
$ in millions    Assets      Liabilities      Assets      Liabilities  

Failed sales

   $         641      $         641      $         285      $         285  

13. Regulatory Requirements

Regulatory Capital Framework

For a discussion of the Firm’s regulatory capital framework, see Note 14 to the consolidated financial statements in the 2016 Form 10-K.

Regulatory Capital Requirements

The Firm is 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

The Firm’s binding risk-based capital ratios for regulatory purposes are the lower of the capital ratios computed under the (i) standardized approaches for calculating credit risk RWAs and market risk RWAs (the “Standardized Approach”) and (ii) applicable advanced approaches for calculating credit risk, market risk and operational risk RWAs (the “Advanced Approach”).

Minimum risk-based capital ratio requirements apply to Common Equity Tier 1 capital, Tier 1 capital and Total capital. Certain adjustments to and deductions from capital are required for purposes of determining these ratios, such as goodwill, intangible assets, certain deferred tax assets, other amounts in 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, the Firm 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 capital surcharge, currently at 3%; and

 

 

Up to a 2.5% Common Equity Tier 1 countercyclical capital buffer, 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 will result in restrictions on the Firm’s ability to make capital distributions, including the payment of dividends and the repurchase of stock, and to pay discretionary bonuses to executive officers.

The methods for calculating each of the Firm’s 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 the Firm’s reported capital ratios from one reporting period to the next that are independent of changes to its capital base, asset composition, off-balance sheet exposures or risk profile.

For a further discussion of the Firm’s calculation of risk-based capital ratios, see Note 14 to the consolidated financial statements in the 2016 Form 10-K.

 

 

  85   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

The Firm’s Regulatory Capital and Capital Ratios

At June 30, 2017 and December 31, 2016, the Firm’s binding ratios are based on the Advanced Approach transitional rules.

Regulatory Capital

 

    At June 30, 2017  

$ in millions

  Amount      Ratio     Minimum
Capital
Ratio1
 

Common Equity Tier 1 capital

  $ 61,604        16.6     7.3%  

Tier 1 capital

    70,380        19.0     8.8%  

Total capital

    81,025        21.9     10.8%  

Tier 1 leverage2

           8.5     4.0%  

Total RWAs

  $     370,679        N/A       N/A  

Adjusted average assets3

    828,365        N/A       N/A  

 

    At December 31, 2016  

$ in millions

  Amount      Ratio     Minimum
Capital
Ratio1
 

Common Equity Tier 1 capital

  $ 60,398        16.9     5.9%  

Tier 1 capital

    68,097        19.0     7.4%  

Total capital

    78,642        22.0     9.4%  

Tier 1 leverage2

           8.4     4.0%  

Total RWAs

  $     358,141        N/A       N/A  

Adjusted average assets3

    811,402        N/A       N/A  

N/A—Not Applicable

1.

Percentages represent minimum regulatory capital ratios under the transitional rules.

2.

Tier 1 leverage ratios are calculated under the Standardized Approach transitional rules.

3.

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, respectively, adjusted for disallowed goodwill, transitional intangible assets, certain deferred tax assets, certain investments in the capital instruments of unconsolidated financial institutions and other adjustments.

U.S. Bank Subsidiaries’ Regulatory Capital and Capital Ratios

The Firm’s U.S. Bank Subsidiaries are subject to similar regulatory capital requirements as the Firm. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that, if undertaken, could have a direct material effect on the U.S. Bank Subsidiaries’ financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, each of the U.S. Bank Subsidiaries must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.

Each U.S. depository institution subsidiary of the Firm must be well-capitalized in order for the Firm to continue to qualify as a financial holding company and to continue to engage in the broadest range of financial activities permitted

for financial holding companies. Under regulatory capital requirements adopted by the U.S. federal banking agencies, U.S. depository institutions must maintain certain minimum capital ratios in order to be considered well-capitalized. At June 30, 2017 and December 31, 2016, the Firm’s U.S. Bank Subsidiaries maintained capital at levels sufficiently in excess of the universally mandated well-capitalized requirements to address any additional capital needs and requirements identified by the U.S. federal banking regulators.

At June 30, 2017 and December 31, 2016, the U.S. Bank Subsidiaries’ binding ratios are based on the Standardized Approach transitional rules.

MSBNA’s Regulatory Capital

 

     At June 30, 2017  

$ in millions

   Amount      Ratio     Minimum
Capital
Ratio1
 

Common Equity Tier 1 capital

   $     14,526        18.5     6.5%  

Tier 1 capital

     14,526        18.5     8.0%  

Total capital

     14,807        18.9     10.0%  

Tier 1 leverage

     14,526        12.0     5.0%  
     At December 31, 2016  

$ in millions

   Amount      Ratio     Minimum
Capital
Ratio1
 

Common Equity Tier 1 capital

   $ 13,398        16.9     6.5%  

Tier 1 capital

     13,398        16.9     8.0%  

Total capital

     14,858        18.7     10.0%  

Tier 1 leverage

     13,398        10.5     5.0%  

 

1.

Capital ratios that are required in order to be considered well-capitalized for U.S. regulatory purposes.

MSPBNA’s Regulatory Capital

 

     At June 30, 2017  

$ in millions

   Amount      Ratio     Minimum
Capital
Ratio1
 

Common Equity Tier 1 capital

   $ 5,898        24.8     6.5%  

Tier 1 capital

     5,898        24.8     8.0%  

Total capital

     5,938        25.0     10.0%  

Tier 1 leverage

     5,898        10.3     5.0%  
     At December 31, 2016  

$ in millions

   Amount      Ratio     Minimum
Capital
Ratio1
 

Common Equity Tier 1 capital

   $     5,589        26.1     6.5%  

Tier 1 capital

     5,589        26.1     8.0%  

Total capital

     5,626        26.3     10.0%  

Tier 1 leverage

     5,589        10.6     5.0%  

 

1.

Capital ratios that are required in order to be considered well-capitalized for U.S. regulatory purposes.

 

 

June 2017 Form 10-Q   86  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

U.S. Broker-Dealer Regulatory Capital Requirements

MS&Co. Regulatory Capital

 

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

Net capital

   $ 10,388      $ 10,311  

Excess net capital

     8,312        8,034  

Morgan Stanley & Co. LLC (“MS&Co.”) is a registered U.S. broker-dealer and registered futures commission merchant and, accordingly, is subject to the minimum net capital requirements of the U.S. Securities and Exchange Commission (“SEC”) and the U.S. Commodity Futures Trading Commission (“CFTC”). As an Alternative Net Capital broker-dealer under SEC rules, MS&Co. is subject to minimum net capital requirements, which it exceeded as presented in the previous table. In addition to these requirements, MS&Co. is required to meet capital requirements imposed by Appendix E of Rule 15c3-1, which are presented in the following table. MS&Co. has consistently operated with capital in excess of its regulatory capital requirements.

 

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

Required tentative net capital1

   $ 1,000      $ 1,000  

Required net capital

     500        500  

 

1.

MS&Co. is required to notify the SEC in the event that its tentative net capital is less than $5 billion.

At June 30, 2017 and December 31, 2016, MS&Co. had tentative net capital in excess of the minimum and the notification requirements.

MSSB LLC Regulatory Capital

 

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

Net capital

   $ 2,288      $ 3,946  

Excess net capital

     2,131        3,797  

Morgan Stanley Smith Barney LLC (“MSSB LLC”) is a registered U.S. broker-dealer and introducing broker for the futures business and, accordingly, is subject to the minimum net capital requirements of the SEC. MSSB LLC has consistently operated with capital in excess of its regulatory capital requirements.

Other Regulated Subsidiaries

Morgan Stanley & Co. International plc (“MSIP”), a London-based broker-dealer subsidiary, is subject to the capital requirements of the Prudential Regulation Authority, and Morgan Stanley MUFG Securities Co., Ltd. (“MSMS”), a Tokyo-based broker-dealer subsidiary, is subject to the capital requirements of the Financial Services Agency. MSIP and MSMS have consistently operated with capital in excess of their respective regulatory capital requirements.

 

Certain other U.S. and non-U.S. subsidiaries of the Firm are subject to various securities, commodities and banking regulations, and capital adequacy requirements promulgated by the regulatory and exchange authorities of the countries in which they operate. These subsidiaries have consistently operated with capital in excess of their local capital adequacy requirements.

14. Total Equity

Dividends and Share Repurchases

The Firm repurchased approximately $500 million of its outstanding common stock as part of the share repurchase program during the current quarter and $1,250 million during the current year period. The Firm repurchased approximately $625 million during the prior year quarter and $1,250 million in the prior year period.

On June 28, 2017, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) announced that they did not object to the Firm’s 2017 capital plan (“Capital Plan”). The Capital Plan includes the share repurchase of up to $5.0 billion of outstanding common stock for the period beginning July 1, 2017 through June 30, 2018, an increase from $3.5 billion in the 2016 Capital Plan. Additionally, the Capital Plan includes an increase in the quarterly common stock dividend to $0.25 per share from $0.20 per share, beginning with the common stock dividend declared on July 19, 2017.

Preferred Stock

For a description of Series A through Series K preferred stock issuances, see Note 15 to the consolidated financial statements in the 2016 Form 10-K. Dividends declared on the Firm’s outstanding preferred stock were $170 million during the current quarter and $156 million during the prior year quarter, and $260 million during the current year period and $234 million during the prior year period. On June 15, 2017, the Firm announced that the Board of Directors (the “Board”) declared a quarterly dividend for preferred stock shareholders of record on June 30, 2017 that was paid on July 17, 2017. The Firm is authorized to issue 30 million shares of preferred stock. The preferred stock has a preference over the common stock upon liquidation. The Firm’s preferred stock qualifies as Tier 1 capital in accordance with regulatory capital requirements (see Note 13).

Series K Preferred Stock. The Series K Preferred Stock offering (net of related issuance costs) in January 2017 resulted in proceeds of approximately $994 million.

 

 

  87   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

Preferred Stock Outstanding

 

$ in millions, except
per share data

  Shares
Outstanding
   

Liquidation
Preference
per Share

    Carrying Value  
  At June 30,
2017
      At June 30,
2017
    At December 31,
2016
 

Series

                       

A

    44,000     $ 25,000     $ 1,100     $ 1,100  

C1

    519,882       1,000       408       408  

E

    34,500       25,000       862       862  

F

    34,000       25,000       850       850  

G

    20,000       25,000       500       500  

H

    52,000       25,000       1,300       1,300  

I

    40,000       25,000       1,000       1,000  

J

    60,000       25,000       1,500       1,500  

K

    40,000       25,000       1,000        

Total

 

  $ 8,520     $ 7,520  

 

1.

Series C is composed of the issuance of 1,160,791 shares of Series C Preferred Stock to MUFG for an aggregate purchase price of $911 million, less the redemption of 640,909 shares of Series C Preferred Stock of $503 million, which were converted to common shares of approximately $705 million.

Comprehensive Income (Loss)

Accumulated Other Comprehensive Income (Loss)

 

$ in millions   Foreign
Currency
Translation
Adjustments
    AFS
Securities
    Pensions,
Postretirement
and Other
    DVA     Total  

March 31, 2017

  $ (879   $ (504   $ (474   $ (593   $ (2,450

OCI during the period1

    23       108       4       (173     (38

June 30, 2017

  $ (856   $ (396   $ (470   $ (766   $ (2,488

March 31, 2016

  $ (831   $ 76     $ (373   $ (110   $ (1,238

OCI during the period1

    52       143       (5     143       333  

June 30, 2016

  $ (779   $ 219     $ (378   $ 33     $ (905

December 31, 2016

  $ (986   $ (588   $ (474   $ (595   $ (2,643

OCI during the period1

    130       192       4       (171     155  

June 30, 2017

  $ (856   $ (396   $ (470   $ (766   $ (2,488

December 31, 2015

  $ (963   $ (319   $ (374   $     $ (1,656

Cumulative adjustment for accounting change related to DVA2

                      (312     (312

OCI during the period1

    184       538       (4     345       1,063  

June 30, 2016

  $ (779   $ 219     $ (378   $ 33     $ (905)  

 

1.

Amounts net of tax and noncontrolling interests.

2.

In accordance with the early adoption of a provision of the accounting update Recognition and Measurement of Financial Assets and Financial Liabilities, a cumulative catch-up adjustment was recorded as of January 1, 2016 to move the cumulative unrealized DVA amount, net of noncontrolling interests and tax, related to outstanding liabilities under the fair value option election from Retained earnings into AOCI. See Note 2 to the consolidated financial statements in the 2016 Form 10-K for further information.

Period Changes in OCI Components

 

   

Three Months Ended

June 30, 2017

 
$ in millions   Pre-tax
gain (loss)
    Income tax
benefit
(provision)
    After-tax
gain (loss)
   

Non-

controlling
interests

    Net  

Foreign currency translation adjustments

 

OCI activity

  $ 1     $ 11     $ 12     $ (11   $ 23  

Reclassified to earnings

                             

Net OCI

  $ 1     $ 11     $ 12     $ (11   $ 23  

Change in net unrealized gains (losses) on AFS securities

 

OCI activity

  $ 185     $ (68   $ 117     $     $ 117  

Reclassified to earnings1

    (14     5       (9           (9

Net OCI

  $ 171     $ (63   $ 108     $     $ 108  

Pension, postretirement and other

 

OCI activity

  $ 3     $     $ 3     $     $ 3  

Reclassified to earnings1

    1             1             1  

Net OCI

    4             4             4  

Change in net DVA

 

OCI activity

  $ (285   $ 99     $ (186   $ (10   $ (176

Reclassified to earnings1

    4       (1     3             3  

Net OCI

  $ (281   $ 98     $ (183   $ (10   $ (173

 

   

Three Months Ended

June 30, 2016

 
$ in millions   Pre-tax
gain (loss)
    Income tax
benefit
(provision)
    After-tax
gain (loss)
   

Non-

controlling
interests

    Net  

Foreign currency translation adjustments

 

OCI activity

  $ 72     $ 59     $ 131     $ 79     $ 52  

Reclassified to earnings

                             

Net OCI

  $ 72     $ 59     $ 131     $ 79     $ 52  

Change in net unrealized gains (losses) on AFS securities

 

OCI activity

  $ 298     $ (110   $ 188     $     $ 188  

Reclassified to earnings1

    (70     25       (45           (45

Net OCI

  $ 228     $ (85   $ 143     $     $ 143  

Pension, postretirement and other

 

OCI activity

  $ (5   $     $ (5   $     $ (5

Reclassified to earnings1

    (1     1                    

Net OCI

  $ (6   $ 1     $ (5   $     $ (5

Change in net DVA

 

OCI activity

  $ 225     $ (80   $ 145     $ 2     $ 143  

Reclassified to earnings1

                             

Net OCI

  $ 225     $ (80   $ 145     $ 2     $ 143  
 

 

June 2017 Form 10-Q   88  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

   

Six Months Ended

June 30, 2017

 
$ in millions   Pre-tax
gain (loss)
    Income tax
benefit
(provision)
    After-tax
gain (loss)
   

Non-

controlling
interests

    Net  

Foreign currency translation adjustments

 

OCI activity

  $ 44     $ 118     $ 162     $ 32     $ 130  

Reclassified to earnings

                             

Net OCI

  $ 44     $ 118     $ 162     $ 32     $ 130  

Change in net unrealized gains (losses) on AFS securities

 

OCI activity

  $ 322     $ (120   $ 202     $     $ 202  

Reclassified to earnings1

    (16     6       (10           (10

Net OCI

  $ 306     $ (114   $ 192     $     $ 192  

Pension, postretirement and other

 

OCI activity

  $ 3     $     $ 3     $     $ 3  

Reclassified to earnings1

    1             1             1  

Net OCI

    4             4             4  

Change in net DVA

 

OCI activity

  $ (278   $ 98     $ (180   $ (3   $ (177

Reclassified to earnings1

    8       (2     6             6  

Net OCI

  $ (270   $ 96     $ (174   $ (3   $ (171

 

   

Six Months Ended

June 30, 20162

 
$ in millions   Pre-tax
gain (loss)
    Income tax
benefit
(provision)
    After-tax
gain (loss)
   

Non-

controlling
interests

    Net  

Foreign currency translation adjustments

 

OCI activity

  $ 143     $ 174     $ 317     $ 133     $ 184  

Reclassified to earnings

                             

Net OCI

  $ 143     $ 174     $ 317     $ 133     $ 184  

Change in net unrealized gains (losses) on AFS securities

 

OCI activity

  $ 934     $ (344   $ 590     $     $ 590  

Reclassified to earnings1

    (82     30       (52           (52

Net OCI

  $ 852     $ (314   $ 538     $     $ 538  

Pension, postretirement and other

 

OCI activity

  $ (6   $ 3     $ (3   $     $ (3

Reclassified to earnings1

    (2     1       (1           (1

Net OCI

  $ (8   $ 4     $ (4   $     $ (4

Change in net DVA

 

OCI activity

  $ 589     $ (215   $ 374     $ 3     $ 371  

Reclassified to earnings1

    (41     15       (26           (26

Net OCI

  $ 548     $ (200   $ 348     $ 3     $ 345  

 

1.

Amounts reclassified to earnings related to: realized gains and losses from sales of AFS securities are classified within Other revenues in the consolidated income statements; Pension, postretirement and other are classified within Compensation and benefits expenses in the consolidated income statements; and realization of DVA are classified within Trading revenues in the consolidated income statements.

2.

Exclusive of 2016 cumulative adjustment for accounting change related to DVA.

 

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

Noncontrolling interests

   $ 1,141      $ 1,127  

The increase in noncontrolling interests was primarily due to the increase in net income attributable to noncontrolling interests, partially offset by deconsolidation of certain investment management funds sponsored by the Firm.

15. Earnings per Common Share

Calculation of Basic and Diluted Earnings per Common Share (“EPS”)

 

    Three Months
Ended June 30,
    Six Months
Ended June 30,
 
in millions, except for per share data   2017     2016     2017     2016  

Basic EPS

       

Income from continuing operations

  $ 1,796     $ 1,650     $ 3,789     $ 2,810  

Income (loss) from discontinued operations

    (5     (4     (27     (7

Net income

    1,791       1,646       3,762       2,803  

Net income applicable to noncontrolling interests

    34       64       75       87  

Net income applicable to Morgan Stanley

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

Less: Preferred stock dividends and other

    (170     (157     (260     (235

Earnings applicable to Morgan Stanley common shareholders

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

Weighted average common shares outstanding

    1,791       1,866       1,796       1,875  

Earnings per basic common share

 

Income from continuing operations

  $ 0.89     $ 0.77     $ 1.92     $ 1.33  

Income (loss) from discontinued operations

          (0.01     (0.01     (0.01

Earnings per basic common share

  $ 0.89     $ 0.76     $ 1.91     $ 1.32  

Diluted EPS

       

Earnings applicable to Morgan Stanley common shareholders

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

Weighted average common shares outstanding

    1,791       1,866       1,796       1,875  

Effect of dilutive securities:

       

Stock options and RSUs1

    39       33       40       32  

Weighted average common shares outstanding and common stock equivalents

    1,830       1,899       1,836       1,907  

Earnings per diluted common share

 

Income from continuing operations

  $ 0.87     $ 0.75     $ 1.88     $ 1.30  

Income (loss) from discontinued operations

                (0.01      

Earnings per diluted common share

  $ 0.87     $ 0.75     $ 1.87     $ 1.30  

Weighted average antidilutive RSUs and stock options (excluded from the computation of diluted EPS)1

          14             15  
 

 

  89   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

1.

Restricted stock units (“RSUs”) that are considered participating securities are treated as a separate class of securities in the computation of basic EPS, and, therefore, such RSUs are not included as incremental shares in the diluted EPS computations.

16. Interest Income and Interest Expense

 

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

Interest income1

       

Investment securities

  $ 304     $ 237     $ 630     $ 473  

Loans

    798       680       1,546       1,327  

Interest bearing deposits with banks

    67       52       122       105  

Securities purchased under agreements to resell and Securities borrowed2

    29       (120     10       (198

Trading assets, net of Trading liabilities3

    491       526       955       1,109  

Customer receivables and Other4

    417       292       808       598  

Total interest income

  $ 2,106     $ 1,667     $ 4,071     $ 3,414  

Interest expense1

       

Deposits

  $ 14     $ 15     $ 25     $ 37  

Short-term and Long-term borrowings

    1,067       851       2,088       1,818  

Securities sold under agreements to repurchase and Securities loaned5

    339       259       587       513  

Customer payables and Other6

    (65     (371     (151     (766

Total interest expense

  $ 1,355     $ 754     $ 2,549     $ 1,602  

Net interest

  $ 751     $ 913     $ 1,522     $ 1,812  

 

1.

Interest income and Interest expense are recorded within the consolidated income statements depending on the nature of the instrument and related market conventions. When interest is included as a component of the instrument’s fair value, interest is included within Trading revenues or Investments revenues. Otherwise, it is included within Interest income or Interest expense.

2.

Includes fees paid on Securities borrowed.

3.

Interest expense on Trading liabilities is reported as a reduction to Interest income on Trading assets.

4.

Includes interest from customer receivables and cash deposited with clearing organizations or segregated under federal and other regulations or requirements.

5.

Includes fees received on Securities loaned.

6.

Includes fees received from prime brokerage customers for stock loan transactions incurred to cover customers’ short positions.

17. Employee Benefit Plans

The Firm sponsors various retirement plans for the majority of its U.S. and non-U.S. employees. The Firm provides certain other postretirement benefits, primarily health care and life insurance, to eligible U.S. employees.

 

Components of the Net Periodic Benefit Expense (Income) for Pension and Other Postretirement Plans

 

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

Service cost, benefits earned during the period

   $ 4     $ 4     $ 8     $ 8  

Interest cost on projected benefit obligation

     38       39       75       77  

Expected return on plan assets

     (29     (30     (58     (60

Net amortization of prior service credit

     (4     (5     (8     (9

Net amortization of actuarial loss

     4       3       8       6  

Net periodic benefit expense (income)

   $ 13     $ 11     $ 25     $ 22  

18. Income Taxes

The Firm is under continuous examination by the Internal Revenue Service (the “IRS”) and other tax authorities in certain countries, such as Japan and the United Kingdom (“U.K.”), and in states in which it has significant business operations, such as New York. The Firm is currently at various levels of field examination with respect to audits by the IRS, as well as New York State and New York City, for tax years 2009-2012 and 2007-2014, respectively. The Firm believes that the resolution of these tax matters will not have a material effect on the annual consolidated financial statements, although a resolution could have a material impact on the consolidated income statements and effective tax rate for any period in which such resolution occurs.

In April 2016, the Firm received a notification from the IRS that the Congressional Joint Committee on Taxation approved the final report of an Appeals Office review of matters from tax years 1999-2005, and the Revenue Agent’s Report reflecting agreed closure of the 2006-2008 tax years. In March 2017, the Firm filed claims with the IRS to contest certain items, associated with tax years 1999-2005, the resolution of which is not expected to have a material impact on the annual consolidated financial statements or effective tax rate.

During 2017, the Firm expects to reach a conclusion with the U.K. tax authorities on substantially all issues through tax year 2010, the resolution of which is not expected to have a material impact on the annual consolidated financial statements or effective tax rate.

The Firm has established a liability for unrecognized tax benefits that it believes is adequate in relation to the potential for additional assessments. Once established, the Firm adjusts liabilities for unrecognized tax benefits only when new information is available or when an event occurs necessitating a change.

 

 

June 2017 Form 10-Q   90  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

The Firm expects to receive new information related to a multi-year IRS field audit examination that may prompt a decrease in the Firm’s recorded unrecognized tax benefits over the next 12 months. The potential change in unrecognized tax benefits is not expected to have a material impact on the Firm’s annual consolidated financial statements or effective tax rate, although it could have a material impact on

the Firm’s consolidated income statements and effective tax rate for the period in which such development occurs.

See Note 11 regarding the Dutch Tax Authority’s challenge, in the Dutch Tax Tribunal in Amsterdam (matters styled Case number 15/3637 and Case number 15/4353), of the Firm’s entitlement to certain withholding tax credits which may impact the balance of unrecognized tax benefits.

 

19. Segment and Geographic Information

Segment Information

 

For a discussion about the Firm’s business segments, see Note 21 to the consolidated financial statements in the 2016 Form 10-K.

Selected Financial Information by Business Segment

 

    Three Months Ended June 30, 2017  
$ in millions   IS1     WM     IM2     I/E     Total  

Total non-interest revenues3

  $ 5,020     $ 3,142     $ 665     $ (75   $ 8,752  

Interest income

    1,243       1,114       1       (252     2,106  

Interest expense

    1,501       105       1       (252     1,355  

Net interest

    (258     1,009                   751  

Net revenues

  $ 4,762     $ 4,151     $ 665     $ (75   $ 9,503  

Income from continuing operations before income taxes

  $ 1,443     $ 1,057     $ 142     $     $ 2,642  

Provision for income taxes

    413       392       41             846  

Income from continuing operations

    1,030       665       101             1,796  

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

    (5                       (5

Net income

    1,025       665       101             1,791  

Net income applicable to noncontrolling interests

    33             1             34  

Net income applicable to Morgan Stanley

  $ 992     $ 665     $ 100     $     $ 1,757  
    Three Months Ended June 30, 2016  
$ in millions   IS4     WM4     IM2     I/E     Total  

Total non-interest revenues3

  $ 4,496     $ 2,982     $ 581     $ (63   $ 7,996  

Interest income

    966       920       3       (222     1,667  

Interest expense

    884       91       1       (222     754  

Net interest

    82       829       2             913  

Net revenues

  $ 4,578     $ 3,811     $ 583     $ (63   $ 8,909  

Income from continuing operations before income taxes

  $ 1,506     $ 859     $ 118     $     $ 2,483  

Provision for income taxes

    453       343       37             833  

Income from continuing operations

    1,053       516       81             1,650  

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

    (4                       (4

Net income

    1,049       516       81             1,646  

Net income applicable to noncontrolling interests

    61             3             64  

Net income applicable to Morgan Stanley

  $ 988     $ 516     $ 78     $     $ 1,582  
    Six Months Ended June 30, 2017  
$ in millions   IS1     WM     IM2     I/E     Total  

Total non-interest revenues3

  $ 10,399     $ 6,206     $ 1,273     $ (152   $ 17,726  

Interest income

    2,367       2,193       2       (491     4,071  

Interest expense

    2,852       190       1       (494     2,549  

Net interest

    (485     2,003       1       3       1,522  

Net revenues

  $ 9,914     $ 8,209     $ 1,274     $ (149   $ 19,248  

Income from continuing operations before income taxes

  $ 3,173     $ 2,030     $ 245     $ 2     $ 5,450  

Provision for income taxes

    872       718       71             1,661  

Income from continuing operations

    2,301       1,312       174       2       3,789  

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

    (27                       (27

Net income

    2,274       1,312       174       2       3,762  

Net income applicable to noncontrolling interests

    68             7             75  

Net income applicable to Morgan Stanley

  $ 2,206     $ 1,312     $ 167     $ 2     $ 3,687  
    Six Months Ended June 30, 2016  
$ in millions   IS4     WM4     IM2     I/E     Total  

Total non-interest revenues3

  $ 8,141     $ 5,819     $ 1,059     $ (130   $ 14,889  

Interest income

    2,019       1,834       4       (443     3,414  

Interest expense

    1,868       174       3       (443     1,602  

Net interest

    151       1,660       1             1,812  

Net revenues

  $ 8,292     $ 7,479     $ 1,060     $ (130   $ 16,701  

Income from continuing operations before income taxes

  $ 2,414     $ 1,645     $ 162     $     $ 4,221  

Provision for income taxes

    728       636       47             1,411  

Income from continuing operations

    1,686       1,009       115             2,810  

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

    (7                       (7

Net income

    1,679       1,009       115             2,803  

Net income (loss) applicable to noncontrolling interests

    100             (13           87  

Net income applicable to Morgan Stanley

  $ 1,579     $ 1,009     $ 128     $     $ 2,716  

IS—Institutional Securities

WM—Wealth Management

IM—Investment Management

I/E—Intersegment eliminations

 

 

  91   June 2017 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

  LOGO

 

1.

In the current quarter, the Firm recorded a provision of $86 million for potential additional value-added tax, interest and penalties in relation to certain intercompany service activities provided to our U.K. Group.

2.

The Firm waives a portion of its fees from certain registered money market funds that comply with the requirements of Rule 2a-7 of the Investment Company Act of 1940. These fee waivers resulted in a reduction of fees of approximately $23 million and $12 million for the current quarter and prior year quarter, respectively, and $45 million and $35 million for the current year period and prior year period, respectively.

3.

In certain management fee arrangements, the Firm is entitled to receive performance-based fees (also referred to as incentive fees and includes carried interest) when the return on assets under management exceeds certain benchmark returns or other performance targets. In such arrangements, performance fee revenues are accrued (or reversed) quarterly based on measuring account/fund performance to date versus the performance benchmark stated in the investment management agreement. The Firm’s portion of net unrealized cumulative performance-based fees (for which the Firm is not obligated to pay compensation) at risk of reversing if fund performance falls below stated investment management agreement benchmarks was approximately $469 million and $397 million at June 30, 2017 and December 31, 2016, respectively. See Note 11 for information regarding general partner guarantees, which include potential obligations to return performance fee distributions previously received.

4.

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.

Total Assets by Business Segment

 

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

Institutional Securities

   $ 665,603      $ 629,149  

Wealth Management

     170,735        181,135  

Investment Management

     4,678        4,665  

Total1

   $ 841,016      $ 814,949  

 

1.

Corporate assets have been fully allocated to the business segments.

Geographic Information

For a discussion about the Firm’s geographic net revenues, see Note 21 to the consolidated financial statements in the 2016 Form 10-K.

Net Revenues by Region

 

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

Americas

   $ 6,746      $ 6,538      $ 13,834      $ 12,290  

EMEA

     1,606        1,312        3,095        2,441  

Asia-Pacific

     1,151        1,059        2,319        1,970  

Net revenues

   $ 9,503      $ 8,909      $ 19,248      $ 16,701  

20. Subsequent Events

The Firm has evaluated subsequent events for adjustment to or disclosure in the consolidated financial statements through the date of this report and has not identified any recordable or disclosable events not otherwise reported in these consolidated financial statements or the notes thereto.

 

 

June 2017 Form 10-Q   92  


Table of Contents

Financial Data Supplement (Unaudited)

Average Balances and Interest Rates and Net Interest Income

  LOGO

 

     Three Months Ended June 30,  
     2017     2016  
$ in millions   

Average

Daily
Balance

     Interest    

Annualized

Average
Rate

   

Average

Daily
Balance

     Interest     Annualized
Average
Rate
 

Interest earning assets1

              

Investment securities2

   $ 74,855      $ 304       1.6   $ 78,233      $ 237       1.2

Loans2

     96,230        798       3.3       89,344        680       3.1  

Interest bearing deposits with banks2

     19,555        67       1.4       29,250        52       0.7  

Securities purchased under agreements to resell and Securities borrowed3:

              

U.S.

     129,845        140       0.4       157,223        (64     (0.2

Non-U.S.

     90,200        (111     (0.5     82,863        (56     (0.3

Trading assets, net of Trading liabilities4:

              

U.S.

     60,963        476       3.1       49,914        459       3.7  

Non-U.S.

     3,409        15       1.8       12,447        67       2.2  

Customer receivables and Other5:

              

U.S.

     48,330        292       2.4       46,144        233       2.0  

Non-U.S.

     25,863        125       1.9       21,655        59       1.1  

Total

   $ 549,250      $ 2,106       1.5   $ 567,073      $ 1,667       1.2

Interest bearing liabilities1

              

Deposits2

   $ 146,982      $ 14         $ 154,835      $ 15      

Short-term and Long-term borrowings2, 6

     180,918        1,067       2.4       164,061        851       2.1  

Securities sold under agreements to repurchase and Securities loaned7:

              

U.S.

     35,066        245       2.8       31,412        141       1.8  

Non-U.S.

     36,974        94       1.0       31,729        118       1.5  

Customer payables and Other8:

              

U.S.

     130,814        (98     (0.3     126,988        (335     (1.1

Non-U.S.

     64,135        33       0.2       65,603        (36     (0.2

Total

   $ 594,889      $ 1,355       0.9     $ 574,628      $ 754       0.5  

Net interest income and net interest rate spread

            $ 751       0.6            $ 913       0.7

 

  93   June 2017 Form 10-Q


Table of Contents

Financial Data Supplement (Unaudited)

Average Balances and Interest Rates and Net Interest Income

  LOGO

 

     Six Months Ended June 30,  
     2017     2016  
$ in millions   

Average

Daily
Balance

     Interest    

Annualized

Average
Rate

   

Average

Daily
Balance

     Interest     Annualized
Average
Rate
 

Interest earning assets1

              

Investment securities2

   $ 77,758      $ 630       1.6   $ 76,999      $ 473       1.2

Loans2

     95,799        1,546       3.3       87,979        1,327       3.0  

Interest bearing deposits with banks2

     19,928        122       1.2       30,514        105       0.7  

Securities purchased under agreements to resell and Securities borrowed3:

              

U.S.

     128,775        216       0.3       154,488        (126     (0.2

Non-U.S.

     92,354        (206     (0.4     84,499        (72     (0.2

Trading assets, net of Trading liabilities4:

              

U.S.

     58,390        922       3.2       48,827        957       4.0  

Non-U.S.

     2,630        33       2.5       13,386        152       2.3  

Customer receivables and Other5:

              

U.S.

     48,173        586       2.5       47,400        468       2.0  

Non-U.S.

     25,664        222       1.7       22,092        130       1.2  

Total

   $ 549,471      $ 4,071       1.5   $ 566,184      $ 3,414       1.2

Interest bearing liabilities1

              

Deposits2

   $ 150,309      $ 25         $ 156,893      $ 37      

Short-term and Long-term borrowings2, 6

     175,937        2,088       2.4       162,059        1,818       2.3  

Securities sold under agreements to repurchase and Securities loaned7:

              

U.S.

     35,199        417       2.4       31,635        271       1.7  

Non-U.S.

     37,654        170       0.9       28,144        242       1.7  

Customer payables and Other8:

              

U.S.

     130,836        (183     (0.3     125,943        (704     (1.1

Non-U.S.

     60,160        32       0.1       65,055        (62     (0.2

Total

   $ 590,095      $ 2,549       0.9     $ 569,729      $ 1,602       0.6  

Net interest income and net interest rate spread

            $ 1,522       0.6            $ 1,812       0.6

 

1.

Certain revisions have been made to prior periods to conform to the current presentation.

2.

Amounts include primarily U.S. balances.

3.

Includes fees paid on Securities borrowed.

4.

Trading assets, net of Trading liabilities exclude non-interest earning assets and non-interest bearing liabilities, such as equity securities.

5.

Includes interest from customer receivables and cash deposited with clearing organizations or segregated under federal and other regulations or requirements.

6.

The Firm also issues structured notes that have coupon or repayment terms linked to the performance of debt or equity securities, indices, currencies or commodities, which are recorded within Trading revenues (see Note 3 to the consolidated financial statements).

7.

Includes fees received on Securities loaned.

8.

Includes fees received from prime brokerage customers for stock loan transactions incurred to cover customers’ short positions.

 

June 2017 Form 10-Q   94  


Table of Contents

Financial Data Supplement (Unaudited)

Rate/Volume Analysis

  LOGO

 

Effect of Volume and Rate Changes on Net Interest Income

 

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

Increase (decrease)

due to change in:

         

Increase (decrease)

due to change in:

       
$ in millions    Volume     Rate     Net Change     Volume     Rate     Net Change  

Interest earning assets

            

Investment securities

   $ (10   $ 77     $ 67     $ 5     $ 152     $ 157  

Loans

     52       66       118       118       101       219  

Interest bearing deposits with banks

     (17     32       15       (37     54       17  

Securities purchased under agreements to resell and Securities borrowed:

            

U.S.

     11       193       204       20       322       342  

Non-U.S.

     (5     (50     (55     (7     (127     (134

Trading assets, net of Trading liabilities:

            

U.S.

     101       (84     17       186       (221     (35

Non-U.S.

     (49     (3     (52     (122     3       (119

Customer receivables and Other:

            

U.S.

     11       48       59       8       110       118  

Non-U.S.

     11       55       66       21       71       92  

Change in interest income

   $ 105     $ 334     $ 439     $ 192     $ 465     $ 657  

Interest bearing liabilities

            

Deposits

   $ (1   $     $ (1   $ (2   $ (10   $ (12

Short-term and Long-term borrowings

     88       128       216       156       114       270  

Securities sold under agreements to repurchase and Securities loaned:

            

U.S.

     16       88       104       31       115       146  

Non-U.S.

     19       (43     (24     82       (154     (72

Customer payables and Other:

            

U.S.

     (10     247       237       (26     547       521  

Non-U.S.

     1       68       69       5       89       94  

Change in interest expense

   $ 113     $ 488     $ 601     $ 246     $ 701     $ 947  

Change in net interest income

   $ (8   $ (154   $ (162   $ (54   $ (236   $ (290

 

  95   June 2017 Form 10-Q


Table of Contents
  LOGO

 

Other Information

Legal Proceedings

The following new matters and developments have occurred since previously reporting certain matters in the Firm’s Annual Report on Form 10-K for the year ended December 31, 2016 (the “Form 10-K”) and the Firm’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2017 (the “First Quarter Form 10-Q”). See also the disclosures set forth under “Legal Proceedings” in Part I, Item 3 of the Form 10-K and Part II, Item 1 of the First Quarter Form 10-Q.

Residential Mortgage and Credit Crisis Related Matters

On April 13, 2017, the Appellate Division, First Department, denied plaintiff’s motion for leave to appeal to the New York Court of Appeals in Federal Housing Finance Agency, as Conservator for the Federal Home Loan Mortgage Corporation, on behalf of the Trustee of the Morgan Stanley ABS Capital I Inc. Trust, Series 2007-NC1 (MSAC 2007-NC1) v. Morgan Stanley ABS Capital I Inc.

On April 13, 2017, the Appellate Division, First Department, denied plaintiff’s motion for leave to appeal to the New York Court of Appeals in Federal Housing Finance Agency, as Conservator for the Federal Home Loan Mortgage Corporation, on behalf of the Trustee of the Morgan Stanley ABS Capital I Inc. Trust, Series 2007-NC3 (MSAC 2007-NC3) v. Morgan Stanley ABS Capital I Inc.

On April 21, 2017 the parties to Morgan Stanley Mortgage Loan Trust 2006-13ARX v. Morgan Stanley Mortgage Capital Holdings LLC, as successor in interest to Morgan Stanley Mortgage Capital Inc. reached an agreement in principle to settle the litigation.

On May 8, 2017, the Firm moved for summary judgment in Deutsche Bank National Trust Company v. Morgan Stanley Mortgage Capital Holdings LLC.

On May 12, 2017, plaintiff filed a notice of appeal of the decision and order by the Supreme Court of the State of New York, which granted the Firm’s motion to dismiss the amended complaint in Royal Park Investments SA/NV v. Morgan Stanley et al.

On May 30, 2017, the parties in Morgan Stanley Mortgage Loan Trust 2006-4SL, et al. v. Morgan Stanley Mortgage Capital Inc. and Morgan Stanley Mortgage Loan Trust 2006-10SL, et al. v. Morgan Stanley Mortgage Capital Holdings LLC, as successor in interest to Morgan Stanley Mortgage Capital Inc. reached an agreement in principle to settle the litigation.

On June 20, 2017, the Appellate Division, First Department, affirmed the order granting in part and denying in part the Firm’s motion to dismiss in Deutsche Zentral-Genossenschaftsbank AG et al. v. Morgan Stanley et al. On July 28, 2017, the Firm filed a motion for leave to appeal that decision to the New York Court of Appeals.

Following the reversal on appeal of the Court’s order granting defendants’ motion to dismiss on November 17, 2016, on June 15, 2017, plaintiffs in Phoenix Light SF Limited, et al. v. Morgan Stanley, et al. filed a second amended complaint. On July 7, 2017, the court so-ordered a stipulation of partial discontinuance dismissing claims relating to certificates having an original face value of approximately $76 million.

On July 11, 2017, the Appellate Division, First Department, affirmed in part and reversed in part, an order granting in part and denying in part the Firm’s motion to dismiss in Wilmington Trust Company v. Morgan Stanley Mortgage Capital Holdings LLC et al.

European Matters

On July 17, 2017, the court in Parma, Italy presiding over the criminal trial against certain present and former employees of the Firm related to the bankruptcy of Parmalat in 2003 issued a decision acquitting the present and former employees of all of the charges pending against them.

On May 31, 2017, Land Salzburg received parliamentary approval for the resolution of all claims in the actions styled Land Salzburg v. Morgan Stanley & Co. International plc and Morgan Stanley Capital Services LLC and Morgan Stanley & Co. International plc v. Land Salzburg.

On July 3, 2017, the Firm was informed that the public prosecutor for the Court of Accounts for the Republic of Italy filed a claim against the Firm styled Case No. 2012/00406/MNV, which is pending in the Regional Prosecutor’s Office at the Judicial Section of the Court of Auditors for Lazio, Italy. The claim relates to certain derivative transactions between the Republic of Italy and the Firm. The transactions were originally entered into between 1999 and 2005, and were terminated in December 2011 and January 2012. The claim alleges, inter alia, that the Firm was acting as an agent of the Republic of Italy, that the derivative transactions were improper and that the termination of the transactions was also improper and asserts claims for damages through an administrative process against the Firm for €2.76 billion. The Firm does not agree with these allegations. A hearing regarding this matter has been scheduled for April 19, 2018.

In matters styled Case number 15/3637 and Case number 15/4353, the Dutch Tax Authority (“Dutch Authority”) is

 

 

June 2017 Form 10-Q   96  


Table of Contents
  LOGO

 

challenging in the Dutch Tax Tribunal in Amsterdam the prior set-off by the Firm of approximately €124 million (plus accrued interest) of withholding tax credits against the Firm’s corporation tax liabilities for the tax years 2007 to 2013. The Dutch Authority alleges that the Firm was not entitled to receive the withholding tax credits on the basis, inter alia, that a Firm subsidiary did not hold legal title to certain securities subject to withholding tax on the relevant dates. The Dutch Authority has also alleged that the Firm failed to provide certain information to the Dutch Authority and keep adequate books and records. The Firm does not agree with these allegations. A hearing regarding this matter has been scheduled on September 19, 2017.

Other

Beginning in February of 2016, the Firm was named as a defendant in multiple purported antitrust class actions now consolidated into a single proceeding in the United States District Court for the Southern District of New York styled In Re: Interest Rate Swaps Antitrust Litigation. Plaintiffs allege, inter alia, that the Firm, together with a number of other financial institution defendants violated United States and

New York state antitrust laws from 2008 through December of 2016 in connection with their alleged efforts to prevent the development of electronic exchange-based platforms for interest rates swaps trading. Complaints were filed both on behalf of a purported class of investors who purchased interest rates swaps from defendants, as well as on behalf of two swap execution facilities that allegedly were thwarted by the defendants in their efforts to develop such platforms. The consolidated complaints seek, among other relief, certification of the investor class of plaintiffs and treble damages. On July 28, 2017, the court granted in part and denied in part the defendants’ motion to dismiss the complaints.

On June 2, 2015, the Firm submitted to the Environmental Protection Agency (“EPA”) a self-disclosure that certain reformulated blendstock the Firm blended and sold during 2013 and 2014 potentially did not meet the applicable volatile organic compound reduction standards of the EPA’s Phase II Reformulated Gasoline standard. On July 7, 2017, the EPA made a settlement demand of approximately $1 million. Further discussions between the parties are ongoing.

 

 

  97   June 2017 Form 10-Q


Table of Contents
  LOGO

 

Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth the information with respect to purchases made by or on behalf of the Firm of its common stock during the quarterly period ended June 30, 2017.

Issuer Purchases of Equity Securities

 

$ in millions, except per share data   

Total Number of

Shares
Purchased

    

Average Price

Paid Per Share

    

Total Number of

Shares Purchased

as Part of Publicly
Announced Plans
or Programs1

    

Approximate
Dollar Value of

Shares that May

Yet be Purchased
Under the Plans
or Programs

 

Month #1 (April 1, 2017—April 30, 2017)

           

Share Repurchase Program2

     1,050,000      $ 43.04        1,050,000      $ 455  

Employee transactions3

     1,049,776      $ 40.86                

Month #2 (May 1, 2017—May 31, 2017)

           

Share Repurchase Program2

     5,728,000      $ 42.89        5,728,000      $ 209  

Employee transactions3

     82,728      $ 43.36                

Month #3 (June 1, 2017—June 30, 2017)

           

Share Repurchase Program2

     4,765,281      $ 43.89        4,765,281      $ 5,000  

Employee transactions3

     29,687      $ 42.57                

Quarter ended at June 30, 2017

           

Share Repurchase Program2

     11,543,281      $ 43.32        11,543,281      $ 5,000  

Employee transactions3

     1,162,191      $ 41.09                

 

1.

Share purchases under publicly announced programs are made pursuant to open-market purchases, Rule 10b5-1 plans or privately negotiated transactions (including with employee benefit plans) as market conditions warrant and at prices the Firm deems appropriate and may be suspended at any time.

2.

The Firm’s Board of Directors has authorized the repurchase of the Firm’s outstanding stock under a share repurchase program (the “Share Repurchase Program”). The Share Repurchase Program is a program for capital management purposes that considers, among other things, business segment capital needs, as well as equity-based compensation and benefit plan requirements. The Share Repurchase Program has no set expiration or termination date. Share repurchases by the Firm are subject to regulatory approval. On June 28, 2017, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) announced that they did not object to our 2017 capital plan, which included a share repurchase of up to $5.0 billion of the Firm’s outstanding common stock during the period beginning July 1, 2017 through June 30, 2018. During the three months ended June 30, 2017, the Firm repurchased approximately $500 million of the Firm’s outstanding common stock as part of its Share Repurchase Program. For further information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Capital Management”.

3.

Includes shares acquired by the Firm in satisfaction of the tax withholding obligations on stock-based awards and the exercise of stock options granted under the Firm’s stock-based compensation plans.

Exhibits

An exhibit index has been filed as part of this Report on page E-1.

 

June 2017 Form 10-Q   98  


Table of Contents
  LOGO

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

MORGAN STANLEY

(Registrant)

 By:

  /S/ JONATHAN PRUZAN
 

Jonathan Pruzan

Executive Vice President and

Chief Financial Officer

 By:

  /S/ PAUL C. WIRTH
 

Paul C. Wirth

Deputy Chief Financial Officer

Date: August 3, 2017

 

  99   June 2017 Form 10-Q


Table of Contents

Exhibit Index

Morgan Stanley

Quarter Ended June 30, 2017

 

Exhibit No.   

Description

12    Statement Re: Computation of Ratio of Earnings to Fixed Charges and Computation of Earnings to Fixed Charges and Preferred Stock Dividends.
15    Letter of awareness from Deloitte & Touche LLP, dated August 3, 2017, concerning unaudited interim financial information.
31.1    Rule 13a-14(a) Certification of Chief Executive Officer.
31.2    Rule 13a-14(a) Certification of Chief Financial Officer.
32.1    Section 1350 Certification of Chief Executive Officer.
32.2    Section 1350 Certification of Chief Financial Officer.
101    Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Income Statements—Three Months and Six Months Ended June 30, 2017 and 2016, (ii) the Consolidated Comprehensive Income Statements—Three Months and Six Months Ended June 30, 2017 and 2016, (iii) the Consolidated Balance Sheets—June 30, 2017 and December 31, 2016, (iv) the Consolidated Statements of Changes in Total Equity—Six Months Ended June 30, 2017 and 2016, (v) the Consolidated Cash Flow Statements—Six Months Ended June 30, 2017 and 2016, and (vi) Notes to Consolidated Financial Statements (unaudited).

 

E-1