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 September 30, 2018

OR

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

EXCHANGE ACT OF 1934

Commission File Number 1-11758

 

 

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(Exact Name of Registrant as specified in its charter)

 

       

Delaware

(State or other jurisdiction of

incorporation or organization)

  

1585 Broadway

New York, NY 10036

(Address of principal executive offices, including zip code)

 

  

36-3145972

(I.R.S. Employer Identification No.)

  

(212) 761-4000

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted 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 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  ☐

 

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 October 31, 2018, there were 1,720,154,771 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.


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QUARTERLY REPORT ON FORM 10-Q

For the quarter ended September 30, 2018

 

Table of Contents    Part    Item    Page  

Financial Information

   I            

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

   I    2       

Introduction

                

Executive Summary

                

Business Segments

                

Supplemental Financial Information and Disclosures

               17   

Accounting Development Updates

               17   

Critical Accounting Policies

               18   

Liquidity and Capital Resources

               18   

Quantitative and Qualitative Disclosures about Risk

   I    3      30   

Market Risk

               30   

Credit Risk

               32   

Report of Independent Registered Public Accounting Firm

               39   

Consolidated Financial Statements and Notes

   I    1      40   

Consolidated Income Statements (Unaudited)

               40   

Consolidated Comprehensive Income Statements (Unaudited)

               41   

Consolidated Balance Sheets (Unaudited at September 30, 2018)

               42   

Consolidated Statements of Changes in Total Equity (Unaudited)

               43   

Consolidated Cash Flow Statements (Unaudited)

               44   

Notes to Consolidated Financial Statements (Unaudited)

               45   

1.  Introduction and Basis of Presentation

               45   

2.  Significant Accounting Policies

               46   

3.  Fair Values

               48   

4.  Derivative Instruments and Hedging Activities

               58   

5.  Investment Securities

               61   

6.  Collateralized Transactions

               64   

7.  Loans, Lending Commitments and Allowance for Credit Losses

               65   

8.  Equity Method Investments

               67   

9.  Deposits

               68   

10.  Borrowings and Other Secured Financings

               68   

11.  Commitments, Guarantees and Contingencies

               68   

12.  Variable Interest Entities and Securitization Activities

               72   

13.  Regulatory Requirements

               74   

14.  Total Equity

               76   

15.  Earnings per Common Share

               79   

16.  Interest Income and Interest Expense

               79   

17.  Employee Benefit Plans

               79   

18.  Income Taxes

               80   

19.  Segment, Geographic and Revenue Information

               80   

20.  Subsequent Events

               83   

Financial Data Supplement (Unaudited)

               84   

Glossary of Common Acronyms

               87   

Other Information

   II           89   

Legal Proceedings

   II    1      89   

Unregistered Sales of Equity Securities and Use of Proceeds

   II    2      90   

Controls and Procedures

   I    4      91   

Exhibits

   II    6      91   

Exhibit Index

               E-1   

Signatures

               S-1   

 

  i  


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Available Information

We file annual, quarterly and current reports, proxy statements and other information with the SEC. 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 (“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 Corporate Political Activities;

   

Policy Regarding Shareholder Rights Plan;

   

Equity Ownership Commitment;

   

Code of Ethics and Business Conduct;

   

Code of Conduct;

   

Integrity Hotline Information; and

   

Environmental and Social Policies.

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

 

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

Introduction

 

Morgan Stanley 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. We define the following as part of our consolidated financial statements (“financial statements”): consolidated income statements (“income statements”), consolidated balance sheets (“balance sheets”), and consolidated cash flow statements (“cash flow statements”). See the “Glossary of Common Acronyms” for definitions of certain acronyms used throughout this Form 10-Q.

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, prime brokerage and market-making activities in equity and fixed income products, including foreign exchange and commodities. Lending services include originating and/or purchasing corporate loans, commercial and residential mortgage lending, asset-backed lending and financing extended to equities and commodities customers and municipalities. Other activities include investments and research.

Wealth Management provides a comprehensive array of financial services and solutions to individual investors and small to medium-sized businesses and institutions covering brokerage and investment advisory services, financial and wealth planning services, annuity and insurance products, credit and other lending products, banking and retirement plan services.

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

The results of operations in the past have been, and in the future may continue to be, materially affected by competition; risk factors; and legislative, legal and regulatory developments; as well as other factors. These factors also may have an adverse impact on our ability to achieve our strategic objectives. Additionally, the discussion of our results of operations herein may contain forward-looking statements. These statements, which reflect management’s beliefs and expectations, are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of the risks and uncertainties that may affect our future results, see “Forward-Looking Statements,” “Business—Competition,” “Business—Supervision and Regulation” and “Risk Factors” in the 2017 Form 10-K, and “Liquidity and Capital Resources” herein.

 

 

  1   September 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Executive Summary

Overview of Financial Results

 

Consolidated Results

Net Revenues

($ in millions)

 

 

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Net Income Applicable to Morgan Stanley

($ in millions)

 

 

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Earnings per Common Share1

 

 

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1.

For the calculation of basic and diluted EPS, see Note 15 to the financial statements.

 

We reported net revenues of $9,872 million in the quarter ended September 30, 2018 (“current quarter,” or “3Q 2018”), compared with $9,197 million in the quarter ended September 30, 2017 (“prior year quarter,” or “3Q 2017”). For the current quarter, net income applicable to Morgan Stanley was $2,112 million, or $1.17 per diluted common share, compared with $1,781 million, or $0.93 per diluted common share, in the prior year quarter.

 

 

We reported net revenues of $31,559 million in the nine months ended September 30, 2018 (“current year period,” or “YTD 2018”), compared with $28,445 million in the nine months ended September 30, 2017 (“prior year period,” or “YTD 2017”). For the current year period, net income applicable to Morgan Stanley was $7,217 million, or $3.92 per diluted common share, compared with $5,468 million, or $2.79 per diluted common share, in the prior year period.

 

 

September 2018 Form 10-Q   2  


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Management’s Discussion and Analysis    LOGO

 

Non-interest Expenses1

($ in millions)

 

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1.

The percentages on the bars in the charts represent the contribution of compensation and benefits expenses and non-compensation expenses to the total.

 

Compensation and benefits expenses of $4,310 million in the current quarter and $13,845 million in the current year period increased 3% and 7%, respectively, from $4,169 million in the prior year quarter and $12,887 million in the prior year period. These results primarily reflected increases in discretionary incentive compensation mainly driven by higher revenues as well as salaries across all business segments. These increases were partially offset by a decrease in the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses were $2,711 million in the current quarter and $8,334 million in the current year period compared with $2,546 million in the prior year quarter and $7,626 million in the prior year period, representing a 6% and a 9% increase, respectively. These increases were primarily as a result of higher volume-related expenses, the gross presentation of certain expenses due to the adoption of the accounting update Revenue from Contracts with Customers (see Notes 2 and 19 to the financial statements for further information) and increased investment in technology. In the current quarter, these increases were partially offset by lower litigation expenses.

Income Taxes

The current year period includes intermittent net discrete tax benefits of $92 million, primarily associated with new information pertaining to the resolution of multi-jurisdiction tax examinations and other matters. The prior year quarter and prior year period included intermittent net discrete tax benefits of $83 million and $65 million, respectively, primarily resulting from the remeasurement of certain deferred taxes. In addition, the effective tax rate is lower in the current quarter and current year period compared with the corresponding prior periods primarily as a result of the enactment of the U.S. Tax Cuts and Jobs Act (“Tax Act”). For further information, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

 

 

  3   September 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Selected Financial Information and Other Statistical Data

 

    Three Months
Ended
September 30,
   

Nine Months

Ended
September 30,

 
$ in millions   2018     2017     2018     2017  

Income from continuing operations applicable to Morgan Stanley

  $     2,113     $     1,775     $     7,222     $     5,489   

Income (loss) from discontinued operations applicable to Morgan Stanley

    (1     6       (5     (21)  

Net income applicable to Morgan Stanley

    2,112       1,781       7,217       5,468   

Preferred stock dividends and other

    93       93       356       353   

Earnings applicable to Morgan Stanley common shareholders

  $ 2,019     $ 1,688     $ 6,861     $ 5,115   

Expense efficiency ratio1

    71.1%       73.0%       70.3%       72.1%   

ROE2

    11.5%       9.6%       13.1%       9.8%   

ROTCE2

    13.2%       11.0%       15.1%       11.3%   

 

in millions, except per share and employee data  

At
September 30,

2018

    At
December 31,
2017
 

GLR3

  $ 214,848     $ 192,660   

Loans4

  $ 109,983     $ 104,126   

Total assets

  $ 865,517     $ 851,733   

Deposits

  $ 175,185     $ 159,436   

Borrowings

  $ 190,889     $ 192,582   

Common shares outstanding

    1,726       1,788   

Common shareholders’ equity

  $ 70,183     $ 68,871   

Tangible common shareholders’ equity2

  $ 61,265     $ 59,829   

Book value per common share5

  $ 40.67     $ 38.52   

Tangible book value per common share2, 5

  $ 35.50     $ 33.46   

Worldwide employees

    59,835       57,633   
    

At

September 30,
2018

   

At

December 31,
2017

 

 Capital ratios6

   

 Common Equity Tier 1 capital ratio

    16.7%       16.5%   

 Tier 1 capital ratio

    19.0%       18.9%   

 Total capital ratio

    21.6%       21.7%   

 Tier 1 leverage ratio

    8.2%       8.3%   

 SLR7

    6.4%       6.5%   

 

1.

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

2.

Represents a non-GAAP measure. See “Selected Non-GAAP Financial Information” herein.

3.

For a discussion of the GLR, see “Liquidity and Capital Resources—Liquidity Risk Management Framework—Global Liquidity Reserve” herein.

4.

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 balance sheets (see Note 7 to the financial statements).

5.

Book value per common share and tangible book value per common share equal common shareholders’ equity and tangible common shareholders’ equity, respectively, divided by common shares outstanding.

6.

Beginning in 2018, our risk based capital ratios are based on the Standardized Approach fully phased-in rules. At December 31, 2017, our risk based capital ratios were based on the Standardized Approach transitional rules. For a discussion of our regulatory capital ratios, see “Liquidity and Capital Resources—Regulatory Requirements” herein.

7.

The SLR became effective as a capital standard on January 1, 2018. For a discussion of the SLR, see “Liquidity and Capital Resources—Regulatory Requirements” herein.

Business Segment Results

Net Revenues by Segment1, 2 

($ in millions)

 

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September 2018 Form 10-Q   4  


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Management’s Discussion and Analysis    LOGO

 

Net Income Applicable to Morgan Stanley by Segment1, 3

($ in millions)

 

 

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1.

The percentages in 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.

2.

The total amount of Net Revenues by Segment includes intersegment eliminations of $(109) million and $(74) million in the current quarter and prior year quarter, respectively, and $(344) million and $(223) million in the current year period and prior year period, respectively.

3.

The total amount of Net Income Applicable to Morgan Stanley by Segment includes intersegment eliminations of $(1) million and $(4) million in the current quarter and prior year quarter, respectively, and $(1) million and $(2) million in the current year period and the prior year period, respectively.

 

Institutional Securities net revenues of $4,929 million in the current quarter and $16,743 million in the current year period increased 13% from the prior year quarter and 17% from the prior year period primarily reflecting higher revenues from both sales and trading and Investment banking.

 

Wealth Management net revenues of $4,399 million in the current quarter and $13,098 million in the current year period increased 4% from the prior year quarter and 5% from the prior year period primarily reflecting growth in Asset management revenues.

 

Investment Management net revenues of $653 million in the current quarter and $2,062 million in the current year period decreased 3% from the prior year quarter and increased 6% from the prior year period. The current quarter results primarily reflected lower investment gains. The current year period reflected higher Asset management revenues, partially offset by lower investment gains.

Net Revenues by Region1, 2

($ in millions)

 

 

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1.

For a discussion of how the geographic breakdown for net revenues is determined, see Note 19 to the financial statements.

2.

The percentages on the bars in the charts represent the contribution of each region to the total.

Selected Non-GAAP Financial Information

We prepare our financial statements using 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

 

 

  5   September 2018 Form 10-Q


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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.

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

 

$ in millions, except

 

 

Three Months Ended
September 30,

 
 

   
Nine Months Ended
September 30,
 
 

per share data

    2018       2017       2018       2017  

Net income applicable to
Morgan Stanley

  $ 2,112     $ 1,781     $ 7,217     $ 5,468   

Impact of adjustments

    (4     (83     (92     (65)  

Adjusted net income applicable to Morgan Stanley—non-GAAP1

  $ 2,108       1,698     $ 7,125       5,403   

Earnings per diluted
common share

  $ 1.17     $ 0.93     $ 3.92     $ 2.79   

Impact of adjustments

          (0.05     (0.05     (0.03)  

Adjusted earnings per diluted common share—non-GAAP1

  $ 1.17     $ 0.88     $ 3.87     $ 2.76   

Effective income tax rate

    24.4%       28.1%       21.9%       29.7%   

Impact of adjustments

    0.2%       3.3%       0.9%       0.8%   

Adjusted effective income tax rate—non-GAAP1

    24.6%       31.4%       22.8%       30.5%   

 

$ in millions  

At

September 30,
2018

   

At
December 31,
2017

 

Tangible Equity

   

U.S. GAAP

   

Morgan Stanley shareholders’ equity

  $ 78,703     $ 77,391   

Less: Goodwill and net intangible assets

    (8,918     (9,042)  

Morgan Stanley tangible shareholders’ equity—non-GAAP

 

  $

 

69,785

 

 

 

  $

 

68,349 

 

 

 

U.S. GAAP

   

Common equity

  $ 70,183     $ 68,871   

Less: Goodwill and net intangible assets

    (8,918     (9,042)  

Tangible common equity—non-GAAP

 

  $

 

61,265

 

 

 

  $

 

59,829 

 

 

 

 

$ in millions

  Average Monthly Balance  
  Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2018          2017         2018         2017    

Tangible Equity

       

U.S. GAAP

       

Morgan Stanley shareholders’ equity

  $ 78,760     $ 79,007     $ 78,165     $ 78,206   

Less: Goodwill and net intangible assets

    (8,970     (9,120     (9,020     (9,192)  

Morgan Stanley tangible shareholders’ equity—non-GAAP

 

  $

 

69,790

 

 

 

  $

 

69,887

 

 

 

  $

 

69,145

 

 

 

  $

 

69,014 

 

 

 

U.S. GAAP

       

Common equity

  $ 70,240     $ 70,487     $ 69,645     $ 69,786   

Less: Goodwill and net intangible assets

    (8,970     (9,120     (9,020     (9,192)  

Tangible common equity—non-GAAP

 

  $

 

61,270

 

 

 

  $

 

61,367

 

 

 

  $

 

  60,625

 

 

 

  $

 

  60,594 

 

 

 

Consolidated Non-GAAP Financial Measures

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in billions       2018             2017             2018             2017      

Average common equity

 

 

Unadjusted

  $ 70.2     $ 70.5     $ 69.6     $ 69.8   

Adjusted1

    70.2       70.5       69.6       69.8   

ROE2

 

 

Unadjusted

    11.5%       9.6%       13.1%       9.8%   

Adjusted1, 3

    11.5%       9.1%       13.0%       9.6%   

Average tangible common equity

 

 

Unadjusted

  $ 61.3     $ 61.4     $ 60.6     $ 60.6   

Adjusted1

    61.3       61.3       60.6       60.6   

ROTCE2

 

 

Unadjusted

    13.2%       11.0%       15.1%       11.3%   

Adjusted1, 3

    13.2%       10.5%       14.9%       11.1%   
 

 

September 2018 Form 10-Q   6  


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Non-GAAP Financial Measures by Business Segment

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

$ in billions

        2018               2017               2018               2017      

Pre-tax profit margin4

 

   

Institutional Securities

    32%       28%       33%       31%   

Wealth Management

    27%       27%       27%       25%   

Investment Management

    16%       19%       19%       19%   

Consolidated

    29%       27%       30%       28%   

Average common equity5

 

     

Institutional Securities

  $ 40.8     $ 40.2     $ 40.8     $ 40.2   

Wealth Management

    16.8       17.2       16.8       17.2   

Investment Management

    2.6       2.4       2.6       2.4   

Parent Company

    10.0       10.7       9.4       10.0   

Consolidated average
common equity

  $ 70.2     $ 70.5     $ 69.6     $ 69.8   

Average tangible common equity5

 

     

Institutional Securities

  $ 40.1     $ 39.6     $ 40.1     $ 39.6   

Wealth Management

    9.2       9.3       9.2       9.3   

Investment Management

    1.7       1.6       1.7       1.6   

Parent Company

    10.3       10.9       9.6       10.1   

Consolidated average
tangible common equity

  $ 61.3     $ 61.4     $ 60.6     $ 60.6   

ROE2, 6

 

     

Institutional Securities

    10.3%       8.9%       12.8%       9.6%   

Wealth Management

    21.3%       15.8%       20.9%       15.0%   

Investment Management

    12.0%       18.8%       15.7%       15.4%   

Consolidated

    11.5%       9.6%       13.1%       9.8%   

ROTCE2, 6

 

     

Institutional Securities

    10.4%       9.1%       13.0%       9.8%   

Wealth Management

    38.9%       29.1%       38.1%       27.7%   

Investment Management

    18.8%       27.7%       24.5%       22.7%   

Consolidated

    13.2%       11.0%       15.1%       11.3%   

 

1.

Adjusted amounts exclude intermittent net discrete tax provisions (benefits). Income tax consequences associated with employee share-based awards are recognized in Provision for income taxes in the income statements but are excluded from the intermittent net discrete tax provisions (benefits) adjustment as we anticipate conversion activity each quarter. For further information on the net discrete tax provisions (benefits), see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

2.

ROE and ROTCE equal annualized net income applicable to Morgan Stanley less preferred dividends as a percentage of average common equity and average tangible common equity, on a consolidated basis as indicated. When excluding intermittent net discrete tax provisions (benefits), both the numerator and denominator are adjusted.

3.

The calculations used in determining our “ROE and ROTCE Targets” referred to in the following section are the Adjusted ROE and Adjusted ROTCE amounts shown in this table.

4.

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

5.

Average common equity and average tangible common equity for each business segment are determined using our Required Capital framework (see “Liquidity and Capital Resources—Regulatory Requirements—Attribution of Average Common Equity According to the Required Capital Framework” herein).

6.

The calculation of the ROE and ROTCE by segment uses the annualized net income applicable to Morgan Stanley by segment less preferred dividends allocated to each segment as a percentage of average common equity and average tangible common equity, respectively, allocated to each segment.

Return on Equity and Tangible Common Equity Targets

In January 2018, we established an ROE Target of 10% to 13% and an ROTCE Target of 11.5% to 14.5% for the medium term.

Our ROE and ROTCE Targets 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; outsize legal expenses or penalties and the ability to maintain a reduced level of expenses; and capital levels. For further information on our ROE and ROTCE Targets and related assumptions, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Executive Summary—Return on Equity and Tangible Common Equity Targets” in the 2017 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. See Note 19 to the financial statements for further information.

Net Revenues, Compensation Expense and Income Taxes

For an overview of the components of our net revenues, compensation expense and income taxes, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments” in the 2017 Form 10-K.

 

 

  7   September 2018 Form 10-Q


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Institutional Securities

Income Statement Information

 

     Three Months Ended  
September 30,

 

       
$ in millions     2018         2017       % Change  

Revenues

     

Investment banking

  $ 1,459     $ 1,270       15%  

Trading

    2,573       2,504       3%  

Investments

    96       52       85%  

Commissions and fees

    589       561       5%  

Asset management

    112       88       27%  

Other

    244       143       71%  

Total non-interest revenues

    5,073       4,618       10%  

Interest income

    2,425       1,421       71%  

Interest expense

    2,569       1,663       54%  

Net interest

    (144     (242     40%  

Net revenues

    4,929       4,376       13%  

Compensation and benefits

    1,626       1,532       6%  

Non-compensation expenses

    1,747       1,608       9%  

Total non-interest expenses

    3,373       3,140       7%  

Income from continuing operations before income taxes

    1,556       1,236       26%  

Provision for income taxes

    397       260       53%  

Income from continuing operations

    1,159       976       19%  

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

    (3     6       (150)%  

Net income

    1,156       982       18%  

Net income applicable to noncontrolling interests

    36       9       N/M  

Net income applicable to Morgan Stanley

  $ 1,120     $ 973       15%  
     Nine Months Ended  
September 30,

 

       
$ in millions     2018         2017       % Change  

Revenues

     

Investment banking

  $ 4,671     $ 4,100       14%  

Trading

    9,344       8,241       13%  

Investments

    234       155       51%  

Commissions and fees

    2,007       1,811       11%  

Asset management

    324       268       21%  

Other

    548       442       24%  

Total non-interest revenues

    17,128       15,017       14%  

Interest income

    6,424       3,788       70%  

Interest expense

    6,809       4,515       51%  

Net interest

    (385     (727     47%  

Net revenues

    16,743       14,290       17%  

Compensation and benefits

    5,779       5,069       14%  

Non-compensation expenses

    5,484       4,812       14%  

Total non-interest expenses

    11,263       9,881       14%  

Income from continuing operations before income taxes

    5,480       4,409       24%  

Provision for income taxes

    1,169       1,132       3%  

Income from continuing operations

    4,311       3,277       32%  

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

    (7     (21     67%  

Net income

    4,304       3,256       32%  

Net income applicable to noncontrolling interests

    100       77       30%  

Net income applicable to Morgan Stanley

  $ 4,204     $ 3,179       32%  
 

 

September 2018 Form 10-Q   8  


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Management’s Discussion and Analysis    LOGO

 

Investment Banking

Investment Banking Revenues

 

      Three Months Ended    
September 30,

 

       
$ in millions       2018             2017         % Change  

Advisory

  $ 510     $ 555         (8)%   

Underwriting:

     

Equity

    441       273         62%   

Fixed income

    508       442         15%   

Total underwriting

    949       715         33%   

Total investment banking

  $ 1,459     $ 1,270         15%   

 

      Nine Months Ended    
September 30,

 

       
$ in millions       2018             2017         % Change  

Advisory

  $ 1,702     $ 1,555         9%   

Underwriting:

     

Equity

    1,403       1,068         31%   

Fixed income

    1,566       1,477         6%   

Total underwriting

    2,969       2,545         17%   

Total investment banking

  $ 4,671     $ 4,100         14%   

Investment Banking Volumes

 

   

Three Months Ended
September 30,

 

   

Nine Months Ended
September 30,

 

 
$ in billions       2018              2017              2018             2017      

Completed mergers and acquisitions1

  $ 164     $ 238     $ 665     $ 615   

Equity and equity-related offerings2, 3

    14       17       52       46   

Fixed income offerings2, 4

    66       65       183       210   

Source: Thomson Reuters, data as of October 1, 2018. 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.

 

1.

Includes transactions of $100 million or more. Based on full credit to each of the advisors in a transaction.

2.

Based on full credit for single book managers and equal credit for joint book managers.

3.

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

4.

Includes Rule 144A and publicly registered issuances, non-convertible preferred stock, mortgage-backed and asset-backed securities, and taxable municipal debt. Excludes 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 $1,459 million in the current quarter and $4,671 million in the current year period increased 15% and 14% from the comparable prior year periods. The adoption of the accounting update Revenue from Contracts with Customers had the effect of increasing the revenues reported in investment banking by approximately $69 million in the current quarter and $230 million in the current year period compared with the prior year periods (see Notes 2 and

19 to the financial statements for further information). The drivers of the increase in our Investment banking revenues, other than the effect of this accounting update, were:

 

 

Advisory revenues decreased in the current quarter primarily reflecting lower volumes of completed M&A activity (see Investment Banking Volumes table), partially offset by higher fee realizations. In the current year period, advisory revenues increased primarily due to higher volumes of completed M&A activity.

 

 

Equity underwriting revenues increased in the current quarter and current year period primarily as a result of higher fee realizations. In both the current quarter and current year period, revenues increased in initial public offerings, convertibles and follow-ons.

 

 

Fixed income underwriting revenues increased in the current quarter and current year period primarily due to higher fee realizations. In the current quarter, revenues increased in investment grade bond fees and loan fees, which benefited from event-related financings, partially offset by lower non-investment grade bond fees. Fixed income underwriting revenues increased in the current year period primarily due to higher loan fees, partially offset by lower non-investment grade bond fees.

Sales and Trading Net Revenues

By Income Statement Line Item

 

      Three Months Ended  
September 30,

 

 

       
$ in millions       2018             2017         % Change   

Trading

  $ 2,573     $ 2,504       3%   

Commissions and fees

    589       561       5%   

Asset management

    112       88       27%   

Net interest

    (144     (242     40%   

Total

  $ 3,130     $ 2,911       8%   

 

      Nine Months Ended  
September 30,

 

       
$ in millions       2018             2017         % Change   

Trading

  $ 9,344     $ 8,241       13%   

Commissions and fees

    2,007       1,811       11%   

Asset management

    324       268       21%   

Net interest

    (385     (727     47%   

Total

  $ 11,290     $ 9,593       18%   

By Business

 

      Three Months Ended  
September 30,

 

       
$ in millions       2018             2017         % Change   

Equity

  $ 2,019     $ 1,891       7%   

Fixed income

    1,179       1,167       1%   

Other

    (68     (147     54%   

Total

  $ 3,130     $ 2,911       8%   
 

 

  9   September 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

    Nine Months Ended
September 30,
       
$ in millions           2018                 2017            % Change    

 

Equity

  $ 7,047     $ 6,062       16%  

Fixed income

    4,441       4,120       8%  

Other

    (198     (589     66%  

Total

  $         11,290     $         9,593       18%  

Sales and Trading Revenues—Equity and Fixed Income

 

    Three Months Ended
September 30, 2018
 
$ in millions   Trading     Fees1     Net
Interest2
    Total  

 

Financing

  $         1,097     $ 99     $         (141   $         1,055   

Execution services

    554       524       (114     964   

Total Equity

  $ 1,651     $         623     $ (255   $ 2,019   

Total Fixed Income

  $ 1,189     $ 78     $ (88   $ 1,179   

 

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

 

Financing

  $         1,029     $ 92     $         (206   $ 915   

Execution services

    540       495       (59     976   

Total Equity

  $ 1,569     $         587     $ (265   $         1,891   

Total Fixed income

  $ 1,073     $ 65     $ 29     $ 1,167   

 

    Nine Months Ended
September 30, 2018
 
$ in millions   Trading     Fees1     Net
Interest2
    Total  

 

Financing

  $         3,704     $ 295     $         (479   $         3,520   

Execution services

    2,006       1,793       (272     3,527   

Total Equity

  $ 5,710     $         2,088     $ (751   $ 7,047   

Total Fixed Income

  $ 4,203     $ 244     $ (6   $ 4,441   

 

    Nine Months Ended
September 30, 2017
 
$ in millions   Trading     Fees1     Net
Interest2
    Total  

 

Financing

  $         3,126     $ 269     $ (621   $         2,774   

Execution services

    1,805       1,643       (160     3,288   

Total Equity

  $ 4,931     $         1,912     $         (781   $ 6,062   

Total Fixed income

  $ 3,785     $ 167     $ 168     $ 4,120   

 

1.

Includes Commissions and fees and Asset management revenues.

2.

Includes funding costs which are allocated to the businesses based on funding usage.

As discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments—Net Revenues by Segment” in the 2017 Form 10-K, we manage each of the sales and trading businesses based on its aggregate net revenues. 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 19 to the financial statements.

Sales and Trading Net Revenues during the Current Quarter

Equity

Equity sales and trading net revenues of $2,019 million in the current quarter increased 7% from the prior year quarter, reflecting higher results in our financing businesses.

 

 

Financing revenues increased from the prior year quarter, primarily due to client positioning and higher average client balances, which resulted in both increased Trading and Net interest revenues.

 

 

Execution services remained relatively unchanged from the prior year quarter as higher commissions revenue was offset by increased funding costs.

Fixed Income

Fixed income net revenues of $1,179 million in the current quarter were 1% higher than the prior year quarter, driven by higher results in commodities products and other, partially offset by lower results in credit products and higher funding costs.

 

 

Global macro products revenues remained relatively unchanged from the prior year quarter as higher results in foreign exchange products were offset by lower results in interest rates products, both of which were primarily driven by levels of client activity.

 

 

Credit products revenues decreased primarily due to a decline in Trading revenue associated with unfavorable corporate credit products inventory management.

 

 

Commodities products and Other increased driven primarily by inventory management gains in power and natural gas products.

Other

Other sales and trading net losses of $68 million in the current quarter decreased from the prior year quarter, primarily from lower net funding costs reflecting changes in the balance sheet.

Sales and Trading Net Revenues during the Current Year Period

Equity

Equity sales and trading net revenues of $7,047 million in the current year period increased 16% from the prior year period, reflecting higher results in both our financing businesses and execution services.

 

 

Financing revenues increased from the prior year period, primarily due to higher average client balances and client positioning, which resulted in both increased Trading and Net interest revenues.

 

 

September 2018 Form 10-Q   10  


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Management’s Discussion and Analysis    LOGO

 

 

Execution services increased from the prior year period, primarily reflecting higher Trading revenues driven by effective inventory management in derivative products. Commissions and fees also increased due to higher client activity in cash equities products, but were partially offset by increased funding costs.

Fixed Income

Fixed income net revenues of $4,441 million in the current year period were 8% higher than the prior year period, primarily driven by higher results in commodities products and other, partially offset by lower results in credit products and higher funding costs.

 

 

Global macro products revenues remained relatively unchanged from the prior year period as higher results in foreign exchange products were offset by lower results in interest rates products, both of which were primarily driven by levels of client activity.

 

 

Credit products revenues decreased as a decline in Trading revenues associated with unfavorable corporate credit products inventory management was partially offset by growth in lending products.

 

 

Commodities products and Other increased primarily due to increased Commodities structured transactions and client flow and higher Trading revenues principally from a reduction in counterparty credit risk.

Other

Other sales and trading net losses of $198 million in the current year period decreased from the prior year period, primarily reflecting lower net funding costs. In addition, losses associated with corporate loan hedging activity were lower in the current year period compared with the prior year period.

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

Investments

 

 

Net investment gains of $96 million in the current quarter and $234 million in the current year period increased from the prior year periods, primarily as a result of higher net gains on business-related investments, partially offset by lower results from real estate limited partnership investments.

Other Revenues

 

 

Other revenues of $244 million in the current quarter increased from the prior year quarter, primarily reflecting higher fees associated with corporate lending activity and

   

improved results from other equity method investments. Other revenues of $548 million in the current year period increased from the prior year period, primarily reflecting improved results from other equity method investments, the recovery of a previously charged off energy industry loan and higher fees associated with corporate lending activity, partially offset by lower gains associated with held-for-sale corporate loans.

Non-interest Expenses

Non-interest expenses of $3,373 million in the current quarter increased from the prior year quarter, reflecting a 6% increase in Compensation and benefits expenses and a 9% increase in Non-compensation expenses. Non-interest expenses of $11,263 million in the current year period increased from the prior year period reflecting a 14% increase in both Compensation and benefits expenses and Non-compensation expenses.

 

 

Compensation and benefits expenses increased in the current quarter and current year period, primarily due to an increase in discretionary incentive compensation driven by higher revenues, as well as salaries, partially offset by a decrease in 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 volume-related expenses, and the gross presentation of certain expenses due to the adoption of the accounting update Revenue from Contracts with Customers (see Notes 2 and 19 to the financial statements for further information), partially offset by lower litigation expenses. In addition, in the current year period, the results were partially offset by the reversal of a portion of previously recorded provisions related to U.K. VAT matters.

Income Tax Items

The current year period includes intermittent net discrete tax benefits of $88 million, primarily associated with new information pertaining to the resolution of multi-jurisdiction tax examinations and other matters. The prior year quarter and prior year period included intermittent net discrete tax benefits of $75 million and $60 million, respectively, primarily resulting from the remeasurement of certain deferred taxes. In addition, the effective tax rate in the current year period is lower compared with the prior year period primarily as a result of the enactment of the Tax Act. For a discussion of the Tax Act, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

 

 

  11   September 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Wealth Management

 

Income Statement Information    

 

    Three Months Ended
September 30,
       
$ in millions       2018           2017       % Change  

Revenues

     

Investment banking

  $ 129     $ 125       3%  

Trading

    160       212       (25)%  

Investments

          1       (100)%  

Commissions and fees

    409       402       2%  

Asset management

    2,573       2,393       8%  

Other

    58       62       (6)%  

Total non-interest revenues

    3,329       3,195       4%  

Interest income

    1,412       1,155       22%  

Interest expense

    342       130       163%  

Net interest

    1,070       1,025       4%  

Net revenues

    4,399       4,220       4%  

Compensation and benefits

    2,415       2,326       4%  

Non-compensation expenses

    790       775       2%  

Total non-interest expenses

    3,205       3,101       3%  

Income from continuing operations before income taxes

    1,194       1,119       7%  

Provision for income taxes

    281       421       (33)%  

Net income applicable to Morgan Stanley

  $ 913     $ 698       31%  

 

    Nine Months Ended
September 30,
       
$ in millions       2018           2017       % Change  

Revenues

     

Investment banking

  $ 383     $ 405       (5)%  

Trading

    404       657       (39)%  

Investments

    3       3       —%  

Commissions and fees

    1,349       1,266       7%  

Asset management

    7,582       6,879       10%  

Other

    195       191       2%  

Total non-interest revenues

    9,916       9,401       5%  

Interest income

    4,012       3,348       20%  

Interest expense

    830       320       159%  

Net interest

    3,182       3,028       5%  

Net revenues

    13,098       12,429       5%  

Compensation and benefits

    7,221       6,940       4%  

Non-compensation expenses

    2,366       2,340       1%  

Total non-interest expenses

    9,587       9,280       3%  

Income from continuing operations before income taxes

    3,511       3,149       11%  

Provision for income taxes

    808       1,139       (29)%  

Net income applicable to Morgan Stanley

  $ 2,703     $ 2,010       34%  

Financial Information and Statistical Data

 

$ in billions  

 

At
September 30,
2018

   

 

At
December 31,
2017

 

Client assets

  $ 2,496     $ 2,373  

Fee-based client assets1

  $ 1,120     $ 1,045  

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

    45%       44%  

Client liabilities2

  $ 83     $ 80  

Investment securities portfolio

  $ 59.8     $ 59.2  

Loans and lending commitments

  $ 81.8     $ 77.3  

Wealth Management representatives

    15,655       15,712  

 

   

Three Months Ended

September 30,

 
         2018              2017      

Per representative:

    

Annualized revenues ($ in thousands)3

  $ 1,125      $ 1,071  

Client assets ($ in millions)4

  $ 159      $ 146  

Fee-based asset flows ($ in billions)5

  $ 16.2      $ 15.8  

 

   

 Nine Months Ended 

September 30,

 
         2018              2017      

Per representative:

    

Annualized revenues ($ in thousands)3

  $ 1,114      $ 1,051  

Client assets ($ in millions)4

  $ 159      $ 146  

Fee-based asset flows ($ in billions)5

  $ 49.7      $ 54.5  

 

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.

 

 

September 2018 Form 10-Q   12  


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Transactional Revenues    

 

     Three Months Ended 
September 30,
        
$ in millions       2018             2017          % Change  

Investment banking

  $ 129     $ 125        3%   

Trading

    160       212        (25)%   

Commissions and fees

    409       402        2%   

Total

  $ 698     $ 739        (6)%   

Transactional revenues as a % of
Net revenues

    16     18%     

 

     Nine Months Ended 
September 30,
        
$ in millions       2018             2017          % Change  

Investment banking

  $ 383     $ 405        (5)%   

Trading

    404       657        (39)%   

Commissions and fees

    1,349       1,266        7%   

Total

  $ 2,136     $ 2,328        (8)%   

Transactional revenues as a % of
Net revenues

    16%       19%     

Net Revenues

Transactional Revenues

Transactional revenues of $698 million in the current quarter and $2,136 million in the current year period decreased 6% and 8%, respectively, from the prior year periods primarily as a result of lower Trading revenues, partially offset by higher Commissions and fees.

 

 

Investment banking revenues were relatively unchanged in the current quarter. In the current year period, Investment banking revenues decreased primarily due to lower revenues from equity issuances.

 

 

Trading revenues decreased in the current quarter primarily as a result of lower fixed income revenue driven by product mix. In addition to lower fixed income revenue, Trading revenues decreased in the current year period as a result of lower gains related to investments associated with certain employee deferred compensation plans.

 

 

Commissions and fees were relatively unchanged in the current quarter. In the current year period, Commissions and fees increased primarily as a result of increased client transactions in alternatives and annuities products, partially offset by decreased activity in mutual funds.

Asset Management

Asset management revenues of $2,573 million in the current quarter and $7,582 million in the current year period increased 8% and 10%, respectively, primarily due to the effect of market appreciation and net positive flows on the respective beginning of period fee-based client assets balances on which billings are generally based, partially offset by lower average fee rates.

See “Fee-Based Client Assets Rollforwards” herein.

Net Interest

Net interest of $1,070 million in the current quarter and $3,182 million in the current year period increased 4% and 5%, respectively, primarily as a result of higher interest rates and higher loan balances. In the current quarter and current year period, the effect of higher interest rates on loans was partially offset by higher average interest rates on Deposits, due to changes in our deposit mix.

Non-interest Expenses

Non-interest expenses of $3,205 million in the current quarter and $9,587 million in the current year period both increased 3% primarily as a result of higher Compensation and benefits expenses.

 

 

Compensation and benefits expenses increased in the current quarter and current year period primarily due to the formulaic payout to Wealth Management representatives linked to higher revenues and increases in salaries. In the current year period, these increases were partially offset by a decrease in the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses were relatively unchanged in both the current quarter and current year period, with increased investment in technology offset by a decrease in litigation expenses.

Income Tax Items

The effective tax rate in the current quarter and current year period is lower compared with the prior year periods primarily as a result of the enactment of the Tax Act. For a discussion of the Tax Act, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

 

 

  13   September 2018 Form 10-Q


Table of Contents
Management’s Discussion and Analysis    LOGO

 

Fee-Based Client Assets

For a description of fee-based client assets, including descriptions of 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” in the 2017 Form 10-K.

Fee-Based Client Assets Rollforwards

 

$ in billions  

At

June 30,
2018

    Inflows     Outflows     Market
Impact
   

At

September 30,

2018

 

Separately managed1

  $ 267     $ 14     $ (6   $ (3   $ 272   

Unified managed

    259       11       (8     5       267   

Mutual fund advisory

    20       1       (1           20   

Advisor

    149       7       (8     5       153   

Portfolio manager

    367       18       (12     13       386   

Subtotal

  $ 1,062     $ 51     $ (35   $ 20     $ 1,098   

Cash management

    22       4       (4           22   

Total fee-based
client assets

  $ 1,084     $ 55     $ (39   $ 20     $ 1,120   

 

$ in billions  

At

June 30,
2017

    Inflows     Outflows     Market
Impact
   

At

September 30,

2017

 

Separately managed1

  $ 237     $ 8     $ (5   $ 3     $ 243   

Unified managed

    228       11       (7     7       239   

Mutual fund advisory

    21       1       (1           21   

Advisor

    138       9       (7     4       144   

Portfolio manager

    321       18       (11     10       338   

Subtotal

  $ 945     $ 47     $ (31   $ 24     $ 985   

Cash management

    17       3       (2           18   

Total fee-based
client assets

  $ 962     $ 50     $ (33   $ 24     $ 1,003   
$ in billions  

At

December 31,
2017

    Inflows     Outflows     Market
Impact
   

At

September 30,

2018

 

Separately managed1

  $ 252      $ 30      $ (15    $ 5     $ 272   

Unified managed

    250       36       (23     4       267   

Mutual fund advisory

    21             (2     1       20   

Advisor

    149       22       (22     4       153   

Portfolio manager

    353       55       (31     9       386   

Subtotal

  $       1,025      $ 143      $ (93    $ 23     $ 1,098   

Cash management

    20       14       (12           22   

Total fee-based
client assets

  $ 1,045      $ 157      $ (105    $ 23     $       1,120   
$ in billions  

At

December 31,
2016

    Inflows     Outflows     Market
Impact
   

At

September 30,

2017

 

Separately managed1

  $ 222      $ 24      $ (16    $ 13     $ 243   

Unified managed

    204       36       (22     21       239   

Mutual fund advisory

    21       1       (3     2       21   

Advisor

    125       27       (20     12       144   

Portfolio manager

    285       57       (29     25       338   

Subtotal

  $ 857      $ 145      $ (90    $ 73     $ 985   

Cash management

    20       9       (11           18   

Total fee-based
client assets

  $ 877      $ 154      $ (101    $ 73     $ 1,003   

 

1.

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

Average Fee Rates

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
Fee rate in bps   2018     2017     2018     2017  

Separately managed

    15       17       16       16   

Unified managed

    97       97       97       98   

Mutual fund advisory

    119       118       119       118   

Advisor

    84       84       84       84   

Portfolio manager

    95       94       95       96   

Subtotal

    75       76       76       76   

Cash management

    6       6       6        

Total fee-based client assets

    74       75       74       75   
 

 

September 2018 Form 10-Q   14  


Table of Contents
Management’s Discussion and Analysis    LOGO

 

Investment Management

Income Statement Information

 

    Three Months Ended
September 30,
       
$ in millions   2018     2017     % Change   

Revenues

     

Trading

  $ 2     $ (7     N/M   

Investments

    40       114       (65)%   

Asset management

    604       568       6%   

Other

    (3     1       N/M   

Total non-interest revenues

    643       676       (5)%   

Interest income

    19       1       N/M   

Interest expense

    9       2       N/M   

Net interest

    10       (1     N/M   

Net revenues

    653       675       (3)%   

Compensation and benefits

    269       311       (14)%   

Non-compensation expenses

    282       233       21%   

Total non-interest expenses

    551       544       1%   

Income from continuing operations before income taxes

    102       131       (22)%   

Provision for income taxes

    18       16       13%   

Income from continuing operations

    84       115       (27)%   

Income from discontinued operations, net of income taxes

    2             N/M   

Net income

    86       115       (25)%   

Net income applicable to noncontrolling interests

    6       1       N/M   

Net income applicable to
Morgan Stanley

  $ 80     $ 114       (30)%   

 

    Nine Months Ended
September 30,
       
$ in millions     2018       2017     % Change   

Revenues

     

Trading

  $ 23     $ (21     N/M   

Investments

    172       337       (49)%   

Asset management

    1,840       1,624       13%   

Other

    10       9       11%   

Total non-interest revenues

    2,045       1,949       5%   

Interest income

    37       3       N/M   

Interest expense

    20       3       N/M   

Net interest

    17             N/M   

Net revenues

    2,062       1,949       6%   

Compensation and benefits

    845       878       (4)%   

Non-compensation expenses

    827       695       19%   

Total non-interest expenses

    1,672       1,573       6%   

Income from continuing operations before income taxes

    390       376       4%   

Provision for income taxes

    73       87       (16)%   

Income from continuing operations

    317       289       10%   

Income from discontinued operations,
net of income taxes

    2             N/M   

Net income

    319       289       10%   

Net income applicable to
noncontrolling interests

    8       8       —%   

Net income applicable to
Morgan Stanley

  $ 311     $ 281       11%   

Net Revenues

Investments

Investments gains of $40 million in the current quarter compared with $114 million in the prior year quarter reflect lower carried interest in certain infrastructure and multi-manager private equity funds.

Investments gains of $172 million in the current year period compared with $337 million in the prior year period reflect lower carried interest in certain infrastructure funds and the reversal of previously accrued carried interest in certain Asia private equity funds, primarily due to losses associated with weakening Asia-Pacific currencies.

Asset Management

Asset management revenues of $604 million in the current quarter and $1,840 million in the current year period increased 6% and 13%, respectively, primarily as a result of higher average long-term AUM. See “AUM Rollforwards” herein.

The adoption of the accounting update Revenue from Contracts with Customers had the effect of increasing Asset management revenues due to the gross presentation of distribution fees. This increase (approximately $17 million in the current quarter and $61 million in the current year period) was partially offset by the delayed recognition of certain performance fees not in the form of carried interest until they are no longer probable of reversing. See Notes 2 and 19 to the financial statements for further details.

Non-interest Expenses

Non-interest expenses of $551 million in the current quarter and $1,672 million in the current year period increased 1% and 6%, respectively, primarily due to higher Non-compensation expenses.

 

 

Compensation and benefits expenses decreased in the current quarter and current year period due to decreases in deferred compensation associated with carried interest and the fair value of investments to which certain deferred compensation plans are referenced. In the current year period, these decreases were partially offset by increases in salaries and discretionary incentive compensation.

 

 

Non-compensation expenses increased in the current quarter and current year period primarily as a result of higher fee sharing on increased average AUM balances and the gross presentation of distribution fees due to the adoption of the accounting update Revenue from Contracts with Customers. See “Asset Management” above.

 

 

  15   September 2018 Form 10-Q


Table of Contents
Management’s Discussion and Analysis    LOGO

 

Income Tax Items

The effective tax rate in the current year period is lower compared with the prior year period primarily as a result of the enactment of the Tax Act. For a discussion of the Tax Act, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

Assets Under Management or Supervision

For a description of the asset classes and 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 the 2017 Form 10-K.

AUM Rollforwards

 

$ in billions  

At

June 30,
2018

    Inflows     Outflows     Market
Impact
    Other1    

At

September 30,

2018

 

Equity

  $ 114     $ 10     $ (9   $ 3     $ (1   $            117   

Fixed income

    69       6       (4                 71   

Alternative/Other

    132       5       (4     1       (1     133   

Long-term AUM subtotal

    315       21       (17     4       (2     321   

Liquidity2

    159       313       (322     1       (1     150   

Total AUM

  $ 474     $ 334     $ (339   $ 5     $ (3   $ 471   

Shares of minority stake assets

    7                                        
$ in billions  

At

June 30,

2017

    Inflows     Outflows     Market
Impact
    Other1    

At

September 30,

2017

 

Equity

  $ 94     $ 5     $ (6   $ 4     $     $                97   

Fixed income

    66       7       (5     1             69   

Alternative/Other

    121       5       (3     1       1       125   

Long-term AUM subtotal

    281       17       (14     6       1       291   

Liquidity

    154       279       (277     1       (1     156   

Total AUM

  $ 435     $ 296     $ (291   $ 7     $     $ 447   

Shares of minority stake assets

    8                                        
$ in billions  

At

December 31,
2017

    Inflows     Outflows     Market
Impact
    Other1    

At

September 30,

2018

 

Equity

  $ 105     $ 30     $ (23   $ 6     $ (1   $                117   

Fixed income

    73       20       (20     (1     (1     71   

Alternative/Other

    128       16       (13     2             133   

Long-term AUM subtotal

    306       66       (56     7       (2     321   

Liquidity2

    176       1,013       (1,039     2       (2     150   

Total AUM

  $         482     $  1,079     $ (1,095   $ 9     $ (4   $ 471   

Shares of minority stake assets

    7                                        
$ in billions  

At

December 31,
2016

    Inflows     Outflows     Market
Impact
    Other1    

At

September 30,

2017

 

Equity

  $ 79     $ 16     $ (16   $ 17     $ 1     $ 97   

Fixed income

    60       20       (16     3       2       69   

Alternative/Other

    115       18       (13     5             125   

Long-term AUM subtotal

    254       54       (45     25       3       291   

Liquidity

    163       915       (923     1             156   

Total AUM

  $ 417     $ 969     $ (968   $ 26     $ 3     $                447   

Shares of minority stake assets

    8                                        

 

1.

Includes distributions and foreign currency impact for all periods and the impact of the Mesa West Capital, LLC acquisition in the current year period.

2.

Included in Liquidity products outflows in the current quarter and current year period are $(8) billion and $(18) billion, respectively, related to the redesign of our brokerage sweep deposits program. See “Liquidity and Capital Resources—Unsecured Financing” herein for more information.

Average AUM

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in billions   2018     2017     2018     2017  

Equity

  $ 116     $ 96     $ 112     $ 90   

Fixed income

    70       68       72       65   

Alternative/Other

    133       123       131       120   

Long-term AUM subtotal

    319       287       315       275   

Liquidity

    153       156       159       155   

Total AUM

  $ 472     $ 443     $ 474     $ 430   

Shares of minority
stake assets

    7       7       7        

Average Fee Rate

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
Fee rate in bps   2018     2017     2018     2017  

Equity

    76       75       76       74   

Fixed income

    33       34       34       33   

Alternative/Other

    65       68       67       69   

Long-term AUM

    62       62       62       62   

Liquidity

    17       18       18       18   

Total AUM

    47       47       47       46   
 

 

September 2018 Form 10-Q   16  


Table of Contents
Management’s Discussion and Analysis    LOGO

 

Supplemental Financial Information and Disclosures

Income Tax Matters

Effective Tax Rate from Continuing Operations

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2018     2017     2018     2017  

U.S. GAAP

    24.4     28.1     21.9     29.7%  

Adjusted effective income tax rate—non-GAAP1

            24.6             31.4             22.8             30.5%  

Net discrete tax provisions/(benefits)

 

                       

Intermittent2

  $ (4   $ (83   $ (92   $ (65)  

Recurring3

  $     $ (11   $ (164   $ (139)  

 

1.

Adjusted effective income tax rate is a non-GAAP measure which excludes intermittent net discrete tax provisions (benefits). For further information on non-GAAP measures, see “Selected Non-GAAP Financial Information” herein.

2.

Includes all tax provisions (benefits) which have been determined to be discrete, other than recurring-type items as defined below.

3.

Recurring-type discrete tax benefits represent income tax consequences associated with employee share-based awards, which are recognized in Provision for income taxes in the income statements but are excluded from the intermittent net discrete tax provisions (benefits) adjustment as we anticipate conversion activity each quarter.

The current year period includes intermittent net discrete tax benefits primarily associated with new information pertaining to the resolution of multi-jurisdiction tax examinations and other matters. The prior year quarter and prior year period included intermittent net discrete tax benefits primarily resulting from the remeasurement of certain deferred taxes.

The effective tax rate reflects our current assumptions, estimates and interpretations related to the Tax Act and other factors. The Tax Act, enacted on December 22, 2017, significantly revised U.S. corporate income tax law by, among other things, reducing the corporate income tax rate to 21%, and implementing a modified territorial tax system that includes a one-time transition tax on deemed repatriated earnings of non-U.S. subsidiaries; imposes a minimum tax on global intangible low-taxed income (“GILTI”) and an alternative base erosion and anti-abuse tax (“BEAT”) on U.S. corporations that make deductible payments to non-U.S. related persons in excess of specified amounts; and broadens the tax base by partially or wholly eliminating tax deductions for certain historically deductible expenses. Our income tax estimates may change as additional clarification and implementation guidance continue to be received from the U.S. Treasury Department and as the interpretation of the Tax Act evolves over time.

U.S. Bank Subsidiaries

Our U.S. bank subsidiaries, Morgan Stanley Bank N.A. (“MSBNA”) and Morgan Stanley Private Bank, National Association (“MSPBNA”) (collectively, “U.S. Bank Subsidiaries”) accept deposit accounts, provide loans to a variety of customers, from large corporate and institutional clients to high net worth individuals, and invest in securities. The

lending activities in the Institutional Securities business segment primarily include loans and lending commitments to corporate clients. The lending activities in the Wealth Management business segment primarily include: securities-based lending, which allows clients to borrow money against the value of qualifying securities; and residential real estate loans.

We expect our lending activities to continue to grow through further market penetration of our client base. For a further discussion of our credit risks, see “Quantitative and Qualitative Disclosures about Risk—Credit Risk.” For further discussion about loans and lending commitments, see Notes 7 and 11 to the financial statements.

U.S. Bank Subsidiaries’ Supplemental Financial Information1

 

$ in billions  

At

September 30,

2018

   

At

December 31,

2017

 

Assets

  $ 203.2     $ 185.3   

Investment securities portfolio:

   

Investment securities—AFS

    41.5       42.0   

Investment securities—HTM

    19.0       17.5   

Total investment securities

  $ 60.5     $ 59.5   

Deposits2

  $ 174.4     $ 159.1   

Wealth Management

   

Securities-based lending and other loans3

  $ 44.4     $ 41.2   

Residential real estate loans

    26.7       26.7   

Total

  $ 71.1     $ 67.9   

Institutional Securities

   

Corporate loans

  $ 30.0     $ 24.2   

Wholesale real estate loans

    10.9       12.2   

Total

  $ 40.9     $ 36.4   

 

1.

Amounts exclude transactions between the bank subsidiaries as well as deposits from the Parent Company and affiliates.

2.

For further information on deposits, see “Liquidity and Capital Resources—Funding Management—Unsecured Financing” herein.

3.

Other loans primarily include tailored lending.

Accounting Development Updates

The Financial Accounting Standards Board has issued certain accounting updates that apply to us. Accounting updates not listed below were assessed and determined to be either not applicable or are not expected to have a significant impact on our financial statements.

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

 

 

Derivatives and Hedging (ASU 2018-16). The amendments in this update permit use of the Overnight Index Swap (“OIS”) rate based on the Secured Overnight Financing Rate (“SOFR”) as a U.S. benchmark interest rate for hedge accounting purposes. This update is effective for us as of

 

 

  17   September 2018 Form 10-Q


Table of Contents
Management’s Discussion and Analysis    LOGO

 

 

January 1, 2019, with early adoption permitted. This update does not impact our existing hedges.

 

 

Leases. This accounting update requires lessees to recognize in 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 accounting for leases where we are the lessor is largely unchanged.

The right of use asset and lease liability will initially be measured using the present value of the remaining rental payments. This change to the accounting for leases where we are lessee requires modifications to our lease accounting systems and determining the discount rate to use in calculating the present value of the remaining rental payments. We will adopt this accounting update as of the effective date, January 1, 2019. Based upon our current population of leases, we expect the right of use asset and corresponding lease liability to be less than 1% of our total assets.

 

 

Financial Instruments–Credit Losses. This accounting update impacts the impairment model for certain financial assets measured at amortized cost by requiring a CECL methodology to estimate expected credit losses over the entire life of the financial asset, recorded at inception or purchase. CECL will replace the loss model currently applicable to loans held for investment, HTM securities and other receivables carried at amortized cost.

The update also eliminates the concept of other-than-temporary impairment for AFS securities. Impairments on AFS securities will be required to be recognized in earnings through an allowance, when the fair value is less than amortized cost and a credit loss exists or the securities are expected to be sold before recovery of amortized cost.

Under the update, there may be an ability to determine there are no expected credit losses in certain circumstances, e.g., based on collateral arrangements for lending and financing transactions or based on the credit quality of the borrower or issuer.

Overall, the amendments in this update are expected to accelerate the recognition of credit losses for portfolios where the CECL models will be applied. This update is effective as of January 1, 2020.

Critical Accounting Policies

Our financial statements are prepared in accordance with U.S. GAAP, which requires us to make estimates and assumptions (see Note 1 to the financial statements). We believe that of our significant accounting policies (see Note 2 to the financial

statements in the 2017 Form 10-K and Note 2 to the 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 the 2017 Form 10-K.

Liquidity and Capital Resources

Senior management, with oversight by the Asset and Liability Management Committee and the Board of Directors (“Board”), establishes and maintains our 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 balance sheet, liquidity and capital structure. Liquidity and capital matters are reported regularly to the Board and the Risk Committee of the Board.

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 September 30, 2018  
$ in millions   IS     WM     IM     Total  

Assets

       

Cash and cash equivalents1

  $ 73,425     $ 18,972     $ 84     $ 92,481   

Trading assets at fair value

    279,579       71       3,538       283,188   

Investment securities

    22,742       59,826             82,568   

Securities purchased under agreements to resell

    57,663       11,423             69,086   

Securities borrowed

    142,177       312             142,489   

Customer and other receivables

    43,010       17,256       573       60,839   

Loans, net of allowance2

    38,878       71,100       5       109,983   

Other assets3

    14,034       9,206       1,643       24,883   

Total assets

  $   671,508     $   188,166     $   5,843     $   865,517   

 

 

 

September 2018 Form 10-Q   18  


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    At December 31, 2017  
$ in millions   IS     WM     IM     Total  

Assets

       

Cash and cash equivalents1

  $ 63,597     $ 16,733     $ 65     $ 80,395   

Trading assets at fair value

    295,678       59       2,545       298,282   

Investment securities

    19,556       59,246             78,802   

Securities purchased under agreements to resell

    74,732       9,526             84,258   

Securities borrowed

    123,776       234             124,010   

Customer and other receivables

    36,803       18,763       621       56,187   

Loans, net of allowance2

    36,269       67,852       5       104,126   

Other assets3

    14,563       9,596       1,514       25,673   

Total assets

  $   664,974     $   182,009     $       4,750     $   851,733   

IS—Institutional Securities

WM—Wealth Management

IM—Investment Management

1.

Cash and cash equivalents includes Cash and due from banks, Interest bearing deposits with banks and Restricted cash.

2.

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 balance sheets (see Note 7 to the financial statements).

3.

Other assets primarily includes Goodwill, Intangible assets, premises, equipment, software, other investments, 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 $865.5 billion at September 30, 2018 from $851.7 billion at December 31, 2017, primarily due to increases in loans across all segments, as well as a net increase to support client activity in secured financings as reflected in Securities borrowed and Securities purchased under agreements to resell in the Institutional Securities business segment. Trading assets within the Institutional Securities business segment declined due to reductions in Equities inventory to support changes in client positioning, which resulted in greater liquidity, as reflected by increases in Cash and cash equivalents and Investment securities.

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 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 the 2017 Form 10-K.

At September 30, 2018 and December 31, 2017, 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 the 2017 Form 10-K.

GLR by Type of Investment

 

 $ in millions  

At

September 30,
2018

   

At

December 31,
2017

 

 Cash deposits with banks1

  $ 10,647     $ 7,167    

 Cash deposits with central banks1

    43,772       33,791    

 Unencumbered highly liquid securities:

   

U.S. government obligations

    93,545       73,422    

U.S. agency and agency mortgage-backed securities

    32,422       55,750    

Non-U.S. sovereign obligations2

    32,019       19,424    

Other investment grade securities

    2,443       3,106    

 Total

  $                 214,848     $                 192,660    

 

1.

Included in Cash and due from banks and Interest bearing deposits with banks in the balance sheets.

2.

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

GLR Managed by Bank and Non-Bank Legal Entities

 

 $ in millions   At
September 30,
2018
    At
December 31,
2017
   

Average Daily Balance

Three Months Ended

September 30, 2018

 

Bank legal entities

 

   

Domestic

  $ 78,320     $ 70,364     $ 76,899    

Foreign

    4,628       4,756       4,343    

Total Bank legal entities

    82,948       75,120       81,242    

Non-Bank legal entities

 

   

Domestic:

     

Parent Company

    44,064       41,642       63,328    

Non-Parent Company

    31,992       35,264       31,208    

Total Domestic

    76,056       76,906       94,536    

Foreign

    55,844       40,634       53,195    

Total Non-Bank legal entities

    131,900       117,540       147,731    

Total

  $             214,848     $             192,660     $             228,973    

Regulatory Liquidity Framework

Liquidity Coverage Ratio

We and our U.S. Bank Subsidiaries are subject to LCR requirements including a requirement to calculate each entity’s LCR on each business day. The requirements are designed to ensure that banking organizations have sufficient HQLA to cover net cash outflows arising from significant stress over 30 calendar days, thus promoting the short-term resilience of the liquidity risk profile of banking organizations.

 

 

  19   September 2018 Form 10-Q


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The regulatory definition of HQLA is substantially the same as our GLR. GLR includes cash placed at institutions other than central banks that is considered an inflow for LCR purposes. HQLA includes a portion of cash placed at central banks, certain unencumbered investment grade corporate bonds and publicly traded common equities, which do not meet the definition of our GLR.

Based on our daily calculations, we and our U.S. Bank Subsidiaries are compliant with the minimum required LCR of 100%.

HQLA by Type of Asset and LCR

 

   

Average Daily Balance

Three Months Ended

 
 $ in millions  

 

September 30, 2018

    June 30, 2018  

HQLA

   

Cash deposits with central banks

  $ 48,962     $                 38,456  

Securities1

    140,060       128,268  

Total

  $ 189,022     $   166,724  

LCR

    135%       128%  

 

1.

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

The increase in the LCR in the current quarter is due to increased HQLA, consistent with higher liquidity levels.

The Firm’s calculations are based on our current understanding of the LCR and other factors, which may be subject to change as we receive additional clarification and implementation guidance from regulators relating to the LCR, and as the interpretation of the LCR evolves over time.

Net Stable Funding Ratio

The objective of the 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 on Banking Supervision (“Basel Committee”) has previously finalized the NSFR framework. In May 2016, the U.S. banking agencies issued a proposal to implement the NSFR in the U.S., which would apply to us and our U.S. Bank Subsidiaries. Our preliminary estimates, based on the current proposal, indicate that actions will be necessary to meet the requirement, which we would expect to accomplish by the effective date of any final rule. Our preliminary estimates are subject to risks and uncertainties that may cause actual results based on the final rule to differ materially from estimates. For an additional discussion of the 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 the 2017 Form 10-K.

Funding Management

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

We fund our balance sheet on a global basis through diverse sources. These sources may include our equity capital, borrowings, securities sold under agreements to repurchase, 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 the 2017 Form 10-K.

At September 30, 2018 and December 31, 2017, the weighted average maturity of our secured financing of less liquid assets was greater than 120 days.

Collateralized Financing Transactions

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Securities purchased under agreements to resell and Securities borrowed

  $ 211,575     $ 208,268  

Securities sold under agreements to repurchase and Securities loaned

  $ 72,161     $ 70,016  

Securities received as collateral1

  $ 8,865     $ 13,749  

 

   

Average Daily Balance

Three Months Ended

 
 $ in millions  

 

September 30,
2018

    December 31,
2017
 

 Securities purchased under agreements to resell and Securities borrowed

  $ 229,243     $ 214,343  

 Securities sold under agreements to repurchase and Securities loaned

  $ 59,346     $ 66,879  

 

1.

Included in Trading assets in the balance sheets.

See Note 2 to the financial statements in the 2017 Form 10-K and Note 6 to the financial statements for more details on collateralized financing transactions.

In addition to the collateralized financing transactions shown in the previous table, we also engage in financing transactions collateralized by customer-owned securities, which are segregated in accordance with regulatory requirements. Receivables under these financing transactions, primarily margin loans, are included in Customer and other receivables in the balance sheets, and payables under these financing transac-

 

 

September 2018 Form 10-Q   20  


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tions, primarily to prime brokerage customers, are included in Customer and other payables in the balance sheets. 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.

Unsecured Financing

For a discussion of our unsecured financing activities, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Funding Management—Unsecured Financing” in the 2017 Form 10-K.

Deposits

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Savings and demand deposits:

   

Brokerage sweep deposits1

  $ 132,835     $ 135,946  

Savings and other

    11,127       8,541  

Total Savings and demand deposits

    143,962       144,487  

Time deposits2

    31,223       14,949  

Total

  $ 175,185     $ 159,436  

 

1.

Represents balances swept from client brokerage accounts.

2.

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

Deposits are primarily sourced from our Wealth Management clients and are considered to have stable, low-cost funding characteristics. Total deposits at September 30, 2018 increased compared with December 31, 2017, primarily driven by increases in Time deposits and Savings and other deposits, partially offset by a reduction in Brokerage sweep deposits due to client deployment of cash into investments and typical seasonal client tax payments. While Brokerage sweep deposits declined since December 31, 2017, the redesign of our brokerage sweep deposit program initiated in the second quarter of 2018 resulted in inflows of approximately $18 billion. These inflows corresponded with outflows from Liquidity products AUM in the Investment Management business segment (see “Business Segments—Investment Management—Assets Under Management or Supervision” herein for more information).

Borrowings

We believe that accessing debt investors through multiple distribution channels helps provide consistent access to the unsecured markets. In addition, the issuance of borrowings with original maturities greater than one year allows us to reduce reliance on short-term credit sensitive instruments. Borrowings with original maturities greater than one year 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.

The 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 also engage in, and may continue to engage in, repurchases of our borrowings in the ordinary course of business.

Borrowings by Remaining Maturity at September 30, 20181

 

$ in millions   Parent
Company
    Subsidiaries     Total  

Original maturities of one year or less

  $ 2     $ 938     $ 940   
Original maturities greater than one year

 

 

2018

  $ 2,673     $ 1,380     $ 4,053   

2019

    21,352       4,350       25,702   

2020

    18,705       2,713       21,418   

2021

    21,236       3,167       24,403   

2022

    14,935       1,961       16,896   

Thereafter

    80,300       17,177       97,477   

Total

  $     159,201     $ 30,748     $ 189,949   

Total Borrowings

  $ 159,203     $ 31,686     $     190,889   

Maturities over next 12 months2

 

  $ 24,122   

 

1.

Original maturity in the table is generally based on contractual final maturity. For borrowings with put options, remaining maturity represents the earliest put date.

2.

Includes only borrowings with original maturities greater than one year.

Borrowings of $190,889 million as of September 30, 2018 remained relatively unchanged compared with $192,582 million at December 31, 2017.

For further information on Borrowings, see Note 10 to the financial statements.

Credit Ratings

We rely on external sources to finance a significant portion of our daily operations. The cost and availability of financing generally are impacted by our credit ratings, among other things. In addition, our credit ratings can have an impact on certain trading revenues, particularly in those businesses where longer-term counterparty performance is a key consideration, such as OTC derivative transactions, including credit derivatives and interest rate swaps. When determining credit ratings, 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 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.

 

 

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Parent Company and MSBNA Senior Unsecured Ratings at October 31, 2018

 

    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  

S&P Global Ratings

  A-2       BBB+       Stable  

 

    MSBNA
    

 

Short-Term    

Debt    

 

 

Long-Term
Debt

 

 

    Rating  

    Outlook  

Fitch Ratings, Inc.

  F1       A+       Stable  

Moody’s Investors Service, Inc.

  P-1       A1       Stable  

S&P Global Ratings

  A-1       A+       Stable  

Incremental Collateral or Terminating Payments

In connection with certain OTC derivatives 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 clearing organizations in the event of a future credit rating downgrade irrespective of whether we are in a net asset or net liability position. See Note 4 to the financial statements for additional information on OTC derivatives that contain such contingent features.

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

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions     2018         2017         2018         2017    

Repurchases of common stock under our share repurchase program

  $ 1,180     $ 1,250     $ 3,680     $ 2,500  

From time to time we repurchase our outstanding common stock, including as part of our share repurchase program. On April 18, 2018, we entered into a sales plan with Mitsubishi UFJ Financial Group, Inc. (“MUFG”) whereby MUFG sells shares of the Firm’s common stock to us, as part of our share repurchase program. The sales plan is only intended to maintain MUFG’s ownership percentage below 24.9% in order to comply with MUFG’s passivity commitments to the Board of Governors of the Federal Reserve System (“Federal Reserve”) and will have no impact on the strategic alliance between MUFG and us, including the joint ventures in Japan. For a description of our share repurchase program, see “Unregistered Sales of Equity Securities and Use of Proceeds.”

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

Common Stock Dividend Announcement

 

Announcement date

  October 16, 2018

Amount per share

  $0.30

Date to be paid

  November 15, 2018

Shareholders of record as of

  October 31, 2018

Preferred Stock

Preferred Stock Dividend Announcement

 

Announcement date

  September 17, 2018

Date paid

  October 15, 2018

Shareholders of record as of

  September 28, 2018

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

 

 

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Regulatory Requirements

Regulatory Capital Framework

We are a financial holding company (“FHC”) under the Bank Holding Company Act of 1956, as amended (“BHC Act”), and are subject to the regulation and oversight of the Federal Reserve. The Federal Reserve establishes capital requirements for us, including “well-capitalized” standards, and evaluates our compliance with such capital requirements. The OCC establishes similar capital requirements and standards for our U.S. Bank Subsidiaries. For us to remain an FHC, we must remain well-capitalized in accordance with standards established by the Federal Reserve and our U.S. Bank Subsidiaries must remain well-capitalized in accordance with standards established by the OCC. For additional information on regulatory capital requirements for our U.S. Bank Subsidiaries, see Note 13 to the financial statements.

Regulatory capital requirements established by the Federal Reserve 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 (“Dodd-Frank Act”).

Regulatory Capital Requirements

We are required to maintain minimum risk-based and leverage-based capital ratios under the regulatory capital requirements. For more information on our regulatory capital requirements, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Capital Requirements” in the 2017 Form 10-K.

Risk-based 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 AOCI and investments in the capital instruments of unconsolidated financial institutions.

In addition to the minimum risk-based capital ratio requirements, by 2019 we will be subject to the following buffers:

 

 

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

 

 

The Common Equity Tier 1 G-SIB capital surcharge, currently at 3%; and

 

 

Up to a 2.5% Common Equity Tier 1 CCyB, currently set by U.S. banking agencies at zero.

In 2018, each of the buffers is 75% of the 2019 requirement noted above (during 2017, the buffers were 50%). 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 the 2017 Form 10-K.

Our risk-based capital ratios for purposes of determining regulatory compliance are the lower of the capital ratios computed under (i) the standardized approaches for calculating credit risk and market risk RWA (“Standardized Approach”) and (ii) the applicable advanced approaches for calculating credit risk, market risk and operational risk RWA (“Advanced Approach”). At September 30, 2018 and December 31, 2017, our ratios are based on the Standardized Approach rules.

Effective January 1, 2019, Common Equity Tier 1 capital, Tier 1 capital and Total capital requirements, inclusive of buffers, will increase to 10.0%, 11.5%, and 13.5%, respectively.

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

Leverage-based Regulatory Capital. Minimum leverage-based capital requirements include a Tier 1 leverage ratio and an SLR. The SLR became effective as a capital standard on January 1, 2018. We are required to maintain a Tier 1 SLR of 3% as well as an enhanced SLR capital buffer of at least 2% (for a total of at least 5%) in order to avoid potential limitations on capital distributions, including dividends and stock repurchases, and discretionary bonus payments to executive officers.

 

 

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Regulatory Capital Ratios

 

    At September 30, 2018  

$ in millions

 

Required

 

Ratio

   

 

Fully Phased-In

 
  Standardized     Advanced  

Risk-based capital

     

Common Equity Tier 1 capital

          $ 61,758      $ 61,758   

Tier 1 capital

            70,328        70,328   

Total capital

            79,899        79,649   

Total RWA

            370,714        357,055   

Common Equity Tier 1 capital ratio

    8.6%       16.7%       17.3%  

Tier 1 capital ratio

    10.1%       19.0%       19.7%  

Total capital ratio

    12.1%       21.6%       22.3%  

Leverage-based capital

     

Adjusted average assets1

          $ 858,944        N/A   

Tier 1 leverage ratio

    4.0%       8.2%       N/A   

Supplementary leverage exposure2

            N/A       $     1,101,263   

SLR

    5.0%       N/A         6.4%  

 

    At December 31, 2017  
   

Required

 

Ratio

    Transitional3          

 

Pro Forma Fully

Phased-In

 
$ in millions   Standardized     Advanced            Standardized     Advanced  

Risk-based capital

 

         

Common Equity Tier 1 capital

          $ 61,134      $ 61,134              $ 60,564      $ 60,564   

Tier 1 capital

            69,938        69,938                69,120        69,120   

Total capital

            80,275        80,046                79,470        79,240   

Total RWA

            369,578        350,212                377,241        358,324   

Common Equity Tier 1 capital ratio

    7.3%       16.5%       17.5%               16.1%       16.9%  

Tier 1 capital ratio

    8.8%       18.9%       20.0%               18.3%       19.3%  

Total capital ratio

    10.8%       21.7%       22.9%               21.1%       22.1%  

Leverage-based capital

 

         

Adjusted average assets1

          $ 842,270        N/A               $ 841,756        N/A    

Tier 1 leverage ratio

    4.0%       8.3%       N/A                 8.2%       N/A    

Supplementary leverage exposure2

            N/A       $   1,082,683                N/A       $   1,082,170   

Pro forma SLR

    5.0%       N/A         6.5%               N/A         6.4%  

 

1.

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

2.

Supplementary leverage exposure is the sum of Adjusted average assets used in the Tier 1 leverage ratio and other adjustments, primarily (i) potential future exposure for derivative exposures, gross-up for cash collateral netting where qualifying criteria are not met, and the effective notional principal amount of sold credit protection offset by qualifying purchased credit protection; (ii) the counterparty credit risk for repo-style transactions; and (iii) the credit equivalent amount for off-balance sheet exposures.

3.

Regulatory compliance was determined based on capital ratios calculated under transitional rules until December 31, 2017.

At December 31, 2017, the pro forma fully phased-in estimated amounts and the pro forma estimated SLR utilized fully phased-in Tier 1 capital, including the fully phased-in Tier 1 capital deductions that applied beginning January 1, 2018. These pro forma fully phased-in estimates were non-GAAP financial measures as the related capital rules were not yet effective at December 31, 2017. These estimates were based on our understanding of the capital rules and other factors at the time.

Regulatory compliance was determined based on capital ratios including regulatory capital and RWA calculated under the transitional rules until December 31, 2017. The regulatory capital analyses in the following tables are presented using pro forma fully phased-in estimates as of December 31, 2017, which are equivalent to amounts calculated as of September 30, 2018.

Fully Phased-In Regulatory Capital

 

$ in millions

 

At

September 30,

2018

   

At

December 31,

20171

    Change  

Common Equity Tier 1 capital

     

Common stock and surplus

  $ 10,852     $ 14,354     $   (3,502)  

Retained earnings

    63,330       57,577       5,753   

AOCI

    (3,999     (3,060     (939)  

Regulatory adjustments and deductions:

     

Net goodwill

    (6,654     (6,599     (55)  

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

    (2,237     (2,446     209   

Other adjustments and deductions2

    466       738       (272)  

Total Common Equity Tier 1 capital

  $ 61,758     $ 60,564     $ 1,194   

Additional Tier 1 capital

     

Preferred stock

  $ 8,520     $ 8,520     $ —   

Noncontrolling interests

    460       415       45   

Other adjustments and deductions

          (23     23   

Additional Tier 1 capital

  $ 8,980     $ 8,912     $ 68   

Deduction for investments in covered funds

    (410     (356     (54)  

Total Tier 1 capital

  $ 70,328     $ 69,120     $ 1,208   

Standardized Tier 2 capital

     

Subordinated debt

  $ 9,052     $ 9,839     $ (787)  

Noncontrolling interests

    108       98       10   

Eligible allowance for credit losses

    431       423        

Other adjustments and deductions

    (20     (10     (10)  

Total Standardized Tier 2 capital

  $ 9,571     $ 10,350     $ (779)  

Total Standardized capital

  $ 79,899     $ 79,470     $ 429   

Advanced Tier 2 capital

     

Subordinated debt

  $ 9,052     $ 9,839     $ (787)  

Noncontrolling interests

    108       98       10   

Eligible credit reserves

    181       193       (12)  

Other adjustments and deductions

    (20     (10     (10)  

Total Advanced Tier 2 capital

  $ 9,321     $ 10,120     $ (799)  

Total Advanced capital

  $ 79,649     $ 79,240     $ 409   

 

1.

The pro forma fully phased-in estimates as of December 31, 2017 are non-GAAP financial measures as the related capital rules were not yet effective at December 31, 2017.

2.

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.

 

 

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Fully Phased-In RWA Rollforward

 

   

Nine Months Ended

September 30, 20181

 
$ in millions   Standardized      Advanced      

Credit risk RWA

    

Balance at December 31, 20172

      $ 301,946      $ 170,754   

Change related to the following items:

    

Derivatives

    (905      2,431   

Securities financing transactions

    1,269        2,583   

Securitizations

    941        (639)  

Investment securities

    (271      6,708   

Commitments, guarantees and loans

    9,491        8,073   

Cash

    960        773   

Equity investments

    (1,346      (1,429)  

Other credit risk3

    (1,945      (1,498)  

Total change in credit risk RWA

      $ 8,194      $ 17,002   

Balance at September 30, 2018

      $           310,140      $           187,756   

Market risk RWA

    

Balance at December 31, 20172

      $ 75,295      $ 74,907   

Change related to the following items:

    

Regulatory VaR

    179        179   

Regulatory stressed VaR

    (5,242      (5,242)  

Incremental risk charge

    1,097        1,097   

Comprehensive risk measure

    (2,636      (2,102)  

Specific risk:

    

Non-securitizations

    (3,838      (3,838)  

Securitizations

    (4,281      (4,281)  

Total change in market risk RWA

      $ (14,721    $ (14,187)  

Balance at September 30, 2018

      $ 60,574      $ 60,720   

Operational risk RWA

    

Balance at December 31, 20172

    N/A      $ 112,663   

Change in operational risk RWA

    N/A        (4,084)  

Balance at September 30, 2018

    N/A      $ 108,579   

Total RWA

      $ 370,714      $ 357,055   

Regulatory VaR—VaR for regulatory capital requirements

1.

The RWA for each category reflects both on- and off-balance sheet exposures, where appropriate.

2.

The pro forma fully phased-in estimates as of December 31, 2017 are non-GAAP financial measures as the related capital rules were not yet effective at December 31, 2017.

3.

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

Credit risk RWA increased in the current year period under the Standardized and Advanced Approaches primarily due to increased corporate lending exposures within the Institutional Securities business segment. Credit risk RWA for Investment securities also increased in the current year period under the Advanced Approach driven by model revisions which increased the risk weighting for certain counterparty types.

Market risk RWA decreased in the current year period under the Standardized and Advanced Approaches primarily due to a decrease in Stressed VaR driven by reduced interest rate and credit spread risk, a decrease in securitization specific risk charges mainly as a result of reduced exposures in mortgage-backed securities, and a decrease in non-securitization specific risk charges primarily due to reduced exposures in bonds and equity derivatives.

The decrease in operational risk RWA under the Advanced Approach in the current year period reflects a continued reduction in the frequency and magnitude of internal losses utilized in the operational risk capital model related to litigation and execution and processing.

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

The Federal Reserve’s proposed modifications to the enhanced SLR would also make corresponding changes to the calibration of the TLAC leverage-based requirements, as well as certain other technical changes to the TLAC rule. For a further discussion of the enhanced SLR, see “Regulatory Developments—Proposed Modifications to the Enhanced SLR and to the SLR Applicable to Our U.S. Bank Subsidiaries” herein.

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 the 2017 Form 10-K. For discussions about the interaction between the SPOE resolution strategy and the TLAC and LTD requirements, see “Business—Supervision and Regulation—Financial Holding Company—Resolution and Recovery Planning” and “Risk Factors—Legal, Regulatory and Compliance Risk” in the 2017 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 BHCs, including us, which form part of the Federal Reserve’s annual CCAR framework.

We submitted our 2018 Capital Plan (“Capital Plan”) and company-run stress test results to the Federal Reserve on April 5, 2018. On June 21, 2018, the Federal Reserve published summary results of the Dodd-Frank Act supervisory stress tests of each large BHC, including us. On June 28, 2018, the Federal Reserve published summary results of CCAR and we received a conditional non-objection to our

 

 

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Capital Plan, where the only condition was that our capital distributions not exceed the greater of the actual distributions we made over the previous four calendar quarters or the annualized average of actual distributions over the previous eight calendar quarters.

Our 2018 Capital Plan includes the repurchase of up to $4.7 billion of outstanding common stock for the period beginning July 1, 2018 through June 30, 2019, and an increase in our quarterly common stock dividend to $0.30 per share, beginning with the common stock dividend announced on July 18, 2018. The total amount of expected 2018 capital distributions is consistent with the $6.8 billion of actual dividends and gross share repurchases included in our 2017 Capital Plan. We disclosed a summary of the results of our company-run stress tests on June 21, 2018 on our Investor Relations webpage. In addition, we submitted the results of our mid-cycle company-run stress test to the Federal Reserve and on October 22, 2018 disclosed a summary of the results on our Investor Relations webpage.

The Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”), which was enacted on May 24, 2018, modifies certain aspects of the stress-testing process applicable to BHCs, including us. Pursuant to EGRRCPA, on October 31, 2018, the Federal Reserve issued a proposal to tailor prudential standards that would, among other things, modify our obligation to perform company-run stress-tests from semi-annually to annually.

Each of our U.S. Bank Subsidiaries is also currently required to conduct an annual stress test. MSBNA and MSPBNA submitted their 2018 annual company-run stress tests to the OCC on April 5, 2018 and published a summary of their stress test results on June 21, 2018.

EGRRCPA also eliminates the statutory requirement for banks with less than $250 billion of total assets, which includes both of our U.S. Bank Subsidiaries, to conduct stress-testing, effective November 2019. The OCC provided guidance in July 2018 that MSPBNA, as a national bank with less than $100 billion of total consolidated assets, would be immediately exempted from company-run stress-testing requirements.

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 the 2017 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 under the Required Capital framework, as well as each business segment’s relative contribution to our total Required Capital.

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 common equity. We generally hold Parent Company common equity for prospective regulatory requirements, organic growth, acquisitions and other capital needs.

The estimation and attribution of common equity to the business segments are based on the fully phased-in regulatory capital rules. The amount of capital allocated to the business segments is generally set at the beginning of each year and remains fixed throughout the year until the next annual reset unless a significant business change occurs (e.g., acquisition or disposition). Differences between available and Required Capital are attributed to Parent Company common equity during the year.

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

Average Common Equity Attribution1

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
 $ in billions       2018             2017             2018             2017      

 Institutional Securities

  $ 40.8     $ 40.2     $ 40.8     $ 40.2    

 Wealth Management

    16.8       17.2       16.8       17.2    

 Investment Management

    2.6       2.4       2.6       2.4    

 Parent Company

    10.0       10.7       9.4       10.0    

 Total

  $ 70.2     $ 70.5     $ 69.6     $ 69.8    

 

1.

Average common equity is a non-GAAP financial measure. See “Selected Non-GAAP Financial Information” herein.

Resolution and Recovery Planning

Pursuant to the Dodd-Frank Act, we are required to periodically submit to the Federal Reserve and the FDIC a 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 an SPOE strategy. The Parent Company has amended and restated its secured support agreement with its

 

 

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material entities, as defined in our 2017 resolution plan. Under the secured 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 contributable 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 entities.

The obligations of the Parent Company under the secured amended and restated support agreement are in most cases 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 entities against the assets of the Parent Company (other than shares in subsidiaries of the Parent Company) are effectively senior to unsecured obligations of the Parent Company.

In addition, on July 1, 2018, MSBNA and MSPBNA each submitted to the FDIC a resolution plan that describes its strategy for a rapid and orderly resolution in the event of its material financial distress or failure.

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” and “Risk Factors—Legal, Regulatory and Compliance Risk” in the 2017 Form 10-K.

Regulatory Developments

Single-Counterparty Credit Limits

On June 14, 2018, the Federal Reserve finalized rules that establish single-counterparty credit limits (“SCCL”) for large banking organizations. U.S. G-SIBs, including us, are subject to a limit of 15% of Tier 1 capital for aggregate net credit exposures to any “major counterparty” (defined to include other U.S. G-SIBs, foreign G-SIBs, and nonbank systemically important financial institutions supervised by the Federal Reserve). In addition, we are subject to a limit of 25% of Tier 1 capital for aggregate net credit exposures to any other unaffiliated counterparty. We must comply with the final SCCL rules beginning on January 1, 2020.

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 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.

On June 5, 2018, the Federal Reserve and the other federal financial regulatory agencies responsible for the Volcker Rule’s implementing regulations released an interagency proposal that would revise certain elements of the Volcker Rule regulations. The proposed changes focus on proprietary trading, including the metrics reporting requirements and certain requirements imposed in connection with permitted market making, underwriting and risk-mitigating hedging activities, including market-making in and underwriting of covered funds. The impact of this proposal on us will not be known with certainty until final rules are issued. For more information about the Volcker Rule, see “Business— Supervision and Regulation—Activities Restrictions under the Volcker Rule” in the 2017 Form 10-K.

Proposed Stress Buffer Requirements

On April 10, 2018, the Federal Reserve issued a proposal to integrate its annual capital planning and stress testing requirements with certain ongoing regulatory capital requirements. The proposal, which would apply to certain BHCs, including us, would introduce a stress capital buffer and a stress leverage buffer (collectively, “Stress Buffer Requirements”) and related changes to the capital planning and stress testing processes. Under the proposal, Stress Buffer Requirements would apply only with respect to the Standardized Approach and Tier 1 leverage regulatory capital requirements and would generally be effective on October 1, 2019.

In the Standardized Approach, the stress capital buffer would replace the existing Common Equity Tier 1 capital conservation buffer, which will be 2.5% as of January 1, 2019. The Standardized Approach stress capital buffer would equal the greater of (i) the maximum decline in our Common Equity Tier 1 capital ratio under the severely adverse scenario over the supervisory stress test measurement period, plus the sum of the ratios of the dollar amount of our planned common stock dividends to our projected RWA for each of the fourth through seventh quarters of the supervisory stress test projection period, and (ii) 2.5%. Regulatory capital requirements under the Standardized Approach would include the stress capital buffer, as summarized above, as well as our Common Equity Tier 1 G-SIB capital surcharge and any applicable Common Equity Tier 1 CCyB.

Like the stress capital buffer, the stress leverage buffer would be calculated based on the results of our annual supervisory stress tests. The stress leverage buffer would equal the maximum decline in our Tier 1 leverage ratio under the severely adverse scenario, plus the sum of the ratios of the dollar amount of our planned common stock dividends to our projected leverage ratio denominator for each of the fourth through seventh quarters of the supervisory stress test projection period. No floor would be established for the stress leverage buffer, which would apply in addition to the current minimum Tier 1 leverage ratio of 4%.

The proposal would make related changes to capital planning and stress testing processes for BHCs subject to the Stress

 

 

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Buffer Requirements. In particular, the proposal would limit projected capital actions to planned common stock dividends in the fourth through seventh quarters of the supervisory stress test projection period and would assume that BHCs maintain a constant level of assets and RWA throughout the supervisory stress test projection period.

The proposal does not change regulatory capital requirements under the Advanced Approach or the SLR, although the Federal Reserve and the OCC have separately proposed to modify the enhanced SLR requirements, as summarized below. If the proposal is adopted in its current form, limitations on capital distributions and discretionary bonus payments to executive officers would be determined by the most stringent limitation, if any, as determined under the Standardized Approach or the Tier 1 leverage ratio, inclusive of Stress Buffer Requirements, or the Advanced Approach or SLR or TLAC requirements, inclusive of applicable buffers.

Proposed Modifications to the Enhanced SLR and to the SLR Applicable to Our U.S. Bank Subsidiaries

On April 11, 2018, the Federal Reserve proposed modifications to the enhanced SLR that would replace the current 2% enhanced SLR buffer applicable to U.S. G-SIBs, including us, with a leverage buffer equal to 50% of our Common Equity Tier 1 G-SIB capital surcharge, which is currently 3%. Under the proposal, our enhanced SLR buffer would become 1.5%, for a total enhanced SLR requirement of 4.5%, assuming that our G-SIB capital surcharge remains the same when the proposal becomes effective.

As part of the same proposal, the Federal Reserve and the OCC also proposed to align the well-capitalized SLR standard applicable to our U.S. Bank Subsidiaries with the proposed enhanced SLR buffer applicable to us. Under the proposal, the well-capitalized SLR requirement for our U.S. Bank Subsidiaries would change from the current 6% to 3% plus 50% of our current Common Equity Tier 1 G-SIB capital surcharge, for a total well-capitalized SLR requirement of 4.5%, assuming that our G-SIB capital surcharge remains the same when the proposal becomes effective.

Proposed Regulatory Capital Adjustments Related to Implementation of the Current Expected Credit Losses Methodology

On April 17, 2018, the U.S. banking agencies issued a proposal to revise the regulatory capital framework applicable to banking organizations, including us and our U.S. Bank Subsidiaries, to address the new accounting standard for credit losses, known as a CECL methodology. For a further discussion of CECL, see “Accounting Development Updates—Financial Instruments—Credit Losses” herein.

The proposal modifies the regulatory capital rules to identify which credit loss allowances under the new accounting standard are eligible for inclusion in regulatory capital and to

provide banking organizations the option to phase in, over a three-year period, the adverse effects on regulatory capital that may result from the adoption of the new accounting standard. The proposal requires a banking organization that has adopted a CECL methodology to include the provision for credit losses beginning in the 2020 stress test cycle.

Proposed Standardized Approach for Counterparty Credit Risk

On October 30, 2018, the U.S. banking agencies issued a proposal to incorporate the standardized approach for counterparty credit risk (“SA-CCR”), a new derivatives counterparty exposure methodology, into the regulatory capital framework and related regulatory standards. As proposed, SA-CCR would replace the current exposure method, on a mandatory basis, in our and our U.S. Bank Subsidiaries’ Standardized Approach RWAs, central counterparty default fund contributions and, in modified form, in Supplementary Leverage Ratio exposure calculations. SA-CCR would be available as an alternative in our and our U.S. Bank Subsidiaries’ Advanced Approach RWAs for trade exposures, in single counterparty credit limits applicable to us, and in bank lending limits applicable to our U.S. Bank Subsidiaries. The proposal would require us and our U.S. Bank Subsidiaries to implement SA-CCR by July 1, 2020, but would permit voluntary early adoption before that date after a final rule adopting SA-CCR is effective.

U.S. Department of Labor Conflict of Interest Rule and SEC Standards of Conduct for Investment Professionals

The U.S. DOL’s final Conflict of Interest Rule under ERISA went into effect on June 9, 2017. On March 15, 2018, the U.S. Court of Appeals for the Fifth Circuit vacated the Conflict of Interest Rule and accompanying exemptions in their entirety. On June 21, 2018, the Court issued the mandate that makes effective its decision to vacate the rule.

On April 18, 2018, the SEC released for public comment a package of proposed rulemaking on the standards of conduct and required disclosures for broker-dealers and investment advisers. One of the proposals, entitled “Regulation Best Interest,” would require broker-dealers to act in the “best interest” of retail customers at the time a recommendation is made without placing the financial or other interests of the broker-dealer ahead of the interest of the retail customer. Additionally, the SEC proposed a new requirement for both broker-dealers and investment advisers to provide a brief relationship summary to retail investors with information intended to clarify the relationship between the parties. Finally, the SEC issued a proposed interpretation regarding the fiduciary duty that investment advisers owe their clients.

U.K. Withdrawal from the E.U.

Following the U.K. electorate vote to leave the E.U., the U.K. invoked Article 50 of the Lisbon Treaty on March 29, 2017, which triggered a two-year period, subject to extension (which would need the unanimous approval of the E.U. Member States), during which the U.K. government has been negotiating its with-

 

 

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drawal agreement with the E.U. For further discussion of the potential impact of the U.K.’s withdrawal from the E.U. on our operations, see “Risk Factors—International Risk” in the 2017 Form 10-K. For further information regarding our exposure to the U.K., see also “Quantitative and Qualitative Disclosures about Risk—Credit Risk—Country Risk Exposure.”

Expected Replacement of London Interbank Offered Rate

Central banks around the world, including the Federal Reserve, have commissioned working groups of market participants and official sector representatives with the goal of finding suitable replacements for LIBOR based on observable market transactions. It is expected that a transition away from the widespread use of LIBOR to alternative rates will occur over the course of the next few years. The U.K. Financial Conduct Authority (“FCA”), which regulates LIBOR, has announced that it has commitments from panel banks to continue to contribute to LIBOR through the end of 2021, but that it will not use its powers to compel contributions beyond such date. Accordingly, there is considerable uncertainty regarding the publication of such rates beyond 2021.

On April 3, 2018, the Federal Reserve Bank of New York commenced publication of three reference rates based on overnight U.S. Treasury repurchase agreement transactions, including SOFR, which has been recommended as an alternative to U.S. dollar LIBOR by the Alternative Reference Rates Committee. Further, the Bank of England has commenced publication of a reformed Sterling Overnight Index Average (“reformed SONIA”), comprised of a broader set of overnight Sterling money market transactions, as of April 23, 2018. Reformed SONIA has been recommended as the alternative to Sterling LIBOR by the working group on Sterling Risk-Free Reference Rates. Central bank sponsored committees in other jurisdictions have, or are expected to, select alternative reference rates denominated in other currencies.

Although the full impact of such reforms and actions, together with any transition away from LIBOR, including the potential or actual discontinuance of LIBOR publication, remains unclear, these changes may have an adverse impact on the value of, return on and trading markets for a broad array of financial products, including any LIBOR-based securities,

loans and derivatives that are included in our financial assets and liabilities. Such reforms and actions may also require extensive changes to the contracts that govern these LIBOR-based products, as well as our systems and processes.

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 the 2017 Form 10-K.

Off-Balance Sheet Arrangements and Contractual Obligations

Off-Balance Sheet Arrangements

We enter into various off-balance sheet arrangements, including through unconsolidated 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 financial statements.

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

Contractual Obligations

For a discussion about our contractual obligations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Contractual Obligations” in the 2017 Form 10-K.

 

 

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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 the 2017 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, volatilities, 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 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 alternative and other funds. For a further discussion of market risk, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Market Risk” in the 2017 Form 10-K.

Trading Risks

Value-at-Risk.    The statistical technique known as VaR is one of the tools we use 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 the 2017 Form 10-K.

We utilize the same VaR model for risk management purposes and for regulatory capital calculations. Our regulators have approved our VaR model 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 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. 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.

95%/One-Day Management VaR

 

   

Three Months Ended

 

September 30, 2018

 
$ in millions  

  Period  

End

      Average         High         Low    

Interest rate and credit spread

  $ 28     $ 29     $     35      $     25   

Equity price

    13       15       17        13   

Foreign exchange rate

    12       12       13         

Commodity price

    7       8       10         

Less: Diversification benefit1, 2

    (25     (27     N/A       N/A  

Primary Risk Categories

  $ 35     $ 37     $ 42      $ 33   

Credit Portfolio

    13       12       14        11   

Less: Diversification benefit1, 2

    (6     (7     N/A       N/A  

Total Management VaR

  $ 42     $ 42     $ 46      $ 38   

 

   

Three Months Ended

June 30, 2018

 
$ in millions  

Period

End

    Average     High     Low  

Interest rate and credit spread

  $ 32     $ 35     $     43      $     29   

Equity price

    13       14       17        12   

Foreign exchange rate

    11       9       12         

Commodity price

    8       9       12         

Less: Diversification benefit1, 2

    (25     (26     N/A       N/A  

Primary Risk Categories

  $ 39     $ 41     $ 51      $ 35   

Credit Portfolio

    14       11       14         

Less: Diversification benefit1, 2

    (10     (8     N/A       N/A  

Total Management VaR

  $ 43     $ 44     $ 54      $ 38   

 

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.

Average total Management VaR and average Management VaR for the Primary Risk Categories of $42 million and $37 million, respectively, decreased from the three-months ended June 30, 2018, primarily as a result of reduced interest rate and credit spread risk within the Fixed Income division of the Institutional Securities business segment.

 

 

September 2018 Form 10-Q   30  


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Distribution of VaR Statistics and Net Revenues.    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 corresponding 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 corresponding 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. There were no days in the current year period on which trading losses exceeded VaR.

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, the average 95%/one-day total Management VaR for the current quarter was $42 million. The following histogram presents the distribution of the daily 95%/one-day total Management VaR for the current quarter.

Daily 95%/One-Day Total Management VaR for the Current Quarter

($ in millions)

 

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 exclude certain items not captured in the VaR model, such as fees, commissions and net interest income, and differ from the definition of revenues required for Regulatory VaR backtesting, which further excludes intraday trading.

Daily Net Trading Revenues for the Current Quarter

($ in millions)

 

LOGO

Non-Trading Risks

We believe that sensitivity analysis is an appropriate representation of our non-trading risks. The following sensitivity analyses cover substantially all of the non-trading risk in our portfolio.

Exposure Related to Our Own Credit Spread.

Credit Spread Risk Sensitivity1

 

$ in millions  

At

September 30, 2018

    

At

    June 30, 2018    

 

Derivatives

    $ 6      $  

Funding liabilities2

    34        32   

 

1.

Amounts represent the increase in value for each 1 bps widening of our credit spread.

2.

Relates to structured note liabilities carried at fair value.

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

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

 

$ in millions

 

At

  September 30,      

2018

   

At

      June 30,      

2018

 

Basis point change

   

+200

  $ 493     $ 531  

+100

    254       273  

-100

    (389     (489
 

 

  31   September 2018 Form 10-Q


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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, including non-parallel rate change scenarios. 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 change in sensitivity to interest rates in the minus 100 basis point scenario between September 30, 2018 and June 30, 2018 is primarily related to higher interest rates.

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

 

    Loss from 10% Decline  
$ in millions   At
September 30,
2018
    At
        June 30,        
2018

Investments related to Investment Management activities

      $ 286     $                 301    

Other investments:

   

MUMSS

    166       164  

Other Firm investments

    183       181  

MUMSS—Mitsubishi UFJ Morgan Stanley Securities Co., Ltd.

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 the 2017 Form 10-K. Also, see Notes 7 and 11 to the financial statements for additional information about our loans and lending commitments, respectively.

Lending Activities Included in Loans and Trading Assets

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 balance sheets, these loans and lending commitments are carried as held for investment, which are recorded at amortized cost; as held for sale, which are recorded at the lower of cost or fair value; or at fair value with changes in fair value recorded in earnings. 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 balance sheets. See Notes 3, 7 and 11 to the financial statements for further information.

Loans and Lending Commitments

 

    At September 30, 2018  
$ in millions   IS     WM     IM1     Total

Corporate loans

  $ 19,284     $ 16,150     $ 5     $ 35,439    

Consumer loans

          28,321             28,321  

Residential real estate loans

          26,644             26,644  

Wholesale real estate loans

    8,157                   8,157  

Loans held for investment, gross of allowance

    27,441       71,115       5       98,561  

Allowance for loan losses

    (188     (43           (231

Loans held for investment, net of allowance

    27,253       71,072       5       98,330  

Corporate loans

    10,035                   10,035  

Residential real estate loans

    1       28             29  

Wholesale real estate loans

    1,589                   1,589  

Loans held for sale

    11,625       28             11,653  

Corporate loans

    9,468             21       9,489  

Residential real estate loans

    912                   912  

Wholesale real estate loans

    1,209             1,156       2,365  

Loans held at fair value

    11,589             1,177       12,766  

Total loans

    50,467       71,100       1,182       122,749  

Lending commitments2, 3

    97,903       10,740       164       108,807  

Total loans and lending commitments2, 3

  $   148,370     $     81,840     $       1,346     $   231,556  
 

 

September 2018 Form 10-Q   32  


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    At December 31, 2017  

$ in millions

  IS     WM     IM     Total

Corporate loans

  $ 15,332     $ 14,417     $ 5     $ 29,754    

Consumer loans

          26,808             26,808  

Residential real estate loans

          26,635             26,635  

Wholesale real estate loans

    9,980                   9,980  

Loans held for investment, gross of allowance

    25,312       67,860       5       93,177  

Allowance for loan losses

    (182     (42           (224

Loans held for investment, net of allowance

    25,130       67,818       5       92,953  

Corporate loans

    9,456                   9,456  

Residential real estate loans

    1       34             35  

Wholesale real estate loans

    1,682                   1,682  

Loans held for sale

    11,139       34             11,173  

Corporate loans

    8,336             22       8,358  

Residential real estate loans

    799                   799  

Wholesale real estate loans

    1,579                   1,579  

Loans held at fair value

    10,714             22       10,736  

Total loans

    46,983       67,852       27       114,862  

Lending commitments2, 3

    92,588       9,481             102,069  

Total loans and lending commitments2, 3

  $   139,571     $     77,333     $            27     $   216,931  

 

1.

Investment Management business segment loans are entered into in conjunction with certain investment advisory activities. The increase in fair value loans in the current year period is a result of the consolidation of a fund managed by Mesa West Capital, LLC that primarily invests in commercial real estate loans with remaining maturities of less than 5 years.

2.

Lending commitments represent the notional amount of legally binding obligations to provide funding to clients for 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.

3.

For syndications led by us, any lending commitments accepted by the borrower but not yet closed are net of amounts syndicated. For syndications that we participate in and do not lead, any 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.

Total loans and lending commitments increased by approximately $15 billion in the current year period, primarily due to increases in collateralized and relationship-based loans and lending commitments within the Institutional Securities business segment.

Credit exposure arising 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.

 

Allowance for Loans and Lending Commitments Held for Investment

 

$ in millions   At
    September 30,    
2018
    At
    December 31,    
2017
 

Loans

  $ 231     $ 224  

Lending commitments

    201       198  

Total allowance for loans and lending commitments

  $ 432     $ 422  

The aggregate allowance for loans and lending commitment losses increased during the current year period, primarily due to overall portfolio changes and qualitative and environmental factors impacting the inherent allowance within the Institutional Securities business segment. See Note 7 to the financial statements for further information.

Status of Loans Held for Investment

 

    At September 30, 2018     At December 31, 2017  
             IS                     WM                     IS                     WM        

Current

    99.8%       99.9%       99.5%       99.9%    

Nonaccrual1

    0.2%       0.1%       0.5%       0.1%  

 

1.

These loans are 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.

Institutional Securities 

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 and financing extended to equities and commodities customers and 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 collateralized lines of credit and term loans with various types of collateral including residential real estate, commercial real estate, corporate and financial assets. These collateralized loans and lending commitments generally provide for over-collateralization. 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. The Firm monitors collateral levels against the requirements of lending agreements. See Note 12 to the financial statements for information about our securitization activities.

 

 

  33   September 2018 Form 10-Q


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Institutional Securities Loans and Lending Commitments1

 

    At September 30, 2018  
    Years to Maturity      
$ in millions   Less than 1     1-3     3-5     Over 5     Total

Loans

         

AA

  $ 10     $ 488     $     $ 19     $ 517    

A

    1,172       3,259       978       325       5,734  

BBB

    3,042       6,108       4,252       796       14,198  

NIG

    7,169       11,395       7,050       2,383       27,997  

Unrated2

    81       184       147       1,609       2,021  

Total loans

    11,474       21,434       12,427       5,132       50,467  

Lending commitments

 

       

AAA

          165                   165  

AA

    2,837       803       3,119             6,759  

A

    4,803       10,409       9,159       370       24,741  

BBB

    2,361       11,490       19,180       771       33,802  

NIG

    1,244       9,401       15,129       6,603       32,377  

Unrated2

    1             19       39       59  

Total lending commitments

    11,246       32,268       46,606       7,783       97,903  

Total exposure

  $ 22,720     $   53,702     $   59,033     $   12,915     $   148,370  

 

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

Loans

         

AA

  $ 14     $ 503     $ 30     $ 5     $ 552    

A

    1,608       1,710       1,235       693       5,246  

BBB

    2,791       6,558       3,752       646       13,747  

NIG

    4,760       12,311       4,480       3,245       24,796  

Unrated2

    243       291       621       1,487       2,642  

Total loans

    9,416       21,373       10,118       6,076       46,983  

Lending commitments

 

       

AAA

          165                   165  

AA

    3,745       1,108       3,002             7,855  

A

    3,769       5,533       11,774       197       21,273  

BBB

    3,987       12,345       16,818       1,095       34,245  

NIG

    4,159       9,776       12,279       2,698       28,912  

Unrated2

    9       40       42       47       138  

Total lending commitments

    15,669       28,967       43,915       4,037       92,588  

Total exposure

  $ 25,085     $   50,340     $   54,033     $   10,113     $   139,571  

NIG–Non-investment grade

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 Risk—Market Risk” herein.

Institutional Securities Loans and Lending Commitments by Industry

 

$ in millions   At
  September 30,  
2018
    At
  December 31,  
2017

Industry

   

Financials

  $ 32,546     $           22,112  

Real estate

    25,005       28,426  

Consumer discretionary

    12,267       11,555  

Industrials

    11,785       11,090  

Information technology

    11,337       11,862  

Utilities

    9,877       9,592  

Healthcare

    9,789       9,956  

Energy

    9,398       10,233  

Consumer staples

    8,640       8,315  

Telecommunications services

    5,720       4,172  

Materials

    5,432       5,069  

Insurance

    4,883       4,739  

Other

    1,691       2,450  

Total

  $ 148,370     $ 139,571  

Event-Driven Loans and Lending Commitments

 

    At September 30, 2018  
    Years to Maturity      
$ in millions   Less than 1     1-3     3-5     Over 5     Total

Loans

  $ 2,565     $ 778     $ 615     $ 662     $ 4,620   

Lending commitments

    396       3,909       2,900       2,188       9,393  

Total loans and lending commitments

  $ 2,961     $   4,687     $   3,515     $   2,850     $   14,013  

 

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

Loans

  $ 1,458     $ 1,058     $ 639     $ 2,012     $ 5,167   

Lending commitments

    1,272       3,206       2,091       1,874       8,443  

Total loans and lending commitments

  $ 2,730     $   4,264     $   2,730     $   3,886     $   13,610  

Event-driven loans and lending commitments, which comprise a portion of corporate loans and lending commitments within the Institutional Securities business segment, 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. The increase in event-driven lending commitments in the current year period is primarily due to an increase in held-for-sale commitments driven by client M&A transactions.

Wealth Management

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

Securities-based lending provided to our clients is primarily conducted through our Liquidity Access Line platform. 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 the 2017 Form 10-K.

 

 

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Wealth Management Loans and Lending Commitments

 

    At September 30, 2018  
    Contractual Years to Maturity        
$ in millions   Less than 1     1-3     3-5     Over 5     Total  

Securities-based lending and other loans

  $ 37,622     $ 3,736     $ 2,005     $ 1,083     $ 44,446    

Residential real estate loans

          27       5       26,622       26,654    

Total loans

  $ 37,622     $ 3,763     $ 2,010     $ 27,705     $ 71,100    

Lending commitments

    9,247       1,129       89       275       10,740    

Total loans and lending commitments

  $ 46,869     $   4,892     $   2,099     $   27,980     $ 81,840    

Securities-based lending—Liquidity Access Line platform loans

 

  $   33,738    

 

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

Securities-based lending and other loans

  $ 34,389     $ 3,687     $ 1,899     $ 1,231     $ 41,206    

Residential real estate loans

          24       15       26,607       26,646    

Total loans

  $ 34,389     $ 3,711     $ 1,914     $ 27,838     $ 67,852    

Lending commitments

    7,253       1,827       120       281       9,481    

Total loans and lending commitments

  $ 41,642     $   5,538     $   2,034     $   28,119     $ 77,333    

Securities-based lending—Liquidity Access Line platform loans

 

  $   32,230    

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

Lending Activities Included in Customer and Other

Receivables

Margin Loans

 

    At September 30, 2018  
$ in millions   IS     WM     Total  

Net customer receivables representing margin loans

  $  22,153     $  11,668     $  33,821   
    At December 31, 2017  
$ in millions   IS     WM     Total  

Net customer receivables representing margin loans

  $  19,977     $  12,135     $  32,112  

The Institutional Securities and Wealth Management business segments provide margin lending arrangements which allow customers to borrow against the value of qualifying securities. Margin lending activities generally have minimal credit risk due to the value of collateral held and their short-term nature.

Employee Loans

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Balance

  $ 3,491     $ 4,185    

Allowance for loan losses

    (70 )      (77)   

Balance, net

  $ 3,421     $ 4,108    

Repayment term range, in years

    1 to 20       1 to 20    

Employee loans are generally granted to retain and recruit certain employees, are full recourse and generally require periodic repayments. 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 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 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 the 2017 Form 10-K.

Counterparty Credit Rating and Remaining Contractual Maturity of OTC Derivative Assets at Fair Value

 

    Credit Rating1        
$ in millions   AAA     AA     A     BBB     NIG     Total  

At September 30, 2018

 

       

< 1 year

  $ 473     $ 6,603     $ 42,113     $ 13,877     $ 7,596     $ 70,662    

1-3 years

    747       3,392       23,551       9,717       7,039       44,446    

3-5 years

    821       2,396       13,462       5,584       2,607       24,870    

Over 5 years

    4,151       9,089       65,037       35,917       10,314       124,508    

Total, gross

  $    6,192     $ 21,480     $ 144,163     $ 65,095     $ 27,556     $ 264,486    

Counterparty netting

    (2,683     (13,855     (116,420     (46,413     (15,519     (194,890)   

Cash and securities collateral

    (3,171     (5,811     (24,039     (13,251     (8,642     (54,914)   

Total, net

  $ 338     $ 1,814     $ 3,704     $ 5,431     $ 3,395     $ 14,682    
 

 

  35   September 2018 Form 10-Q


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    Credit Rating1, 2        
$ in millions   AAA     AA     A     BBB     NIG     Total  

At December 31, 2017

 

       

< 1 year

  $ 356     $ 5,302     $ 36,001     $ 11,577     $ 5,904     $ 59,140    

1-3 years

    558       4,118       23,137       8,887       4,827       41,527    

3-5 years

    702       3,183       15,577       5,489       4,879       29,830    

Over 5 years

    5,470       11,667       78,779       37,286       12,079       145,281    

Total, gross

  $    7,086     $ 24,270     $ 153,494     $ 63,239     $ 27,689     $ 275,778    

Counterparty netting

    (3,018     (15,261     (125,378     (45,421     (15,828     (204,906)   

Cash and securities collateral

    (3,188     (6,785     (23,257     (12,844     (9,123     (55,197)   

Total, net

  $ 880     $ 2,224     $ 4,859     $ 4,974     $ 2,738     $ 15,675    

 

1.

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

2.

Prior period amounts have been revised to conform to the current presentation.

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

 

$ in millions   At
  September 30,
2018
    At
  December 31,  
2017
 

Industry

 

Utilities

  $ 4,290     $ 4,382    

Financials

    3,487       3,330    

Regional governments

    894       1,005    

Industrials

    858       1,124    

Energy

    781       646    

Healthcare

    705       882    

Information technology

    704       715    

Consumer discretionary

    508       464    

Not-for-profit organizations

    500       703    

Sovereign governments

    486       1,084    

Insurance

    388       206    

Real estate

    341       374    

Materials

    289       329    

Consumer staples

    208       161    

Other

    243       270    

Total

  $ 14,682     $ 15,675    

For additional information on derivative instruments, including credit derivatives, see Note 4 to the financial statements.

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 the 2017 Form 10-K.

 

Our sovereign exposures consist of financial contracts/obligations entered into with sovereign and local governments. Our non-sovereign exposures consist of financial contracts/obligations entered into primarily with corporations and financial institutions. Index credit derivatives are included in the following 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.

Top Ten Non-U.S. Country Exposures at September 30, 2018

 

United Kingdom

     
$ in millions       Sovereigns           Non-sovereigns         Total    

Net inventory1

  $ (594   $ 1,958     $ 1,364    

Net counterparty exposure2

          8,129       8,129    

Loans

          1,894       1,894    

Lending commitments

          5,702       5,702    

Exposure before hedges

    (594     17,683       17,089    

Hedges3

    (355     (1,550     (1,905)   

Net exposure

  $ (949   $ 16,133     $ 15,184    

Japan

     
$ in millions       Sovereigns           Non-sovereigns         Total    

Net inventory1

  $             7,266     $ 120     $         7,386    

Net counterparty exposure2

    43       3,199       3,242    

Loans

                —    

Lending commitments

                —    

Exposure before hedges

    7,309       3,319       10,628    

Hedges3

    (118     (114     (232)   

Net exposure

  $ 7,191     $ 3,205     $ 10,396    

Spain

     
$ in millions       Sovereigns           Non-sovereigns         Total    

Net inventory1

  $ (101   $ (49   $ (150)   

Net counterparty exposure2

          115       115    

Loans

          1,894       1,894    

Lending commitments

          4,110       4,110    

Exposure before hedges

    (101     6,070       5,969    

Hedges3

          (199     (199)   

Net exposure

  $ (101   $ 5,871     $ 5,770    

Brazil

     
$ in millions       Sovereigns           Non-sovereigns         Total    

Net inventory1

  $ 3,955     $ 98     $ 4,053    

Net counterparty exposure2

          337       337    

Loans

          68       68    

Lending commitments

          279       279    

Exposure before hedges

    3,955       782       4,737    

Hedges3

    (12     (18     (30)   

Net exposure

  $ 3,943     $ 764     $ 4,707    
 

 

September 2018 Form 10-Q   36  


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Risk Disclosures    LOGO

 

France                  
$ in millions       Sovereigns           Non-sovereigns       Total  

Net inventory1

  $ 66     $ 539     $ 605   

Net counterparty exposure2

          1,813       1,813   

Loans

          284       284   

Lending commitments

          2,102       2,102   

Exposure before hedges

    66       4,738       4,804   

Hedges3

    (56     (655     (711)  

Net exposure

  $ 10     $ 4,083     $       4,093   

China

     
$ in millions   Sovereigns     Non-sovereigns     Total  

Net inventory1

  $ 434     $ 1,082     $ 1,516   

Net counterparty exposure2

    281       128       409   

Loans

          1,304       1,304   

Lending commitments

          630       630   

Exposure before hedges

    715       3,144       3,859   

Hedges3

    (40     (10     (50)  

Net exposure

  $ 675     $ 3,134     $ 3,809   

Netherlands

     
$ in millions   Sovereigns     Non-sovereigns     Total  

Net inventory1

  $ (77   $ 569     $ 492   

Net counterparty exposure2

          732       732   

Loans

          1,540       1,540   

Lending commitments

          1,119       1,119   

Exposure before hedges

    (77     3,960       3,883   

Hedges3

    (32     (252     (284)  

Net exposure

  $ (109   $ 3,708     $ 3,599   

Germany

     
$ in millions   Sovereigns     Non-sovereigns     Total  

Net inventory1

  $ (2,450   $ 684     $ (1,766)  

Net counterparty exposure2

    476       1,746       2,222   

Loans

          947       947   

Lending commitments

          3,260       3,260   

Exposure before hedges

    (1,974     6,637       4,663   

Hedges3

    (510     (1,048     (1,558)  

Net exposure

  $ (2,484   $ 5,589     $ 3,105   

Italy

     
$ in millions   Sovereigns     Non-sovereigns     Total  

Net inventory1

  $ 1,218     $ 642     $ 1,860   

Net counterparty exposure2

    (16     392       376   

Loans

          122       122   

Lending commitments

          410       410   

Exposure before hedges

    1,202       1,566       2,768   

Hedges3

    16       (77     (61)  

Net exposure

  $ 1,218     $ 1,489     $ 2,707   
Canada                  
$ in millions       Sovereigns           Non-sovereigns       Total  

Net inventory1

  $ (913   $ 246     $ (667)  

Net counterparty exposure2

    35       1,845       1,880   

Loans

          60       60   

Lending commitments

          1,401       1,401   

Exposure before hedges

    (878     3,552       2,674   

Hedges3

          (149     (149)  

Net exposure

  $ (878   $ 3,403     $       2,525   

 

1.

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 the fair value of any receivable or payable).

2.

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

3.

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. 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 “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Credit Risk—Credit Exposure—Derivatives” in the 2017 Form 10-K.

Credit Derivatives Included in Net Inventory

 

$ in millions   At
  September 30,  
2018
 

Gross purchased protection

  $ (77,227)  

Gross written protection

    76,461   

Net exposure

  $ (766)  

As a market maker, we may transact in CDS positions to facilitate client trading. The previous table includes exposures related to single-name and index credit derivatives for those countries shown in the Top Ten Non-U.S. Country Exposures table.

Benefit of Collateral Received against Counterparty Credit

Exposure

 

$ in millions        At
  September 30,  
2018
 

Counterparty credit exposure

  Collateral1  

United Kingdom

  U.K., U.S. and France   $ 9,653   

Germany

  Germany and France     8,818   

Other

  U.S., Japan and France     15,448   

 

1.

Collateral primarily consists of cash and government obligations.

Net counterparty exposure shown in the Top Ten Non-U.S. Country Exposures table is net of the benefit of collateral received shown in the previous table.

Country Risk Exposures Related to the U.K.     At September 30, 2018, our country risk exposures in the U.K. included net exposures of $15,184 million as shown in the Top Ten Country Exposures table, and overnight deposits of $6,483 million. The $16,133 million of exposures to non-sovereigns were diversified across both names and

 

 

  37   September 2018 Form 10-Q


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Risk Disclosures    LOGO

 

sectors. Of these exposures, $4,928 million were to U.K.-focused counterparties that generate more than one-third of their revenues in the U.K., $4,591 million were to geographically diversified counterparties, and $4,706 million were to exchanges and clearinghouses.

Country Risk Exposures Related to Brazil.     At September 30, 2018, our country risk exposures in Brazil included net exposures of $4,707 million as shown in the Top Ten Country Exposures table. Our sovereign net exposures in Brazil were principally in the form of local currency government bonds held onshore to support client activity. The $764 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, from 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 the 2017 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 strategy. For a further discussion about our model risk, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Model Risk” in the 2017 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 the 2017 Form 10-K and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” herein.

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 AML 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 the 2017 Form 10-K.

 

 

September 2018 Form 10-Q   38  


Table of Contents
Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of Morgan Stanley:

 

Results of Review of Interim Financial Information

We have reviewed the accompanying condensed consolidated balance sheet of Morgan Stanley and subsidiaries (the “Firm”) as of September 30, 2018, and the related condensed consolidated income statements and comprehensive income statements for the three-month and nine-month periods ended September 30, 2018 and 2017, and the cash flow statements and statements of changes in total equity for the nine-month periods ended September 30, 2018 and 2017, and the related notes (collectively referred to as the “interim financial information”). Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial information for it 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) (PCAOB), the consolidated balance sheet of the Firm as of December 31, 2017, and the related 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, 2018, 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, 2017 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results

This interim financial information is the responsibility of the Firm’s management. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Firm in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our reviews in accordance with the standards of the PCAOB. 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 PCAOB, 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.

 

 

/s/ Deloitte & Touche LLP

New York, New York

November 5, 2018

 

  39   September 2018 Form 10-Q


Table of Contents

Consolidated Income Statements

(Unaudited)

   LOGO

 

    Three Months Ended           Nine Months Ended  
    September 30,              September 30,  
in millions, except per share data   2018      2017            2018     2017

Revenues

          

Investment banking

  $ 1,567      $ 1,380             $ 4,994     $       4,455    

Trading

    2,752        2,704               9,815       8,870  

Investments

    136        167               409       495  

Commissions and fees

    932        937               3,144       2,997  

Asset management

    3,251        3,026               9,632       8,695  

Other

    298        200               748       628  

Total non-interest revenues

    8,936        8,414               28,742       26,140  

Interest income

    3,627        2,340               9,781       6,411  

Interest expense

    2,691        1,557               6,964       4,106  

Net interest

    936        783               2,817       2,305  

Net revenues

    9,872        9,197               31,559       28,445  

Non-interest expenses

          

Compensation and benefits

    4,310        4,169               13,845       12,887  

Occupancy and equipment

    351        330               1,033       990  

Brokerage, clearing and exchange fees

    559        522               1,795       1,556  

Information processing and communications

    513        459               1,487       1,320  

Marketing and business development

    152        128               471       419  

Professional services

    570        534               1,660       1,622  

Other

    566        573               1,888       1,719  

Total non-interest expenses

    7,021        6,715               22,179       20,513  

Income from continuing operations before income taxes

    2,851        2,482               9,380       7,932  

Provision for income taxes

    696        697               2,050       2,358  

Income from continuing operations

    2,155        1,785               7,330       5,574  

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

    (1      6               (5     (21

Net income

  $ 2,154      $ 1,791             $ 7,325     $ 5,553  

Net income applicable to noncontrolling interests

    42        10               108       85  

Net income applicable to Morgan Stanley

  $ 2,112      $ 1,781             $ 7,217     $ 5,468  

Preferred stock dividends and other

    93        93               356       353  

Earnings applicable to Morgan Stanley common shareholders

  $ 2,019      $ 1,688             $ 6,861     $ 5,115  
                       

Earnings per basic common share

          

Income from continuing operations

  $ 1.19      $ 0.95             $ 3.99     $ 2.87  

Income (loss) from discontinued operations

                               (0.01

Earnings per basic common share

  $ 1.19      $ 0.95             $ 3.99     $ 2.86  

Earnings per diluted common share

          

Income from continuing operations

  $ 1.17      $ 0.93             $ 3.92     $ 2.81  

Income (loss) from discontinued operations

                               (0.02

Earnings per diluted common share

  $ 1.17      $ 0.93             $ 3.92     $ 2.79  

Dividends declared per common share

  $ 0.30      $ 0.25             $ 0.80     $ 0.65  

Average common shares outstanding

          

Basic

    1,697        1,776               1,719       1,789  

Diluted

    1,727        1,818               1,749       1,830  

 

September 2018 Form 10-Q   40   See Notes to Consolidated Financial Statements


Table of Contents

Consolidated Comprehensive Income Statements

(Unaudited)

   LOGO

 

 

   

Three Months Ended

September 30,

         

Nine Months Ended

September 30,

 
$ in millions   2018     2017           2018     2017

Net income

  $         2,154     $         1,791          $       7,325     $       5,553    

Other comprehensive income (loss), net of tax:

          

Foreign currency translation adjustments

  $ (79   $ 61          $ (154   $ 223  

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

    (171     26            (707     218  

Pension, postretirement and other

    5                  16       4  

Change in net debt valuation adjustment

    (743     (149          347       (323

Total other comprehensive income (loss)

  $ (988   $ (62        $ (498   $ 122  

Comprehensive income

  $ 1,166     $ 1,729          $ 6,827     $ 5,675  

Net income applicable to noncontrolling interests

    42       10            108       85  

Other comprehensive income (loss) applicable to noncontrolling interests

    (59     (6          4       23  

Comprehensive income applicable to Morgan Stanley

  $ 1,183     $ 1,725          $ 6,715     $ 5,567  

 

See Notes to Consolidated Financial Statements   41   September 2018 Form 10-Q


Table of Contents
Consolidated Balance Sheets    LOGO

 

    (Unaudited)      
   

At

September 30,

   

At

December 31,

$ in millions, except share data   2018     2017

Assets

   

Cash and cash equivalents:

   

Cash and due from banks

  $ 36,641     $                24,816    

Interest bearing deposits with banks

    22,638       21,348  

Restricted cash

    33,202       34,231  

Trading assets at fair value ($127,919 and $169,735 were pledged to various parties)

    283,188       298,282  

Investment securities (includes $57,232 and $55,203 at fair value)

    82,568       78,802  

Securities purchased under agreements to resell

    69,086       84,258  

Securities borrowed

    142,489       124,010  

Customer and other receivables

    60,839       56,187  

Loans:

   

Held for investment (net of allowance of $231 and $224)

    98,330       92,953  

Held for sale

    11,653       11,173  

Goodwill

    6,680       6,597  

Intangible assets (net of accumulated amortization of $2,995 and $2,730)

    2,240       2,448  

Other assets

    15,963       16,628  

Total assets

  $ 865,517     $ 851,733  

Liabilities

   

Deposits (includes $382 and $204 at fair value)

  $ 175,185     $ 159,436  

Trading liabilities at fair value

    129,032       131,295  

Securities sold under agreements to repurchase (includes $784 and $800 at fair value)

    60,328       56,424  

Securities loaned

    11,833       13,592  

Other secured financings (includes $4,554 and $3,863 at fair value)

    10,057       11,271  

Customer and other payables

    191,026       191,510  

Other liabilities and accrued expenses

    17,093       17,157  

Borrowings (includes $50,506 and $46,912 at fair value)

    190,889       192,582  

Total liabilities

    785,443       773,267  

Commitments and contingent liabilities (see Note 11)

   

Equity

   

Morgan Stanley shareholders’ equity:

   

Preferred stock

    8,520       8,520  

Common stock, $0.01 par value:

   

Shares authorized: 3,500,000,000; Shares issued: 2,038,893,979; Shares outstanding: 1,725,792,278 and 1,788,086,805

    20       20  

Additional paid-in capital

    23,664       23,545  

Retained earnings

    63,330       57,577  

Employee stock trusts

    2,797       2,907  

Accumulated other comprehensive income (loss)

    (3,999     (3,060

Common stock held in treasury at cost, $0.01 par value (313,101,701 and 250,807,174 shares)

    (12,832     (9,211

Common stock issued to employee stock trusts

    (2,797     (2,907

Total Morgan Stanley shareholders’ equity

    78,703       77,391  

Noncontrolling interests

    1,371       1,075  

Total equity

    80,074       78,466  

Total liabilities and equity

  $ 865,517     $ 851,733  

 

September 2018 Form 10-Q   42   See Notes to Consolidated Financial Statements


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, 2017

  $ 8,520     $ 20     $ 23,545     $ 57,577     $ 2,907     $ (3,060   $ (9,211   $ (2,907   $ 1,075     $ 78,466   

Cumulative adjustment for accounting changes1

                      306             (437                       (131)  

Net income applicable to Morgan Stanley

                      7,217                                     7,217   

Net income applicable to noncontrolling interests

                                                    108       108   

Dividends

                      (1,770                                   (1,770)  

Shares issued under employee plans

                119             (110           759               110             878   

Repurchases of common stock and employee tax withholdings

                                        (4,380                 (4,380)  

Net change in Accumulated other comprehensive income (loss)

                                  (502                 4       (498)  

Other net increases

                                                    184       184   

Balance at September 30, 2018

  $ 8,520     $ 20     $ 23,664     $ 63,330     $ 2,797     $ (3,999   $ (12,832   $ (2,797   $ 1,371     $ 80,074   

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

                      5,468                                     5,468   

Net income applicable to noncontrolling interests

                                                    85       85   

Dividends

                      (1,558                                   (1,558)  

Shares issued under employee plans

                79             48                       844       (48           923   

Repurchases of common stock and employee tax withholdings

                                        (3,008                 (3,008)  

Net change in Accumulated other comprehensive income (loss)

                                  99                   23       122   

Issuance of preferred stock

    1,000             (6                                         994   

Other net decreases

                                                    (99     (99)  

Balance at September 30, 2017

  $ 8,520     $ 20     $ 23,389     $     57,554     $ 2,899     $ (2,544   $ (7,961   $ (2,899   $ 1,136     $     80,114   

 

1.

  The cumulative adjustments relate to the adoption of certain accounting updates during the current and prior year periods. See Notes 2 and 14 for further information.

 

See Notes to Consolidated Financial Statements   43   September 2018 Form 10-Q


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Consolidated Cash Flow Statements

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    Nine Months Ended
September 30,
 
$ in millions   2018      2017  

Cash flows from operating activities

    

Net income

  $ 7,325      $ 5,553    

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

    

(Income) loss from equity method investments

    (62      —    

Stock-based compensation expense

    743        775    

Depreciation and amortization

    1,375        1,340    

(Release of) Provision for credit losses on lending activities

    (27      32    

Other operating adjustments

    35        (62)   

Changes in assets and liabilities:

    

Trading assets, net of Trading liabilities

    10,039        (19,646)   

Securities borrowed

    (18,479      (7,656)   

Securities loaned

    (1,759      (214)   

Customer and other receivables and other assets

    (4,092      (7,930)   

Customer and other payables and other liabilities

    310        8,055    

Securities purchased under agreements to resell

    15,172        11,849    

Securities sold under agreements to repurchase

    3,904        (645)   

Net cash provided by (used for) operating activities

    14,484        (8,549)   

Cash flows from investing activities

    

Proceeds from (payments for):

    

Other assets—Premises, equipment and software, net

    (1,361      (1,177)   

Changes in loans, net

    (7,697      (9,350)   

Investment securities:

                

Purchases

    (16,836      (19,713)   

Proceeds from sales

    2,947        16,111    

Proceeds from paydowns and maturities

    9,126        5,378    

Other investing activities

    (245      (77)   

Net cash provided by (used for) investing activities

    (14,066      (8,828)   

Cash flows from financing activities

    

Net proceeds from (payments for):

    

Noncontrolling interests

    (95      (43)   

Other secured financings

    (1,874      1,400    

Deposits

    15,749        (1,224)   

Proceeds from:

    

Derivatives financing activities

           73    

Issuance of preferred stock, net of issuance costs

           994    

Issuance of Borrowings

    34,233        46,121    

Payments for:

    

Borrowings

    (28,235      (25,097)   

Derivatives financing activities

           (73)   

Repurchases of common stock and employee tax withholdings

    (4,380      (3,008)   

Cash dividends

    (1,788      (1,562)   

Other financing activities

    (248      (48)   

Net cash provided by (used for) financing activities

    13,362        17,533    

Effect of exchange rate changes on cash and cash equivalents

    (1,694      3,406    

Net increase (decrease) in cash and cash equivalents

    12,086        3,562    

Cash and cash equivalents, at beginning of period

    80,395        77,360    

Cash and cash equivalents, at end of period

  $ 92,481      $ 80,922    

Cash and cash equivalents:

    

Cash and due from banks

  $ 36,641      $ 24,047    

Interest bearing deposits with banks

    22,638        24,144    

Restricted cash

    33,202        32,731    

Cash and cash equivalents, at end of period

  $ 92,481      $ 80,922    

 

Supplemental Disclosure of Cash Flow Information

    

Cash payments for:

    

Interest

  $ 6,818      $ 3,422    

Income taxes, net of refunds

    1,009        967    

 

September 2018 Form 10-Q   44   See Notes to Consolidated Financial Statements


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Notes to Consolidated Financial Statements

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1. Introduction and Basis of Presentation

 

The Firm

Morgan Stanley 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. See the “Glossary of Common Acronyms” for definitions of certain acronyms used throughout this Form 10-Q.

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, prime brokerage and market-making activities in equity and fixed income products, including foreign exchange and commodities. Lending services include originating and/or purchasing corporate loans, commercial and residential mortgage lending, asset-backed lending and financing extended to equities and commodities customers and municipalities. Other activities include investments and research.

Wealth Management provides a comprehensive array of financial services and solutions to individual investors and small to medium-sized businesses and institutions covering brokerage and investment advisory services, financial and wealth planning services, annuity and insurance products, credit and other lending products, banking and retirement plan services.

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

Basis of Financial Information

The unaudited consolidated financial statements (“financial statements”) are prepared in accordance with U.S. GAAP, which requires 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 financial statements and related disclosures. The Firm believes that the estimates utilized in the preparation of its 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 financial statements should be read in conjunction with the Firm’s financial statements and notes thereto included in the 2017 Form 10-K. Certain footnote disclosures included in the 2017 Form 10-K have been condensed or omitted from these financial statements as they are not required for interim reporting under U.S. GAAP. The 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 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 VIEs (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 (“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 (“balance sheets”).

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 financial statements in the 2017 Form 10-K.

 

 

  45   September 2018 Form 10-Q


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Notes to Consolidated Financial Statements

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2. Significant Accounting Policies

For a detailed discussion about the Firm’s significant accounting policies, see Note 2 to the financial statements in the 2017 Form 10-K.

During the nine months ended September 30, 2018 (“current year period”), there were no significant revisions to the Firm’s significant accounting policies, other than for Carried Interest and the accounting updates adopted.

Carried Interest

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. Beginning January 1, 2018, when the Firm earns carried interest from funds as specified performance thresholds are met, that carried interest and any related general or limited partner interest is accounted for under the equity method of accounting and measured based on the Firm’s claim on the NAV of the fund at the reporting date, taking into account the distribution terms applicable to the interest held. Performance-based fees in the form of carried interest considered equity method investments are therefore outside the scope of the policies for revenue from contracts with customers discussed below. See Note 11 for information regarding general partner guarantees, which include potential obligations to return performance fee distributions previously received.

Accounting Updates Adopted

The Firm adopted the following accounting updates in the current year period. Prior period results are presented under previous policies. See Note 14 for a summary of the Retained earnings impacts of these and other minor adoptions effective in the current year period.

Revenue from Contracts with Customers

On January 1, 2018, we adopted Revenue from Contracts with Customers using the modified retrospective method, which resulted in a net decrease to Retained earnings of $32 million, net of tax. Prior period amounts were not restated.

Our revised accounting policy in accordance with this adoption is effective January 1, 2018, and is discussed below.

Revenue Recognition

Revenues are recognized when the promised goods or services are delivered to our customers, in an amount that is based on the consideration the Firm expects to receive in exchange for those goods or
services when such amounts are not probable of significant reversal.

Investment Banking

Revenue from investment banking activities consists of revenues earned from underwriting primarily equity and fixed income securities and advisory fees for mergers, acquisitions, restructuring and advisory assignments.

Underwriting revenues are generally recognized on trade date if there is no uncertainty or contingency related to the amount to be paid. Underwriting costs are deferred and recognized in the relevant non-interest expenses line items when the related underwriting revenues are recorded.

Advisory fees are recognized as advice is provided to the client, based on the estimated progress of work and when the revenue is not probable of a significant reversal. Advisory costs are recognized as incurred in the relevant non-interest expenses line items, including when reimbursed.

 

Commissions and Fees

Commission and fee revenues result from transaction-based arrangements in which the client is charged a fee for the execution of transactions. Such revenues primarily arise from transactions in equity securities; services related to sales and trading activities; and sales of mutual funds, alternative funds, futures, insurance products and options. Commission and fee revenues are recognized on trade date when the performance obligation is satisfied.

 

Asset Management Revenues

Asset management, distribution and administration fees are generally based on related asset levels being managed, such as the AUM of a customer’s account, or the net asset value of a fund. These fees are generally recognized when services are performed and the fees become known. Management fees are reduced by estimated fee waivers and expense caps, if any, provided to the customer.

Performance-based fees not in the form of carried interest are recorded when the annual performance target is met and the revenue is not probable of a significant reversal. Performance-based fees in the form of carried interest are considered equity method investments and are therefore outside the scope of these policies for revenue from contracts with customers.

Sales commissions paid by the Firm in connection with the sale of certain classes of shares of its open-end mutual fund products are accounted for as deferred commission assets and amortized to expense over the expected life of the contract.

 

 

September 2018 Form 10-Q   46  


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Notes to Consolidated Financial Statements

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The Firm periodically tests deferred commission assets for recoverability based on cash flows expected to be received in future periods. Other asset management and distribution costs are recognized as incurred in the relevant non-interest expenses line items.

 

Other Items

Revenue from commodities-related contracts is recognized as the promised goods or services are delivered to the customer.

Receivables from contracts with customers are recognized in Customer and other receivables in the balance sheets when the underlying performance obligations have been satisfied and the Firm has the right per the contract to bill the customer. Contract assets are recognized in Other assets when the Firm has satisfied its performance obligations, but customer payment is conditional. Contract liabilities are recognized in Other liabilities when the Firm has collected payment from a customer based on the terms of the contract, but the underlying performance obligations are not yet satisfied.

For contracts with a term less than one year, incremental costs to obtain the contract are expensed as incurred. Revenues are not discounted when payment is expected within one year.

The Firm presents, net within revenues, all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by the Firm from a customer.

Derivatives and Hedging–Targeted Improvements to Accounting for Hedging Activities

This accounting update aims to better align the hedge accounting requirements with an entity’s risk management strategies and improve the financial reporting of hedging relationships. It also results in simplification of the application of hedge accounting related to the assessment of hedge effectiveness.

The Firm early adopted this accounting update in the first quarter of 2018. Upon adoption, the Firm recorded a cumulative catch-up adjustment, decreasing Retained earnings by $99 million, net of tax. This adjustment represents the cumulative effect of applying the new rules from the inception of certain fair value hedges of the interest rate risk of our borrowings, in particular the provision allowing only the benchmark rate component of coupon cash flows to be hedged.

Effective January 1, 2018, in accordance with this adoption, the Firm has updated its accounting policies to permit the hedged item in a fair value hedge of interest rate risk to be defined as including only the benchmark

rate component of contractual coupon cash flows, and to allow for hedging part of the contractual term of the hedged instrument. The accounting policy also requires the entire gain or loss from revaluing hedges of net investments in foreign operations at the spot rate to be reported within AOCI.

In the current quarter, the Firm began designating interest rate swaps as fair value hedges of changes in the benchmark interest rate of certain AFS securities. Consistent with the Firm’s existing fair value hedges of borrowings, the Firm uses regression analysis to perform an ongoing prospective and retrospective assessment of the effectiveness of these hedging relationships.

For qualifying fair value hedges of benchmark interest rates, the changes in the fair value of the derivative and the changes in the fair value of the hedged asset due to changes in the benchmark interest rate provide an offset of one another and are recorded in Interest income. When a derivative is de-designated as a hedge, any basis adjustment remaining on the hedged asset is amortized to Interest income over the remaining life of the asset using the effective interest method.

Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income

This accounting update, which the Firm elected to early adopt as of January 1, 2018, allows companies to reclassify from AOCI to Retained earnings the stranded tax effects associated with enactment of the Tax Act on December 22, 2017. These stranded tax effects resulted from the requirement to reflect the total amount of the remeasurement of and other adjustments to deferred tax assets and liabilities in 2017 in income from continuing operations, regardless of whether the deferred taxes were originally recorded in AOCI. Accordingly, as of January 1, 2018, the Firm recorded a net increase to Retained earnings as a result of the reclassification of $443 million of such stranded tax effects previously recorded in AOCI, which were primarily the result of the remeasurement of deferred tax assets and liabilities associated with the change in tax rates.

Aside from the above treatment related to the Tax Act, the Firm releases stranded tax effects from AOCI into earnings once the related category of instruments or transactions giving rise to these effects no longer exists. For further detail on the tax effects reclassified, refer to Note 14 to the financial statements.

Goodwill

The Firm completed its annual goodwill impairment testing as of July 1, 2018. The Firm’s impairment testing did not indicate any goodwill impairment, as each of the Firm’s reporting units with goodwill had a fair value that was substantially in excess of its carrying value.

 

 

  47   September 2018 Form 10-Q


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Notes to Consolidated Financial Statements

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3. Fair Values

Fair Value Measurement

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

    At September 30, 2018  
 $ in millions   Level 1     Level 2     Level 3     Netting1     Total

 Assets at fair value

         

 Trading assets:

         

U.S. Treasury and agency securities

  $ 25,578     $ 24,183     $ 5     $     $ 49,766   

Other sovereign government
obligations

    26,698       5,016       36             31,750  

State and municipal securities

          3,002       4             3,006  

MABS

          2,652       316             2,968  

Loans and lending commitments2

          6,031       6,735             12,766  

Corporate and other debt

          21,722       710             22,432  

Corporate equities3

    125,028       413       106             125,547  

Derivative and other contracts:

 

       

Interest rate

    1,883       156,753       1,029             159,665  

Credit

          5,740       416             6,156  

Foreign exchange

    72       63,647       10             63,729  

Equity

    3,206       45,505       1,207             49,918  

Commodity and other

    519       7,105       3,487             11,111  

Netting1

    (4,417     (208,658     (1,003     (45,862     (259,940

Total derivative and other contracts

    1,263       70,092       5,146       (45,862     30,639  

Investments4

    603       255       818             1,676  

Physical commodities

          226                   226  

 Total trading assets4

    179,170       133,592       13,876       (45,862     280,776  

 Investment securities— AFS

    32,846       24,386                   57,232  

 Intangible assets

          3                    —       3  

 Total assets at fair value

  $    212,016     $    157,981     $    13,876     $    (45,862   $    338,011  
    At September 30, 2018  
$ in millions   Level 1     Level 2     Level 3     Netting1     Total

Liabilities at fair value

 

       

Deposits

  $     $ 309     $ 73     $     $ 382   

Trading liabilities:

         

U.S. Treasury and agency securities

    14,169       245                   14,414  

Other sovereign government
obligations

    18,779       1,770                   20,549  

Corporate and other
debt

          8,421       1             8,422  

Corporate equities3

    59,630       178       13             59,821  

Derivative and other contracts:

 

       

Interest rate

    1,860       141,016       452             143,328  

Credit

          6,156       395             6,551  

Foreign exchange

    12       61,662       54             61,728  

Equity

    3,070       45,439       2,878             51,387  

Commodity and other

    659       8,255       1,467             10,381  

Netting1

    (4,417     (208,658     (1,003     (33,471     (247,549

Total derivative and other contracts

    1,184       53,870       4,243       (33,471     25,826  

Total trading liabilities

    93,762       64,484       4,257       (33,471     129,032  

Securities sold under agreements to
repurchase

          784                   784  

Other secured financings

          4,382       172             4,554  

Borrowings

          46,886       3,620              —       50,506  

Total liabilities at fair value

  $    93,762     $    116,845     $    8,122     $    (33,471   $    185,258  
 

 

September 2018 Form 10-Q   48  


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Notes to Consolidated Financial Statements

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    At December 31, 2017  
 $ in millions   Level 1     Level 2     Level 3     Netting1     Total

 Assets at fair value

 

       

 Trading assets:

         

U.S. Treasury and agency securities

  $ 22,077     $ 26,888     $     $     $ 48,965    

Other sovereign government obligations

    20,234       7,825       1             28,060  

State and municipal securities

          3,592       8             3,600  

MABS

          2,364       423             2,787  

Loans and lending commitments2

          4,791       5,945             10,736  

Corporate and other debt

          16,837       701             17,538  

Corporate equities3

    149,697       492       166             150,355  

Derivative and other contracts:

 

       

Interest rate

    472       178,704       1,763             180,939  

Credit

          7,602       420             8,022  

Foreign exchange

    58       53,724       15             53,797  

Equity

    1,101       40,359       3,530             44,990  

Commodity and other

    1,126       5,390       4,147             10,663  

Netting1

    (2,088     (216,764     (1,575     (47,171     (267,598

Total derivative and other contracts

    669       69,015       8,300       (47,171     30,813  

Investments4

    297       523       1,020             1,840  

Physical commodities

          1,024                   1,024  

 Total trading assets4

    192,974       133,351       16,564       (47,171     295,718  

 Investment securities—AFS

    27,522       27,681                   55,203  

 Intangible assets

          3                   —       3  

 Total assets at fair value

  $  220,496     $  161,035     $  16,564     $  (47,171   $  350,924  
    At December 31, 2017  
$ in millions   Level 1     Level 2     Level 3     Netting1     Total

Liabilities at fair value

 

       

Deposits

  $     $ 157     $ 47     $     $ 204   

Trading liabilities:

         

U.S. Treasury and agency securities

    17,802       24                   17,826  

Other sovereign government obligations

    24,857       2,016                   26,873  

Corporate and other debt

          7,141       3             7,144  

Corporate equities3

    52,653       82       22             52,757  

Derivative and other contracts:

 

       

Interest rate

    364       162,239       545             163,148  

Credit

          8,166       379             8,545  

Foreign exchange

    23       55,118       127             55,268  

Equity

    1,001       44,666       2,322             47,989  

Commodity and other

    1,032       5,156       2,701             8,889  

Netting1

    (2,088     (216,764     (1,575     (36,717     (257,144

Total derivative and other contracts

    332       58,581       4,499       (36,717     26,695  

Total trading liabilities

    95,644       67,844       4,524       (36,717     131,295  

Securities sold under agreements to repurchase

          650       150             800  

Other secured financings

          3,624       239             3,863  

Borrowings

          43,928       2,984             —       46,912  

Total liabilities at fair value

  $  95,644     $  116,203     $  7,944     $  (36,717   $  183,074  

MABS—Mortgage- and asset-backed securities

1.

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.” Positions classified within the same level that are with the same counterparty are netted within that level. For further information on derivative instruments and hedging activities, see Note 4.

2.

For a further breakdown by type, see the following Loans and Lending Commitments at Fair Value table.

3.

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

4.

Amounts exclude certain investments that are measured based on NAV per share, which are not classified in the fair value hierarchy. For additional disclosure about such investments, see “Measured Based on Net Asset Value” herein.

Loans and Lending Commitments at Fair Value

 

$ in millions   At
  September 30,  
2018
    At
  December 31,  
2017
 

Corporate

  $ 9,489     $ 8,358   

Residential real estate

    912       799   

Wholesale real estate

    2,365       1,579   

Total

  $ 12,766     $ 10,736   

Unsettled Fair Value of Futures Contracts1

 

 $ in millions   At
  September 30,  
2018
    At
  December 31,  
2017
 

 Customer and other receivables, net

  $ 660     $ 831   

 

1.

These contracts are primarily Level 1, actively traded, valued based on quoted prices from the exchange and are excluded from the previous recurring fair value tables.

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 financial statements in the 2017 Form 10-K. During the current year period, there were no significant revisions made to the Firm’s valuation techniques.

 

 

  49   September 2018 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

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 quarter ended September 30, 2018 (“current quarter”) and September 30, 2017 (“prior year quarter”), the current year period and the nine months ended September 30, 2017 (“prior year period”). Level 3 instruments may be hedged with instruments classified in Level 1 and Level 2. 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, 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 income statements.

 

 

Rollforward of Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Current Quarter

 

$ in millions   Beginning
Balance at
June 30, 2018
    Realized
and
Unrealized
Gains
(Losses)
    Purchases1     Sales and
Issuances2
    Settlements1     Net
Transfers
    Ending
Balance at
September 30,
2018
    Unrealized
Gains
(Losses)
 

Assets at Fair Value

               

Trading assets:

               

U.S. Treasury and agency securities

  $     $     $ 5     $     $     $     $ 5     $           —   

Other sovereign government obligations

    5             32       (2           1       36       —   

State and municipal securities

    2             2                         4       —   

MABS

    327       (1     23       (46     (14     27       316       (8)  

Loans and lending commitments

    6,923       17       2,076       (1,184     (777     (320     6,735       12   

Corporate and other debt

    701       (4     109       (153     (6     63       710        

Corporate equities

    171       (7     15       (50           (23     106        

Net derivative and other contracts3:

               

Interest rate

    567       (3     12       (9     (2     12       577       24   

Credit

    (2     (39     4             58             21       (41)  

Foreign exchange

    (26     (35                 2       15       (44     (9)  

Equity

    (1,535     (149     29       (138     84       38       (1,671     (132)  

Commodity and other

    2,032       (29           (11     (1     29       2,020       (105)  

Total net derivative and other contracts

    1,036       (255     45       (158     141       94       903       (263)  

Investments

    941       5       72       (103           (97     818        

Liabilities at Fair Value

               

Deposits

  $ 37     $ (2   $     $ 11     $     $ 23     $ 73     $ (2)  

Trading liabilities:

               

Corporate and other debt

    1                                     1       —   

Corporate equities

    24             (12     3             (2     13       —   

Other secured financings

    170       (2                             172       (2)  

Borrowings

    3,295       (56           344       (81     6       3,620       (55)  

 

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, Other secured financings and 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. Amounts are presented before counterparty netting.

 

September 2018 Form 10-Q   50  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

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Rollforward of Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Prior Year Quarter

 

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

Assets at Fair Value

               

Trading assets:

               

Other sovereign government obligations

  $ 100     $ 2     $ 86     $ (82   $     $ (2   $ 104     $                 1   

State and municipal securities

    9             4       (3                 10       —   

MABS

    264       4       52       (54           8       274        

Loans and lending commitments

    4,864       25       1,772       (1,431     (236     (129     4,865       17   

Corporate and other debt

    693       41       220       (241     (4     (21     688       34   

Corporate equities

    500       (9     24       (268           49       296       —   

Net derivative and other contracts3:

               

Interest rate

    970       105       13       (29     33       (16     1,076       92   

Credit

    (305     (33     7       (9     35       2       (303     (33)  

Foreign exchange

    2       (59     9             17       (47     (78     (50)  

Equity

    1,093       114       60       (77     79       (38     1,231       110   

Commodity and other

    1,509       158       1       (1     (112     (21     1,534       45   

Total net derivative and other contracts

    3,269       285       90       (116     52       (120     3,460       164   

Investments

    946       (4     13       (17     (16     3       925       (5)  

Liabilities at Fair Value

               

Deposits

  $ 79     $ (1   $     $ 32     $     $ (6   $ 106     $ (1)  

Trading liabilities:

               

Corporate and other debt

    15       (2     (18     9                   8       (1)  

Corporate equities

    28       1       (10     24             10       51        

Securities sold under agreements to repurchase

    148       (1                             149       (1)  

Other secured financings

    244       (5           2       (1           250       (5)  

Borrowings

    2,646       (53           679       (49     (726     2,603       (47)  

 

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, Other secured financings and 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. Amounts are presented before counterparty netting.

 

  51   September 2018 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

Rollforward of Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Current Year Period

 

$ in millions   Beginning
Balance at
December 31,
2017
    Realized and
Unrealized
Gains
(Losses)
    Purchases1     Sales and
Issuances2
    Settlements1     Net Transfers     Ending
Balance at
September 30,
2018
    Unrealized Gains
(Losses)
 

Assets at fair value

               

Trading assets:

               

U.S. Treasury and agency securities

  $     $     $ 5     $     $     $     $ 5     $                     —   

Other sovereign government obligations

    1             35                         36       —   

State and municipal securities

    8             3       (7                 4       —   

MABS

    423       88       73       (317     (16     65       316       (6)  

Loans and lending commitments

    5,945       16       4,030       (978     (1,926     (352     6,735       (8)  

Corporate and other debt

    701       51       276       (227     (8     (83     710       16   

Corporate equities

    166       17       69       (134           (12     106       14   

Net derivative and other contracts3:

               

Interest rate

    1,218       (46     84       (38     (92     (549     577       (47)  

Credit

    41       (17     9       (40     30       (2     21       (20)  

Foreign exchange

    (112     71       2       (48     43             (44      

Equity4

    1,208       83       120       (1,052     319       (2,349     (1,671     19   

Commodity and other

    1,446       332       80       (18     17       163       2,020       33   

Total net derivative and other contracts

    3,801       423       295       (1,196     317       (2,737     903       (14)  

Investments

    1,020       5       134       (209           (132     818        

Liabilities at fair value

               

Deposits

  $ 47     $ 1     $     $ 27     $ (2   $ 2     $ 73     $  

Trading liabilities:

               

Corporate and other debt

    3             (3     1                   1       —   

Corporate equities

    22       4       (12     11             (4     13        

Securities sold under agreements to repurchase

    150                               (150           —   

Other secured financings

    239       16             8       (18     (41     172       16   

Borrowings

    2,984       156             1,275       (339     (144     3,620       168   

 

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 derivative and other contracts, Deposits, Other secured financings and 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. Amounts are presented before counterparty netting.

4.  

During the current year period, the Firm transferred from Level 3 to Level 2 $2.4 billion of Equity Derivatives due to a reduction in the significance of the unobservable inputs relating to volatility.

 

September 2018 Form 10-Q   52  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

Rollforward of Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Prior Year Period

 

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

Assets at fair value

               

Trading assets:

               

U.S. Treasury and agency securities

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

Other sovereign government obligations

    6             104       (5           (1     104       —   

State and municipal securities

    250       3       6       (81           (168     10       —   

MABS

    217       49       120       (120     (16     24       274       13   

Loans and lending commitments

    5,122       88       2,470       (1,927     (964     76       4,865       85   

Corporate and other debt

    475       67       437       (383     (7     99       688        

Corporate equities

    446       8       74       (604           372       296        

Net derivative and other contracts3:

               

Interest rate

    420       137       36       (42     658       (133     1,076       146   

Credit

    (373     (18     6       (9     96       (5     (303     (34)  

Foreign exchange

    (43     (92     9             48             (78     (72)  

Equity

    184       168       816       (231     209       85       1,231       277   

Commodity and other

    1,600       523       13       (21     (431     (150     1,534       88   

Total net derivative and other contracts

    1,788       718       880       (303     580       (203     3,460       405   

Investments

    958       16       96       (44     (78     (23     925       10   

Liabilities at fair value

               

Deposits

  $ 42     $ (2   $     $ 62     $     $     $ 106     $ (2)  

Trading liabilities:

               

Corporate and other debt

    36       (1     (55     99             (73     8       —   

Corporate equities

    35             (69     27             58       51       (1)  

Securities sold under agreements to repurchase

    149                                     149        

Other secured financings

    434       (28           54       (223     (43     250       (21)  

Borrowings

    2,014       (142           1,418       (328     (643     2,603       (136)  

 

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 derivative and other contracts, Deposits, Other secured financings and 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. Amounts are presented before counterparty netting.

 

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 financial statements in the 2017 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.

 

Valuation Techniques and Sensitivity of Unobservable Inputs

Used in Level 3 Fair Value Measurements

Recurring Fair Value Measurement

 

    Balance / Range (Average1)  
 $ in millions, except inputs  

 

At September 30, 2018

    At December 31, 2017

 Assets at Fair Value

 

 

 MABS

  $ 316     $ 423    

 Comparable pricing:

   

Bond price

    0 to 100 points (34 points     0 to 95 points (26 points

 Loans and lending commitments

  $ 6,735     $ 5,945  

 Margin loan model:

   

Discount rate

    1% to 6% (2%     0% to 3% (1%

Volatility skew

    14% to 59% (27%     7% to 41% (22%

 Comparable pricing:

   

Loan price

    56 to 105 points (97 points     55 to 102 points (95 points

 Corporate and other debt

  $ 710     $ 701  

 Comparable pricing:

   

Bond price

    0 to 100 points (62 points     3 to 134 points (59 points

 Discounted cash flow:

   

Recovery rate

    20%       6% to 36% (27%

Discount rate

    15% to 25% (16%     7% to 20% (14%

 Option model:

   

At the money volatility

    23% to 51% (34%     17% to 52% (52%

 Corporate equities

  $ 106     $ 166  

 Comparable pricing:

   

Equity price

    100%       100%  
 

 

  53   September 2018 Form 10-Q


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(Unaudited)

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    Balance / Range (Average1)  
  $ in millions, except inputs       At September 30, 2018           At December 31, 2017    

 Net derivative and other contracts2:

 

 

 Interest rate

  $ 577      $ 1,218    

 Option model:

   

IR volatility skew

    27% to 95% (43% / 41%)       31% to 97% (41% / 47%)   

Inflation volatility

    26% to 66% (46% / 43%)       23% to 63% (44% / 41%)   

IR curve

    2%        2%    

 Credit

  $ 21      $ 41    

 Comparable pricing:

   

Cash synthetic basis

    8 to 9 points (9 points)       12 to 13 points (12 points)   

Bond price

    0 to 75 points (28 points)       0 to 75 points (25 points)   

Credit spread

    195 to 474 bps (349 bps)       N/M    

 Correlation model:

   

Credit correlation

    35% to 74% (48%)       38% to 100% (48%)   

 Foreign exchange3

  $ (44)     $ (112)   

 Option model:

   

IR - FX correlation

    53% to 57% (55% / 55%)       54% to 57% (56% / 56%)   

IR volatility skew

    27% to 95% (43% / 41%)       31% to 97% (41% / 47%)   

Contingency probability

    85% to 95% (93% / 95%)       95% to 100% (96% / 95%)   

 Equity3

  $ (1,671)     $ 1,208    

 Option model:

   

At the money volatility

    12% to 56% (34%)       7% to 54% (32%)   

Volatility skew

    -2% to 0% (-1%)       -5% to 0% (-1%)   

Equity correlation

    5% to 99% (67%)       5% to 99% (76%)   

FX correlation

    -64% to 10% (-47%)       -55% to 40% (36%)   

IR correlation

    -7% to 44% (15% /10%)       -7% to 49% (18% / 20%)   

 Commodity and other

  $ 2,020      $ 1,446    

 Option model:

   

Forward power price

    $3 to $169 ($30) per MWh        $4 to $102 ($31) per MWh    

Commodity volatility

    5% to 104% (15%)       7% to 205% (17%)   

Cross-commodity correlation

    5% to 99% (92%)       5% to 99% (92%)   

 Investments

  $ 818      $ 1,020    

 Discounted cash flow:

   

WACC

    8% to 15% (9%)       8% to 15% (9%)   

Exit multiple

    7 to 10 times (10 times)       8 to 11 times (10 times)   

 Market approach:

   

EBITDA multiple

    3 to 23 times (13 times)       6 to 25 times (11 times)   

 Comparable pricing:

   

Equity price

    25% to 100% (95%)       45% to 100% (92%)   
 Liabilities at Fair Value

 

 

 Deposits

  $ 73      $ 47    

 Option Model

   

At the money volatility

    17% to 38% (20%)       N/M    

Volatility skew

    0%        N/M    

 Other secured financings

  $ 172      $ 239    

 Discounted cash flow:

   

Funding spread

    60 to 260 bps (160 bps)       39 to 76 bps (57 bps)   

 Option model:

   

Volatility skew

    N/A        -1%    

At the money volatility

    10% to 40% (26%)       10% to 40% (26%)   
   

 

Balance / Range (Average1)

 
$ in millions, except inputs   At September 30, 2018     At December 31, 2017  

Borrowings

  $ 3,620       $ 2,984    

Option model:

   

At the money volatility

    5% to 35% (23%)        5% to 35% (22%)   

Volatility skew

    -2% to 0% (0%)        -2% to 0% (0%)   

Equity correlation

    38% to 98% (75%)        39% to 95% (86%)   

Equity - FX correlation

    -75% to 50% (-28%)        -55% to 10% (-18%)   
Nonrecurring Fair Value Measurement        

Loans

  $ 1,096       $ 924    

Corporate loan model:

   

Credit spread

    96 to 400 bps (160 bps)        93 to 563 bps (239 bps)   

Expected recovery:

   

Asset coverage

    N/M         95% to 99% (95%)   

Points—Percentage of par

IR—Interest rate

FX—Foreign exchange

1.

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

2.

CVA and FVA are included in the balance but excluded from the Valuation Technique(s) and Significant Unobservable Inputs. 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).

For a description of the Firm’s significant unobservable inputs and related sensitivity, see Note 3 to the financial statements in the 2017 Form 10-K. During the current year period, there were no significant revisions made to the Firm’s significant unobservable inputs.

Measured Based on Net Asset Value

 

    At September 30, 2018     At December 31, 2017      
$ in millions   Carrying
Value
    Commitment     Carrying
Value
    Commitment  

Private equity

  $ 1,568     $ 328     $ 1,674     $ 308  

Real estate

    749       168       800       183  

Hedge1

    95       4       90       4  

Total

  $ 2,412     $ 500     $ 2,564     $ 495  

 

1.

Investments in hedge funds may be subject to initial period lock-up or gate provisions, which restrict an investor from withdrawing from the fund during a certain initial period or restrict the redemption amount on any redemption date, respectively.

For a description of the Firm’s investments in private equity funds, real estate funds and hedge funds, which are measured based on NAV, see Note 3 to the financial statements in the 2017 Form 10-K.

Amounts in the previous table represent the Firm’s carrying value of general and limited partnership interests in fund investments, as well as any related performance fees in the form of carried interest. The carrying amounts are measured based on the NAV of the fund taking into account the distribution terms applicable to the interest held. This same measurement applies whether investments are accounted for under the equity method or fair value.

 

 

September 2018 Form 10-Q   54  


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

See Note 11 for information regarding general partner guarantees, which include potential obligations to return performance fee distributions previously received. See Note 19 for information regarding related performance fees at risk of reversal, including performance fees in the form of carried interest.

Nonredeemable Funds by Contractual Maturity

 

    Carrying Value at September 30, 2018  
 $ in millions   Private Equity     Real Estate  

 Less than 5 years

  $ 621     $ 408  

 5-10 years

    816       313  

 Over 10 years

    131       28  

 Total

  $ 1,568     $ 749  

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.

Borrowings Measured at Fair Value on a Recurring Basis

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Business Unit Responsible for Risk Management

 

Equity

  $ 25,049     $ 25,903  

Interest rates

    22,101       19,230  

Foreign exchange

    504       666  

Credit

    863       815  

Commodities

    1,989       298  

Total

  $ 50,506     $ 46,912  

Earnings Impact of Borrowings under the Fair Value Option

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
 $ in millions   2018     2017     2018     2017  

 Trading revenues

  $ 449     $ (964   $ 1,334     $ (3,484

 Interest expense

    (59     (107     (234     (338

 Net revenues1

  $ 390     $ (1,071   $ 1,100     $ (3,822

 

1.

Amounts do not reflect any gains or losses on related hedging instruments.

Gains (losses) are mainly attributable to changes in foreign exchange rates, or interest rates or movements in the reference price or index.

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

 

    Three Months Ended September 30,  
    2018     2017  
 $ in millions   Trading
Revenues
    OCI     Trading
Revenues
    OCI  

 Borrowings

  $ (4   $ (1,010   $ 9     $ (226

 Loans and other debt1

    55             49               —  

 Lending commitments2

    (6                  

 Other

    (32             28             (3

 

    Nine Months Ended September 30,  
    2018     2017  
 $ in millions   Trading
Revenues
    OCI     Trading
Revenues
    OCI  

 Borrowings

  $ (22   $ 425     $ 1     $ (493

 Loans and other debt1

    199             94               —  

 Lending commitments2

    (3             —              

 Other

    (32     32             (6

 

 $ in millions  

At

September 30, 2018

   

At

December 31, 2017

 

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

  $ (1,374   $ (1,831

 

1.

Loans and other debt instrument-specific credit gains (losses) were determined by excluding the non-credit components of gains and losses.

2.

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.

Excess of Contractual Principal Amount Over Fair Value

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Loans and other debt1

  $ 12,809     $ 13,481  

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

    10,678       11,253  

Borrowings2

    1,438       71  

 

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.

Borrowings in this table 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
September 30,
2018
    At
December 31, 
2017
 

Nonaccrual loans

  $ 1,522     $ 1,240   

Nonaccrual loans 90 or more days past due

  $ 802     $ 779   

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.

 

 

  55   September 2018 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

Measured at Fair Value on a Nonrecurring Basis

 

Carrying and Fair Values

 

    At September 30, 2018  
    Fair Value  
$ in millions   Level 2      Level 31      Total  

Assets

       

Loans

  $     1,460      $ 1,096      $     2,556  

Other assets—Other investments

    15        36        51  

Other assets—Premises, equipment and software

                   

Total

  $ 1,475      $ 1,132      $ 2,607  

Liabilities

       

Other liabilities and accrued expenses—Lending commitments

  $ 185      $ 48      $ 233  

Total

  $ 185      $ 48      $ 233  
    At December 31, 2017  
    Fair Value  
$ in millions   Level 2      Level 31      Total  

Assets

       

Loans

  $     1,394      $ 924      $     2,318  

Other assets—Other investments

           144        144  

Total

  $ 1,394      $ 1,068      $ 2,462  

Liabilities

       

Other liabilities and accrued expenses—Lending commitments

  $ 158      $ 38      $ 196  

Total

  $ 158      $ 38      $ 196  

 

1.

For significant Level 3 balances, 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.

Gains (Losses) from Fair Value Remeasurements1

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions        2018               2017          2018     2017  

Assets

       

Loans2

  $ (5   $     $ 1     $ 41  

Other assets—Other investments3

    (2     (6     (9     (6

Other assets—Premises, equipment and software4

    (3     (1     (13     (7

Total

  $ (10   $ (7   $ (21   $ 28  

Liabilities

       

Other liabilities and accrued expenses—Lending commitments2

  $ 31     $ 4     $ 41     $ 64  

Total

  $ 31     $ 4     $ 41     $ 64  

 

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 in Other expenses.

2.

Nonrecurring 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 CDS 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 were determined using techniques that included a default recovery analysis and recently executed transactions.

 

 

September 2018 Form 10-Q   56  


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Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

Financial Instruments Not Measured at Fair Value

 

    At September 30, 2018  
 $ in millions  

Carrying

Value

    Fair Value  
  Level 1     Level 2     Level 3     Total  

 Financial Assets

         

 Cash and cash equivalents:

 

Cash and due from banks

  $ 36,641     $     36,641     $     $     $ 36,641  

Interest bearing deposits with banks

    22,638       22,638                   22,638  

Restricted cash

    33,202       33,202                   33,202  

 Investment securities—HTM

    25,336       12,757       10,883       442       24,082  

 Securities purchased under agreements to resell

    69,086             69,026             69,026  

 Securities borrowed

    142,489             142,433             142,433  

 Customer and other receivables1

    55,189             51,768       3,251       55,019  

 Loans2

    109,983             21,259       88,321       109,580  

 Other assets

    483             483             483  

 Financial Liabilities

         

 Deposits

  $     174,803     $     $     174,764     $     $     174,764  

 Securities sold under agreements to repurchase

    59,544             59,495             59,495  

 Securities loaned

    11,833             11,909             11,909  

 Other secured financings

    5,503             3,876       1,634       5,510  

 Customer and
other payables1

    188,054             188,054             188,054  

 Borrowings

    140,383             145,076       30       145,106  
    At December 31, 2017  
   

Carrying

Value

    Fair Value  
$ in millions   Level 1     Level 2     Level 3     Total  

Financial Assets

         

Cash and cash equivalents:

 

Cash and due from banks

  $ 24,816     $     24,816     $     $     $ 24,816  

Interest bearing deposits with banks

    21,348       21,348                   21,348  

Restricted cash

    34,231       34,231                   34,231  

Investment securities— HTM

    23,599       11,119       11,673       289       23,081  

Securities purchased under agreements to resell

    84,258             78,239       5,978       84,217  

Securities borrowed

    124,010             124,018       1       124,019  

Customer and other receivables1

    51,269             47,159       3,984       51,143  

Loans2

    104,126             21,290       82,928       104,218  

Other assets

    433             433             433  

Financial Liabilities

         

Deposits

  $     159,232     $     $     159,232     $     $     159,232  

Securities sold under agreements to repurchase

    55,624             51,752       3,867       55,619  

Securities loaned

    13,592             13,191       401       13,592  

Other secured financings

    7,408             5,987       1,431       7,418  

Customer and
other payables1

    188,464             188,464             188,464  

Borrowings

    145,670             151,692       30       151,722  

 

1.

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

2.

Amounts include loans measured at fair value on a nonrecurring basis.

Lending Commitments—Held for Investment and Held for Sale

 

   

Commitment

Amount1

     Fair Value  
 $ in millions    Level 2     Level 3     Total  

 September 30, 2018

  $         106,904      $         702     $         204     $         906  

 December 31, 2017

    100,151        620       174       794  

 

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. During the current year period, there were no significant updates made to the Firm’s valuation techniques for financial instruments not measured at fair value.

 

 

  57   September 2018 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

4. Derivative Instruments and Hedging Activities

Derivative Fair Values

At September 30, 2018

 

    Assets  
$ in millions   Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

     

Interest rate contracts

  $ 467     $     $     $ 467  

Foreign exchange contracts

    107       46             153  

Total

    574       46             620  

Not designated as accounting hedges

 

     

Interest rate contracts

    156,859       1,960       379       159,198  

Credit contracts

    4,446       1,710             6,156  

Foreign exchange contracts

    61,596       1,798       182       63,576  

Equity contracts

    26,522             23,396       49,918  

Commodity and other contracts

    8,975             2,136       11,111  

Total

    258,398       5,468       26,093       289,959  

Total gross derivatives

  $ 258,972     $ 5,514     $ 26,093     $ 290,579  

Amounts offset

       

Counterparty netting

    (190,040     (4,850     (24,242     (219,132

Cash collateral netting

    (40,294     (514           (40,808

Total in Trading assets

  $ 28,638     $ 150     $ 1,851     $ 30,639  

Amounts not offset1

       

Financial instruments collateral

    (14,077                 (14,077

Other cash collateral

    (29                 (29

Net amounts

  $ 14,532     $ 150     $ 1,851     $ 16,533  

Net amounts for which master netting or collateral agreements are not in place or may not be legally enforceable

 

  $ 3,590  
    Liabilities  
$ in millions  

Bilateral

OTC

    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

     

Interest rate contracts

  $ 270     $ 1     $     $ 271  

Foreign exchange contracts

    19       14             33  

Total

    289       15             304  

Not designated as accounting hedges

 

     

Interest rate contracts

    140,816       1,733       508       143,057  

Credit contracts

    4,452       2,099             6,551  

Foreign exchange contracts

    59,763       1,848       84       61,695  

Equity contracts

    28,920             22,467       51,387  

Commodity and other contracts

    8,308             2,073       10,381  

Total

    242,259       5,680       25,132       273,071  

Total gross derivatives

  $ 242,548     $ 5,695     $ 25,132     $ 273,375  

Amounts offset

       

Counterparty netting

    (190,040     (4,850     (24,242     (219,132

Cash collateral netting

    (27,777     (640           (28,417

Total in Trading liabilities

  $ 24,731     $ 205     $ 890     $ 25,826  

Amounts not offset1

       

Financial instruments collateral

    (4,729           (143     (4,872

Other cash collateral

    (33                 (33

Net amounts

  $ 19,969     $ 205     $ 747     $ 20,921  

Net amounts for which master netting or collateral agreements are not in place or may not be legally enforceable

 

  $ 5,763  

At December 31, 2017

 

    Assets  
$ in millions   Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

     

Interest rate contracts

  $ 1,057     $     $     $ 1,057  

Foreign exchange contracts

    57       6             63  

Total

    1,114       6             1,120  

Not designated as accounting hedges

 

     

Interest rate contracts

    177,948       1,700       234       179,882  

Credit contracts

    5,740       2,282             8,022  

Foreign exchange contracts

    52,878       798       58       53,734  

Equity contracts

    24,452             20,538       44,990  

Commodity and other contracts

    8,861             1,802       10,663  

Total

    269,879       4,780       22,632       297,291  

Total gross derivatives

  $ 270,993     $ 4,786     $ 22,632     $ 298,411  

Amounts offset

       

Counterparty netting

    (201,051     (3,856     (19,861     (224,768

Cash collateral netting

    (42,141     (689           (42,830

Total in Trading assets

  $ 27,801     $ 241     $ 2,771     $ 30,813  

Amounts not offset1

       

Financial instruments collateral

    (12,363                 (12,363

Other cash collateral

    (4                 (4

Net amounts

  $ 15,434     $ 241     $ 2,771     $ 18,446  

Net amounts for which master netting or collateral agreements are not in place or may not be legally enforceable

 

  $ 3,154  
    Liabilities  
$ in millions  

Bilateral

OTC

    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

     

Interest rate contracts

  $ 67     $ 1     $     $ 68  

Foreign exchange contracts

    72       57             129  

Total

    139       58             197  

Not designated as accounting hedges

 

     

Interest rate contracts

    161,758       1,178       144       163,080  

Credit contracts

    6,273       2,272             8,545  

Foreign exchange contracts

    54,191       925       23       55,139  

Equity contracts

    27,993             19,996       47,989  

Commodity and other contracts

    7,117             1,772       8,889  

Total

    257,332       4,375       21,935       283,642  

Total gross derivatives

  $ 257,471     $ 4,433     $ 21,935     $ 283,839  

Amounts offset

       

Counterparty netting

    (201,051     (3,856     (19,861     (224,768

Cash collateral netting

    (31,892     (484           (32,376

Total in Trading liabilities

  $ 24,528     $ 93     $ 2,074     $ 26,695  

Amounts not offset1

       

Financial instruments collateral

    (5,523           (412     (5,935

Other cash collateral

    (18     (14           (32

Net amounts

  $ 18,987     $ 79     $ 1,662     $ 20,728  

Net amounts for which master netting or collateral agreements are not in place or may not be legally enforceable

 

  $ 3,751  

 

1.

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.

 

 

September 2018 Form 10-Q   58  


Table of Contents
Notes to Consolidated Financial Statements
(Unaudited)
   LOGO

 

See Note 3 for information related to the unsettled fair value of futures contracts not designated as accounting hedges, which are excluded from the previous tables.

Derivative Notionals

At September 30, 2018

 

    Assets  
$ in billions   Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

   

Interest rate contracts

  $ 16     $ 8     $     $ 24  

Foreign exchange contracts

    5       1             6  

Total

    21       9             30  

Not designated as accounting hedges

 

   

Interest rate contracts

    5,359       7,067       1,206       13,632  

Credit contracts

    139       71             210  

Foreign exchange contracts

    2,160       91       18       2,269  

Equity contracts

    433             406       839  

Commodity and other contracts

    95             64       159  

Total

    8,186       7,229       1,694       17,109  

Total gross derivatives

  $     8,207     $     7,238     $ 1,694     $     17,139  

 

    Liabilities  
$ in billions   Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

   

Interest rate contracts

  $ 2     $ 153     $     $ 155  

Foreign exchange contracts

    3       1             4  

Total

    5       154             159  

Not designated as accounting hedges

 

   

Interest rate contracts

    5,317       6,361       710       12,388  

Credit contracts

    146       79             225  

Foreign exchange contracts

    2,155       87       17       2,259  

Equity contracts

    462             578       1,040  

Commodity and other contracts

    77             62       139  

Total

    8,157       6,527       1,367       16,051  

Total gross derivatives

  $     8,162     $     6,681     $ 1,367     $     16,210  

At December 31, 2017

 

    Assets  
$ in billions   Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

   

Interest rate contracts

  $ 20     $ 46     $     $ 66  

Foreign exchange contracts

    4                   4  

Total

    24       46             70  

Not designated as accounting hedges

 

   

Interest rate contracts

    3,999       6,458       2,714       13,171  

Credit contracts

    194       100             294  

Foreign exchange contracts

    1,960       67       9       2,036  

Equity contracts

    397             334       731  

Commodity and other contracts

    86             72       158  

Total

    6,636       6,625       3,129       16,390  

Total gross derivatives

  $     6,660     $     6,671     $ 3,129     $     16,460  
    Liabilities  
$ in billions   Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

   

Interest rate contracts

  $ 2     $ 102     $     $ 104  

Foreign exchange contracts

    4       2             6  

Total

    6       104             110  

Not designated as accounting hedges

 

   

Interest rate contracts

    4,199       6,325       1,089       11,613  

Credit contracts

    226       80             306  

Foreign exchange contracts

    2,014       78       51       2,143  

Equity contracts

    394             405       799  

Commodity and other contracts

    68             61       129  

Total

    6,901       6,483       1,606       14,990  

Total gross derivatives

  $     6,907     $     6,587     $ 1,606     $     15,100  

The Firm believes that the notional amounts of derivative contracts generally overstate its exposure.

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 financial statements in the 2017 Form 10-K.

Gains (Losses) on Accounting Hedges

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions   2018     2017     2018     2017  

Fair Value Hedges—Recognized in Interest Expense

 

   

Interest rate contracts

  $ (1,124   $ (218   $ (3,584   $ (878

Borrowings

        1,124       175           3,563               670  

Net Investment Hedges—Foreign exchange contracts

 

 

Recognized in OCI

  $ 107     $ (88   $ 354     $ (340

Forward points excluded from hedge effectiveness testing—Recognized in Interest income

    13       (3     44       (22

Fair Value Hedges—Hedged Items

 

$ in millions   At September 30,
2018
 

Investment Securities—AFS1

 

Carrying amount2 currently or previously hedged

  $ 86  

Borrowings

 

Carrying amount2 currently or previously hedged

  $ 103,269  

Basis adjustments included in carrying amount3

  $ (3,744

 

1.

In the current quarter, the Firm began designating interest rate swaps as fair value hedges of certain AFS securities. Amounts recognized in interest income and basis adjustments related to AFS securities were not material.

2.

Carrying amount represents amortized cost basis.

3.

Hedge accounting basis adjustments for Borrowings are primarily related to outstanding hedges.

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.

 

 

  59   September 2018 Form 10-Q


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Net Derivative Liabilities and Collateral Posted

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Net derivative liabilities with credit
risk-related contingent features

  $ 16,081     $ 20,675  

Collateral posted

    12,745       16,642  

The previous 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.

Incremental Collateral or Termination Payments upon Potential Future Ratings Downgrade

 

$ in millions   At
September 30,
2018
 

One-notch downgrade

  $ 429  

Two-notch downgrade

    325  

Bilateral downgrade agreements included
in the amounts above1

  $ 653  

 

1.

Amount represents 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.

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 S&P Global Ratings. The previous 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.

Credit Derivatives and Other Credit Contracts

The Firm enters into credit derivatives, principally CDS, 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 financial statements in the 2017 Form 10-K.

Protection Sold and Purchased with CDS

 

    At September 30, 2018  
    Fair Value (Asset)/Liability     Notional  
$ in millions   Protection
Sold
    Protection
Purchased
    Protection
Sold
    Protection
Purchased
 

Single name

  $       (326   $       469     $ 111,848     $ 127,114  

Index and basket

    159       (67     81,810       94,320  

Tranched index and basket

    (207     367       6,844       12,738  

Total

  $ (374   $       769     $   200,502     $ 234,172  

 

    At December 31, 2017  
    Fair Value (Asset)/Liability     Notional  
$ in millions   Protection
Sold
    Protection
Purchased
    Protection
Sold
    Protection
Purchased
 

Single name

  $ (1,277)     $       1,658     $ 146,948     $ 164,773  

Index and basket

    (341     209       131,073       120,348  

Tranched index and basket

    (342     616       11,864       24,498  

Total

  $     (1,960)     $ 2,483     $   289,885     $ 309,619  

Maximum Potential Payout/Notional of Credit Protection Sold1

 

    Years to maturity at September 30, 2018  
$ in millions   < 1     1-3     3-5     Over 5     Total  

Single name CDS

         

Investment grade

  $ 24,275     $ 25,802     $ 17,512     $ 9,721     $ 77,310  

Non-investment grade

    11,777       12,006       8,743       2,012       34,538  

Total

  $ 36,052     $ 37,808     $ 26,255     $ 11,733     $ 111,848  

Index and basket CDS

         

Investment grade

  $ 6,594     $ 8,975     $ 22,203     $ 16,832     $ 54,604  

Non-investment grade

    5,300       6,884       9,727       12,139       34,050  

Total

  $ 11,894     $ 15,859     $ 31,930     $ 28,971     $ 88,654  

Total CDS sold

  $ 47,946     $ 53,667     $ 58,185     $ 40,704     $   200,502  

Other credit contracts

                      129       129  

Total credit protection sold

  $   47,946     $   53,667     $   58,185     $   40,833     $ 200,631  

CDS protection sold with identical protection purchased

 

          $ 186,961  

 

    Years to maturity at December 31, 2017  
$ in millions   < 1     1-3     3-5     Over 5     Total  

Single name CDS

         

Investment grade

  $ 39,721     $ 42,591     $ 18,157     $ 8,872     $ 109,341  

Non-investment grade

    14,213       16,293       6,193       908       37,607  

Total

  $ 53,934     $ 58,884     $ 24,350     $ 9,780     $ 146,948  

Index and basket CDS

         

Investment grade

  $ 29,046     $ 15,418     $ 37,343     $ 6,807     $ 88,614  

Non-investment grade

    5,246       7,371       32,417       9,289       54,323  

Total

  $ 34,292     $ 22,789     $ 69,760     $ 16,096     $ 142,937  

Total CDS sold

  $ 88,226     $ 81,673     $ 94,110     $ 25,876     $ 289,885  

Other credit contracts

    2                   134       136  

Total credit protection sold

  $   88,228     $   81,673     $   94,110     $   26,010     $   290,021  

CDS protection sold with identical protection purchased

 

          $ 274,473  
 

 

September 2018 Form 10-Q   60  


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Fair Value (Asset)/Liability of Credit Protection Sold1

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Single name CDS

   

Investment grade

  $ (387   $ (1,167)  

Non-investment grade

    61       (110)  

Total

  $ (326   $ (1,277)  

Index and basket CDS

   

Investment grade

  $ (683   $ (1,091)  

Non-investment grade

    635       408   

Total

  $ (48   $ (683)  

Total CDS sold

  $ (374   $ (1,960)  

Other credit contracts

    21       16   

Total credit protection sold

  $ (353   $ (1,944)  

 

1.

Investment grade/non-investment grade determination is based on the internal credit rating of the reference obligation.

The fair value amounts as shown in the previous table are prior to cash collateral or counterparty netting. 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.

5. Investment Securities

AFS and HTM Securities

 

    At September 30, 2018  
$ in millions   Amortized
Cost
    Gross
Unrealized
Gains
    Gross
Unrealized
Losses
    Fair Value  

AFS securities

       

U.S. government and agency securities:

       

U.S. Treasury securities

  $ 33,093     $     $ 1,026     $ 32,067   

U.S. agency securities1

    20,368       14       658       19,724   

Total U.S. government and agency securities

    53,461       14       1,684       51,791   

Corporate and other debt:

       

Agency CMBS

    1,198       1       70       1,129   

Non-agency CMBS

    465             18       447   

Corporate bonds

    1,402             34       1,368   

State and municipal securities

    200                   200   

CLO

    262                   262   

FFELP student loan ABS2

    2,027       15       7       2,035   

Total corporate and other debt

    5,554       16       129       5,441   

Total AFS securities

    59,015       30       1,813       57,232   

HTM securities

       

U.S. government and agency securities:

       

U.S. Treasury securities

    13,387             630       12,757   

U.S. agency securities1

    11,500             617       10,883   

Total U.S. government and agency securities

    24,887             1,247       23,640   

Corporate and other debt:

       

Non-agency CMBS

    449       1       8       442   

Total HTM securities

    25,336       1       1,255       24,082   

Total investment securities

  $ 84,351     $ 31     $ 3,068     $ 81,314   
    At December 31, 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

  $ 26,842     $     $ 589     $ 26,253   

U.S. agency securities1

    22,803       28       247       22,584   

Total U.S. government and agency securities

    49,645       28       836       48,837   

Corporate and other debt:

       

Agency CMBS

    1,370       2       49       1,323   

Non-agency CMBS

    1,102             8       1,094   

Corporate bonds

    1,379       5       12       1,372   

CLO

    398       1             399   

FFELP student loan ABS2

    2,165       15       7       2,173   

Total corporate and other debt

    6,414       23       76       6,361   

Total AFS debt securities

    56,059       51       912       55,198   

AFS equity securities

    15             10        

Total AFS securities

    56,074       51       922       55,203   

HTM securities

       

U.S. government and agency securities:

       

U.S. Treasury securities

    11,424             305       11,119   

U.S. agency securities1

    11,886       7       220       11,673   

Total U.S. government and agency securities

    23,310       7       525       22,792   

Corporate and other debt:

       

Non-agency CMBS

    289       1       1       289   

Total HTM securities

    23,599       8       526       23,081   

Total investment securities

  $ 79,673     $ 59     $ 1,448     $   78,284   

 

1.

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

2.

Underlying loans are backed by a guarantee, ultimately from the U.S. Department of Education, of at least 95% of the principal balance and interest outstanding.

 

 

  61   September 2018 Form 10-Q


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Investment Securities in an Unrealized Loss Position

 

    At September 30, 2018  
    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 securities

               

 U.S. government and agency securities:

               

 U.S. Treasury securities

  $ 26,238       $ 858               $ 5,284       $ 168               $ 31,522       $ 1,026  

 U.S. agency securities

    13,615         525                 2,604         133                 16,219         658  

 Total U.S. government and agency securities

    39,853         1,383                 7,888         301                 47,741         1,684  

 Corporate and other debt:

               

 Agency CMBS

    828         70                 —         —                 828         70  

 Non-agency CMBS

    224         7                 223         11                 447         18  

 Corporate bonds

    725         14                 521         20                 1,246         34  

 FFELP student loan ABS

    881         7                 —         —                 881         7  

 Total corporate and other debt

    2,658         98                 744         31                 3,402         129  

 Total AFS securities

    42,511         1,481                 8,632         332                 51,143         1,813  

 HTM securities

               

 U.S. government and agency securities:

               

 U.S. Treasury securities

    3,102         44                 9,655         586                 12,757         630  

 U.S. agency securities

    2,373         73                 8,510         544                 10,883         617  

 Total U.S. government and agency securities

    5,475         117                 18,165         1,130                 23,640         1,247  

 Corporate and other debt:

                      

 Non-agency CMBS

    195         5                 68         3                 263         8  

 Total HTM securities

    5,670         122                 18,233         1,133                 23,903         1,255  

 Total investment securities

  $ 48,181       $ 1,603               $ 26,865       $ 1,465               $ 75,046       $ 3,068  
    At December 31, 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

  $ 21,941     $ 495               $ 4,287       $ 94               $ 26,228     $ 589  

 U.S. agency securities

    12,673       192                 2,513         55                 15,186       247  

 Total U.S. government and agency securities

    34,614       687                 6,800         149                 41,414       836  

 Corporate and other debt:

                      

 Agency CMBS

    930       49                 —         —                 930       49  

 Non-agency CMBS

    257       1                 559         7                 816       8  

 Corporate bonds

    316       3                 389         9                 705       12  

 FFELP student loan ABS

    984       7                 —         —                 984       7  

 Total corporate and other debt

    2,487       60                 948         16                 3,435       76  

 Total AFS debt securities

    37,101       747                 7,748         165                 44,849       912  

 AFS equity securities

          —                 5         10                 5       10  

 Total AFS securities

    37,101       747                 7,753         175                 44,854       922  

 HTM securities

               

 U.S. government and agency securities:

               

 U.S. Treasury securities

    6,608       86                 4,512         219                 11,120       305  

 U.S. agency securities

    2,879       24                 7,298         196                 10,177       220  

 Total U.S. government and agency securities

    9,487       110                 11,810         415                 21,297       525  

 Corporate and other debt:

               

 Non-agency CMBS

    124       1                 —         —                 124       1  

 Total HTM securities

    9,611       111                 11,810         415                 21,421       526  

 Total investment securities

  $         46,712     $ 858               $         19,563       $ 590               $         66,275     $ 1,448  

 

September 2018 Form 10-Q   62  


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The Firm believes there are no securities in an unrealized loss position that are other-than-temporarily impaired after performing the analysis described in Note 2 to the financial statements in the 2017 Form 10-K. 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 the amortized cost basis. Furthermore, 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.

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

Investment Securities by Contractual Maturity

 

    At September 30, 2018
$ in millions   Amortized
Cost
  Fair Value   Annualized
Average
Yield

AFS securities

           

U.S. government and agency securities:

           

U.S. Treasury securities:

           

Due within 1 year

    $ 3,447     $ 3,432       1.3%

After 1 year through 5 years

      27,517             26,734       1.9%

After 5 years through 10 years

      2,129       1,901       1.4%

Total

      33,093       32,067          

U.S. agency securities:

           

Due within 1 year

      473       467       1.0%

After 1 year through 5 years

      806       789       1.2%

After 5 years through 10 years

      1,718       1,644       1.8%

After 10 years

      17,371       16,824       2.1%

Total

      20,368       19,724          

Total U.S. government and agency securities

      53,461       51,791       1.9%

Corporate and other debt:

           

Agency CMBS:

           

Due within 1 year

      3       3       0.9%

After 1 year through 5 years

      384       382       1.3%

After 5 years through 10 years

      40       41       1.2%

After 10 years

      771       703       1.6%

Total

      1,198       1,129          

Non-agency CMBS:

                             

After 5 years through 10 years

      36       34       2.5%

After 10 years

      429       413       2.4%

Total

      465       447          

Corporate bonds:

           

Due within 1 year

      70       70       1.7%

After 1 year through 5 years

      1,270       1,237       2.4%

After 5 years through 10 years

      62       61       3.4%

Total

      1,402       1,368          

State and municipal securities:

                             

After 1 year through 5 years

      200       200       3.5%

Total

      200       200          

CLO:

           

After 5 years through 10 years

      64       64       1.5%

After 10 years

      198       198       2.4%

Total

      262       262          
    At September 30, 2018  
$ in millions   Amortized
Cost
    Fair Value     Annualized
Average
Yield
 

FFELP student loan ABS:

     

After 1 year through 5 years

    84       83       0.8%  

After 5 years through 10 years

    319       316       0.8%  

After 10 years

    1,624       1,636       1.2%  

Total

    2,027       2,035          

Total corporate and other debt

    5,554       5,441       1.8%  

Total AFS securities

    59,015             57,232       1.9%  

HTM securities

     

U.S. government securities:

     

U.S. Treasury securities:

     

Due within 1 year

    2,126       2,118       1.2%  

After 1 year through 5 years

    5,423       5,303       2.0%  

After 5 years through 10 years

    5,112       4,725       1.9%  

After 10 years

    726       611       2.3%  

Total

    13,387       12,757          

U.S. agency securities:

                       

After 5 years through 10 years

    31       30       1.9%  

After 10 years

    11,469       10,853       2.6%  

Total

    11,500       10,883          

Total U.S. government and agency securities

    24,887       23,640       2.2%  

Corporate and other debt:

     

Non-agency CMBS:

     

Due within 1 year

    68       68       3.5%  

After 1 year through 5 years

    61       61       4.4%  

After 5 years through 10 years

    301       295       4.0%  

After 10 years

    19       18       4.0%  

Total corporate and other debt

    449       442       4.0%  

Total HTM securities

    25,336       24,082       2.2%  

Total investment securities

  $ 84,351     $ 81,314       2.0%  

Gross Realized Gains (Losses) on Sales of AFS Securities

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions   2018     2017     2018     2017  

Gross realized gains

  $ 5     $ 11     $ 11     $ 38  

Gross realized (losses)

                (3     (11

Total1

  $ 5     $ 11     $ 8     $ 27  

 

1.

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

 

 

  63   September 2018 Form 10-Q


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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 financial statements in the 2017 Form 10-K.

Offsetting of Certain Collateralized Transactions

 

    At September 30, 2018  
$ in millions   Gross
Amounts
   

Amounts

Offset

   

Net

Amounts
Presented

   

Amounts

Not Offset1

    Net
Amounts
 

Assets

         

Securities purchased under agreements to resell

  $ 212,796     $ (143,710   $ 69,086     $ (63,821   $ 5,265  

Securities borrowed

    161,903       (19,414     142,489       (136,940     5,549  

Liabilities

                                

Securities sold under agreements to repurchase

  $   204,038     $ (143,710   $ 60,328     $ (52,421   $ 7,907  

Securities loaned

    31,247       (19,414     11,833       (11,664     169  

Net amounts for which master netting agreements are not in place or may not be legally enforceable

 

Securities purchased under agreements to resell

 

          $ 3,640  

Securities borrowed

 

            1,377  

Securities sold under agreements to repurchase

 

            6,074  

Securities loaned

 

            142  
    At December 31, 2017  
$ in millions   Gross
Amounts
    Amounts
Offset
    Net
Amounts
Presented
   

Amounts

Not Offset1

    Net
Amounts
 

Assets

         

Securities purchased under agreements to resell

  $ 199,044     $ (114,786   $ 84,258     $ (78,009   $ 6,249  

Securities borrowed

    133,431       (9,421     124,010       (119,358     4,652  

Liabilities

         

Securities sold under agreements to repurchase

  $ 171,210     $ (114,786   $ 56,424     $ (48,067   $ 8,357  

Securities loaned

    23,014       (9,422     13,592       (13,271     321  

Net amounts for which master netting agreements are not in place or may not be legally enforceable

 

Securities purchased under agreements to resell

 

          $ 5,687  

Securities borrowed

 

            572  

Securities sold under agreements to repurchase

 

            6,945  

Securities loaned

 

            307  

 

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.

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

Maturities and Collateral Pledged

Gross Secured Financing Balances by Remaining Contractual Maturity

 

    At September 30, 2018  
$ in millions  

Overnight

and Open

   

Less than

30 Days

   

30-90

Days

   

Over

90 Days

    Total  

Securities sold under agreements to repurchase

  $ 69,184     $ 59,181     $ 32,727     $ 42,946     $ 204,038  

Securities loaned

    19,930       3,698       1,733       5,886       31,247  

Total included in the offsetting disclosure

  $ 89,114     $ 62,879     $ 34,460     $ 48,832     $ 235,285  

Trading liabilities—Obligation to return securities received as collateral

    18,727                         18,727  

Total

  $ 107,841     $ 62,879     $   34,460     $   48,832     $   254,012  
    At December 31, 2017  
$ in millions  

Overnight

and Open

   

Less than

30 Days

   

30-90

Days

   

Over

90 Days

    Total  

Securities sold under agreements to repurchase

  $ 41,332     $ 66,593     $ 28,682     $ 34,603     $ 171,210  

Securities loaned

    12,130       873       1,577       8,434       23,014  

Total included in the offsetting disclosure

  $ 53,462     $ 67,466     $ 30,259     $ 43,037     $ 194,224  

Trading liabilities—Obligation to return securities received as collateral

    22,555                         22,555  

Total

  $ 76,017     $ 67,466     $ 30,259     $ 43,037     $ 216,779  

Gross Secured Financing Balances by Class of Collateral Pledged

 

$ in millions  

At

September 30,

2018

   

At

December 31,
2017

 

Securities sold under agreements to repurchase

 

U.S. Treasury and agency securities

  $ 54,625     $ 43,346  

State and municipal securities

    1,516       2,451  

Other sovereign government obligations

    115,046       87,141  

ABS

    2,257       1,130  

Corporate and other debt

    8,142       7,737  

Corporate equities

    21,756       28,497  

Other

    696       908  

Total

  $ 204,038     $ 171,210  

Securities loaned

   

Other sovereign government obligations

  $ 19,850     $ 9,489  

Corporate equities

    11,270       13,174  

Other

    127       351  

Total

  $ 31,247     $ 23,014  

Total included in the offsetting disclosure

  $ 235,285     $ 194,224  

Trading liabilities—Obligation to return securities received as collateral

 

Corporate equities

  $ 18,727     $ 22,555  

Total

  $ 254,012     $ 216,779  
 

 

September 2018 Form 10-Q   64  


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Assets Pledged

The Firm pledges its trading assets and loans to collateralize securities sold under agreements to repurchase, securities loaned, other secured financings and derivatives, and cover customer short sales. 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 balance sheets.

Carrying Value of Assets Loaned or Pledged without

Counterparty Right to Sell or Repledge

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Trading assets

  $ 31,347     $ 31,324   

Loans (gross of allowance for loan losses)

    570       228   

Total

  $ 31,917     $ 31,552   

Collateral Received

The Firm receives collateral in the form of securities in connection with securities purchased under agreements to resell, securities borrowed, securities-for-securities transactions, 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.

Fair Value of Collateral Received with Right to Sell or Repledge

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Collateral received with right to sell or repledge

  $ 658,309     $ 599,244   

Collateral that was sold or repledged1

    505,108       475,113   

 

1.

Does not include securities used to meet federal regulations for the Firm’s broker-dealers.

Customer Margin Lending and Other

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Net customer receivables representing margin loans

  $ 33,821     $ 32,112   

The Firm provides margin lending arrangements which allow customers to borrow against the value of qualifying securities. Customer receivables representing margin loans are included within Customer and other receivables in the 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 financial statements in the 2017 Form 10-K.

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

Restricted Cash and Segregated Securities

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Restricted cash

  $ 33,202     $ 34,231   

Segregated securities1

    25,820       20,549   

Total

  $ 59,022     $ 54,780   

 

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 balance sheets.

7. Loans, Lending Commitments 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 balance sheets. For a further description of these loans, refer to Note 7 to the financial statements in the 2017 Form 10-K. See Note 3 for further information regarding Loans and lending commitments held at fair value. See Note 11 for details of current commitments to lend in the future.

Loans by Type

 

    At September 30, 2018  
$ in millions   Loans Held
for Investment
    Loans Held
for Sale
    Total Loans  

Corporate loans

  $ 35,439     $ 10,035     $ 45,474   

Consumer loans

    28,321             28,321   

Residential real estate loans

    26,644       29       26,673   

Wholesale real estate loans

    8,157       1,589       9,746   

Total loans, gross

    98,561       11,653       110,214   

Allowance for loan losses

    (231           (231)  

Total loans, net

  $ 98,330     $ 11,653     $     109,983   

Fixed rate loans, net

                  $ 15,263   

Floating or adjustable rate loans, net

 

            94,720   

Loans to non-U.S. borrowers, net

 

            14,346   
 

 

  65   September 2018 Form 10-Q


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    At December 31, 2017  
$ in millions   Loans Held
for Investment
    Loans Held
for Sale
    Total Loans  

Corporate loans

  $ 29,754     $ 9,456     $ 39,210  

Consumer loans

    26,808             26,808  

Residential real estate loans

    26,635       35       26,670  

Wholesale real estate loans

    9,980       1,682       11,662  

Total loans, gross

    93,177       11,173       104,350  

Allowance for loan losses

    (224           (224

Total loans, net

  $ 92,953     $ 11,173     $ 104,126  

Fixed rate loans, net

                  $ 13,339  

Floating or adjustable rate loans, net

 

            90,787  

Loans to non-U.S. borrowers, net

 

            9,977  

Credit Quality

For a further discussion about the Firm’s evaluation of credit transactions, monitoring and credit quality indicators, as well as factors considered by the Firm in determining the allowance for loan losses and impairments, see Notes 2 and 7 to the financial statements in the 2017 Form 10-K.

Loans Held for Investment before Allowance by Credit Quality

 

    At September 30, 2018  
$ in millions   Corporate     Consumer    

Residential

Real Estate

   

Wholesale

Real Estate

    Total  

Pass

  $ 35,062     $ 28,316     $ 26,563     $ 7,625     $ 97,566  

Special mention

    108       5             360       473  

Substandard

    268             81       172       521  

Doubtful

    1                         1  

Loss

                             

Total

  $ 35,439     $ 28,321     $ 26,644     $ 8,157     $     98,561  

 

    At December 31, 2017  
$ in millions   Corporate     Consumer    

Residential

Real Estate

   

Wholesale

Real Estate

    Total  

Pass

  $ 29,166     $ 26,802     $ 26,562     $ 9,480     $ 92,010  

Special mention

    188       6             200       394  

Substandard

    393             73       300       766  

Doubtful

    7                         7  

Loss

                             

Total

  $ 29,754     $ 26,808     $ 26,635     $ 9,980     $     93,177  

Impaired Loans and Lending Commitments before Allowance

 

    At September 30, 2018  
$ in millions   Corporate     Residential
Real Estate
    Total  

Loans

     

With allowance

  $ 23     $     $ 23  

Without allowance1

    42       60       102  

Total impaired loans

  $ 65     $ 60     $         125  

UPB

    71       61       132  

Lending Commitments

     

With allowance

  $ 21     $     $ 21  

Without allowance1

    24             24  
    At December 31, 2017  
$ in millions   Corporate     Residential
Real Estate
    Total  

Loans

     

With allowance

  $ 16     $     $ 16  

Without allowance1

    118       45       163  

Total impaired loans

  $ 134     $ 45     $         179  

UPB

    146       46       192  

Lending Commitments

     

Without allowance1

  $ 199     $     $ 199  

 

1.

At September 30, 2018 and December 31, 2017, no allowance was recorded for these loans and lending commitments as the present value of the expected future cash flows (or, alternatively, the observable market price of the instrument or the fair value of the collateral held) equaled or exceeded the carrying value.

Loans and lending commitments in the previous table have been evaluated for a specific allowance. All remaining loans and lending commitments are assessed under the inherent allowance methodology.

Impaired Loans and Total Allowance by Region

 

    At September 30, 2018  
$ in millions   Americas     EMEA     Asia     Total  

Impaired loans

  $ 125     $     $     $         125  

Total Allowance for loan losses

    192       38       1       231  
    At December 31, 2017  
$ in millions   Americas     EMEA     Asia     Total  

Impaired loans

  $ 160     $ 9     $         10     $         179  

Total Allowance for loan losses

    194               27       3       224  

Troubled Debt Restructurings

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Loans

  $ 46     $ 51  

Lending commitments

    37       28  

Allowance for loan losses and lending commitments

    4       10  

Impaired loans and lending commitments classified as held for investment within corporate loans include TDRs as shown in the previous table. These restructurings typically include modifications of interest rates, collateral requirements, other loan covenants and payment extensions.

 

 

September 2018 Form 10-Q   66  


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Allowance for Loan Losses Rollforward

 

$ in millions   Corporate     Consumer     Residential
Real Estate
    Wholesale
Real Estate
    Total  

December 31, 2017

  $ 126     $ 4     $ 24     $ 70     $ 224  

Gross charge-offs

    (4                       (4

Recoveries1

    54                         54  

Net recoveries (charge-offs)

    50                         50  

Provision (release)1, 2

    (39     1       (4     9       (33

Other

    (2                 (8     (10

September 30, 2018

  $ 135     $ 5     $ 20     $ 71     $ 231  

Inherent

  $ 130     $ 5     $ 20     $ 71     $       226  

Specific

    5                         5  

 

$ in millions   Corporate     Consumer     Residential
Real Estate
    Wholesale
Real Estate
    Total  

December 31, 2016

  $ 195     $ 4     $ 20     $ 55     $ 274  

Gross charge-offs

    (75                       (75

Recoveries

    1                         1  

Net recoveries (charge-offs)

    (74                       (74

Provision (release)2

    26             4       12       42  

Other

    2                   1       3  

September 30, 2017

  $ 149     $ 4     $ 24     $ 68     $ 245  

Inherent

  $ 142     $ 4     $ 24     $ 68     $       238  

Specific

    7                         7  

 

1. The current year period release was primarily due to the recovery of a previously charged off energy industry related loan.

2. The Firm recorded a provision of $1 million and $13 million for loan losses in the current quarter and prior year quarter, respectively.

 

Allowance for Lending Commitments Rollforward

 

  

  

 

$ in millions   Corporate     Consumer     Residential
Real Estate
    Wholesale
Real Estate
    Total  

December 31, 2017

  $ 194     $ 1     $     $ 3     $ 198  

Provision (release)1

    5                   1       6  

Other

    (2                 (1     (3

September 30, 2018

  $ 197     $ 1     $     $ 3     $ 201  

Inherent

  $ 190     $ 1     $     $ 3     $       194  

Specific

    7                         7  

 

$ in millions   Corporate     Consumer     Residential
Real Estate
    Wholesale
Real Estate
    Total  

December 31, 2016

  $ 185     $ 1     $     $ 4     $ 190  

Provision (release)1

    (10                       (10

Other

    1                         1  

September 30, 2017

  $ 176     $ 1     $     $ 4     $ 181  

Inherent

  $ 173     $ 1     $     $ 4     $       178  

Specific

    3                         3  

 

1.

The Firm recorded a provision of $1 million, and release of $6 million for lending commitments in the current quarter and prior year quarter, respectively.

Employee Loans

 

 $ in millions   At
September 30,
2018
    At
December 31,
2017
 

 Balance

  $ 3,491     $ 4,185  

 Allowance for loan losses

    (70     (77

 Balance, net

  $ 3,421     $ 4,108  

 Repayment term range, in years

    1 to 20       1 to 20  

Employee loans are granted in conjunction with a program established to retain and recruit certain employees, are full recourse and generally require periodic repayments. These loans are recorded in Customer and other receivables in the balance sheets. The Firm establishes an allowance for loan amounts it does not consider recoverable, and the related provision is recorded in Compensation and benefits expense.

8. Equity Method Investments

Overview

Equity method investments other than certain investments in funds are summarized below and included in Other assets in the balance sheets with related income or loss included in Other revenues in the income statements. See the Measured Based on Net Asset Value table in Note 3 for the carrying value of the Firm’s fund interests, which are comprised of general and limited partnership interests, as well as any related performance-based fees in the form of carried interest.

Equity Method Investment Balances

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Investments

  $ 2,452     $ 2,623  

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
 $ in millions   2018     2017     2018     2017  

 Income (loss)

  $ 8     $     $ 62     $  

Japanese Securities Joint Venture

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
 $ in millions   2018     2017     2018     2017  

 Income from investment in MUMSS

  $ 17     $ 25     $ 99     $ 96  

Included in the equity method investments is the Firm’s 40% voting 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.

 

 

  67   September 2018 Form 10-Q


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9. Deposits

Deposits

 

$ in millions   At
 September 30,
2018
    At
 December 31,
2017
 

Savings and demand deposits

  $ 143,962     $ 144,487  

Time deposits

    31,223       14,949  

Total

  $ 175,185     $ 159,436  

Deposits subject to FDIC insurance

  $ 134,872     $ 127,017  

Time deposits that equal or exceed the FDIC insurance limit

  $ 12     $ 38  

Time Deposit Maturities

 

$ in millions   At
September 30,
2018
 

2018

  $ 7,238  

2019

    12,519  

2020

    7,879  

2021

    1,569  

2022

    631  

Thereafter

    1,387  

10. Borrowings and Other Secured Financings

Borrowings

 

$ in millions   At
 September 30,
2018
    At
December 31,
2017
 

Original maturities of one year or less

  $ 940     $ 1,519  

Original maturities greater than one year

 

Senior

  $ 180,136     $ 180,835  

Subordinated

    9,813       10,228  

Total

  $ 189,949     $ 191,063  

Total borrowings

  $ 190,889     $ 192,582  

Weighted average stated maturity, in years1

    6.6       6.6  

 

1.

Includes only borrowings with original maturities greater than one year.

Other Secured Financings

Other secured financings include the liabilities related to certain ELNs, transfers of financial assets that are accounted for as financings rather than sales, pledged commodities, consolidated VIEs where the Firm is deemed to be the primary beneficiary 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
September 30,  
2018
    At
  December 31,
2017
 

Original maturities:

   

Greater than one year

  $ 7,840     $ 8,685  

One year or less

    1,555       2,034  

Failed sales

    662       552  

Total

  $ 10,057     $ 11,271  

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 balance sheets.

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.

11. Commitments, Guarantees and Contingencies

Commitments

 

    Years to Maturity at September 30, 2018        
$ in millions  

Less

than 1

    1-3     3-5     Over 5     Total  

Lending:

         

Corporate

  $ 13,345     $ 32,893     $ 46,671     $ 7,805     $ 100,714  

Consumer

    7,074             11             7,085  

Residential real estate

          83       13       253       349  

Wholesale real estate

    129       530                   659  

Forward-starting secured financing receivables

    82,818                   1,181       83,999  

Investment activities

    517       100       47       257       921  

Letters of credit and other financial guarantees

    184       1             39       224  

Total

  $   104,067     $   33,607     $   46,742     $   9,535     $   193,951  

Corporate lending commitments participated to third parties

 

  $ 7,620  

Forward-starting secured financing receivables
settled within three business days

 

  $ 77,520  

Since commitments associated with these instruments may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.

For a further description of these commitments, refer to Note 12 to the financial statements in the 2017 Form 10-K.

 

 

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Guarantees

Obligations under Guarantee Arrangements at September 30, 2018

 

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

Credit derivatives

  $ 47,946     $ 53,667     $ 58,185     $ 40,704     $ 200,502  

Other credit contracts

                      129       129  

Non-credit derivatives

    1,870,310       1,471,732       405,669       648,797       4,396,508  

Standby letters of credit and other financial guarantees issued1

    1,009       913       1,452       4,908       8,282  

Market value guarantees

    16       101       24             141  

Liquidity facilities

    3,994                         3,994  

Whole loan sales guarantees

          1             23,215       23,216  

Securitization representations and warranties

                      63,208       63,208  

General partner guarantees

    4       52       338       34       428  

 

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

Credit derivatives2

  $ (374   $  

Other credit contracts

    21        

Non-credit derivatives2

          40,951        

Standby letters of credit and other
financial guarantees issued1

    (234           6,717  

Market value guarantees

          3  

Liquidity facilities

    (6     6,459  

Whole loan sales guarantees

    9        

Securitization representations and warranties

    62        

General partner guarantees

    73        

 

1.

These amounts include certain issued standby letters of credit participated to third parties, totaling $0.6 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 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.

In certain situations, collateral may be held by the Firm for those contracts that meet the definition of a guarantee. Generally, the Firm sets collateral requirements by counterparty so that the collateral covers various transactions and products and is not allocated specifically to individual contracts. Also, the Firm may recover amounts related to the underlying asset delivered to the Firm under a derivative contract.

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 financial statements in the 2017 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 financial statements in the 2017 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 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 addition to the matters described below, 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 litigation, 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.

 

 

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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 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 government 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 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 CDS 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 CDS with CDIB. The complaint seeks compensatory damages related to the approximately $228 million that CDIB alleges it has already lost under the CDS, 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. On June 27, 2018, the Firm filed a motion for summary judgment and spoliation sanctions against CDIB. 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 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, 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. On August 13, 2018, the Firm filed a motion to renew its motion to dismiss. 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.

 

 

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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 September 13, 2018, the Appellate Division, First Department, affirmed the lower court’s order denying 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 $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 September 13, 2018, the Appellate Division, First Department, affirmed in part and reversed in part the lower court’s order denying the Firm’s motion to dismiss. On October 15, 2018, the plaintiff filed a motion for leave to appeal the decision of the Appellate Division, First Department, to the New York Court of Appeals or, in the alternative, for reargument. 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. On October 19, 2018, the court granted the Firm’s motion for leave to amend its answer and to stay the case pending resolution of Deutsche Bank National Trust Company’s appeal to the New York Court of Appeals in another case. 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 District Court in Amsterdam, the prior set-off by the Firm of approximately €124 million (approximately $144 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. A hearing took place in this matter on September 19, 2017. On April 26, 2018, the District Court in Amsterdam issued a decision dismissing the Dutch Authority’s claims. On June 6, 2018, the Dutch Authority filed an appeal against the decision issued by the District Court in Amsterdam. Based on currently available information, the Firm believes that

 

 

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it could incur a loss in this action of up to approximately €124 million (approximately $144 million) plus accrued interest.

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 financial statements in the 2017 Form 10-K.

Consolidated VIEs

Assets and Liabilities by Type of Activity

 

    At September 30, 2018     At December 31, 2017  
$ in millions  

 

VIE Assets

    VIE Liabilities     VIE Assets     VIE Liabilities  

OSF

  $ 273     $     $ 378     $ 3  

MABS1

    66       44       249       210  

Other2

    2,234       834       1,174       250  

Total

  $ 2,573     $              878     $ 1,801     $             463  

OSF—Other structured financings

1.

Amounts 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 as the fair values for the liabilities and interests owned are more observable.

2.

Other primarily includes investment funds, certain operating entities and structured transactions. At September 30, 2018, Other includes the consolidation of a fund managed by Mesa West Capital, LLC, which was acquired in the first quarter of 2018.

Assets and Liabilities by Balance Sheet Caption

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Assets

   

Cash and cash equivalents:

   

Cash and due from banks

  $ 99     $ 69  

Restricted cash

    170       222  

Trading assets at fair value

    1,712       833  

Customer and other receivables

    22       19  

Goodwill

    18       18  

Intangible assets

    134       155  

Other assets

    418       485  

Total

  $ 2,573     $ 1,801  

Liabilities

   

Other secured financings

  $ 845     $ 438  

Other liabilities and accrued expenses

    33       25  

Total

  $ 878     $ 463  

Noncontrolling interests

  $ 437     $ 189  

Consolidated VIE assets and liabilities are presented in the previous tables after intercompany eliminations. Most assets owned by consolidated VIEs cannot be removed unilaterally by the Firm and are not generally available to the Firm. Most related liabilities issued by 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 net assets recognized in its financial statements, net of amounts absorbed by third-party variable interest holders.

Non-consolidated VIEs

 

    At September 30, 2018  
$ in millions  

 

MABS

    CDO     MTOB     OSF     Other  

VIE assets (UPB)

  $     73,812     $     15,427     $     6,314     $     3,457     $     20,199  

Maximum exposure to loss

 

   

Debt and equity interests

  $ 8,598     $ 1,505     $ 17     $ 1,579     $ 5,006  

Derivative and other contracts

                3,994             1,756  

Commitments, guarantees and other

    863       630             139       327  

Total

  $ 9,461     $ 2,135     $ 4,011     $ 1,718     $ 7,089  

Carrying value of exposure to loss—Assets

 

   

Debt and equity interests

  $ 8,598     $ 1,505     $ 17     $ 1,166     $ 5,006  

Derivative and other contracts

                6             70  

Total

  $ 8,598     $ 1,505     $ 23     $ 1,166     $ 5,076  

Additional VIE assets owned1

 

                  $ 12,231  

 

    At December 31, 2017  
$ in millions  

 

MABS

    CDO     MTOB     OSF     Other  

VIE assets (UPB)

  $     89,288     $     9,807     $     5,306     $     3,322     $     31,934  

Maximum exposure to loss

 

   

Debt and equity interests

  $ 10,657     $ 1,384     $ 80     $ 1,628     $ 4,730    

Derivative and other contracts

                3,333             1,686    

Commitments, guarantees and other

    1,214       668             164       433    

Total

  $ 11,871     $ 2,052     $ 3,413     $ 1,792     $ 6,849    

Carrying value of exposure to loss—Assets

 

   

Debt and equity interests

  $ 10,657     $ 1,384     $ 43     $ 1,202     $ 4,730  

Derivative and other contracts

                5             184  

Total

  $ 10,657     $ 1,384     $ 48     $ 1,202     $ 4,914  

Additional VIE assets owned1

 

                          $ 11,318  

MTOB—Municipal tender option bonds

1.

Additional VIE Assets owned represents the carrying value of total exposure to non-consolidated VIEs for which the maximum exposure to loss is less than specific thresholds, primarily interests issued by securitization SPEs.

Most of the VIEs included in the previous tables are sponsored by unrelated parties; the Firm’s involvement generally

 

 

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is the result of its secondary market-making activities, securities held in its Investment securities portfolio (see Note 5) and certain investments in funds.

The Firm’s maximum exposure to loss is dependent on the nature of the Firm’s variable interest in the VIE and is limited to:

 

 

notional amounts of certain liquidity facilities;

 

other credit support;

 

total return swaps;

 

written put options; and

 

fair value of certain other derivatives and investments the Firm has made in the VIE.

Where notional amounts are utilized in quantifying the maximum exposure related to derivatives, such amounts do not reflect changes in fair value recorded by the Firm.

The Firm’s maximum exposure to loss presented in the previous table does not include:

 

 

offsetting benefit of any financial instruments that the Firm may utilize to hedge these risks associated with its variable interests; and

 

any reductions associated with 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.

Liabilities issued by VIEs generally are non-recourse to the Firm.

The Firm’s primary risk exposure related to additional VIE assets owned is to the most subordinate class of beneficial interest, which are typically acquired by the Firm in the secondary market and generally issued by SPEs sponsored by unrelated parties. These assets, which generally consist of MABS, CDO, MTOB and other exposure, are primarily 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.

Mortgage- and Asset-Backed Securitization Assets

 

      At September 30, 2018     At December 31, 2017  
$ in millions   UPB    

 

Debt and
Equity

Interests

    UPB     Debt and
Equity
Interests
 

Residential mortgages

  $ 9,299     $ 923     $ 15,636     $ 1,272  

Commercial mortgages

    39,554       1,289       46,464       2,331  

U.S. agency collateralized mortgage obligations

    14,176       2,822       16,223       3,439  

Other consumer or commercial loans

    10,783       3,564       10,965       3,615  

Total

  $       73,812     $         8,598     $       89,288     $       10,657  

Transfers of Assets with Continuing Involvement

 

    At September 30, 2018  
$ in millions   RML     CML    

 

U.S. Agency
CMO

   

CLN and

Other1

 

SPE assets (UPB)2

  $      14,775     $      66,829     $ 14,793     $      17,101  

Retained interests

 

Investment grade

  $ 18     $ 492     $ 850     $ 14  

Non-investment grade
(fair value)

    3       119             359  

Total

  $ 21     $ 611     $ 850     $ 373  

Interests purchased in the secondary market (fair value)

 

Investment grade

  $ 7     $ 141     $ 71     $  

Non-investment grade

    51       47              

Total

  $ 58     $ 188     $ 71     $  

Derivative assets (fair value)

  $     $     $     $ 140  

Derivative liabilities (fair value)

                      136  

 

    At December 31, 2017  
$ in millions  

RML

    CML    

 

U.S. Agency
CMO

   

CLN and

Other1

 

SPE assets (UPB)2

  $      15,555     $      62,744     $ 11,612     $      17,060  

Retained interests

 

Investment grade

  $     $ 293     $ 407     $ 4  

Non-investment grade (fair value)

    1       98             478  

Total

  $ 1     $ 391     $ 407     $ 482  

Interests purchased in the secondary market (fair value)

 

Investment grade

  $     $ 94     $ 439     $  

Non-investment grade

    16       66             4  

Total

  $ 16     $ 160     $ 439     $ 4  

Derivative assets (fair value)

  $ 1     $     $     $ 226  

Derivative liabilities (fair value)

                      85  

RML—Residential mortgage loans

CML—Commercial mortgage loans

1.

Amounts include CLO transactions managed by unrelated third parties.

2.

Amounts include assets transferred by unrelated transferors.

 

 

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    Fair Value at September 30, 2018  
$ in millions  

 

Level 2

    Level 3     Total  

Retained interests

     

Investment grade

  $ 868     $ 56     $ 924  

Non-investment grade

    139       342       481  

Total

  $         1,007     $            398     $         1,405  

Interests purchased in the secondary market

 

Investment grade

  $ 208     $ 11     $ 219  

Non-investment grade

    88       10       98  

Total

  $ 296     $ 21     $ 317  

Derivative assets

  $ 28     $ 112     $ 140  

Derivative liabilities

    133       3       136  

 

    Fair Value at December 31, 2017  
$ in millions  

 

Level 2

    Level 3     Total  

Retained interests

     

Investment grade

  $ 407     $ 4     $ 411  

Non-investment grade

    22       555       577  

Total

  $            429     $            559     $            988  

Interests purchased in the secondary market

 

Investment grade

  $ 531     $ 2     $ 533  

Non-investment grade

    57       29       86  

Total

  $ 588     $ 31     $ 619  

Derivative assets

  $ 78     $ 149     $ 227  

Derivative liabilities

    81       4       85  

The previous tables include transactions with SPEs in which the Firm, acting as principal, transferred financial assets with continuing involvement and received sales treatment.

Transferred assets are carried at fair value prior to securitization, and any changes in fair value are recognized in the income statements. The Firm may act as underwriter of the beneficial interests issued by these securitization vehicles, for which Investment banking revenues are recognized. 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 balance sheets with changes in fair value recognized in the income statements.

Proceeds from New Securitization Transactions and Sales of Loans

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions  

 

2018

    2017     2018     2017  

New transactions1

  $         7,299     $         6,875     $       19,056     $       17,622  

Retained interests

    584       648       2,222       1,607  

Sales of corporate loans to CLO SPEs1, 2

    17       56       253       148  

 

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).

Assets Sold with Retained Exposure

 

$ in millions   At September 30,
2018
    At December 31,
2017
 

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

  $ 28,121     $ 19,115  

Fair value

   

Assets sold

  $ 28,820     $ 19,138  

Derivative assets recognized in the balance sheets

    826       176  

Derivative liabilities recognized in the balance sheets

    127       153  

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

13. Regulatory Requirements

Regulatory Capital Framework and Requirements

For a discussion of the Firm’s regulatory capital framework, see Note 14 to the financial statements in the 2017 Form 10-K.

The Firm is required to maintain minimum risk-based and leverage-based capital ratios under the regulatory capital requirements. A summary of the calculations of regulatory capital, RWA and transition provisions follows.

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

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 AOCI and investments in the capital instruments of unconsolidated financial institutions.

In addition to the minimum risk-based capital ratio requirements, by 2019 the Firm will be subject to the following buffers:

 

 

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

 

 

The Common Equity Tier 1 G-SIB capital surcharge, currently at 3%; and

 

 

September 2018 Form 10-Q   74  


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Up to a 2.5% Common Equity Tier 1 CCyB, currently set by U.S. banking agencies at zero.

In 2018, each of the buffers is 75% of the 2019 requirement noted above (during 2017, the buffers were 50%). Failure to maintain the buffers would 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.

For a further discussion of the Firm’s calculation of risk-based capital ratios, see Note 14 to the financial statements in the 2017 Form 10-K.

The Firm’s Regulatory Capital and Capital Ratios

 

    At September 30, 2018  
$ in millions   Required
Ratio1
     Amount     Ratio  

Risk-based capital

      

Common Equity Tier 1 capital

    8.6%      $ 61,758       16.7%  

Tier 1 capital

    10.1%        70,328       19.0%  

Total capital

    12.1%        79,899       21.6%  

Total RWA

             370,714          

Leverage-based capital

      

Tier 1 leverage

    4.0%      $ 70,328       8.2%  

Adjusted average assets2

             858,944          

SLR3

    5.0%        70,328       6.4%  

Supplementary leverage exposure4

             1,101,263          

 

    At December 31, 2017  
$ in millions   Required
Ratio1
     Amount     Ratio5  

Risk-based capital

      

Common Equity Tier 1 capital

    7.3%      $ 61,134       16.5%  

Tier 1 capital

    8.8%        69,938       18.9%  

Total capital

    10.8%        80,275       21.7%  

Total RWA

             369,578          

Leverage-based capital

      

Tier 1 leverage

    4.0%      $ 69,938       8.3%  

Adjusted average assets2

             842,270          

 

1.

Percentages represent minimum required regulatory capital ratios—for risk-based capital, the ratios are under the transitional rules.

2.

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

3.

The SLR became effective as a capital standard on January 1, 2018.

4.

Supplementary Leverage exposure is the sum of Adjusted average assets used in the Tier 1 leverage ratio and other adjustments, primarily (i) potential future exposure for derivative exposures, gross-up for cash collateral netting where qualifying criteria are not met, and the effective notional principal amount of sold credit protection offset by qualifying purchased credit protection; (ii) the counterparty credit risk for repo-style transactions; and (iii) the credit equivalent amount for off-balance sheet exposures.

5.

For risk- and leverage-based capital, regulatory compliance was determined based on capital ratios calculated under the transitional rules until December 31, 2017.

At September 30, 2018 and December 31, 2017, the Firm’s risk-based capital ratios are based on the Standardized Approach rules.

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

The OCC establishes capital requirements for our U.S. Bank Subsidiaries and evaluates their compliance with such capital requirements. Regulatory capital requirements for our U.S. Bank Subsidiaries are calculated in a similar manner to the Firm’s regulatory capital requirements, although G-SIB capital surcharge requirements do not apply to our U.S. Bank Subsidiaries.

The OCC’s regulatory capital framework includes Prompt Corrective Action (“PCA”) standards, including “well-capitalized” PCA standards that are based on specified regulatory capital ratio minimums. For us to remain an FHC, our U.S. Bank Subsidiaries must remain well-capitalized in accordance with the OCC’s PCA standards. In addition, failure by our U.S. Bank Subsidiaries to meet minimum capital requirements may result in certain mandatory and discretionary actions by regulators that, if undertaken, could have a direct material effect on the U.S. Bank Subsidiaries’ and the Firm’s financial statements.

At September 30, 2018 and December 31, 2017, the U.S. Bank Subsidiaries’ risk-based capital ratios are based on the Standardized Approach rules and exceeded well-capitalized requirements.

MSBNA’s Regulatory Capital

 

    At September 30, 2018  
$ in millions   Required
Ratio1
     Amount     Ratio  

Risk-based capital

      

Common Equity Tier 1 capital

    6.5%      $ 15,683       20.4%  

Tier 1 capital

    8.0%        15,683       20.4%  

Total capital

    10.0%        15,933       20.7%  

Leverage-based capital

      

Tier 1 leverage

    5.0%      $     15,683       10.9%  

SLR2

    6.0%        15,683       8.5%  

 

    At December 31, 2017  
$ in millions   Required
Ratio1
     Amount     Ratio3  

Risk-based capital

      

Common Equity Tier 1 capital

    6.5%      $ 15,196       20.5%  

Tier 1 capital

    8.0%        15,196       20.5%  

Total capital

    10.0%        15,454       20.8%  

Leverage-based capital

      

Tier 1 leverage

    5.0%      $     15,196       11.8%  
 

 

  75   September 2018 Form 10-Q


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MSPBNA’s Regulatory Capital

 

    At September 30, 2018  
$ in millions   Required
Ratio1
     Amount     Ratio  

Risk-based capital

      

Common Equity Tier 1 capital

    6.5%      $ 6,841       25.0%  

Tier 1 capital

    8.0%        6,841       25.0%  

Total capital

    10.0%        6,886       25.1%  

Leverage-based capital

      

Tier 1 leverage

    5.0%      $ 6,841       9.7%  

SLR2

    6.0%        6,841       9.4%  

 

    At December 31, 2017  
$ in millions   Required
Ratio1
     Amount     Ratio3  

Risk-based capital

      

Common Equity Tier 1 capital

    6.5%      $ 6,215       24.4%  

Tier 1 capital

    8.0%        6,215       24.4%  

Total capital

    10.0%        6,258       24.6%  

Leverage-based capital

      

Tier 1 leverage

    5.0%      $ 6,215       9.7%  

 

1.

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

2.

The SLR became effective as a capital standard on January 1, 2018.

3.

For risk- and leverage-based capital, regulatory compliance was determined based on capital ratios calculated under the transitional rules until December 31, 2017.

U.S. Broker-Dealer Regulatory Capital Requirements

MS&Co. Regulatory Capital

 

$ in millions       At September 30, 2018          At December 31, 2017  

Net capital

  $ 12,627      $ 10,142  

Excess net capital

    10,253        8,018  

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 SEC and the CFTC. MS&Co. has consistently operated with capital in excess of its regulatory capital requirements.

As an Alternative Net Capital broker-dealer, and in accordance with the market and credit risk standards of Appendix E of SEC Rule 15c3-1, MS&Co. is subject to minimum net capital and tentative net capital requirements. In addition, MS&Co. must notify the SEC if its tentative net capital falls below certain levels. At September 30, 2018 and December 31, 2017, MS&Co. has exceeded its net capital requirement and has tentative net capital in excess of the minimum and notification requirements.

MSSB LLC Regulatory Capital

 

$ in millions       At September 30, 2018         At December 31, 2017  

Net capital

  $ 3,030     $ 2,567  

Excess net capital

    2,864       2,400  

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

MSIP, a London-based broker-dealer subsidiary, is subject to the capital requirements of the PRA, and 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

Share Repurchases

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions       2018             2017             2018             2017      

Repurchases of common stock under the Firm’s share repurchase program

  $ 1,180     $ 1,250     $ 3,680     $ 2,500  

The Firm’s 2018 Capital Plan (“Capital Plan”) includes the share repurchase of up to $4.7 billion of outstanding common stock for the period beginning July 1, 2018 through June 30, 2019. Additionally, the Capital Plan includes quarterly common stock dividends of up to $0.30 per share.

On April 18, 2018, the Firm entered into a sales plan with MUFG whereby MUFG sells shares of the Firm’s common stock to the Firm, as part of the Firm’s share repurchase program. The sales plan is only intended to maintain MUFG’s ownership percentage below 24.9% in order to comply with MUFG’s passivity commitments to the Board of Governors of the Federal Reserve System and will have no impact on the strategic alliance between MUFG and the Firm, including the joint ventures in Japan.

Preferred Stock

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions       2018             2017             2018             2017      

Dividends declared

  $ 93     $ 93     $ 356     $ 353  

For a description of Series A through Series K preferred stock issuances, see Note 15 to the financial statements in the 2017

 

 

September 2018 Form 10-Q   76  


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Form 10-K. 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).

Preferred Stock Outstanding

 

    Shares
Outstanding
          Carrying Value  

$ in millions, except

    per share data

  At
September 30,
2018
    Liquidation
Preference
per Share
    At
September 30,
2018
    At
December 31,
2017
 

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       1,000  

Total

 

  $     8,520     $     8,520  

 

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)1

 

$ in millions   Foreign
Currency
Translation
Adjustments
    AFS
Securities
    Pension,
Postretirement
and Other
    DVA     Total  

June 30, 2018

    $ (864   $ (1,194     $ (704   $ (308   $ (3,070

OCI during the period

    (54 )      (171     5       (709     (929

September 30, 2018

    $ (918   $ (1,365     $ (699   $ (1,017   $ (3,999

June 30, 2017

    $ (856   $ (396     $ (470   $ (766   $ (2,488

OCI during the period

    61       26             (143     (56

September 30, 2017

    $ (795   $ (370     $ (470   $ (909   $ (2,544

December 31, 2017

    $ (767   $ (547     $ (591   $ (1,155   $ (3,060

Cumulative adjustment for accounting changes2

    (8     (111     (124     (194     (437

OCI during the period

    (143     (707     16             332       (502

September 30, 2018

    $ (918   $ (1,365     $ (699   $ (1,017   $ (3,999

December 31, 2016

    $ (986   $ (588     $ (474   $ (595   $ (2,643

OCI during the period

    191       218       4       (314             99  

September 30, 2017

    $ (795   $ (370     $ (470   $ (909   $ (2,544

 

1.

Amounts net of tax and noncontrolling interests.

2.

The cumulative adjustment for accounting changes is primarily the effect of the adoption of the accounting update Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This adjustment was recorded as of January 1, 2018 to reclassify certain income tax effects related to enactment of the Tax Act from AOCI to Retained earnings, primarily related to the remeasurement of deferred tax assets and liabilities resulting from the reduction in corporate income tax rate to 21%. See Note 2 for further information.

Components of Period Changes in OCI

 

   

Three Months Ended

 

September 30, 2018

 
$ 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   $ (35   $ (79   $ (25   $ (54)  

Reclassified to earnings

                             

Net OCI

  $ (44   $ (35   $ (79   $ (25   $ (54)  

Change in net unrealized gains (losses) on AFS securities

 

OCI activity

  $ (219   $ 51     $ (168   $     $ (168)  

Reclassified to earnings

    (5     2       (3           (3)  

Net OCI

  $ (224   $ 53     $ (171   $     $       (171)  

Pension, postretirement and other

 

OCI activity

  $     $     $     $     $  

Reclassified to earnings

    7       (2     5             5  

Net OCI

  $ 7     $ (2   $ 5     $     $ 5  

Change in net DVA

 

OCI activity

  $   (1,018   $ 248     $ (770   $ (34   $ (736)  

Reclassified to earnings

    36       (9     27             27  

Net OCI

  $ (982   $ 239     $ (743   $ (34   $ (709)  

 

   

Three Months Ended

 

September 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

  $ 19     $ 42     $ 61     $     $ 61  

Reclassified to earnings

                             

Net OCI

  $ 19     $ 42     $ 61     $     $ 61  

Change in net unrealized gains (losses) on AFS securities

 

OCI activity

  $ 52     $ (19   $ 33     $     $ 33  

Reclassified to earnings

    (11     4       (7           (7)  

Net OCI

  $ 41     $ (15   $ 26     $     $ 26  

Pension, postretirement and other

 

OCI activity

  $     $     $     $     $  

Reclassified to earnings

    1       (1                  

Net OCI

  $ 1     $ (1   $     $     $  

Change in net DVA

 

OCI activity

  $   (220   $ 77     $ (143   $ (6   $       (137)  

Reclassified to earnings

    (9     3       (6           (6)  

Net OCI

  $ (229   $ 80     $ (149   $ (6   $ (143)  
 

 

  77   September 2018 Form 10-Q


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Nine Months Ended

 

September 30, 20181

 
$ in millions   Pre-tax
Gain
(Loss)
    Income
Tax Benefit
(Provision)
    After-tax
Gain
(Loss)
   

Non-

controlling
Interests

    Net  

Foreign currency translation adjustments

 

OCI activity

  $ (52   $ (102   $ (154   $ (11   $ (143)  

Reclassified to earnings

                            —   

Net OCI

  $ (52   $ (102   $ (154   $ (11   $ (143)  

Change in net unrealized gains (losses) on AFS securities

 

OCI activity

  $ (916   $ 215     $ (701   $     $ (701)  

Reclassified to earnings

    (8     2       (6           (6)  

Net OCI

  $ (924   $ 217     $ (707   $     $ (707)  

Pension, postretirement and other

 

OCI activity

  $ 2     $     $ 2     $     $  

Reclassified to earnings

    19       (5     14             14   

Net OCI

  $ 21     $ (5   $ 16     $     $ 16   

Change in net DVA

 

OCI activity

  $ 403     $ (97   $ 306     $ 15     $ 291  

Reclassified to earnings

    54       (13     41             41  

Net OCI

  $ 457     $ (110   $ 347     $ 15     $ 332  

 

   

Nine Months Ended

 

September 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

  $ 63     $ 160     $ 223     $ 32     $ 191   

Reclassified to earnings

                            —   

Net OCI

  $ 63     $ 160     $ 223     $ 32     $ 191   

Change in net unrealized gains (losses) on AFS securities

 

OCI activity

  $ 374     $ (139   $ 235     $     $ 235   

Reclassified to earnings

    (27     10       (17           (17)  

Net OCI

  $ 347     $ (129   $ 218     $     $ 218   

Pension, postretirement and other

 

OCI activity

  $ 3     $     $ 3     $     $  

Reclassified to earnings

    2       (1     1              

Net OCI

  $ 5     $ (1   $ 4     $     $  

Change in net DVA

 

OCI activity

  $   (498   $ 175     $ (323   $ (9   $ (314)  

Reclassified to earnings

    (1     1                   —   

Net OCI

  $ (499   $ 176     $ (323   $ (9   $ (314)  

 

1.

Exclusive of 2018 cumulative adjustments related to the adoption of certain accounting updates in the current year period. Refer to the table below and Note 2 for further information.

 

 

Cumulative Adjustments to Retained Earnings Related to Adoption of Accounting Updates

 

 

$ in millions   Nine Months Ended  
September 30, 2018  
 

Revenue from contracts with customers

  $ (32

Derivatives and hedging-targeted improvements to accounting for hedging activities

    (99

Reclassification of certain tax effects from AOCI

    443  

Other1

    (6

Total

  $                           306  

 

$ in millions   Nine Months Ended  
September 30, 2017  
 

Improvements to employee share-based payment accounting2

    (30)  

Intra-entity transfers of assets other than inventory

    (5)  

Total

  $                           (35)  

 

1.

Other includes the adoption of accounting updates related to Recognition and Measurement of Financial Assets and Financial Liabilities (other than the provision around presenting unrealized DVA in OCI which the Firm early adopted in 2016) and Derecognition of Nonfinancial Assets. The impact of these adoptions on Retained earnings was not significant.

2.

See Note 2 to the 2017 Form 10-K for further information.

 

 

September 2018 Form 10-Q   78  


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15. Earnings per Common Share

Calculation of Basic and Diluted EPS

 

   

Three Months Ended
September 30,

    Nine Months Ended
September 30,
 
in millions, except for per share data       2018             2017             2018             2017      

 

Basic EPS

       

Income from continuing operations

  $ 2,155     $ 1,785     $ 7,330     $ 5,574  

Income (loss) from discontinued operations

    (1     6       (5     (21

Net income

    2,154       1,791       7,325       5,553  

Net income applicable to noncontrolling interests

    42       10       108       85  

Net income applicable to Morgan Stanley

    2,112       1,781       7,217       5,468  

Preferred stock dividends and other

    93       93       356       353  

Earnings applicable to Morgan Stanley common shareholders

  $ 2,019     $ 1,688     $ 6,861     $ 5,115  

Weighted average common shares outstanding

    1,697       1,776       1,719       1,789  

Earnings per basic common share

       

Income from continuing operations

  $ 1.19     $ 0.95     $ 3.99     $ 2.87  

Income (loss) from discontinued operations

                      (0.01

Earnings per basic common share

  $ 1.19     $ 0.95     $ 3.99     $ 2.86  

 

Diluted EPS

       

Earnings applicable to Morgan Stanley common shareholders

  $ 2,019     $ 1,688     $ 6,861     $ 5,115  

Weighted average common shares outstanding

    1,697       1,776       1,719       1,789  

Effect of dilutive securities:

       

Stock options and RSUs

    30       42       30       41  

 

Weighted average common shares outstanding and common stock equivalents

    1,727       1,818       1,749       1,830  

 

Earnings per diluted common share

       

Income from continuing operations

  $ 1.17     $ 0.93     $ 3.92     $ 2.81  

Income (loss) from discontinued operations

                      (0.02

Earnings per diluted common share

  $ 1.17     $ 0.93     $ 3.92     $ 2.79  

Weighted average antidilutive RSUs and stock options (excluded from the computation of diluted EPS)

    1             1        

16. Interest Income and Interest Expense

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions       2018             2017             2018             2017      

Interest income

       

Investment securities

  $ 440     $ 313     $ 1,281     $ 943  

Loans

    1,085       853       3,097       2,399  

Securities purchased under agreements to resell and Securities borrowed1

    575       76       1,156       86  

Trading assets, net of Trading liabilities

    571       506       1,687       1,461  

Customer receivables and Other2

    956       592       2,560       1,522  

Total interest income

  $ 3,627     $ 2,340     $ 9,781     $ 6,411  

 

Interest expense

       

Deposits

  $ 377     $ 63     $ 809     $ 88  

Borrowings

    1,287       1,109       3,683       3,197  

Securities sold under agreements to repurchase and Securities loaned3

    478       325       1,326       912  

Customer payables and Other4

    549       60       1,146       (91

Total interest expense

  $ 2,691     $ 1,557     $ 6,964     $ 4,106  

Net interest

  $ 936     $ 783     $ 2,817     $ 2,305  

 

1.

Includes fees paid on Securities borrowed.

2.

Includes interest from Customer receivables and Cash and cash equivalents.

3.

Includes fees received on Securities loaned.

4.

Includes fees received from prime brokerage customers for stock loan transactions incurred to cover customers’ short positions.

Interest income and Interest expense are classified in the income statements based on the nature of the instrument and related market conventions. When 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.

17. Employee Benefit Plans

The Firm sponsors various retirement plans for the majority of its U.S. employees. The Firm provides certain other postretirement benefits, primarily health care and life insurance, to eligible U.S. employees.

Components of Net Periodic Benefit Expense (Income) for Pension and Other Postretirement Plans

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions   2018     2017     2018     2017  

Service cost, benefits earned during the period

  $ 4     $ 4     $ 12     $ 12  

Interest cost on projected benefit obligation

    34       37       103       112  

Expected return on plan assets

    (29     (29     (85     (87

Net amortization of prior service credit

    (1     (4     (1     (12

Net amortization of actuarial loss

    8       4       20       12  

Net periodic benefit expense (income)

  $ 16     $ 12     $ 49     $ 37  
 

 

  79   September 2018 Form 10-Q


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18. Income Taxes

The Firm is under continuous examination by the IRS and other tax authorities in certain countries, such as Japan and the U.K., and in states in which it has significant business operations, such as New York. The Firm has established a liability for unrecognized tax benefits, and associated interest, if applicable (“tax liabilities”), that it believes is adequate in relation to the potential for additional assessments. Once established, the Firm adjusts such tax liabilities only when new information is available or when an event occurs necessitating a change.

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 2009-2016 and 2007-2014, respectively.

The Firm believes that the resolution of the above tax matters will not have a material effect on the annual financial statements, although a resolution could have a material impact in the income statements and effective tax rate for any period in which such resolution occurs.

Furthermore, by the end of the first quarter of 2018, the Firm reached a conclusion with the U.K. tax authorities on certain issues through tax year 2010, the resolution of which did not have a material impact on the financial statements or effective tax rate.

See Note 11 regarding the Dutch Tax Authority’s challenge, in the District Court 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.

It is reasonably possible that significant changes in the balance of unrecognized tax benefits occur within the next 12 months. At this time, however, it is not possible to reasonably estimate the expected change to the total amount of unrecognized tax benefits and the impact on the Firm’s effective tax rate over the next 12 months.

The Firm’s effective tax rate for the current year period includes recurring-type discrete tax benefits associated with employee share-based payments of $164 million. Additionally, as a result of new information pertaining to the resolution of multi-jurisdiction tax examinations and other matters, the Firm’s effective tax rate for the current year period includes intermittent net discrete tax benefits of $92 million with a corresponding reduction in the total amount of gross unrecognized tax benefits (excluding federal benefit of state items, competent authority and foreign tax credit offsets) of approximately $430 million.

19. Segment, Geographic and Revenue Information

Segment Information

For a discussion about the Firm’s business segments, see Note 21 to the financial statements in the 2017 Form 10-K.

Selected Financial Information by Business Segment

 

    Three Months Ended September 30, 2018  
$ in millions       IS             WM             IM             I/E             Total      

Investment banking1, 2

  $ 1,459     $ 129     $     $ (21   $ 1,567  

Trading

    2,573       160       2       17       2,752  

Investments

    96             40             136  

Commissions and fees1

    589       409             (66     932  

Asset management1

    112       2,573       604       (38     3,251  

Other

    244       58       (3     (1     298  

Total non-interest
revenues3, 4

    5,073       3,329       643       (109     8,936  

Interest income

    2,425       1,412       19       (229     3,627  

Interest expense

    2,569       342       9       (229     2,691  

Net interest

    (144     1,070       10             936  

Net revenues

  $   4,929     $ 4,399     $ 653     $ (109   $ 9,872  

Income from continuing operations before
income taxes

  $ 1,556     $ 1,194     $ 102     $ (1   $ 2,851  

Provision for income taxes

    397       281       18             696  

Income from continuing operations

    1,159       913       84       (1     2,155  

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

    (3           2             (1

Net income

    1,156       913       86       (1     2,154  

Net income applicable to noncontrolling interests

    36             6             42  

Net income applicable to Morgan Stanley

  $ 1,120     $ 913     $ 80     $ (1   $ 2,112  
 

 

September 2018 Form 10-Q   80  


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    Three Months Ended September 30, 2017  
 $ in millions   IS     WM     IM     I/E     Total  

 Investment banking

  $ 1,270     $ 125     $     $ (15   $ 1,380   

 Trading

    2,504       212       (7     (5     2,704   

 Investments

    52       1       114             167   

 Commissions and fees

    561       402             (26     937   

 Asset management

    88       2,393       568       (23     3,026   

 Other

    143       62       1       (6     200   

 Total non-interest revenues

    4,618       3,195       676       (75     8,414   

 Interest income

    1,421       1,155       1       (237     2,340   

 Interest expense

    1,663       130       2       (238     1,557   

 Net interest

    (242     1,025       (1     1       783   

 Net revenues

  $   4,376     $   4,220     $   675     $ (74   $   9,197   

 Income from continuing operations before income taxes

  $ 1,236     $ 1,119     $ 131     $ (4   $ 2,482   

 Provision for income taxes

    260       421       16               —       697   

 Income from continuing operations

    976       698       115       (4     1,785   

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

    6                          

 Net income

    982       698       115       (4     1,791   

 Net income applicable to noncontrolling interests

    9             1             10   

 Net income applicable to Morgan Stanley

  $ 973     $ 698     $ 114     $ (4   $ 1,781   

 

    Nine Months Ended September 30, 2018  
$ in millions   IS     WM     IM     I/E     Total  

Investment banking1, 2

  $ 4,671     $ 383     $     $ (60   $ 4,994   

Trading

    9,344       404       23       44       9,815   

Investments

    234       3       172             409   

Commissions and fees1

    2,007       1,349             (212     3,144   

Asset management1

    324       7,582       1,840       (114     9,632   

Other

    548       195       10       (5     748   

Total non-interest revenues3, 4

    17,128       9,916       2,045       (347     28,742   

Interest income

    6,424       4,012       37       (692     9,781   

Interest expense

    6,809       830       20       (695     6,964   

Net interest

    (385     3,182       17                3       2,817   

Net revenues

  $   16,743     $   13,098     $   2,062     $ (344   $   31,559   

Income from continuing operations before income taxes

  $ 5,480     $ 3,511     $ 390     $ (1   $ 9,380   

Provision for income taxes

    1,169       808       73             2,050   

Income from continuing operations

    4,311       2,703       317       (1     7,330   

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

    (7           2             (5)  

Net income

    4,304       2,703       319       (1     7,325   

Net income applicable to noncontrolling interests

    100             8             108   

Net income applicable to Morgan Stanley

  $ 4,204     $ 2,703     $ 311     $ (1   $ 7,217   
    Nine Months Ended September 30, 2017  
$ in millions   IS     WM     IM     I/E     Total  

Investment banking

  $ 4,100     $ 405     $     $ (50   $ 4,455   

Trading

    8,241       657       (21     (7     8,870   

Investments

    155       3       337             495   

Commissions and fees

    1,811       1,266             (80     2,997   

Asset management

    268       6,879       1,624       (76     8,695   

Other

    442       191       9       (14     628   

Total non-interest revenues

    15,017       9,401       1,949       (227     26,140   

Interest income

    3,788       3,348       3       (728     6,411   

Interest expense

    4,515       320       3       (732     4,106   

Net interest

    (727     3,028                   4       2,305   

Net revenues

  $   14,290     $   12,429     $   1,949     $   (223   $   28,445   

Income from continuing operations before income taxes

  $ 4,409     $ 3,149     $ 376     $ (2   $ 7,932   

Provision for income taxes

    1,132       1,139       87             2,358   

Income from continuing operations

    3,277       2,010       289       (2     5,574   

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

    (21                       (21)  

Net income

    3,256       2,010       289       (2     5,553   

Net income applicable to noncontrolling interests

    77             8             85   

Net income applicable to Morgan Stanley

  $ 3,179     $ 2,010     $ 281     $ (2   $ 5,468   

I/E–Intersegment Eliminations

1.

Approximately 85% of Investment banking revenues and substantially all of Commissions and fees and Asset management revenues in the current quarter and current year period were determined under the Revenues from Contracts with Customers accounting update.

2.

Current quarter Institutional Securities Investment banking revenues are composed of $510 million of Advisory and $949 million of Underwriting revenues. Current year period Institutional Securities Investment banking revenues are composed of $1,702 million of Advisory and $2,969 million of Underwriting revenues.

3.

The Firm enters into certain contracts which contain a current obligation to perform services in the future. Excluding contracts where billing is commensurate with the value of the services performed at each stage of the contract, contracts with variable consideration that is subject to reversal, and contracts with less than one year duration, we expect to record the following approximate revenues in the future: $25 million in the remainder of 2018; $100 million per year over the next two years; and between $10 million and $50 million per year thereafter through 2035. These revenues are primarily related to certain commodities contracts with customers.

4.

Includes $804 million and $2,192 million in revenue recognized in the current quarter and current year period, respectively, where some or all services were performed in prior periods. This amount is primarily composed of investment banking advisory fees, and distribution fees.

Total Assets by Business Segment

 

$ in millions   At
September 30,
2018
    At
December 31,
2017
 

Institutional Securities

  $ 671,508     $             664,974   

Wealth Management

    188,166       182,009   

Investment Management

    5,843       4,750   

Total1

  $                     865,517     $                     851,733   

 

1.

Parent assets have been fully allocated to the business segments.

 

 

  81   September 2018 Form 10-Q


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Additional Segment Information—Investment Management

Net Unrealized Performance-based Fees

 

$ in millions  

At

September 30,
2018

   

At

December 31,
2017

 

Net cumulative unrealized performance-based fees at risk of reversing

  $                              406     $                                  442   

The Firm’s portion of net cumulative unrealized performance-based fees (for which the Firm is not obligated to pay compensation) are at risk of reversing if the fund performance falls below the stated investment management agreement benchmarks. See Note 11 for information regarding general partner guarantees, which include potential obligations to return performance fee distributions previously received.

Reduction of Fees due to Fee Waivers

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions   2018     2017     2018     2017  

Fee waivers

  $ 11     $ 20     $ 45     $ 66   

The Firm waives a portion of its fees in the Investment Management business segment from certain registered money market funds that comply with the requirements of Rule 2a-7 of the Investment Company Act of 1940.

Geographic Information

For a discussion about the Firm’s geographic net revenues, see Note 21 to the financial statements in the 2017 Form 10-K.

Net Revenues by Region

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions   2018     2017     2018     2017  

Americas

  $ 7,357     $       6,833     $ 22,989     $ 20,667   

EMEA

    1,355       1,325       4,892       4,420   

Asia

    1,160       1,039       3,678       3,358   

Total

  $     9,872     $ 9,197     $   31,559     $   28,445   

Revenue Information

Trading Revenues by Product Type

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
$ in millions       2018             2017             2018             2017      

Interest rate contracts

  $ 744     $ 648     $ 2,396     $ 1,693   

Foreign exchange contracts

    223       181       622       613   

Equity security and index contracts1

    1,432       1,416       5,094       4,875   

Commodity and other contracts

    254       223       1,047       522   

Credit contracts

    99       236       656       1,167   

Total

  $   2,752     $   2,704     $   9,815     $   8,870   

 

1.

Dividend income is included within equity security and index contracts.

The previous table summarizes gains and losses included in Trading revenues in the income statements. 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. The trading revenues presented in the 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.

Change in Revenue and Expense as a Result of Application of the New Revenue Recognition Standard

 

$ in millions  

Three

Months Ended
September 30, 2018

   

Nine

Months Ended
September 30, 2018

 

Gross presentation impact—Revenue

 

 

Investment banking—Advisory

  $ 12     $ 56   

Underwriting

    59       161   

Asset management

    8       22   

Other

    14       41   

Subtotal

    93       280   

Gross presentation impact—Expense

 

 

Brokerage, clearing and exchange fees

  $ 8     $ 22   

Marketing and business development

    8       20   

Professional services

    39       93   

Other1

    38       145   

Subtotal

    93       280   

Timing impact—Revenue

 

 

Investment banking—Advisory

    (2     13   

Asset management

    (15     (31)  

Other

    5       10   

Subtotal

    (12     (8)  

Net change in revenue and expense

  $ (12   $ (8)  

 

1.

Primarily composed of Investment banking transaction-related costs.

As a result of adopting the accounting update Revenue from Contracts with Customers, the accounting for certain transactions has changed (see Note 2 for further details). As summarized in the previous table, the change is composed of transactions which are now presented on a gross basis within both Non-interest revenues and Non-interest expenses as well as transactions where revenues are recognized with different timing compared to the previous GAAP. For example, timing impacts shown as negative amounts in the previous table represent revenues for which recognition has been deferred to future periods under the new standard.

 

 

September 2018 Form 10-Q   82  


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Receivables from Contracts with Customers

 

$ in millions   At
September 30,
2018
     At    
January 1,    
2018    
 

Customer and other receivables

  $ 2,418      $             2,805   

Receivables from contracts with customers, which are included within Customer and other receivables in the balance sheets, arise when the Firm has both recorded revenues and has the right per the contract to bill customers.

20. Subsequent Events

The Firm has evaluated subsequent events for adjustment to or disclosure in the financial statements through the date of this report and has not identified any recordable or disclosable events not otherwise reported in these financial statements or the notes thereto.

 

 

  83   September 2018 Form 10-Q


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Average Balances and Interest Rates and Net Interest Income   

 

 

    Three Months Ended September 30,  
   

 

2018

     2017  
$ in millions  

 

Average

Daily
Balance

     Interest    

Annualized

Average
Rate

    

Average

Daily
Balance

     Interest     Annualized
Average
Rate
 

Interest earning assets1

              

Investment securities2

  $ 82,594      $ 440       2.1  %     $ 73,599      $ 313       1.7  % 

Loans2

    110,592        1,085       3.9        99,655        853       3.4  

Securities purchased under agreements to resell and Securities borrowed3:

              

U.S.

    139,418        637       1.8        128,127        190       0.6  

Non-U.S.

    89,825        (62     (0.3      99,019        (114     (0.5

Trading assets, net of Trading liabilities4:

              

U.S.

    55,399        508       3.6        58,000        463       3.2  

Non-U.S.

    8,637        63       2.9        5,826        43       3.0  

Customer receivables and Other5:

              

U.S.

    75,627        716       3.8        70,331        447       2.5  

Non-U.S.

    33,099        240       2.9        28,210        145       2.1  

Total

  $       595,191      $       3,627       2.4  %     $       562,767      $       2,340       1.7  % 

Interest bearing liabilities

              

Deposits2

  $ 173,921      $ 377       0.9  %     $ 150,116      $ 63       0.2  % 

Borrowings2, 6

    191,606        1,287       2.7        192,575        1,109       2.3  

Securities sold under agreements to repurchase and Securities loaned7:

              

U.S.

    24,386        346       5.6        30,027        234       3.1  

Non-U.S.

    34,960        132       1.5        38,536        91       0.9  

Customer payables and Other8:

              

U.S.

    120,958        321       1.1        129,365        (13      

Non-U.S.

    71,998        228       1.3        66,697        73       0.4  

Total

  $ 617,829      $ 2,691       1.7  %     $ 607,316      $ 1,557       1.0  % 

Net interest income and net interest rate spread

           $ 936       0.7  %              $ 783       0.7  % 

 

September 2018 Form 10-Q   84  


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Average Balances and Interest Rates and Net Interest Income

 

 

    Nine Months Ended September 30,  
    2018      2017  
$ in millions  

 

Average
Daily
Balance

    Interest     Annualized
Average
Rate
     Average
Daily
Balance
     Interest     Annualized
Average
Rate
 

Interest earning assets1

             

Investment securities2

  $ 80,886     $ 1,281       2.1  %     $ 76,356      $ 943       1.7  % 

Loans2

    109,001       3,097       3.8        97,099        2,399       3.3  

Securities purchased under agreements to resell and Securities borrowed3:

             

U.S.

    133,208       1,410       1.4        126,738        406       0.4  

Non-U.S.

    89,699       (254     (0.4      96,419        (320     (0.4

Trading assets, net of Trading liabilities4:

             

U.S.

    55,162       1,520       3.7        58,260        1,385       3.2  

Non-U.S.

    7,045       167       3.2        3,701        76       2.7  

Customer receivables and Other5:

             

U.S.

    71,293       1,880       3.5        68,611        1,128       2.2  

Non-U.S.

    33,747       680       2.7        26,743        394       2.0  

Total

  $       580,041     $       9,781       2.3  %     $       553,927      $       6,411       1.5  % 

Interest bearing liabilities

             

Deposits2

  $ 166,384     $ 809       0.7  %     $ 150,244      $ 88       0.1  % 

Borrowings2, 6

    192,746       3,683       2.6        181,544        3,197       2.4  

Securities sold under agreements to repurchase and Securities loaned7:

             

U.S.

    24,871       952       5.1        31,958        651       2.7  

Non-U.S.

    38,248       374       1.3        39,449        261       0.9  

Customer payables and Other8:

             

U.S.

    121,556       577       0.6        128,420        (196     (0.2

Non-U.S.

    71,382       569       1.1        64,257        105       0.2  

Total

  $ 615,187     $ 6,964       1.5     $ 595,872      $ 4,106       0.9  % 

Net interest income and net interest rate spread

          $ 2,817       0.8              $ 2,305       0.6  % 

 

1.  

Prior period amounts have been revised 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 and cash equivalents.

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 Notes 3 and 11 to the financial statements in the 2017 Form 10-K).

7.  

Includes fees received on Securities loaned. The annualized average rate was calculated using (a) interest expense incurred on all securities sold under agreements to repurchase and securities loaned transactions, whether or not such transactions were reported in the balance sheets and (b) net average on-balance sheet balances, which exclude certain securities-for-securities transactions.

8.  

Includes fees received from prime brokerage customers for stock loan transactions incurred to cover customers’ short positions.

 

  85   September 2018 Form 10-Q


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Financial Data Supplement (Unaudited)    LOGO
Effect of Volume and Rate Changes on Net Interest Income

 

 

   

Current Quarter

versus

Prior Year Quarter

    

Current Year Period

versus

Prior Year Period

 
   

 

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

  $ 38     $ 89     $ 127      $ 56     $ 282      $ 338  

Loans

    94       138       232        295       403        698  

Securities purchased under agreements to resell and Securities borrowed:

             

U.S.

    17       430       447        25       979        1,004  

Non-U.S.

    11       41       52        21       45        66  

Trading assets, net of Trading liabilities:

             

U.S.

    (21     66       45        (65     200        135  

Non-U.S.

    21       (1     20        51       40        91  

Customer receivables and Other:

             

U.S.

    34       235       269        52       700        752  

Non-U.S.

    25       70       95        95       191        286  

Change in interest income

  $ 219     $ 1,068     $ 1,287      $ 530     $ 2,840      $ 3,370  

Interest bearing liabilities

             

Deposits

  $ 10     $ 304     $ 314      $ 12     $ 709      $ 721  

Borrowings

    (6     184       178        201       285        486  

Securities sold under agreements to repurchase and Securities loaned:

             

U.S.

    (44     156       112        (160     461        301  

Non-U.S.

    (8     49       41        1       112        113  

Customer payables and Other:

             

U.S.

    1       333       334        8       765        773  

Non-U.S.

    6       149       155        11       453        464  

Change in interest expense

  $ (41   $ 1,175     $ 1,134      $ 73     $ 2,785      $ 2,858  

Change in net interest income

  $ 260     $ (107   $ 153      $ 457     $ 55      $ 512  

 

September 2018 Form 10-Q   86  


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Glossary of Common Acronyms    LOGO

 

2017 Form 10-K—Annual Report on Form 10-K for year ended December 31, 2017 filed with the SEC

ABS—Asset-backed securities

AFS—Available-for-sale

AML—Anti-money laundering

AOCI—Accumulated other comprehensive income (loss)

AUM—Assets under management or supervision

BHC—Bank holding company

bps—Basis points; one basis point equals 1/100th of 1%

CCAR—Comprehensive Capital Analysis and Review

CCyB—Countercyclical capital buffer

CDO—Collateralized debt obligations, including collateralized loan obligations

CDS—Credit default swaps

CECL—Current expected credit loss

CFTC—U.S. Commodity Futures Trading Commission

CLN—Credit-linked notes

CLO—Collateralized loan obligations

CMBS—Commercial mortgage-backed securities

CMO—Collateralized mortgage obligations

CVA—Credit valuation adjustment

DVA—Debt valuation adjustment

EBITDA—Earnings before interest, taxes, depreciation and amortization

ELN—Equity-linked note

EMEA—Europe, Middle East and Africa

EPS—Earnings per common share

ERISA—Employee Retirement Income Security Act of 1974

E.U.—European Union

FDIC—Federal Deposit Insurance Corporation

FFELP—Federal Family Education Loan Program

FVA—Funding valuation adjustment

GLR—Global liquidity reserve

G-SIB—Global systemically important banks

HQLA—High-quality liquid assets

HTM—Held-to-maturity

I/E—Intersegment eliminations

IM—Investment Management

IRS—Internal Revenue Service

IS—Institutional Securities

LCR—Liquidity coverage ratio, as adopted by the U.S. banking agencies

LIBOR—London Interbank Offered Rate

M&A—Merger, acquisition and restructuring transaction

MSBNA—Morgan Stanley Bank, N.A.

MS&Co.—Morgan Stanley & Co. LLC

MSIP—Morgan Stanley & Co. International plc

MSMS—Morgan Stanley MUFG Securities Co., Ltd.

MSPBNA—Morgan Stanley Private Bank, National Association

MSSB LLC—Morgan Stanley Smith Barney LLC

MUFG—Mitsubishi UFJ Financial Group, Inc.

MUMSS—Mitsubishi UFJ Morgan Stanley Securities Co., Ltd.

MWh—Megawatt hour

N/A—Not Applicable

NAV—Net asset value

N/M—Not Meaningful

Non-GAAP—Non-generally accepted accounting principles

NSFR—Net stable funding ratio, as proposed by the U.S. banking agencies

 

 

  87   September 2018 Form 10-Q


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Glossary of Common Acronyms    LOGO

 

 

OCC—Office of the Comptroller of the Currency

OCI—Other comprehensive income (loss)

OTC—Over-the-counter

PRA—Prudential Regulation Authority

RMBS—Residential mortgage-backed securities

ROE—Return on average common equity

ROTCE—Return on average tangible common equity

RSU—Restricted stock unit

RWA—Risk-weighted assets

SEC—U.S. Securities and Exchange Commission

SLR—Supplementary leverage ratio

S&P—Standard & Poor’s

SPE—Special purpose entity

SPOE—Single point of entry

TDR—Troubled debt restructuring

TLAC—Total loss-absorbing capacity

U.K.—United Kingdom

UPB—Unpaid principal balance

U.S.—United States of America

U.S. DOL—U.S. Department of Labor

U.S. GAAP—Accounting principles generally accepted in the United States of America

VaR—Value-at-Risk

VAT—Value-added tax

VIE—Variable interest entity

WACC—Implied weighted average cost of capital

WM—Wealth Management

 

 

September 2018 Form 10-Q   88  


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Other Information

Legal Proceedings

 

The following new matters and developments have occurred since previously reporting certain matters in the Firm’s 2017 Form 10-K, the Firm’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2018 (the “First Quarter Form 10-Q”) and the Firm’s Quarterly Report on Form 10-Q for the period ending June 30, 2018 (the “Second Quarter Form 10-Q”). See also the disclosures set forth under “Legal Proceedings” in the 2017 Form 10-K and Part II, Item 1 of the First Quarter Form 10-Q and the Second Quarter Form 10-Q.

Residential Mortgage and Credit Crisis Related Matters

On August 13, 2018, the Firm filed a motion to renew its motion to dismiss in 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, et al.

On September 13, 2018, the court affirmed the lower court’s order denying the Firm’s motion to dismiss the complaint relating to a securitization issued by Basket of Aggregated Residential NIMS 2007-I Ltd. in Financial Guaranty Insurance Company v. Morgan Stanley ABS Capital I Inc. et al.

On September 13, 2018, the court affirmed in part and reversed in part the lower court’s order denying the Firm’s motion to dismiss the complaint relating to the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4 in Financial Guaranty Insurance Company v. Morgan Stanley ABS Capital I Inc. et al. On October 15, 2018, the plaintiff filed a motion for leave to appeal the decision of the Appellate Division, First Department, to the New York Court of Appeals or, in the alternative, for reargument.

On October 8, 2018, the parties in the litigation styled Morgan Stanley Mortgage Loan Trust 2006-14SL, et al. v. Morgan Stanley Mortgage Capital Holdings LLC, filed a joint stipulation of discontinuance with prejudice.

On October 9, 2018, the Appellate Division, First Department affirmed the lower court’s order dismissing the amended complaint in Royal Park SA/NV v. Morgan Stanley et al.

On October 19, 2018, the court granted the Firm’s motion for leave to amend its answer in 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, et al., and to stay the case pending resolution of Deutsche Bank National Trust Company’s appeal to the New York Court of Appeals in another case.

European Matters

On September 11, 2018, in the matter styled Banco Popolare Societá Cooperativa v. Morgan Stanley & Co. International plc et al., the court dismissed in full the claim against the Firm.

On September 20, 2018, the Court of Accounts for the Republic of Italy in the matter styled Case number 2012/00406/MNV scheduled the hearing of the public prosecutor’s appeal for January 10, 2019.

Other Litigation

In August of 2017, the Firm was named as a defendant in a purported antitrust class action in the United States District Court for the SDNY styled Iowa Public Employees’ Retirement System et al. v. Bank of America Corporation et al. Plaintiffs allege, inter alia, that the Firm, together with a number of other financial institution defendants, violated U.S. antitrust laws and New York state law in connection with their alleged efforts to prevent the development of electronic exchange-based platforms for securities lending. The class action complaint was filed on behalf of a purported class of borrowers and lenders who entered into stock loan transactions with the defendants. The class action complaint seeks, among other relief, certification of the class of plaintiffs and treble damages. On September 27, 2018, the court denied the defendants’ motion to dismiss the class action complaint.

 

 

  89   September 2018 Form 10-Q


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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 current quarter ended September 30, 2018.

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 (July 1, 2018—July 31, 2018)

       

Share Repurchase Program2

    4,855,200     $ 50.77       4,855,200     $ 4,473  

Employee transactions3

    492,295     $ 50.33              

 

Month #2 (August 1, 2018—August 31, 2018)

       

Share Repurchase Program2

    9,539,000     $ 49.18       9,539,000     $ 4,004  

Employee transactions3

    12,162     $ 50.38              

 

Month #3 (September 1, 2018—September 30, 2018)

       

Share Repurchase Program2

    9,525,673     $ 48.75       9,525,673     $ 3,540  

Employee transactions3

    16,632     $ 48.47              

 

Quarter ended at September 30, 2018

       

Share Repurchase Program2

    23,919,873     $ 49.33       23,919,873     $ 3,540  

Employee transactions3

    521,089     $ 50.27              

 

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. On April 18, 2018, the Firm entered into a sales plan with Mitsubishi UFJ Financial Group, Inc. (“MUFG”) and Morgan Stanley & Co. LLC (“MS&Co.”) whereby MUFG will sell shares of the Firm’s common stock to the Firm, through the Firm’s agent MS&Co., as part of the Company’s share repurchase program (as defined below). The sales plan is only intended to maintain MUFG’s ownership percentage below 24.9% in order to comply with MUFG’s passivity commitments to the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and will have no impact on the strategic alliance between MUFG and the Firm, including the joint ventures in Japan.

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, 2018, the Federal Reserve published summary results of CCAR and the Firm received a conditional non-objection to its 2018 Capital Plan, where the only condition was that the Firm’s capital distributions not exceed the greater of the actual distributions it made over the previous four calendar quarters or the annualized average of actual distributions over the previous eight calendar quarters. As a result, the Firm’s 2018 Capital Plan includes a share repurchase of up to $4.7 billion of its outstanding common stock during the period beginning July 1, 2018 through June 30, 2019. During the quarter ended September 30, 2018, the Firm repurchased approximately $1.2 billion of the Firm’s outstanding common stock as part of its Share Repurchase Program. For further information, see “Liquidity and Capital Resources—Capital Management.”

3.  

Includes shares acquired by the Firm in satisfaction of the tax withholding obligations on stock-based awards granted under the Firm’s stock-based compensation plans.

 

September 2018 Form 10-Q   90  


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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.

Exhibits

An exhibit index has been filed as part of this Report on page E-1.

 

 

  91   September 2018 Form 10-Q


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Exhibit Index

Morgan Stanley

Quarter Ended September 30, 2018

 

    Exhibit No.      

Description

15  

Letter of awareness from Deloitte  & Touche LLP, dated November 5, 2018, 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 (unaudited): (i) the Consolidated Income Statements—Three Months and Nine Months Ended September 30, 2018 and 2017, (ii) the Consolidated Comprehensive Income Statements—Three Months and Nine Months Ended September 30, 2018 and 2017, (iii) the Consolidated Balance Sheets—at September 30, 2018 and December 31, 2017, (iv) the Consolidated Statements of Changes in Total Equity—Nine Months Ended September 30, 2018 and 2017, (v) the Consolidated Cash Flow Statements—Nine Months Ended September 30, 2018 and 2017, and (vi) Notes to Consolidated Financial Statements.

 

E-1


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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: November 5, 2018

 

S-1