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Morgan Stanley – ‘10-Q’ for 3/31/18

On:  Friday, 5/4/18, at 4:43pm ET   ·   For:  3/31/18   ·   Accession #:  1193125-18-152899   ·   File #:  1-11758

Previous ‘10-Q’:  ‘10-Q’ on 11/3/17 for 9/30/17   ·   Next:  ‘10-Q’ on 8/3/18 for 6/30/18   ·   Latest:  ‘10-Q’ on 11/3/20 for 9/30/20   ·   2 References:   

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  As Of               Filer                 Filing    For·On·As Docs:Size             Issuer                      Filing Agent

 5/04/18  Morgan Stanley                    10-Q        3/31/18  131:34M                                    Donnelley … Solutions/FA

Quarterly Report   —   Form 10-Q   —   Sect. 13 / 15(d) – SEA’34
Filing Table of Contents

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‘10-Q’   —   Quarterly Report
Document Table of Contents

Page (sequential)   (alphabetic) Top
 
11st Page  –  Filing Submission
"Table of Contents
"Management's Discussion and Analysis of Financial Condition and Results of Operations
"Introduction
"Executive Summary
"Business Segments
"Supplemental Financial Information and Disclosures
"Accounting Development Updates
"Critical Accounting Policies
"Liquidity and Capital Resources
"Quantitative and Qualitative Disclosures about Market Risk
"Report of Independent Registered Public Accounting Firm
"Financial Statements
"Consolidated Financial Statements and Notes
"Consolidated Income Statements (Unaudited)
"Consolidated Comprehensive Income Statements (Unaudited)
"Consolidated Balance Sheets (Unaudited at March 31, 2018)
"Consolidated Statements of Changes in Total Equity (Unaudited)
"Consolidated Cash Flow Statements (Unaudited)
"Notes to Consolidated Financial Statements (Unaudited)
"1. Introduction and Basis of Presentation
"2. Significant Accounting Policies
"3. Fair Values
"4. Derivative Instruments and Hedging Activities
"5. Investment Securities
"6. Collateralized Transactions
"7. Loans, Lending Commitments and Allowance for Credit Losses
"8. Equity Method Investments
"9. Deposits
"10. Borrowings and Other Secured Financings
"11. Commitments, Guarantees and Contingencies
"12. Variable Interest Entities and Securitization Activities
"13. Regulatory Requirements
"14. Total Equity
"15. Earnings per Common Share
"16. Interest Income and Interest Expense
"17. Employee Benefit Plans
"18. Income Taxes
"19. Segment and Geographic Information
"20. Revenues from Contracts with Customers
"21. Subsequent Events
"Financial Data Supplement (Unaudited)
"Glossary of Common Acronyms
"Other Information
"Legal Proceedings
"Unregistered Sales of Equity Securities and Use of Proceeds
"Controls and Procedures
"Exhibits
"Exhibit Index
"Signatures

This is an HTML Document rendered as filed.  [ Alternative Formats ]



  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 March 31, 2018

OR

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

EXCHANGE ACT OF 1934

Commission File Number 1-11758

LOGO

(Exact Name of Registrant as specified in its charter)

 

       

Delaware

(State or other jurisdiction of

incorporation or organization)

  

1585 Broadway

New York, NY 10036

(Address of principal executive offices, including zip code)

  

36-3145972

(I.R.S. Employer Identification No.)

  

(212) 761-4000

(Registrant’s telephone number, including area code)

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

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

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

 

Large Accelerated Filer    ☒

  

Accelerated Filer  ☐

Non-Accelerated Filer       ☐

  

Smaller reporting company  ☐

(Do not check if a smaller reporting company)

  

Emerging growth company  ☐

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

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

As of April 30, 2018, there were 1,770,260,439 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.


Table of Contents

LOGO

 

QUARTERLY REPORT ON FORM 10-Q

For the quarter ended March 31, 2018

 

Table of Contents

     Part        Item        Page  
Financial Information      I                 1  
Management’s Discussion and Analysis of Financial Condition and Results of Operations      I        2        1  

Introduction

                       1  

Executive Summary

                       2  

Business Segments

                       6  

Supplemental Financial Information and Disclosures

                       14  

Accounting Development Updates

                       15  

Critical Accounting Policies

                       15  

Liquidity and Capital Resources

                       15  
Quantitative and Qualitative Disclosures about Market Risk      I        3        29  
Report of Independent Registered Public Accounting Firm                        39  
Financial Statements      I        1        40  
Consolidated Financial Statements and Notes                        40  

Consolidated Income Statements (Unaudited)

                       40  

Consolidated Comprehensive Income Statements (Unaudited)

                       41  

Consolidated Balance Sheets (Unaudited at March 31, 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

                       57  

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

                       76  

14. Total Equity

                       78  

15. Earnings per Common Share

                       80  

16. Interest Income and Interest Expense

                       80  

17. Employee Benefit Plans

                       80  

18. Income Taxes

                       81  

19. Segment and Geographic Information

                       81  

20. Revenues from Contracts with Customers

                       82  

21. Subsequent Events

                       83  
Financial Data Supplement (Unaudited)                        84  
Glossary of Common Acronyms                        86  
Other Information      II                 88  
Legal Proceedings      II        1        88  
Unregistered Sales of Equity Securities and Use of Proceeds      II        2        89  
Controls and Procedures      I        4        90  
Exhibits      II        6        90  
Exhibit Index                        E-1  
Signatures                        S-1  

 

   i   


Table of Contents

Available Information

We file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any document we file with the SEC at the SEC’s public reference room at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an internet site, www.sec.gov, that contains annual, quarterly and current reports, proxy and information statements and other information that issuers file electronically with the SEC. Our electronic SEC filings are available to the public at the SEC’s internet site.

Our internet site is www.morganstanley.com. You can access our Investor Relations webpage at www.morganstanley.com/about-us-ir. We make available free of charge, on or through our Investor Relations webpage, our Proxy Statements, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (“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.

 

   ii   


Table of Contents
   LOGO

 

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, financing extended to equities and commodities customers, and loans to 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” and “Business—Supervision and Regulation,” “Risk Factors” in the 2017 Form 10-K and “Liquidity and Capital Resources—Regulatory Requirements” herein.

 

 

   1    March 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 $11,077 million in the quarter ended March 31, 2018 (“current quarter,” or “1Q 2018”), compared with $9,745 million in the quarter ended March 31, 2017 (“prior year quarter,” or “1Q 2017”). For the current quarter, net income applicable to Morgan Stanley was $2,668 million, or $1.45 per diluted common share, compared with $1,930 million, or $1.00 per diluted common share, in the prior year quarter.

Non-interest Expenses

($ in millions)

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Compensation and benefits expenses of $4,914 million in the current quarter increased 10% from $4,466 million in the prior year quarter, primarily due to increases in discretionary incentive compensation across segments, the formulaic payout to Wealth Management representatives linked to higher revenues and salaries, partially offset by a decrease in the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses were $2,743 million in the current quarter compared with $2,471 million in the prior year quarter representing an 11% increase. This increase was primarily a result of 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 20 to the financial statements for further information). These results were partially offset in the current quarter by the reversal of a portion of previously recorded provisions related to U.K. VAT matters.

 

 

March 2018 Form 10-Q    2   


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Management’s Discussion and Analysis    LOGO

 

Expense Efficiency Ratio1

 

 

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Return on Average Common Equity2

 

 

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Return on Average Tangible Common Equity2

 

 

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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.

 

Business Segment Results

Net Revenues by Segment1, 2 

($ in millions)

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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 also includes intersegment eliminations of $(115) million and $(74) million in the current quarter and prior year quarter, respectively.

3.

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

 

 

Institutional Securities net revenues of $6,100 million in the current quarter increased 18% from the prior year quarter, primarily reflecting higher sales and trading and Investment banking revenues across all regions.

 

 

Wealth Management net revenues of $4,374 million in the current quarter increased 8% from the prior year quarter, primarily reflecting growth in Asset management revenues.

 

 

Investment Management net revenues of $718 million in the current quarter increased 18% from the prior year quarter, primarily reflecting higher revenues from Asset management.

 

 

   3    March 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Net Revenues by Region1

($ 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.

Selected Financial Information and Other Statistical Data

 

     Three Months Ended
March 31,
 
$ in millions        2018              2017      

Income from continuing operations applicable to Morgan Stanley

   $ 2,670      $     1,952  

Income (loss) from discontinued operations applicable to Morgan Stanley

     (2      (22

Net income applicable to Morgan Stanley

     2,668        1,930  

Preferred stock dividends and other

     93        90  

Earnings applicable to Morgan Stanley common shareholders

   $ 2,575      $ 1,840  

 

in millions, except per share and
employee data
  At March 31,
2018
    At December 31,
2017
 

GLR1

  $ 206,463     $     192,660  

Loans2

  $ 109,135     $ 104,126  

Total assets

  $ 858,495     $ 851,733  

Deposits

  $ 160,424     $ 159,436  

Borrowings

  $ 194,964     $ 192,582  

Common shareholders’ equity

  $ 69,514     $ 68,871  

Common shares outstanding

    1,774       1,788  

Book value per common share3

  $ 39.19     $ 38.52  

Worldwide employees

    57,810       57,633  
in millions, except per share and
employee data
  At March 31,
2018
    At December 31,
2017
 

Capital ratios4

   

Common Equity Tier 1 capital ratio

    15.5     16.5

Tier 1 capital ratio

    17.7     18.9

Total capital ratio

    20.3     21.7

Tier 1 leverage ratio

    8.2     8.3

 

1.

For a discussion of the 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.

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.

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

4.

Beginning in 2018, our capital ratios are based on the Standardized Approach fully phased-in rules. At December 31, 2017, our 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.

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 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.

 

 

March 2018 Form 10-Q    4   


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

 

     Three Months Ended
March 31,
 
$ in millions, except per share data        2018              2017      

Net income applicable to Morgan Stanley

   $ 2,668      $     1,930  

Impact of adjustments

            14  

Adjusted net income applicable to Morgan Stanley—non-GAAP1

   $ 2,668        1,944  

Earnings per diluted common share

   $ 1.45      $ 1.00  

Impact of adjustments

            0.01  

Adjusted earnings per diluted common share—non-GAAP1

   $ 1.45      $ 1.01  

Effective income tax rate

     20.9%        29.0%  

Impact of adjustments

     —%        (0.5)%  

Adjusted effective income tax rate —non-GAAP1

     20.9%        28.5%  

 

                Average Monthly
Balance
 
    At March 31,
2018
    At December 31,
2017
    Three Months
Ended March 31,
 
$ in millions       2018     2017  

Tangible Equity

                               

U.S. GAAP

       

Morgan Stanley shareholders’ equity

  $ 78,034     $ 77,391     $ 77,507     $ 77,259  

Less: Goodwill and net intangible assets

    (9,129     (9,042     (9,043     (9,262

Morgan Stanley tangible shareholders’ equity—non-GAAP

  $ 68,905     $ 68,349     $ 68,464     $ 67,997  

U.S. GAAP

       

Common equity

  $ 69,514     $ 68,871     $ 68,987     $ 68,989  

Less: Goodwill and net intangible assets

    (9,129     (9,042     (9,043     (9,262

Tangible common equity—non-GAAP

  $ 60,385     $ 59,829     $     59,944     $     59,727  

Consolidated Non-GAAP Financial Measures

 

     Three Months Ended
March 31,
 
$ in billions    2018      2017  

Average common equity

     

Unadjusted

   $ 69.0      $ 69.0  

Adjusted1

     69.0        69.0  

ROE2

 

  

Unadjusted

     14.9%            10.7%  

Adjusted1, 3

         14.9%        10.7%  

Average tangible common equity

 

  

Unadjusted

   $ 59.9      $ 59.7  

Adjusted1

     59.9        59.7  

ROTCE2

 

  

Unadjusted

     17.2%        12.3%  

Adjusted1, 3

     17.2%        12.4%  

 

      At March 31,
2018
    

At December 31,

2017

 

Tangible book value per common share4

   $ 34.04      $ 33.46  

Non-GAAP Financial Measures by Business Segment

 

     Three Months Ended
March 31,
 
$ in billions    2018      2017  

Pre-tax profit margin5

     

Institutional Securities

     35%        34%  

Wealth Management

     27%        24%  

Investment Management

     21%        17%  

Consolidated

     31%        29%  

Average common equity6

     

Institutional Securities

   $             40.8      $             40.2  

Wealth Management

     16.8        17.2  

Investment Management

     2.6        2.4  

Parent Company

     8.8        9.2  

Consolidated average
common equity

   $ 69.0      $ 69.0  

Average tangible common equity6

 

  

Institutional Securities

   $ 40.1      $ 39.6  

Wealth Management

     9.2        9.3  

Investment Management

     1.7        1.6  

Parent Company

     8.9        9.2  

Consolidated average
tangible common equity

   $ 59.9      $ 59.7  

ROE2, 7

 

  

Institutional Securities

     15.2%        11.4%  

Wealth Management

     21.3%        14.6%  

Investment Management

     19.3%        11.1%  

Consolidated

     14.9%        10.7%  

ROTCE2, 7

 

  

Institutional Securities

     15.5%        11.5%  

Wealth Management

     38.9%        27.0%  

Investment Management

     30.3%        16.3%  

Consolidated

     17.2%        12.3%  

 

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 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 the Firm’s “ROE and ROTCE Targets” referred to below are the Adjusted ROE and Adjusted ROTCE amounts shown in this table.

4.

Tangible book value per common share equals tangible common equity divided by common shares outstanding.

5.

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

6.

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).

7.

The calculation of ROE and ROTCE by segment uses 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, allocated to each segment.

 

 

   5    March 2018 Form 10-Q


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Return on Equity and Tangible Common Equity Targets

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

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; capital levels; and intermittent discrete tax items. 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.

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.

 

 

March 2018 Form 10-Q    6   


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Institutional Securities

 

Income Statement Information

 

    Three Months Ended
March 31,
       
$ in millions   2018     2017     % Change  

Revenues

     

Investment banking

  $         1,513     $         1,417       7%  

Trading

    3,643       3,012       21%  

Investments

    49       66       (26)%  

Commissions and fees

    744       620       20%  

Asset management

    110       91       21%  

Other

    136       173       (21)%  

Total non-interest revenues

    6,195       5,379       15%  

Interest income

    1,804       1,124       60%  

Interest expense

    1,899       1,351       41%  

Net interest

    (95)       (227)       58%  

Net revenues

    6,100       5,152       18%  

Compensation and benefits

    2,160       1,870       16%  

Non-compensation expenses

    1,828       1,552               18%  

Total non-interest expenses

    3,988       3,422       17%  

Income from continuing operations before income taxes

    2,112       1,730       22%  

Provision for income taxes

    449       459       (2)%  

Income from continuing operations

    1,663       1,271       31%  

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

    (2)       (22)       91%  

Net income

    1,661       1,249       33%  

Net income applicable to
noncontrolling interests

    34       35       (3)%  

Net income applicable to
Morgan Stanley

  $ 1,627     $ 1,214       34%  

Investment Banking

Investment Banking Revenues

 

     Three Months Ended
March 31,
        
$ in millions    2018      2017      % Change  

Advisory

   $ 574      $ 496        16%  

Underwriting:

        

Equity

     421        390        8%  

Fixed income

     518        531        (2)%  

Total underwriting

     939        921        2%  

Total investment banking

   $         1,513      $         1,417        7%  

Investment Banking Volumes

 

     Three Months Ended
March 31,
 
$ in billions    2018      2017  

Completed mergers and acquisitions1

   $         145      $         163  

Equity and equity-related offerings2, 3

     21        10  

Fixed income offerings2, 4

     54        75  

Source: Thomson Reuters, data as of April 2, 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.

Amounts include transactions of $100 million or more. Completed mergers and acquisitions volumes are based on full credit to each of the advisors in a transaction.

2.

Equity and equity-related offerings and fixed income offerings are based on full credit for single book managers and equal credit for joint book managers.

3.

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

4.

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

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

Investment banking revenues of $1,513 million in the current quarter increased 7% from the prior year quarter. The adoption of the accounting update Revenue from Contracts with Customers had the effect of increasing the revenues reported in investment banking by approximately $60 million compared with the prior year quarter (see Notes 2 and 20 to the financial statements for further information). The drivers of the increase in our Investment banking revenues, other than the effect of the above accounting update, were:

 

 

Advisory revenues increased in the current quarter primarily reflecting higher M&A fee realizations on larger transactions.

 

 

Equity underwriting revenues increased in the current quarter primarily as a result of higher market volumes (see Investment Banking Volumes table), partially offset by the effect of lower fee realizations.

 

 

Fixed income underwriting revenues decreased in the current quarter primarily due to lower market volumes, which resulted in lower bond fees, partially offset by higher loan fees.

 

 

   7    March 2018 Form 10-Q


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Sales and Trading Net Revenues

By Income Statement Line Item

 

     Three Months Ended
March 31,
        
$ in millions    2018      2017      % Change  

Trading

   $         3,643      $         3,012        21%  

Commissions and fees

     744        620        20%  

Asset management

     110        91        21%  

Net interest

     (95)        (227)        58%  

Total

   $ 4,402      $ 3,496        26%  

By Business

 

     Three Months Ended
March 31,
        
$ in millions    2018      2017      % Change  

Equity

   $         2,558      $         2,016        27%  

Fixed income

     1,873        1,714        9%  

Other

     (29)        (234)        88%  

Total

   $ 4,402      $ 3,496        26%  

Sales and Trading Revenues—Equity and Fixed Income

 

     Three Months Ended
March 31, 2018
 
$ in millions    Trading      Fees1      Net
Interest2
     Total  

Financing

   $ 1,234      $ 107      $ (146    $ 1,195  

Execution services

     791        664        (92      1,363  

Total Equity

   $ 2,025      $     771      $ (238    $     2,558  

Total Fixed income

   $     1,715      $ 83      $           75      $ 1,873  

 

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

Financing

   $ 931      $ 89      $ (188    $ 832  

Execution services

     664        568        (48      1,184  

Total Equity

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

Total Fixed income

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

 

1.

Includes Commissions and fees and Asset management revenues.

2.

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

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 4 to the financial statements.

Equity

Equity sales and trading net revenues of $2,558 million in the current quarter increased 27% from the prior year quarter, reflecting higher results in both our financing businesses and execution services.

 

 

Financing revenues increased from the prior year quarter, primarily reflecting higher client activity across all products as reflected in Trading revenues.

 

 

Execution services increased from the prior year quarter, primarily reflecting higher Trading revenues driven by higher client activity in derivatives products. In addition, Commissions and fees increased from higher client activity in cash equities products.

Fixed Income

Fixed income net revenues of $1,873 million in the current quarter were 9% higher than in the prior year quarter, driven by higher results in global macro products and commodities products and other, partially offset by lower results in credit products.

 

 

Global macro products increased due to higher Trading revenues in foreign exchange driven by inventory management and client activity, partially offset by lower client activity in structured rates.

 

 

Credit products Trading revenues decreased primarily due to the effect of the widening of corporate credit spreads on inventory prices.

 

 

Commodities products and other increased primarily due to higher Trading revenues from hedging counterparty risk and increased Commodities structured transactions and customer flow in power and natural gas products.

Other

Other sales and trading net losses of $29 million in the current quarter decreased from the prior year quarter, primarily reflecting higher revenues on economic hedges related to our long-term debt and lower losses associated with corporate loan hedging activity.

 

 

March 2018 Form 10-Q    8   


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Investments, Other Revenues and Non-interest Expenses

Investments

 

 

Net investment gains of $49 million in the current quarter decreased from the prior year quarter as a result of losses on investments to which certain deferred compensation plans are referenced in the current quarter compared with gains in the prior year quarter.

Other Revenues

 

 

Other revenues of $136 million in the current quarter decreased from the prior year quarter, primarily reflecting lower gains associated with held-for-sale corporate loans.

Non-interest Expenses

Non-interest expenses of $3,988 million in the current quarter increased from the prior year quarter, primarily reflecting a 16% increase in Compensation and benefits expenses and an 18% increase in Non-compensation expenses in the current quarter.

 

 

Compensation and benefits expenses increased in the current quarter, primarily due to increases in discretionary incentive compensation driven by higher revenues and salaries.

 

 

Non-compensation expenses increased in the current quarter, primarily as a result of 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 20 to the financial statements for further information). These results were partially offset in the current quarter by the reversal of a portion of previously recorded provisions related to U.K. VAT matters.

 

 

   9    March 2018 Form 10-Q


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Wealth Management

Income Statement Information

 

    Three Months Ended
March 31,
       
$ in millions       2018             2017         % Change  

Revenues

     

Investment banking

  $ 140     $ 145       (3)%  

Trading

    109       238       (54)%  

Investments

          1       N/M  

Commissions and fees

    498       440       13%  

Asset management

    2,495       2,184       14%  

Other

    63       56       13%  

Total non-interest revenues

    3,305       3,064       8%  

Interest income

    1,280       1,079       19%  

Interest expense

    211       85       148%  

Net interest

    1,069       994       8%  

Net revenues

    4,374       4,058       8%  

Compensation and benefits

    2,450       2,317       6%  

Non-compensation expenses

    764       768       (1)%  

Total non-interest expenses

    3,214       3,085       4%  

Income from continuing operations before income taxes

    1,160       973       19%  

Provision for income taxes

    246       326       (25)%  

Net income applicable to Morgan Stanley

  $ 914     $ 647       41%  

Financial Information and Statistical Data

 

$ in billions    At
March 31,
2018
     At
December 31,
2017
 

Client assets

   $ 2,371      $ 2,373  

Fee-based client assets1

   $ 1,058      $ 1,045  

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

     45%        44%  

Client liabilities2

   $ 80      $ 80  

Investment securities portfolio

   $ 60.7      $ 59.2  

Loans and lending commitments

   $ 78.7      $ 77.3  

Wealth Management representatives

     15,682        15,712  

 

     Three Months Ended
March 31,
 
          2018              2017      

Per representative:

     

Annualized revenues ($ in thousands)3

   $ 1,115      $ 1,029  

Client assets ($ in millions)4

   $ 151      $ 139  

Fee-based asset flows ($ in billions)5

   $ 18.2      $ 18.8  

 

1.

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

2.

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

3.

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

4.

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

5.

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

Transactional Revenues

 

     Three Months Ended
March 31,
        
$ in millions    2018      2017      % Change  

Investment banking

   $ 140      $ 145        (3)%  

Trading

     109        238        (54)%  

Commissions and fees

     498        440        13%  

Total

   $ 747      $ 823        (9)%  

Transactional revenues as a % of Net revenues

     17%        20%     

Net Revenues

Transactional Revenues

Transactional revenues of $747 million in the current quarter decreased 9% from the prior year quarter primarily as a result of decreased Trading revenues, partially offset by increased Commissions and fees.

 

 

Investment banking revenues were relatively unchanged in the current quarter compared with prior year quarter.

 

 

Trading revenues decreased in the current quarter primarily as a result of losses related to investments associated with certain employee deferred compensation plans and lower client activity in fixed income products.

 

 

Commissions and fees increased in the current quarter primarily as a result of higher client trading activity in equities.

 

 

March 2018 Form 10-Q    10   


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Asset Management

Asset management revenues of $2,495 million in the current quarter increased 14% from the prior year quarter primarily due to the effect of market appreciation and net positive flows on average fee-based client assets.

See “Fee-Based Client Assets Rollforwards” herein.

Net Interest

Net interest of $1,069 million in the current quarter increased 8% from the prior year quarter primarily as a result of higher interest rates and higher loan balances.

Non-interest Expenses

Non-interest expenses of $3,214 million in the current quarter increased 4% from the prior year quarter.

 

 

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

 

 

Non-compensation expenses were relatively unchanged in the current quarter compared with prior year quarter.

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

December 31,
2017

    Inflows     Outflows     Market
Impact
   

At

March 31,
2018

 

Separately managed1

  $ 252     $ 10     $ (6   $ 4     $ 260  

Unified managed

    250       14       (8     (2     254  

Mutual fund advisory

    21             (1         —       20  

Advisor

    149       9       (9     (2     147  

Portfolio manager

    353       21       (12     (6     356  

Subtotal

  $ 1,025     $ 54     $ (36   $ (6   $ 1,037  

Cash management

    20       4       (3           21  

Total fee-based client assets

  $ 1,045     $     58     $     (39   $ (6   $     1,058  

 

$ in billions  

At

December 31,
2016

    Inflows     Outflows     Market
Impact
   

At

March 31,
2017

 

Separately managed1

  $ 222     $ 9     $ (5)     $ 4     $ 230  

Unified managed

    204       13       (9)       9       217  

Mutual fund advisory

    21             (1)       1       21  

Advisor

    125       10       (7)       5       133  

Portfolio manager

    285       20       (11)       11       305  

Subtotal

  $ 857     $     52     $     (33)     $     30     $     906  

Cash management

    20       3       (2)             21  

Total fee-based client assets

  $ 877     $ 55     $ (35)     $ 30     $ 927  

Average Fee Rates

 

     Three Months Ended
March 31,
 
Fee rate in bps        2018              2017          

Separately managed

     16        16  

Unified managed

     98        100  

Mutual fund advisory

     119        120  

Advisor

     85        86  

Portfolio manager

     96        98  

Subtotal

     76        77  

Cash management

     6        6  

Total fee-based client assets

     75        75  

 

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.

 

 

   11    March 2018 Form 10-Q


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Investment Management

Income Statement Information

 

    Three Months Ended
March 31,
       
$ in millions       2018             2017         % Change  

Revenues

     

Trading

  $ 5     $ (11     145%  

Investments

    77       98       (21)%  

Asset management

    626       517       21%  

Other

    10       4       150%  

Total non-interest revenues

    718       608       18%  

Interest income

    1       1       —%  

Interest expense

    1             N/M  

Net interest

          1       N/M  

Net revenues

    718       609       18%  

Compensation and benefits

    304       279       9%  

Non-compensation expenses

    266       227       17%  

Total non-interest expenses

    570       506       13%  

Income from continuing operations before income taxes

    148       103       44%  

Provision for income taxes

    19       30       (37)%  

Net income

    129       73       77%  

Net income (loss) applicable to noncontrolling interests

    2       6       (67)%  

Net income applicable to
Morgan Stanley

  $ 127     $ 67       90%  

Net Revenues

Investments

Investments gains of $77 million in the current quarter decreased 21% from the prior year quarter primarily as a result of lower carried interest in certain private equity funds.

Asset Management

Asset management revenues of $626 million in the current quarter increased 21% from the prior year quarter primarily as a result of higher average AUM across all asset classes. In addition, Asset management revenues increased as a result of the gross presentation of distribution fees due to the adoption of the accounting update Revenue from Contracts with Customers (see Notes 2 and 20 to the financial statements for further details).

In addition to the gross presentation described above, the timing of the recognition of certain performance fees not in the form of carried interest is generally expected to be deferred within a fiscal year until the fees are no longer probable of being reversed. Thus, the recognition of a greater portion of such revenues is expected to be recognized in the second half of each fiscal year based on current fee arrangements.

See “Assets Under Management or Supervision” herein.

Non-interest Expenses

Non-interest expenses of $570 million in the current quarter increased 13% from the prior year quarter primarily as a result of increases in both Compensation and benefits expenses and Non-compensation expenses.

 

 

Compensation and benefits expenses increased in the current quarter primarily as a result of increases in discretionary incentive compensation driven mainly by higher revenues, increases in salaries, and deferred compensation associated with carried interest.

 

 

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

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
December 31,
2017
    Inflows     Outflows     Market
Impact
    Other1     At
March 31,
2018
 

Equity

  $ 105     $ 9     $ (7   $ 1     $ 1     $ 109  

Fixed income

    73       7       (8     (1     1       72  

Alternative/Other

    128       4       (4           3       131  

Long-term AUM subtotal

    306       20       (19           5       312  

Liquidity

    176       325       (344                 157  

Total AUM

  $ 482     $ 345     $ (363   $     $ 5     $ 469  

Shares of minority stake assets

    7                                       7  
$ in billions   At
December 31,
2016
    Inflows     Outflows     Market
Impact
    Other1     At
March 31,
2017
 

Equity

  $ 79     $ 5     $ (5   $ 8     $     $ 87  

Fixed income

    60       5       (5     1       1       62  

Alternative/Other

    115       7       (4     1             119  

Long-term AUM subtotal

    254       17       (14     10       1       268  

Liquidity

    163       328       (338                 153  

Total AUM

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

Shares of minority stake assets

    8                                       7  

 

1.

Includes distributions and foreign currency impact for both periods and the impact of the Mesa West Capital, LLC acquisition in the current quarter.

 

 

March 2018 Form 10-Q    12   


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Average AUM

 

     Three Months Ended
March 31,
 
$ in billions              2018                          2017            

Equity

   $ 109      $ 83  

Fixed income

     73        62  

Alternative/Other

     129        117  

Long-term AUM subtotal

     311        262  

Liquidity

     163        157  

Total AUM

   $ 474      $ 419  

Shares of minority
stake assets

     7        7  

Average Fee Rate

 

     Three Months Ended
March 31,
 
Fee rate in bps              2018                          2017            

Equity

     76        74  

Fixed income

     35        33  

Alternative/Other

     68        71  

Long-term AUM

     63        63  

Liquidity

     18        18  

Total AUM

     47        46  
 

 

   13    March 2018 Form 10-Q


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Supplemental Financial Information and Disclosures

Income Tax Matters

Effective Tax Rate from Continuing Operations

 

     Three Months Ended
March 31,
 
          2018              2017      

U.S. GAAP

     20.9%        29.0%  

Adjusted effective income tax rate—non-GAAP1

     20.9%        28.5%  

 

1.

Adjusted amounts exclude an intermittent net discrete tax provision of $14 million in the prior year quarter. 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 non-GAAP measures, see “Selected Non-GAAP Financial Information” herein.

The effective tax rates include recurring-type discrete tax benefits associated with employee share-based payments of $147 million and $112 million in the current quarter and prior year quarter, respectively.

The effective tax rate reflects our current assumptions, estimates and interpretations related to the U.S. Tax Cuts and Jobs Act (“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 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. Taking into account continuing developments related to provisions of the Tax Act such as the modified territorial tax system and GILTI, we expect our effective tax rate from continuing operations for 2018 to be approximately 22% to 25% (see “Forward-Looking Statements” in the 2017 Form 10-K).

U.S. Bank Subsidiaries

We provide loans to a variety of customers, from large corporate and institutional clients to high net worth individuals, primarily through our U.S. bank subsidiaries, Morgan Stanley Bank N.A. (“MSBNA”) and Morgan Stanley Private Bank, National Association (“MSPBNA”) (collectively, “U.S. Bank Subsidiaries). The lending activities in the Institutional Securities business segment primarily include loans 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 the client base. For a further discussion of our credit risks, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Credit Risk.” For further discussion about loans and lending commitments, see Notes 7 and 11 to the financial statements.

U.S. Bank Subsidiaries’ Supplemental Financial Information1

 

$ in billions   

At
    March 31,    

2018

     At
  December 31,  
2017
 

Assets

   $ 188.3      $ 185.3  

Investment securities portfolio:

     

Investment securities—AFS

     43.1        42.0  

Investment securities—HTM

     18.0        17.5  

Total investment securities

   $ 61.1      $ 59.5  

Deposits2

   $ 160.1      $ 159.1  

Wealth Management

 

Securities-based lending and other loans3

   $ 41.7      $ 41.2  

Residential real estate loans

     26.6        26.7  

Total

   $ 68.3      $ 67.9  

Institutional Securities

 

Corporate loans

   $ 27.4      $ 24.2  

Wholesale real estate loans

     12.4        12.2  

Total

   $ 39.8      $ 36.4  

 

1.

Amounts exclude transactions with the Parent Company and between the bank subsidiaries.

2.

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

3.

Other loans primarily include tailored lending.

 

 

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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:

 

 

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 present value of the remaining rental payments. Key aspects of the latter include concluding upon the discount rate and determining whether to include non-lease components in rental payments. This update is effective as of January 1, 2019 with early adoption permitted.

 

 

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 with early adoption permitted as of January 1, 2019.

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.

 

 

   15    March 2018 Form 10-Q


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Total Assets by Business Segment

 

    At March 31, 2018  
$ in millions   IS     WM     IM     Total  

Assets

       

Cash and cash equivalents1

  $ 74,096     $ 13,173     $ 75     $ 87,344  

Trading assets at fair value

    269,200       85       3,759       273,044  

Investment securities

    19,913       60,728             80,641  

Securities purchased under agreements to resell

    72,460       7,786             80,246  

Securities borrowed

    135,608       227             135,835  

Customer and other receivables

    48,257       17,973       605       66,835  

Loans, net of allowance2

    40,804       68,326       5       109,135  

Other assets3

    14,447       9,305       1,663       25,415  

Total assets

  $   674,785     $   177,603     $   6,107     $   858,495  
    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 $858.5 billion at March 31, 2018 from $851.7 billion at December 31, 2017, primarily driven by an increase in Customer and other receivables and growth within the Institutional Securities loan portfolios. Trading Assets within the Institutional Securities business segment declined as we sold inventory in Equities to support increased demand and changes in client positioning. This was offset by increases in Securities borrowed and GLR cash deposits. For further information regarding our GLR, see “Global Liquidity Reserve” herein.

Securities Repurchase Agreements and Securities Lending

Securities borrowed or securities purchased under agreements to resell and securities loaned or securities sold under agreements to repurchase are treated as collateralized financings (see Note 2 to the financial statements in the 2017 Form 10-K and Note 6 to the financial statements).

Collateralized Financing Transactions

 

$ in millions    At
March 31,
2018
     At
December 31,
2017
 

Securities purchased under agreements to resell and Securities borrowed

   $         216,081      $         208,268  

Securities sold under agreements to repurchase and Securities loaned

   $ 65,131      $ 70,016  

Securities received as collateral1

   $ 8,693      $ 13,749  
     Average Daily Balance
Three Months Ended
 
$ in millions             March 31,
         2018
     December 31,
2017
 

Securities purchased under agreements to resell and Securities borrowed

   $ 211,753      $ 214,343  

Securities sold under agreements to repurchase and Securities loaned

   $ 65,684      $ 66,879  

 

1.

Included in Trading assets in the balance sheets.

Customer Securities Financing

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

Liquidity Risk Management Framework

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

The core components of our Liquidity Risk Management Framework are the Required Liquidity Framework, Liquidity Stress Tests and the 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

 

 

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Condition and Results of Operations—Liquidity and Capital Resources—Liquidity Risk Management Framework” in the 2017 Form 10-K.

At March 31, 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

March 31,
2018

     At
December 31,
2017
 

Cash deposits with banks1

   $ 9,930      $ 7,167  

Cash deposits with central banks1

     37,243        33,791  

Unencumbered highly liquid securities:

     

U.S. government obligations

     84,155        73,422  

U.S. agency and agency mortgage-backed securities

     51,805        55,750  

Non-U.S. sovereign obligations2

     20,334        19,424  

Other investment grade securities

     2,996        3,106  

Total

   $         206,463      $         192,660  

 

1.

Primarily 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 German, French, Dutch, U.K. and Japanese government obligations.

GLR Managed by Bank and Non-Bank Legal Entities

 

   

At
March 31,

2018

 

   

At
December 31,

2017

 

   

Average Daily     
Balance     
Three Months Ended     

 

 
$ in millions       March 31, 2018       

Bank legal entities

                       

Domestic

  $ 68,826     $ 70,364     $ 69,955  

Foreign

    4,602       4,756       4,263  

Total Bank legal entities

    73,428       75,120       74,218  

Non-Bank legal entities

 

   

Domestic:

     

Parent Company

    48,998       41,642       44,184  

Non-Parent Company

    32,415       35,264       32,356  

Total Domestic

    81,413       76,906       76,540  

Foreign

    51,622       40,634       44,216  

Total Non-Bank legal entities

    133,035       117,540       120,756  

Total

  $     206,463     $     192,660     $     194,974  

Regulatory Liquidity Framework

Liquidity Coverage Ratio

We and our U.S. Bank Subsidiaries are subject to the 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. 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        March 31, 2018      December 31, 2017  

HQLA

     

Cash deposits with central banks

   $ 33,350      $ 33,450  

Securities1

     125,015        125,269  

Total

   $ 158,365      $ 158,719  

LCR

     121%        128%  

 

1.

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

The decrease in the LCR in the current quarter is due to an increase in net outflows (the denominator of the ratio) driven by the impact of an increase in lending commitments, primarily within the Institutional Securities business segment.

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.

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

 

 

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

Unsecured Financing

For a discussion of our unsecured financing activities, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Funding Management—Unsecured Financing” in the 2017 Form 10-K and see Note 4 to the financial statements.

Deposits

 

$ in millions    At March 31,
2018
     At
December 31,
2017
 

Savings and demand deposits:

     

Brokerage sweep deposits1

   $ 129,177      $ 135,946  

Savings and other

     9,181        8,541  

Total Savings and demand deposits

     138,358        144,487  

Time deposits2

     22,066        14,949  

Total

   $         160,424      $         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 March 31, 2018 were up slightly compared with December 31, 2017, primarily driven by measures to increase Time deposits and Savings and other deposits, partially offset by a reduction in Brokerage sweep deposits due to client deployment of cash into investments.

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.

 

 

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Borrowings by Remaining Maturity at March 31, 20181

 

$ in millions    Parent
Company
     Subsidiaries      Total  

Original maturities of one year or less

   $ —        $ 1,256      $ 1,256  

Original maturities greater than one year

 

  

2018

   $ 12,783      $ 3,318      $ 16,101  

2019

     21,765        3,769        25,534  

2020

     18,775        2,284        21,059  

2021

     20,163        2,650        22,813  

2022

     15,261        1,985        17,246  

Thereafter

     78,873        12,082        90,955  

Total

   $ 167,620      $ 26,088      $ 193,708  

Total Borrowings

   $       167,620      $       27,344      $       194,964  

Maturities over next 12 months2

 

   $ 23,029  

 

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 increased to $194,964 million as of March 31, 2018 compared with $192,582 million at December 31, 2017. This increase is a result of issuances, partially offset primarily by maturities and retirements as presented in the following table.

 

$ in millions    Three Months Ended
March 31, 2018
 

Issued

   $ 15,370  

Matured or retired

     11,377  

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.

 

Parent Company and MSBNA Senior Unsecured Ratings at April 30, 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  

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

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

Incremental Collateral or Terminating Payments upon

Potential Future Rating Downgrade

 

$ in millions   

At
March 31,

2018

    

At
December 31,

2017

 

One-notch downgrade

   $ 806      $ 822  

Two-notch downgrade

     611        596  
 

 

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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
March 31,
 

$ in millions

     2018        2017  

Repurchases of common stock under our share repurchase program

   $         1,250      $         750  

From time to time we repurchase our outstanding common stock, including as part of our share repurchase program. As previously announced, on April 18, 2018, we entered into a sales plan with Mitsubishi UFJ Financial Group, Inc. (“MUFG”) whereby MUFG will sell 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 Federal Reserve and will have no impact on the strategic alliance between MUFG and us, including the joint venture 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

   April 18, 2018

Amount per share

   $0.25

Date to be paid

   May 15, 2018

Shareholders of record as of

   April 30, 2018

Preferred Stock

Preferred Stock Dividend Announcement

 

Announcement date

   March 15, 2018

Date paid

   April 16, 2018

Shareholders of record as of

   March 29, 2018

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

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 Board of Governors of the Federal Reserve System (“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. The regulatory capital requirements are largely based on the Basel III capital standards established by the Basel Committee and also implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).

Regulatory Capital Requirements

We are required to maintain minimum risk-based and leverage 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 Requirements—Regulatory Capital Requirements” in the 2017 Form 10-K.

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.

 

 

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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 2017 and 2018, each of the buffers is 50% and 75%, respectively, of the 2019 requirement noted above. 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 March 31, 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.

Regulatory Capital Ratios

 

     At March 31, 2018  
            Fully Phased-In  
$ in millions    Required
Ratio
     Standardized      Advanced  

Risk-based capital

        

Common Equity Tier 1 capital

      $ 60,568      $ 60,568  

Tier 1 capital

              69,213        69,213  

Total capital

              79,363        79,138  

Total RWA

              390,390        378,442  

Common Equity Tier 1 capital ratio

     8.6%        15.5%        16.0%  

Tier 1 capital ratio

     10.1%        17.7%        18.3%  

Total capital ratio

     12.1%        20.3%        20.9%  

Leverage-based capital

        

Adjusted average assets1

            $       846,868        N/A  

Tier 1 leverage ratio

     4.0%        8.2%        N/A  

 

    At December 31, 2017  
          Transitional2     Fully Phased-In  
$ in millions   Required
Ratio
    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  

 

1.

Adjusted average assets represent the denominator of the Tier 1 leverage ratio and are composed of the average daily balance of consolidated on-balance sheet assets under U.S. GAAP during the 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.

2.

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 utilize 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 because 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.

 

 

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Well-Capitalized Regulatory Capital Ratio Requirements for U.S. Bank Subsidiaries

 

      At March 31, 2018  

Common Equity Tier 1 risk-based capital ratio

     6.5%  

Tier 1 risk-based capital ratio

     8.0%  

Total risk-based capital ratio

     10.0%  

Tier 1 leverage ratio

     5.0%  

SLR

     6.0%  

For us to remain an FHC, our U.S. Bank Subsidiaries must qualify as well-capitalized by maintaining the ratio requirements set forth in the previous table. The Federal Reserve has not yet revised the well-capitalized standard for FHCs to reflect the higher capital standards required of us under the capital rules. Assuming that the Federal Reserve would apply the same or very similar well-capitalized standards to FHCs, each of our risk-based capital ratios, Tier 1 leverage ratio and SLR at March 31, 2018 would have exceeded the revised well-capitalized standard. The Federal Reserve may require an FHC to maintain risk- and leverage-based capital ratios substantially in excess of mandated well-capitalized levels, depending upon general economic conditions and the FHC’s particular condition, risk profile and growth plans.

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 March 31, 2018.

Fully Phased-In Regulatory Capital

 

$ in millions  

At

March 31, 2018

   

At

December 31, 20171

 

Common Equity Tier 1 capital

   

Common stock and surplus

  $ 12,911     $ 14,354  

Retained earnings

    60,009       57,577  

AOCI

    (3,406     (3,060

Regulatory adjustments and deductions:

   

Net goodwill

    (6,716     (6,599

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

    (2,424     (2,446

Other adjustments and deductions2

    194       738  

Total Common Equity Tier 1 capital

  $ 60,568     $ 60,564  

Additional Tier 1 capital

   

Preferred stock

  $ 8,520     $ 8,520  

Noncontrolling interests

    482       415  

Other adjustments and deductions

    (23     (23

Additional Tier 1 capital

  $ 8,979     $ 8,912  

Deduction for investments in covered funds

    (334     (356

Total Tier 1 capital

  $ 69,213     $ 69,120  

Standardized Tier 2 capital

   

Subordinated debt

  $ 9,612     $ 9,839  

Noncontrolling interests

    113       98  

Eligible allowance for credit losses

    448       423  

Other adjustments and deductions

    (23     (10

Total Standardized Tier 2 capital

  $ 10,150     $ 10,350  

Total Standardized capital

  $ 79,363     $ 79,470  

Advanced Tier 2 capital

   

Subordinated debt

  $ 9,612     $ 9,839  

Noncontrolling interests

    113       98  

Eligible credit reserves

    223       193  

Other adjustments and deductions

    (23     (10

Total Advanced Tier 2 capital

  $ 9,925     $ 10,120  

Total Advanced capital

  $ 79,138     $               79,240  
 

 

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Fully Phased-In Regulatory Capital Rollforward

 

$ in millions   Three Months Ended
March 31, 2018
 

Common Equity Tier 1 capital

 

Common Equity Tier 1 capital at December 31, 20171

  $ 60,564  

Change related to the following items:

 

Value of shareholders’ common equity

    643  

Net goodwill

    (117

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

    22  

Other adjustments and deductions2

    (544

Common Equity Tier 1 capital at March 31, 2018

  $ 60,568  

Additional Tier 1 capital

 

Additional Tier 1 capital at December 31, 20171

  $ 8,912  

Change related to the following items:

 

Noncontrolling interests

    67  

Other adjustments and deductions

     

Additional Tier 1 capital at March 31, 2018

    8,979  

Deduction for investments in covered funds at December 31, 2017

    (356

Change in deduction for investments in covered funds

    22  

Deduction for investments in covered funds at March 31, 2018

    (334

Tier 1 capital at March 31, 2018

  $ 69,213  

Standardized Tier 2 capital

 

Tier 2 capital at December 31, 20171

  $ 10,350  

Change related to the following items:

 

Eligible allowance for credit losses

    25  

Other changes, adjustments and deductions3

    (225

Standardized Tier 2 capital at March 31, 2018

  $ 10,150  

Total Standardized capital at March 31, 2018

  $ 79,363  

Advanced Tier 2 capital

 

Tier 2 capital at December 31, 20171

  $ 10,120  

Change related to the following items:

 

Eligible credit reserves

    30  

Other changes, adjustments and deductions3

    (225

Advanced Tier 2 capital at March 31, 2018

  $ 9,925  

Total Advanced capital at March 31, 2018

  $ 79,138  

 

1.

The pro forma fully phased-in estimates as of December 31, 2017 are non-GAAP financial measures. See “Selected Non-GAAP Financial Information” herein.

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.

3.

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

Fully Phased-In RWA Rollforward

 

     Three Months Ended
March 31, 20181
 
$ in millions    Standardized      Advanced  

Credit risk RWA

     

Balance at December 31, 20172

   $ 301,946      $ 170,754  

Change related to the following items:

     

Derivatives

     (229      3,568  

Securities financing transactions

     177        2,242  

Securitizations

     (357      (1,277

Investment securities

     (270      320  

Commitments, guarantees and loans

     12,934        15,090  

Cash

     784        294  

Equity investments

     2,726        2,887  

Other credit risk3

     634        236  

Total change in credit risk RWA

   $ 16,399      $ 23,360  

Balance at March 31, 2018

   $ 318,345      $ 194,114  

Market risk RWA

     

Balance at December 31, 20172

   $ 75,295      $ 74,907  

Change related to the following items:

     

Regulatory VaR

     1,187        1,187  

Regulatory stressed VaR

     235        235  

Incremental risk charge

     2,968        2,968  

Comprehensive risk measure

     (2,135      (1,947

Specific risk:

                 

Non-securitizations

     (2,590      (2,590

Securitizations

     (2,915      (2,917

Total change in market risk RWA

   $ (3,250    $ (3,064

Balance at March 31, 2018

   $ 72,045      $ 71,843  

Operational risk RWA

     

Balance at December 31, 20172

   $ N/A      $ 112,663  

Change in operational risk RWA

     N/A        (178

Balance at March 31, 2018

   $ N/A      $ 112,485  

Total RWA

   $ 390,390      $     378,442  

Regulatory VaR—VaR for regulatory capital requirements

1.

The RWA for each category in the table 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. See “Selected Non-GAAP Financial Information” herein.

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 quarter under the Standardized and Advanced Approaches primarily due to increased exposures in corporate lending within the Institutional Securities business segment. Credit risk RWA also increased under the Advanced Approach due to increased exposures in derivatives.

Market risk RWA decreased in the current quarter under the Standardized and Advanced Approaches primarily due to a decrease in standardized specific risk charges.

 

 

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The decrease in operational risk RWA under the Advanced Approach reflects a reduction in the internal loss frequency related to litigation utilized in the operational risk capital model.

Supplementary Leverage Ratio

Supplementary Leverage Exposure and Ratio

 

     At March 31,
2018
     At December 31, 2017  

$ in millions

   Fully Phased-in      Transitional
Basis1
     Fully
Phased-in2
 

Average total assets3

   $ 856,738      $ 851,510      $ 851,510  

Adjustments4, 5

     234,780        231,173        230,660  

Supplementary leverage exposure

   $ 1,091,518      $       1,082,683      $       1,082,170  

SLR

     6.3%        6.5%        6.4%  

 

1.

Transitional provisions applied until December 31, 2017.

2.

Estimated amounts utilize fully phased-in Tier 1 capital, including the fully phased-in Tier 1 capital deductions that apply beginning January 1, 2018.

3.

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

4.

Computed as the average of the month-end balances over the current quarter and the quarter ended December 31, 2017.

5.

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

The SLR became effective as a capital standard on January 1, 2018. We are required to maintain a Tier 1 supplementary leverage ratio 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 limitations on capital distributions, including dividends and stock repurchases, and discretionary bonus payments to executive officers. In addition, our U.S. Bank Subsidiaries must maintain an SLR of 6% to be considered well-capitalized.

U.S. Bank Subsidiaries’ Fully Phased-In Supplementary Leverage Ratios

 

      At March 31, 2018      At December 31, 20171  

MSBNA

     9.0%        9.1%  

MSPBNA

     9.3%        9.3%  

 

1.

Estimated amounts utilize fully phased-in Tier 1 capital, including the fully phased-in Tier 1 capital deductions that apply beginning January 1, 2018.

The pro forma transitional and fully phased-in supplementary leverage exposures and ratios are non-GAAP financial measures because they were not yet effective at December 31, 2017.

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. We expect that the Federal Reserve will provide its response to our 2018 Capital Plan by June 30, 2018. There could be a range of potential outcomes to our Capital Plan whereby the Federal Reserve could object to, or otherwise require us to modify, such plan. See “Risk Factors” in the 2017 Form 10-K. The Federal Reserve is expected to publish summary results of the CCAR and Dodd-Frank Act supervisory stress tests of each large BHC, including us, by

 

 

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June 30, 2018. We are required to disclose a summary of the results of our company-run stress tests within 15 days of the date the Federal Reserve discloses the results of the supervisory stress tests. In addition, we must submit the results of our mid-cycle company-run stress test to the Federal Reserve by October 5, 2018 and disclose a summary of the results between October 5, 2018 and November 4, 2018.

The Dodd-Frank Act also requires each of our U.S. Bank Subsidiaries 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 must publish a summary of their stress test results between June 15, 2018 and July 15, 2018.

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

Common equity estimation and attribution to the business segments are based on our 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 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
March 31,
 

$ in billions

   2018      2017  

Institutional Securities

       $ 40.8      $ 40.2  

Wealth Management

     16.8        17.2  

Investment Management

     2.6        2.4  

Parent Company

     8.8        9.2  

Total

       $             69.0      $             69.0  

 

1.

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

Regulatory Developments

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 support agreement with its 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.

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.

 

 

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Volcker Rule

The Volcker Rule prohibits “banking entities,” including us and our affiliates, from engaging in certain “proprietary trading” activities, as defined in the Volcker Rule, subject to exemptions for underwriting, market-making-related activities, risk-mitigating hedging and certain other activities. The Volcker Rule also prohibits certain investments and relationships by banking entities with “covered funds,” with a number of exemptions and exclusions. For more information about the Volcker Rule, see “Business—Supervision and Regulation—Activities Restrictions under the Volcker Rule” in the 2017 Form 10-K.

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, with certain aspects subject to phased-in compliance. Full compliance with the rule’s related exemptions was scheduled to be required by July 1, 2019. However, 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. While the U.S. DOL could appeal to the U.S. Supreme Court, the order to vacate the rule could take effect as soon as May 7, 2018. For a discussion of the U.S. DOL Conflict of Interest Rule, see “Business—Supervision and Regulation—Institutional Securities and Wealth Management” in the 2017 Form 10-K.

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. We are reviewing the SEC’s package of proposed rules.

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 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.

 

 

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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, which may be as early as 2018 under the proposal.

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 the Firm. 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.

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 withdrawal 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 Market Risk—Risk Management—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 the Secured Overnight Financing Rate (“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.

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.

 

 

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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 Market Risk—Risk Management—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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Quantitative and Qualitative Disclosures about Market Risk

 

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.

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

Trading Risks

95%/One-Day Management VaR

 

    95%/One-Day VaR for
the Three Months Ended
March 31, 2018
 

$ in millions

 

    Period    

End

    Average     High     Low  

Interest rate and credit spread

      $ 41     $ 35     $ 46     $ 30  

Equity price

    16       14       17       11  

Foreign exchange rate

    10       9       13       7  

Commodity price

    10       9       11       7  

Less: Diversification benefit1, 2

    (27     (25     N/A       N/A  

Primary Risk Categories

      $ 50     $     42     $   51     $   36  

Credit Portfolio

    11       10       11       9  

Less: Diversification benefit1, 2

    (7     (6     N/A       N/A  

Total Management VaR

      $ 54     $ 46     $ 55     $ 40  
    95%/One-Day VaR for
the Three Months Ended
December 31, 2017
 

$ in millions

 

Period

End

    Average     High     Low  

Interest rate and credit spread

      $ 32     $ 29     $ 36     $ 24  

Equity price

    11       13       15       10  

Foreign exchange rate

    9       8       11       6  

Commodity price

    7       8       11       6  

Less: Diversification benefit1, 2

    (20     (23     N/A       N/A  

Primary Risk Categories

      $ 39     $   35     $    41     $    30  

Credit Portfolio

    9       9       10       8  

Less: Diversification benefit1, 2

    (5     (6     N/A       N/A  

Total Management VaR

      $ 43     $ 38     $ 44     $ 34  

 

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 $46 million and $42 million, respectively, increased from the three-months ended December 31, 2017, primarily as a result of increases in trading inventory across the Fixed Income Macro and Credit trading businesses in the Institutional Securities business segment and increased market volatility, particularly in Equities.

 

 

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Distribution of VaR Statistics and Net Revenues for the current quarter.    One method of evaluating the reasonableness of our VaR model as a measure of our potential volatility of net revenues is to compare VaR with 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. During the current quarter, we experienced net trading losses on one day, which was not in excess of the 95%/one-day Total Management VaR.

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 $46 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 also include intraday trading activities but exclude certain items not captured in the VaR model, such as fees, commissions and net interest income. Daily net trading revenues differ from the definition of revenues required for Regulatory VaR backtesting, which further excludes intraday trading.

Daily Net Trading Revenues for the Current Quarter

($ in millions)

 

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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
March 31, 2018
     At
December 31, 2017
 

Derivatives

   $ 6      $ 6  

Funding liabilities2

     31        29  

 

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, including our deposit deployment strategy and asset-liability management hedges.

 

 

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

 

$ in millions   

At

March 31, 2018

    

At

December 31, 2017

 

Basis point change

     

+200

   $ 438      $ 489  

+100

     226        367  

-100

     (464      (500

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 between March 31, 2018 and December 31, 2017 is related to overall changes in our asset-liability profile and higher market 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

March 31,

2018

    

At

December 31,

2017

 

Investments related to Investment

     

Management activities

   $ 321      $ 316  

Other investments:

     

MUMSS

     172        168  

Other Firm investments

     187        178  

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.

 

 

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Loans and Lending Commitments

 

    At March 31, 2018  
$ in millions   IS     WM     IM1     Total  

Corporate loans

  $ 17,005     $ 14,893     $ 5     $ 31,903  

Consumer loans

          26,877             26,877  

Residential real estate loans

          26,566             26,566  

Wholesale real estate loans

    10,021                   10,021  

Loans held for investment, gross of allowance

    27,026       68,336       5       95,367  

Allowance for loan losses

    (201     (42           (243

Loans held for investment, net of allowance

    26,825       68,294       5       95,124  

Corporate loans

    12,000                   12,000  

Residential real estate loans

    1       32             33  

Wholesale real estate loans

    1,978                   1,978  

Loans held for sale

    13,979       32             14,011  

Corporate loans

    9,323             23       9,346  

Residential real estate loans

    706                   706  

Wholesale real estate loans

    1,770             1,171       2,941  

Loans held at fair value

    11,799             1,194       12,993  

Total loans

    52,603       68,326       1,199       122,128  

Lending commitments2, 3

    109,025       10,404       187       119,616  

Total loans and lending commitments2, 3

  $     161,628     $     78,730     $     1,386     $     241,744  

 

    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 quarter 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 $25 billion in the current quarter, primarily due to increases in Corporate lending commitments within the Institutional Securities business segment.

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

Allowance for Loans and Lending Commitments Held for Investment

 

$ in millions    At
March 31,
2018
     At
December 31,
2017
 

Loans

   $                 243      $ 224  

Lending commitments

     205        198  

The aggregate allowance for loans and lending commitment losses increased during the current quarter 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 March 31, 2018      At December 31, 2017  
          IS                WM                  IS                WM      

Current

     99.7%        99.9%        99.5%        99.9%  

Non-accrual1

     0.3%        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.

 

 

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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, financing extended to equities and commodities customers and loans to municipalities. These loans and lending commitments may have varying terms; may be senior or subordinated; may be secured or unsecured; are generally contingent upon representations, warranties and contractual conditions applicable to the borrower; and may be syndicated, traded or hedged by us.

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

Institutional Securities Loans and Lending Commitments1

 

    At March 31, 2018  
    Years to Maturity        
$ in millions   Less than 1     1-3     3-5     Over 5     Total  

Loans

         

AA

  $     $ 450     $ 28     $ 5     $ 483  

A

    1,435       2,262       1,287       389       5,373  

BBB

    3,626       8,398       3,709       875       16,608  

NIG

    6,213       10,940       7,521       3,199       27,873  

Unrated2

    59       98       262       1,847       2,266  

Total loans

    11,333       22,148       12,807       6,315       52,603  

Lending commitments

 

       

AAA

          165                   165  

AA

    3,127       1,348       2,707             7,182  

A

    4,374       14,521       11,316       425       30,636  

BBB

    4,865       14,276       18,546       166       37,853  

NIG

    1,436       11,241       13,636       6,801       33,114  

Unrated2

    1       25       10       39       75  

Total lending
commitments

    13,803       41,576       46,215       7,431       109,025  

Total exposure

  $ 25,136     $     63,724     $     59,022     $     13,746     $     161,628  

 

    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 Market Risk—Risk Management—Market Risk” herein.

Institutional Securities Loans and Lending Commitments by Industry

 

$ in millions

  

At

March 31,

2018

    

At

December 31,

2017

 

Industry

     

Real estate

   $ 28,847      $ 28,426  

Financials

     27,224        22,112  

Consumer discretionary

     15,706        11,555  

Industrials

     13,768        11,090  

Information technology

     12,434        11,862  

Insurance

     10,747        4,739  

Healthcare

     10,456        9,956  

Energy

     10,354        10,233  

Utilities

     10,296        9,592  

Consumer staples

     10,054        8,315  

Materials

     5,123        5,069  

Telecommunications services

     4,533        4,172  

Other

     2,086        2,450  

Total

   $         161,628      $         139,571  

Institutional Securities business segment loans and lending commitments are mainly related to relationship-based and event-driven lending to select corporate clients. Relationship-based loans and lending commitments are used for general corporate purposes, working capital and liquidity purposes by our investment banking clients and typically consist of

 

 

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revolving lines of credit, letter of credit facilities and term loans. In connection with the relationship-based lending activities, we enter into hedges, as detailed below.

Relationship-based Lending Activities Hedges—Notional Amounts

 

$ in billions

  

At

March 31,

2018

    

At

December 31,

2017

 

Single-name and index CDS

   $ 15.0      $ 16.6  

Event-Driven Loans and Lending Commitments

 

    At March 31, 2018  
    Years to Maturity        
$ in millions     Less than 1     1-3     3-5     Over 5     Total  

Loans

    $ 2,631     $ 689     $ 518     $ 1,835     $ 5,673  

Lending commitments

    2,902       11,963       3,262       3,982       22,109  

Total loans and lending commitments

    $ 5,533     $   12,652     $   3,780     $   5,817     $   27,782  

 

    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 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 quarter is primarily due to an increase in held-for-sale commitments driven by new client transactions in the latter part of the quarter.

Wealth Management

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

Securities-based lending provided to our retail clients is primarily conducted through our 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.

Wealth Management Loans and Lending Commitments

 

    At March 31, 2018  
    Contractual Years to Maturity        
$ in millions     Less than 1     1-3     3-5     Over 5     Total  

Securities-based lending and other loans1

    $ 34,730     $ 3,789     $ 1,849     $ 1,382     $ 41,750  

Residential real estate loans

          30       10       26,536       26,576  

Total loans

    $ 34,730     $ 3,819     $ 1,859     $ 27,918     $ 68,326  

Lending commitments

    7,392       2,283       444       285       10,404  

Total loans and lending commitments

    $ 42,122     $   6,102     $   2,303     $   28,203     $   78,730  

 

    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 loans1

    $ 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  

 

1.

The Liquidity Access Line platform had an outstanding loan balance of $32.1 billion and $32.2 billion at March 31, 2018 and December 31, 2017, respectively.

For the current quarter, loans and lending commitments associated with the Wealth Management business segment lending activities increased by approximately 2%, primarily due to growth in securities-based lending and other loans.

Lending Activities Included in Customer and Other Receivables

Margin Loans

 

     At March 31, 2018  
$ in millions    IS      WM      Total  

Net customer receivables
representing margin loans

   $     22,396      $     11,986      $     34,382  

 

     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 the client 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.

 

 

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Employee Loans

 

$ in millions

  

At

March 31,

2018

    

At

December 31,

2017

 

Employee loans:

     

Balance

   $ 3,687      $     4,185  

Allowance for loan losses

     (75      (77

Balance, net

   $ 3,612      $ 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. See Note 7 to the financial statements for a further description of our employee loans.

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.

Fair values as shown below represent the Firm’s net exposure to counterparties related to its OTC derivative products. Obligor credit ratings are determined internally by the Credit Risk Management department.

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

 

    Credit Rating        
                            Non-        
                            investment        
$ in millions   AAA     AA     A     BBB     grade     Total  

At March 31, 2018

 

       

< 1 year

  $ 543     $ 5,281     $ 37,768     $ 12,570     $ 6,192     $ 62,354  

1-3 years

    690       3,687       22,356       7,981       4,425       39,139  

3-5 years

    767       2,907       15,236       5,093       4,989       28,992  

Over 5 years

    4,813       11,955       77,582       36,990       12,395       143,735  

Total, gross

  $   6,813     $   23,830     $   152,942     $   62,634     $     28,001     $   274,220  

Counterparty Netting

    (3,339     (15,278     (123,256     (44,638     (15,195     (201,706

Cash and Securities collateral

    (3,158     (6,512     (24,812     (12,055     (9,077     (55,614

Total, net

  $ 316     $ 2,040     $ 4,874     $ 5,941     $ 3,729     $ 16,900  

 

    Credit Rating1        
$ in millions   AAA     AA     A     BBB    

Non-

investment

grade

    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.

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

March 31,

2018

    

At

December 31,

2017

 

Industry

  

Utilities

   $ 4,912      $ 4,382  

Financials

     4,245        3,330  

Industrials

     1,335        1,124  

Regional governments

     1,002        1,005  

Information technology

     869        715  

Healthcare

     842        882  

Energy

     656        646  

Not-for-profit organizations

     633        703  

Sovereign governments

     502        1,084  

Consumer discretionary

     463        464  

Real estate

     378        374  

Materials

     276        329  

Insurance

     243        206  

Consumer staples

     118        161  

Other

     426        270  

Total1

   $ 16,900      $     15,675  

 

1.

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

 

 

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For additional credit exposure information on our credit derivative portfolio, 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 instruments entered into with sovereign and local governments. Our non-sovereign exposures consist of financial instruments

entered into primarily with corporations and financial institutions. The following table shows our 10 largest non-U.S. country risk net exposures at March 31, 2018. Index credit derivatives are included in the country risk exposure table. Each reference entity within an index is allocated to that reference entity’s country of risk. Index exposures are allocated to the underlying reference entities in proportion to the notional weighting of each reference entity in the index, adjusted for any fair value receivable/payable for that reference entity. Where credit risk crosses multiple jurisdictions, for example, a CDS purchased from an issuer in a specific country that references bonds issued by an entity in a different country, the fair value of the CDS is reflected in the Net Counterparty Exposure column based on the country of the CDS issuer. Further, the notional amount of the CDS adjusted for the fair value of the receivable/payable is reflected in the Net Inventory column based on the country of the underlying reference entity.

 

 

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Top Ten Country Exposures at March 31, 2018

 

$ in millions    Net Inventory1     

Net

Counterparty

Exposure2

     Loans      Lending
Commitments
     Exposure
before Hedges
     Hedges3      Net Exposure  

Country

                    

U.K.:

                    

Sovereigns

   $ (836    $ 53      $      $      $ (783    $ (357    $ (1,140

Non-sovereigns

     1,003        10,249        2,533        7,022        20,807        (1,875      18,932  

Total

   $ 167      $     10,302      $     2,533      $     7,022      $     20,024      $ (2,232    $     17,792  

Germany:

                    

Sovereigns

   $ 1,645      $ 460      $      $      $ 2,105      $ (858    $ 1,247  

Non-sovereigns

     328        2,200        1,132        3,787        7,447        (1,317      6,130  

Total

   $ 1,973      $ 2,660      $ 1,132      $ 3,787      $ 9,552      $ (2,175    $ 7,377  

France:

                    

Sovereigns

   $ (924    $ 2      $      $      $ (922    $ (50    $ (972

Non-sovereigns

     9        1,862        294        4,100        6,265        (748      5,517  

Total

   $ (915    $ 1,864      $ 294      $ 4,100      $ 5,343      $ (798    $ 4,545  

Spain:

                    

Sovereigns

   $ (1,648    $      $      $      $ (1,648    $             —      $ (1,648

Non-sovereigns

     54        283        3,249        2,748        6,334        (193      6,141  

Total

   $ (1,594    $ 283      $ 3,249      $ 2,748      $ 4,686      $ (193    $ 4,493  

Japan:

                    

Sovereigns

   $ 164      $ 84      $      $      $ 248      $ (118    $ 130  

Non-sovereigns

     476        3,783                      4,259        (118      4,141  

Total

   $ 640      $ 3,867      $      $      $ 4,507      $ (236    $ 4,271  

Canada:

                    

Sovereigns

   $ (326    $ 48      $      $      $ (278    $      $ (278

Non-sovereigns

     574        2,033        92        1,417        4,116        (278      3,838  

Total

   $ 248      $ 2,081      $ 92      $ 1,417      $ 3,838      $ (278    $ 3,560  

China:

                    

Sovereigns

   $ 659      $ 188      $      $      $ 847      $ (54    $ 793  

Non-sovereigns

     737        228        1,291        434        2,690        (10      2,680  

Total

   $ 1,396      $ 416      $ 1,291      $ 434      $ 3,537      $ (64    $ 3,473  

Brazil:

                    

Sovereigns

   $ 2,561      $      $      $      $ 2,561      $ (12    $ 2,549  

Non-sovereigns

     69        167        26        451        713        (16      697  

Total

   $ 2,630      $ 167      $ 26      $ 451      $ 3,274      $ (28    $ 3,246  

Netherlands:

                    

Sovereigns

   $ (75    $      $      $      $ (75    $ (20    $ (95

Non-sovereigns

     374        733        1,150        1,153        3,410        (305      3,105  

Total

   $ 299      $ 733      $ 1,150      $ 1,153      $ 3,335      $ (325    $ 3,010  

India:

                    

Sovereigns

   $ 1,744      $      $      $      $ 1,744      $      $ 1,744  

Non-sovereigns

     696        534                      1,230               1,230  

Total

   $ 2,440      $ 534      $      $      $ 2,974      $      $ 2,974  

 

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 any fair value 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 for us. Amounts are based on the CDS notional amount assuming zero recovery adjusted for any fair value receivable or payable. For a further description of the contractual terms for purchased credit protection and whether they may limit the effectiveness of our hedges, see “Credit Exposure—Derivatives” herein.

 

   37    March 2018 Form 10-Q


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Risk Disclosures    LOGO

 

As a market maker, we may transact in CDS positions to facilitate client trading. Exposures related to single-name and index credit derivatives for those countries shown in the previous table were as follows:

Credit Derivatives Included in Net Inventory

 

$ in millions

  

At

March 31,

2018

 

Gross purchased protection

   $ (78,994

Gross written protection

             76,135  

Net exposure

   $ (2,859

Net counterparty exposure shown in the Top Ten Country Exposures table above are net of the benefit of collateral received, which is typically composed of cash and government obligations.

Benefit of Collateral Received against Counterparty Credit Exposure

 

$ in millions

  

Collateral1

  

At

March 31,

2018

 

Counterparty credit exposure

     

U.K.

   U.K., U.S. and Japan    $ 9,215  

Germany

   Belgium and Germany      9,193  

Other

   Japan, France and Spain      14,696  

 

1.

Collateral primarily consists of cash and government obligations.

Country Risk Exposures Related to the U.K. At March 31, 2018, our country risk exposures in the U.K. included net exposures of $17,792 million as shown in the Top Ten Country Exposures table, and overnight deposits of $7,047 million. The $18,932 million of exposures to non-sovereigns were diversified across both names and sectors. Of these exposures, $6,168 million were to U.K.-focused counterparties that generate more than one-third of their revenues in the U.K., $5,562 million were to geographically diversified counterparties, and $6,248 million were to exchanges and clearinghouses.

Country Risk Exposures Related to Brazil. At March 31, 2018, our country risk exposures in Brazil included net exposures of $3,246 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 $697 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.”

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.

 

 

March 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 March 31, 2018, and the related condensed consolidated income statements, comprehensive income statements, cash flow statements and statements of changes in total equity for the three-month periods ended March 31, 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

May 4, 2018

 

   39    March 2018 Form 10-Q


Table of Contents

Financial Statements

Consolidated Financial Statements and Notes

Consolidated Income Statements

(Unaudited)

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     Three Months Ended
March 31,
 
in millions, except per share data            2018                      2017          

Revenues

     

Investment banking

   $ 1,634      $         1,545  

Trading

     3,770        3,235  

Investments

     126        165  

Commissions and fees

     1,173        1,033  

Asset management

     3,192        2,767  

Other

     207        229  

Total non-interest revenues

     10,102        8,974  

Interest income

     2,860        1,965  

Interest expense

     1,885        1,194  

Net interest

     975        771  

Net revenues

     11,077        9,745  

Non-interest expenses

     

Compensation and benefits

     4,914        4,466  

Occupancy and equipment

     336        327  

Brokerage, clearing and exchange fees

     627        509  

Information processing and communications

     478        428  

Marketing and business development

     140        136  

Professional services

     510        527  

Other

     652        544  

Total non-interest expenses

     7,657        6,937  

Income from continuing operations before income taxes

     3,420        2,808  

Provision for income taxes

     714        815  

Income from continuing operations

     2,706        1,993  

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

     (2      (22

Net income

   $ 2,704      $ 1,971  

Net income applicable to noncontrolling interests

     36        41  

Net income applicable to Morgan Stanley

   $ 2,668      $ 1,930  

Preferred stock dividends and other

     93        90  

Earnings applicable to Morgan Stanley common shareholders

   $ 2,575      $ 1,840  

Earnings per basic common share

     

Income from continuing operations

   $ 1.48      $ 1.03  

Income (loss) from discontinued operations

            (0.01

Earnings per basic common share

   $ 1.48      $ 1.02  

Earnings per diluted common share

     

Income from continuing operations

   $ 1.46      $ 1.01  

Income (loss) from discontinued operations

     (0.01      (0.01

Earnings per diluted common share

   $ 1.45      $ 1.00  

Dividends declared per common share

   $ 0.25      $ 0.20  

Average common shares outstanding

     

Basic

     1,740        1,801  

Diluted

     1,771        1,842  

 

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


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Consolidated Comprehensive Income Statements

(Unaudited)

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     Three Months Ended
March 31,
 
$ in millions            2018                      2017          

Net income

   $ 2,704      $         1,971  

Other comprehensive income (loss), net of tax:

                 

Foreign currency translation adjustments

   $ 117      $ 150  

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

     (410      84  

Pension, postretirement and other

     5         

Change in net debt valuation adjustment

     451        9  

Total other comprehensive income (loss)

   $ 163      $ 243  

Comprehensive income

   $ 2,867      $ 2,214  

Net income applicable to noncontrolling interests

     36        41  

Other comprehensive income (loss) applicable to noncontrolling interests

     72        50  

Comprehensive income applicable to Morgan Stanley

   $ 2,759      $ 2,123  

 

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


Table of Contents
Consolidated Balance Sheets    LOGO

 

$ in millions, except share data    (Unaudited)
At
March 31,
2018
     At
December 31,
2017
 

Assets

     

Cash and cash equivalents:

     

Cash and due from banks

   $ 29,073      $         24,816  

Interest bearing deposits with banks

     22,980        21,348  

Restricted cash

     35,291        34,231  

Trading assets at fair value ($163,158 and $169,735 were pledged to various parties)

     273,044        298,282  

Investment securities (includes $56,749 and $55,203 at fair value)

     80,641        78,802  

Securities purchased under agreements to resell

     80,246        84,258  

Securities borrowed

     135,835        124,010  

Customer and other receivables

     66,835        56,187  

Loans:

     

Held for investment (net of allowance of $243 and $224)

     95,124        92,953  

Held for sale

     14,011        11,173  

Goodwill

     6,706        6,597  

Intangible assets (net of accumulated amortization of $2,817 and $2,730)

     2,427        2,448  

Other assets

     16,282        16,628  

Total assets

   $ 858,495      $ 851,733  

Liabilities

     

Deposits (includes $242 and $204 at fair value)

   $ 160,424      $ 159,436  

Trading liabilities at fair value

     139,023        131,295  

Securities sold under agreements to repurchase (includes $792 and $800 at fair value)

     51,575        56,424  

Securities loaned

     13,556        13,592  

Other secured financings (includes $3,423 and $3,863 at fair value)

     10,275        11,271  

Customer and other payables

     194,924        191,510  

Other liabilities and accrued expenses

     14,265        17,157  

Borrowings (includes $47,533 and $46,912 at fair value)

     194,964        192,582  

Total liabilities

     779,006        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: 1,773,934,393 and 1,788,086,805

     20        20  

Additional paid-in capital

     23,260        23,545  

Retained earnings

     60,009        57,577  

Employee stock trusts

     2,907        2,907  

Accumulated other comprehensive income (loss)

     (3,406      (3,060

Common stock held in treasury at cost, $0.01 par value (264,959,586 and 250,807,174 shares)

     (10,369      (9,211

Common stock issued to employee stock trusts

     (2,907      (2,907

Total Morgan Stanley shareholders’ equity

     78,034        77,391  

Noncontrolling interests

     1,455        1,075  

Total equity

     79,489        78,466  

Total liabilities and equity

   $ 858,495      $ 851,733  

 

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


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Consolidated Statements of Changes in Total Equity

(Unaudited)

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$ 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

                      2,668                                     2,668  

Net income applicable to noncontrolling interests

                                                    36       36  

Dividends

                      (542                                   (542

Shares issued under employee plans

                (285                       710                   425  

Repurchases of common stock and employee tax withholdings

                                        (1,868                 (1,868

Net change in Accumulated other comprehensive income (loss)

                                  91                   72       163  

Other net increases

                                                    272       272  

Balance at March 31, 2018

  $     8,520     $     20     $     23,260     $     60,009     $     2,907     $ (3,406   $ (10,369   $ (2,907   $ 1,455     $ 79,489  

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

                      1,930                                     1,930  

Net income applicable to noncontrolling interests

                                                    41       41  

Dividends

                      (465                                   (465

Shares issued under employee plans

                (430           186                         803       (186           373  

Repurchases of common stock and employee tax withholdings

                                        (1,161                 (1,161

Net change in Accumulated other comprehensive income (loss)

                                              193                   50       243  

Issuance of preferred stock

    1,000             (6                                         —             994  

Other net decreases

                                                    (58     (58

Balance at March 31, 2017

  $ 8,520     $ 20     $ 22,880     $ 55,109     $ 3,037     $ (2,450   $ (6,155   $ (3,037   $     1,160     $     79,084  

 

1.

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

 

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


Table of Contents

Consolidated Cash Flow Statements

(Unaudited)

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     Three Months Ended
March 31,
 
$ in millions            2018                      2017          

Cash flows from operating activities

     

Net income

   $ 2,704      $ 1,971  

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

     

(Income) loss from equity method investments

     (50      (9

Stock-based compensation expense

     321        269  

Depreciation and amortization

     390        434  

Net gain on sale of available-for-sale securities

            (2

Impairment charges

     8        5  

Provision for credit losses on lending activities

     26        25  

Other operating adjustments

     5        (74

Changes in assets and liabilities:

     

Trading assets, net of Trading liabilities

     33,832        (12,838

Securities borrowed

     (11,825      13,433  

Securities loaned

     (36      3,090  

Customer and other receivables and other assets

     (13,019      (1,687

Customer and other payables and other liabilities

     1,129        (3,556

Securities purchased under agreements to resell

     4,012        (2,868

Securities sold under agreements to repurchase

     (4,849      1,897  

Net cash provided by (used for) operating activities

     12,648        90  

Cash flows from investing activities

     

Proceeds from (payments for):

     

Other assets—Premises, equipment and software, net

     (410      (350

Changes in loans, net

     (3,801      (1,105

Investment securities:

     

Purchases

     (5,482      (6,449

Proceeds from sales

     810        3,604  

Proceeds from paydowns and maturities

     2,125        2,071  

Other investing activities

     (164      61  

Net cash provided by (used for) investing activities

     (6,922      (2,168

Cash flows from financing activities

     

Net proceeds from (payments for):

     

Noncontrolling interests

     (5      (2

Other secured financings

     (2,101      199  

Deposits

     988        (3,754

Proceeds from:

     

Derivatives financing activities

            48  

Issuance of preferred stock, net of issuance costs

            994  

Issuance of Borrowings

     15,370        18,433  

Payments for:

     

Borrowings

     (11,377      (11,538

Repurchases of common stock and employee tax withholdings

     (1,868      (1,161

Cash dividends

     (599      (511

Other financing activities

     (45      14  

Net cash provided by (used for) financing activities

     363        2,722  

Effect of exchange rate changes on cash and cash equivalents

     860        877  

Net increase (decrease) in cash and cash equivalents

     6,949        1,521  

Cash and cash equivalents, at beginning of period

     80,395        77,360  

Cash and cash equivalents, at end of period

   $ 87,344      $ 78,881  

Cash and cash equivalents:

     

Cash and due from banks

   $ 29,073      $         22,081  

Interest bearing deposits with banks

     22,980        20,773  

Restricted cash

     35,291        36,027  

Cash and cash equivalents, at end of period

   $ 87,344      $ 78,881  

Supplemental Disclosure of Cash Flow Information

     

Cash payments for:

     

Interest

   $ 1,407      $ 737  

Income taxes, net of refunds

     250        262  

 

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


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Notes to Consolidated Financial Statements

(Unaudited)

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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, financing extended to equities and commodities customers, and loans to 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”).

 

 

   45    March 2018 Form 10-Q


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Notes to Consolidated Financial Statements

(Unaudited)

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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.

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 three months ended March 31, 2018 (“current quarter”), there were no significant revisions to the Firm’s significant accounting policies, other than the following 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 quarter. Prior year quarter results are presented under previous policies. See Note 14 for a summary of the Retained earnings impacts of these and other minor adoptions effective this quarter.

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. See Note 20 for new disclosures related to the adoption of this standard.

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-compensation expense 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-compensation expense 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.

 

 

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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. 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-compensation expense 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.

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 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.

 

 

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3. Fair Values

Fair Value Measurement

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

    At March 31, 2018  
$ in millions   Level 1     Level 2     Level 3     Netting1     Total  

Assets at fair value

         

Trading assets:

         

U.S. Treasury and agency securities

  $ 22,675     $ 23,430     $     $     $ 46,105  

Other sovereign government obligations

    18,185       9,371       7             27,563  

State and municipal securities

          3,235       2             3,237  

MABS

          1,799       342             2,141  

Loans and lending commitments2

          4,865       8,128             12,993  

Corporate and other debt

          21,392       814             22,206  

Corporate equities3

    120,280       494       233             121,007  

Derivative and other contracts:

 

 

Interest rate

    989       176,030       1,250             178,269  

Credit

          6,971       362             7,333  

Foreign exchange

    45       53,504       29             53,578  

Equity

    1,165       44,506       3,871             49,542  

Commodity and other

    383       6,908       4,576             11,867  

Netting1

    (1,665     (216,759     (1,581     (47,436     (267,441

Total derivative and other contracts

    917       71,160       8,507       (47,436     33,148  

Investments4

    482       372       1,012             1,866  

Physical commodities

          205                   205  

Total trading assets4

    162,539       136,323       19,045       (47,436     270,471  

Investment securities— AFS

    29,979       26,770                   56,749  

Intangible assets

          3                   3  

Total assets at fair value

  $ 192,518     $ 163,096     $ 19,045     $ (47,436   $ 327,223  

 

 

    At March 31, 2018  
$ in millions   Level 1     Level 2     Level 3     Netting1     Total  

Liabilities at fair value

         

Deposits

  $     $ 198     $ 44     $     $ 242  

Trading liabilities:

         

U.S. Treasury and agency securities

    20,182       32                   20,214  

Other sovereign government obligations

    24,281       3,890       3             28,174  

Corporate and other debt

          7,886       4             7,890  

Corporate equities3

    56,667       60       32             56,759  

Derivative and other contracts:

 

 

Interest rate

    1,043       159,538       580             161,161  

Credit

          7,456       392             7,848  

Foreign exchange

    31       53,408       62             53,501  

Equity

    1,054       46,616       2,856             50,526  

Commodity and other

    543       5,680       2,916             9,139  

Netting1

    (1,665     (216,759     (1,581     (36,184     (256,189

Total derivative and other contracts

    1,006       55,939       5,225       (36,184     25,986  

Total trading liabilities

    102,136       67,807       5,264       (36,184     139,023  

Securities sold under agreements to repurchase

          792                   792  

Other secured financings

          3,203       220             3,423  

Borrowings

          43,907       3,626             47,533  

Total liabilities at fair value

  $ 102,136     $ 115,907     $ 9,154     $ (36,184   $ 191,013  
 

 

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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