Form 10-Q
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

OR

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

EXCHANGE ACT OF 1934

Commission File Number 1-11758

 

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(Exact Name of Registrant as specified in its charter)

 

       

Delaware

(State or other jurisdiction of

incorporation or organization)

  

1585 Broadway

New York, NY 10036

(Address of principal executive offices, including zip code)

 

  

36-3145972

(I.R.S. Employer Identification No.)

  

(212) 761-4000

(Registrant’s telephone number, including area code)

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

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

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

 

Large Accelerated Filer  ☒

  

Accelerated Filer  ☐

Non-Accelerated Filer   ☐

  

Smaller reporting company  ☐

(Do not check if a smaller reporting company)

  

Emerging growth company  ☐

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

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

As of July 31, 2018, there were 1,744,789,709 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.


Table of Contents

QUARTERLY REPORT ON FORM 10-Q

For the quarter ended June 30, 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

                       7  

Supplemental Financial Information and Disclosures

                       18  

Accounting Development Updates

                       19  

Critical Accounting Policies

                       19  

Liquidity and Capital Resources

                       19  

Quantitative and Qualitative Disclosures about Market Risk

     I        3        32  

Report of Independent Registered Public Accounting Firm

                       41  

Financial Statements

     I        1        42  

Consolidated Financial Statements and Notes

                       42  

Consolidated Income Statements (Unaudited)

                       42  

Consolidated Comprehensive Income Statements (Unaudited)

                       43  

Consolidated Balance Sheets (Unaudited at June 30, 2018)

                       44  

Consolidated Statements of Changes in Total Equity (Unaudited)

                       45  

Consolidated Cash Flow Statements (Unaudited)

                       46  

Notes to Consolidated Financial Statements (Unaudited)

                       47  

1. Introduction and Basis of Presentation

                       47  

2. Significant Accounting Policies

                       48  

3. Fair Values

                       50  

4. Derivative Instruments and Hedging Activities

                       61  

5. Investment Securities

                       65  

6. Collateralized Transactions

                       68  

7. Loans, Lending Commitments and Allowance for Credit Losses

                       69  

8. Equity Method Investments

                       71  

9. Deposits

                       72  

10.Borrowings and Other Secured Financings

                       72  

11.Commitments, Guarantees and Contingencies

                       72  

12.Variable Interest Entities and Securitization Activities

                       76  

13.Regulatory Requirements

                       79  

14.Total Equity

                       81  

15.Earnings per Common Share

                       83  

16.Interest Income and Interest Expense

                       84  

17.Employee Benefit Plans

                       84  

18.Income Taxes

                       84  

19.Segment, Geographic and Revenue Information

                       85  

20.Subsequent Events

                       87  
Financial Data Supplement (Unaudited)                        88  
Glossary of Common Acronyms                        91  
Other Information      II                 93  
Legal Proceedings      II        1        93  
Unregistered Sales of Equity Securities and Use of Proceeds      II        2        94  
Controls and Procedures      I        4        95  
Exhibits      II        6        95  
Exhibit Index                        E-1  
Signatures                        S-1  

 

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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.

 

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

Introduction

 

Morgan Stanley is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Wealth Management and Investment Management. Morgan Stanley, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. Unless the context otherwise requires, the terms “Morgan Stanley,” “Firm,” “us,” “we” or “our” mean Morgan Stanley (the “Parent Company”) together with its consolidated subsidiaries. We define the following as part of our consolidated financial statements (“financial statements”): consolidated income statements (“income statements”), consolidated balance sheets (“balance sheets”), and consolidated cash flow statements (“cash flow statements”). See the “Glossary of Common Acronyms” for definitions of certain acronyms used throughout this Form 10-Q.

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

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

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

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

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

 

 

   1    June 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 $10,610 million in the quarter ended June 30, 2018 (“current quarter,” or “2Q 2018”), compared with $9,503 million in the quarter ended June 30, 2017 (“prior year quarter,” or “2Q 2017”). For the current quarter, net income applicable to Morgan Stanley was $2,437 million, or $1.30 per diluted common share, compared with $1,757 million, or $0.87 per diluted common share, in the prior year quarter.

 

 

We reported net revenues of $21,687 million in the six months ended June 30, 2018 (“current year period,” or “YTD 2018”), compared with $19,248 million in the six months ended June 30, 2017 (“prior year period,” or “YTD 2017”). For the current year period, net income applicable to Morgan Stanley was $5,105 million, or $2.75 per diluted common share, compared with $3,687 million, or $1.87 per diluted common share, in the prior year period.

 

 

June 2018 Form 10-Q    2   


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Management’s Discussion and Analysis    LOGO

 

 

Non-interest Expenses1

($ in millions)

 

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1.

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

 

Compensation and benefits expenses of $4,621 million in the current quarter and $9,535 million in the current year period each increased 9% from $4,252 million in the prior year quarter and $8,718 million in the prior year period. These results primarily reflected increases in discretionary incentive compensation mainly driven by higher revenues, as well as salaries, across all business segments, the formulaic payout to Wealth Management representatives, and amortization of deferred cash and equity awards. These increases were partially offset by a decrease in the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses were $2,880 million in the current quarter and $5,623 million in the current year period compared with $2,609 million in the prior year quarter and $5,080 million in the prior year period, representing a 10% and an 11% increase, respectively. These increases were 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 19 to the financial statements for further information).

Income Taxes

The current quarter and current year period included intermittent net discrete tax benefits of $88 million primarily associated with new information pertaining to the resolution of multi-jurisdiction tax examinations and other matters. The prior year quarter and prior year period included intermittent tax provisions of $4 million and $18 million, respectively. For further information, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

 

 

   3    June 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Selected Financial Information and Other Statistical Data

 

   

Three Months
Ended

June 30,

   

Six Months

Ended

June 30,

 
$ in millions   2018     2017     2018     2017  

Income from continuing operations applicable to Morgan Stanley

  $ 2,439     $ 1,762     $ 5,109     $ 3,714  

Income (loss) from discontinued operations applicable to Morgan Stanley

    (2     (5     (4     (27

Net income applicable to Morgan Stanley

    2,437       1,757       5,105       3,687  

Preferred stock dividends and other

    170       170       263       260  

Earnings applicable to Morgan Stanley common shareholders

  $ 2,267     $ 1,587     $ 4,842     $ 3,427  

Expense efficiency ratio1

    70.7%       72.2%       69.9%       71.7%  

ROE2

    13.0%       9.1%       13.9%       9.9%  

ROTCE2

    14.9%       10.4%       16.0%       11.4%  

 

in millions, except per share and
employee data
  At June 30,
2018
    At December 31,
2017
 

GLR3

  $ 226,322     $ 192,660  

Loans4

  $ 112,113     $ 104,126  

Total assets

  $ 875,875     $ 851,733  

Deposits

  $ 172,802     $ 159,436  

Borrowings

  $ 192,244     $ 192,582  

Common shareholders’ equity

  $ 70,589     $ 68,871  

Common shares outstanding

    1,750       1,788  

Book value per common share5

  $ 40.34     $ 38.52  

Worldwide employees

    58,010       57,633  

 

     At June 30,
2018
    At December 31,
2017
 

Capital ratios6

   

Common Equity Tier 1 capital ratio

    15.8%       16.5%  

Tier 1 capital ratio

    18.1%       18.9%  

Total capital ratio

    20.6%       21.7%  

Tier 1 leverage ratio

    8.2%       8.3%  

SLR7

    6.4%       6.5%  

 

1.

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

2.

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

3.

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

4.

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

5.

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

6.

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

7.

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

Business Segment Results

Net Revenues by Segment1, 2 

($ in millions)

 

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June 2018 Form 10-Q    4   


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Management’s Discussion and Analysis    LOGO

 

Net Income Applicable to Morgan Stanley by Segment1, 3

($ in millions)

 

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1.

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

2.

The total amount of Net Revenues by Segment also includes intersegment eliminations of $(120) million and $(75) million in the current quarter and prior year quarter, respectively, and $(235) million and $(149) million in the current year period and prior year period, 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 period.

 

 

Institutional Securities net revenues of $5,714 million in the current quarter and $11,814 million in the current year period increased 20% from the prior year quarter and 19% from the prior year period primarily reflecting higher sales and trading and Investment banking revenues.

 

 

Wealth Management net revenues of $4,325 million in the current quarter and $8,699 million in the current year period increased 4% from the prior year quarter and 6% from the prior year period primarily reflecting growth in Asset management revenues.

 

 

Investment Management net revenues of $691 million in the current quarter and $1,409 million in the current year period increased 4% from the prior year quarter and 11% from the prior year period primarily reflecting higher revenues from Asset management.

Net Revenues by Region1, 2

($ in millions)

 

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1.

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

2.

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

 

 

   5    June 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

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.

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

 

$ in millions, except   Three Months Ended
June 30,
    Six Months Ended
June 30,
 
per share data       2018             2017             2018             2017      

Net income applicable to Morgan Stanley

  $ 2,437     $ 1,757     $ 5,105     $ 3,687  

Impact of adjustments

    (88     4       (88     18  

Adjusted net income applicable to Morgan Stanley—non-GAAP1

  $ 2,349       1,761     $ 5,017       3,705  

Earnings per diluted common share

  $ 1.30     $ 0.87     $ 2.75     $ 1.87  

Impact of adjustments

    (0.05           (0.05     0.01  

Adjusted earnings per diluted common share —non-GAAP1

  $ 1.25     $ 0.87     $ 2.70     $ 1.88  

Effective income tax rate

    20.6%       32.0%       20.7%       30.5%  

Impact of adjustments

    2.8%       (0.1)%       1.4%       (0.4)%  

Adjusted effective income tax rate—non-GAAP1

    23.4%       31.9%       22.1%       30.1%  
                Average Monthly Balance  
   

At
June 30,

2018

   

At
December 31,

2017

   

Three Months

Ended June 30,

   

Six Months

Ended June 30,

 
$ in millions   2018     2017     2018     2017  

Tangible Equity

           

U.S. GAAP

           

Morgan Stanley shareholders’ equity

  $ 79,109     $ 77,391     $ 78,432     $ 78,436     $ 77,960     $ 77,836  

Less: Goodwill and net intangible assets

    (9,022     (9,042     (9,076     (9,194     (9,049     (9,227

Morgan Stanley tangible shareholders’ equity—non-GAAP

  $ 70,087     $ 68,349     $ 69,356     $ 69,242     $ 68,911     $ 68,609  

U.S. GAAP

           

Common equity

  $ 70,589     $ 68,871     $ 69,912     $ 69,916     $ 69,440     $ 69,459  

Less: Goodwill and net intangible assets

    (9,022     (9,042     (9,076     (9,194     (9,049     (9,227

Tangible common equity—non-GAAP

  $   61,567     $ 59,829     $   60,836     $   60,722     $   60,391     $   60,232  

Consolidated Non-GAAP Financial Measures

 

    Three Months Ended
June 30,
     Six Months Ended
June 30,
 
$ in billions   2018      2017      2018      2017  

Average common equity

 

        

Unadjusted

  $ 69.9      $ 69.9      $ 69.4      $ 69.5  

Adjusted1

    69.9        69.9        69.4        69.5  

ROE2

 

        

Unadjusted

    13.0%        9.1%        13.9%        9.9%  

Adjusted1, 3

    12.5%        9.1%        13.7%        9.9%  

Average tangible common equity

 

        

Unadjusted

  $ 60.8      $ 60.7      $ 60.4      $ 60.2  

Adjusted1

    60.8        60.7        60.4        60.2  

ROTCE2

 

        

Unadjusted

    14.9%        10.4%        16.0%        11.4%  

Adjusted1, 3

    14.3%        10.5%        15.7%        11.4%  

 

     

At June 30,

2018

    

At December 31,

2017

 

Tangible book value per common share4

   $             35.19      $ 33.46  
 

 

June 2018 Form 10-Q    6   


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Management’s Discussion and Analysis    LOGO

 

Non-GAAP Financial Measures by Business Segment

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
$ in billions   2018     2017     2018     2017  

Pre-tax profit margin5

       

Institutional Securities

    32%       30%       33%       32%  

Wealth Management

    27%       25%       27%       25%  

Investment Management

    20%       21%       20%       19%  

Consolidated

    29%       28%       30%       28%  

Average common equity6

 

     

Institutional Securities

  $ 40.8     $ 40.2     $ 40.8     $ 40.2  

Wealth Management

    16.8       17.2       16.8       17.2  

Investment Management

    2.6       2.4       2.6       2.4  

Parent Company

    9.7       10.1       9.2       9.7  

Consolidated average common equity

  $ 69.9     $ 69.9     $ 69.4     $ 69.5  

Average tangible common equity6

 

     

Institutional Securities

  $ 40.1     $ 39.6     $ 40.1     $ 39.6  

Wealth Management

    9.2       9.3       9.2       9.3  

Investment Management

    1.7       1.6       1.7       1.6  

Parent Company

    9.8       10.2       9.4       9.7  

Consolidated average tangible common equity

  $ 60.8     $ 60.7     $ 60.4     $ 60.2  

ROE2, 7

 

     

Institutional Securities

    13.0%       8.5%       14.1%       9.9%  

Wealth Management

    20.0%       14.6%       20.7%       14.6%  

Investment Management

    15.7%       16.3%       17.5%       13.7%  

Consolidated

    13.0%       9.1%       13.9%       9.9%  

ROTCE2, 7

 

     

Institutional Securities

    13.2%       8.7%       14.3%       10.1%  

Wealth Management

    36.6%       27.0%       37.8%       27.0%  

Investment Management

    24.5%       24.1%       27.4%       20.2%  

Consolidated

    14.9%       10.4%       16.0%       11.4%  

 

1.

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

2.

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

3.

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

Return on Equity and Tangible Common Equity Targets

In January 2018, we established an ROE Target of 10% to 13% 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; and capital levels. For further information on our ROE and ROTCE Targets and related assumptions, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Executive Summary—Return on Equity and Tangible Common Equity Targets” in the 2017 Form 10-K.

Business Segments

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

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

Net Revenues, Compensation Expense and Income Taxes

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

 

 

   7    June 2018 Form 10-Q


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Institutional Securities

Income Statement Information

 

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

Revenues

     

Investment banking

  $       1,699     $       1,413       20%  

Trading

    3,128       2,725       15%  

Investments

    89       37       141%  

Commissions and fees

    674       630       7%  

Asset management

    102       89       15%  

Other

    168       126       33%  

Total non-interest revenues

    5,860       5,020       17%  

Interest income

    2,195       1,243       77%  

Interest expense

    2,341       1,501       56%  

Net interest

    (146     (258     43%  

Net revenues

    5,714       4,762       20%  

Compensation and benefits

    1,993       1,667       20%  

Non-compensation expenses

    1,909       1,652               16%  

Total non-interest expenses

    3,902       3,319       18%  

Income from continuing operations before income taxes

    1,812       1,443       26%  

Provision for income taxes

    323       413       (22)%  

Income from continuing operations

    1,489       1,030       45%  

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

    (2     (5     60%  

Net income

    1,487       1,025       45%  

Net income applicable to noncontrolling interests

    30       33       (9)%  

Net income applicable to Morgan Stanley

  $ 1,457     $ 992       47%  

 

    Six Months Ended
June 30,
       
$ in millions   2018     2017     % Change  

Revenues

     

Investment banking

  $       3,212     $       2,830       13%  

Trading

    6,771       5,737       18%  

Investments

    138       103       34%  

Commissions and fees

    1,418       1,250       13%  

Asset management

    212       180       18%  

Other

    304       299       2%  

Total non-interest revenues

    12,055       10,399       16%  

Interest income

    3,999       2,367       69%  

Interest expense

    4,240       2,852       49%  

Net interest

    (241     (485     50%  

Net revenues

    11,814       9,914       19%  

Compensation and benefits

    4,153       3,537       17%  

Non-compensation expenses

    3,737       3,204               17%  

Total non-interest expenses

    7,890       6,741       17%  

Income from continuing operations before income taxes

    3,924       3,173       24%  

Provision for income taxes

    772       872       (11)%  

Income from continuing operations

    3,152       2,301       37%  

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

    (4     (27     85%  

Net income

    3,148       2,274       38%  

Net income applicable to noncontrolling interests

    64       68       (6)%  

Net income applicable to Morgan Stanley

  $ 3,084     $ 2,206       40%  
 

 

June 2018 Form 10-Q    8   


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Investment Banking

Investment Banking Revenues

 

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

Advisory

  $ 618     $ 504        23%  

Underwriting:

      

Equity

    541       405        34%  

Fixed income

    540       504        7%  

Total underwriting

    1,081       909        19%  

Total investment banking

  $ 1,699     $ 1,413        20%  

 

     Six Months Ended
June 30,
        
$ in millions    2018      2017      % Change  

Advisory

   $ 1,192      $ 1,000        19%  

Underwriting:

        

Equity

     962        795        21%  

Fixed income

     1,058        1,035        2%  

Total underwriting

     2,020        1,830        10%  

Total investment banking

   $ 3,212      $ 2,830        13%  

Investment Banking Volumes

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
$ in billions   2018     2017     2018     2017  

Completed mergers and acquisitions1

  $ 325     $ 212     $ 488     $ 375  

Equity and equity-related offerings2, 3

    16       20       37       30  

Fixed income offerings2, 4

    61       70       116       145  

Source: Thomson Reuters, data as of July 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 $1,699 million in the current quarter and $3,212 million in the current year period increased 20% and 13% from the comparable prior year periods. The adoption of the accounting update Revenue from Contracts with Customers had the effect of increasing the revenues reported in investment banking by approximately $101 million in the current quarter and $161 million in the current year period compared with the prior year periods (see Notes 2 and 19 to the financial statements for further information). The drivers of the increase in our Investment banking revenues, other than the effect of the above accounting update, were:

 

 

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

 

 

Equity underwriting revenues increased in the current quarter primarily as a result of higher fee realizations in initial public offerings and convertibles. In the current year period, equity underwriting revenues increased due to higher equity market volumes (see Investment Banking Volumes table).

 

 

Fixed income underwriting revenues increased in the current quarter primarily due to higher non-investment grade loan fees. Fixed income underwriting revenues in the current year period were relatively unchanged from the prior year period.

Sales and Trading Net Revenues

By Income Statement Line Item

 

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

Trading

   $ 3,128      $ 2,725        15%  

Commissions and fees

     674        630        7%  

Asset management

     102        89        15%  

Net interest

     (146      (258      43%  

Total

   $ 3,758      $ 3,186        18%  

 

     Six Months Ended
June 30,
        
$ in millions    2018      2017      % Change  

Trading

   $ 6,771      $ 5,737        18%  

Commissions and fees

     1,418        1,250        13%  

Asset management

     212        180        18%  

Net interest

     (241      (485      50%  

Total

   $ 8,160      $ 6,682        22%  
 

 

   9    June 2018 Form 10-Q


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By Business

 

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

Equity

   $ 2,470      $ 2,155        15%  

Fixed income

     1,389        1,239        12%  

Other

     (101      (208      51%  

Total

   $ 3,758      $ 3,186        18%  

 

     Six Months Ended
June 30,
        
$ in millions    2018      2017      % Change  

Equity

   $ 5,028      $ 4,171        21%  

Fixed income

     3,262        2,953        10%  

Other

     (130      (442      71%  

Total

   $ 8,160      $ 6,682        22%  

Sales and Trading Revenues—Equity and Fixed Income

 

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

Financing

  $ 1,373     $ 89     $ (192   $ 1,270  

Execution services

    661       605       (66     1,200  

Total Equity

  $ 2,034     $ 694     $ (258   $ 2,470  

Total Fixed Income

  $ 1,299     $ 83     $ 7     $ 1,389  

 

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

Financing

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

Execution services

    601       580       (53     1,128  

Total Equity

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

Total Fixed income

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

 

    Six Months Ended
June 30, 2018
 
$ in millions   Trading     Fees1     Net
Interest2
    Total  

Financing

  $ 2,607     $ 196     $ (338   $ 2,465  

Execution services

    1,452       1,269       (158     2,563  

Total Equity

  $ 4,059     $ 1,465     $ (496   $ 5,028  

Total Fixed Income

  $ 3,014     $ 166     $ 82     $ 3,262  

 

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

Financing

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

Execution services

    1,265       1,148       (101     2,312  

Total Equity

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

Total Fixed income

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

 

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.

Sales and Trading Net Revenues during the Current Quarter

Equity

Equity sales and trading net revenues of $2,470 million in the current quarter increased 15% 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 due to higher average client balances and changes in funding mix which resulted in increased Trading and Net interest revenues.

 

 

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

Fixed Income

Fixed income net revenues of $1,389 million in the current quarter were 12% higher than the prior year quarter, driven by higher results in commodities products and other and credit products, partially offset by lower results in global macro products.

 

 

Global macro products revenues decreased as higher client activity was more than offset by unfavorable inventory management results in foreign exchange and emerging markets products.

 

 

Credit products Trading and Net interest revenues increased primarily as a result of increased client activity in lending products, partially offset by the impact of credit spread widening on inventory.

 

 

Commodities products and Other increased primarily due to increased client trading activity across commodities products and higher Trading revenues principally from a reduction in counterparty credit risk.

 

 

June 2018 Form 10-Q    10   


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Other

Other sales and trading net losses of $101 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 corporate loan activity.

Sales and Trading Net Revenues during the Current Year Period

Equity

Equity sales and trading net revenues of $5,028 million in the current year period increased 21% from the prior year period, reflecting higher results in both our financing businesses and execution services.

 

 

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

 

 

Execution services increased from the prior year period, primarily reflecting higher Trading revenues driven by effective inventory management and higher client activity in derivative products. In addition, Commissions and fees increased from higher client activity in cash equities products.

Fixed Income

Fixed income net revenues of $3,262 million in the current year period were 10% higher than the prior year period, primarily driven by higher results in commodities products and other.

 

 

Global macro and Credit products revenues remained relatively unchanged from the prior year period.

 

 

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

Other

Other sales and trading net losses of $130 million in the current year period decreased from the prior year period, primarily reflecting higher revenues on economic hedges related to our long-term debt and lower losses associated with corporate loan hedging activity.

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

Investments

 

 

Net investment gains of $89 million in the current quarter and $138 million in the current year period increased from the prior year periods, primarily as a result of higher gains on business-related investments, partially offset by lower results from real estate limited partnership investments.

Other Revenues

 

 

Other revenues of $168 million in the current quarter and $304 million in the current year period increased from the prior year periods, reflecting the recovery of a previously charged off energy industry related loan and improved results from other equity method investments. These results were partially offset by losses associated with held-for-sale corporate loans compared with gains in the respective prior year periods.

Non-interest Expenses

Non-interest expenses of $3,902 million in the current quarter increased from the prior year quarter, reflecting a 20% increase in Compensation and benefits expenses and a 16% increase in Non-compensation expenses. Non-interest expenses of $7,890 million in the current year period increased from the prior year period reflecting a 17% increase in both Compensation and benefits expenses and Non-compensation expenses.

 

 

Compensation and benefits expenses increased in the current quarter and current year period, primarily due to increases in discretionary incentive compensation driven by higher revenues, as well as amortization of deferred cash and equity awards and salaries, partially offset by a decrease in the fair value of investments to which certain deferred compensation plans are referenced.

 

 

Non-compensation expenses increased in the current quarter and current year period, primarily due to higher volume-related expenses and the gross presentation of certain expenses due to the adoption of the accounting update Revenue from Contracts with Customers (see Notes 2 and 19 to the financial statements for further information). In addition, in the current year period, the results were partially offset by the reversal of a portion of previously recorded provisions related to U.K. VAT matters.

 

 

   11    June 2018 Form 10-Q


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Income Tax Items

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

 

In both the current quarter and current year period, we recognized in Provision for income taxes an intermittent net discrete tax benefit of $97 million, primarily associated with new information pertaining to the resolution of multi-jurisdiction tax examinations and other matters.

 

 

June 2018 Form 10-Q    12   


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Wealth Management

Income Statement Information

 

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

Revenues

     

Investment banking

  $ 114     $ 135       (16)%  

Trading

    135       207       (35)%  

Investments

    3       1       200%  

Commissions and fees

    442       424       4%  

Asset management

    2,514       2,302       9%  

Other

    74       73       1%  

Total non-interest revenues

    3,282       3,142       4%  

Interest income

    1,320       1,114       18%  

Interest expense

    277       105       164%  

Net interest

    1,043       1,009       3%  

Net revenues

    4,325       4,151       4%  

Compensation and benefits

    2,356       2,297       3%  

Non-compensation expenses

    812       797       2%  

Total non-interest expenses

    3,168       3,094       2%  

Income from continuing

operations before income taxes

    1,157       1,057       9%  

Provision for income taxes

    281       392       (28)%  

Net income applicable to Morgan Stanley

  $ 876     $ 665       32%  

 

    Six Months Ended
June 30,
       
$ in millions       2018             2017         % Change  

Revenues

     

Investment banking

  $ 254     $ 280       (9)%  

Trading

    244       445       (45)%  

Investments

    3       2       50%  

Commissions and fees

    940       864       9%  

Asset management

    5,009       4,486       12%  

Other

    137       129       6%  

Total non-interest revenues

    6,587       6,206       6%  

Interest income

    2,600       2,193       19%  

Interest expense

    488       190       157%  

Net interest

    2,112       2,003       5%  

Net revenues

    8,699       8,209       6%  

Compensation and benefits

    4,806       4,614       4%  

Non-compensation expenses

    1,576       1,565       1%  

Total non-interest expenses

    6,382       6,179       3%  

Income from continuing operations before income taxes

    2,317       2,030       14%  

Provision for income taxes

    527       718       (27)%  

Net income applicable to Morgan Stanley

  $ 1,790     $ 1,312       36%  

 

Financial Information and Statistical Data

 

$ in billions  

At

June 30,
        2018        

     At
December 31,
2017
 

Client assets

  $ 2,411      $ 2,373  

Fee-based client assets1

  $ 1,084      $ 1,045  

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

    45%        44%  

Client liabilities2

  $ 82      $ 80  

Investment securities portfolio

  $ 59.7      $ 59.2  

Loans and lending commitments

  $ 80.7      $ 77.3  

Wealth Management representatives

    15,632        15,712  

 

     Three Months Ended
June 30,
 
          2018              2017      

Per representative:

     

Annualized revenues ($ in thousands)3

   $ 1,105      $ 1,052  

Client assets ($ in millions)4

   $ 154      $ 142  

Fee-based asset flows ($ in billions)5

   $ 15.3      $ 19.9  
     Six Months Ended
June 30,
 
      2018      2017  

Per representative:

     

Annualized revenues ($ in thousands)3

   $ 1,110      $ 1,041  

Client assets ($ in millions)4

   $ 154      $ 142  

Fee-based asset flows ($ in billions)5

   $ 33.5      $ 38.7  

 

1.

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

2.

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

3.

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

4.

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

5.

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

 

 

   13    June 2018 Form 10-Q


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Transactional Revenues

 

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

Investment banking

   $ 114      $ 135        (16)%  

Trading

     135        207        (35)%  

Commissions and fees

     442        424        4%  

Total

   $ 691      $ 766        (10)%  

Transactional revenues as a % of Net revenues

     16%        18%     

 

     Six Months Ended
June 30,
        
$ in millions    2018      2017      % Change  

Investment banking

   $ 254      $ 280        (9)%  

Trading

     244        445        (45)%  

Commissions and fees

     940        864        9%  

Total

   $ 1,438      $ 1,589        (10)%  

Transactional revenues as a % of Net revenues

     17%        19%     

Net Revenues

Transactional Revenues

Transactional revenues of $691 million in the current quarter and $1,438 million in the current year period decreased 10% from the respective prior year periods primarily as a result of lower Trading and Investment banking revenues, partially offset by higher Commissions and fees.

 

 

Investment banking revenues decreased in the current quarter and current year period primarily due to lower revenues from equity and structured products issuances.

 

 

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

 

 

Commissions and fees increased in the current quarter and current year period primarily as a result of increased client transactions in alternative products, and options and futures.

Asset Management

Asset management revenues of $2,514 million in the current quarter and $5,009 million in the current year period increased 9% and 12%, respectively, primarily due to the effect of market appreciation and net positive flows on the respective beginning of period fee-based client assets balances on which billings are generally based.

See “Fee-Based Client Assets Rollforwards” herein.

Net Interest

Net interest of $1,043 million in the current quarter and $2,112 million in the current year period increased 3% and 5%, respectively, primarily as a result of higher Loan balances. In the current quarter and current year period, the effect of higher interest rates on Loans and Investment securities was essentially offset by higher average interest rates on Deposits, due to changes in our deposit mix.

Non-interest Expenses

Non-interest expenses of $3,168 million in the current quarter and $6,382 million in the current year period increased 2% and 3%, respectively, primarily as a result of higher Compensation and benefits expenses.

 

 

Compensation and benefits expenses increased in the current quarter and current year period primarily due to the formulaic payout to Wealth Management representatives linked to higher revenues and increases in salaries, 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 both the current quarter and current year period.

Income Tax Items

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

 

 

June 2018 Form 10-Q    14   


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Management’s Discussion and Analysis    LOGO

 

Fee-Based Client Assets

For a description of fee-based client assets, including descriptions of the fee based client asset types and rollforward items in the following tables, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Segments—Wealth Management—Fee-Based Client Assets” in the 2017 Form 10-K.

Fee-Based Client Assets Rollforwards

 

$ in billions  

At

March 31,
2018

    Inflows     Outflows     Market
Impact
   

At

June 30,

2018

 

Separately managed1

  $ 260     $ 9     $ (5)     $ 3     $ 267  

Unified managed

    254       12       (8)       1       259  

Mutual fund advisory

    20             (1)       1       20  

Advisor

    147       8       (8)       2       149  

Portfolio manager

    356       20       (12)       3       367  

Subtotal

  $ 1,037     $ 49     $ (34)     $ 10     $ 1,062  

Cash management

    21       6       (5)           —       22  

Total fee-based client assets

  $ 1,058     $     55     $     (39)     $ 10     $     1,084  

 

$ in billions  

At

March 31,
2017

    Inflows     Outflows     Market
Impact
   

At

June 30,

2017

 

Separately managed1

  $ 230     $ 8     $ (7)     $ 6     $ 237  

Unified managed

    217       13       (7)       5       228  

Mutual fund advisory

    21             (1)       1       21  

Advisor

    133       10       (8)       3       138  

Portfolio manager

    305       23       (11)       4       321  

Subtotal

  $ 906     $     54     $     (34)     $     19     $     945  

Cash management

    21       2       (6)             17  

Total fee-based client assets

  $ 927     $ 56     $ (40)     $ 19     $ 962  
$ in billions  

At

December 31,
2017

    Inflows     Outflows     Market
Impact
   

At

June 30,

2018

 

Separately managed1

  $ 252     $ 18     $ (10)     $ 7     $ 267  

Unified managed

    250       25       (16)             259  

Mutual fund advisory

    21       1       (2)             20  

Advisor

    149       16       (16)             149  

Portfolio manager

    353       39       (22)       (3)       367  

Subtotal

  $ 1,025     $     99     $ (66)     $ 4     $ 1,062  

Cash management

    20       11       (9)           —       22  

Total fee-based client assets

  $ 1,045     $ 110     $     (75)     $ 4     $     1,084  

 

$ in billions  

At

December 31,
2016

    Inflows     Outflows     Market
Impact
   

At

June 30,

2017

 

Separately managed1

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

Unified managed

    204       25       (15)       14       228  

Mutual fund advisory

    21       1       (3)       2       21  

Advisor

    125       19       (14)       8       138  

Portfolio manager

    285           42       (21)       15       321  

Subtotal

  $ 857     $ 103     $     (64)     $     49     $     945  

Cash management

    20       5       (8)             17  

Total fee-based client assets

  $ 877     $ 108     $ (72)     $ 49     $ 962  

Average Fee Rates

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
Fee rate in bps       2018         2017             2018         2017      

Separately managed

    16       17       16       16  

Unified managed

    97       98       98       98  

Mutual fund advisory

    120       118       120       118  

Advisor

    84       84       85       85  

Portfolio manager

    96       96       96       97  

Subtotal

    77       77       76       76  

Cash management

    6       6       6       6  

Total fee-based client assets

    75       75       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.

 

 

   15    June 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Investment Management

Income Statement Information

 

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

Revenues

     

Trading

  $ 16     $ (3     N/M  

Investments

    55       125       (56)%  

Asset management

    610       539       13%  

Other

    3       4       (25)%  

Total non-interest revenues

    684       665       3%  

Interest income

    17       1       N/M  

Interest expense

    10       1       N/M  

Net interest

    7             N/M  

Net revenues

    691       665       4%  

Compensation and benefits

    272       288       (6)%  

Non-compensation expenses

    279       235       19%  

Total non-interest expenses

    551       523       5%  

Income from continuing operations before income taxes

    140       142       (1)%  

Provision for income taxes

    36       41       (12)%  

Net income

    104       101       3%  

Net income (loss) applicable to noncontrolling interests

          1       N/M  

Net income applicable to Morgan Stanley

  $ 104     $ 100       4%  

 

    Six Months Ended
June 30,
       
$ in millions       2018             2017         % Change  

Revenues

     

Trading

  $ 21     $ (14     N/M  

Investments

    132       223       (41)%  

Asset management

    1,236       1,056       17%  

Other

    13       8       63%  

Total non-interest revenues

    1,402       1,273       10%  

Interest income

    18       2       N/M  

Interest expense

    11       1       N/M  

Net interest

    7       1       N/M  

Net revenues

    1,409       1,274       11%  

Compensation and benefits

    576       567       2%  

Non-compensation expenses

    545       462       18%  

Total non-interest expenses

    1,121       1,029       9%  

Income from continuing operations before income taxes

    288       245       18%  

Provision for income taxes

    55       71       (23)%  

Net income

    233       174       34%  

Net income (loss) applicable to noncontrolling interests

    2       7       (71)%  

Net income applicable to Morgan Stanley

  $ 231     $ 167       38%  

Net Revenues

Investments

Investments gains of $55 million in the current quarter and $132 million in the current year period compared with $125 million in the prior year quarter and $223 million in the prior year period, respectively. These decreases reflect the absence of realized investment gains in an infrastructure fund, as well as the reversal of previously accrued carried interest in certain Asia private equity funds, primarily due to losses associated with weakening Asia-Pacific currencies.

Asset Management

Asset management revenues of $610 million in the current quarter and $1,236 million in the current year period increased 13% and 17%, respectively, primarily as a result of higher average AUM across all asset classes. See “AUM Rollforwards” herein.

The adoption of the accounting update Revenue from Contracts with Customers had the effect of increasing Asset management revenues due to the gross presentation of distribution fees. This increase (approximately $44 million in the current year period) was partially offset by the delayed recognition of certain performance fees not in the form of carried interest until they are no longer probable of reversing. For 2018, the recognition of a greater portion of these revenues is expected to occur in the fourth quarter based on current fee arrangements. See Notes 2 and 19 to the financial statements for further details.

Non-interest Expenses

Non-interest expenses of $551 million in the current quarter and $1,121 million in the current year period increased 5% and 9%, respectively, primarily due to higher Non-compensation expenses.

 

 

Compensation and benefits expenses decreased in the current quarter due to decreases in deferred compensation associated with carried interest and the fair value of investments to which certain deferred compensation plans are referenced. Compensation and benefits expenses were relatively unchanged in the current year period.

 

 

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

 

 

June 2018 Form 10-Q    16   


Table of Contents
Management’s Discussion and Analysis    LOGO

 

Income Tax Items

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

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

March 31,
2018

    Inflows     Outflows     Market
Impact
    Other1    

At

June 30,

2018

 

Equity

  $ 109     $ 10     $ (7   $ 3     $ (1   $ 114  

Fixed income

    72       7       (7     (1     (2     69  

Alternative/Other

    131       6       (4     1       (2     132  

Long-term AUM subtotal

    312       23       (18     3       (5     315  

Liquidity

    157       375       (373     1       (1     159  

Total AUM

  $ 469     $ 398     $ (391   $ 4     $ (6   $ 474  

Shares of minority stake assets

    7                                       7  
$ in billions  

At

March 31,

2017

    Inflows     Outflows     Market
Impact
    Other1    

At

June 30,

2017

 

Equity

  $ 87     $ 6     $ (5   $ 5     $ 1     $ 94  

Fixed income

    62       8       (6     1       1       66  

Alternative/Other

    119       6       (6     3       (1     121  

Long-term AUM subtotal

    268       20       (17     9       1       281  

Liquidity

    153       308       (308           1       154  

Total AUM

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

Shares of minority stake assets

    7                                       8  
$ in billions  

At

December 31,
2017

    Inflows     Outflows     Market
Impact
    Other1    

At

June 30,

2018

 

Equity

  $ 105     $ 20     $ (14   $ 3     $     $ 114  

Fixed income

    73       14       (16     (1     (1     69  

Alternative/Other

    128       11       (9     1       1       132  

Long-term AUM subtotal

    306       45       (39     3             315  

Liquidity

    176       700       (717     1       (1     159  

Total AUM

  $ 482     $ 745     $ (756   $ 4     $ (1   $ 474  

Shares of minority stake assets

    7                                       7  
$ in billions  

At

December 31,
2016

    Inflows     Outflows     Market
Impact
    Other1    

At

June 30,

2017

 

Equity

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

Fixed income

    60       13       (11     2       2       66  

Alternative/Other

    115       13       (10     4       (1     121  

Long-term AUM subtotal

    254       37       (31     19       2       281  

Liquidity

    163       636       (646           1       154  

Total AUM

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

Shares of minority stake assets

    8                                       8  

 

1.

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

Average AUM

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
$ in billions    2018      2017      2018      2017  

Equity

   $ 111      $ 91      $ 110      $ 87  

Fixed income

     71        64        72        63  

Alternative/Other

     131        120        130        119  

Long-term AUM subtotal

     313        275        312        269  

Liquidity

     161        153        163        155  

Total AUM

   $ 474      $ 428      $ 475      $ 424  

Shares of minority stake assets

     7        8        7        8  

Average Fee Rate

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
Fee rate in bps    2018      2017      2018      2017  

Equity

     77        73        76        74  

Fixed income

     33        33        34        33  

Alternative/Other

     67        70        67        70  

Long-term AUM

     63        62        63        63  

Liquidity

     18        17        18        18  

Total AUM

     47        46        47        46  
 

 

   17    June 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Supplemental Financial Information and Disclosures

Income Tax Matters

Effective Tax Rate from Continuing Operations

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
          2018              2017              2018              2017      

U.S. GAAP

     20.6%        32.0%        20.7%        30.5%  

Adjusted effective income tax rate—non-GAAP1

     23.4%        31.9%        22.1%        30.1%  

 

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 non-GAAP measures, see “Selected Non-GAAP Financial Information” herein.

Adjusted amounts exclude an intermittent net discrete tax benefit of $88 million in the current quarter and current year period, primarily associated with new information pertaining to the resolution of multi-jurisdiction tax examinations and other matters. Intermittent net discrete tax provisions were $4 million and $18 million in the prior year quarter and prior year period, respectively.

The effective tax rates include recurring-type discrete tax benefits associated with employee share-based payments of $17 million and $16 million in the current quarter and prior year quarter, respectively. The effective tax rates include recurring-type discrete tax benefits associated with employee share-based payments of $164 million and $128 million in the current year period and prior year period, respectively.

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

Our income tax estimates may change as additional clarification and implementation guidance continue to be received from the U.S. Treasury Department and as the interpretation of the Tax Act evolves over time. 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

Our U.S. bank subsidiaries, Morgan Stanley Bank N.A. (“MSBNA”) and Morgan Stanley Private Bank, National Association (“MSPBNA”) (collectively, “U.S. Bank Subsidiaries”) accept deposit accounts, provide loans to a variety of customers, from large corporate and institutional clients to high net worth individuals, and invest in securities. The lending activities in the Institutional Securities business segment primarily include loans and lending commitments to corporate clients. The lending activities in the Wealth Management business segment primarily include: securities-based lending, which allows clients to borrow money against the value of qualifying securities; and residential real estate loans.

We expect our lending activities to continue to grow through further market penetration of 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
    June 30,    

2018

     At
  December 31,  
2017
 

Assets

   $ 200.5      $ 185.3  

Investment securities portfolio:

     

Investment securities—AFS

     41.3        42.0  

Investment securities—HTM

     18.8        17.5  

Total investment securities

   $ 60.1      $ 59.5  

Deposits2

   $ 172.6      $ 159.1  

Wealth Management

 

Securities-based lending and other loans3

   $ 43.6      $ 41.2  

Residential real estate loans

     26.4        26.7  

Total

   $ 70.0      $ 67.9  

Institutional Securities

 

Corporate loans

   $ 26.7      $ 24.2  

Wholesale real estate loans

     14.5        12.2  

Total

   $ 41.2      $ 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.

 

 

June 2018 Form 10-Q    18   


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Management’s Discussion and Analysis    LOGO

 

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. Currently, we plan to adopt this accounting update as of the effective date, January 1, 2019. Based upon our current population of leases, we expect the right of use asset and corresponding lease liability to be less than 1% of our total assets.

 

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

 

  

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

 

  

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

 

  

Overall, the amendments in this update are expected to accelerate the recognition of credit losses for portfolios

 

where the CECL models will be applied. This update is effective as of January 1, 2020 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.

 

 

   19    June 2018 Form 10-Q


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Management’s Discussion and Analysis    LOGO

 

Total Assets by Business Segment

 

    At June 30, 2018  
$ in millions   IS     WM     IM     Total  

Assets

       

Cash and cash equivalents1

  $ 66,624     $ 14,891     $ 74     $ 81,589  

Trading assets at fair value

    262,743       78       3,617       266,438  

Investment securities

    22,204       59,744             81,948  

Securities purchased under agreements to resell

    79,509       14,419             93,928  

Securities borrowed

    153,062       186             153,248  

Customer and other receivables

    43,664       17,467       583       61,714  

Loans, net of allowance2

    42,071       70,037       5       112,113  

Other assets3

    14,011       9,227       1,659       24,897  

Total assets

  $   683,888     $   186,049     $   5,938     $   875,875  
    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 $875.9 billion at June 30, 2018 from $851.7 billion at December 31, 2017, primarily driven by increases to support client activity in Securities borrowed in the Institutional Securities business segment and Loans across all segments. Trading assets within the Institutional Securities business segment declined due to reductions in Equities inventory to support increased demand and changes in client positioning. The decrease in Trading assets resulted in greater liquidity, as reflected by increases in GLR-eligible Securities purchased under agreements to resell, Investment securities and Cash and cash equivalents. For further information regarding our GLR, see “Global Liquidity Reserve” herein.

Collateralized Financing Transactions

 

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

Securities purchased under agreements to resell and Securities borrowed

   $           247,176      $           208,268  

Securities sold under agreements to repurchase and Securities loaned

   $ 63,370      $ 70,016  

Securities received as collateral1

   $ 8,209      $ 13,749  
    

Average Daily Balance

Three Months Ended

 
$ in millions   

June 30,

2018

     December 31,
2017
 

Securities purchased under agreements to resell and Securities borrowed

   $ 227,527      $ 214,343  

Securities sold under agreements to repurchase and Securities loaned

   $ 64,404      $ 66,879  

 

1.

Included in Trading assets in the balance sheets.

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

In addition to the collateralized financing transactions shown in the previous table, we also engage in financing transactions collateralized by customer-owned securities, which are segregated in accordance with regulatory requirements. Receivables under these financing transactions, primarily margin loans, are included in Customer and other receivables in the balance sheets, and payables under these financing transactions, primarily to prime brokerage customers, are included in Customer and other payables in the balance sheets. Our risk exposure on these transactions is mitigated by collateral maintenance policies that limit our credit exposure to customers and liquidity reserves held against this risk exposure.

Liquidity Risk Management Framework

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

The core components of our Liquidity Risk Management Framework are the Required Liquidity Framework, Liquidity Stress Tests and the GLR, which support our target liquidity profile. For further discussion about the Firm’s Required Liquidity Framework and Liquidity Stress Tests, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Liquidity Risk Management Framework” in the 2017 Form 10-K.

 

 

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At June 30, 2018 and December 31, 2017, we maintained sufficient liquidity to meet current and contingent funding obligations as modeled in our Liquidity Stress Tests.

Global Liquidity Reserve

We maintain sufficient global liquidity reserves pursuant to our Required Liquidity Framework. For further discussion of our GLR, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Liquidity Risk Management Framework—Global Liquidity Reserve” in the 2017 Form 10-K.

GLR by Type of Investment

 

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

Cash deposits with banks1

   $ 10,345      $ 7,167  

Cash deposits with central banks1

     33,948        33,791  

Unencumbered highly liquid securities:

     

U.S. government obligations

     88,979        73,422  

U.S. agency and agency mortgage-backed securities

     59,143        55,750  

Non-U.S. sovereign obligations2

     31,157        19,424  

Other investment grade securities

     2,750        3,106  

Total

   $         226,322      $         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 Japanese, U.K., German, Brazilian and French government obligations.

GLR Managed by Bank and Non-Bank Legal Entities

 

   

At
June 30,

2018

   

At
December 31,

2017

    Average Daily
Balance
Three Months Ended
 
$ in millions   June 30, 2018  

Bank legal entities

                       

Domestic

  $ 76,667     $ 70,364     $ 70,962  

Foreign

    4,365       4,756       4,144  

Total Bank legal entities

    81,032       75,120       75,106  

Non-Bank legal entities

 

   

Domestic:

     

Parent Company

    63,401       41,642       55,887  

Non-Parent Company

    31,652       35,264       32,307  

Total Domestic

    95,053       76,906       88,194  

Foreign

    50,237       40,634       50,650  

Total Non-Bank legal entities

    145,290       117,540       138,844  

Total

  $     226,322     $     192,660     $     213,950  

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

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

HQLA by Type of Asset and LCR

 

     Average Daily Balance
Three Months Ended
 
$ in millions        June 30, 2018            March 31, 2018  

HQLA

     

Cash deposits with central banks

   $ 38,456      $ 33,350  

Securities1

     128,268        125,015  

Total

   $ 166,724      $ 158,365  

LCR

     128%        121%  

 

1.

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

The increase in the LCR in the current quarter is due to increased HQLA resulting from changes in the composition of assets 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.

 

 

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The Basel Committee on Banking Supervision (“Basel Committee”) has previously finalized the NSFR framework. In May 2016, the U.S. banking agencies issued a proposal to implement the NSFR in the U.S., which would apply to us and our U.S. Bank Subsidiaries. Our preliminary estimates, based on the current proposal, indicate that actions will be necessary to meet the requirement, which we would expect to accomplish by the effective date of any final rule. Our preliminary estimates are subject to risks and uncertainties that may cause actual results based on the final rule to differ materially from estimates. For an additional discussion of the NSFR, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Liquidity Framework—Net Stable Funding Ratio” in the 2017 Form 10-K.

Funding Management

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

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

Secured Financing

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

At June 30, 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.

Deposits

 

$ in millions  

At

June 30,
2018

    At
December 31,
2017
 

Savings and demand deposits:

   

Brokerage sweep deposits1

  $ 130,698     $ 135,946  

Savings and other

    9,038       8,541  

Total Savings and demand deposits

    139,736       144,487  

Time deposits2

    33,066       14,949  

Total

  $         172,802     $         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 June 30, 2018 increased compared with December 31, 2017, primarily driven by increases in Time deposits and Savings and other deposits, partially offset by a reduction in Brokerage sweep deposits due to client deployment of cash into investments and typical seasonal client tax payments. In the current quarter we initiated a redesign of our Brokerage sweep deposit program, resulting in approximately $10 billion in incremental deposits in higher balance accounts, which partially offset the reductions noted since December 31, 2017. As we make additional adjustments in the third quarter of 2018, we anticipate a similar amount of incremental deposits.

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 June 30, 20181

 

$ in millions    Parent
Company
     Subsidiaries      Total  

Original maturities of one year or less

   $      $ 2,329      $ 2,329  

Original maturities greater than one year

 

  

2018

   $ 3,652      $ 2,436      $ 6,088  

2019

     21,497        4,095        25,592  

2020

     18,781        2,400        21,181  

2021

     21,294        2,984        24,278  

2022

     14,969        1,874        16,843  

Thereafter

     80,964        14,969        95,933  

Total

   $ 161,157      $ 28,758      $ 189,915  

Total Borrowings

   $       161,157      $       31,087      $       192,244  

Maturities over next 12 months2

 

   $ 17,330  

 

1.

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

2.

Includes only borrowings with original maturities greater than one year.

Borrowings of $192,244 million as of June 30, 2018 remained relatively unchanged compared with $192,582 million at December 31, 2017.

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

Credit Ratings

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

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

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

 

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

DBRS, Inc.

  R-1 (middle)   A (high)     Stable  

Fitch Ratings, Inc.

  F1   A     Stable  

Moody’s Investors Service, Inc.

  P-2   A3     Stable  

Rating and Investment Information, Inc.

  a-1   A-     Stable  

S&P Global Ratings

  A-2   BBB+     Stable  
    MSBNA  
     Short-Term
Debt
  Long-Term
Debt
  Rating
Outlook
 

Fitch Ratings, Inc.

  F1   A+     Stable  

Moody’s Investors Service, Inc.

  P-1   A1     Stable  

S&P Global Ratings

  A-1   A+     Stable  

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

June 30,
2018

     At
December 31,
2017
 

One-notch downgrade

   $                 828      $ 822  

Two-notch downgrade

     596        596  

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

 

 

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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 June 30,

   

Six Months

Ended June 30,

 

$ in millions

    2018       2017       2018       2017  

Repurchases of common stock under our share repurchase program

  $     1,250     $ 500     $     2,500     $ 1,250  

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

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

Common Stock Dividend Announcement

 

Announcement date

   July 18, 2018

Amount per share

   $0.30

Date to be paid

   August 15, 2018

Shareholders of record as of

   July 31, 2018

Preferred Stock

Preferred Stock Dividend Announcement

 

Announcement date

   June 15, 2018

Date paid

   July 16, 2018

Shareholders of record as of

   June 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 Federal Reserve. The Federal Reserve establishes capital requirements for us, including “well-capitalized” standards, and evaluates our compliance with such capital requirements. The OCC establishes similar capital requirements and standards for our U.S. Bank Subsidiaries. For us to remain an FHC, we must remain well-capitalized in accordance with standards established by the Federal Reserve and our U.S. Bank Subsidiaries must remain well-capitalized in accordance with standards established by the OCC. For additional information on regulatory capital requirements for our U.S. Bank Subsidiaries, see Note 13 to the financial statements.

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

Regulatory Capital Requirements

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

Risk-based Regulatory Capital.    Minimum risk-based capital ratio requirements apply to Common Equity Tier 1 capital, Tier 1 capital and Total capital (which includes Tier 2 capital). Certain adjustments to and deductions from capital are required for purposes of determining these ratios, such as goodwill, intangible assets, certain deferred tax assets, other amounts in AOCI and investments in the capital instruments of unconsolidated financial institutions.

 

 

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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 June 30, 2018 and December 31, 2017, our ratios are based on the Standardized Approach rules.

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

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

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

Regulatory Capital Ratios

 

     At June 30, 2018  
            Fully Phased-In  
$ in millions    Required
Ratio
     Standardized      Advanced  

Risk-based capital

        

Common Equity Tier 1 capital

            $ 61,352      $ 61,352  

Tier 1 capital

              70,017        70,017  

Total capital

              79,681        79,425  

Total RWA

              387,414        369,383  

Common Equity Tier 1 capital

ratio

     8.6%        15.8%        16.6%  

Tier 1 capital ratio

     10.1%        18.1%        19.0%  

Total capital ratio

     12.1%        20.6%        21.5%  

Leverage-based capital

        

Adjusted average assets1

            $       852,726        N/A  

Tier 1 leverage ratio

     4.0%        8.2%        N/A  

Supplementary leverage exposure2

              N/A        1,096,953  

SLR

     5.0%        N/A        6.4%  

 

    At December 31, 2017  
          Transitional3     Pro Forma 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  

Supplementary leverage exposure2

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

Pro forma SLR

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

 

1.

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

2.

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

3.

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

At December 31, 2017, the pro forma fully phased-in estimated amounts and the pro forma estimated SLR utilized fully phased-in Tier 1 capital, including the fully phased-in Tier 1 capital deductions that applied beginning January 1, 2018. These pro forma fully phased-in estimates were

 

 

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non-GAAP financial measures as the related capital rules were not yet effective at December 31, 2017. These estimates were based on our understanding of the capital rules and other factors at the time.

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

Fully Phased-In Regulatory Capital

 

$ in millions  

At

June 30, 2018

   

At

December 31, 20171

 

Common Equity Tier 1 capital

   

Common stock and surplus

  $ 11,824     $ 14,354  

Retained earnings

    61,835       57,577  

AOCI

    (3,070     (3,060

Regulatory adjustments and deductions:

   

Net goodwill

    (6,682     (6,599

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

    (2,329     (2,446

Other adjustments and deductions2

    (226     738  

Total Common Equity Tier 1 capital

  $ 61,352     $ 60,564  

Additional Tier 1 capital

   

Preferred stock

  $ 8,520     $ 8,520  

Noncontrolling interests

    501       415  

Other adjustments and deductions

    (1     (23

Additional Tier 1 capital

  $ 9,020     $ 8,912  

Deduction for investments in covered funds

    (355     (356

Total Tier 1 capital

  $ 70,017     $ 69,120  

Standardized Tier 2 capital

   

Subordinated debt

  $ 9,141     $ 9,839  

Noncontrolling interests

    118       98  

Eligible allowance for credit losses

    444       423  

Other adjustments and deductions

    (39     (10

Total Standardized Tier 2 capital

  $ 9,664     $ 10,350  

Total Standardized capital

  $ 79,681     $ 79,470  

Advanced Tier 2 capital

   

Subordinated debt

  $ 9,141     $ 9,839  

Noncontrolling interests

    118       98  

Eligible credit reserves

    188       193  

Other adjustments and deductions

    (39     (10

Total Advanced Tier 2 capital

  $ 9,408     $ 10,120  

Total Advanced capital

  $ 79,425     $ 79,240  

Fully Phased-In Regulatory Capital Rollforward

 

$ in millions   Six Months Ended
June 30, 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

    1,718  

Net goodwill

    (83

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

    117  

Other adjustments and deductions2

    (964

Common Equity Tier 1 capital at June 30, 2018

  $ 61,352  

Additional Tier 1 capital

 

Additional Tier 1 capital at December 31, 20171

  $ 8,912  

Change related to the following items:

 

Noncontrolling interests

    86  

Other adjustments and deductions

    22  

Additional Tier 1 capital at June 30, 2018

    9,020  

Deduction for investments in covered funds at December 31, 20171

    (356

Change in deduction for investments in covered funds

    1  

Deduction for investments in covered funds at June 30, 2018

    (355

Tier 1 capital at June 30, 2018

  $ 70,017  

Standardized Tier 2 capital

 

Tier 2 capital at December 31, 20171

  $ 10,350  

Change related to the following items:

 

Eligible allowance for credit losses

    21  

Other changes, adjustments and deductions3

    (707

Standardized Tier 2 capital at June 30, 2018

  $ 9,664  

Total Standardized capital at June 30, 2018

  $ 79,681  

Advanced Tier 2 capital

 

Tier 2 capital at December 31, 20171

  $ 10,120  

Change related to the following items:

 

Eligible credit reserves

    (5

Other changes, adjustments and deductions3

    (707

Advanced Tier 2 capital at June 30, 2018

  $ 9,408  

Total Advanced capital at June 30, 2018

  $ 79,425  

 

1.

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

2.

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

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.

 

 

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Fully Phased-In RWA Rollforward

 

     Six Months Ended
June 30, 2018
1
 
$ in millions    Standardized      Advanced  

Credit risk RWA

     

Balance at December 31, 20172

   $ 301,946      $ 170,754  

Change related to the following items:

     

Derivatives

     (1,584      2,153  

Securities financing transactions

     2,558        1,120  

Securitizations

     (599      (2,103

Investment securities

     (435      384  

Commitments, guarantees and loans

     16,870        19,132  

Cash

     783        420  

Equity investments

     1,824        1,933  

Other credit risk3

     685        901  

Total change in credit risk RWA

   $ 20,102      $ 23,940  

Balance at June 30, 2018

   $ 322,048      $ 194,694  

Market risk RWA

     

Balance at December 31, 20172

   $ 75,295      $ 74,907  

Change related to the following items:

     

Regulatory VaR

     435        435  

Regulatory stressed VaR

     (2,634      (2,634

Incremental risk charge

     1,986        1,986  

Comprehensive risk measure

     (2,035      (1,752

Specific risk:

                 

Non-securitizations

     (3,018      (3,018

Securitizations

     (4,663      (4,663

Total change in market risk RWA

   $ (9,929    $ (9,646

Balance at June 30, 2018

   $ 65,366      $ 65,261  

Operational risk RWA

     

Balance at December 31, 20172

   $ N/A      $ 112,663  

Change in operational risk RWA

     N/A        (3,235

Balance at June 30, 2018

   $ N/A      $ 109,428  

Total RWA

   $ 387,414      $     369,383  

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 as the related capital rules were not yet effective at December 31, 2017.

3.

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

Credit risk RWA increased in the current year period under the Standardized and Advanced Approaches primarily due to increased exposures in corporate lending within the Institutional Securities business segment.

Market risk RWA decreased in the current year period under the Standardized and Advanced Approaches primarily due to decreases in both securitization and non-securitization standardized specific risk charges driven by reduced exposures in residential mortgage-backed securities and equity derivatives, respectively.

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

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

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

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

For a further discussion of TLAC and LTD requirements, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Requirements—Total Loss-Absorbing Capacity, Long-Term Debt and Clean Holding Company Requirements” in the 2017 Form 10-K. For discussions about the interaction between the SPOE resolution strategy and the TLAC and LTD requirements, see “Business—Supervision and Regulation—Financial Holding Company—Resolution and Recovery Planning” and “Risk Factors—Legal, Regulatory and Compliance Risk” in the 2017 Form 10-K.

Capital Plans and Stress Tests

Pursuant to the Dodd-Frank Act, the Federal Reserve has adopted capital planning and stress test requirements for large BHCs, including us, which form part of the Federal Reserve’s annual CCAR framework.

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

 

 

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On June 28, 2018, the Federal Reserve published summary results of CCAR and we received a conditional non-objection to our Capital Plan, where the only condition was that our capital distributions not exceed the greater of the actual distributions we made over the previous four calendar quarters or the annualized average of actual distributions over the previous eight calendar quarters. Our 2018 Capital Plan includes the repurchase of up to $4.7 billion of outstanding common stock for the period beginning July 1, 2018 through June 30, 2019, and an increase in our quarterly common stock dividend to $0.30 per share from the current $0.25 per share, beginning with the common stock dividend announced on July 18, 2018. The total amount of expected 2018 capital distributions is consistent with the $6.8 billion of actual dividends and gross share repurchases included in our 2017 Capital Plan. We disclosed a summary of the results of our company-run stress tests on June 21, 2018 on our Investor Relations website. 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 Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”), which was enacted on May 24, 2018, modifies certain aspects of the stress-testing process applicable to BHCs, including us. The Federal Reserve has not yet taken actions to modify its stress-testing rules applicable to us in response to EGRRCPA, which becomes effective, in relevant part, in November 2019.

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

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

For a further discussion of our capital plans and stress tests, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Requirements—Capital Plans and Stress Tests” in the 2017 Form 10-K.

Attribution of Average Common Equity According to the Required Capital Framework

Our required capital (“Required Capital”) estimation is based on the Required Capital framework, an internal capital

adequacy measure. Common equity attribution to the business segments is based on capital usage calculated under the Required Capital framework, as well as each business segment’s relative contribution to our total Required Capital.

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

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

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

Average Common Equity Attribution1

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
$ in billions   2018     2017     2018     2017  

Institutional Securities

  $ 40.8     $ 40.2     $ 40.8     $ 40.2  

Wealth Management

    16.8       17.2       16.8       17.2  

Investment Management

    2.6       2.4       2.6       2.4  

Parent Company

    9.7       10.1       9.2       9.7  

Total

  $         69.9     $         69.9     $         69.4     $         69.5  

 

1.

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

Resolution and Recovery Planning

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

 

 

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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.

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

For more information about resolution and recovery planning requirements and our activities in these areas, including the implications of such activities in a resolution scenario, see “Business—Supervision and Regulation—Financial Holding Company—Resolution and Recovery Planning” and “Risk Factors—Legal, Regulatory and Compliance Risk” in the 2017 Form 10-K.

Regulatory Developments

Single-Counterparty Credit Limits

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

Volcker Rule

The Volcker Rule prohibits “banking entities,” including us and our affiliates, from engaging in certain “proprietary trading” activities, as defined in the Volcker Rule, subject to

exemptions for underwriting, market-making activities, risk-mitigating hedging and certain other activities. The Volcker Rule also prohibits certain investments and relationships by banking entities with “covered funds,” with a number of exemptions and exclusions.

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

Proposed Stress Buffer Requirements

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

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

Like the stress capital buffer, the stress leverage buffer would be calculated based on the results of our annual supervisory stress tests. The stress leverage buffer would equal the maximum decline in our Tier 1 leverage ratio under the severely adverse scenario, plus the sum of the ratios of the

 

 

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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.

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 us. Under the proposal, the well-capitalized SLR requirement for our U.S. Bank Subsidiaries would change from the current 6% to 3% plus 50% of our current Common Equity Tier 1 G-SIB capital surcharge, for a total well-capitalized SLR requirement of 4.5%, assuming that our G-SIB capital surcharge remains the same when the proposal becomes effective.

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

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

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

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

The U.S. DOL’s final Conflict of Interest Rule under ERISA went into effect on June 9, 2017. On March 15, 2018, the U.S. Court of Appeals for the Fifth Circuit vacated the Conflict of Interest Rule and accompanying exemptions in their entirety. On June 22, 2018, the Court issued the mandate that makes effective its decision to vacate the rule.

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

U.K. Withdrawal from the E.U.

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

 

 

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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.

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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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. 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

 

    Three Months Ended
June 30, 2018
 

$ in millions

 

    Period    

End

    Average     High     Low  

Interest rate and credit spread

      $ 32     $ 35     $ 43     $ 29  

Equity price

    13       14       17       12  

Foreign exchange rate

    11       9       12       7  

Commodity price

    8       9       12       7  

Less: Diversification benefit1, 2

    (25     (26     N/     N/

Primary Risk Categories

      $ 39     $         41     $       51     $       35  

Credit Portfolio

    14       11       14       9  

Less: Diversification benefit1, 2

    (10     (8     N/     N/

Total Management VaR

      $ 43     $ 44     $ 54     $ 38  
    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/     N/

Primary Risk Categories

      $ 50     $ 42     $ 51     $ 36  

Credit Portfolio

    11       10       11       9  

Less: Diversification benefit1, 2

    (7     (6     N/     N/

Total Management VaR

      $ 54     $ 46     $ 55     $ 40  

 

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 $44 million and $41 million, respectively, decreased from the three-months ended March 31, 2018, primarily as a result of lower market volatility and increased diversification benefit.

 

 

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Distribution of VaR Statistics and Net Revenues.    One method of evaluating the reasonableness of our VaR model as a measure of our potential volatility of net revenues is to compare VaR with corresponding actual trading revenues. Assuming no intraday trading, for a 95%/one-day VaR, the expected number of times that trading losses should exceed VaR during the year is 13, and, in general, if trading losses were to exceed VaR more than 21 times in a year, the adequacy of the VaR model would be questioned.

We evaluate the reasonableness of our VaR model by comparing the potential declines in portfolio values generated by the model with corresponding actual trading results for the Firm, as well as individual business units. For days where losses exceed the VaR statistic, we examine the drivers of trading losses to evaluate the VaR model’s accuracy relative to realized trading results. There were no days in the current year period on which trading losses exceeded VaR.

The distribution of VaR statistics and net revenues is presented in the following histograms for the Total Trading populations.

Total Trading.    As shown in the 95%/One-Day Management VaR table, the average 95%/one-day total Management VaR for the current quarter was $44 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)

 

LOGO

Non-Trading Risks

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

Exposure Related to Our Own Credit Spread.

Credit Spread Risk Sensitivity1

 

$ in millions    At
June 30, 2018
     At
March 31, 2018
 

Derivatives

   $ 6      $ 6  

Funding liabilities2

     32        31  

 

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

June 30, 2018

    

At

March 31, 2018

 

Basis point change

     

+200

   $ 531      $ 438  

+100

     273        226  

-100

     (489      (464

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 June 30, 2018 and March 31, 2018 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
June 30,
2018
     At
March 31,
2018
 

Investments related to Investment

     

Management activities

   $ 301      $ 321  

Other investments:

     

MUMSS

     164        172  

Other Firm investments

     181        187  

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

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

Therefore, overall revenues do not correlate completely with changes in the equity markets.

Credit Risk

Credit risk refers to the risk of loss arising when a borrower, counterparty or issuer does not meet its financial obligations to us. We primarily incur credit risk exposure to institutions and individuals through our Institutional Securities and Wealth Management business segments. For a further discussion of our credit risks, see “Quantitative and Qualitative Disclosures about Market Risk–Risk Management–Credit Risk” in the 2017 Form 10-K. Also, see Notes 7 and 11 to the financial statements for additional information about our loans and lending commitments, respectively.

Lending Activities Included in Loans and Trading Assets

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

Loans and Lending Commitments

 

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

Corporate loans

  $ 16,689     $ 15,688     $ 5     $ 32,382  

Consumer loans

          27,954             27,954  

Residential real estate loans

          26,405             26,405  

Wholesale real estate loans

    9,866                   9,866  

Loans held for investment, gross of allowance

    26,555       70,047       5       96,607  

Allowance for loan losses

    (202     (39           (241

Loans held for investment, net of allowance

    26,353       70,008       5       96,366  

Corporate loans

    13,366                   13,366  

Residential real estate loans

    1       29             30  

Wholesale real estate loans

    2,351                   2,351  

Loans held for sale

    15,718       29             15,747  

Corporate loans

    8,730             22       8,752  

Residential real estate loans

    1,334                   1,334  

Wholesale real estate loans

    2,703             1,130       3,833  

Loans held at fair value

    12,767             1,152       13,919  

Total loans

    54,838       70,037       1,157       126,032  

Lending commitments2, 3

    112,833       10,706       173       123,712  

Total loans and lending commitments2, 3

  $     167,671     $     80,743     $     1,330     $     249,744  
 

 

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

Corporate loans

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

Consumer loans

          26,808             26,808  

Residential real estate loans

          26,635             26,635  

Wholesale real estate loans

    9,980                   9,980  

Loans held for investment, gross of allowance

    25,312       67,860       5       93,177  

Allowance for loan losses

    (182     (42           (224

Loans held for investment, net of allowance

    25,130       67,818       5       92,953  

Corporate loans

    9,456                   9,456  

Residential real estate loans

    1       34             35  

Wholesale real estate loans

    1,682                   1,682  

Loans held for sale

    11,139       34             11,173  

Corporate loans

    8,336             22       8,358  

Residential real estate loans

    799                   799  

Wholesale real estate loans

    1,579                   1,579  

Loans held at fair value

    10,714             22       10,736  

Total loans

    46,983       67,852       27       114,862  

Lending commitments2, 3

    92,588       9,481             102,069  

Total loans and lending commitments2, 3

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

 

1.

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

2.

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

3.

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

Total loans and lending commitments increased by approximately $33 billion in the current year period, primarily due to increases in corporate loan 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
June 30,
2018
     At
December 31,
2017
 

Loans

   $                 241      $ 224  

Lending commitments

     202        198  

Total allowance for loans and lending commitments

   $ 443      $ 422  

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

Status of Loans Held for Investment

 

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

Current

     99.6 %        99.9 %        99.5 %        99.9 %  

Nonaccrual1

     0.4 %        0.1 %        0.5 %        0.1 %  

 

1.

These loans are on nonaccrual status because the loans were past due for a period of 90 days or more or payment of principal or interest was in doubt.

Institutional Securities 

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

We also participate in securitization activities, whereby we extend short-term or long-term 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, the Firm 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.

 

 

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Institutional Securities Loans and Lending Commitments1

 

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

Loans

         

AA

  $     $ 472     $     $ 20     $ 492  

A

    712       2,465       1,313       412       4,902  

BBB

    3,465       6,811       4,690       1,257       16,223  

NIG

    6,996       11,124       8,824       3,526       30,470  

Unrated2

    140       124       133       2,354       2,751  

Total loans

    11,313       20,996       14,960       7,569       54,838  

Lending commitments

 

       

AAA

          165                   165  

AA

    3,293       1,037       2,950       350       7,630  

A

    4,243       17,434       8,165       765       30,607  

BBB

    2,150       16,094       17,867       728       36,839  

NIG

    1,691       10,865       14,057       10,928       37,541  

Unrated2

    1             21       29       51  

Total lending commitments

    11,378       45,595       43,060       12,800       112,833  

Total exposure

  $ 22,691     $     66,591     $     58,020     $     20,369     $     167,671  

 

    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—Market Risk” herein.

Institutional Securities Loans and Lending Commitments by Industry

 

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

Industry

     

Financials

   $ 30,994      $ 22,112  

Real estate

     28,729        28,426  

Industrials

     15,256        11,090  

Consumer discretionary

     14,252        11,555  

Information technology

     13,645        11,862  

Consumer Staples

     10,924        8,315  

Healthcare

     10,909        9,956  

Utilities

     10,187        9,592  

Insurance

     9,888        4,739  

Energy

     9,720        10,233  

Telecommunications services

     5,767        4,172  

Materials

     5,398        5,069  

Other

     2,002        2,450  

Total

   $         167,671      $         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 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 Hedges—Notional Amounts

 

$ in billions   

At

June 30,
2018

     At
December 31,
2017
 

Single-name and index CDS

   $             13.5      $ 16.6  

Event-Driven Loans and Lending Commitments

 

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

Loans

    $ 1,773      $ 838      $ 1,803      $ 1,867      $ 6,281  

Lending commitments

    613        14,514        2,737        5,018        22,882  

Total loans and lending commitments

    $ 2,386      $   15,352      $   4,540      $   6,885      $   29,163  

 

    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  
 

 

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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 year period is primarily due to an increase in held-for-sale commitments driven by client M&A transactions.

Wealth Management

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

Securities-based lending provided to our 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 June 30, 2018  
    Contractual Years to Maturity        
$ in millions     Less than 1     1-3     3-5     Over 5     Total  

Securities-based lending
and other loans1

    $ 36,299     $ 4,485     $ 1,642     $ 1,195     $ 43,621  

Residential real
estate loans

          27       6       26,383       26,416  

Total loans

    $ 36,299     $ 4,512     $ 1,648     $ 27,578     $ 70,037  

Lending commitments

    8,596       1,735       99       276       10,706  

Total loans and lending commitments

    $ 44,895     $     6,247     $     1,747     $     27,854     $     80,743  

 

    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 $33.4 billion and $32.2 billion at June 30, 2018 and December 31, 2017, respectively.

For the current year period, loans and lending commitments associated with the Wealth Management business segment lending activities increased by approximately 4%, primarily due to growth in securities-based lending and other loans.

Lending Activities Included in Customer and Other Receivables

Margin Loans

 

    At June 30, 2018  
$ in millions   IS     WM     Total  

Net customer receivables representing margin loans

  $  21,026     $  11,785     $  32,811  

 

    At December 31, 2017  
$ in millions   IS     WM     Total  

Net customer receivables representing margin loans

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

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

Employee Loans

 

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

Employee loans:

     

Balance

   $             3,564      $             4,185  

Allowance for loan losses

     (74      (77

Balance, net

   $ 3,490      $         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

 

 

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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        
$ in millions   AAA     AA     A     BBB     NIG     Total  

At June 30, 2018

 

       

< 1 year

  $ 599     $ 7,435     $ 40,004     $ 14,284     $ 7,828     $ 70,150  

1-3 years

    739       3,785       23,108       8,246       6,507       42,385  

3-5 years

    760       2,579       14,910       4,951       2,638       25,838  

Over 5 years

    4,461       10,459       73,771       35,558       11,509       135,758  

Total, gross

  $   6,559     $   24,258     $   151,793     $   63,039     $   28,482     $   274,131  

Counterparty Netting

    (3,328     (15,944     (124,298     (44,666     (15,405     (203,641

Cash and Securities collateral

    (2,918     (6,066     (23,179     (12,924     (9,401     (54,488

Total, net

  $ 313     $ 2,248     $ 4,316     $ 5,449     $ 3,676     $ 16,002  

 

    Credit Rating1        
$ in millions   AAA     AA     A     BBB     NIG     Total  

At December 31, 2017

 

       

< 1 year

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

1-3 years

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

3-5 years

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

Over 5 years

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

Total, gross

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

Counterparty Netting

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

Cash and Securities collateral

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

Total, net

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

 

1.

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
June 30,
2018
     At
December 31,
2017
 

Industry

  

Utilities

   $ 4,670      $ 4,382  

Financials

     4,078        3,330  

Energy

     1,040        646  

Industrials

     965        1,124  

Regional governments

     899        1,005  

Healthcare

     733        882  

Information technology

     631        715  

Not-for-profit organizations

     553        703  

Sovereign governments

     548        1,084  

Consumer discretionary

     461        464  

Real estate

     320        374  

Materials

     303        329  

Insurance

     254        206  

Consumer staples

     228        161  

Other

     319        270  

Total

   $             16,002      $             15,675  

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

Country Risk Exposure

Country risk exposure is the risk that events in, or that affect, a foreign country (any country other than the U.S.) might adversely affect us. We actively manage country risk exposure through a comprehensive risk management framework that combines credit and market fundamentals and allows us to effectively identify, monitor and limit country risk. Country risk exposure before and after hedging is monitored and managed. For a further discussion of our country risk exposure see, “Quantitative and Qualitative Disclosures about Market Risk–Risk Management–Country Risk Exposure” in the 2017 Form 10-K.

Our sovereign exposures consist of financial 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 June 30, 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

 

 

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Risk Disclosures    LOGO

 

country that references bonds issued by an entity in a different country, the fair value of the CDS is reflected in the Net Counterparty Exposure column based on the country of the CDS issuer. Further, the notional amount of the CDS adjusted for the fair value of the receivable/payable is reflected in the Net Inventory column based on the country of the underlying reference entity.

Top Ten Country Exposures at June 30, 2018

 

United Kingdom                     
$ in millions    Sovereigns      Non-sovereigns      Total  

Net Inventory1

   $               562      $ 1,087      $ 1,649  

Net Counterparty Exposure2

     110        10,174          10,284  

Loans

            2,476        2,476  

Lending Commitments

            6,191        6,191  

Exposure before Hedges

     672        19,928        20,600  

Hedges3

     (356      (1,619      (1,975

Net Exposure

   $ 316      $ 18,309      $ 18,625  
Japan                     
$ in millions    Sovereigns      Non-sovereigns      Total  

Net Inventory1

   $ 4,868      $ 301      $ 5,169  

Net Counterparty Exposure2

     77        3,575        3,652  

Loans

                    

Lending Commitments

                    

Exposure before Hedges

     4,945        3,876        8,821  

Hedges3

     (118      (115      (233

Net Exposure

   $ 4,827      $ 3,761      $ 8,588  
Spain                     
$ in millions    Sovereigns      Non-sovereigns      Total  

Net Inventory1

   $ (1,225    $ (98    $ (1,323

Net Counterparty Exposure2

            110        110  

Loans

            2,704        2,704  

Lending Commitments

            5,679        5,679  

Exposure before Hedges

     (1,225      8,395        7,170  

Hedges3

            (189      (189

Net Exposure

   $ (1,225    $ 8,206      $ 6,981  

Germany

        
$ in millions    Sovereigns      Non-sovereigns      Total  

Net Inventory1

   $ 61      $ 439      $ 500  

Net Counterparty Exposure2

     519        1,941        2,460  

Loans

            1,310        1,310  

Lending Commitments

            3,629        3,629  

Exposure before Hedges

     580        7,319        7,899  

Hedges3

     (509      (1,098      (1,607

Net Exposure

   $ 71      $ 6,221      $ 6,292  

Brazil

        
$ in millions    Sovereigns      Non-sovereigns      Total  

Net Inventory1

   $ 4,275      $ 85      $ 4,360  

Net Counterparty Exposure2

            312        312  

Loans

            73        73  

Lending Commitments

            320        320  

Exposure before Hedges

     4,275        790        5,065  

Hedges3

     (11      (19      (30

Net Exposure

   $ 4,264      $ 771      $ 5,035  

Netherlands

        
$ in millions    Sovereigns      Non-sovereigns      Total  

Net Inventory1

   $ (293    $ 104      $ (189

Net Counterparty Exposure2

            712        712  

Loans

            1,852        1,852  

Lending Commitments

            1,641        1,641  

Exposure before Hedges

     (293      4,309        4,016  

Hedges3

     (20      (264      (284

Net Exposure

   $ (313    $ 4,045      $     3,732  

China

        
$ in millions    Sovereigns      Non-sovereigns      Total  

Net Inventory1

   $ 432      $ 765      $ 1,197  

Net Counterparty Exposure2

     203        147        350  

Loans

            1,241        1,241  

Lending Commitments

            657        657  

Exposure before Hedges

     635        2,810        3,445  

Hedges3

     (49      (10      (59

Net Exposure

   $ 586      $ 2,800      $ 3,386  
France                     
$ in millions    Sovereigns      Non-sovereigns      Total  

Net Inventory1

   $ (220    $ (115    $ (335

Net Counterparty Exposure2

            2,034        2,034  

Loans

            186        186  

Lending Commitments

            2,092        2,092  

Exposure before Hedges

     (220      4,197        3,977  

Hedges3

     (50      (671      (721

Net Exposure

   $ (270    $ 3,526      $ 3,256  
Canada                     
$ in millions    Sovereigns      Non-sovereigns      Total  

Net Inventory1

   $ (500    $ 214      $ (286

Net Counterparty Exposure2

     32        1,869        1,901  

Loans

            58        58  

Lending Commitments

            1,433        1,433  

Exposure before Hedges

     (468      3,574        3,106  

Hedges3

            (262      (262

Net Exposure

   $ (468    $ 3,312      $ 2,844  

Italy

        
$ in millions    Sovereigns      Non-sovereigns      Total  

Net Inventory1

   $ 1,286      $ 374      $ 1,660  

Net Counterparty Exposure2

     (8      451        443  

Loans

            125        125  

Lending Commitments

            418        418  

Exposure before Hedges

     1,278        1,368        2,646  

Hedges3

     7        (76      (69

Net Exposure

   $ 1,285      $ 1,292      $ 2,577  

 

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.

 

 

   39    June 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
June 30,
2018
 

Gross purchased protection

   $ (78,476

Gross written protection

             76,933  

Net exposure

   $ (1,543

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          At
June 30,
2018
 

Counterparty credit exposure

   Collateral1   

Germany

   Belgium and Germany    $         9,409  

United Kingdom

   U.K., U.S. and Japan      9,039  

Other

   Japan, France and Spain      15,213  

 

1.

Collateral primarily consists of cash and government obligations.

Country Risk Exposures Related to the U.K. At June 30, 2018, our country risk exposures in the U.K. included net exposures of $18,625 million as shown in the Top Ten Country Exposures table, and overnight deposits of $6,236 million. The $18,309 million of exposures to non-sovereigns were diversified across both names and sectors. Of these exposures, $5,743 million were to U.K.-focused counterparties that generate more than one-third of their revenues in the U.K., $5,076 million were to geographically diversified counterparties, and $6,454 million were to exchanges and clearinghouses.

Country Risk Exposures Related to Brazil. At June 30, 2018, our country risk exposures in Brazil included net exposures of $5,035 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 $771 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.

 

 

June 2018 Form 10-Q    40   


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 June 30, 2018, and the related condensed consolidated income statements and comprehensive income statements for the three-month and six-month periods ended June 30, 2018 and 2017, and the cash flow statements and statements of changes in total equity for the six-month periods ended June 30, 2018 and 2017, and the related notes (collectively referred to as the “interim financial information”). Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Firm as of December 31, 2017, and the related consolidated income statement, comprehensive income statement, cash flow statement and statement of changes in total equity for the year then ended (not presented herein) included in the Firm’s Annual Report on Form 10-K; and in our report dated February 27, 2018, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2017 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results

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

We conducted our reviews in accordance with the standards of the PCAOB. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

 

/s/ Deloitte & Touche LLP

New York, New York

August 3, 2018

 

   41    June 2018 Form 10-Q


Table of Contents

Consolidated Income Statements

(Unaudited)

   LOGO

 

    

Three Months Ended

June 30,

          

Six Months Ended

June 30,

 
in millions, except per share data          2018                  2017                         2018                  2017        

Revenues

             

Investment banking

   $ 1,793      $ 1,530              $ 3,427      $ 3,075  

Trading

     3,293        2,931                7,063        6,166  

Investments

     147        163                273        328  

Commissions and fees

     1,039        1,027                2,212        2,060  

Asset management

     3,189        2,902                6,381        5,669  

Other

     243        199                450        428  

Total non-interest revenues

     9,704        8,752                19,806              17,726  

Interest income

     3,294        2,106                6,154        4,071  

Interest expense

     2,388        1,355                4,273        2,549  

Net interest

     906        751                1,881        1,522  

Net revenues

     10,610        9,503                      21,687        19,248  

Non-interest expenses

             

Compensation and benefits

     4,621        4,252                9,535        8,718  

Occupancy and equipment

     346        333                682        660  

Brokerage, clearing and exchange fees

     609        525                1,236        1,034  

Information processing and communications

     496        433                974        861  

Marketing and business development

     179        155                319        291  

Professional services

     580        561                1,090        1,088  

Other

     670        602                1,322        1,146  

Total non-interest expenses

     7,501        6,861                15,158        13,798  

Income from continuing operations before income taxes

     3,109        2,642                6,529        5,450  

Provision for income taxes

     640        846                1,354        1,661  

Income from continuing operations

     2,469        1,796                5,175        3,789  

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

     (2      (5              (4      (27

Net income

   $ 2,467      $ 1,791              $ 5,171      $ 3,762  

Net income applicable to noncontrolling interests

     30        34                66        75  

Net income applicable to Morgan Stanley

   $ 2,437      $ 1,757              $ 5,105      $ 3,687  

Preferred stock dividends and other

     170        170                263        260  

Earnings applicable to Morgan Stanley common shareholders

   $ 2,267      $         1,587              $ 4,842      $ 3,427  

Earnings per basic common share

             

Income from continuing operations

   $ 1.32      $ 0.89              $ 2.80      $ 1.92  

Income (loss) from discontinued operations

                                  (0.01

Earnings per basic common share

   $ 1.32      $ 0.89              $ 2.80      $ 1.91  

Earnings per diluted common share

             

Income from continuing operations

   $ 1.30      $ 0.87              $ 2.75      $ 1.88  

Income (loss) from discontinued operations

                                  (0.01

Earnings per diluted common share

   $ 1.30      $ 0.87              $ 2.75      $ 1.87  

Dividends declared per common share

   $ 0.25      $ 0.20              $ 0.50      $ 0.40  

Average common shares outstanding

             

Basic

     1,720        1,791                1,730        1,796  

Diluted

     1,748        1,830                1,760        1,836  

 

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


Table of Contents

Consolidated Comprehensive Income Statements

(Unaudited)

   LOGO

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
$ in millions        2018           2017          2018                 2017  

Net income

   $ 2,467     $ 1,791      $ 5,171     $ 3,762  

Other comprehensive income (loss), net of tax:

         

Foreign currency translation adjustments

   $ (192   $ 12      $ (75   $ 162  

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

     (126     108        (536     192  

Pension, postretirement and other

     6       4        11       4  

Change in net debt valuation adjustment

     639       (183      1,090       (174

Total other comprehensive income (loss)

   $ 327     $ (59    $ 490     $ 184  

Comprehensive income

   $ 2,794     $ 1,732      $ 5,661     $ 3,946  

Net income applicable to noncontrolling interests

     30       34        66       75  

Other comprehensive income (loss) applicable to noncontrolling interests

     (9     (21      63       29  

Comprehensive income applicable to Morgan Stanley

   $ 2,773     $ 1,719      $ 5,532     $ 3,842  

 

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


Table of Contents
Consolidated Balance Sheets    LOGO

 

$ in millions, except share data    (Unaudited)
At
June 30,
2018
     At
December 31,
2017
 

Assets

     

Cash and cash equivalents:

     

Cash and due from banks

   $ 30,176      $ 24,816  

Interest bearing deposits with banks

     18,707        21,348  

Restricted cash

     32,706        34,231  

Trading assets at fair value ($168,810 and $169,735 were pledged to various parties)

     266,438        298,282  

Investment securities (includes $56,704 and $55,203 at fair value)

     81,948        78,802  

Securities purchased under agreements to resell

     93,928        84,258  

Securities borrowed

     153,248        124,010  

Customer and other receivables

     61,714        56,187  

Loans:

     

Held for investment (net of allowance of $241 and $224)

     96,366        92,953  

Held for sale

     15,747        11,173  

Goodwill

     6,692        6,597  

Intangible assets (net of accumulated amortization of $2,909 and $2,730)

     2,332        2,448  

Other assets

     15,873        16,628  

Total assets

   $ 875,875      $ 851,733  

Liabilities

     

Deposits (includes $285 and $204 at fair value)

   $         172,802      $         159,436  

Trading liabilities at fair value

     139,359        131,295  

Securities sold under agreements to repurchase (includes $788 and $800 at fair value)

     50,650        56,424  

Securities loaned

     12,720        13,592  

Other secured financings (includes $3,606 and $3,863 at fair value)

     9,890        11,271  

Customer and other payables

     201,737        191,510  

Other liabilities and accrued expenses

     15,967        17,157  

Borrowings (includes $50,350 and $46,912 at fair value)

     192,244        192,582  

Total liabilities

     795,369        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: 1,749,653,071 and 1,788,086,805

     20        20  

Additional paid-in capital

     23,454        23,545  

Retained earnings

     61,835        57,577  

Employee stock trusts

     2,829        2,907  

Accumulated other comprehensive income (loss)

     (3,070      (3,060

Common stock held in treasury at cost, $0.01 par value (289,240,908 and 250,807,174 shares)

     (11,650      (9,211

Common stock issued to employee stock trusts

     (2,829      (2,907

Total Morgan Stanley shareholders’ equity

     79,109        77,391  

Noncontrolling interests

     1,397        1,075  

Total equity

     80,506        78,466  

Total liabilities and equity

   $ 875,875      $ 851,733  

 

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


Table of Contents

Consolidated Statements of Changes in Total Equity

(Unaudited)

   LOGO

 

$ in millions

 

Preferred

Stock

   

Common

Stock

   

Additional

Paid-in

Capital

   

Retained

Earnings

   

Employee

Stock

Trusts

   

Accumulated

Other

Comprehensive

Income (Loss)

   

Common

Stock

Held in

Treasury

at Cost

   

Common

Stock

Issued to

Employee

Stock

Trusts

   

Non-

controlling

Interests

   

Total

Equity

 

Balance at December 31, 2017

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

Cumulative adjustment for accounting changes1

                      306             (437                       (131

Net income applicable to Morgan Stanley

                      5,105                                     5,105  

Net income applicable to noncontrolling interests

                                                    66       66  

Dividends

                      (1,153                                   (1,153

Shares issued under employee plans

                (91           (78           734       78             643  

Repurchases of common stock and employee tax withholdings

                                        (3,173                 (3,173

Net change in Accumulated other comprehensive income (loss)

                                  427                   63       490  

Other net increases

                                                    193       193  

Balance at June 30, 2018

  $ 8,520     $ 20     $ 23,454     $ 61,835     $ 2,829     $ (3,070   $ (11,650   $ (2,829   $ 1,397     $ 80,506  

Balance at December 31, 2016

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

Cumulative adjustment for accounting changes1

                45       (35                                   10  

Net income applicable to Morgan Stanley

                      3,687                                     3,687  

Net income applicable to noncontrolling interests

                                                    75       75  

Dividends

                      (1,006                                   (1,006

Shares issued under employee plans

                (170           94             815       (94           645  

Repurchases of common stock and employee tax withholdings

                                        (1,709                 (1,709

Net change in Accumulated other comprehensive income (loss)

                                  155                   29       184  

Issuance of preferred stock

    1,000             (6                                         994  

Other net decreases

                                                    (90     (90

Balance at June 30, 2017

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

 

1.

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

 

See Notes to Consolidated Financial Statements    45    June 2018 Form 10-Q


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Consolidated Cash Flow Statements

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Six Months Ended

June 30,

 
$ in millions    2018      2017  

Cash flows from operating activities

     

Net income

   $ 5,171      $                 3,762  

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

     

(Income) loss from equity method investments

     (54       

Stock-based compensation expense

     526        518  

Depreciation and amortization

     907        889  

(Release of) Provision for credit losses on lending activities

     (29      25  

Other operating adjustments

     72        (158

Changes in assets and liabilities:

     

Trading assets, net of Trading liabilities

     39,106        (18,797

Securities borrowed

     (29,238      (1,486

Securities loaned

     (872      1,018  

Customer and other receivables and other assets

     (9,279      (6,144

Customer and other payables and other liabilities

     9,053        5,598  

Securities purchased under agreements to resell

     (9,670      4,547  

Securities sold under agreements to repurchase

     (5,774      (3,931

Net cash provided by (used for) operating activities

     (81      (14,159

Cash flows from investing activities

     

Proceeds from (payments for):

     

Other assets—Premises, equipment and software, net

     (908      (723

Changes in loans, net

     (4,560      (5,326

Investment securities:

     

Purchases

     (12,388      (8,418

Proceeds from sales

     2,231        13,533  

Proceeds from paydowns and maturities

     6,469        3,668  

Other investing activities

     (147      (39

Net cash provided by (used for) investing activities

     (9,303      2,695  

Cash flows from financing activities

     

Net proceeds from (payments for):

     

Noncontrolling interests

     (85      (35

Other secured financings

     (2,275      4,272  

Deposits

     13,366        (10,950

Proceeds from:

     

Derivatives financing activities

            73  

Issuance of preferred stock, net of issuance costs

            994  

Issuance of Borrowings

     28,234        33,522  

Payments for:

     

Borrowings

     (22,981      (17,821

Derivatives financing activities

            (48

Repurchases of common stock and employee tax withholdings

     (3,173      (1,709

Cash dividends

     (1,115      (954

Other financing activities

     (145      21  

Net cash provided by (used for) financing activities

     11,826        7,365  

Effect of exchange rate changes on cash and cash equivalents

     (1,248      1,569  

Net increase (decrease) in cash and cash equivalents

     1,194        (2,530

Cash and cash equivalents, at beginning of period

     80,395        77,360  

Cash and cash equivalents, at end of period

   $ 81,589      $ 74,830  

Cash and cash equivalents:

     

Cash and due from banks

   $                 30,176      $ 25,008  

Interest bearing deposits with banks

     18,707        19,651  

Restricted cash

     32,706        30,171  

Cash and cash equivalents, at end of period

   $ 81,589      $ 74,830  

Supplemental Disclosure of Cash Flow Information

     

Cash payments for:

     

Interest

   $ 3,934      $ 1,922  

Income taxes, net of refunds

     790        732  

 

June 2018 Form 10-Q    46    See Notes to Consolidated Financial Statements


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Notes to Consolidated Financial Statements

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1. Introduction and Basis of Presentation

The Firm

Morgan Stanley is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Wealth Management and Investment Management. Morgan Stanley, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. Unless the context otherwise requires, the terms “Morgan Stanley” or the “Firm” mean Morgan Stanley (the “Parent Company”) together with its consolidated subsidiaries. See the “Glossary of Common Acronyms” for definitions of certain acronyms used throughout this Form 10-Q.

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

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

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

Investment Management provides a broad range of investment strategies and products that span geographies, asset classes, and public and private markets to a diverse group of clients across institutional and intermediary channels. Strategies and products include equity, fixed income,

liquidity and alternative/other products. Institutional clients include defined benefit/defined contribution plans, foundations, endowments, government entities, sovereign wealth funds, insurance companies, third-party fund sponsors and corporations. Individual clients are serviced through intermediaries, including affiliated and non-affiliated distributors.

Basis of Financial Information

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

The accompanying financial statements should be read in conjunction with the Firm’s financial statements and notes thereto included in the 2017 Form 10-K. Certain footnote disclosures included in the 2017 Form 10-K have been condensed or omitted from these financial statements as they are not required for interim reporting under U.S. GAAP. The financial statements reflect all adjustments of a normal, recurring nature that are, in the opinion of management, necessary for the fair presentation of the results for the interim period. The results of operations for interim periods are not necessarily indicative of results for the entire year.

Consolidation

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

 

 

   47    June 2018 Form 10-Q


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Notes to Consolidated Financial Statements

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

Carried Interest

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

Accounting Updates Adopted

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

Revenue from Contracts with Customers

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

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

Revenue Recognition

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

 

 

Investment Banking

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

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

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

 

 

Commissions and Fees

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

 

 

Asset Management Revenues

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

 

 

June 2018 Form 10-Q    48   


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Notes to Consolidated Financial Statements

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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-interest expenses line items.

 

 

Other Items

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

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

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

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

Derivatives and Hedging–Targeted Improvements to Accounting for Hedging Activities

This accounting update aims to better align the hedge accounting requirements with an entity’s risk management

strategies and improve the financial reporting of hedging relationships. It also results in simplification of the application of hedge accounting related to the assessment of hedge effectiveness.

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

Effective January 1, 2018, in accordance with this adoption, the Firm has updated its accounting policies to permit the hedged item in a fair value hedge of interest rate risk to be defined as including only the benchmark rate component of contractual coupon cash flows, and to allow for hedging part of the contractual term of the hedged instrument. The accounting policy also requires the entire gain or loss from revaluing hedges of net investments in foreign operations at the spot rate to be reported within AOCI.

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.

 

 

   49    June 2018 Form 10-Q


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Notes to Consolidated Financial Statements

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3. Fair Values

Fair Value Measurement

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

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

Assets at fair value

         

Trading assets:

         

U.S. Treasury and agency securities

  $ 25,629     $ 24,986     $     $     $ 50,615  

Other sovereign government obligations

    24,899       6,680       5             31,584  

State and municipal securities

          3,602       2             3,604  

MABS

          1,913       327             2,240  

Loans and lending commitments2

          6,996       6,923             13,919  

Corporate and other debt

          19,335       701             20,036  

Corporate equities3

    106,657       512       171             107,340  

Derivative and other contracts:

 

 

Interest rate

    953       166,598       1,118             168,669  

Credit

          5,414       406             5,820  

Foreign exchange

    88       65,440       67             65,595  

Equity

    862       44,608       1,177             46,647  

Commodity and other

    278       6,795       4,652             11,725  

Netting1

    (1,302     (215,518     (1,693     (47,389     (265,902

Total derivative and other contracts

    879       73,337       5,727       (47,389     32,554  

Investments4

    519       411       941             1,871  

Physical commodities

          255                   255  

Total trading assets4

    158,583       138,027       14,797       (47,389     264,018  

Investment securities—AFS

    31,601       25,103                   56,704  

Intangible assets

          3                   3  

Total assets
at fair value

  $  190,184     $ 163,133     $  14,797     $  (47,389   $ 320,725  
    At June 30, 2018  
$ in millions   Level 1     Level 2     Level 3     Netting1     Total  

Liabilities at fair value

         

Deposits

  $     $ 248     $ 37     $     $ 285  

Trading liabilities:

         

U.S. Treasury and
agency securities

    15,625       26                   15,651  

Other sovereign
government obligations

    22,059       2,796                   24,855  

Corporate and other debt

          8,370       1             8,371  

Corporate equities3

    62,807       809       24             63,640  

Derivative and other contracts:

 

 

Interest rate

    1,105       152,302       551             153,958  

Credit

          5,735       408             6,143  

Foreign exchange

    15       61,612       93             61,720  

Equity

    831       44,460       2,712             48,003  

Commodity and other

    614       7,580       2,620             10,814  

Netting1

    (1,302     (215,518     (1,693     (35,283     (253,796

Total derivative and
other contracts

    1,263       56,171       4,691       (35,283     26,842  

Total trading liabilities

    101,754       68,172       4,716       (35,283     139,359  

Securities sold under
agreements to repurchase

          788                   788  

Other secured financings

          3,436       170             3,606  

Borrowings

          47,055       3,295             50,350  

Total liabilities
at fair value

  $   101,754     $   119,699     $   8,218     $   (35,283   $   194,388  
 

 

June 2018 Form 10-Q    50   


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

Assets at fair value

 

     

Trading assets:

         

U.S. Treasury and agency securities

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

Other sovereign government obligations

    20,234       7,825       1             28,060  

State and municipal securities

          3,592       8             3,600  

MABS

          2,364       423             2,787  

Loans and lending commitments2

          4,791       5,945             10,736  

Corporate and other debt

          16,837       701             17,538  

Corporate equities3

    149,697       492       166             150,355  

Derivative and other contracts:

 

 

Interest rate

    472       178,704       1,763             180,939  

Credit

          7,602       420             8,022  

Foreign exchange

    58       53,724       15             53,797  

Equity

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

Commodity and other

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

Netting1

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

Total derivative and other contracts

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

Investments4

    297       523       1,020             1,840  

Physical commodities

          1,024                   1,024  

Total trading assets4

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

Investment securities—AFS

    27,522       27,681                   55,203  

Intangible assets

          3                   3  

Total assets
at fair value

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

Liabilities at fair value

 

Deposits

  $     $ 157     $ 47     $     $ 204  

Trading liabilities:

         

U.S. Treasury and agency securities

    17,802       24                   17,826  

Other sovereign government obligations

    24,857       2,016                   26,873  

Corporate and other debt

          7,141       3             7,144  

Corporate equities3

    52,653       82       22             52,757  

Derivative and other contracts:

 

 

Interest rate

    364       162,239       545             163,148  

Credit

          8,166       379             8,545  

Foreign exchange

    23       55,118       127             55,268  

Equity

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

Commodity and other

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

Netting1

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

Total derivative and

other contracts

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

Total trading liabilities

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

Securities sold under agreements to repurchase

          650       150             800  

Other secured financings

          3,624       239             3,863  

Borrowings

          43,928       2,984             46,912  

Total liabilities
at fair value

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

 

MABS—Mortgage-

and asset-backed securities

1.

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

2.

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

3.

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

4.

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

Loans and Lending Commitments at Fair Value

 

$ in millions   

At

June 30, 2018

    

At

December 31, 2017

 

Corporate

   $ 8,752      $ 8,358  

Residential real estate

     1,334        799  

Wholesale real estate

     3,833        1,579  

Total

   $ 13,919      $ 10,736  
 

 

   51    June 2018 Form 10-Q


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Unsettled Fair Value of Futures Contracts1

 

$ in millions  

At

June 30, 2018

   

At

December 31, 2017

 

Customer and other receivables, net

  $ 958     $ 831  

 

1.

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

For a description of the valuation techniques applied to the Firm’s major categories of assets and liabilities measured at fair value on a recurring basis, see Note 3 to the financial statements in the 2017 Form 10-K. During the current year period, there were no significant revisions made to the Firm’s valuation techniques.

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

The following tables present additional information about Level 3 assets and liabilities measured at fair value on a

recurring basis for the quarter ended June 30, 2018 (“current quarter”) and June 30, 2017 (“prior year quarter”), the current year period and the six months ended June 30, 2017 (“prior year period”). Level 3 instruments may be hedged with instruments classified in Level 1 and Level 2. As a result, the realized and unrealized gains (losses) for assets and liabilities within the Level 3 category presented in the following tables do not reflect the related realized and unrealized gains (losses) on hedging instruments that have been classified by the Firm within the Level 1 and/or Level 2 categories.

Additionally, the unrealized gains (losses) during the period for assets and liabilities within the Level 3 category presented in the following tables herein may include changes in fair value during the period that were attributable to both observable and unobservable inputs. Total realized and unrealized gains (losses) are primarily included in Trading revenues in the income statements.

 

 

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

 

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

Assets at Fair Value

               

Trading assets:

               

Other sovereign government obligations

  $ 7     $ (3   $ 2     $ (1   $     $     $ 5     $  

State and municipal securities

    2             1       (1                 2        

MABS

    342             35       (88     (7     45       327       (6

Loans and lending commitments

    8,128       (62     1,726       (615     (1,781     (473     6,923       (78

Corporate and other debt

    814       37       166       (194     (3     (119     701       5  

Corporate equities

    233       (4     21       (25           (54     171       (3

Net derivative and other contracts3:

               

Interest rate

    670       (75     61       (24     (45     (20     567       (99

Credit

    (30     111       15       (41     (57           (2     115  

Foreign exchange

    (33     37             (19     (3     (8     (26     43  

Equity4

    1,015       51       29       (191     185       (2,624     (1,535     (14

Commodity and other

    1,660       170       1       (3     122       82       2,032       107  

Total net derivative and other contracts

    3,282       294       106       (278     202       (2,570     1,036       152  

Investments

    1,012       (8     17       (28           (52     941       2  

Liabilities at Fair Value

               

Deposits

  $ 44     $ 1     $     $ 5     $     $ (11   $ 37     $ 1  

Trading liabilities:

               

Other sovereign government obligations

    3             (3                              

Corporate and other debt

    4             (6     4             (1     1        

Corporate equities

    32       3       (8     3                   24       2  

Other secured financings

    220       5             4       (8     (41     170       5  

Borrowings

    3,626       130             306       (141     (366     3,295       133  

 

1.

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

2.

Amounts related to entering into Net derivatives and other contracts, Deposits, Other secured financings and Borrowings primarily represent issuances. Amounts for other line items primarily represent sales.

3.

Net derivative and other contracts represent Trading assets—Derivative and other contracts, net of Trading liabilities—Derivative and other contracts. Amounts are presented before counterparty netting.

4.

During the current quarter, the Firm transferred from Level 3 to Level 2 $2.6 billion of Equity Derivatives due to a reduction in the significance of the unobservable inputs relating to volatility.

 

June 2018 Form 10-Q    52   


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

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

 

$ in millions

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

Assets at Fair Value

               

Trading assets:

               

U.S. Treasury and agency securities

  $ 42     $     $     $     $     $ (42   $     $  

Other sovereign government obligations

    65             87       (52                 100        

State and municipal securities

    55       3       3       (52                 9        

MABS

    216       36       32       (44     (5     29       264       8  

Loans and lending commitments

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

Corporate and other debt

    717       33       206       (292     (1     30       693       26  

Corporate equities

    310       8       101       (60           141       500       9  

Net derivative and other contracts3:

               

Interest rate

    298       35       28       (27     637       (1     970       58  

Credit

    (351     28                   16       2       (305     24  

Foreign exchange

    (71     53       1       (1     22       (2     2       64  

Equity

    217       185       677       (171     80       105       1,093       189  

Commodity and other

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

Total net derivative and other contracts

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

Investments

    961       11       20       (25     4       (25     946       7  

Liabilities at Fair Value

               

Deposits

  $ 56     $     $     $ 23     $     $     $ 79     $  

Trading liabilities:

                                                               

Corporate and other debt

    36             (135     124             (10     15       (1

Corporate equities

    2       (12     (36     45             5       28       (11

Securities sold under agreements to repurchase

    148                                     148        

Other secured financings

    203       (4           38       (1           244       (4

Borrowings

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

 

1.

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

2.

Amounts related to entering into Net derivatives and other contracts, Deposits, Other secured financings and Borrowings primarily represent issuances. Amounts for other line items primarily represent sales.

3.

Net derivative and other contracts represent Trading assets—Derivative and other contracts, net of Trading liabilities—Derivative and other contracts. Amounts are presented before counterparty netting.

 

   53    June 2018 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

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

 

$ in millions   Beginning
Balance at
December 31,
2017
   

Realized and
Unrealized
Gains

(Losses)

    Purchases1     Sales and
Issuances2
    Settlements1     Net Transfers     Ending
Balance at
June 30,
2018
    Unrealized Gains
(Losses)
 

Assets at fair value

               

Trading assets:

               

Other sovereign government obligations

  $ 1     $     $ 4     $     $     $     $ 5     $  

State and municipal securities

    8             1       (7                 2        

MABS

    423       76       74       (282     (12     48       327        

Loans and lending commitments

    5,945       (6     3,841       (913     (1,531     (413     6,923       (61

Corporate and other debt

    701       43       366       (165     (1     (243     701       6  

Corporate equities

    166       2       43       (49           9       171       (7

Net derivative and other contracts3:

               

Interest rate

    1,218       (1     69       (51     (131     (537     567       (13

Credit

    41       (22     4       (40     17       (2     (2     (28

Foreign exchange

    (112     96             (46     46       (10     (26     28  

Equity4

    1,208       163       94       (930     294       (2,364     (1,535     135  

Commodity and other

    1,446       392       35       (6     7       158       2,032       230  

Total net derivative and other contracts

    3,801       628       202       (1,073     233       (2,755     1,036       352  

Investments

    1,020       23       64       (133           (33     941       7  

Liabilities at fair value

               

Deposits

  $ 47     $ 1     $     $ 10     $ (1   $ (18   $ 37     $ 1  

Trading liabilities:

               

Corporate and other debt

    3             (9     7                   1        

Corporate equities

    22       6       (10     15             3       24       4  

Securities sold under agreements to repurchase

    150                               (150            

Other secured financings

    239       17             7       (18     (41     170       17  

Borrowings

    2,984       201             825       (195     (118     3,295       199  

 

1.

Loan originations and consolidations of VIEs are included in Purchases and deconsolidations of VIEs are included in Settlements.

2.

Amounts related to entering into Net derivative and other contracts, Deposits, Other secured financings and Borrowings primarily represent issuances. Amounts for other line items primarily represent sales.

3.

Net derivative and other contracts represent Trading assets—Derivative and other contracts, net of Trading liabilities—Derivative and other contracts. Amounts are presented before counterparty netting.

4.

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

 

June 2018 Form 10-Q    54   


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

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

 

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

Assets at fair value

               

Trading assets:

               

U.S. Treasury and agency securities

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

Other sovereign government obligations

    6             98       (4                 100        

State and municipal securities

    250       3       3       (77           (170     9        

MABS

    217       44       78       (83     (16     24       264       27  

Loans and lending commitments

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

Corporate and other debt

    475       31       290       (225     (2     124       693       30  

Corporate equities

    446       10       97       (159           106       500       15  

Net derivative and other contracts3:

               

Interest rate

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

Credit

    (373     1                   62       5       (305     (13

Foreign exchange

    (43     23       1       (1     8       14       2       43  

Equity

    184       118       758       (158     121       70       1,093       200  

Commodity and other

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

Total net derivative and other contracts

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

Investments

    958       19       82       (28     (63     (22     946       11  

Liabilities at fair value

               

Deposits

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

Trading liabilities:

               

Corporate and other debt

    36             (164     129             14       15        

Corporate equities

    35             (63     5             51       28        

Securities sold under agreements to repurchase

    149       1                               148       1  

Other secured financings

    434       (23           52       (221     (44     244       (16

Borrowings

    2,014       (104           981       (288     (165     2,646       (95

 

1.

Loan originations and consolidations of VIEs are included in Purchases and deconsolidations of VIEs are included in Settlements.

2.

Amounts related to entering into Net derivative and other contracts, Deposits, Other secured financings and Borrowings primarily represent issuances. Amounts for other line items primarily represent sales.

3.

Net derivative and other contracts represent Trading assets—Derivative and other contracts, net of Trading liabilities—Derivative and other contracts. Amounts are presented before counterparty netting.

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

The following disclosures provide information on the valuation techniques, significant unobservable inputs, and their ranges and averages for each major category of assets and liabilities measured at fair value on a recurring and nonrecurring basis with a significant Level 3 balance. The level of aggregation and breadth of products cause the range of inputs to be wide and not evenly distributed across the inventory. Further, the range of unobservable inputs may differ across firms in the financial services industry because of diversity in the types of products included in each firm’s inventory. For qualitative information on the sensitivity of the fair value measurements to changes in the significant unobservable inputs, see Note 3 to the financial statements in the 2017 Form 10-K. There are no predictable relationships between multiple significant unobservable inputs attributable to a given valuation technique. A single amount is disclosed when there is no significant difference between the minimum, maximum and average (weighted average or simple average/median).

 

   55    June 2018 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

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

 

   

Predominant Valuation Techniques/

Significant Unobservable Inputs

  

Range (Weighted Average or Simple Average/Median)1

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

Recurring Fair Value Measurement

  

Assets at fair value

  

MABS ($327 and $423)

       

Comparable pricing:

  Comparable bond price    0 to 100 points (44 points)    0 to 95 points (26 points)

Loans and lending commitments ($6,923 and $5,945)

     

Margin loan model:

  Discount rate    1% to 5% (2%)    0% to 3% (1%)
    Volatility skew    15% to 55% (24%)    7% to 41% (22%)

Comparable pricing:

  Comparable loan price    55 to 101 points (94 points)    55 to 102 points (95 points)

Corporate and other debt ($701 and $701)

     

Comparable pricing:

  Comparable bond price    0 to 101 points (74 points)    3 to 134 points (59 points)

Discounted cash flow:

  Recovery rate    18%    6% to 36% (27%)
    Discount rate    8% to 20% (15%)    7% to 20% (14%)

Option model:

  At the money volatility    15% to 51% (38%)    17% to 52% (52%)

Corporate equities ($171 and $166)

     

Comparable pricing:

  Comparable equity price    100%    100%

Net derivative and other contracts2:

     

Interest rate ($567 and $1,218)

     

Option model:

  Interest rate volatility skew    28% to 94% (39% / 43%)    31% to 97% (41% / 47%)
    Inflation volatility    26% to 66% (46% / 43%)    23% to 63% (44% / 41%)
    Interest rate curve    2%    2%

Credit ($(2) and $41)

     

Comparable pricing:

  Cash synthetic basis    9 to 10 points (9 points)    12 to 13 points (12 points)
    Comparable bond price    0 to 75 points (28 points)    0 to 75 points (25 points)

Correlation model:

  Credit correlation    36% to 63% (48%)    38% to 100% (48%)

Foreign exchange3 ($(26) and $(112))

     

Option model:

  Interest rate - Foreign exchange correlation    53% to 56% (55% / 55%)    54% to 57% (56% / 56%)
    Interest rate volatility skew    28% to 94% (39% / 43%)    31% to 97% (41% / 47%)
    Contingency probability    95% to 99% (97% / 97%)    95% to 100% (96% / 95%)

Equity3 ($(1,535) and $1,208)

     

Option model:

  At the money volatility    15% to 56% (34%)    7% to 54% (32%)
    Volatility skew    -3% to 0% (-1%)    -5% to 0% (-1%)
    Equity - Equity correlation    5% to 99% (80%)    5% to 99% (76%)
    Equity - Foreign exchange correlation    -60% to 55% (-55%)    -55% to 40% (36%)
    Equity - Interest rate correlation    -7% to 47% (15% / 10%)    -7% to 49% (18% / 20%)

Commodity and other ($2,032 and $1,446)

     

Option model:

  Forward power price    $6 to $133 ($30) per MWh    $4 to $102 ($31) per MWh
    Commodity volatility    5% to 219% (14%)    7% to 205% (17%)
    Cross-commodity correlation    5% to 99% (91%)    5% to 99% (92%)

Investments ($941 and $1,020)

     

Discounted cash flow:

  WACC    8% to 15% (9%)    8% to 15% (9%)
    Exit multiple    8 to 10 times (10 times)    8 to 11 times (10 times)

Market approach:

  EBITDA multiple    3 to 24 times (13 times)    6 to 25 times (11 times)

Comparable pricing:

  Comparable equity price    35% to 100% (93%)    45% to 100% (92%)

 

June 2018 Form 10-Q    56   


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

   

Predominant Valuation Techniques/

Significant Unobservable Inputs

  

Range (Weighted Average or Simple Average/Median)1

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

Liabilities at Fair Value

     

Securities sold under agreements to repurchase ($— and $150)

  

Discounted cash flow:

  Funding spread    N/A    107 to 126 bps (120 bps)

Other secured financings ($170 and $239)

     

Discounted cash flow:

  Funding spread    25 to 73 bps (49 bps)    39 to 76 bps (57 bps)

Option model:

  Volatility skew    N/A    -1%
    At the money volatility    10% to 40% (27%)    10% to 40% (26%)

Borrowings ($3,295 and $2,984)

     

Option model:

  At the money volatility    6% to 35% (23%)    5% to 35% (22%)
    Volatility skew    -2% to 0% (0%)    -2% to 0% (0%)
    Equity - Equity correlation    45% to 95% (84%)    39% to 95% (86%)
    Equity - Foreign exchange correlation    -51% to 30% (-27%)    -55% to 10% (-18%)

Nonrecurring Fair Value Measurement

     

Assets at fair value

     

Loans ($1,058 and $924)

     

Corporate loan model:

  Credit spread    95 to 427 bps (166 bps)    93 to 563 bps (239 bps)

Expected recovery:

  Asset coverage    N/M    95% to 99% (95%)

 

Points—Percentage of par

1.

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

2.

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

3.

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

 

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

Measured Based on Net Asset Value

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

 

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

Private equity

   $ 1,571      $ 289      $ 1,674      $ 308  

Real estate

     753        174        800        183  

Hedge1

     96        4        90        4  

Total

   $ 2,420      $ 467      $ 2,564      $ 495  

 

1.

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

Amounts in the previous table represent the Firm’s carrying value of general and limited partnership interests in fund investments, as well as any related performance fees in the form of carried interest. The carrying amounts are measured

based on the NAV of the fund taking into account the distribution terms applicable to the interest held. This same measurement applies whether investments are accounted for under the equity method or fair value.

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

Nonredeemable Funds by Contractual Maturity

 

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

Less than 5 years

   $ 481      $ 53  

5-10 years

     886        483  

Over 10 years

     204        217  

Total

   $ 1,571      $ 753  

Fair Value Option

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

 

 

   57    June 2018 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

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Earnings Impact of Borrowings under the Fair Value Option

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
$ in millions   2018     2017     2018     2017  

Trading revenues

  $ 859     $ (895   $ 885     $ (2,520

Interest income (expense)

    (73     (112     (175     (231

Net revenues

  $ 786     $     (1,007   $ 710     $     (2,751

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

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

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

 

     Three Months Ended June 30,  
     2018      2017  

$ in millions

   Trading
Revenues
     OCI      Trading
Revenues
     OCI  

Borrowings

   $ (3    $ 842      $ (4    $     (281

Loans and other debt1

     63               48         

Lending commitments2

     1                       
     Six Months Ended June 30,  
     2018      2017  

$ in millions

   Trading
Revenues
     OCI      Trading
Revenues
     OCI  

Borrowings

   $ (18    $     1,435      $ (8    $     (267

Securities sold under agreements to repurchase

            2               (3

Loans and other debt1

     144               45         

Lending commitments2

     3                       

 

$ in millions  

At

June 30, 2018

   

At

December 31, 2017

 

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

  $ (392   $ (1,831

 

1.

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

2.

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

Borrowings Measured at Fair Value on a Recurring Basis

 

$ in millions   

At

June 30,

2018

     At
December 31,
2017
 

Business Unit Responsible for Risk Management

 

Equity

   $ 26,139      $ 25,903  

Interest rates

     20,541        19,230  

Foreign exchange

     822        666  

Credit

     845        815  

Commodities

     2,003        298  

Total

   $ 50,350      $ 46,912  

Excess of Contractual Principal Amount Over Fair Value

 

$ in millions   

At

June 30,
2018

     At
December 31,
2017
 

Loans and other debt1

   $ 13,748      $ 13,481  

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

     10,977        11,253  

Borrowings2

     1,830        71  

 

1.

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

2.

Borrowings in this table do not include structured notes where the repayment of the initial principal amount fluctuates based on changes in a reference price or index.

Fair Value Loans on Nonaccrual Status

 

$ in millions   

At

June 30,
2018

     At
December 31,
2017
 

Nonaccrual loans

   $ 1,705      $ 1,240  

Nonaccrual loans 90 or more
days past due

   $ 965      $ 779  

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

Measured at Fair Value on a Nonrecurring Basis

Carrying and Fair Values

 

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

Assets

        

Loans

   $ 1,481      $ 1,058      $ 2,539  

Other assets—Other investments

     17        36        53  

Other assets—Premises, equipment and software

                    

Total

   $ 1,498      $ 1,094      $ 2,592  

Liabilities

        

Other liabilities and accrued expenses—Lending commitments

   $ 210      $ 42      $ 252  

Total

   $ 210      $ 42      $ 252  
 

 

June 2018 Form 10-Q    58   


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

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

Assets

        

Loans

   $ 1,394      $ 924      $ 2,318  

Other assets—Other investments

            144        144  

Total

   $ 1,394      $ 1,068      $ 2,462  

Liabilities

        

Other liabilities and accrued expenses—Lending commitments

   $ 158      $ 38      $ 196  

Total

   $ 158      $ 38      $ 196  

 

1.

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

Gains (Losses) from Fair Value Remeasurements1

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
$ in millions    2018      2017      2018      2017  

Assets

           

Loans2

   $ (1    $ 20      $ 8      $ 44  

Other assets—Other investments3

     (7             (7       

Other assets—Premises, equipment and software4

     (2      (1      (10      (6

Total

   $ (10    $ 19      $ (9    $ 38  

Liabilities

           

Other liabilities and accrued expenses—
Lending commitments2

   $ (30    $ 21      $ (12    $ 48  

Total

   $ (30    $ 21      $ (12    $ 48  

 

1.

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

2.

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

3.

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

4.

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

Financial Instruments Not Measured at Fair Value

 

    At June 30, 2018  
    Carrying     Fair Value  
$ in millions   Value     Level 1     Level 2     Level 3     Total  

Financial Assets

         

Cash and cash equivalents:

 

       

Cash and due from banks

  $ 30,176     $   30,176     $     $     $ 30,176  

Interest bearing deposits with banks

    18,707       18,707                   18,707  

Restricted cash

    32,706       32,706                   32,706  

Investment securities—HTM

    25,244       12,656       11,188       331       24,175  

Securities purchased under agreements to resell

    93,928             93,844             93,844  

Securities borrowed

    153,248             153,193             153,193  

Customer and other receivables1

    55,598             52,108       3,305       55,413  

Loans2

    112,113             24,963       86,827       111,790  

Other assets

    427             427             427  

Financial Liabilities

         

Deposits

  $   172,517     $     $   172,488     $     $   172,488  

Securities sold under agreements to repurchase

    49,862             49,398       404       49,802  

Securities loaned

    12,720             12,611       175       12,786  

Other secured financings

    6,284             4,621       1,674       6,295  

Customer and other payables1

    198,236             198,236             198,236  

Borrowings

    141,894             145,351       30       145,381  

 

    At December 31, 2017  
    Carrying     Fair Value  
$ in millions   Value     Level 1     Level 2     Level 3     Total  

Financial Assets

         

Cash and cash equivalents:

 

       

Cash and due from banks

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

Interest bearing deposits with banks

    21,348       21,348                   21,348  

Restricted cash

    34,231       34,231                   34,231  

Investment securities—HTM

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

Securities purchased under agreements to resell

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

Securities borrowed

    124,010             124,018       1       124,019  

Customer and other receivables1

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

Loans2

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

Other assets

    433             433             433  

Financial Liabilities

         

Deposits

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

Securities sold under agreements to repurchase

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

Securities loaned

    13,592             13,191       401       13,592  

Other secured financings

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

Customer and other payables1

    188,464             188,464             188,464  

Borrowings

    145,670             151,692       30       151,722  

 

1.

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

2.

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

 

 

   59    June 2018 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

Commitments—Held for Investment and Held for Sale

 

    

Commitment

Amount1

     Fair Value  
$ in millions    Level 2      Level 3      Total  

June 30, 2018

   $ 122,253      $   820      $   200      $     1,020  

December 31, 2017

     100,151        620        174        794  

 

1.

For further discussion on lending commitments, see Note 11.

The previous tables exclude certain financial instruments such as equity method investments and all non-financial assets and liabilities such as the value of the long-term relationships with the Firm’s deposit customers. During the current year period, there were no significant updates made to the Firm’s valuation techniques for financial instruments not measured at fair value.

 

 

June 2018 Form 10-Q    60   


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

4. Derivative Instruments and Hedging Activities

 

Derivative Fair Values  

At June 30, 2018

 

    Assets  

$ in millions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

 

Interest rate contracts

  $ 638     $ 1     $     $ 639  

Foreign exchange contracts

    174       61             235  

Total

    812       62             874  

Not designated as accounting hedges

 

 

Interest rate contracts

    165,607       1,795       628       168,030  

Credit contracts

    4,389       1,431             5,820  

Foreign exchange contracts

    63,383       1,740       237       65,360  

Equity contracts

    24,804             21,843       46,647  

Commodity and other contracts

    10,108             1,617       11,725  

Total

    268,291       4,966       24,325       297,582  

Total gross derivatives

  $     269,103     $     5,028     $     24,325     $     298,456  

Amounts offset

 

 

Counterparty netting

    (199,543     (4,098     (20,669     (224,310

Cash collateral netting

    (41,007     (585           (41,592

Total in Trading assets

  $ 28,553     $ 345     $ 3,656     $ 32,554  

Amounts not offset1

 

 

Financial instruments collateral

    (12,869                 (12,869

Other cash collateral

    (27                 (27

Net amounts

  $ 15,657     $ 345     $ 3,656     $ 19,658  

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

 

  $ 4,484  

 

    Liabilities  

$ in millions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

 

Interest rate contracts

  $ 209     $ 4     $     $ 213  

Foreign exchange contracts

    18       1             19  

Total

    227       5             232  

Not designated as accounting hedges

 

 

Interest rate contracts

    151,813       1,275       657       153,745  

Credit contracts

    4,395       1,748             6,143  

Foreign exchange contracts

    59,766       1,802       133       61,701  

Equity contracts

    26,776             21,227       48,003  

Commodity and other contracts

    9,106             1,708       10,814  

Total

    251,856       4,825       23,725       280,406  

Total gross derivatives

  $     252,083     $     4,830     $     23,725     $     280,638  

Amounts offset

 

 

Counterparty netting

    (199,543     (4,098     (20,669     (224,310

Cash collateral netting

    (29,119     (367           (29,486

Total in Trading liabilities

  $ 23,421     $ 365     $ 3,056     $ 26,842  

Amounts not offset1

 

 

Financial instruments collateral

    (4,599           (364     (4,963

Other cash collateral

    (31                 (31

Net amounts

  $ 18,791     $ 365     $ 2,692     $ 21,848  

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

 

  $ 4,980  

 

At December 31, 2017  
    Assets  

$ in millions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

 

Interest rate contracts

  $ 1,057     $     $     $ 1,057  

Foreign exchange contracts

    57       6             63  

Total

    1,114       6             1,120  

Not designated as accounting hedges

 

 

Interest rate contracts

    177,948       1,700       234       179,882  

Credit contracts

    5,740       2,282             8,022  

Foreign exchange contracts

    52,878       798       58       53,734  

Equity contracts

    24,452             20,538       44,990  

Commodity and other contracts

    8,861             1,802       10,663  

Total

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

Total gross derivatives

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

Amounts offset

 

 

Counterparty netting

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

Cash collateral netting

    (42,141     (689           (42,830

Total in Trading assets

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

Amounts not offset1

 

 

Financial instruments collateral

    (12,363                 (12,363

Other cash collateral

    (4                 (4

Net amounts

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

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

 

  $ 3,154  

 

    Liabilities  

$ in millions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

 

Interest rate contracts

  $ 67     $ 1     $     $ 68  

Foreign exchange contracts

    72       57             129  

Total

    139       58             197  

Not designated as accounting hedges

 

 

Interest rate contracts

    161,758       1,178       144       163,080  

Credit contracts

    6,273       2,272             8,545  

Foreign exchange contracts

    54,191       925       23       55,139  

Equity contracts

    27,993             19,996       47,989  

Commodity and other contracts

    7,117             1,772       8,889  

Total

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

Total gross derivatives

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

Amounts offset

 

 

Counterparty netting

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

Cash collateral netting

    (31,892     (484           (32,376

Total in Trading liabilities

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

Amounts not offset1

 

 

Financial instruments collateral

    (5,523           (412     (5,935

Other cash collateral

    (18     (14           (32

Net amounts

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

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

 

  $ 3,751  

 

1.

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

 

 

   61    June 2018 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

   LOGO

 

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

Derivative Notionals

 

At June 30, 2018

 

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

Designated as accounting hedges

 

 

Interest rate contracts

  $ 16     $ 32     $     $ 48  

Foreign exchange contracts

    7       2             9  

Total

    23       34             57  

Not designated as accounting hedges

 

 

Interest rate contracts

    4,739       8,012       3,181       15,932  

Credit contracts

    143       68             211  

Foreign exchange contracts

    2,402       88       18       2,508  

Equity contracts

    417             378       795  

Commodity and other contracts

    90             60       150  

Total

    7,791       8,168       3,637       19,596  

Total gross derivatives

  $     7,814     $     8,202     $ 3,637     $     19,653  

 

    Liabilities  

$ in billions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

 

Interest rate contracts

  $ 2     $ 130     $     $ 132  

Foreign exchange contracts

    2                   2  

Total

    4       130             134  

Not designated as accounting hedges

 

 

Interest rate contracts

    5,030       7,184       1,246       13,460  

Credit contracts

    146       75             221  

Foreign exchange contracts

    2,278       86       10       2,374  

Equity contracts

    414             467       881  

Commodity and other contracts

    83             53       136  

Total

    7,951       7,345       1,776       17,072  

Total gross derivatives

  $     7,955     $     7,475     $   1,776     $     17,206  

 

At December 31, 2017

 

    Assets  

$ in billions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

 

Interest rate contracts

  $ 20     $ 46     $     $ 66  

Foreign exchange contracts

    4                   4  

Total

    24       46             70  

Not designated as accounting hedges

 

 

Interest rate contracts

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

Credit contracts

    194       100             294  

Foreign exchange contracts

    1,960       67       9       2,036  

Equity contracts

    397             334       731  

Commodity and other contracts

    86             72       158  

Total

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

Total gross derivatives

  $     6,660     $     6,671     $     3,129     $     16,460  
    Liabilities  

$ in billions

  Bilateral
OTC
    Cleared
OTC
    Exchange-
Traded
    Total  

Designated as accounting hedges

 

 

Interest rate contracts

  $ 2     $ 102     $     $ 104  

Foreign exchange contracts

    4       2             6  

Total

    6       104             110  

Not designated as accounting hedges

 

 

Interest rate contracts

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

Credit contracts

    226       80             306  

Foreign exchange contracts

    2,014       78       51       2,143  

Equity contracts

    394             405       799  

Commodity and other contracts

    68             61       129  

Total

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

Total gross derivatives

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

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

For information related to offsetting of certain collateralized transactions, see Note 6. For a discussion of the Firm’s derivative instruments and hedging activities, see Note 4 to the financial statements in the 2017 Form 10-K.

Gains (Losses) on Accounting Hedges

 

     Three Months Ended     Six Months Ended  
     June 30,     June 30,  
$ in millions    2018     2017     2018     2017  

Fair Value Hedges—Recognized in Interest Expense

 

Interest rate contracts

   $ (619   $ 138     $ (2,460   $ (660

Borrowings

             587           (213             2,439     $         495  

Net Investment Hedges—Foreign exchange contracts

 

Recognized in OCI

   $ 395     $ (47   $ 247     $ (251

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

   $ 24     $ (9   $ 31     $ (19

Borrowings under Fair Value Hedges

 

$ in millions    At June 30,
2018
 

Carrying amount of Borrowings currently or previously hedged

   $ 104,509  

Basis adjustments included in carrying amount

   $ (2,624

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

 

 

June 2018 Form 10-Q    62   


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

 

Trading Revenues by Product Type

 

    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
$ in millions   2018     2017     2018     2017  

Interest rate contracts

  $ 781     $ 451     $ 1,652     $ 1,045  

Foreign exchange contracts

    138       197       399       432  

Equity security and index contracts1

    1,785       1,818       3,661       3,459  

Commodity and other contracts

    358       110       794       299  

Credit contracts

    231       355       557       931  

Total

  $       3,293     $       2,931     $       7,063     $       6,166  

 

1.

Dividend income is included within equity security and index contracts.

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

Credit Risk-Related Contingencies

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

Net Derivative Liabilities and Collateral Posted

 

$ in millions  

At

June 30,
2018

    At
December 31,
2017
 

Net derivative liabilities with credit risk-related contingent features

  $         17,026     $ 20,675  

Collateral posted

    14,494       16,642  

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

Incremental Collateral or Termination Payments upon Potential Future Ratings Downgrade

 

$ in millions  

At

June 30,
2018

 

One-notch downgrade

  $               647  

Two-notch downgrade

    367  

Bilateral downgrade agreements included in the amounts above1

  $ 881  
1.

Amount represents arrangements between the Firm and other parties where upon the downgrade of one party, the downgraded party must deliver collateral to the other party. These bilateral downgrade arrangements are used by the Firm to manage the risk of counterparty downgrades.

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

Credit Derivatives and Other Credit Contracts

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

For further information on credit derivatives and other credit contracts, see Note 4 to the financial statements in the 2017 Form 10-K.

Protection Sold and Purchased with CDS

 

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

Single name

  $ (517   $ 688     $ 119,286     $ 133,926  

Index and basket

    456       (501     74,089       86,016  

Tranched index and basket

    (146     343       6,072       12,347  

Total

  $ (207   $ 530     $ 199,447     $ 232,289  

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

 

  $     193,224     $     219,407  

 

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

Single name

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

Index and basket

    (341     209       131,073       120,348  

Tranched index and basket

    (342     616       11,864       24,498  

Total

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

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

 

  $     274,473     $     281,162  
 

 

   63    June 2018 Form 10-Q


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Notes to Consolidated Financial Statements

(Unaudited)

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Credit Ratings of Reference Obligation and Maturities of Credit Protection Sold

 

     At June 30, 2018  
     Maximum Potential Payout/Notional      Fair Value
(Asset)/
Liability
 
     Years to Maturity  
$ in millions    Less than 1      1-3      3-5      Over 5      Total  

Single name CDS

                 

Investment grade

   $ 28,320      $ 31,006      $ 18,746      $ 8,410      $ 86,482      $ (425

Non-investment grade

     11,423        12,571        8,019        791        32,804        (92

Total single name CDS

   $ 39,743      $ 43,577      $ 26,765      $ 9,201      $ 119,286      $ (517

Index and basket CDS

                 

Investment grade

   $ 6,604      $ 8,565      $ 17,286      $ 8,006      $ 40,461      $ (474

Non-investment grade

     3,808        7,521        18,934        9,437        39,700        784  

Total index and basket CDS

   $ 10,412      $ 16,086      $ 36,220      $ 17,443      $ 80,161      $ 310  

Total CDS sold

   $ 50,155      $ 59,663      $ 62,985      $ 26,644      $ 199,447      $ (207

Other credit contracts

                          119        119        11  

Total credit derivatives and other credit contracts

   $ 50,155      $ 59,663      $ 62,985      $ 26,763      $ 199,566      $ (196

 

     At December 31, 2017  
     Maximum Potential Payout/Notional      Fair Value
(Asset)/
Liability
 
     Years to Maturity  
$ in millions    Less than 1      1-3      3-5      Over 5      Total  

Single name CDS

                 

Investment grade

   $ 39,721      $ 42,591      $ 18,157      $ 8,872      $ 109,341      $ (1,167

Non-investment grade

     14,213        16,293        6,193        908        37,607        (110

Total single name CDS

   $ 53,934      $ 58,884      $ 24,350      $ 9,780      $ 146,948      $ (1,277

Index and basket CDS

                 

Investment grade

   $ 29,046      $ 15,418      $ 37,343      $ 6,807      $ 88,614      $ (1,091

Non-investment grade

     5,246        7,371        32,417        9,289        54,323        408  

Total index and basket CDS

   $ 34,292      $ 22,789      $ 69,760      $ 16,096      $ 142,937      $ (683

Total CDS sold

   $ 88,226      $ 81,673      $ 94,110      $ 25,876      $ 289,885      $ (1,960

Other credit contracts

     2                      134        136        16  

Total credit derivatives and other credit contracts

   $ 88,228      $ 81,673      $ 94,110      $ 26,010      $ 290,021      $ (1,944

 

The fair value amounts as shown in the previous table are on a gross basis prior to cash collateral or counterparty netting. In order to provide an indication of the current payment status or performance risk of the CDS, a breakdown of CDS based on the Firm’s internal credit ratings by investment grade and non-investment grade is provided.

Internal credit ratings serve as the Credit Risk Management Department’s assessment of credit risk and the basis for a comprehensive credit limits framework used to control credit risk. The Firm uses quantitative models and judgment to estimate the various risk parameters related to each obligor.

 

 

June 2018 Form 10-Q    64   


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Notes to Consolidated Financial Statements (Unaudited)    LOGO

 

5. Investment Securities

AFS and HTM Securities

 

    At June 30, 2018  

$ in millions

  Amortized
Cost
    Gross
Unrealized
Gains
    Gross
Unrealized
Losses
    Fair Value  

AFS securities

       

U.S. government and agency securities:

       

U.S. Treasury securities

  $ 31,725     $ 2     $ 906     $     30,821  

U.S. agency securities1

    20,808       20       571       20,257  

Total U.S. government and agency securities

    52,533       22       1,477       51,078  

Corporate and other debt:

       

Agency CMBS

    1,233       1       67       1,167  

Non-agency CMBS

    757       1       17       741  

Corporate bonds

    1,329             33       1,296  

CLO

    313       1             314  

FFELP student loan ABS2

    2,098       16       6       2,108  

Total corporate and other debt

    5,730       19       123       5,626  

Total AFS securities

    58,263       41       1,600       56,704  

HTM securities

       

U.S. government and agency securities:

       

U.S. Treasury securities

    13,188       1       533       12,656  

U.S. agency securities1

    11,716             528       11,188  

Total U.S. government and agency securities

    24,904       1       1,061       23,844  

Corporate and other debt:

       

Non-agency CMBS

    340             9       331  

Total HTM securities

    25,244       1       1,070       24,175  

Total investment securities

  $ 83,507     $ 42     $ 2,670     $ 80,879  
    At December 31, 2017  
$ in millions   Amortized
Cost
    Gross
Unrealized
Gains
    Gross
Unrealized
Losses
    Fair Value  

AFS debt securities

       

U.S. government and agency securities:

       

U.S. Treasury securities

  $ 26,842     $     $ 589     $ 26,253  

U.S. agency securities1

    22,803       28       247       22,584  

Total U.S. government and agency securities

    49,645       28       836       48,837  

Corporate and other debt:

       

Agency CMBS

    1,370       2       49       1,323  

Non-agency CMBS

    1,102             8       1,094  

Corporate bonds

    1,379       5       12       1,372  

CLO

    398       1             399  

FFELP student loan ABS2

    2,165       15       7       2,173  

Total corporate and other debt

    6,414       23       76       6,361  

Total AFS debt securities

    56,059       51       912       55,198  

AFS equity securities

    15             10       5  

Total AFS securities

    56,074       51       922       55,203  

HTM securities

       

U.S. government and agency securities:

       

U.S. Treasury securities

    11,424             305       11,119  

U.S. agency securities1

    11,886       7       220       11,673  

Total U.S. government and agency securities

    23,310       7       525       22,792  

Corporate and other debt:

       

Non-agency CMBS

    289       1       1       289  

Total HTM securities

    23,599       8       526       23,081  

Total investment securities

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

 

1.

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

2.

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

 

 

   65    June 2018 Form 10-Q


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Notes to Consolidated Financial Statements

(Unaudited)

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Investment Securities in an Unrealized Loss Position

 

     At June 30, 2018  
     Less than 12 Months      12 Months or Longer      Total  
  

 

 

 
$ in millions    Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 

AFS securities

                 

U.S. government and agency securities:

                 

U.S. Treasury securities

   $ 24,282      $ 779      $ 4,591      $ 127      $ 28,873      $ 906  

U.S. agency securities

     13,684        459        2,381        112        16,065        571  

Total U.S. government and agency securities

     37,966        1,238        6,972        239        44,938        1,477  

Corporate and other debt:

                 

Agency CMBS

     852        67                      852        67  

Non-agency CMBS

     338        6        211        11        549        17  

Corporate bonds

     858        16        380        17        1,238        33  

FFELP student loan ABS

     892        6                      892        6  

Total corporate and other debt

     2,940        95        591        28        3,531        123  

Total AFS securities

     40,906        1,333        7,563        267        48,469        1,600  

HTM securities

                 

U.S. government and agency securities:

                 

U.S. Treasury securities

     5,866        197        5,614        336        11,480        533  

U.S. agency securities

     4,566        140        6,622        388        11,188        528  

Total U.S. government and agency securities

     10,432        337        12,236        724        22,668        1,061  

Corporate and other debt:

                 

Non-agency CMBS

     209        7        41        2        250        9  

Total HTM securities

     10,641        344        12,277        726        22,918        1,070  

Total investment securities

   $ 51,547      $ 1,677      $ 19,840      $ 993      $ 71,387      $ 2,670  
     At December 31, 2017  
     Less than 12 Months      12 Months or Longer      Total  
  

 

 

 
$ in millions    Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 

AFS debt securities

                 

U.S. government and agency securities:

                 

U.S. Treasury securities

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

U.S. agency securities

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

Total U.S. government and agency securities

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

Corporate and other debt:

                 

Agency CMBS

     930        49                      930        49  

Non-agency CMBS

     257        1        559        7        816        8  

Corporate bonds

     316        3        389        9        705        12  

FFELP student loan ABS

     984        7                      984        7  

Total corporate and other debt

     2,487        60        948        16        3,435        76  

Total AFS debt securities

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

AFS equity securities

                   5        10        5        10  

Total AFS securities

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

HTM securities

                 

U.S. government and agency securities:

                 

U.S. Treasury securities

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

U.S. agency securities

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

Total U.S. government and agency securities

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

Corporate and other debt:

                 

Non-agency CMBS

     124        1                      124        1  

Total HTM securities

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

Total investment securities

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

 

June 2018 Form 10-Q    66   


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

 

The Firm believes there are no securities in an unrealized loss position that are other-than-temporarily impaired after performing the analysis described in Note 2 to the financial statements in the 2017 Form 10-K. For AFS debt securities, the Firm does not intend to sell the securities and is not likely to be required to sell the securities prior to recovery of amortized cost basis. Furthermore, for AFS and HTM debt securities, the securities have not experienced credit losses as the net unrealized losses reported in the previous table are primarily due to higher interest rates since those securities were purchased.

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

Investment Securities by Contractual Maturity

 

    At June 30, 2018  

$ in millions

  Amortized
Cost
    Fair Value     Annualized
Average
Yield
 

AFS securities

     

U.S. government and agency securities:

     

U.S. Treasury securities:

     

Due within 1 year

  $ 3,554     $ 3,539       1.0%  

After 1 year through 5 years

    24,707       24,102       1.8%  

After 5 years through 10 years

    3,464       3,180       1.5%  

Total

    31,725       30,821          

U.S. agency securities:

     

Due within 1 year

    94       93       1.1%  

After 1 year through 5 years

    1,222       1,200       1.1%  

After 5 years through 10 years

    1,780       1,712       1.8%  

After 10 years

    17,712       17,252       2.0%  

Total

    20,808       20,257          

Total U.S. government and agency securities

    52,533       51,078       1.8%  

Corporate and other debt:

     

Agency CMBS:

     

Due within 1 year

    4       4       1.3%  

After 1 year through 5 years

    403       401       1.3%  

After 5 years through 10 years

    44       44       1.2%  

After 10 years

    782       718       1.6%  

Total

    1,233       1,167          

Non-agency CMBS:

     

After 5 years through 10 years

    36       34       2.5%  

After 10 years

    721       707       1.9%  

Total

    757       741          

Corporate bonds:

     

Due within 1 year

    81       81       1.6%  

After 1 year through 5 years

    1,209       1,178       2.4%  

After 5 years through 10 years

    39       37       2.6%  

Total

    1,329       1,296          

CLO:

     

After 5 years through 10 years

    115       115       1.4%  

After 10 years

    198       199       2.4%  

Total

    313       314          
    At June 30, 2018  
$ in millions   Amortized
Cost
    Fair Value     Annualized
Average
Yield
 

FFELP student loan ABS:

     

After 1 year through 5 years

  $ 88     $ 87       0.8%  

After 5 years through 10 years

    332       330       0.8%  

After 10 years

    1,678       1,691       1.1%  

Total

    2,098       2,108          

Total corporate and other debt

    5,730       5,626       1.6%  

Total AFS securities

    58,263       56,704       1.8%  

HTM securities

     

U.S. government securities:

     

U.S. Treasury securities:

     

Due within 1 year

    2,127       2,114       1.2%  

After 1 year through 5 years

    5,223       5,129       2.0%  

After 5 years through 10 years

    5,112       4,777       1.9%  

After 10 years

    726       636       2.3%  

Total

    13,188       12,656          

U.S. agency securities:

     

After 5 years through 10 years

    33       32       1.9%  

After 10 years

    11,683       11,156       2.6%  

Total

    11,716       11,188          

Total U.S. government and agency

     

securities

    24,904       23,844       2.2%  

Corporate and other debt:

     

Non-agency CMBS:

     

Due within 1 year

    23       23       3.7%  

After 1 year through 5 years

    63       63       3.7%  

After 5 years through 10 years

    235       227       3.9%  

After 10 years

    19       18       4.1%  

Total corporate and other debt

    340       331       3.9%  

Total HTM securities

    25,244       24,175       2.2%  

Total investment securities

  $ 83,507     $ 80,879       1.9%  

Gross Realized Gains and Losses on Sales of AFS Securities

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
$ in millions   2018     2017     2018     2017  

Gross realized gains

  $ 6     $ 23     $ 7     $ 27  

Gross realized (losses)

    (3     (9     (4     (11

Total1

  $ 3     $ 14     $ 3     $ 16  

 

1.

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

 

 

   67    June 2018 Form 10-Q


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Notes to Consolidated Financial Statements

(Unaudited)

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6. Collateralized Transactions

The Firm enters into securities purchased under agreements to resell, securities sold under agreements to repurchase, securities borrowed and securities loaned transactions to, among other things, acquire securities to cover short positions and settle other securities obligations, to accommodate customers’ needs and to finance its inventory positions. For further discussion of the Firm’s collateralized transactions, see Note 6 to the financial statements in the 2017 Form 10-K.

Offsetting of Certain Collateralized Transactions

 

    At June 30, 2018  

$ in millions

  Gross
Amounts
   

Amounts

Offset

    Net
Amounts
Presented
    Amounts
Not Offset1
    Net
Amounts
 

Assets

         

Securities purchased under agreements to resell

  $   226,847     $   (132,919)     $ 93,928     $ (88,769)     $   5,159  

Securities borrowed

    169,491       (16,243)         153,248         (147,966)       5,282  

Liabilities

         

Securities sold under agreements to repurchase

  $ 183,569     $ (132,919)     $ 50,650     $ (43,738)     $ 6,912  

Securities loaned

    28,963       (16,243)       12,720       (12,672)       48  

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

 

Securities purchased under agreements to resell

 

  $ 4,974  

Securities borrowed

                                    998  

Securities sold under agreements to repurchase

 

    5,693  

Securities loaned

                                    19  

 

    At December 31, 2017  

$ in millions

  Gross
Amounts
    Amounts
Offset
    Net
Amounts
Presented
    Amounts
Not Offset1
    Net
Amounts
 

Assets

         

Securities purchased under agreements to resell

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

Securities borrowed

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

Liabilities

         

Securities sold under agreements to repurchase

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

Securities loaned

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

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

 

Securities purchased under agreements to resell

 

  $ 5,687  

Securities borrowed

                                    572  

Securities sold under agreements to repurchase

 

    6,945  

Securities loaned

                                    307  

 

1.

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

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

Maturities and Collateral Pledged

Gross Secured Financing Balances by Remaining Contractual Maturity

 

    At June 30, 2018  

$ in millions

 

Overnight

and Open

   

Less than

30 Days

    30-90
Days
   

Over

90 Days

    Total  

Securities sold under agreements to repurchase

  $ 44,577     $ 67,770     $ 30,336     $ 40,886     $ 183,569  

Securities loaned

    17,693       2,430       2,228       6,612       28,963  

Total included in the offsetting disclosure

  $ 62,270     $ 70,200     $ 32,564     $ 47,498     $ 212,532  

Trading liabilities—

Obligation to return securities received as collateral

    19,646                         19,646  

Total

  $ 81,916     $ 70,200     $   32,564     $   47,498     $   232,178  

 

    At December 31, 2017  

$ in millions

 

Overnight

and Open

   

Less than

30 Days

    30-90
Days
   

Over

90 Days

    Total  

Securities sold under agreements to repurchase

  $ 41,332     $ 66,593     $ 28,682     $ 34,603     $ 171,210  

Securities loaned

    12,130       873       1,577       8,434       23,014  

Total included in the offsetting disclosure

  $ 53,462     $ 67,466     $ 30,259     $ 43,037     $ 194,224  

Trading liabilities—

Obligation to return securities received as collateral

    22,555                         22,555  

Total

  $ 76,017     $ 67,466     $   30,259     $   43,037     $   216,779  

Gross Secured Financing Balances by Class of Collateral Pledged

 

$ in millions   

At

June 30,

2018

    

At

December 31,
2017

 

Securities sold under agreements to repurchase

 

U.S. Treasury and agency securities

   $ 40,728      $ 43,346  

State and municipal securities

     1,432        2,451  

Other sovereign government obligations

     109,893        87,141  

ABS

     2,088        1,130  

Corporate and other debt

     8,286        7,737  

Corporate equities

     20,348        28,497  

Other

     794        908  

Total

   $       183,569      $ 171,210  

Securities loaned

     

U.S. Treasury and agency securities

   $ 1      $ 81  

Other sovereign government obligations

     16,530        9,489  

Corporate and other debt

     18        14  

Corporate equities

     12,048        13,174  

Other

     366        256  

Total

   $ 28,963      $ 23,014  

Total included in the offsetting disclosure

   $ 212,532      $ 194,224  

Trading liabilities—Obligation to return securities received as collateral

 

Corporate equities

   $ 19,646      $ 22,555  

Total

   $ 232,178      $ 216,779  
 

 

June 2018 Form 10-Q    68   


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Notes to Consolidated Financial Statements (Unaudited)    LOGO

 

Assets Pledged

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

Pledged financial instruments that can be sold or repledged by the secured party are identified as Trading assets (pledged to various parties) in the balance sheets.

 

Carrying Value of Assets Loaned or Pledged without Counterparty
Right to Sell or Repledge
 
$ in millions  

At

June 30,

2018

   

At

December 31,

2017

 

Trading assets

  $       32,682     $ 31,324  

Loans (gross of allowance for loan losses)

          228  

Total

  $ 32,682     $ 31,552  

Collateral Received

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

 

Fair Value of Collateral Received with Right to Sell or Repledge  
$ in millions  

At

June 30,

2018

   

At

December 31,

2017

 

Collateral received with right to sell or repledge

  $       668,906     $ 599,244  

Collateral that was sold or repledged

    528,660       475,113  

Customer Margin Lending and Other

 

$ in millions  

At

June 30,

2018

   

At

December 31,

2017

 

Net customer receivables representing margin loans

  $       32,811     $ 32,112  

The Firm provides margin lending arrangements which allow customers to borrow against the value of qualifying securities. Customer receivables representing margin loans are included within Customer and other receivables in the balance sheets. Under these agreements and transactions, the Firm receives collateral, including U.S. government and agency securities, other sovereign government obligations,

corporate and other debt, and corporate equities. Customer receivables generated from margin lending activities are collateralized by customer-owned securities held by the Firm. The Firm monitors required margin levels and established credit terms daily and, pursuant to such guidelines, requires customers to deposit additional collateral, or reduce positions, when necessary.

For a further discussion of the Firm’s margin lending activities, see Note 6 to the financial statements in the 2017 Form 10-K.

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

 

Restricted Cash and Segregated Securities  
$ in millions  

At

June 30,

2018

   

At

December 31,

2017

 

Restricted cash

  $ 32,706     $ 34,231  

Segregated securities1

    25,974       20,549  

Total

  $ 58,680     $ 54,780  

 

1.

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

7. Loans, Lending Commitments and Allowance for Credit Losses

Loans

The Firm’s loans held for investment are recorded at amortized cost, and its loans held for sale are recorded at the lower of cost or fair value in the balance sheets. For a further description of these loans, refer to Note 7 to the financial statements in the 2017 Form 10-K. See Note 3 for further information regarding Loans and lending commitments held at fair value. See Note 11 for details of current commitments to lend in the future.

 

Loans by Type  
    At June 30, 2018  
$ in millions   Loans Held
  for Investment
      Loans Held
for Sale
      Total Loans  

Corporate loans

  $ 32,382     $ 13,366     $ 45,748  

Consumer loans

    27,954             27,954  

Residential real estate loans

    26,405       30       26,435  

Wholesale real estate loans

    9,866       2,351       12,217  

Total loans, gross

    96,607       15,747       112,354  

Allowance for loan losses

    (241           (241

Total loans, net

  $ 96,366     $   15,747     $   112,113  

Fixed rate loans, net

                  $ 14,593  

Floating or adjustable rate loans, net

 

            97,520  

Loans to non-U.S. borrowers, net

 

            15,417  
 

 

   69    June 2018 Form 10-Q


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Notes to Consolidated Financial Statements

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    At December 31, 2017  
$ in millions   Loans Held
  for Investment
      Loans Held
for Sale
      Total Loans  

Corporate loans

  $ 29,754     $ 9,456     $ 39,210  

Consumer loans

    26,808             26,808  

Residential real estate loans

    26,635       35       26,670  

Wholesale real estate loans

    9,980       1,682       11,662  

Total loans, gross

    93,177       11,173       104,350  

Allowance for loan losses

    (224           (224

Total loans, net

  $ 92,953     $   11,173     $   104,126  

Fixed rate loans, net

 

  $ 13,339  

Floating or adjustable rate loans, net

 

    90,787  

Loans to non-U.S. borrowers, net

 

    9,977  

Credit Quality

For a further discussion about the Firm’s evaluation of credit transactions and monitoring and credit quality indicators, as well as factors considered by the Firm in determining the allowance for loan losses and impairments, see Notes 2 and 7 to the financial statements in the 2017 Form 10-K.

Loans Held for Investment before Allowance by Credit Quality

    At June 30, 2018  

$ in millions

  Corporate     Consumer    

Residential

Real Estate

   

Wholesale

Real Estate

    Total  

Pass

  $ 31,829     $ 27,949     $ 26,333     $ 8,794     $ 94,905  

Special mention

    187       5             555       747  

Substandard

    361             72       517       950  

Doubtful

    5                         5  

Loss

                             

Total

  $ 32,382     $     27,954     $        26,405     $          9,866     $   96,607  

 

    At December 31, 2017  

$ in millions

  Corporate     Consumer    

Residential

Real Estate

   

Wholesale

Real Estate

    Total  

Pass

  $ 29,166     $ 26,802     $ 26,562     $ 9,480     $ 92,010  

Special mention

    188       6             200       394  

Substandard

    393             73       300       766  

Doubtful

    7                         7  

Loss

                             

Total

  $ 29,754     $     26,808     $        26,635     $          9,980     $   93,177  

The following loans and lending commitments have been evaluated for a specific allowance. All remaining loans and lending commitments are assessed under the inherent allowance methodology.

Impaired Loans and Lending Commitments before Allowance

    At June 30, 2018  
$ in millions   Corporate     Residential
Real Estate
    Total  

Loans

     

With allowance

  $ 17     $     $ 17  

Without allowance1

    80       46       126  

Total impaired loans

  $ 97     $ 46     $ 143  

UPB

    106       46       152  

Lending Commitments

     

With allowance

  $ 9     $     $ 9  

Without allowance1

  $             193     $     $             193  
    At December 31, 2017  
$ in millions   Corporate     Residential
Real Estate
    Total  

Loans

     

With allowance

  $ 16     $     $ 16  

Without allowance1

    118       45       163  

Total impaired loans

  $ 134     $ 45     $ 179  

UPB

    146       46       192  

Lending Commitments

     

Without allowance1

  $ 199     $     $ 199  

 

1.

At June 30, 2018 and December 31, 2017, no allowance was recorded for these loans and lending commitments as the present value of the expected future cash flows (or, alternatively, the observable market price of the instrument or the fair value of the collateral held) equaled or exceeded the carrying value.

 

Impaired Loans and Total Allowance by Region        
    At June 30, 2018  
$ in millions   Americas     EMEA     Asia     Total  

Impaired loans

  $           139     $     $ 4     $ 143  

Total Allowance for loan losses

    201                 39       1       241  
    At December 31, 2017  

$ in millions

  Americas     EMEA     Asia     Total  

Impaired loans

  $ 160     $ 9     $           10     $           179  

Total Allowance for loan losses

    194       27       3       224  

 

Troubled Debt Restructurings  
$ in millions   At June 30,
2018
    At December 31,
2017
 

Loans

  $                       65     $                       51  

Lending commitments

    20       28  

Allowance for loan losses and lending commitments

    4       10  

Impaired loans and lending commitments classified as held for investment within corporate loans include TDRs as shown in the previous table. These restructurings typically include modifications of interest rates, collateral requirements, other loan covenants and payment extensions.

 

 

June 2018 Form 10-Q    70   


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Allowance for Loan Losses Rollforward        
$ in millions   Corporate     Consumer     Residential
Real Estate
    Wholesale
Real Estate
    Total  

December 31, 2017

  $         126     $             4     $             24     $             70     $ 224  

Gross charge-offs

    (1                       (1

Recoveries1

    54                         54  

Net recoveries (charge-offs)

    53                         53  

Provision (release)1, 2

    (51     1       (5     21       (34

Other

    (1           (1           (2

June 30, 2018

  $ 127     $ 5     $ 18     $ 91     $ 241  

Inherent

  $ 123     $ 5     $ 18     $ 91     $             237  

Specific

    4                         4  
$ in millions   Corporate     Consumer     Residential
Real Estate
    Wholesale
Real Estate
    Total  

December 31, 2016

  $ 195     $ 4     $ 20     $ 55     $ 274  

Recoveries

    1                         1  

Provision (release)2

    14             1       14       29  

Other

    1                   1       2  

June 30, 2017

  $ 211     $ 4     $ 21     $ 70     $ 306  

Inherent

  $ 142     $ 4     $ 21     $ 70     $             237  

Specific

    69                         69  

 

1.

The current quarter release was primarily due to the recovery of a previously charged off energy industry related loan.

2.

The Firm recorded a release of $53 million, and a provision of $7 million for loan losses in the current quarter and prior year quarter, respectively.

 

Allowance for Lending Commitments Rollforward  
$ in millions   Corporate     Consumer     Residential
Real Estate
    Wholesale
Real Estate
    Total  

December 31, 2017

  $         194     $             1     $             —     $ 3     $ 198  

Provision (release)1

    5                               —       5  

Other

                      (1     (1

June 30, 2018

  $ 199     $ 1     $     $ 2     $ 202  

Inherent

  $ 195     $ 1     $     $ 2     $             198  

Specific

    4                         4  
$ in millions   Corporate     Consumer     Residential
Real Estate
    Wholesale
Real Estate
    Total  

December 31, 2016

  $ 185     $ 1     $     $ 4     $ 190  

Provision (release)1

    (3                 (1     (4

June 30, 2017

  $ 182     $ 1     $     $ 3     $ 186  

Inherent

  $ 179     $ 1     $     $ 3     $             183  

Specific

    3                         3  

 

1.

The Firm recorded a release of $2 million, and $7 million for lending commitments in the current quarter and prior year quarter, respectively.

Employee Loans  
$ in millions  

At

June 30,

2018

    At
December 31,
2017
 

Balance

  $ 3,564     $ 4,185  

Allowance for loan losses

    (74     (77

Balance, net

  $ 3,490     $ 4,108  

Repayment term range, in years

                1 to 20                   1 to 20  

Employee loans are granted in conjunction with a program established to retain and recruit certain employees, are full recourse and generally require periodic repayments. These loans are recorded in Customer and other receivables in the balance sheets. The Firm establishes an allowance for loan amounts it does not consider recoverable, and the related provision is recorded in Compensation and benefits expense.

8. Equity Method Investments

Overview

Equity method investments other than certain investments in funds are summarized below and included in Other assets in the balance sheets with related income or loss included in Other revenues in the income statements. See the Measured Based on Net Asset Value table in Note 3 for the carrying value of the Firm’s fund interests, which are comprised of general and limited partnership interests, as well as any related performance-based fees in the form of carried interest.

Equity Method Investment Balances

 

$ in millions  

At

June 30, 2018

   

At

December 31, 2017

 

Investments

  $                     2,491     $                     2,623  

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
$ in millions   2018     2017     2018     2017  

Income (loss)

  $ 4     $ (9   $ 54     $  

Japanese Securities Joint Venture

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

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
$ in millions   2018     2017     2018     2017  

Income from investment in MUMSS

  $ 26     $ 23     $ 82     $ 71  

 

 

 

   71    June 2018 Form 10-Q


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9. Deposits

Deposits

 

$ in millions  

    At June 30,

    2018

      At December 31,
  2017
 

Savings and demand deposits

  $ 139,736     $ 144,487  

Time deposits

    33,066       14,949  

Total

  $ 172,802     $ 159,436  

Deposits subject to FDIC insurance

  $           135,229     $                 127,017  

Time deposits that equal or exceed the FDIC insurance limit

  $ 11     $ 38  

Time Deposit Maturities

 

$ in millions   

  At

  June 30, 2018

 

2018

   $                              15,493  

2019

     8,840  

2020

     5,452  

2021

     1,466  

2022

     667  

Thereafter

     1,148  

10. Borrowings and Other Secured Financings

Borrowings

 

$ in millions  

  At

  June 30,

  2018

      At
  December 31,
  2017
 

Original maturities of one year or less

  $ 2,329     $ 1,519  

Original maturities greater than one year

   

Senior

  $ 180,008     $ 180,835  

Subordinated

    9,907       10,228  

Total

  $ 189,915     $         191,063  

Total borrowings

  $           192,244     $ 192,582  

Weighted average stated maturity, in years1

    6.7       6.6  

 

1.

Includes only borrowings with original maturities greater than one year.

Other Secured Financings

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

Other Secured Financings by Original Maturity and Type

 

$ in millions   

At

June 30,

2018

       At
  December 31,
  2017
 

Original maturities:

     

Greater than one year

   $ 8,439      $ 8,685  

One year or less

     745        2,034  

Failed sales

     706        552  

Total

   $               9,890      $             11,271  

Failed Sales

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

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

11. Commitments, Guarantees and Contingencies

Commitments

 

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

Lending:

         

Corporate

  $ 12,850     $ 47,036     $ 43,123     $ 12,723     $ 115,732  

Consumer

    6,895             11             6,906  

Residential real estate

    5       69       25       253       352  

Wholesale real estate

    268       337       17       100       722  

Forward-starting secured financing receivables

    84,321                   1,177       85,498  

Investment activities

    489       77       42       253       861  

Letters of credit and

other financial guarantees

    186       1             39       226  

Total

  $   105,014     $   47,520     $   43,218     $   14,545     $   210,297  

Corporate lending commitments participated to third parties

 

  $ 7,183  

Forward-starting secured financing receivables settled within three business days

 

  $ 80,137  
 

 

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Since commitments associated with these instruments may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.

For a further description of these commitments, refer to Note 12 to the financial statements in the 2017 Form 10-K.

Guarantees

Obligations under Guarantee Arrangements at June 30, 2018

 

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

Credit derivatives

  $ 50,155     $ 59,663     $ 62,985     $ 26,644     $ 199,447  

Other credit contracts

                      119       119  

Non-credit derivatives

    2,166,063       1,346,622       414,569       643,110       4,570,364  

Standby letters of credit and other financial guarantees issued1

    897       1,062       1,304       5,053       8,316  

Market value guarantees

    16       110       24             150  

Liquidity facilities

    3,585                         3,585  

Whole loan sales guarantees

          1             23,230       23,231  

Securitization representations and warranties

                      62,081       62,081  

General partner guarantees

    4       51       342       30       427  

 

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

Credit derivatives2

  $ (207   $  

Other credit contracts

    11        

Non-credit derivatives2

    43,962        

Standby letters of credit and other financial guarantees issued1

    (241             6,777  

Market value guarantees

          3  

Liquidity facilities

    (5     5,770  

Whole loan sales guarantees

    9        

Securitization representations and warranties

    71        

General partner guarantees

    66        

 

1.

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

2.

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

The Firm also has obligations under certain guarantee arrangements, including contracts and indemnification agreements, that contingently require the Firm to make payments

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

In certain situations, collateral may be held by the Firm for those contracts that meet the definition of a guarantee. Generally, the Firm sets collateral requirements by counterparty so that the collateral covers various transactions and products and is not allocated specifically to individual contracts. Also, the Firm may recover amounts related to the underlying asset delivered to the Firm under the derivative contract.

For more information on the nature of the obligation and related business activity for market value guarantees, liquidity facilities, whole loan sales guarantees and general partner guarantees related to certain investment management funds, as well as the other products in the previous table, see Note 12 to the financial statements in the 2017 Form 10-K.

Other Guarantees and Indemnities

In the normal course of business, the Firm provides guarantees and indemnifications in a variety of transactions. These provisions generally are standard contractual terms. Certain of these guarantees and indemnifications related to indemnities, exchange/clearinghouse member guarantees and merger and acquisition guarantees are described in Note 12 to the financial statements in the 2017 Form 10-K.

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

Finance Subsidiary

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

 

 

   73    June 2018 Form 10-Q


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Contingencies

Legal. In addition to the matters described below, in the normal course of business, the Firm has been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with its activities as a global diversified financial services institution. Certain of the actual or threatened legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. In some cases, the entities that would otherwise be the primary defendants in such cases are bankrupt or are in financial distress. These actions have included, but are not limited to, residential mortgage and credit crisis-related matters.

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

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

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

For certain legal proceedings and investigations, the Firm cannot reasonably estimate such losses, particularly for proceedings and investigations where the factual record is being developed or contested or where plaintiffs or government entities seek substantial or indeterminate damages, restitution, disgorgement or penalties. Numerous issues may need to be resolved, including through potentially lengthy

discovery and determination of important factual matters, determination of issues related to class certification and the calculation of damages or other relief, and by addressing novel or unsettled legal questions relevant to the proceedings or investigations in question, before a loss or additional loss or range of loss or additional range of loss can be reasonably estimated for a proceeding or investigation.

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

On July 15, 2010, China Development Industrial Bank (“CDIB”) filed a complaint against the Firm, styled China Development Industrial Bank v. Morgan Stanley & Co. Incorporated et al., which is pending in the Supreme Court of the State of New York, New York County (“Supreme Court of NY”). The complaint relates to a $275 million CDS referencing the super senior portion of the STACK 2006-1 CDO. The complaint asserts claims for common law fraud, fraudulent inducement and fraudulent concealment and alleges that the Firm misrepresented the risks of the STACK 2006-1 CDO to CDIB, and that the Firm knew that the assets backing the CDO were of poor quality when it entered into the CDS with CDIB. The complaint seeks compensatory damages related to the approximately $228 million that CDIB alleges it has already lost under the CDS, rescission of CDIB’s obligation to pay an additional $12 million, punitive damages, equitable relief, fees and costs. On February 28, 2011, the court denied the Firm’s motion to dismiss the complaint. On June 27, 2018, the Firm filed a motion for summary judgment and spoliation sanctions against CDIB. Based on currently available information, the Firm believes it could incur a loss in this action of up to approximately $240 million plus pre- and post-judgment interest, fees and costs.

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

 

 

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complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, unspecified damages and interest. On August 22, 2013, the Firm filed a motion to dismiss the complaint, which was granted in part and denied in part on November 24, 2014. Based on currently available information, the Firm believes that it could incur a loss in this action of up to approximately $240 million, the total original unpaid balance of the mortgage loans for which the Firm received repurchase demands that it did not repurchase, plus pre- and post-judgment interest, fees and costs, but plaintiff is seeking to expand the number of loans at issue and the possible range of loss could increase.

On September 19, 2014, Financial Guaranty Insurance Company (“FGIC”) filed a complaint against the Firm in the Supreme Court of NY, styled Financial Guaranty Insurance Company v. Morgan Stanley ABS Capital I Inc. et al. relating to a securitization issued by Basket of Aggregated Residential NIMS 2007-1 Ltd. The complaint asserts claims for breach of contract and alleges, among other things, that the net interest margin securities (“NIMS”) in the trust breached various representations and warranties. FGIC issued a financial guaranty policy with respect to certain notes that had an original balance of approximately $475 million. The complaint seeks, among other relief, specific performance of the NIMS breach remedy procedures in the transaction documents, unspecified damages, reimbursement of certain payments made pursuant to the transaction documents, attorneys’ fees and interest. On November 24, 2014, the Firm filed a motion to dismiss the complaint, which the court denied on January 19, 2017. On February 24, 2017, the Firm filed a notice of appeal of the denial of its motion to dismiss the complaint and perfected its appeal on November 22, 2017. Based on currently available information, the Firm believes that it could incur a loss in this action of up to approximately $126 million, the unpaid balance of these notes, plus pre- and post-judgment interest, fees and costs, as well as claim payments that FGIC has made and will make in the future.

On September 23, 2014, FGIC filed a complaint against the Firm in the Supreme Court of NY styled Financial Guaranty Insurance Company v. Morgan Stanley ABS Capital I Inc. et al. relating to the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4. The complaint asserts claims for breach of contract and fraudulent inducement and alleges, among other things, that the loans in the trust breached various representations and warranties and defendants made untrue statements and material omissions to induce FGIC to issue a financial guaranty policy on certain classes of certificates that had an original balance of approximately $876 million. The complaint seeks, among other relief, specific performance of

the loan breach remedy procedures in the transaction documents, compensatory, consequential and punitive damages, attorneys’ fees and interest. On January 23, 2017, the court denied the Firm’s motion to dismiss the complaint. On February 24, 2017, the Firm filed a notice of appeal of the court’s order and perfected its appeal on November 22, 2017. Based on currently available information, the Firm believes that it could incur a loss in this action of up to approximately $277 million, the total original unpaid balance of the mortgage loans for which the Firm received repurchase demands from a certificate holder and FGIC that the Firm did not repurchase, plus pre- and post-judgment interest, fees and costs, as well as claim payments that FGIC has made and will make in the future. In addition, plaintiff is seeking to expand the number of loans at issue and the possible range of loss could increase.

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

In matters styled Case number 15/3637 and Case number 15/4353, the Dutch Tax Authority (“Dutch Authority”) is challenging, in the District Court in Amsterdam, the prior set-off by the Firm of approximately €124 million (approximately $145 million) plus accrued interest of withholding tax

 

 

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credits against the Firm’s corporation tax liabilities for the tax years 2007 to 2013. The Dutch Authority alleges that the Firm was not entitled to receive the withholding tax credits on the basis, inter alia, that a Firm subsidiary did not hold legal title to certain securities subject to withholding tax on the relevant dates. The Dutch Authority has also alleged that the Firm failed to provide certain information to the Dutch Authority and keep adequate books and records. A hearing took place in this matter on September 19, 2017. On April 26, 2018, the District Court in Amsterdam issued a decision dismissing the Dutch Authority’s claims. On June 6, 2018, the Dutch Authority filed an appeal against the decision issued by the District Court in Amsterdam. Based on currently available information, the Firm believes that it could incur a loss in this action of up to approximately €124 million (approximately $145 million) plus accrued interest.

12. Variable Interest Entities and Securitization Activities

Overview

For a discussion of the Firm’s VIEs, the determination and structure of VIEs and securitization activities, see Note 13 to the financial statements in the 2017 Form 10-K.

Consolidated VIEs

 

Assets and Liabilities by Type of Activity  
                         
    At June 30, 2018     At December 31, 2017  
$ in millions   VIE Assets         VIE Liabilities     VIE Assets         VIE Liabilities  

OSF

  $ 282     $                 1     $ 378     $                 3  

MABS1

    73       52       249       210  

Other2

    2,545       1,030       1,174       250  

Total

  $          2,900     $ 1,083     $         1,801     $ 463  

OSF—Other structured financings

1.

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

2.

Other primarily includes investment funds, certain operating entities, CLOs and structured transactions. At June 30, 2018, Other includes the consolidation of a fund managed by Mesa West Capital, LLC, which was acquired in the first quarter of 2018.

Assets and Liabilities by Balance Sheet Caption

 

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

Assets

     

Cash and cash equivalents:

     

Cash and due from banks

   $ 93      $ 69  

Restricted cash

     169        222  

Trading assets at fair value

     2,032        833  

Customer and other receivables

     21        19  

Goodwill

     18        18  

Intangible assets

     140        155  

Other assets

     427        485  

Total

   $ 2,900      $ 1,801  

Liabilities

     

Other secured financings

   $ 1,049      $ 438  

Other liabilities and accrued expenses

     34        25  

Total

   $ 1,083      $ 463  

Noncontrolling interests

   $                       441      $ 189  

Consolidated VIE assets and liabilities are presented in the previous tables after intercompany eliminations. Most assets owned by consolidated VIEs cannot be removed unilaterally by the Firm and are not generally available to the Firm. Most related liabilities issued by consolidated VIEs are non-recourse to the Firm. In certain other consolidated VIEs, the Firm either has the unilateral right to remove assets or provides additional recourse through derivatives such as total return swaps, guarantees or other forms of involvement.

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

Non-consolidated VIEs

Most of the VIEs included in the following tables are sponsored by unrelated parties; the Firm’s involvement generally is the result of its secondary market-making activities, securities held in its Investment securities portfolio (see Note 5) and certain investments in funds.

 

 

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Non-consolidated VIEs  
    At June 30, 2018  
$ in millions   MABS     CDO     MTOB     OSF     Other  

VIE assets (UPB)

  $     66,680     $     11,274     $     5,618     $     3,277     $     20,153  

Maximum exposure to loss

 

     

Debt and equity interests

  $ 8,013     $ 1,289     $ 1     $ 1,566     $ 4,388  

Derivative and other contracts

                3,585             2,627  

Commitments, guarantees and other

    762       427             150       327  

Total

  $ 8,775     $ 1,716     $ 3,586     $ 1,716     $ 7,342  

Carrying value of exposure to loss—Assets

 

     

Debt and equity interests

  $ 8,013     $ 1,289     $ 1     $ 1,157     $ 4,388  

Derivative and other contracts

                5             122  

Total

  $ 8,013     $ 1,289     $ 6     $ 1,157     $ 4,510  

Additional VIE assets owned1

 

          $ 12,173  
    At December 31, 2017  
$ in millions        MABS           CDO          MTOB           OSF          Other  

VIE assets (UPB)

  $   89,288     $   9,807     $   5,306     $   3,322     $   31,934  

Maximum exposure to loss

 

     

Debt and equity interests

  $ 10,657     $ 1,384     $ 80     $ 1,628     $ 4,730  

Derivative and other contracts

                3,333             1,686  

Commitments, guarantees and other

    1,214       668             164       433  

Total

  $ 11,871     $ 2,052     $ 3,413     $ 1,792     $ 6,849  

Carrying value of exposure to loss—Assets

 

     

Debt and equity interests

  $ 10,657     $ 1,384     $ 43     $ 1,202     $ 4,730  

Derivative and other contracts

                5             184  

Total

  $ 10,657     $ 1,384     $ 48     $ 1,202     $ 4,914  

Additional VIE assets owned1

 

          $ 11,318  

MTOB—Municipal tender option bonds

1.

Additional VIE Assets owned represents the carrying value of total exposure to non-consolidated VIEs that does not meet the criteria for detailed breakout in the previous table, primarily interests issued by securitization SPEs for which the maximum exposure to loss is less than specific thresholds.

The Firm’s maximum exposure to loss presented in the previous table is dependent on the nature of the Firm’s variable interest in the VIE and is limited to:

 

 

notional amounts of certain liquidity facilities;

 

other credit support;

 

total return swaps;

 

written put options; and

 

fair value of certain other derivatives and investments the Firm has made in the VIE.

Where notional amounts are utilized in quantifying the maximum exposure related to derivatives, such amounts do not reflect changes in fair value recorded by the Firm.

The Firm’s maximum exposure to loss presented in the previous table does not include:

 

 

offsetting benefit of any financial instruments that the Firm may utilize to hedge these risks associated with its variable interests; and

 

any reductions associated with the amount of collateral held as part of a transaction with the VIE or any party to the VIE directly against a specific exposure to loss.

Liabilities issued by VIEs generally are non-recourse to the Firm.

The Firm’s primary risk exposure related to additional VIE assets owned is to the most subordinate class of beneficial interest, which are typically acquired by the Firm in the secondary market and generally issued by SPEs sponsored by unrelated parties. These assets, which generally consist of MABS, CDO, MTOB and other exposure, are primarily included in Trading assets—Corporate and other debt, Trading assets—Investments or AFS securities within its Investment securities portfolio and are measured at fair value (see Note 3). The Firm does not provide additional support in these transactions through contractual facilities, such as liquidity facilities, guarantees or similar derivatives. The Firm’s maximum exposure to loss generally equals the fair value of the assets owned.

Mortgage- and Asset-Backed Securitization Assets

 

    At June 30, 2018     At December 31, 2017  
$ in millions   UPB     Debt and
Equity
Interests
    UPB     Debt and
Equity
Interests
 

Residential mortgages

  $       11,611     $ 813     $ 15,636     $ 1,272  

Commercial mortgages

    31,713       1,218             46,464       2,331  

U.S. agency collateralized mortgage obligations

    13,610               2,578       16,223       3,439  

Other consumer or commercial loans

    9,746       3,404       10,965       3,615  

Total

  $   66,680     $   8,013     $   89,288     $       10,657  
 

 

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Transfers of Assets with Continuing Involvement

 

    At June 30, 2018  
$ in millions  

RML   

    CML        U.S. Agency
CMO
   

CLN and  

Other1  

 

SPE assets (UPB)2

  $     14,383     $     64,392     $     14,904     $     15,867  

Retained interests

       

Investment grade

  $     $ 418     $ 619     $ 3  

Non-investment grade (fair value)

    1       57             296  

Total

  $ 1     $ 475     $ 619     $ 299  

Interests purchased in the secondary market (fair value)

 

 

Investment grade

  $     $ 158     $ 40     $  

Non-investment grade

    16       18              

Total

  $ 16     $ 176     $ 40     $  

Derivative assets (fair value)

  $     $     $     $ 222  

Derivative liabilities (fair value)

                      164  
    At December 31, 2017  
$ in millions   RML       CML       U.S. Agency  
CMO  
   

CLN and  

Other1  

 

SPE assets(UPB)2

  $     15,555     $     62,744     $     11,612     $     17,060  

Retained interests

       

Investment grade

  $     $ 293     $ 407     $ 4  

Non-investment grade (fair value)

    1       98             478  

Total

  $ 1     $ 391     $ 407     $ 482  

Interests purchased in the secondary market (fair value)

 

 

Investment grade

  $     $ 94     $ 439     $  

Non-investment grade

    16       66             4  

Total

  $ 16     $ 160     $ 439     $ 4  

Derivative assets (fair value)

  $ 1     $     $     $ 226  

Derivative liabilities (fair value)

                      85  

RML—Residential mortgage loans

CML—Commercial mortgage loans

1.

Amounts include CLO transactions managed by unrelated third parties.

2.

Amounts include assets transferred by unrelated transferors.

 

     Fair Value at June 30, 2018  
$ in millions    Level 2        Level 3        Total    

Retained interests

        

Investment grade

   $ 624      $ 56      $ 680  

Non-investment grade

     10        344        354  

Total

   $ 634      $ 400      $ 1,034  

Interests purchased in the secondary market

 

Investment grade

   $ 183      $ 15      $ 198  

Non-investment grade

     21        13        34  

Total

   $             204      $ 28      $             232  

Derivative assets

   $ 97      $             125      $ 222  

Derivative liabilities

     157        7        164  
     Fair Value at December 31, 2017  
$ in millions    Level 2        Level 3        Total    

Retained interests

        

Investment grade

   $ 407      $ 4      $ 411  

Non-investment grade

     22        555        577  

Total

   $             429      $             559      $             988  

Interests purchased in the secondary market

 

Investment grade

   $ 531      $ 2      $ 533  

Non-investment grade

     57        29        86  

Total

   $ 588      $ 31      $ 619  

Derivative assets

   $ 78      $ 149      $ 227  

Derivative liabilities

     81        4        85  

The previous tables include transactions with SPEs in which the Firm, acting as principal, transferred financial assets with continuing involvement and received sales treatment.

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

Proceeds from New Securitization Transactions and Sales of Loans

 

   

Three Months Ended

 

June 30,

   

Six Months Ended

 

June 30,

 
$ in millions   2018      2017       2018        2017  

New transactions1

  $         5,624     $         4,750     $         11,758     $         10,747  

Retained interests

    1,156       529       1,637       959  

Sales of corporate loans to CLO SPEs1, 2

    142       239       236       418  

 

1.

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

2.

Sponsored by non-affiliates.

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

 

 

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

Assets Sold with Retained Exposure

 

$ in millions   

At June 30,

2018

     At December 31,
2017
 

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

   $                     32,433      $                     19,115  

Fair value

     

Assets sold

   $ 32,089      $ 19,138  

Derivative assets recognized in the balance sheets

     204        176  

Derivative liabilities recognized in the balance sheets

     548        153  

13. Regulatory Requirements

Regulatory Capital Framework and Requirements

For a discussion of the Firm’s regulatory capital framework, see Note 14 to the financial statements in the 2017 Form 10-K.

The Firm is required to maintain minimum risk-based and leverage-based capital ratios under the regulatory capital requirements. A summary of the calculations of regulatory capital, RWA and transition provisions follows.

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

Minimum risk-based capital ratio requirements apply to Common Equity Tier 1 capital, Tier 1 capital and Total capital (which includes Tier 2 capital). Certain adjustments to and deductions from capital are required for purposes of determining these ratios, such as goodwill, intangible assets, certain deferred tax assets, other amounts in AOCI and investments in the capital instruments of unconsolidated financial institutions.

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

 

 

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

 

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

 

 

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 the Firm’s ability to make capital distributions, including the payment of dividends and the repurchase of stock, and to pay discretionary bonuses to executive officers.

For a further discussion of the Firm’s calculation of risk-based capital ratios, see Note 14 to the financial statements in the 2017 Form 10-K.

The Firm’s Regulatory Capital and Capital Ratios

At June 30, 2018 and December 31, 2017, the Firm’s risk-based capital ratios are based on the Standardized Approach rules.

Regulatory Capital

 

    At June 30, 2018  

$ in millions

  Required
Ratio1
    Amount     Ratio  

Risk-based capital

     

Common Equity Tier 1 capital

    8.6%     $ 61,352       15.8%  

Tier 1 capital

    10.1%       70,017       18.1%  

Total capital

    12.1%       79,681       20.6%  

Total RWA

    N/A       387,414       N/A  

Leverage-based capital

     

Tier 1 leverage

    4.0%       70,017       8.2%  

Adjusted average assets2

    N/A       852,726       N/A  

SLR3

    5.0%       70,017       6.4%  

Supplementary leverage exposure4

    N/A         1,096,953       N/A  
    At December 31, 2017  

$ in millions

  Required
Ratio1
    Amount     Ratio  

Risk-based capital

     

Common Equity Tier 1 capital

    7.3%     $       61,134       16.5%  

Tier 1 capital

    8.8%       69,938       18.9%  

Total capital

    10.8%       80,275       21.7%  

Total RWA

    N/A       369,578       N/A  

Leverage-based capital

     

Tier 1 leverage

    4.0%       69,938       8.3%  

Adjusted average assets2

    N/A       842,270       N/A  

 

1.

Percentages represent minimum required regulatory capital ratios—for risk-based capital the ratios are under the transitional rules. For risk- and leverage-based capital, regulatory compliance was determined based on capital ratios calculated under the transitional rules until December 31, 2017.

2.

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

 

 

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3.

The SLR became effective as a capital standard on January 1, 2018.

4.

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

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

The OCC establishes capital requirements for our U.S. Bank Subsidiaries and evaluates their compliance with such capital requirements. Regulatory capital requirements for our U.S. Bank Subsidiaries are calculated in a similar manner to the Firm’s regulatory capital requirements, although G-SIB capital surcharge requirements do not apply to our U.S. Bank Subsidiaries.

The OCC’s regulatory capital framework includes Prompt Corrective Action (“PCA”) standards, including “well capitalized” PCA standards that are based on specified regulatory capital ratio minimums. For us to remain an FHC, our U.S. Bank Subsidiaries must remain well capitalized in accordance with the OCC’s PCA standards. In addition, failure by our U.S. Bank Subsidiaries to meet minimum capital requirements may result in certain mandatory and discretionary actions by regulators that, if undertaken, could have a direct material effect on the U.S. Bank Subsidiaries’ and the Firm’s financial statements.

At June 30, 2018 and December 31, 2017, the U.S. Bank Subsidiaries’ risk-based capital ratios are based on the Standardized Approach rules and exceeded well capitalized requirements.

MSBNA’s Regulatory Capital

 

     At June 30, 2018  

$ in millions

   Required
Ratio1
      Amount     Ratio  

Risk-based capital

      

Common Equity Tier 1 capital

     6.5   $       15,065       18.7%  

Tier 1 capital

     8.0     15,065       18.7%  

Total capital

     10.0     15,327       19.1%  

Leverage-based capital

      

Tier 1 leverage

     5.0     15,065       11.0%  

SLR2

     6.0     15,065       8.4%  
     At December 31, 2017  
$ in millions    Required
Ratio1
    Amount     Ratio  

Risk-based capital

      

Common Equity Tier 1 capital

     6.5   $       15,196       20.5%  

Tier 1 capital

     8.0     15,196       20.5%  

Total capital

     10.0     15,454       20.8%  

Leverage-based capital

      

Tier 1 leverage

     5.0     15,196       11.8%  
MSPBNA’s Regulatory Capital

 

 
     At June 30, 2018  
$ in millions    Required
Ratio1
    Amount     Ratio  

Risk-based capital

      

Common Equity Tier 1 capital

     6.5   $       6,608       24.6%  

Tier 1 capital

     8.0     6,608       24.6%  

Total capital

     10.0     6,649       24.8%  

Leverage-based capital

      

Tier 1 leverage

     5.0     6,608       9.8%  

SLR2

     6.0     6,608       9.4%  
     At December 31, 2017  
$ in millions    Required
Ratio1
    Amount     Ratio  

Risk-based capital

      

Common Equity Tier 1 capital

     6.5   $ 6,215       24.4%  

Tier 1 capital

     8.0     6,215       24.4%  

Total capital

     10.0     6,258       24.6%  

Leverage-based capital

      

Tier 1 leverage

     5.0     6,215       9.7%  

 

1.

Ratios that are required in order to be considered well-capitalized for U.S. regulatory purposes. Regulatory compliance was determined based on capital ratios calculated under the transitional rules until December 31, 2017.

2.

The SLR became effective as a capital standard on January 1, 2018.

U.S. Broker-Dealer Regulatory Capital Requirements

MS&Co. Regulatory Capital

 

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

Net capital

   $                              13,056      $                              10,142  

Excess net capital

     10,661        8,018  

MS&Co. is a registered U.S. broker-dealer and registered futures commission merchant and, accordingly, is subject to the minimum net capital requirements of the SEC and the CFTC. MS&Co. has consistently operated with capital in excess of its regulatory capital requirements.

As an Alternative Net Capital broker-dealer, and in accordance with the market and credit risk standards of Appendix E of SEC Rule 15c3-1, MS&Co. is subject to minimum net capital and tentative net capital requirements. In addition, MS&Co. must notify the SEC if its tentative net capital falls below certain levels. At June 30, 2018 and December 31, 2017, MS&Co. has exceeded its net capital requirement and has tentative net capital in excess of the minimum and notification requirements.

 

 

June 2018 Form 10-Q    80   


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MSSB LLC Regulatory Capital

 

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

Net capital

   $                                2,710      $                                2,567  

Excess net capital

     2,556        2,400  

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

Other Regulated Subsidiaries

MSIP, a London-based broker-dealer subsidiary, is subject to the capital requirements of the PRA, and MSMS, a Tokyo-based broker-dealer subsidiary, is subject to the capital requirements of the Financial Services Agency. MSIP and MSMS have consistently operated with capital in excess of their respective regulatory capital requirements.

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

14. Total Equity

Share Repurchases

 

   

Three Months Ended

 

June 30,

   

Six Months Ended

 

June 30,

 
$ in millions     2018       2017       2018       2017  

Repurchases of common stock under the Firm’s share repurchase program

  $       1,250     $       500     $       2,500     $       1,250  

The Firm’s 2018 Capital Plan (“Capital Plan”) includes the share repurchase of up to $4.7 billion of outstanding common stock for the period beginning July 1, 2018 through June 30, 2019. Additionally, the Capital Plan includes quarterly common stock dividends of up to $0.30 per share.

On April 18, 2018, the Firm entered into a sales plan with MUFG whereby MUFG sells shares of the Firm’s common stock to the Firm, as part of the Firm’s share repurchase program. The sales plan, which began to be executed in the current quarter, is only intended to maintain MUFG’s ownership percentage below 24.9% in order to comply with MUFG’s passivity commitments to the Board of Governors of the Federal Reserve System and will have no impact on the strategic alliance between MUFG and the Firm, including the joint ventures in Japan.

Preferred Stock

 

   

Three Months Ended

 

June 30,

   

Six Months Ended

 

June 30,

 
$ in millions   2018     2017     2018     2017  

Dividends declared

  $           170     $           170     $           263     $           260  

For a description of Series A through Series K preferred stock issuances, see Note 15 to the financial statements in the 2017 Form 10-K. The Firm is authorized to issue 30 million shares of preferred stock. The preferred stock has a preference over the common stock upon liquidation. The Firm’s preferred stock qualifies as Tier 1 capital in accordance with regulatory capital requirements (see Note 13).

Preferred Stock Outstanding

 

    Shares
Outstanding
          Carrying Value  
$ in millions, except
per share data
 

At

June 30,
2018

    Liquidation
Preference
per Share
    At
June 30,
2018
    At
December 31,
2017
 

Series

       

A

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

C1

    519,882       1,000       408       408  

E

    34,500       25,000       862       862  

F

    34,000       25,000       850       850  

G

    20,000       25,000       500       500  

H

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

I

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

J

    60,000       25,000       1,500       1,500  

K

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

Total

      $     8,520     $     8,520  

 

1.

Series C is composed of the issuance of 1,160,791 shares of Series C Preferred Stock to MUFG for an aggregate purchase price of $911 million, less the redemption of 640,909 shares of Series C Preferred Stock of $503 million, which were converted to common shares of approximately $705 million.

 

 

   81    June 2018 Form 10-Q


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(Unaudited)

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Comprehensive Income (Loss)

Accumulated Other Comprehensive Income (Loss)1

 

$ in millions   Foreign
Currency
Translation
Adjustments
    AFS
Securities
    Pension,
Postretirement
and Other
    DVA     Total  

March 31, 2018

  $ (715   $ (1,068   $ (710   $ (913   $ (3,406

OCI during the period

    (149     (126                 6             605             336  

June 30, 2018

  $ (864   $ (1,194   $ (704   $ (308   $ (3,070

March 31, 2017

  $ (879   $ (504   $ (474   $ (593   $ (2,450

OCI during the period

                23               108       4       (173     (38

June 30, 2017

  $ (856   $ (396   $ (470   $ (766   $ (2,488

December 31, 2017

  $ (767   $ (547   $ (591   $ (1,155   $ (3,060

Cumulative adjustment for accounting changes2

    (8     (111     (124     (194     (437

OCI during the period

    (89     (536                     11         1,041       427  

June 30, 2018

  $ (864   $ (1,194   $ (704   $ (308   $ (3,070

December 31, 2016

  $ (986   $ (588   $ (474   $ (595   $ (2,643

OCI during the period

    130               192       4       (171     155  

June 30, 2017

  $ (856   $ (396   $ (470   $ (766   $ (2,488

 

1.

Amounts net of tax and noncontrolling interests.

2.

The cumulative adjustment for accounting changes is primarily the effect of the adoption of the accounting update Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This adjustment was recorded as of January 1, 2018 to reclassify certain income tax effects related to enactment of the Tax Act from AOCI to Retained earnings, primarily related to the remeasurement of deferred tax assets and liabilities resulting from the reduction in corporate income tax rate to 21%. See Note 2 for further information.

Components of Period Changes in OCI

 

   

Three Months Ended

 

June 30, 2018

 
$ in millions   Pre-tax
Gain (Loss)
    Income
Tax Benefit
(Provision)
    After-tax
Gain (Loss)
    Non-controlling
Interests
    Net  

Foreign currency translation adjustments

 

   

OCI activity

  $ (86   $ (106   $ (192   $ (43   $ (149

Reclassified to earnings

                        —              

Net OCI

  $ (86   $ (106   $ (192   $ (43   $ (149

Change in net unrealized gains (losses) on AFS securities

 

 

OCI activity

  $ (162   $           39     $ (123   $     $ (123

Reclassified to earnings

    (3           (3           (3

Net OCI

  $ (165   $ 39     $ (126   $     $ (126

Pension, postretirement and other

 

   

OCI activity

  $           2     $     $ 2     $     $ 2  

Reclassified to earnings

    6       (2     4             4  

Net OCI

  $ 8     $ (2   $ 6     $     $ 6  

Change in net DVA

         

OCI activity

  $ 841     $ (205   $ 636     $ 34     $ 602  

Reclassified to earnings

    3             3             3  

Net OCI

  $   844     $ (205   $         639     $                 34     $         605  
   

Three Months Ended

 

June 30, 2017

 
$ in millions   Pre-tax
Gain (Loss)
    Income
Tax Benefit
(Provision)
    After-tax
Gain (Loss)
    Non-controlling
Interests
    Net  

Foreign currency translation adjustments

 

   

OCI activity

  $             1     $           11     $           12     $ (11   $         23  

Reclassified to earnings

                                      —        

Net OCI

  $ 1     $ 11     $ 12     $ (11   $ 23  

Change in net unrealized gains (losses) on AFS securities

 

 

OCI activity

  $ 185     $ (68   $ 117     $     $ 117  

Reclassified to earnings

    (14     5       (9           (9

Net OCI

  $ 171     $ (63   $ 108     $     $       108  

Pension, postretirement and other

 

   

OCI activity

  $ 3     $     $ 3     $     $ 3  

Reclassified to earnings

    1             1             1  

Net OCI

  $ 4     $     $ 4     $     $ 4  

Change in net DVA

         

OCI activity

  $ (285   $ 99     $ (186   $ (10   $ (176

Reclassified to earnings

    4       (1     3             3  

Net OCI

  $ (281   $ 98     $ (183   $ (10   $ (173

 

   

Six Months Ended

 

June 30, 20181

 
$ in millions   Pre-tax
Gain (Loss)
    Income
Tax Benefit
(Provision)
    After-tax
Gain (Loss)
    Non-controlling
Interests
    Net  

Foreign currency translation adjustments

 

   

OCI activity

  $ (8   $ (67   $ (75   $ 14     $ (89

Reclassified to earnings

                             

Net OCI

  $ (8   $ (67   $ (75   $ 14     $ (89

Change in net unrealized gains (losses) on AFS securities

 

 

OCI activity

  $ (697   $ 164     $ (533   $     $ (533

Reclassified to earnings

    (3           (3           (3

Net OCI

  $ (700   $         164     $ (536   $     $ (536

Pension, postretirement and other

 

   

OCI activity

  $ 2     $     $ 2     $     $ 2  

Reclassified to earnings

    12       (3     9             9  

Net OCI

  $ 14     $ (3   $ 11     $     $ 11  

Change in net DVA

         

OCI activity

  $       1,421     $ (345   $ 1,076     $ 49     $ 1,027  

Reclassified to earnings

    18       (4     14             14  

Net OCI

  $ 1,439     $ (349   $     1,090     $                 49     $     1,041  
 

 

June 2018 Form 10-Q    82   


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Notes to Consolidated Financial Statements (Unaudited)    LOGO

 

   

Six Months Ended

 

June 30, 2017

 
$ in millions   Pre-tax
Gain (Loss)
    Income
Tax Benefit
(Provision)
    After-tax
Gain (Loss)
    Non-controlling
Interests
    Net  

Foreign currency translation adjustments

 

   

OCI activity

  $             44     $         118     $           162     $                 32     $ 130  

Reclassified to earnings

                             

Net OCI

  $ 44     $ 118     $ 162     $ 32     $ 130  

Change in net unrealized gains (losses) on AFS securities

 

 

OCI activity

  $ 322     $ (120   $ 202     $     $     202  

Reclassified to earnings

    (16     6       (10           (10

Net OCI

  $ 306     $ (114   $ 192     $     $ 192  

Pension, postretirement and other

 

 

OCI activity

  $ 3     $     $ 3     $     $ 3  

Reclassified to earnings

    1             1             1  

Net OCI

  $ 4     $     $ 4     $     $ 4  

Change in net DVA

         

OCI activity

  $ (278   $ 98     $ (180   $ (3   $ (177

Reclassified to earnings

    8       (2     6             6  

Net OCI

  $ (270   $ 96     $ (174   $ (3   $ (171

 

1.

Exclusive of 2018 cumulative adjustments related to the adoption of certain accounting updates in the current year period. Refer to the table below and Note 2 for further information.

Cumulative Adjustments to Retained Earnings Related to Adoption of Accounting Updates

 

$ in millions   

Six Months Ended

 

June 30, 2018

 

Revenue from contracts with customers

       $ (32

Derivatives and hedging–targeted improvements to accounting for hedging activities

     (99

Reclassification of certain tax effects from AOCI

     443  

Other1

     (6

Total

       $ 306  
$ in millions   

Six Months Ended

 

June 30, 2017

 

Improvements to employee share-based payment accounting2

     (30

Intra-entity transfers of assets other than inventory

     (5

Total

       $ (35

 

1.

Other includes the adoption of accounting updates related to Recognition and Measurement of Financial Assets and Financial Liabilities (other than the provision around presenting unrealized DVA in OCI which we early adopted in 2016) and Derecognition of Nonfinancial Assets. The impact of these adoptions on Retained earnings was not significant.

2.

See Note 2 to the 2017 Form 10-K for further information.

15. Earnings per Common Share

Calculation of Basic and Diluted EPS

 

   

Three Months Ended

 

June 30,

   

Six Months Ended

 

June 30,

 
in millions, except for per share data   2018     2017     2018     2017  

Basic EPS

       

Income from continuing operations

  $ 2,469     $ 1,796     $ 5,175     $ 3,789  

Income (loss) from discontinued operations

    (2     (5     (4     (27

Net income

    2,467       1,791       5,171       3,762  

Net income applicable to noncontrolling interests

    30       34       66       75  

Net income applicable to Morgan Stanley

    2,437       1,757       5,105       3,687  

Preferred stock dividends and other

    170       170       263       260  

Earnings applicable to Morgan Stanley common shareholders

  $ 2,267     $ 1,587     $ 4,842     $ 3,427  

Weighted average common shares outstanding

    1,720       1,791       1,730       1,796  

Earnings per basic common share

 

     

Income from continuing operations

  $ 1.32     $ 0.89     $ 2.80     $ 1.92  

Income (loss) from discontinued operations

                      (0.01

Earnings per basic common share

  $ 1.32     $ 0.89     $ 2.80     $ 1.91  

Diluted EPS

       

Earnings applicable to Morgan Stanley common shareholders

  $ 2,267     $ 1,587     $ 4,842     $ 3,427  

Weighted average common shares outstanding

        1,720           1,791           1,730           1,796  

Effect of dilutive securities: Stock options and RSUs1

    28       39       30       40  

Weighted average common shares outstanding and common stock equivalents

    1,748       1,830       1,760       1,836  

Earnings per diluted common share

 

     

Income from continuing operations

  $ 1.30     $ 0.87     $ 2.75     $ 1.88  

Income (loss) from discontinued operations

                      (0.01

Earnings per diluted common share

  $ 1.30     $ 0.87     $ 2.75     $ 1.87  

Weighted average antidilutive RSUs and stock options (excluded from the computation of diluted EPS)1

    1             1        

 

1.

RSUs that are considered participating securities are treated as a separate class of securities in the computation of basic EPS, and, therefore, such RSUs are not included as incremental shares in the diluted EPS computation.

 

 

   83    June 2018 Form 10-Q


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16. Interest Income and Interest Expense

Interest income and Interest expense are classified in the income statements based on the nature of the instrument and related market conventions. When included as a component of the instrument’s fair value, interest is included within Trading revenues or Investments revenues. Otherwise, it is included within Interest income or Interest expense.

 

   

Three Months Ended

 

June 30,

   

Six Months Ended

 

June 30,

 
$ in millions   2018     2017     2018     2017  

Interest income

       

Investment securities

  $ 417     $ 304     $ 841     $ 630  

Loans

    1,074       798       2,012       1,546  

Securities purchased under agreements to resell and Securities borrowed1

    366       29       581       10  

Trading assets, net of Trading liabilities

    576       491       1,116       955  

Customer receivables and Other2

    861       484       1,604       930  

Total interest income

  $ 3,294     $ 2,106     $ 6,154     $ 4,071  

Interest expense

       

Deposits

  $ 273     $ 14     $ 432     $ 25  

Borrowings

    1,258       1,067       2,396       2,088  

Securities sold under agreements to repurchase and Securities loaned3

    446       339       848       587  

Customer payables and Other4

    411       (65     597       (151

Total interest expense

  $       2,388     $       1,355     $       4,273     $       2,549  

Net interest

  $ 906     $ 751     $ 1,881     $ 1,522  

 

1.

Includes fees paid on Securities borrowed.

2.

Includes interest from Customer receivables and Cash and cash equivalents.

3.

Includes fees received on Securities loaned.

4.

Includes fees received from prime brokerage customers for stock loan transactions incurred to cover customers’ short positions.

17. Employee Benefit Plans

The Firm sponsors various retirement plans for the majority of its U.S. employees. The Firm provides certain other postretirement benefits, primarily health care and life insurance, to eligible U.S. employees.

Components of Net Periodic Benefit Expense (Income) for Pension and Other Postretirement Plans

 

   

Three Months
Ended

 

June 30,

   

Six Months
Ended

 

June 30,

 
$ in millions   2018     2017     2018     2017  

Service cost, benefits earned during the period

  $ 4     $ 4     $ 8     $ 8  

Interest cost on projected benefit obligation

    35       38       69       75  

Expected return on plan assets

    (28     (29     (56     (58

Net amortization of prior service credit

          (4           (8

Net amortization of actuarial loss

    6       4       12       8  

Net periodic benefit expense (income)

  $         17     $         13     $         33     $         25  

18. Income Taxes

The Firm is under continuous examination by the IRS and other tax authorities in certain countries, such as Japan and the U.K., and in states in which it has significant business operations, such as New York. The Firm has established a liability for unrecognized tax benefits, and associated interest, if applicable (“tax liabilities”), that it believes is adequate in relation to the potential for additional assessments. Once established, the Firm adjusts such tax liabilities only when new information is available or when an event occurs necessitating a change.

The Firm is currently at various levels of field examination with respect to audits by the IRS, as well as New York State and New York City, for tax years 2009-2016 and 2007-2014, respectively.

The Firm believes that the resolution of the above tax matters will not have a material effect on the annual financial statements, although a resolution could have a material impact in the income statements and effective tax rate for any period in which such resolution occurs.

Furthermore, by the end of the first quarter of 2018, the Firm reached a conclusion with the U.K. tax authorities on certain issues through tax year 2010, the resolution of which did not have a material impact on the financial statements or effective tax rate.

See Note 11 regarding the Dutch Tax Authority’s challenge, in the District Court in Amsterdam (matters styled Case number 15/3637 and Case number 15/4353), of the Firm’s entitlement to certain withholding tax credits which may impact the balance of unrecognized tax benefits.

 

 

June 2018 Form 10-Q    84   


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(Unaudited)

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It is reasonably possible that significant changes in the balance of unrecognized tax benefits occur within the next 12 months. At this time, however, it is not possible to reasonably estimate the expected change to the total amount of unrecognized tax benefits and the impact on the Firm’s effective tax rate over the next 12 months.

The Firm’s effective tax rate for the current quarter and current year period included recurring-type discrete tax benefits associated with employee share-based payments of $17 million and $164 million, respectively. Additionally, as a result of new information pertaining to the resolution of multi-jurisdiction tax examinations and other matters the Firm’s effective tax rate for the current quarter and current year period included intermittent net discrete tax benefits of $88 million with a corresponding reduction in the total amount of gross unrecognized tax benefits (excluding federal benefit of state items, competent authority and foreign tax credit offsets) of approximately $430 million.

19. Segment, Geographic and Revenue Information

Segment Information

For a discussion about the Firm’s business segments, see Note 21 to the financial statements in the 2017 Form 10-K.

Selected Financial Information by Business Segment

 

    Three Months Ended June 30, 2018  
$ in millions   IS     WM     IM     I/E     Total  

Investment banking1, 2

  $ 1,699     $ 114     $     $ (20   $ 1,793  

Trading

    3,128       135       16       14       3,293  

Investments

    89       3       55             147  

Commissions and fees1

    674       442             (77     1,039  

Asset management1

    102       2,514       610       (37     3,189  

Other

    168       74       3       (2     243  

Total non-interest revenues3, 4

    5,860       3,282       684       (122     9,704  

Interest income

    2,195       1,320       17       (238     3,294  

Interest expense

    2,341       277       10       (240     2,388  

Net interest

    (146     1,043       7       2       906  

Net revenues

  $   5,714     $   4,325     $   691     $   (120   $   10,610  

Income from continuing operations before income taxes

  $ 1,812     $ 1,157     $ 140     $     $ 3,109  

Provision for income taxes

    323       281       36             640  

Income from continuing operations

    1,489       876       104             2,469  

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

    (2                       (2

Net income

    1,487       876       104             2,467  

Net income applicable to noncontrolling interests

    30                         30  

Net income applicable to Morgan Stanley

  $ 1,457     $ 876     $ 104     $     $ 2,437  
    Three Months Ended June 30, 2017  
$ in millions   IS     WM     IM     I/E     Total  

Investment banking

  $ 1,413     $ 135     $     $ (18   $ 1,530  

Trading

    2,725       207       (3     2       2,931  

Investments

    37       1       125             163  

Commissions and fees

    630       424             (27     1,027  

Asset management

    89       2,302       539       (28     2,902  

Other

    126       73       4       (4     199  

Total non-interest revenues

    5,020       3,142       665       (75     8,752  

Interest income

    1,243       1,114       1       (252     2,106  

Interest expense

    1,501       105       1       (252     1,355  

Net interest

    (258     1,009                   751  

Net revenues

  $ 4,762     $ 4,151     $ 665     $ (75   $ 9,503  

Income from continuing operations before income taxes

  $ 1,443     $ 1,057     $ 142     $     $ 2,642  

Provision for income taxes

    413       392       41             846  

Income from continuing operations

    1,030       665       101             1,796  

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

    (5                       (5

Net income

    1,025       665       101             1,791  

Net income applicable to noncontrolling interests

    33             1             34  

Net income applicable to Morgan Stanley

  $ 992     $ 665     $ 100     $     $ 1,757  
    Six Months Ended June 30, 2018  
$ in millions   IS     WM     IM     I/E     Total  

Investment banking1, 2

  $ 3,212     $ 254     $     $ (39   $ 3,427  

Trading

    6,771       244       21       27       7,063  

Investments

    138       3       132             273  

Commissions and fees1

    1,418       940             (146     2,212  

Asset management1

    212       5,009       1,236       (76     6,381  

Other

    304       137       13       (4     450  

Total non-interest revenues3, 4

    12,055       6,587       1,402       (238     19,806  

Interest income

    3,999       2,600       18       (463     6,154  

Interest expense

    4,240       488       11       (466     4,273  

Net interest

    (241     2,112       7       3       1,881  

Net revenues

  $   11,814     $   8,699     $   1,409     $   (235   $   21,687  

Income from continuing operations before income taxes

  $ 3,924     $ 2,317     $ 288     $     $ 6,529  

Provision for income taxes

    772       527       55             1,354  

Income from continuing operations

    3,152       1,790       233             5,175  

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

    (4                       (4

Net income

    3,148       1,790       233             5,171  

Net income applicable to noncontrolling interests

    64             2             66  

Net income applicable to Morgan Stanley

  $ 3,084     $ 1,790     $ 231     $     $ 5,105  
 

 

   85    June 2018 Form 10-Q


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

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    Six Months Ended June 30, 2017  
$ in millions   IS     WM     IM     I/E     Total  

Investment banking

  $ 2,830     $ 280     $     $ (35   $ 3,075  

Trading

    5,737       445       (14     (2     6,166  

Investments

    103       2       223             328  

Commissions and fees

    1,250       864             (54     2,060  

Asset management

    180       4,486       1,056       (53     5,669  

Other

    299       129       8       (8     428  

Total non-interest revenues

    10,399       6,206       1,273       (152     17,726  

Interest income

    2,367       2,193       2       (491     4,071  

Interest expense

    2,852       190       1       (494     2,549  

Net interest

    (485     2,003       1       3       1,522  

Net revenues

  $ 9,914     $   8,209     $   1,274     $   (149)     $   19,248  

Income from continuing operations before income taxes

  $ 3,173     $ 2,030     $ 245     $ 2     $ 5,450  

Provision for income taxes

    872       718       71             1,661  

Income from continuing operations

    2,301       1,312       174       2       3,789  

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

    (27                       (27

Net income

    2,274       1,312       174       2       3,762  

Net income applicable to noncontrolling interests

    68             7             75  

Net income applicable to Morgan Stanley

  $ 2,206     $ 1,312     $ 167     $ 2     $ 3,687  

I/E–Intersegment Eliminations

1.

Approximately 85% of Investment banking revenues and substantially all of Commissions and fees and Asset management revenues in the current quarter and current year period were determined under the Revenues from Contracts with Customers accounting update.

2.

Current quarter Institutional Securities Investment banking revenues are composed of $618 million of Advisory and $1,081 million of Underwriting revenues. Current year period Institutional Securities Investment banking revenues are composed of $1,192 million of Advisory and $2,020 million of Underwriting revenues.

3.

The Firm enters into certain contracts which contain a current obligation to perform services in the future. Excluding contracts where billing is commensurate with the value of the services performed at each stage of the contract, contracts with variable consideration that is subject to reversal, and contracts with less than one year duration, we expect to record the following approximate annual revenues in the future: $100 million per year over the next three years; between $10 million and $50 million per year thereafter through 2035. These revenues are primarily related to certain commodities contracts with customers.

4.

Includes $862 million and $1,628 million in revenue recognized in the current quarter and current year period, respectively, where some or all services were performed in prior periods. This amount is primarily composed of investment banking advisory fees, and distribution fees.

Total Assets by Business Segment

 

$ in millions   

At

June 30,

2018

    

At

December 31,

2017

 

Institutional Securities

   $ 683,888      $ 664,974  

Wealth Management

     186,049        182,009  

Investment Management

     5,938        4,750  

Total1

   $                 875,875      $                 851,733  

 

1.

Parent assets have been fully allocated to the business segments.

Additional Information – Investment Management

Net Unrealized Performance-based Fees

 

$ in millions   

At

June 30,

2018

    

At

December 31,

2017

 

Net cumulative unrealized performance-based fees at risk of reversing

   $                     426      $                     442  

The Firm’s portion of net cumulative unrealized performance-based fees (for which the Firm is not obligated to pay compensation) are at risk of reversing if the fund performance falls below the stated investment management agreement benchmarks. See Note 11 for information regarding general partner guarantees, which include potential obligations to return performance fee distributions previously received.

Reduction of Fees due to Fee Waivers

 

    

Three Months Ended

June 30,

    

Six Months Ended

June 30,

 
$ in millions    2018      2017      2018      2017  

Fee waivers

   $ 16      $ 23      $ 34      $ 45  

The Firm waives a portion of its fees in the Investment Management business segment from certain registered money market funds that comply with the requirements of Rule 2a-7 of the Investment Company Act of 1940.

Geographic Information

For a discussion about the Firm’s geographic net revenues, see Note 21 to the financial statements in the 2017 Form 10-K.

 

 

June 2018 Form 10-Q    86   


Table of Contents

Notes to Consolidated Financial Statements

(Unaudited)

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Net Revenues by Region

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
$ in millions    2018      2017      2018      2017  

Americas

   $ 7,614      $ 6,746      $ 15,632      $ 13,834  

EMEA

     1,829        1,606        3,537        3,095  

Asia

     1,167        1,151        2,518        2,319  

Total

   $ 10,610      $ 9,503      $ 21,687      $ 19,248  

Additional Information—Revenues from Contracts with Customers

 

Change in Revenue as a Result of Application of the New  
Revenue Recognition Standard  
$ in millions   Three
Months Ended
June 30, 2018
    Six
Months Ended
June 30, 2018
 

Gross presentation impact

   

Investment banking—

   

Advisory

  $ 29     $ 44  

Underwriting

    57       102  

Asset management

    7       14  

Other

    15       27  

Subtotal

    108       187  

Timing impact

   

Investment banking—

   

Advisory

    15       15  

Asset management

    (18     (16

Other

    3       5  

Subtotal

          4  

Total change

  $ 108     $ 191  

As a result of adopting the accounting update Revenue from Contracts with Customers, the accounting for certain transactions has changed (see Note 2 for further details). As summarized in the previous table, the change is composed of transactions which are now presented on a gross basis within both Non-interest revenues and Non-interest expenses as well as transactions where revenues are recognized with different timing compared to the previous GAAP. For example, timing impacts shown as negative amounts in the previous table represent revenues for which recognition has been deferred to future periods under the new standard.

Receivables from Contracts with Customers

 

$ in millions    At        
June 30,        
2018         
     At        
January 1,        
2018         
 

Customer and other receivables

   $ 2,462      $ 2,805  

Receivables from contracts with customers, which are included within Customer and other receivables in the balance sheets, arise when the Firm has both recorded revenues and has the right per the contract to bill customers.

20. Subsequent Events

The Firm has evaluated subsequent events for adjustment to or disclosure in the financial statements through the date of this report and has not identified any recordable or disclosable events not otherwise reported in these financial statements or the notes thereto.

 

 

   87    June 2018 Form 10-Q


Table of Contents

Financial Data Supplement (Unaudited)

Average Balances and Interest Rates and Net Interest Income

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    Three Months Ended June 30,  
    2018     2017  
$ in millions  

Average

Daily
Balance

    Interest    

Annualized

Average
Rate

   

Average

Daily
Balance

    Interest     Annualized
Average
Rate
 

Interest earning assets1

           

Investment securities2

  $ 79,502     $ 417       2.1   $ 74,855     $ 304       1.6

Loans2

    111,939       1,074       3.8       96,230       798       3.3  

Securities purchased under agreements to resell and Securities borrowed3:

           

U.S.

    137,413       463       1.4       129,845       140       0.4  

Non-U.S.

    90,114       (97     (0.4     90,200       (111     (0.5

Trading assets, net of Trading liabilities4:

           

U.S.

    56,327       525       3.7       60,963       476       3.1  

Non-U.S.

    7,926       51       2.6       3,409       15       1.8  

Customer receivables and Other5:

           

U.S.

    66,954       623       3.7       65,736       344       2.1  

Non-U.S.

    33,722       238       2.8       28,012       140       2.0  

Total

  $ 583,897     $ 3,294       2.3   $ 549,250     $ 2,106       1.5

Interest bearing liabilities

 

         

Deposits2

  $ 165,251     $ 273       0.7   $ 146,982     $ 14      

Borrowings2, 6

    192,122       1,258       2.6       180,918       1,067       2.4  

Securities sold under agreements to repurchase and Securities loaned7:

           

U.S.

    24,868       321       5.2       35,066       245       2.8  

Non-U.S.

    39,536       125       1.3       36,974       94       1.0  

Customer payables and Other8:

           

U.S.

    121,968       208       0.7       130,814       (98     (0.3

Non-U.S.

    72,915       203       1.1       64,135       33       0.2  

Total

  $     616,660     $         2,388       1.6   $     594,889     $         1,355       0.9

Net interest income and net interest rate spread

          $ 906       0.7           $ 751       0.6

 

June 2018 Form 10-Q    88   


Table of Contents

Financial Data Supplement (Unaudited)

Average Balances and Interest Rates and Net Interest Income

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    Six Months Ended June 30,  
    2018     2017  
$ in millions   Average
Daily
Balance
    Interest     Annualized
Average
Rate
   

Average
Daily

Balance

    Interest     Annualized
Average
Rate
 

Interest earning assets1

           

Investment securities2

  $ 80,016     $ 841       2.1   $ 77,758     $ 630       1.6

Loans2

    108,193       2,012       3.8       95,799       1,546       3.3  

Securities purchased under agreements to resell and Securities borrowed3:

           

U.S.

    130,611       772       1.2       128,775       216       0.3  

Non-U.S.

    89,074       (191     (0.4     92,354       (206     (0.4 )  

Trading assets, net of Trading liabilities4:

           

U.S.

    55,089       1,012       3.7       58,390       922       3.2  

Non-U.S.

    6,051       104       3.5       2,630       33       2.5  

Customer receivables and Other5:

           

U.S.

    69,003       1,165       3.4       66,143       681       2.1  

Non-U.S.

    34,126       439       2.6       27,622       249       1.8  

Total

  $ 572,163     $ 6,154       2.2   $ 549,471     $ 4,071       1.5

Interest bearing liabilities

           

Deposits2

  $ 162,607     $ 432       0.5   $ 150,309     $ 25      

Borrowings2, 6

    193,323       2,396       2.5       175,937       2,088       2.4  

Securities sold under agreements to repurchase and Securities loaned7:

           

U.S.

    24,948       607       4.9       35,199       417       2.4  

Non-U.S.

    40,091       241       1.2       37,654       170       0.9  

Customer payables and Other8:

           

U.S.

    121,798       257       0.4       130,836       (183     (0.3 )  

Non-U.S.

    71,210       340       1.0       60,160       32       0.1  

Total

  $     613,977     $         4,273       1.4   $     590,095     $         2,549       0.9

Net interest income and net interest rate spread

          $ 1,881       0.8           $ 1,522       0.6

 

1.

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

2.

Amounts include primarily U.S. balances.

3.

Includes fees paid on Securities borrowed.

4.

Trading assets, net of Trading liabilities exclude non-interest earning assets and non-interest bearing liabilities, such as equity securities.

5.

Includes interest from Customer receivables and Cash and cash equivalents.

6.

The Firm also issues structured notes that have coupon or repayment terms linked to the performance of debt or equity securities, indices, currencies or commodities, which are recorded within Trading revenues (see Notes 3 and 11 to the financial statements in the 2017 Form 10-K).

7.

Includes fees received on Securities loaned. The annualized average rate was calculated using (a) interest expense incurred on all securities sold under agreements to repurchase and securities loaned transactions, whether or not such transactions were reported in the balance sheets and (b) net average on-balance sheet balances, which exclude certain securities-for-securities transactions.

8.

Includes fees received from prime brokerage customers for stock loan transactions incurred to cover customers’ short positions.

 

   89    June 2018 Form 10-Q


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Financial Data Supplement (Unaudited)

Effect of Volume and Rate Changes on Net Interest Income

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Current Quarter

versus

Prior Year Quarter

   

Current Year Period

versus

Prior Year Period

 
   

Increase (Decrease)

Due to Change in:

         

Increase (Decrease)

Due to Change in:

       
$ in millions   Volume     Rate     Net Change     Volume     Rate     Net Change  

Interest earning assets

           

Investment securities

  $ 19     $ 94     $ 113     $ 18     $ 193     $ 211  

Loans

    130       146       276       201       265       466  

Securities purchased under agreements to resell and Securities borrowed:

           

U.S.

    8       315       323       8       548       556  

Non-U.S.

          14       14       10       5       15  

Trading assets, net of Trading liabilities:

           

U.S.

    (36     85       49       (44     134       90  

Non-U.S.

    20       16       36       30       41       71  

Customer receivables and Other:

           

U.S.

    6       273       279       18       466       484  

Non-U.S.

    29       69       98       70       120       190  

Change in interest income

  $ 176     $ 1,012     $ 1,188     $ 311     $ 1,772     $ 2,083  

Interest bearing liabilities

           

Deposits

  $ 2     $ 257     $ 259     $ 2     $ 405     $ 407  

Borrowings

    66       125       191       207       101       308  

Securities sold under agreements to repurchase and Securities loaned:

           

U.S.

    (71     147       76       (116     306       190  

Non-U.S.

    7       24       31       9       62       71  

Customer payables and Other:

           

U.S.

    7       299       306       7       433       440  

Non-U.S.

    5       165       170       5       303       308  

Change in interest expense

  $ 16     $ 1,017     $ 1,033     $ 114     $ 1,610     $ 1,724  

Change in net interest income

  $ 160     $ (5   $ 155     $ 197     $ 162     $ 359  

 

June 2018 Form 10-Q    90   


Table of Contents
Glossary of Common Acronyms    LOGO

 

2017 Form 10-K—Annual Report on Form 10-K for year ended December 31, 2017 filed with the SEC

ABS—Asset-backed securities

AFS—Available-for-sale

AML—Anti-money laundering

AOCI—Accumulated other comprehensive income (loss)

AUM—Assets under management or supervision

BHC—Bank holding company

bps—Basis points; one basis point equals 1/100th of 1%

CCAR—Comprehensive Capital Analysis and Review

CCyB—Countercyclical capital buffer

CDO—Collateralized debt obligations, including collateralized loan obligations

CDS—Credit default swaps

CECL—Current expected credit loss

CFTC—U.S. Commodity Futures Trading Commission

CLN—Credit-linked notes

CLO—Collateralized loan obligations

CMBS—Commercial mortgage-backed securities

CMO—Collateralized mortgage obligations

CVA—Credit valuation adjustment

DVA—Debt valuation adjustment

EBITDA—Earnings before interest, taxes, depreciation and amortization

ELN—Equity-linked notes

EMEA—Europe, Middle East and Africa

EPS—Earnings per common share

ERISA—Employee Retirement Income Security Act of 1974

E.U.—European Union

FDIC—Federal Deposit Insurance Corporation

FFELP—Family Education Loan Program

FVA—Funding valuation adjustment

GLR—Global liquidity reserve

G-SIB—Global systemically important banks

HQLA—High-quality liquid assets

HTM—Held-to-maturity

I/E—Intersegment eliminations

IM—Investment Management

IRS—Internal Revenue Service

IS—Institutional Securities

LCR—Liquidity coverage ratio, as adopted by the U.S. banking agencies

LIBOR—London Interbank Offered Rate

M&A—Merger, acquisition and restructuring transaction

MSBNA—Morgan Stanley Bank, N.A.

MS&Co.—Morgan Stanley & Co. LLC

MSIP—Morgan Stanley & Co. International plc

MSMS—Morgan Stanley MUFG Securities Co., Ltd.

MSPBNA—Morgan Stanley Private Bank, National Association

MSSB LLC—Morgan Stanley Smith Barney LLC

MUFG—Mitsubishi UFJ Financial Group, Inc.

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

MWh—Megawatt hour

N/A—Not Applicable

 

 

   91    June 2018 Form 10-Q


Table of Contents
Glossary of Common Acronyms    LOGO

 

NAV—Net asset value

N/M—Not Meaningful

Non-GAAP—Non-generally accepted accounting principles

NSFR—Net stable funding ratio, as proposed by the U.S. banking agencies

OCC—Office of the Comptroller of the Currency

OCI—Other comprehensive income (loss)

OTC—Over-the-counter

PRA—Prudential Regulation Authority

RMBS—Residential mortgage-backed securities

ROE—Return on average common equity

ROTCE—Return on average tangible common equity

RSU—Restricted stock units

RWA—Risk-weighted assets

SEC—U.S. Securities and Exchange Commission

SLR—Supplementary leverage ratio

S&P—Standard & Poor’s

SPE—Special purpose entity

SPOE—Single point of entry

TDR—Troubled debt restructuring

TLAC—Total loss-absorbing capacity

U.K.—United Kingdom

UPB—Unpaid principal balance

U.S.—United States of America

U.S. DOL—U.S. Department of Labor

U.S. GAAP—Accounting principles generally accepted in the United States of America

VaR—Value-at-Risk

VAT—Value-added tax

VIE—Variable interest entities

WACC—Implied weighted average cost of capital

WM—Wealth Management

 

 

June 2018 Form 10-Q    92   


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Other Information

Legal Proceedings

 

The following new matters and developments have occurred since previously reporting certain matters in the Firm’s 2017 Form 10-K and the Firm’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2018 (the “First Quarter Form 10-Q”). See also the disclosures set forth under “Legal Proceedings” in the 2017 Form 10-K and Part II, Item 1 of the First Quarter Form 10-Q.

Residential Mortgage and Credit Crisis Related Matters

On June 27, 2018, the Firm in China Development Industrial Bank (“CDIB”) v. Morgan Stanley & Co. Incorporated et al. filed a motion for summary judgment and spoliation sanctions against CDIB.

On June 8, 2018, the parties in Wilmington Trust Company v. Morgan Stanley Mortgage Capital Holdings LLC et al. reached an agreement in principle to settle the litigation.

On June 26, 2018, the parties in Deutsche Zentral-Genossenschaftsbank AG et al. v. Morgan Stanley et al. entered into an agreement to settle the litigation.

European Matters

On May 17, 2018, the hearing for the parties’ final submissions was held in the case styled Banco Popolare Societá Cooperativa v. Morgan Stanley & Co. International plc & others.

On June 6, 2018, the Dutch Tax Authority filed an appeal against the decision issued by the District Court in Amsterdam in matters styled Case number 15/3637 and Case number 15/4353.

On June 8, 2018, the City Court of Copenhagen, Denmark ordered that the matters styled Case number BS 99-6998/2017 and Case number B-2073-16 be heard together before the High Court of Eastern Denmark. On June 29, 2018, the Firm filed its defense to the matter styled Case number B-2073-16.

On June 15, 2018, the Court of Accounts for the Republic of Italy in the matter styled Case number 2012/00406/MNV issued a decision declining jurisdiction and dismissing the claim against the Firm. On July 24, 2018, the Firm was served with an appeal by the public prosecutor.

Currency Related Matters

On June 13, 2018, the Firm entered into an agreement to settle a proceeding before Brazil’s Council for Economic Defense related to alleged anticompetitive activity in the foreign exchange market related to the Brazilian Real.

Other Litigation

On June 22, 2018, the parties in Genesee County Employees’ Retirement System v. Bank of America Corporation et al. entered into an agreement to settle the litigation. The court granted preliminary approval of the settlement on June 26, 2018.

 

 

   93    June 2018 Form 10-Q


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Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth the information with respect to purchases made by or on behalf of the Firm of its common stock during the current quarter ended June 30, 2018.

Issuer Purchases of Equity Securities

 

$ in millions, except per share data    Total Number of
Shares
Purchased
    

Average Price

Paid Per Share

     Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs1
    

Approximate Dollar
Value of

Shares that May
Yet be Purchased
Under the Plans or
Programs

 

Month #1 (April 1, 2018—April 30, 2018)

           

Share Repurchase Program2

     3,291,200      $ 53.42        3,291,200      $ 1,074  

Employee transactions3

     991,956      $ 53.04                

Month #2 (May 1, 2018—May 31, 2018)

           

Share Repurchase Program2

     8,301,300      $ 53.32        8,301,300      $ 632  

Employee transactions3

     33,887      $ 51.73                

Month #3 (June 1, 2018—June 30, 2018)

           

Share Repurchase Program2

     12,246,810      $ 51.57        12,246,810      $  

Employee transactions3

     17,641      $ 50.60                

Quarter ended at June 30, 2018

           

Share Repurchase Program2

     23,839,310      $ 52.43        23,839,310      $  

Employee transactions3

     1,043,484      $ 52.96                

 

1.

Share purchases under publicly announced programs are made pursuant to open-market purchases, Rule 10b5-1 plans or privately negotiated transactions (including with employee benefit plans) as market conditions warrant and at prices the Firm deems appropriate and may be suspended at any time. On April 18, 2018, the Firm entered into a sales plan with Mitsubishi UFJ Financial Group, Inc. (“MUFG”) and Morgan Stanley & Co. LLC (“MS&Co.”) whereby MUFG will sell shares of the Firm’s common stock to the Firm, through its agent MS&Co., as part of the Company’s share repurchase program (as defined below). The sales plan is only intended to maintain MUFG’s ownership percentage below 24.9% in order to comply with MUFG’s passivity commitments to the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and will have no impact on the strategic alliance between MUFG and the Firm, including the joint venture in Japan.

2.

The Firm’s Board of Directors has authorized the repurchase of the Firm’s outstanding stock under a share repurchase program (the “Share Repurchase Program”). The Share Repurchase Program is a program for capital management purposes that considers, among other things, business segment capital needs, as well as equity-based compensation and benefit plan requirements. The Share Repurchase Program has no set expiration or termination date. Share repurchases by the Firm are subject to regulatory approval. On June 28, 2018, the Federal Reserve published summary results of CCAR and the Firm received a conditional non-objection to its 2018 Capital Plan, where the only condition was that the Firm’s capital distributions not exceed the greater of the actual distributions it made over the previous four calendar quarters or the annualized average of actual distributions over the previous eight calendar quarters. As a result, the Firm’s 2018 Capital Plan includes a share repurchase of up to $4.7 billion of its outstanding common stock during the period beginning July 1, 2018 through June 30, 2019. During the quarter ended June 30, 2018, the Firm repurchased approximately $1.25 billion of the Firm’s outstanding common stock as part of its Share Repurchase Program. For further information, see “Liquidity and Capital Resources—Capital Management.”

3.

Includes shares acquired by the Firm in satisfaction of the tax withholding obligations on stock-based awards granted under the Firm’s stock-based compensation plans.

 

June 2018 Form 10-Q    94   


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Controls and Procedures

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

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

Exhibits

An exhibit index has been filed as part of this Report on page E-1.

 

 

   95    June 2018 Form 10-Q


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Exhibit Index

Morgan Stanley

Quarter Ended June 30, 2018

 

    Exhibit No.  

Description

 

12

 

 

Statement Re: Computation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Fixed Charges and Preferred Stock Dividends (unaudited).

15  

Letter of awareness from Deloitte & Touche LLP, dated August  3, 2018, concerning unaudited interim financial information.

31.1  

Rule 13a-14(a) Certification of Chief Executive Officer.

31.2  

Rule 13a-14(a) Certification of Chief Financial Officer.

32.1  

Section 1350 Certification of Chief Executive Officer.

32.2  

Section 1350 Certification of Chief Financial Officer.

101  

Interactive data files pursuant to Rule 405 of Regulation S-T (unaudited): (i) the Consolidated Income Statements—Three Months and Six Months Ended June 30, 2018 and 2017, (ii) the Consolidated Comprehensive Income Statements—Three Months and Six Months Ended June 30, 2018 and 2017, (iii) the Consolidated Balance Sheets—at June 30, 2018 and December 31, 2017, (iv) the Consolidated Statements of Changes in Total Equity—Six Months Ended June 30, 2018 and 2017, (v) the Consolidated Cash Flow Statements—Six Months Ended June 30, 2018 and 2017, and (vi) Notes to Consolidated Financial Statements.

 

   E-1   


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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

MORGAN STANLEY

(Registrant)

By:                    /s/ JONATHAN PRUZAN

Jonathan Pruzan

Executive Vice President and

Chief Financial Officer

By:                        /s/  PAUL C. WIRTH

Paul C. Wirth

Deputy Chief Financial Officer

Date: August 3, 2018

 

   S-1