01—Abstract
Summary
Summary of the 10-K filed February 13, 2007. Cited figures are marked; the original filing is the authoritative source.
Morgan Stanley's fiscal 2006 Form 10-K (year ended November 30, 2006) reports a record year: net income rose 51% to $7,472 milliona, net revenues rose 26% to a record $33,858 million, and diluted EPS was $7.07 versus $4.57 a year earlier.
Return on average common equity reached 23.5% (up from 17.3%). Growth was led by Institutional Securities, where net revenues rose 38% to $21,562 millionb on record fixed income and equity sales and trading and strong advisory and underwriting results. Non-interest expenses rose 18% to $22,858 million, with compensation up 27%, so margins expanded while the cost base grew.
The other segments were more mixed. Global Wealth Management Group net revenues grew 10% to $5,505 millionc, but pre-tax income fell 13% to $509 million, and its global representative count fell to 8,030. Asset Management pre-tax income fell 29% to $711 million on weaker private equity results and net outflows, and Discover delivered record pre-tax income of $1,587 million on lower charge-offs following the October 2005 bankruptcy reform.
Management guided that Discover margins would normalize in fiscal 2007. Investors should also weigh the company's disclosed risks and corporate actions. The Coleman litigation carries a $1,578 milliond judgment on appeal against a $360 million reserve, with the upper end of potential exposure exceeding $1.4 billion.
The company also announced a planned spin-off of Discover expected in the third quarter of fiscal 2007 and a new $6 billion share repurchase authorization. Total assets grew to $1.12 trillion, and leverage remains high at 30.4x on a leverage ratio basis (17.7x adjusted).
02—Key points
Key Highlights
- Record net revenues of $33,858 million (+26%) and net income of $7,472 million (+51%); diluted EPS of $7.07 versus $4.57 in fiscal 2005.
- Return on average common equity rose to 23.5% from 17.3%, with Institutional Securities at 31%.
- Institutional Securities drove growth, with net revenues up 38% to $21,562 million on record fixed income ($9,577 million) and equity ($6,320 million) sales and trading revenues.
- Discover reported record pre-tax income of $1,587 million (+72%), helped by a managed net charge-off rate that fell to 4.08% from 5.23%; management expects margins to normalize in fiscal 2007.
- Global Wealth Management pre-tax income fell 13% to $509 million and Asset Management pre-tax income fell 29% to $711 million, despite growing client assets ($686 billion) and AUM ($478 billion).
- Announced a spin-off of Discover to shareholders, expected in Q3 2007, and a new $6 billion share repurchase authorization over 12-18 months.
- Coleman litigation remains a material overhang: a $1,578 million judgment is under appeal, with a $360 million reserve and potential additional expense that could exceed $1.4 billion.
03—Questions
Frequently Asked Questions
What drove Morgan Stanley's record fiscal 2006 earnings?
Institutional Securities was the main driver. Its net revenues rose 38% to $21,562 million, with record fixed income and equity sales and trading revenues and higher investment banking revenues (up 24% to $4,318 million). Discover and the favorable credit environment also contributed, with Discover's pre-tax income up 72%. Compensation and benefits rose 27%, reflecting higher net revenues.
Why is the planned Discover spin-off important for investors?
The Board approved spinning off Discover, which will be distributed to Morgan Stanley shareholders on a tax-free basis, with completion expected in the third quarter of fiscal 2007 subject to regulatory approval. Management says the separation will let it focus on its Institutional Securities, Global Wealth Management and Asset Management segments. Discover was the company's largest source of consumer credit exposure, so the spin-off changes the company's risk and earnings mix.
What is the biggest legal risk disclosed in the filing?
The Coleman Litigation. A Florida jury and trial court awarded Coleman (Parent) Holdings $1,578 million, including punitive damages. Morgan Stanley has appealed and believes the awards will probably be overturned and the case remanded for a new trial. It has a $360 million reserve, but if the awards are upheld in whole or in part, the additional expense could be material, with the upper end of the range exceeding $1.4 billion.
Are there concerns about Morgan Stanley's balance sheet or leverage?
Total assets grew to $1,120,645 million from $898,523 million, mainly from financial instruments owned, securities borrowed and customer receivables. The leverage ratio (total assets to tangible shareholders' equity) was 30.4x, and the adjusted leverage ratio was 17.7x. Management views the adjusted ratio as more relevant for comparisons. Liquidity is supported by a liquidity reserve averaging about $44 billion during the year and a Credit Facility covenant surplus of $16.4 billion. Credit ratings were Aa3 (Moody's) and A+ (S&P), and Fitch had moved its outlook to Negative in December 2006.
How are shareholders being returned capital?
In fiscal 2006 the company repurchased about $3.4 billion of common stock (about 52 million shares at an average $65.43) and paid $1,167 million in dividends ($1.08 per share annually, or $0.27 per quarter). In December 2006 the Board authorized a new repurchase program of up to $6 billion, replacing the prior Equity Anti-dilution and Capital Management programs, to be used over 12-18 months subject to surplus capital, market conditions and regulatory considerations.
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