Morgan Stanley Reports Second Quarter 2012:

Morgan Stanley (NYSE: MS) today reported net revenues of $7.0 billion for the second quarter ended June 30, 2012 compared with $9.2 billion a year ago. For the current quarter, income from continuing operations applicable to Morgan Stanley was $563 million, or $0.28 per diluted share, ⁴ compared with income of $1.2 billion, or a loss of $0.36 per diluted share, ⁴ for the same period a year ago. The earnings per share calculation for the prior year second quarter included a negative adjustment of approximately $1.7 billion, or $1.02 per diluted share, related to the conversion of the Firm’s Series B Preferred Stock held by Mitsubishi UFJ Financial Group, Inc. (MUFG) into common stock.

Results for the quarter included positive revenue of $350 million compared with $244 million a year ago related to changes in Morgan Stanley’s debt-related credit spreads and other credit factors (Debt Valuation Adjustment, DVA). ¹

Excluding DVA, net revenues for the current quarter were $6.6 billion compared with $9.0 billion a year ago and income from continuing operations applicable to Morgan Stanley was $338 million, or $0.16 per diluted share, compared with income of $1.1 billion, or a loss of $0.46 a year ago. ^{2, 4, 5}

Compensation expense of $3.6 billion declined from $4.6 billion a year ago. Non-compensation expenses of $2.4 billion decreased from $2.6 billion a year ago.

For the current quarter, net income applicable to Morgan Stanley, including discontinued operations, was $0.29 per diluted share, compared with a net loss of $0.38 per diluted share in the second quarter of 2011. ⁶

Summary of Firm Results (dollars in millions)
		As Reported							Excluding DVA (2), (3)
		Net			MS Earnings				Net			MS Earnings
		Revenues			Cont. Ops (1)				Revenues			Cont. Ops (1)
2Q 2012		$	6,953		$	536			$	6,603		$	312
1Q 2012		$	6,935			($103	)		$	8,913		$	1,344
2Q 2011		$	9,207			($530	)		$	8,963			($679	)

⁽¹⁾ Represents income (loss) from continuing operations applicable to Morgan Stanley common shareholders less preferred dividends.

⁽²⁾ Net revenues for 2Q 2012, 1Q 2012 and 2Q 2011 exclude positive (negative) revenue from DVA of $350 million, ($1,978) million and $244 million, respectively.

⁽³⁾ Earnings / (loss) from continuing operations applicable to Morgan Stanley common shareholders for 2Q 2012, 1Q 2012 and 2Q 2011 excludes after tax DVA impact of $225 million, ($1,454) million and $149 million, respectively.

Business Overview

• Global Wealth Management Group net revenues were $3.3 billion despite the challenging markets. The pre-tax margin for the current quarter was 12% compared with 9% a year ago. Discontinued operations included a pre-tax gain of $108 million from the previously announced sale of Quilter & Co. Ltd. (Quilter) in the U.K. Global fee based asset flows were $4.1 billion. On June 1, 2012, the Firm advised Citigroup Inc. of its intention to exercise its right to purchase an additional 14% of Morgan Stanley Smith Barney (MSSB).
• Investment Banking revenues were $884 million. The Firm ranked #1 in global IPOs, #2 in global announced M&A and #3 in global Equity. ⁷
• Sales and trading net revenues were $2.3 billion, or $1.9 billion excluding DVA. ⁸ Fixed Income and Commodities and Equity sales and trading net revenues reflected the challenging global market environment with reduced levels of client activity.
• Asset Management reported net revenues of $456 million and assets under management or supervision of $311 billion and positive net flows of $13.1 billion.

James P. Gorman, Chairman and Chief Executive Officer, said, “Although global economic uncertainty remains a headwind, we are proactively positioning the Firm for success. Our businesses showed resilience in key areas during the quarter, and we made progress against strategic goals. Despite muted volumes, Investment Banking maintained its industry-leading rankings. In Global Wealth Management, we increased our pre-tax margin to 12 percent in an environment marked by investor caution, and we integrated substantially all of our technology systems, which should bring additional value to our clients. We continue to be focused on taking the necessary steps to deliver strong returns for our shareholders.”

Summary of Institutional Securities Results (dollars in millions)
		As Reported							Excluding DVA (1)
		Net			Pre-Tax				Net			Pre-Tax
		Revenues			Income				Revenues			Income
2Q 2012		$	3,234		$	508			$	2,884		$	158
1Q 2012		$	3,023			($312	)		$	5,001		$	1,666
2Q 2011		$	5,159		$	1,485			$	4,915		$	1,241

⁽¹⁾ Net revenues and pre-tax income for 2Q 2012, 1Q 2012 and 2Q 2011 exclude positive (negative) revenue from DVA of $350 million, ($1,978) million and $244 million, respectively.

INSTITUTIONAL SECURITIES

Institutional Securities reported pre-tax income from continuing operations of $508 million compared with pre-tax income of $1.5 billion in the second quarter of last year. Net revenues for the current quarter were $3.2 billion compared with $5.2 billion a year ago. DVA resulted in positive revenue of $350 million in the current quarter compared with $244 million a year ago. The following discussion for sales and trading excludes DVA.

• Advisory revenues were $263 million compared with $533 million a year ago on lower levels of market activity. Fixed income and equity underwriting revenues were $621 million compared with $940 million a year ago primarily reflecting lower market volume.
• Fixed income and commodities sales and trading net revenues were $770 million compared with $1.9 billion a year ago. The decrease in net revenues from last year’s second quarter reflected reduced levels of client activity across geographies and most products. ⁸
• Equity sales and trading net revenues were $1.1 billion compared with $1.8 billion in the prior year quarter primarily reflecting lower results in the derivatives and cash businesses. ⁸
• Other sales and trading net losses were $11 million compared with losses of $507 million in last year’s second quarter reflecting gains on hedges associated with corporate lending activity and the net positive impact of $76 million representing an out of period gain of $300 million on the incorrect application of hedge accounting on certain derivative contracts previously designated as net investment hedges of certain foreign, non-U.S. dollar denominated subsidiaries, partially offset by a loss of $224 million resulting from fair value changes within the quarter of the related derivative positions not qualifying for net investment hedge accounting. ⁹
• Compensation expense was $1.4 billion compared with $2.2 billion a year ago. The current quarter reflects an adjustment of approximately $160 million to reduce previously accrued discretionary above base compensation due to an updated 2012 financial outlook. The reported compensation to net revenue ratio was 44%; excluding DVA, this ratio was 49%. ¹⁰ Non-compensation expenses were $1.3 billion compared with $1.5 billion a year ago.
• Morgan Stanley’s average trading Value-at-Risk measured at the 95% confidence level was $91 million compared with $84 million in the first quarter of 2012 and $145 million in the second quarter of the prior year.

Summary of Global Wealth Management Group Results (dollars in millions)
		Net			Pre-Tax
		Revenues			Income
2Q 2012		$	3,305		$	393
1Q 2012		$	3,414		$	387
2Q 2011		$	3,440		$	317

GLOBAL WEALTH MANAGEMENT GROUP

Global Wealth Management Group reported pre-tax income from continuing operations of $393 million compared with $317 million in the second quarter of last year. Net revenues for the current quarter were $3.3 billion compared to $3.4 billion a year ago. The quarter’s pre-tax margin was 12%. ¹¹ Aggregate pre-tax income, which included pre-tax income from continuing operations and the pre-tax gain in discontinued operations related to the sale of Quilter, was $420 million after the noncontrolling interest allocation to Citigroup Inc. ^{12, 13}

• Asset management fee revenues of $1.9 billion increased from $1.8 billion a year ago primarily reflecting an increase in fee based assets.
• Transactional revenues ¹⁴ of $976 million declined from $1.2 billion a year ago primarily reflecting reduced commissions and fees from lower levels of client activity.
• Compensation expense for the current quarter was $2.0 billion with a compensation to net revenue ratio of 60%. Non-compensation expenses of $918 million decreased from $991 million a year ago.
• Total client assets were $1.7 trillion at quarter end. Client assets in fee-based accounts were $526 billion, or 31% of total client assets. Global fee based asset flows for the quarter were $4.1 billion.
• The 16,934 global representatives at quarter end achieved average annualized revenue per global representative of $775,000. Total client assets per global representative were $101 million.

Summary of Asset Management Results (dollars in millions)
		Net			Pre-Tax
		Revenues			Income
2Q 2012		$	456		$	43
1Q 2012		$	533		$	128
2Q 2011		$	636		$	168

ASSET MANAGEMENT

Asset Management reported pre-tax income from continuing operations of $43 million compared with $168 million in last year’s second quarter. ¹⁵ Income after the noncontrolling interest allocation and before taxes was $20 million.

• Net revenues of $456 million decreased from $636 million a year ago as results in the Traditional Asset Management business were primarily offset by losses on principal investments in the Merchant Banking business compared with gains in the prior year quarter and lower gains on principal investments in the Real Estate Investing business. ¹⁶
• Compensation expense for the current quarter was $214 million with a compensation to net revenue ratio of 47%. Non-compensation expenses of $199 million increased from $188 million a year ago.
• Assets under management or supervision at June 30, 2012 of $311 billion increased from $296 billion a year ago. The increase primarily reflected net customer inflows in Morgan Stanley’s liquidity and alternatives funds, partly offset by market depreciation. The business recorded strong net flows of $13.1 billion in the current quarter, including approximately $4.5 billion related to the conversion of MSSB client balances into liquidity funds.

CAPITAL

Morgan Stanley’s Tier 1 capital ratio under Basel I was approximately 17.1% and Tier 1 common ratio was approximately 13.5% at June 30, 2012. ¹⁷

At June 30, 2012, book value and tangible book value per common share were $31.02 and $27.70, ¹⁸ respectively, based on approximately 2.0 billion shares outstanding.

OTHER MATTERS

As a result of a rating agency downgrade of the Firm’s long-term credit rating in June, the amount of additional collateral requirements or other payments that could be called by counterparties, exchanges or clearing organizations under the terms of certain OTC trading agreements and certain other agreements was approximately $6.3 billion, of which $2.9 billion was called and posted at June 30, 2012.

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