ACCN 7230

PBS Paribas
FALL 2010
Copyright © 2010 Deen Kemsley
Lecture 13

Bank Accounting:
Morgan Stanley Case

Copyright © 2010 Deen Kemsley

Case Outline
This is a hands-on case that is meant to help you learn how
to navigate through a bank’s financial statements. The
case is structured as follows:

• Find Morgan Stanley’s 2009 financial statements online.

See http://www.morganstanley.com/about/ir/shareholder/10k2009/10k2009.pdf
• Note that the course pack includes some key items.
• Address the questions that follow. Note that a short
tutorial precedes some of the questions.
• Write up your answers in a Word file that you will submit.

Copyright © 2010 Deen Kemsley

Question Set 1:
General Issues
• What is the amount of total assets for 2009 and 2008?
• In percentage terms, how much did total assets change?
• What is the ratio of total equity to total assets for 2009
and 2008?
• Given your answers to the previous questions, explain how
Morgan Stanley changed its balance sheet during 2009.
Why do you believe it changed?
• On the income statement, how would you describe the
general trend in “Total non-interest revenues”?
• What item most accounts for the change in non-interest
revenues from 2008 to 2009?

Copyright © 2010 Deen Kemsley

Question Set 1: Solution
General Balance Sheet Issues
• Total assets
– 2009: $771,462 2008: $676,764
• Change in assets
– (771,462 – 676,764)/676,764 = 14% Increase
• Shareholders’ equity to total assets
– 2009: 52,780/771462=6.8% 2008: 49,456/676,764=7.3%
• Change in balance sheet
– After de-levering from 2007 to 2008, MS is levering up its balance
sheet a little again in 2009, possibly for acquisitions and to take
advantage of the strong market
• Trend in non-interest revenues
– Down from 2007 to 2008, but back up again in 2009
• Item that explains the change in non-interest revenues
– Principal Transactions did poorly in 2008.
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Cash and Security Deposits
The SEC and the Commodities Futures Trading Commission
require brokerage firms to maintain cash and/or security
reserves against customers’ net deposits. These
segregated reserves are subject to detailed withdrawal
restrictions.

In addition, the clearing organizations brokerage firms often

use to conduct trades generally require minimum deposit
requirements.

GAAP requires brokerage firms to disclose the amount of

these cash reserves.

Copyright © 2010 Deen Kemsley

Question Set 2:
Cash and Security Reserves
Consider Morgan Stanley’s Financial Statements at the end of
this lecture to answer the following:

• What total cash reserves did Morgan Stanley maintain as

of:
– 12/31/2009?
– 12/31/2008?

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Question Set 2: Solution
Total Cash and Security Reserves:

12/31/2009: $23,712

12/31/2008: $24,039

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Fair Value Accounting
A key accounting standard (from FAS 115, FAS 157, FAS 159,
etc.) is that brokerage firms use fair value accounting to
account for many of their securities (assets) and security
obligations (liabilities). Under fair value accounting:

• On the balance sheet, firms mark the value of trading

securities to market at the end of each accounting period.
• On the income statement, firms report any unrealized
gains or losses on trading securities as income or expense.

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 Question Set 3: Fair Value
Accounting
Consider Morgan Stanley’s financial statements and footnotes to address
these questions:
• From the balance sheet, at 12/31/2009, what is the total value of
“financial instruments owned” that Morgan Stanley accounts for at fair
value (i.e., the “Long Inventory” of securities)?

• From the balance sheet, at 12/31/2009, what is the total value of

“financial instruments sold, not yet purchased” that Morgan Stanley
accounts for at fair value (i.e., the “Short Inventory” of securities)?

• Per Footnote 4, what are the key differences between Level 1, Level 2,
and Level 4 assets that a company reports at fair value (very short
description of each will suffice)?

• Per Footnote 4, what percentage of Total Financial Instruments Owned

are Level 1, Level 2, and Level 3 assets? (Exclude netting column)

• Where does Morgan Stanley report unrealized gains and losses on its
fair value assets? Copyright © 2010 Deen Kemsley
 Question Set 3: Solution
• Financial instruments owned (Long Inventory):
– $299,778
• Financial instruments sold, not yet purchased (Short Inventory):
– $107,383
• Description of Levels
– Level 1: Observable market prices
– Level 2: Observable inputs to estimate market prices
– Level 3: Some inputs must be assumed
• Percentage in Each Level
– Level 1: 108,929/(108,929+217,902+43,191) = 29%
– Level 2: 217,902 /(108,929+217,902+43,191) = 59%
– Level 3: 43,191 /(108,929+217,902+43,191) = 12%
• Unrealized gains and losses on the securities it reports at fair value:
– Principal transactions Trading: $7,446
– Principal transactions Investments: $(1,054)

Copyright © 2010 Deen Kemsley

 Question Set 4: Credit Default
Swaps
Consider Morgan Stanley’s financial statements and footnote 9 to address
these questions:

• Given the description in Footnote 10 (and/or other sources), briefly describe

the purpose and mechanics of a credit default swap.

• Per the table in Footnote 10, what is the total maximum liability exposure
Morgan Stanley carries on the credit default swaps it has sold as of 12/2009
(Do not include other credit contracts and linked notes)? Of this amount,
how much is the fair value of the liability reported on the balance sheet?

• What percent of the maximum credit default swap liability exposure is rated
BBB or lower?

• What has Morgan Stanley done to reduce the risk associated with the credit
default swaps the company has sold?

• What is counterparty risk (you may visit www.dictionary.com) and how does
it relate to Morgan Stanley and credit default swaps?
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 Question Set 4: Solution
• Description of a credit default swap
– The seller of a credit default swaps insures potential default losses for
the buyer. The payment from the buyer essentially represents an
insurance premium.

• Maximum Liability Exposure

– 2,447,025 of which $43,621 is reported on the balance sheet.

• Percentage Rated BBB or Lower

– (450,647+426,562+356,055+493,666)/2,447,025 = 71%

• What reduces the risk?

– Morgan Stanley has purchased $2.5 trillion of credit protection, of which
$1.9 trillion is related to the same instruments on which Morgan Stanley
has sold credit protection.

• Counterparty Risk
– If a counterparty that insures Morgan Stanley’s exposure goes bankrupt,
Morgan Stanley could lose any un-netted protection)
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Pledged Securities

Brokerage firms often pledge some of their

securities as collateral to support
transactions. In some cases, the counter-
party has the right to sell or re-pledge the
securities. In other cases, the counter-party
does not have this right.

Copyright © 2010 Deen Kemsley

Question Set 5: Pledged
Securities
Consider Morgan Stanley’s financial statements and Footnote
4 to address these questions:

• How much pledged securities does Morgan Stanley have as

of 12/2009, where the counter-party has the right to sell
the securities?

• How much pledged securities does Morgan Stanley have as

of 12/2009, where the counter-party does not have the
right to sell the securities?

Copyright © 2010 Deen Kemsley

Question Set 5: Solution
Pledged securities where the counter-party has the right to
sell the securities (from balance sheet):

• $101 billion

Pledged securities where the counter-party does not have the

right to sell the securities (from footnote 5):

• $46.4 billion

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Securities Received as Collateral

In addition to the securities a brokerage firm

pledges to others, brokerage firms often
receive securities as collateral for
transactions.

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Question Set 6: Collateral
Securities
Consider Morgan Stanley’s balance sheet to answer the
following:

• As of 12/2009, how much collateral securities has Morgan

Stanley received and have on hand?

• If Morgan Stanley received a new security worth $5,000 as

collateral for a transaction, how do you think the firm
would record the transaction? Hint: Look at both the asset
and liability sections of the firm’s balance sheet to see how
the firm reports the securities.

Copyright © 2010 Deen Kemsley

 Question Set 6: Solution
Securities received as collateral:

• 13,656

Accounting for receipt of collateral security:

Sec. Received as Collateral +5,000 Obligation to Return +5,000

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Borrowed Securities
Brokerage firms often borrow and lend securities. Borrowing
allows firms to implement trading strategies or cover
shorts, etc., while avoiding the transaction costs of a
purchase, including the potential impact of a purchase on
price.

Lending securities is a low-risk way to enhance yield on the

securities.

When borrowing a security, the borrower gives cash (or some

other asset) to the lender as collateral. On a daily basis,
the value of borrowed securities are marked to market to
determine if the collateral is sufficient. Any required
adjustment of collateral is settled in cash (or other assets).
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Borrowed Securities Transaction

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Question Set 7: Borrowed
Securities
Consider Morgan Stanley’s balance sheet to answer the
following:

• As of 12/2009, how much borrowed securities does

Morgan Stanley have on hand?
• As of 12/2009, how much loaned securities does Morgan
Stanley have outstanding?
• What balances out the borrowed securities on the balance
sheet. In particular, Morgan Stanley debits borrowed
securities when they receive them. What account does
Morgan Stanley credit?

Copyright © 2010 Deen Kemsley

Question Set 7: Solution
• Borrowed Securities on Hand at 12/2009:

– $167,501

• Loaned Securities Outstanding at 12/2009:

– $26,246

• Account that offsets Borrowed Securities:

– Cash (i.e., the collateral given to the lender)

Copyright © 2010 Deen Kemsley

Repurchase Agreements
Brokerage firms often use REPOs for secured short-term (or
sometimes long-term) borrowing and lending. A typical
REPO, has a borrower (seller/cash receiver) sell securities
for cash to a lender (buyer/cash provider) and agrees to
repurchase those securities at a later date for more cash.
The REPO rate is the difference between borrowed and
paid back cash expressed as a percentage.

A reverse REPO is the same transaction from the lender’s

perspective.

Copyright © 2010 Deen Kemsley

Question Set 8: REPOs
Consider Morgan Stanley’s balance sheet to answer the
following:

As of 12/2009, what is the total amount of REPOs?

As of 12/2009, what is the total amount of reverse REPOs

(including related federal funds)?

What balances out the REPOs on the balance sheet?

Copyright © 2010 Deen Kemsley

Question Set 8: Solution
As of 12/2009, what is the total amount of REPOs?

• $159,401

As of 12/2009, what is the total amount of reverse REPOs?

• $143,208

What balances out the REPOs on the balance sheet?

• Cash

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Customer Receivables and
Payables
Customer receivables (customer debits) typically arise from
the purchase of securities on behalf of the customers.
Often, the receivable is secured by the underlying
securities.

Customer payables (customer credits) typically arise from the

sale of the securities on behalf of the customers.

Copyright © 2010 Deen Kemsley

Question Set 9: Customer
Receivables and Payables
Consider Morgan Stanley’s balance sheet to answer the
following:

• As of 12/2009, how much customer receivables (customer

debits) are there?

• As of 12/2009, how much customer payables (customer

credits) are there?

Copyright © 2010 Deen Kemsley

Question Set 9: Solution
Customer Receivables:

• $27,594

Customer Payables:

• $117,058

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Wrap up

What are your key takeaways from

this lecture?

Copyright © 2010 Deen Kemsley

Morgan Stanley

Financial
Statements
Sample Pages
For complete statements, see
http://www.morganstanley.com/about/ir/shareholder/10k2009/10
k2009.pdf

Copyright © 2010 Deen Kemsley

Morgan Stanley Assets

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Morgan Stanley Liabilities and
OE

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Morgan Stanley Income

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Morgan Stanley Cash Flow

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Morgan Stanley Footnote 2:
Excerpt on Fair Values

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Morgan Stanley Footnote 2
Continued

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Morgan Stanley Footnote 4
Excerpt

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Morgan Stanley Footnote 4
Continued (Excerpt Only)

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Morgan Stanley Footnote 5
Excerpt on Pledged Securities

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Morgan Stanley Footnote 10
Excerpt on Credit Default Swaps

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Morgan Stanley Footnote 10
Excerpt on Credit Default Swaps

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Morgan Stanley Footnote 10
Excerpt on Credit Default Swaps

Copyright © 2010 Deen Kemsley