Edgar Filing: MORGAN STANLEY

Form 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

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

EXCHANGE ACT OF 1934

Commission File Number 1-11758

LOGO

(Exact Name of Registrant as specified in its charter)

Delaware

(State or other jurisdiction of

incorporation or organization)

1585 Broadway

New York, NY 10036

(Address of principal executive offices, including zip code)

36-3145972

(I.R.S. Employer Identification No.)

(212) 761-4000

(Registrant’s telephone number, including area code)

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

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


Large Accelerated Filer x		Accelerated Filer ¨
Non-Accelerated Filer ¨		Smaller reporting company ¨
(Do not check if a smaller reporting company)

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

As of July 31, 2014, there were 1,963,354,359 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.

LOGO

QUARTERLY REPORT ON FORM 10-Q

For the quarter ended June 30, 2014


Table of Contents		Page
Part I—Financial Information
Item 1.	Financial Statements (unaudited)		1
	Condensed Consolidated Statements of Financial Condition—June 30, 2014 and December 31, 2013		1
	Condensed Consolidated Statements of Income—Three and Six Months Ended June 30, 2014 and 2013		2
	Condensed Consolidated Statements of Comprehensive Income—Three and Six Months Ended June 30, 2014 and 2013		3
	Condensed Consolidated Statements of Cash Flows—Six Months Ended June 30, 2014 and 2013		4
	Condensed Consolidated Statements of Changes in Total Equity—Six Months Ended June 30, 2014 and 2013		5
	Notes to Condensed Consolidated Financial Statements (unaudited)		7
	Report of Independent Registered Public Accounting Firm		96
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		97
	Introduction		97
	Executive Summary		98
	Business Segments		105
	Accounting Developments		121
	Other Matters		122
	Critical Accounting Policies		126
	Liquidity and Capital Resources		130
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		150
Item 4.	Controls and Procedures		167
Financial Data Supplement (unaudited)			168

Part II—Other Information
Item 1.	Legal Proceedings		174
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		177
Item 6.	Exhibits		177


		i

AVAILABLE INFORMATION

Morgan Stanley files annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (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 that contains annual, quarterly and current reports, proxy and information statements and other information that issuers (including Morgan Stanley) file electronically with the SEC. Morgan Stanley’s electronic SEC filings are available to the public at the SEC’s internet site, www.sec.gov.

Morgan Stanley’s internet site is www.morganstanley.com. You can access Morgan Stanley’s Investor Relations webpage at www.morganstanley.com/about/ir. Morgan Stanley makes available free of charge, on or through its Investor Relations webpage, its 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 (the “Exchange Act”), as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. Morgan Stanley also makes available, through its Investor Relations webpage, via a link to the SEC’s internet site, statements of beneficial ownership of Morgan Stanley’s equity securities filed by its directors, officers, 10% or greater shareholders and others under Section 16 of the Exchange Act.

Morgan Stanley has a Corporate Governance webpage. You can access information about Morgan Stanley’s corporate governance at www.morganstanley.com/about/company/governance. Morgan Stanley posts the following on its Corporate Governance webpage:

•

Amended and Restated Certificate of Incorporation;

•

Amended and Restated Bylaws;

•

Charters for its Audit Committee; Operations and Technology Committee; Compensation, Management Development and Succession Committee; Nominating and Governance Committee; and Risk Committee;

•

Corporate Governance Policies;

•

Policy Regarding Communication with the Board of Directors;

•

Policy Regarding Director Candidates Recommended by Shareholders;

•

Policy Regarding Corporate Political Activities;

•

Policy Regarding Shareholder Rights Plan;

•

Code of Ethics and Business Conduct;

•

Code of Conduct; and

•

Integrity Hotline information.

Morgan Stanley’s Code of Ethics and Business Conduct applies to all directors, officers and employees, including its Chief Executive Officer, Chief Financial Officer and Deputy Chief Financial Officer. Morgan Stanley 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 its 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 Morgan Stanley’s internet site is not incorporated by reference into this report.


		ii

Part I—Financial Information.

Item 1.

Financial Statements.

MORGAN STANLEY

Condensed Consolidated Statements of Financial Condition

(dollars in millions, except share data)

(unaudited)


	June 30, 2014			December 31, 2013
Assets
Cash and due from banks ($48 and $544 at June 30, 2014 and December 31, 2013, respectively, related to consolidated variable interest entities, generally not available to the Company)	$	18,863		$	16,602
Interest bearing deposits with banks		22,022			43,281
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements ($129 and $117 at June 30, 2014 and December 31, 2013, respectively, related to consolidated variable interest entities, generally not available to the Company)		44,713			39,203
Trading assets, at fair value ($126,867 and $151,078 were pledged to various parties at June 30, 2014 and December 31, 2013, respectively) ($1,218 and $2,825 at June 30, 2014 and December 31, 2013, respectively, related to consolidated variable interest entities, generally not available to the Company)		259,561			280,744
Available for sale securities, at fair value		65,474			53,430
Securities received as collateral, at fair value		19,498			20,508
Federal funds sold and securities purchased under agreements to resell (includes $864 and $866 at fair value at June 30, 2014 and December 31, 2013, respectively)		108,956			118,130
Securities borrowed		147,466			129,707
Customer and other receivables		54,557			57,104
Loans:
Held for investment (net of allowances of $138 and $156 at June 30, 2014 and December 31, 2013, respectively)		48,630			36,545
Held for sale		6,630			6,329
Other investments ($511 and $561 at June 30, 2014 and December 31, 2013, respectively, related to consolidated variable interest entities, generally not available to the Company)		4,899			5,086
Premises, equipment and software costs (net of accumulated depreciation of $6,406 and $6,420 at June 30, 2014 and December 31, 2013, respectively) ($194 and $201 at June 30, 2014 and December 31, 2013, respectively, related to consolidated variable interest entities, generally not available to the Company)		5,911			6,019
Goodwill		6,600			6,595
Intangible assets (net of accumulated amortization of $1,849 and $1,703 at June 30, 2014 and December 31, 2013, respectively) (includes $6 and $8 at fair value at June 30, 2014 and December 31, 2013, respectively)		3,137			3,286
Other assets ($23 and $11 at June 30, 2014 and December 31, 2013, respectively, related to consolidated variable interest entities, generally not available to the Company)		9,651			10,133

Total assets	$	826,568		$	832,702

Liabilities
Deposits (includes $0 and $185 at fair value at June 30, 2014 and December 31, 2013, respectively).	$	117,695		$	112,379
Commercial paper and other short-term borrowings (includes $1,315 and $1,347 at fair value at June 30, 2014 and December 31, 2013, respectively)		1,783			2,142
Trading liabilities, at fair value ($1 and $33 at June 30, 2014 and December 31, 2013, respectively, related to consolidated variable interest entities, generally non-recourse to the Company)		109,877			104,521
Obligation to return securities received as collateral, at fair value		25,449			24,568
Securities sold under agreements to repurchase (includes $614 and $561 at fair value at June 30, 2014 and December 31, 2013, respectively)		111,420			145,676
Securities loaned		30,808			32,799
Other secured financings (includes $5,056 and $5,206 at fair value at June 30, 2014 and December 31, 2013, respectively) ($370 and $543 at June 30, 2014 and December 31, 2013, respectively, related to consolidated variable interest entities, generally non-recourse to the Company)		14,007			14,215
Customer and other payables		178,883			157,125
Other liabilities and accrued expenses ($70 and $76 at June 30, 2014 and December 31, 2013, respectively, related to consolidated variable interest entities, generally non-recourse to the Company)		14,962			16,672
Long-term borrowings (includes $35,219 and $35,637 at fair value at June 30, 2014 and December 31, 2013, respectively)		149,483			153,575

Total liabilities		754,367			763,672

Commitments and contingent liabilities (see Note 11)
Equity
Morgan Stanley shareholders’ equity:
Preferred stock (see Note 13)		5,020			3,220
Common stock, $0.01 par value:
Shares authorized: 3,500,000,000 at June 30, 2014 and December 31, 2013;
Shares issued: 2,038,893,979 at June 30, 2014 and December 31, 2013;
Shares outstanding: 1,964,503,356 and 1,944,868,751 at June 30,2014 and December 31, 2013, respectively		20			20
Additional paid-in capital		23,608			24,570
Retained earnings		45,145			42,172
Employee stock trusts		2,147			1,718
Accumulated other comprehensive loss		(733	)		(1,093	)
Common stock held in treasury, at cost, $0.01 par value:
Shares outstanding: 74,390,623 and 94,025,228 at June 30, 2014 and December 31, 2013, respectively		(2,305	)		(2,968	)
Common stock issued to employee stock trusts		(2,147	)		(1,718	)

Total Morgan Stanley shareholders’ equity		70,755			65,921
Nonredeemable noncontrolling interests		1,446			3,109

Total equity		72,201			69,030

Total liabilities and equity	$	826,568		$	832,702

See Notes to Condensed Consolidated Financial Statements


		1

MORGAN STANLEY

Condensed Consolidated Statements of Income

(dollars in millions, except share and per share data)

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014		2013
Revenues:
Investment banking	$	1,633		$	1,303		$	2,941	$	2,527
Trading		2,516			2,894			5,478		5,588
Investments		227			188			586		526
Commissions and fees		1,138			1,217			2,354		2,384
Asset management, distribution and administration fees		2,621			2,404			5,170		4,750
Other		206			305			451		522

Total non-interest revenues		8,341			8,311			16,980		16,297

Interest income		1,250			1,268			2,593		2,612
Interest expense		983			1,064			2,018		2,226

Net interest		267			204			575		386

Net revenues		8,608			8,515			17,555		16,683

Non-interest expenses:
Compensation and benefits		4,200			4,103			8,505		8,317
Occupancy and equipment		359			374			718		751
Brokerage, clearing and exchange fees		458			456			901		884
Information processing and communications		411			470			835		918
Marketing and business development		165			163			312		297
Professional services		532			458			984		898
Other		550			695			1,042		1,221

Total non-interest expenses		6,675			6,719			13,297		13,286

Income from continuing operations before income taxes		1,933			1,796			4,258		3,397
Provision for income taxes		15			574			795		925

Income from continuing operations		1,918			1,222			3,463		2,472

Discontinued operations:
Income (loss) from discontinued operations before income taxes		(2	)		(44	)		42		(74	)
Provision for (benefit from) income taxes		(1	)		(13	)		4		(24	)

Income (loss) from discontinued operations		(1	)		(31	)		38		(50	)

Net income	$	1,917		$	1,191		$	3,501	$	2,422
Net income applicable to redeemable noncontrolling interests		—			100			—		222
Net income applicable to nonredeemable noncontrolling interests		18			111			97		258

Net income applicable to Morgan Stanley	$	1,899		$	980		$	3,404	$	1,942
Preferred stock dividends and other		79			177			135		203

Earnings applicable to Morgan Stanley common shareholders	$	1,820		$	803		$	3,269	$	1,739

Amounts applicable to Morgan Stanley:
Income from continuing operations	$	1,900		$	1,011		$	3,366	$	1,992
Income (loss) from discontinued operations		(1	)		(31	)		38		(50	)

Net income applicable to Morgan Stanley	$	1,899		$	980		$	3,404	$	1,942

Earnings per basic common share:
Income from continuing operations	$	0.94		$	0.44		$	1.68	$	0.94
Income (loss) from discontinued operations		—			(0.02	)		0.02		(0.03	)

Earnings per basic common share	$	0.94		$	0.42		$	1.70	$	0.91

Earnings per diluted common share:
Income from continuing operations	$	0.92		$	0.43		$	1.64	$	0.92
Income (loss) from discontinued operations		—			(0.02	)		0.02		(0.03	)

Earnings per diluted common share	$	0.92		$	0.41		$	1.66	$	0.89

Dividends declared per common share	$	0.10		$	0.05		$	0.15	$	0.10
Average common shares outstanding:
Basic		1,928,250,328			1,907,737,175			1,926,260,244		1,904,470,952

Diluted		1,969,698,239			1,951,362,736			1,969,675,518		1,945,813,411

See Notes to Condensed Consolidated Financial Statements.


		2

MORGAN STANLEY

Condensed Consolidated Statements of Comprehensive Income

(dollars in millions)

(unaudited)


	Three Months Ended June 30,					Six Months Ended June 30,
	2014		2013			2014		2013
Net income	$	1,917	$	1,191		$	3,501	$	2,422
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments(1)	$	86	$	(201	)	$	152	$	(446	)
Amortization of cash flow hedges(2)		1		1			2		2
Change in net unrealized gains (losses) on available for sale securities(3)		162		(342	)		236		(369	)
Pension, postretirement and other related adjustments(4)		4		10			6		11

Total other comprehensive income (loss)	$	253	$	(532	)	$	396	$	(802	)

Comprehensive income	$	2,170	$	659		$	3,897	$	1,620
Net income applicable to redeemable noncontrolling interests		—		100			—		222
Net income applicable to nonredeemable noncontrolling interests		18		111			97		258
Other comprehensive income (loss) applicable to nonredeemable noncontrolling interests		18		(57	)		36		(149	)

Comprehensive income applicable to Morgan Stanley	$	2,134	$	505		$	3,764	$	1,289

(1)	Amounts are net of provision for (benefit from) income taxes of $(56) million and $135 million for the quarters ended June 30, 2014 and 2013, respectively, and $(112) million and $300 million for the six months ended June 30, 2014 and 2013, respectively.

(2)	Amounts are net of provision for income taxes of $1 million for the quarter ended June 30, 2013, and $1 million and $2 million for the six months ended June 30, 2014 and 2013, respectively.

(3)	Amounts are net of provision for (benefit from) income taxes of $112 million and $(234) million for the quarters ended June 30, 2014 and 2013, respectively, and $162 million and $(253) million for the six months ended June 30, 2014 and 2013, respectively.

(4)	Amounts are net of provision for income taxes of $1 million and $6 million for the quarters ended June 30, 2014 and 2013, respectively, and $2 million and $11 million for the six months ended June 30, 2014 and 2013, respectively.

See Notes to Condensed Consolidated Financial Statements.


		3

MORGAN STANLEY

Condensed Consolidated Statements of Cash Flows

(dollars in millions)

(unaudited)


	Six Months Ended June 30,
	2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	3,501		$	2,422
Adjustments to reconcile net income to net cash provided by operating activities:
Income from equity method investments		(76	)		(228	)
Compensation payable in common stock and options		629			559
Depreciation and amortization		612			716
Net gain on business dispositions		(88	)		(30	)
Net gain on sale of available for sale securities		(16	)		(38	)
Impairment charges		77			112
Provision for credit losses on lending activities		15			63
Other non-cash adjustments to net income		(43	)		13
Changes in assets and liabilities:
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements		(5,510	)		(4,393	)
Trading assets, net of Trading liabilities		26,695			12,075
Securities borrowed		(17,759	)		(7,413	)
Securities loaned		(1,991	)		(714	)
Customer and other receivables and other assets		2,904			(883	)
Customer and other payables and other liabilities		21,972			13,315
Federal funds sold and securities purchased under agreements to resell		9,174			(8,082	)
Securities sold under agreements to repurchase		(34,221	)		10,908

Net cash provided by operating activities		5,875			18,402

CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from (payments for):
Premises, equipment and software		(413	)		(583	)
Business dispositions, net of cash disposed		167			530
Loans		(11,798	)		(3,441	)
Purchases of available for sale securities		(19,329	)		(14,335	)
Sales of available for sale securities		5,499			8,377
Maturities and redemptions of available for sale securities		2,153			2,663
Other investing activities		(388	)		186

Net cash used for investing activities		(24,109	)		(6,603	)

CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from (payments for):
Commercial paper and other short-term borrowings		(359	)		228
Noncontrolling interests		(189	)		(540	)
Other secured financings		194			(1,761	)
Deposits		5,316			(1,752	)
Proceeds from:
Excess tax benefits associated with stock-based awards		85			13
Derivatives financing activities		360			459
Issuance of preferred stock, net of issuance costs		1,788			—
Issuance of long-term borrowings		14,825			21,698
Payments for:
Long-term borrowings		(21,342	)		(22,958	)
Derivatives financing activities		(170	)		(498	)
Repurchases of common stock and employee tax withholdings		(964	)		(314	)
Purchase of additional stake in Wealth Management JV		—			(4,725	)
Cash dividends		(387	)		(239	)

Net cash used for financing activities		(843	)		(10,389	)

Effect of exchange rate changes on cash and cash equivalents		127			(735	)

Effect of cash and cash equivalents related to variable interest entities		(48	)		(380	)

Net increase (decrease) in cash and cash equivalents		(18,998	)		295
Cash and cash equivalents, at beginning of period		59,883			46,904

Cash and cash equivalents, at end of period	$	40,885		$	47,199

Cash and cash equivalents include:
Cash and due from banks	$	18,863		$	16,295
Interest bearing deposits with banks		22,022			30,904

Cash and cash equivalents, at end of period	$	40,885		$	47,199

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash payments for interest were $1,162 million and $2,177 million for the six months ended June 30, 2014 and 2013, respectively.

Cash payments for income taxes were $374 million and $537 million for the six months ended June 30, 2014 and 2013, respectively.

See Notes to Condensed Consolidated Financial Statements.


		4

MORGAN STANLEY

Condensed Consolidated Statements of Changes in Total Equity

Six Months Ended June 30, 2014

(dollars in millions)

(unaudited)


	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- redeemable Non- controlling Interests			Total Equity
BALANCE AT DECEMBER 31, 2013	$	3,220	$	20	$	24,570		$	42,172		$	1,718	$	(1,093	)	$	(2,968	)	$	(1,718	)	$	3,109		$	69,030
Net income applicable to Morgan Stanley		—		—		—			3,404			—		—			—			—			—			3,404
Net income applicable to nonredeemable noncontrolling interests		—		—		—			—			—		—			—			—			97			97
Dividends		—		—		—			(431	)		—		—			—			—			—			(431	)
Shares issued under employee plans and related tax effects		—		—		(950	)		—			429		—			1,627			(429	)		—			677
Repurchases of common stock and employee tax withholdings		—		—		—			—			—		—			(964	)		—						(964	)
Net change in Accumulated other comprehensive income		—		—		—			—			—		360			—			—			36			396
Issuance of preferred stock		1,800		—		(12	)		—			—		—			—			—			—			1,788
Deconsolidation of certain legal entities associated with a real estate fund		—		—		—			—			—		—			—			—			(1,606	)		(1,606	)
Other net decreases		—		—		—			—			—		—			—			—			(190	)		(190	)

BALANCE AT JUNE 30, 2014	$	5,020	$	20	$	23,608		$	45,145		$	2,147	$	(733	)	$	(2,305	)	$	(2,147	)	$	1,446		$	72,201

See Notes to Condensed Consolidated Financial Statements.


		5

MORGAN STANLEY

Condensed Consolidated Statements of Changes in Total Equity—(Continued)

Six Months Ended June 30, 2013

(dollars in millions)

(unaudited)


	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- Redeemable Non- controlling Interests			Total Equity
BALANCE AT DECEMBER 31, 2012	$	1,508	$	20	$	23,426	$	39,912		$	2,932		$	(516	)	$	(2,241	)	$	(2,932	)	$	3,319		$	65,428
Net income applicable to Morgan Stanley		—		—		—		1,942			—			—			—			—			—			1,942
Net income applicable to nonredeemable noncontrolling interests		—		—		—		—			—			—			—			—			258			258
Dividends		—		—		—		(248	)		—			—			—			—			—			(248	)
Shares issued under employee plans and related tax effects		—		—		507		—			(1,111	)		—			(11	)		1,111			—			496
Repurchases of common stock and employee tax withholdings		—		—		—		—			—			—			(314	)		—			—			(314	)
Net change in Accumulated other comprehensive income		—		—		—		—			—			(653	)		—			—			(149	)		(802	)
Wealth Management JV redemption value adjustment		—		—		—		(151	)		—			—			—			—			—			(151	)
Other net decreases		—		—		—		—			—			—			—			—			(495	)		(495	)

BALANCE AT JUNE 30, 2013	$	1,508	$	20	$	23,933	$	41,455		$	1,821		$	(1,169	)	$	(2,566	)	$	(1,821	)	$	2,933		$	66,114

See Notes to Condensed Consolidated Financial Statements.


		6

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.	Introduction and Basis of Presentation.

The Company. Morgan Stanley, a financial holding company, is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Wealth Management and Investment Management. The Company, 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 “Company” mean Morgan Stanley (the “Parent”) together with its consolidated subsidiaries.

A summary of the activities of each of the Company’s business segments is as follows:

Institutional Securities provides financial advisory and capital raising services, including: advice on mergers and acquisitions, restructurings, real estate and project finance; corporate lending; sales, trading, financing and market-making activities in equity and fixed income securities and related products, including foreign exchange and commodities; and investment activities.

Wealth Management provides brokerage and investment advisory services to individual investors and small-to-medium sized businesses and institutions covering various investment alternatives; financial and wealth planning services; annuity and other insurance products; credit and other lending products; cash management services; retirement services; and engages in fixed income trading, which primarily facilitates clients’ trading or investments in such securities.

Investment Management provides a broad array of investment strategies that span the risk/return spectrum across geographies, asset classes and public and private markets to a diverse group of clients across the institutional and intermediary channels as well as high net worth clients.

Discontinued Operations. On March 27, 2014, the Company completed the sale of its Canadian terminal business, Canterm Canadian Terminals Inc. (“CanTerm”), for approximately $110 million, resulting in a gain of approximately $45 million. Given completion of the sale in the prior quarter, net revenues were $0 million and $5 million for the quarter ended June 30, 2014 and 2013, respectively, and $49 million and $10 million for the six months ended June 30, 2014 and 2013, respectively. Net pre-tax gain (loss) was $44 million for the six months ended June 30, 2014. Net pre-tax gain (loss) for the quarter ended June 30, 2014 and the quarter ended and six months ended June 30, 2013 were not material. The results of CanTerm are reported as discontinued operations within the Institutional Securities business segment for all periods presented.

Remaining pre-tax loss amounts for the quarter and six months ended June 30, 2014 were not material. Remaining pre-tax loss amounts were $(43) million and $(73) million for the quarter and six months ended June 30, 2013, respectively, that were included in discontinued operations primarily related to the prior sale of Saxon and a principal investment.

Prior-period amounts have been recast for discontinued operations, see Note 2.

Basis of Financial Information. The condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”), which require the Company 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 litigation and tax matters, allowance for credit losses and other matters that affect the condensed consolidated financial statements and related disclosures. The Company believes that the estimates utilized in the preparation of the condensed consolidated financial statements are prudent and reasonable. Actual results could differ materially from these estimates. Intercompany balances and transactions have been eliminated.


		7

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 (“Form 10-K”). The condensed consolidated 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 condensed consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and other entities in which the Company has a controlling financial interest, including certain variable interest entities (“VIE”) (see Note 7). For consolidated subsidiaries that are less than wholly owned, the third-party holdings of equity interests are referred to as noncontrolling interests. The portion of net income attributable to noncontrolling interests for such subsidiaries is presented as either Net income (loss) applicable to redeemable noncontrolling interests or Net income (loss) applicable to nonredeemable noncontrolling interests in the condensed consolidated statements of income. The portion of shareholders’ equity of such subsidiaries that is redeemable would be presented as Redeemable noncontrolling interests outside of the equity section in the condensed consolidated statements of financial condition. The portion of shareholders’ equity of such subsidiaries that is nonredeemable is presented as Nonredeemable noncontrolling interests, a component of total equity, in the condensed consolidated statements of financial condition.

For entities where (1) the total equity investment at risk is sufficient to enable the entity to finance its activities without additional subordinated financial support and (2) the equity holders bear the economic residual risks and returns of the entity and have the power to direct the activities of the entity that most significantly affect its economic performance, the Company consolidates those entities it controls either through a majority voting interest or otherwise. For VIEs (i.e., entities that do not meet these criteria), the Company consolidates those entities where the Company has the power to make the decisions that most significantly affect the economic performance of the VIE and has the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE, except for certain VIEs that are money market funds, are investment companies or are entities qualifying for accounting purposes as investment companies. Generally, the Company consolidates those entities when it absorbs a majority of the expected losses or a majority of the expected residual returns, or both, of the entities.

For investments in entities in which the Company does not have a controlling financial interest but has significant influence over operating and financial decisions, the Company generally applies the equity method of accounting with net gains and losses recorded within Other revenues. Where the Company has elected to measure certain eligible investments at fair value in accordance with the fair value option, net gains and losses are recorded within Investments revenues (see Note 4).

Equity and partnership interests held by entities qualifying for accounting purposes as investment companies are carried at fair value.

The Company’s significant regulated U.S. and international subsidiaries include Morgan Stanley & Co. LLC (“MS&Co.”), Morgan Stanley Smith Barney LLC (“MSSB LLC”), Morgan Stanley & Co. International plc (“MSIP”), Morgan Stanley MUFG Securities Co., Ltd. (“MSMS”), Morgan Stanley Bank, N.A. (“MSBNA”) and Morgan Stanley Private Bank, National Association (“MSPBNA”).

Income Statement Presentation. The Company, 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. In connection with the delivery of the various products and


		8

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

services to clients, the Company manages its revenues and related expenses in the aggregate. As such, when assessing the performance of its businesses, primarily in its Institutional Securities business segment, the Company considers its trading, investment banking, commissions and fees, and interest income, along with the associated interest expense, as one integrated activity.

2.	Significant Accounting Policies.

For a detailed discussion about the Company’s significant accounting policies, see Note 2 to the consolidated financial statements on Form 10-K.

During the quarter ended June 30, 2014, other than the following, no updates were made to the Company’s significant accounting policies.

Software Costs.

As a result of an analysis completed by the Company, effective April 1, 2014, the Company revised the estimated useful lives for software costs from generally 3 to 5 years to generally 3 to 10 years. The adoption of these revised estimated useful lives for software costs resulted in lower amortization expense of approximately $27 million in the second quarter of 2014.

Condensed Consolidated Statements of Cash Flows.

For purposes of the condensed consolidated statements of cash flows, cash and cash equivalents consist of Cash and due from banks and Interest bearing deposits with banks, which are highly liquid investments with original maturities of three months or less, held for investment purposes, and readily convertible to known amounts of cash.

On April 1, 2014, the Company deconsolidated approximately $1.6 billion in total assets that were related to certain legal entities associated with a real estate fund sponsored by the Company. The deconsolidation resulted in a non-cash reduction of assets of $1.3 billion. The Company had no significant non-cash activities in the six months ended June 30, 2013.

Goodwill.

The Company completed its annual goodwill impairment testing at July 1, 2013. The Company’s impairment testing did not indicate any goodwill impairment as each of the Company’s reporting units with goodwill had a fair value that was substantially in excess of its carrying value. Adverse market or economic events could result in impairment charges in future periods.

Accounting Developments.

Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date. In February 2013, the Financial Accounting Standards Board (the “FASB”) issued an accounting update that requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date, as the sum of the amount the reporting entity agreed to pay and any additional amount the reporting entity expects to pay on behalf of its co-obligors. This update also requires additional disclosures about those obligations. This guidance became effective for the Company retrospectively beginning on January 1, 2014. The adoption of this accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.


		9

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity. In March 2013, the FASB issued an accounting update requiring the parent entity to release any related cumulative translation adjustment into net income when the parent ceases to have a controlling financial interest in a subsidiary that is a foreign entity. When the parent ceases to have a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity, the related cumulative translation adjustment would be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. This guidance became effective for the Company prospectively beginning on January 1, 2014. The adoption of this accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.

Amendments to the Scope, Measurement, and Disclosure Requirements of an Investment Company. In June 2013, the FASB issued an accounting update that modifies the criteria used in defining an investment company under generally accepted accounting principles in the U.S. (“U.S. GAAP”) and sets forth certain measurement and disclosure requirements. This update requires an investment company to measure noncontrolling interests in another investment company at fair value and requires an entity to disclose the fact that it is an investment company, and provide information about changes, if any, in its status as an investment company. An entity will also need to include disclosures around financial support that has been provided or is contractually required to be provided to any of its investees. This guidance became effective for the Company prospectively beginning January 1, 2014. The adoption of this accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.

Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. In July 2013, the FASB issued an accounting update providing guidance on the financial statement presentation of an unrecognized tax benefit when a deferred tax asset from a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. This guidance requires an unrecognized tax benefit, or a portion of an unrecognized tax benefit, to be presented in the financial statements as a reduction to such deferred tax asset if a settlement in such manner is expected in the event the uncertain tax position is disallowed. This guidance became effective for the Company beginning January 1, 2014. This guidance was applied prospectively to unrecognized tax benefits that existed at the effective date. The adoption of this accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.

Accounting for Investments in Qualified Affordable Housing Projects. In January 2014, the FASB issued an accounting update providing guidance on accounting for investments in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. The Company adopted this guidance on April 1, 2014, as early adoption is permitted. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements. For further information on the adoption of this guidance, see Note 17.

Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. In April 2014, the FASB issued an accounting update that changes the requirements and disclosure for reporting discontinued operations. The new guidance defines a discontinued operation as a disposal of a component or group of components that is disposed of or is classified as held for sale and represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. Individually significant components that have been disposed of or are held for sale that do not meet the definition of a discontinued operation require new disclosures. The Company adopted this guidance on April 1, 2014, as early adoption is permitted. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.


		10

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

3.	Wealth Management JV.

In 2009, the Company and Citigroup Inc. (“Citi”) consummated the combination of each institution’s respective wealth management business. The combined businesses operated as the “Wealth Management JV”. Prior to September 2012, the Company owned 51% and Citi owned 49% of the Wealth Management JV. In September 2012, the Company purchased an additional 14% stake in the Wealth Management JV from Citi for $1.89 billion, increasing the Company’s interest from 51% to 65%. In June 2013, the Company purchased the remaining 35% stake in the Wealth Management JV for $4.725 billion, increasing the Company’s interest from 65% to 100%.

For the quarter and six months ended June 30, 2014, no results were attributed to Citi since the Company owned 100% of the Wealth Management JV. For the quarter and six months ended June 30, 2013, Citi’s 35% interest was reported on the balance sheet as redeemable noncontrolling interest and the results related to its 35% interest were reported in net income (loss) applicable to redeemable noncontrolling interests in the condensed consolidated statement of income.

Concurrent with the acquisition of the remaining 35% stake in the Wealth Management JV, the deposit sweep agreement between Citi and the Company was terminated. During the quarter and six months ended June 30, 2014, $5 billion and $10 billion, respectively, of deposits held by Citi relating to the Company’s customer accounts were transferred to the Company’s depository institutions. At June 30, 2014, approximately $18 billion of additional deposits are scheduled to be transferred to the Company’s depository institutions on an agreed-upon basis through June 2015.

4.	Fair Value Disclosures.

Fair Value Measurements.

For a description of the valuation techniques applied to the Company’s major categories of assets and liabilities measured at fair value on a recurring basis, see Note 4 to the consolidated financial statements on Form 10-K.

The following fair value hierarchy tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis at June 30, 2014 and December 31, 2013.


		11

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Assets and Liabilities Measured at Fair Value on a Recurring Basis at June 30, 2014.


	Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Counterparty and Cash Collateral Netting			Balance at June 30, 2014
	(dollars in millions)
Assets at Fair Value
Trading assets:
U.S. government and agency securities:
U.S. Treasury securities	$	24,740		$	—		$	—		$	—		$	24,740
U.S. agency securities		1,317			12,968			—			—			14,285

Total U.S. government and agency securities		26,057			12,968			—			—			39,025
Other sovereign government obligations		23,114			7,370			14			—			30,498
Corporate and other debt:
State and municipal securities		—			1,594			4			—			1,598
Residential mortgage-backed securities		—			2,210			55			—			2,265
Commercial mortgage-backed securities		—			1,316			47			—			1,363
Asset-backed securities		—			644			65			—			709
Corporate bonds		—			17,494			510			—			18,004
Collateralized debt and loan obligations		—			520			1,332			—			1,852
Loans and lending commitments		—			7,898			5,829			—			13,727
Other debt		—			2,485			22			—			2,507

Total corporate and other debt		—			34,161			7,864			—			42,025
Corporate equities(1)		104,842			1,128			243			—			106,213
Derivative and other contracts:
Interest rate contracts		855			448,625			2,729			—			452,209
Credit contracts		—			32,638			1,711			—			34,349
Foreign exchange contracts		8			41,493			241			—			41,742
Equity contracts		855			53,810			1,503			—			56,168
Commodity contracts		2,179			13,592			2,307			—			18,078
Other		—			227			—			—			227
Netting(2)		(3,324	)		(504,880	)		(4,564	)		(58,039	)		(570,807	)

Total derivative and other contracts		573			85,505			3,927			(58,039	)		31,966
Investments:
Private equity funds		—			—			2,555			—			2,555
Real estate funds		—			7			1,813			—			1,820
Hedge funds		—			373			371			—			744
Principal investments		80			40			883			—			1,003
Other		205			86			380			—			671

Total investments		285			506			6,002			—			6,793
Physical commodities		—			3,041			—			—			3,041

Total trading assets		154,871			144,679			18,050			(58,039	)		259,561
Available for sale securities		35,170			30,304			—			—			65,474
Securities received as collateral		19,456			42			—			—			19,498
Federal funds sold and securities purchased under agreements to resell		—			864			—			—			864
Intangible assets(3)		—			—			6			—			6

Total assets measured at fair value	$	209,497		$	175,889		$	18,056		$	(58,039	)	$	345,403


		12

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


	Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Counterparty and Cash Collateral Netting			Balance at June 30, 2014
	(dollars in millions)
Liabilities at Fair Value
Commercial paper and other short-term borrowings	$	—		$	1,315		$	—		$	—		$	1,315
Trading liabilities:
U.S. government and agency securities:
U.S. Treasury securities		11,522			—			—			—			11,522
U.S. agency securities		1,634			118			—			—			1,752

Total U.S. government and agency securities		13,156			118			—			—			13,274
Other sovereign government obligations		17,861			2,516			—			—			20,377
Corporate and other debt:
State and municipal securities		—			2			—			—			2
Asset-backed securities		—			1			—			—			1
Corporate bonds		—			5,187			14			—			5,201
Collateralized debt and loan obligations		—			2			—			—			2
Unfunded lending commitments		—			17			12			—			29
Other debt		—			184			42			—			226

Total corporate and other debt		—			5,393			68			—			5,461
Corporate equities(1)		34,364			971			6			—			35,341
Derivative and other contracts:
Interest rate contracts		820			426,855			2,838			—			430,513
Credit contracts		—			30,969			2,421			—			33,390
Foreign exchange contracts		3			42,456			132			—			42,591
Equity contracts		927			59,122			2,600			—			62,649
Commodity contracts		2,492			13,639			1,175			—			17,306
Other		—			57			3			—			60
Netting(2)		(3,324	)		(504,880	)		(4,564	)		(38,317	)		(551,085	)

Total derivative and other contracts		918			68,218			4,605			(38,317	)		35,424

Total trading liabilities		66,299			77,216			4,679			(38,317	)		109,877
Obligation to return securities received as collateral		25,396			53			—			—			25,449
Securities sold under agreements to repurchase		—			459			155			—			614
Other secured financings		—			4,921			135			—			5,056
Long-term borrowings		—			33,440			1,779			—			35,219

Total liabilities measured at fair value	$	91,695		$	117,404		$	6,748		$	(38,317	)	$	177,530

(1)	The Company holds or sells short for trading purposes equity securities issued by entities in diverse industries and of varying size.

(2)

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 “Counterparty and Cash Collateral Netting.” For contracts with the same counterparty, counterparty netting among positions classified within the same level is included within that level. For further information on derivative instruments and hedging activities, see Note 10.

(3)	Amount represents mortgage servicing rights (“MSR”) accounted for at fair value.

Transfers Between Level 1 and Level 2 During the Quarter and Six Months Ended June 30, 2014.

For assets and liabilities that were transferred between Level 1 and Level 2 during the period, fair values are ascribed as if the assets or liabilities had been transferred as of the beginning of the period.

In the quarter and six months ended June 30, 2014, there were no material transfers between Level 1 and Level 2.


		13

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2013.


	Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Counterparty and Cash Collateral Netting			Balance at December 31, 2013
	(dollars in millions)
Assets at Fair Value
Trading assets:
U.S. government and agency securities:
U.S. Treasury securities	$	32,083		$	—		$	—		$	—		$	32,083
U.S. agency securities		1,216			17,720			—			—			18,936

Total U.S. government and agency securities		33,299			17,720			—			—			51,019
Other sovereign government obligations		25,363			6,610			27			—			32,000
Corporate and other debt:
State and municipal securities		—			1,615			—			—			1,615
Residential mortgage-backed securities		—			2,029			47			—			2,076
Commercial mortgage-backed securities		—			1,534			108			—			1,642
Asset-backed securities		—			878			103			—			981
Corporate bonds		—			16,592			522			—			17,114
Collateralized debt and loan obligations		—			802			1,468			—			2,270
Loans and lending commitments		—			7,483			5,129			—			12,612
Other debt		—			6,365			27			—			6,392

Total corporate and other debt		—			37,298			7,404			—			44,702
Corporate equities(1)		107,818			1,206			190			—			109,214
Derivative and other contracts:
Interest rate contracts		750			526,127			2,475			—			529,352
Credit contracts		—			42,258			2,088			—			44,346
Foreign exchange contracts		52			61,570			179			—			61,801
Equity contracts		1,215			51,656			1,234			—			54,105
Commodity contracts		2,396			8,595			2,380			—			13,371
Other		—			43			—			—			43
Netting(2)		(3,836	)		(606,878	)		(4,931	)		(54,906	)		(670,551	)

Total derivative and other contracts		577			83,371			3,425			(54,906	)		32,467
Investments:
Private equity funds		—			—			2,531			—			2,531
Real estate funds		—			6			1,637			—			1,643
Hedge funds		—			377			432			—			809
Principal investments		43			42			2,160			—			2,245
Other		202			45			538			—			785

Total investments		245			470			7,298			—			8,013
Physical commodities		—			3,329			—			—			3,329

Total trading assets		167,302			150,004			18,344			(54,906	)		280,744
Available for sale securities		24,412			29,018			—			—			53,430
Securities received as collateral		20,497			11			—			—			20,508
Federal funds sold and securities purchased under agreements to resell		—			866			—			—			866
Intangible assets(3)		—			—			8			—			8

Total assets measured at fair value	$	212,211		$	179,899		$	18,352		$	(54,906	)	$	355,556


		14

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


	Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Counterparty and Cash Collateral Netting			Balance at December 31, 2013
	(dollars in millions)
Liabilities at Fair Value
Deposits	$	—		$	185		$	—		$	—		$	185
Commercial paper and other short-term borrowings		—			1,346			1			—			1,347
Trading liabilities:
U.S. government and agency securities:
U.S. Treasury securities		15,963			—			—			—			15,963
U.S. agency securities		2,593			116			—			—			2,709

Total U.S. government and agency securities		18,556			116			—			—			18,672
Other sovereign government obligations		14,717			2,473			—			—			17,190
Corporate and other debt:
State and municipal securities		—			15			—			—			15
Corporate bonds		—			5,033			22			—			5,055
Collateralized debt and loan obligations		—			3			—			—			3
Unfunded lending commitments		—			127			2			—			129
Other debt		—			1,144			48			—			1,192

Total corporate and other debt		—			6,322			72			—			6,394
Corporate equities(1)		27,983			513			8			—			28,504
Derivative and other contracts:
Interest rate contracts		675			504,292			2,362			—			507,329
Credit contracts		—			40,391			2,235			—			42,626
Foreign exchange contracts		23			61,925			111			—			62,059
Equity contracts		1,033			57,797			2,065			—			60,895
Commodity contracts		2,637			8,749			1,500			—			12,886
Other		—			72			4			—			76
Netting(2)		(3,836	)		(606,878	)		(4,931	)		(36,465	)		(652,110	)

Total derivative and other contracts		532			66,348			3,346			(36,465	)		33,761

Total trading liabilities		61,788			75,772			3,426			(36,465	)		104,521
Obligation to return securities received as collateral		24,549			19			—			—			24,568
Securities sold under agreements to repurchase		—			407			154			—			561
Other secured financings		—			4,928			278			—			5,206
Long-term borrowings		—			33,750			1,887			—			35,637

Total liabilities measured at fair value	$	86,337		$	116,407		$	5,746		$	(36,465	)	$	172,025

(1)	The Company holds or sells short for trading purposes equity securities issued by entities in diverse industries and of varying size.

(2)

(3)	Amount represents MSRs accounted for at fair value.

Transfers Between Level 1 and Level 2 During the Quarter and Six Months Ended June 30, 2013.

In the quarter and six months ended June 30, 2013, there were no material transfers between Level 1 and Level 2.

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 quarters and six months ended June 30, 2014 and 2013, respectively. Level 3 instruments may


		15

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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 tables below do not reflect the related realized and unrealized gains (losses) on hedging instruments that have been classified by the Company within the Level 1 and/or Level 2 categories.

Additionally, both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the unrealized gains (losses) during the period for assets and liabilities within the Level 3 category presented in the tables below may include changes in fair value during the period that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.

For assets and liabilities that were transferred into Level 3 during the period, gains (losses) are presented as if the assets or liabilities had been transferred into Level 3 at the beginning of the period; similarly, for assets and liabilities that were transferred out of Level 3 during the period, gains (losses) are presented as if the assets or liabilities had been transferred out at the beginning of the period.


		16

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Quarter Ended June 30, 2014.


	Beginning Balance at March 31, 2014			Total Realized and Unrealized Gains (Losses)(1)			Purchases			Sales			Issuances			Settlements			Net Transfers			Ending Balance at June 30, 2014			Unrealized Gains (Losses) for Level 3 Assets/ Liabilities Outstanding at June 30, 2014(2)
	(dollars in millions)
Assets at Fair Value
Trading assets:
Other sovereign government obligations	$	8		$	—		$	7		$	(2	)	$	—		$	—		$	1		$	14		$	—
Corporate and other debt:
State and municipal securities		—			—			4			—			—			—			—			4			—
Residential mortgage-backed securities		51			10			1			(7	)		—			—			—			55			8
Commercial mortgage-backed securities		80			5			14			(52	)		—			—			—			47			(1	)
Asset-backed securities		146			—			28			(115	)		—			—			6			65			—
Corporate bonds		538			64			100			(223	)		—			—			31			510			42
Collateralized debt and loan obligations		1,293			79			497			(534	)		—			(27	)		24			1,332			32
Loans and lending commitments		4,988			146			1,505			(423	)		—			(304	)		(83	)		5,829			188
Other debt		31			2			8			(17	)		—			(2	)		—			22			2

Total corporate and other debt		7,127			306			2,157			(1,371	)		—			(333	)		(22	)		7,864			271
Corporate equities		263			16			68			(29	)		—			—			(75	)		243			11
Net derivative and other contracts(3):
Interest rate contracts		(121	)		(64	)		1			—			—			77			(2	)		(109	)		(25	)
Credit contracts		(231	)		(362	)		8			—			(8	)		(157	)		40			(710	)		(357	)
Foreign exchange contracts		52			21			3			(1	)		—			30			4			109			21
Equity contracts		(1,099	)		3			29			(1	)		(32	)		(102	)		105			(1,097	)		(25	)
Commodity contracts		1,074			(43	)		108			—			—			(7	)		—			1,132			(55	)
Other		(1	)		(1	)		—			—			—			(1	)		—			(3	)		(1	)

Total net derivative and other contracts		(326	)		(446	)		149			(2	)		(40	)		(160	)		147			(678	)		(442	)
Investments:
Private equity funds		2,576			126			35			(183	)		—			—			1			2,555			30
Real estate funds		1,643			93			124			(47	)		—			—			—			1,813			135
Hedge funds		394			4			18			(9	)		—			—			(36	)		371			4
Principal investments		2,193			(14	)		16			(72	)		—			(1,234	)		(6	)		883			65
Other		521			2			2			(10	)		—			—			(135	)		380			9

Total investments		7,327			211			195			(321	)		—			(1,234	)		(176	)		6,002			243
Securities received as collateral		3			—			—			—			—			(3	)		—			—			—
Intangible assets		7			(1	)		—			—			—			—			—			6			(1	)
Liabilities at Fair Value
Trading liabilities:
Corporate and other debt:
Corporate bonds	$	3		$	(1	)	$	(4	)	$	13		$	—		$	—		$	1		$	14		$	—
Unfunded lending commitments		6			(5	)		—			1			—			—			—			12			(5	)
Other debt		68			11			—			5			—			(20	)		—			42			2

Total corporate and other debt		77			5			(4	)		19			—			(20	)		1			68			(3	)
Corporate equities		10			(1	)		(21	)		17			—			—			(1	)		6			—
Obligation to return securities received as collateral		3			—			—			—			—			(3	)		—			—			—
Securities sold under agreements to repurchase		154			(1	)		—			—			—			—			—			155			(1	)
Other secured financings		275			(5	)		—			—			17			(178	)		16			135			(4	)
Long-term borrowings		1,878			(50	)		—			—			160			(89	)		(220	)		1,779			(50	)


		17

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(1)	Total realized and unrealized gains (losses) are primarily included in Trading revenues in the condensed consolidated statements of income except for $211 million related to Trading assets—Investments, which is included in Investments revenues.

(2)	Amounts represent unrealized gains (losses) for the quarter ended June 30, 2014 related to assets and liabilities still outstanding at June 30, 2014.

(3)	Net derivative and other contracts represent Trading assets—Derivative and other contracts net of Trading liabilities—Derivative and other contracts. For further information on derivative instruments and hedging activities, see Note 10.

In the quarter ended June 30, 2014, there were no material transfers into or out of Level 3.

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Six Months Ended June 30, 2014.


	Beginning Balance at December 31, 2013			Total Realized and Unrealized Gains (Losses)(1)			Purchases		Sales			Issuances			Settlements			Net Transfers			Ending Balance at June 30, 2014			Unrealized Gains (Losses) for Level 3 Assets/ Liabilities Outstanding at June 30, 2014(2)
	(dollars in millions)
Assets at Fair Value
Trading assets:
Other sovereign government obligations	$	27		$	—		$	8	$	(21	)	$	—		$	—		$	—		$	14		$	—
Corporate and other debt:
State and municipal securities		—			—			4		—			—			—			—			4			—
Residential mortgage-backed securities		47			13			1		(5	)		—			—			(1	)		55			9
Commercial mortgage-backed securities		108			13			23		(97	)		—			—			—			47			(1	)
Asset-backed securities		103			(4	)		30		(88	)		—			—			24			65			—
Corporate bonds		522			96			169		(304	)		—			—			27			510			68
Collateralized debt and loan obligations		1,468			134			658		(886	)		—			(72	)		30			1,332			52
Loans and lending commitments		5,129			(137	)		1,770		(343	)		—			(634	)		44			5,829			(117	)
Other debt		27			2			8		(18	)		—			—			3			22			1

Total corporate and other debt		7,404			117			2,663		(1,741	)		—			(706	)		127			7,864			12
Corporate equities		190			18			79		(38	)		—			—			(6	)		243			14
Net derivative and other contracts(3):
Interest rate contracts		113			(141	)		1		—			—			(46	)		(36	)		(109	)		(130	)
Credit contracts		(147	)		(576	)		45		—			(62	)		47			(17	)		(710	)		(582	)
Foreign exchange contracts		68			14			4		(1	)		—			38			(14	)		109			15
Equity contracts		(831	)		(15	)		175		(2	)		(218	)		(280	)		74			(1,097	)		(58	)
Commodity contracts		880			121			164		—			—			(33	)		—			1,132			98
Other		(4	)		(3	)		—		—			—			4			—			(3	)		(3	)

Total net derivative and other contracts		79			(600	)		389		(3	)		(280	)		(270	)		7			(678	)		(660	)
Investments:
Private equity funds		2,531			297			110		(384	)		—			—			1			2,555			119
Real estate funds		1,637			145			134		(103	)		—			—			—			1,813			177
Hedge funds		432			17			36		(21	)		—			—			(93	)		371			17
Principal investments		2,160			47			16		(84	)		—			(1,234	)		(22	)		883			128
Other		538			(10	)		13		(21	)		—			—			(140	)		380			(3	)

Total investments		7,298			496			309		(613	)		—			(1,234	)		(254	)		6,002			438
Intangible assets		8			(1	)		—		—			—			(1	)		—			6			(1	)


		18

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


	Beginning Balance at December 31, 2013		Total Realized and Unrealized Gains (Losses)(1)			Purchases			Sales		Issuances		Settlements			Net Transfers			Ending Balance at June 30, 2014		Unrealized Gains (Losses) for Level 3 Assets/ Liabilities Outstanding at June 30, 2014(2)
	(dollars in millions)
Liabilities at Fair Value
Commercial paper and other short-term borrowings	$	1	$	—		$	—		$	—	$	—	$	(1	)	$	—		$	—	$	—
Trading liabilities:
Corporate and other debt:
Corporate bonds		22		1			(50	)		47		—		—			(4	)		14		—
Unfunded lending commitments		2		(9	)		—			1		—		—			—			12		(9	)
Other debt		48		10			—			—		—		3			1			42		1

Total corporate and other debt		72		2			(50	)		48		—		3			(3	)		68		(8	)
Corporate equities		8		(1	)		(22	)		15		—		—			4			6		(1	)
Securities sold under agreements to repurchase		154		(1	)		—			—		—		—			—			155		(1	)
Other secured financings		278		(9	)		—			—		18		(186	)		16			135		(5	)
Long-term borrowings		1,887		(80	)		—			—		359		(233	)		(314	)		1,779		(81	)

(1)	Total realized and unrealized gains (losses) are primarily included in Trading revenues in the condensed consolidated statements of income except for $496 million related to Trading assets—Investments, which is included in Investments revenues.

(2)	Amounts represent unrealized gains (losses) for the six months ended June 30, 2014 related to assets and liabilities still outstanding at June 30, 2014.

(3)	Net derivative and other contracts represent Trading assets—Derivative and other contracts net of Trading liabilities—Derivative and other contracts. For further information on derivative instruments and hedging activities, see Note 10.

In the six months ended June 30, 2014, there were no material transfers into or out of Level 3.


		19

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Quarter Ended June 30, 2013.


	Beginning Balance at March 31, 2013			Total Realized and Unrealized Gains (Losses)(1)			Purchases		Sales			Issuances			Settlements			Net Transfers			Ending Balance at June 30, 2013		Unrealized Gains (Losses) for Level 3 Assets/ Liabilities Outstanding at June 30, 2013(2)
	(dollars in millions)
Assets at Fair Value
Trading assets:
Other sovereign government obligations	$	3		$	—		$	7	$	(6	)	$	—		$	—		$	—		$	4	$	—
Corporate and other debt:
Residential mortgage-backed securities		19			—			15		(5	)		—			—			(10	)		19		(1	)
Commercial mortgage-backed securities		174			—			26		(19	)		—			—			—			181		21
Asset-backed securities		11			1			107		(11	)		—			—			—			108		—
Corporate bonds		888			(11	)		183		(402	)		—			—			(149	)		509		2
Collateralized debt obligations		1,666			36			302		(596	)		—			(87	)		12			1,333		20
Loans and lending commitments		5,284			(55	)		1,086		(190	)		—			(850	)		(32	)		5,243		8
Other debt		1			7			4		—			—			—			—			12		7

Total corporate and other debt		8,043			(22	)		1,723		(1,223	)		—			(937	)		(179	)		7,405		57
Corporate equities		270			(24	)		20		(13	)		—			—			3			256		12
Net derivative and other contracts(3):
Interest rate contracts		(22	)		(43	)		3		—			(24	)