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

3% Change in balance sheet After de-levering from 2007 to 2008.456/676.Question Set 1: Solution General Balance Sheet Issues Total assets 2009: $771.764)/676. Copyright © 2010 Deen Kemsley .462 2008: $676. possibly for acquisitions and to take advantage of the strong market Trend in non-interest revenues Down from 2007 to 2008.8% 2008: 49. but back up again in 2009 Item that explains the change in non-interest revenues Principal Transactions did poorly in 2008.764 = 14% Increase Shareholders equity to total assets 2009: 52.462 676.764 Change in assets (771.780/771462=6.764=7. MS is levering up its balance sheet a little again in 2009.

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. Copyright © 2010 Deen Kemsley . the clearing organizations brokerage firms often use to conduct trades generally require minimum deposit requirements. These segregated reserves are subject to detailed withdrawal restrictions. GAAP requires brokerage firms to disclose the amount of these cash reserves. In addition.

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? Copyright © 2010 Deen Kemsley .

039 Copyright © 2010 Deen Kemsley .712 12/31/2008: $24.Question Set 2: Solution Total Cash and Security Reserves: 12/31/2009: $23.

firms report any unrealized gains or losses on trading securities as income or expense. Copyright © 2010 Deen Kemsley . firms mark the value of trading securities to market at the end of each accounting period. etc.Fair Value Accounting A key accounting standard (from FAS 115. On the income statement. Under fair value accounting: On the balance sheet. FAS 157. FAS 159.) is that brokerage firms use fair value accounting to account for many of their securities (assets) and security obligations (liabilities).

the Long Inventory of securities)? From the balance sheet. the Short Inventory of securities)? Per Footnote 4. 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 .e. Level 2. what percentage of Total Financial Instruments Owned are Level 1. at 12/31/2009. Level 2.e. what is the total value of financial instruments owned that Morgan Stanley accounts for at fair value (i..Question Set 3: Fair Value Accounting Consider Morgan Stanley s financial statements and footnotes to address these questions: From the balance sheet. and Level 4 assets that a company reports at fair value (very short description of each will suffice)? Per Footnote 4. at 12/31/2009. not yet purchased that Morgan Stanley accounts for at fair value (i. what are the key differences between Level 1.. what is the total value of financial instruments sold.

778 Financial instruments sold.902 /(108.929+217.191 /(108.054) Copyright © 2010 Deen Kemsley .929/(108.902+43.383 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: 108.191) = 29% Level 2: 217.Question Set 3: Solution Financial instruments owned (Long Inventory): $299.902+43.191) = 12% Unrealized gains and losses on the securities it reports at fair value: Principal transactions Trading: $7.929+217. not yet purchased (Short Inventory): $107.191) = 59% Level 3: 43.929+217.446 Principal transactions Investments: $(1.902+43.

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. 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.com) and how does it relate to Morgan Stanley and credit default swaps? Copyright © 2010 Deen Kemsley . Per the table in Footnote 10.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).dictionary. briefly describe the purpose and mechanics of a credit default swap.

447. of which $1.5 trillion of credit protection. Morgan Stanley could lose any un-netted protection) Copyright © 2010 Deen Kemsley .666)/2. Percentage Rated BBB or Lower (450.025 = 71% What reduces the risk? Morgan Stanley has purchased $2.025 of which $43.Question Set 4: Solution Description of a credit default swap The seller of a credit default swaps insures potential default losses for the buyer. Maximum Liability Exposure 2.647+426.9 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.562+356.621 is reported on the balance sheet. The payment from the buyer essentially represents an insurance premium.055+493.447.

the counterparty 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 .Pledged Securities Brokerage firms often pledge some of their securities as collateral to support transactions. In some cases.

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 Copyright © 2010 Deen Kemsley .

Copyright © 2010 Deen Kemsley . brokerage firms often receive securities as collateral for transactions.Securities Received as Collateral In addition to the securities a brokerage firm pledges to others.

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.000 as collateral for a transaction.Question Set 6: Collateral Securities Consider Morgan Stanley s balance sheet to answer the following: As of 12/2009. Copyright © 2010 Deen Kemsley . how much collateral securities has Morgan Stanley received and have on hand? If Morgan Stanley received a new security worth $5.

656 Accounting for receipt of collateral security: Sec.000 Obligation to Return +5.Question Set 6: Solution Securities received as collateral: 13.000 Copyright © 2010 Deen Kemsley . Received as Collateral +5.

Borrowing allows firms to implement trading strategies or cover shorts. Lending securities is a low-risk way to enhance yield on the securities.. When borrowing a security. Copyright © 2010 Deen Kemsley . including the potential impact of a purchase on price.Borrowed Securities Brokerage firms often borrow and lend securities. Any required adjustment of collateral is settled in cash (or other assets). the borrower gives cash (or some other asset) to the lender as collateral. while avoiding the transaction costs of a purchase. etc. the value of borrowed securities are marked to market to determine if the collateral is sufficient. On a daily basis.

Borrowed Securities Transaction Copyright © 2010 Deen Kemsley .

Question Set 7: Borrowed Securities Consider Morgan Stanley s balance sheet to answer the following: As of 12/2009. how much loaned securities does Morgan Stanley have outstanding? What balances out the borrowed securities on the balance sheet. What account does Morgan Stanley credit? Copyright © 2010 Deen Kemsley . In particular. how much borrowed securities does Morgan Stanley have on hand? As of 12/2009. Morgan Stanley debits borrowed securities when they receive them.

501 Loaned Securities Outstanding at 12/2009: $26.e.246 Account that offsets Borrowed Securities: Cash (i.Question Set 7: Solution Borrowed Securities on Hand at 12/2009: $167.. the collateral given to the lender) Copyright © 2010 Deen Kemsley .

The REPO rate is the difference between borrowed and paid back cash expressed as a percentage. Copyright © 2010 Deen Kemsley . 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.Repurchase Agreements Brokerage firms often use REPOs for secured short-term (or sometimes long-term) borrowing and lending. A reverse REPO is the same transaction from the lender s perspective.

what is the total amount of REPOs? As of 12/2009.Question Set 8: REPOs Consider Morgan Stanley s balance sheet to answer the following: 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 12/2009.208 What balances out the REPOs on the balance sheet? Cash Copyright © 2010 Deen Kemsley . what is the total amount of REPOs? $159. what is the total amount of reverse REPOs? $143.401 As of 12/2009.

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 .Customer Receivables and Payables Customer receivables (customer debits) typically arise from the purchase of securities on behalf of the customers. Often.

how much customer receivables (customer debits) are there? As of 12/2009.Question Set 9: Customer Receivables and Payables Consider Morgan Stanley s balance sheet to answer the following: As of 12/2009. how much customer payables (customer credits) are there? Copyright © 2010 Deen Kemsley .

594 Customer Payables: $117.058 Copyright © 2010 Deen Kemsley .Question Set 9: Solution Customer Receivables: $27.

Wrap up What are your key takeaways from this lecture? Copyright © 2010 Deen Kemsley .

pdf Copyright © 2010 Deen Kemsley . see http://www.Morgan Stanley Financial Statements Sample Pages For complete statements.morganstanley.com/about/ir/shareholder/10k2009/10k2009.

Morgan Stanley Assets Copyright © 2010 Deen Kemsley .

Morgan Stanley Liabilities and OE Copyright © 2010 Deen Kemsley .

Morgan Stanley Income Copyright © 2010 Deen Kemsley .

Morgan Stanley Cash Flow Copyright © 2010 Deen Kemsley .

Morgan Stanley Footnote 2: Excerpt on Fair Values Copyright © 2010 Deen Kemsley .

Morgan Stanley Footnote 2 Continued Copyright © 2010 Deen Kemsley .

Morgan Stanley Footnote 4 Excerpt Copyright © 2010 Deen Kemsley .

Morgan Stanley Footnote 4 Continued (Excerpt Only) Copyright © 2010 Deen Kemsley .

Morgan Stanley Footnote 5 Excerpt on Pledged Securities Copyright © 2010 Deen Kemsley .

Morgan Stanley Footnote 10 Excerpt on Credit Default Swaps Copyright © 2010 Deen Kemsley .

Morgan Stanley Footnote 10 Excerpt on Credit Default Swaps Copyright © 2010 Deen Kemsley .

Morgan Stanley Footnote 10 Excerpt on Credit Default Swaps Copyright © 2010 Deen Kemsley .

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