摩根士丹利 (MS) 2002 Q1 法說會逐字稿

Welcome to the Morgan Stanley quarterly earnings release conference call.

The following is a live broadcast of a presentation by Stephen Crawford of Morgan Stanley, and is provided as a courtesy. Please note that this conference is being broadcasted on the Internet, through the company's Web site, morganstanley.com. A playback of the call will also be available through the company's Web site, and by phone, until April 9,2002.

Morgan Stanley has asked me to remind you that the information conveyed in this conference call may contain forward-looking statements.

These statements, which reflect management's beliefs and expectations, are subject to risks and uncertainties that may cause actual results to differ materially.

For a discussion of the risks and uncertainties that may affect the company's future results, please see Certain Factors Affecting the Results of Operations in Management's Discussions and Analysis of Financial Condition and Results of Operations, Competition and Regulation under each of Securities, Asset Management and Credit Services in Part I, Item I, in the company's 2001 annual report on form 10-K.

Any recording, rebroadcast or other use of this presentation in whole or in part is strictly prohibited without prior written consent of Morgan Stanley. This presentation is copyrighted and proprietary to Morgan Stanley.

At this time, I would like to turn the call over to your moderator for today's call, Mr. Stephen Crawford. Please go ahead, sir.

Thank you and good morning.

As all of you know from announcements over the past week, in the first quarter, the difficult conditions really persisted.

If you look at the macro factors which drive our business, they were down pretty much across the board, whether it's volumes; volatility and values in the equity market; long-term fund flows in the retail side; underwriting activity, which wasn't up very much in the fourth quarter, but down a lot from year ago levels; and M&A activity finally running about 30 percent off of last quarter. The last time I checked their historical context, I think the announced activity is running about mid-90s levels.

In spite of the environment, I think we delivered very good returns. On an absolute basis, 16 percent return on equity is below our long-term goal, but still reasonable.

And on a relative basis, I think the returns are outstanding. In part, this reflects real progress we've made on the expense side, particularly on the non-comps. Throughout the quarter, we retained our focus on our intermediary strategy.

Clearly, there were some markets over the past couple of months where one could stretch the revenues and market share.

Finally, into each one of the businesses, I'm going to start with securities.

And what I want to do is make comparisons with the fourth quarter of last year. The first quarter seems like a long time ago.

This is obviously the business that is most levered to market conditions.

If you look, net revenues were up 22 percent, with a stronger contribution from equities, but particularly better results in fixed income.

In the securities segment, we reduced non-comps by about $200 million a quarter, excluding the impact of non-amortizing goodwill. If you look down the line items, there's really progress in every area.

It reflects the hard work that we started over a year ago. And you know that non-comps, as we've talked about in the past, are a little bit stickier and harder to move.

Assuming the same level of business activity throughout the year, plus or minus, we would expect non-comps to stay in this type of range.

Finally, on the comp side, it is too early to put too much weight on the compensation expenses, but we have continued with our normal conservative posture.

We are not assuming there will be any options benefit at year-end. And furthermore, as we have always done, we are accruing the institutional business at a 50 percent rate. The reason that you see the comp to net revenues ratio going up to 55 percent, is the higher fixed costs within retail.

Going into more detail on revenues within the securities segment, and starting with our largest business sales and trading. As we promised a while ago, we would increase the level of disclosure of our sales and trading business.

Of you look on page F-7, we've now broken out sales and trading revenues into the primary components equity and fixed income. Overall, sales and trading revenues were up 45 percent from depressed levels of a quarter ago. If you look on a product basis within equities, they're up 9 percent, versus a fourth quarter down almost 40 percent from a year ago.

And it really reflects volumes and volatility, which were off year-ago levels. This quarter, the convertibles market and derivatives market were slightly better than the fourth quarter, but again, still way off historical means. And in the business, we continued to build on themes that we have stressed in the past.

We added another 100 stocks in our Nasdaq, which we are trading on an automated basis. And for the first, like to talk about a comparable business we've started on the options side. Again, it's an automated platform. We're now making markets in over 400 names and 50,000 instruments. We have a 5 percent share of this options market from really a standing start in the business about nine months ago, and less than a handful of traders executing the volume.

Looking ahead for equities, the competition for market share remains very high, and that is certainly having an impact on returns. Optimistically, I'm not sure if volatility's, either intraday or implied, can move a lot lower than they have been.

Also, looking at our hedge fund business, both in terms of margin and insured balances, it appears that hedge funds are recommitting more to the equity market. On the fixed income side, again, this is the real story in the quarter. Second best revenue contribution ever. It really reflects a balanced contribution across all of the product areas.

If you look ahead, the tightening bias of the fed would lead one to expect a more difficult trading environment.

It's worth stopping for a second and mentioning some of the secular trends, which we've been expecting, that could be a positive and an offset to the potential lack of reduction in interest rates from the fed side, in that there is certainly newfound appreciation for capital structure in liquidity management.

I think banks are even more cautious of their position as the liquidity backs-out the corporations.

If you look at the CP market, it shrunk over 30 percent in the last 12 months, and the credit derivatives market continues to grow rapidly.

On the investment banking front, revenues were down 15 percent from the fourth quarter.

And if you look at underwriting, it was primarily a drop in debt issuance on the advisory side. Completed M&A for the industry was down 37 percent from the fourth quarter, compared to about a 9 percent decline in our advisory revenues.

Backing up and looking at the pipeline for the entire corporate business, on the equity side, industry-filed backlogs down about 64 percent from where it was a year ago, 50 percent from the fourth quarter. Our backlog is up marginally from the fourth quarter.

But, again, given the small numbers, not a material revenue item.

The debt side, much less visible.

I would expect, again, issuance levels to decline just based on what's happening with the interest rate environment. But it really will depend on what I talked about before with respect to corporations focusing more on liquidity and capital structure, which could drive an increase in capital markets activity.

M&A is shaping up as a very difficult year. Announced activity was down another 33 percent in the first quarter.

Our backlog is down around 30 percent from a year ago, and not materially different from the end of the fourth quarter. Despite the gloom on the corporate side, looking at recent trends in the economy and the activity level of our bankers, there's no reason to dramatically change our resource levels in this area.

The last part of securities, individual investor, continues to reflect lack of retail activity, whether it's indexes, primary activity. Long-term fund flows were risk appetites for the average retail investor; they're all relatively low.

And there's no reason to expect a quick return.

On the positive side, revenues are up for the first time in seven quarters.

We've had - we've made real progress in reducing our cost base. If you look at fee-based assets as a percent of

, they're up to 19 percent versus 17 percent a year ago, which has been a big push.

And we're introducing new initiatives and products, coordinating marketing, training and sales incentives to really push these services and products.

An example would be what we're doing on the IRA rollover side, and with the separate account business.

Finally, on the private equity front, the first positive quarter in over a year. The portfolio, in terms of aggregate size, is stable at about $900 million.

The TMT portion of the business is down again to about 35 percent of the overall portfolio.

Moving to asset management, really driven by most of the same factors as the retail business, and as a result, revenues are also up marginally over the fourth quarter.

If you look at assets management, they declined for three reasons. First, the unit investment trust business is down; it's really increasingly being replace by extreme traded funds. WE had the decline in money markets, and in the rest of the complex, redemptions slightly offset net sales. On the performance front, our performance held out with 57 four and five-star rated funds, up from 56 at the end of the year.

And our Lippert rankings are relatively unchanged.

Again, here a good story on non-comps, down approximately 8 percent, excluding the benefit from no longer amortizing goodwill.

We've retained our focus on strategies to increase sales, and none of the things that we implemented this quarter as we restructured, the wholesales now have six product areas, rather than the prior 15, calling on financial advisers.

On the credit services front, looking at revenues versus the fourth quarter, lower yields and higher charge-offs more than offset an increase in sales. We've shown continued vigilance on the cost front, with non-interest expenses being down 6 percent. looking forward, I think we expect yields to remain around the current levels, depending upon what happens in interest rates.

Charge-offs will be a function, as always, of two things. First, bankruptcy trends. Bankruptcies have clearly moderated since the specter of legislation went away. If legislation comes back into the equation, that could drive bankruptcies up. Delinquencies have also leveled off, and here we're cautiously optimistic, as unemployment levels appear to have stabilized.

Our focus remains on portfolio quality, as it has for the last year, not on growth in this part of the cycle.

Just moving to a couple of other topics. On the market share front, really uncharged at Discover and retail. In the corporate side, we're still suffering from relatively small numbers, and obviously only a three month period. My favorite example, between lunch and dinner a couple of weeks ago, I think we went from eighth to first in European M&A.

So obviously market share is a little less meaningful in this type of environment.

On the sales and trading front, which is our largest business, across the board, market share rankings were either neutral to positive over the quarter.

Worthwhile spending a second on, the airplane front, there was no repossession or impairment this quarter.

The industry, particularly in Europe, if you compare what certainly, I think, we expected going back and looking forward from the end of September to what actually seems to be unfolding, it's better than expected.

There's still, however, significant uncertainty. The industry across the board is not in wonderful health.

The next few quarters will be a very good source of information for us, as lease expirations - normal lease expirations - will test the demand for aircraft.

The head count reductions you'll see in the disclosure this quarter are largely a result of actions taken last year.

No plans to materially change head count one way or another. As we have discussed

to a more conservative capital structure for the past year or more, including extending the maturities of our debt, carrying a larger liquidity position and really pursuing a less aggressive stock repurchase plan.

As a result, our short-term funding, including CP, has declined relative to assets, and the weighted average maturity of our portfolio - debt portfolio - has increased over the past year. We believe this is the best posture for our clients and shareholders to retain a conservative capital structure.

On the loan portfolio side, total loans and commitments are really flat fourth quarter to first quarter. The investment grade - non-investment grade percentage has not changed.

Again, we have built the business here. We would not expect, as we did not last year, for the business to stay at this level.

We expect it to grow. But given the environment it has been a surprise that credit outstandings have not increased.

Overall in terms of finances, it was a very clean quarter. We had a $73 million pretax gain from the sale of our building, which will be found in other revenues on a consolidated level.

And it's split, if you look at the divisional level between securities and investment management.

We also took $25 million in additional reserves that Discover; again, just really reflecting on the uncertainty with respect to the - the consumer is headed and whether the recent positive trends we've seen are sustainable.

In closing, I think, again, we have positioned the firm for a recovery. We have made significant progress on the non-comp expenses, down roughly $300 million a quarter in terms of run rate.

We've strengthened our capital and liquidity position, and we really restructured around a client-driven mantra to focus as many resources as we can on clients, and to reduce the administrative burden of those people, so that they can focus entirely on clients.

I'll turn now to questions. If I could ask everybody to limit their questions to a few follow-ups so we can give more people a chance to ask questions.

Thank you. At this time, if you do have a question, please press the one on your touch-tone phone. And press pound to withdraw your question. Once again, if you do have a question, please press the one on your touch-tone phone, and press pound to withdraw your question.

We will have our first question in just a moment.

We'll take our first question from

from JP Morgan. Please go ahead, sir.

Thanks. Just two quick questions here. I wonder if you could just give us a little bit of color. The non-comp expenses were obviously outstanding, in terms of what you've been able to do there.

And specifically, I wonder if you could update us on asset management, which is been an area I know you've been focusing on combining a number of operations there? That's my first question. And then just one follow-up.

OK, on the asset management front, non-comps I think were in, again, depending upon the level of business, the right type of range for non-comps looking forward.

So I wouldn't expect dramatic changes from where we are.

OK, so that's essentially complete then, with respect to your saying?

Plus or minus, yes. A lot of the work has been done and is reflected in the financial statements.

OK. And then, just want to make sure I heard you right on the asset worldwide side. Did you say that you've got some lease expirations coming up next quarter that will allow you to retest that marketplace?

Over the next couple of quarters, yes, we have lease expirations. Normal lease expirations, which again, will enable us to see what the demands levels are like.

Can you tell us how many clients are coming up fro re-lease this year?

I really don't want to get into that level of detail,

.

OK, thank you.

Thank you. We'll take our next question from Richard Strauss from Goldman Sachs. Please go ahead, sir.

OK, Steve, yes, a couple questions here. Number one, on fixed income, I think you've actually posted the biggest sequential gain, even relative to Lehman, and they had talked about the World Trade Center here. I'm just wondering, in terms of your risk profile, has it changed at all? Has your outlook changed in terms of how protracted the good environment could stay in fixed income?

And how much of this also reflects write-downs in paper that you may have taken last quarter in terms of the gains you posted this quarter?

Yes.

In terms of balance sheet commitments or capital outstanding, overall, you won't see a dramatic change quarter over quarter. So that's not what's driving the revenues.

Really, there was stronger performance across the board relative to fourth quarter in all of the product areas. And you're right, as we talked about at the end of last year, clearly, the actions we took during the year to reduce the size of both our private equity - which wouldn't be in fixed income - but our high yield portfolio also hurt revenues.

You also mentioned here that in terms of managing liquidity in your balance sheet that, you know, you've done the responsible thing in terms of your

and everything. And, you know, with

having just kind of ripped into GE.

And some big players out there have not done what you have done. You kind of alluded to the fact that there might be an opportunity here that could really translate into a reprieve for the fixed income business.

Can you quantify that at all and maybe just give us a sense as to how much you think there might still be needed to be done on that front?

I really can't,

.

I would say that I think last year, again, you saw the CP market go down 30 percent in terms of outstandings, and there's just a lot more focus on it. It's changed from an issue of the banks being focused on risk and profitability to - you know, which is a way of just transferring pricing, if you will, to, in some respects, a risk concern on the part of corporations as to what is the right capital structure for them.

And that's helpful to us both in terms of the advisory business as well as the capital markets business. But trying to quantify that I think is very difficult.

But a lot of the recent decline is probably due also to the fact that just many of the big players - or many players - have just been shut out of the market too, right?

Yes.

Well - and whether or not they - I think as a result of being shut out of the market, whether they ever depend on the market to the extent that they did in the past is the question.

Right. Great - OK, well thank you.

Thanks,

.

Thank you.

We'll take our next question from Guy Moszkowski from Salomon Smith Barney.

Please go ahead, sir.

Hi.

This is actually Patrick Pinchman.

Quick question on the comp line.

You mentioned on the call that the sort of normal 1Q conservatism and the weak retail environment drove it up a little bit. But, also, was there any impact on severance given the decline in head count?

And then just a quick follow up on - if you could kind of give some more detail on how you account for options expense in the comp line.

Well I'm glad you brought up compensation.

I think, you know, one of the issues you have to recognize here, at least as far as we can see, there are some differences in policies really on three fronts.

The first is with respect to recognition of equity awards. I think you'll see certain people treat them as expenses that are amortized over the vesting period.

At Morgan Stanley, we actually recognize all of that as an expense in the year that they're granted. That's one of the things that accounts for differences in comp lines.

The second is mix of compensation.

If one is to move towards more options in the mix, this is a benefit. And what I can tell you at Morgan Stanley it's been the same mix 50/50 for a long time.

And to the extent that we changed that mix, we'll let you know what the impact is on our profits.

And then finally, is the recognition of the benefit that one has as a result of using options in the mix. For the past - as many years as I can remember - our policy has been to assume for the first three quarters that we will not have an options benefit.

so if you go back and look at our compensation expense, it has historically been higher in the first three quarters than in the fourth quarter.

So if you add all of these three assumptions together, we think they've not only the most conservative way of accounting for comp, it's also the most transparent way of accounting for comp, in that revenues and expenses are matched.

Great. And then also, just really quickly on the severance, if that was in

?

I'm sorry, there was no material severance in the quarter.

OK, great. Thank you.

Thank you. We'll take our next question from Mark Constant from Lehman Brothers. Please go ahead.

Thanks, good morning, Steve.

Hey, Mark.

First actually just a smaller numbers issue on the taxes.

I was trying to figure out some of the fluctuations in effective tax rates, and I actually kind of got a backwards explanation, looking at the new reporting for the trust deferred dividends. Has the deductibility of those dividends changed in some reason?

Is that why they've been moved down below the tax provisions, or something else there?

No, it's materiality.

OK.

Larger percent of the capital structure.

OK. And just to quantify the aggregate exposure for people on asset worldwide. Does Morgan Stanley ultimately guarantee their liabilities as a matter of fact, or is your maximum potential exposure there in a worst-case scenario ultimately limited to your equity interest there?

We have $5 billion of assets - plane assets - so that's the size of our commitment to the airplane business.

But if that entity filed for independent bankruptcy, would you be responsible for their liabilities, is my ...?

It is our entity, it's consolidated. There's no difference - we are Ansett, so we're one and the same.

And the merchant and card member fee income, even I just for the lower securitization gains, seemed a little weak relative to the strong transaction volume. Is there anything there worthy enough for their explanation?

No.

OK.

Last question. You talked about volatility in your comments. You know, really not being able to go much lower.

It kind of has into March, and I don't want to make too much out of a few weeks' results, but are you suggesting that - that that is not negatively impacting equity trading environment in that sense? That it's in a low enough level that you're really not getting the benefit anyway?

Well I guess what I meant to say is if you believe at all in

to the mean, volatilities both

and implied should certainly pick up versus where they were in the fourth quarter or the first quarter. Now in any one particular period, whether it's March or April, you know, it's kind of hard to predict.

But, again, if you look at where we are versus where we've been, even on a mean level they're pretty low.

OK.

Thanks.

Yes.

Thank you.

We'll take our next question from Reilly Tierney from Fox-Pitt, Kelton.

Please go ahead.

Hi, Steve.

You know, I just - I'd just like to get a little comment, a little bit maybe more color on the pipeline. I think last quarter in your comments you gave us a little bit of a hint that maybe there was a build in the pipeline.

We've heard a couple of positive comments from people around the industry that the pipeline - in fact, in M&A in particular - might be getting a little better. But you seem to hesitate or be willing to make that statement this quarter.

Is there any change, or is that just too subtle?

I don't think there's any change.

Our coverage officers, our client people have continued to be very busy. And there's still - if you look around the industry groups globally and the

pressures that they have, there's still a need for consolidation across a lot of different industry groups.

But when that actually translates into revenue is very difficult to forecast. So that's what you're hearing, is that there's a hesitancy in terms of putting a line in the sand and telling you the third quarter is going to better or the fourth quarter is going to be better.

It's just hard to tell.

You also seem to be a little bit more upbeat, or at least cautiously optimistic about the trends

Discover on the credit quality side.

Do you want to maybe make - give us a little better sense of maybe when you think the charge-offs will peak. Do you have any sense at this point?

Well, I guess what I - what we were trying to say is they were better than we would have expected, if you go back and asked us in the fourth quarter. We're still not happy with where our charge-offs are.

They're in line with where the industry is, but they're high from a historical perspective. And our expectation is that they're going to come down.

And what the timing of that is, I think is difficult to forecast. Particularly the biggest uncertainty in the forecast was what happens on the bankruptcy side?

And there've been some rumblings about legislation coming back onto the table. If it does, that will tend to have a negative impact on our credit quality this year.

OK. Just one last one. If you could comment on the trend of the non-comp expenses, you mentioned in the asset management? Could you just talk in general? Do you think you could possibly get those kinds of improvements going forward? Should we expect that in modeling it?

I think we have done a very good job. The businesses all have, starting with plans they've put in place from the beginning of last year to bring non-comps down.

Across the complex in general, we don't see them changing very much, plus or minus. To change non-comps a lot, we would have to change the size of our infrastructure and the business overall.

OK. Thanks.

Thank you. We'll take our next question from Joan Solotar from Credit Suisse First Boston. Please go ahead.

Thank you, two questions. First, on the comp issue. If we assume the normal institutional accrual of 50 percent, we can get to about a 70 percent comp-to-net revenue ratio on the retail side. And so, I just wanted to check if that's somewhat accurate?

And then, that would also imply just very little profitability for the whole retail business? Is that accurate?

Well, I guess you can back into some of the numbers, based on revenue. There are other things going on, and we aren't going to disclose the full P&L for the retail side.

And on the question of profitability of retail, it really does depend on how you count it. I mean, the investment management business is very integrally tied with the distribution business.

And where the value added gets split between the investment management business, and the distribution business, I think you see everybody treat that differently. If you look at our overall retail business together, both asset management and the distribution side, it's still a very profitable business.

Obviously well off where it was a year ago.

OK, but if you account for it internally, would I be close?

Sorry.

OK, you

. All right.

I can't go much further than I have, Joan.

OK, that's fine. And then, second, can you comment on the strategy in the credit card business? We saw just a continued drop in marketing expense, that was actually dramatically below where it was last year's first quarter.

And given the outlook for improved credit, and perhaps an economic recovery, why would you put the brakes on growth now?

Well, it's one of the levers that we have to manage returns.

And we've said for the past year the focus really needed to be on the credit side.

And one of the most important things in terms of positioning us for growth in the next cycle is really how strong we come out of it. And we're hoping that a couple of our, shall I say, more aggressive competitors that are pricing things at levels that are maybe not all that attractive economically have difficulty making it through this environment.

So that's going to be more important, or at least as important to growth as marketing spend. And to the extent we start to see more evidence that the economic return - economic recovery is sustained, you will see marketing expenses turned upward.

OK.

And then just one final question on fixed income.

Is there any way to just give us a sense for how much of the sequential movement was, in a sense, a reversal of marks from what had been a gapping out in credit spreads and then became

in credit spreads?

Well, I thought you were going towards marks in the high yield portfolio.

Well I guess I...

Our credit business overall is very big.

I would say, if you want to talk about the high yield portfolio,

much more significant to our fourth quarter, the first quarter would be overall contribution across

. Then differences in what we had to do in the high yield front.

OK. Well I guess one other way to think about it, the

million swing, roughly, how much of that would have been a change in mark versus just greater trading volumes and underwriting?

Well underwriting is broken out separately.

And aside from that, Joan, it really kind of

at the

in the way that you would like. What I would say on credit spreads is, as you know, towards the end of the quarter, they increased fairly dramatically.

So while the first two months were generally positive for fixed income, if you look at the end of the quarter, which is where we're obviously marking, credit spreads widened significantly.

OK, great.

Thank you very much.

Thank you.

We'll take our next question from Judah Kraushaar from Merrill Lynch. Please go ahead.

Hi Steve.

Hi Judah.

Two questions. I just want to come back on this comp issue.

On the securities business, you went from 51 percent comp a year ago and 54 percent in the third quarter to 55 percent. And I just want to make sure I understand the explanation.

You're saying that the delta in both those periods is fully explained by greater drag from the retail business? There's been no underlying erosion in the pure institutional business on comp

?

That's - yes, that's the predominant cause.

OK.

I'm just - you know, I'm curious whether - conceptually, when you think about comp-setting going forward, to what extent do you want to pay more attention to two issues, both the - you know, the loss of share, admittedly with a slack market in M&A and equities.

And also the fact that you've pretty lean in the good times and in the tough times here, and whether you're facing any noticeable pressures in retaining key people, or attracting people?

Or, whether that's a factor at all in terms of how you're setting comp this year? And in fact, in the institutional business, are you assuming kind of a level comp rate, versus what you were assuming a year ago?

I guess there've been, for different reasons, a lot of concern about ability to manage comp, or to keep people.

And that really has not been an issue. And if you look at our comp over a long period of time, with respect to percent of revenues, I think it compares very favorably to the peers.

And obviously, a lot of people were worried about significant departures fro various reasons, and that hasn't occurred. I think the franchise has a lot more pull, frankly, in this type of environment, when people are looking for a stable home with the strongest brand.

So if anything, I think, in general, we feel less pressure on the comp side, than we did in '99 and 2000, when every financial institution wanted to get into the business, just based on the level of returns. Does that answer the question?

Yes, I think so. I'm just trying to gauge your mindset going forward. I was having a hard time totally reconciling whether it was all the private client business that was explaining the step up.

Perhaps you get the

question.

Well, and you really do have to back up on the comp side, and really understand how if you want to do comparisons, how everybody treats the two or three things that I went through. Because it can lead to pretty different approaches, in terms of comp expense.

That's fair. The other broad question I have is on the private client business, in terms of margins, I hear your comment that maybe revenues are stabilizing, but don't expect a dramatic recovery here for the time being.

But I thought you said in your remarks that you were beginning to see some improvement in operating leverage or margins in that business? And I'm curious what our current thinking is, without a dramatic recovery in revenues, what your view is in terms of profit margin outlook for the

client group would be?

Well, what I'd say there is if you look at some of the activity of recent months, it does feel like we're able to engage clients in a dialogue that's more constructive, than if you go back three or four months when they really didn't want to talk much about investing.

One of the areas which has been a real success for us recently is on the IRA rollover front, where we went out and I think we've done 500 training sessions, going to 700. And obviously, that's a very significant product opportunity, particularly in this type of market environment that may be a lift to that business.

The focus on the fee side I think is also making a difference.

So, you know, we don't want to - I don't want to be overly optimistic.

And if there is a recovery, it's certainly not going to be a - probably a big uptick in a short period of time. But if you just look at the monthly revenue trends, either on the transaction side or the fee-based side, it feels like there's more stability in them.

It sounds, though, that margin improvement is dependent upon on revenue growth, as opposed to reallocating resources more efficiently within the business. Is that a fair view?

Yes. Revenues are definitely going to be much more important in terms of recovery of operating margins.

There's more to do on the expense front; but, clearly, revenues are going to be important.

OK.

And just one last thing. I don't think you mentioned this in your prepared remarks.

Where do you stand with

?

We I think by the end of January had moved to commissions across the board.

And I know you're going to want estimates in terms of how much of an impact. I would say it's very difficult to determine that.

What I will tell you is the competitive environment for market share within Nasdaq I think is still much more important than the change from the structure to a commission-based structure.

Thanks, Steve.

I appreciate it.

Thank you.

We'll take our next question from

from Dresdner Kleinwort Wasserstein. Please go ahead.

One simple numbers question. Did you say that you had a pre-tax gain of $73 million on the sale of the building?

and divide by shares for the effect on the quarter?

I'm sorry, take the $72 million and...

Did you say you had a pretax gain?

Of $73 million, yes.

And no offset

?

Just run that through - just run that through

?

Well, taxes, that's correct.

OK, thank you.

The two different - the two - the two items that stand out were that and the $25 million we added in reserves on Discover.

OK, fine.

And then just a follow-up question on your market share.

When we look at your announced M&A that you give us in the quarter, when we look at equity underwriting, I keep coming up with a decline in market share for Morgan Stanley in underwriting equity, underwriting fixed income and in M&A.

Yet you seem to be saying that it's not going down that much or not going down at all.

Well, I would say there's a long answer and a short answer to that question.

The long answer is, you know, we go through a litany of three months doesn't make a year to certainly a small and lumpy market. In certain markets, the risk reward tradeoff was pretty unfavorable.

And if you look at equities in particular, there's a high level of industry issuance.

But, you know, the short answer is we're not happy with our recent share.

If we had secured what we believe was our fair share, it would have been an outstanding quarter both on a relative basis, which it already was, and an absolute basis. And by the end of the year, we expect to be back to our leadership position.

OK, so you're saying that basically it's the lumpiness of the industry numbers?

You're not unhappy with your people, I guess is what you're saying? And what they're doing, and what they're - you're happy with your share?

We're unhappy with our share. Would have made a big difference if we had gotten our fair share this quarter.

OK, thank you.

Yes.

Thank you. We'll take our next question from Glenn Schorr from Deutsche Bank. Please go ahead.

Thank you very much. Two quick ones. First, you had made a comment on the loan book being relatively unchanged from last quarter? I was curious if it's just a function of limited to no demand out there? Or if Morgan Stanley's just saying no?

No, it's not a function of limited demand. I think there is demand, but I also think we're managing the demand consistent with building the relationships - the client relationships - that we'd like. There's a much better understanding of the lending product now throughout the investment bank. And I think we're using it where we need to, but sporadically.

Understood. And then, completely separately, you mentioned that you added about 100 Nasdaq stocks in the quarter, on the automated side.

I think that brings the total somewhere in the neighborhood of 1,600, and it probably covers over 90 percent of total volume on the Nasdaq. Could you revisit just how much more there is to add here, and what areas, if there are, of any increasing that number more significantly?

We're getting pretty close to the level of stocks that we'd like to have, and now it's just getting more flow.

OK. Maybe a comment on how you get more flow?

In other words, I know it's a dynamic process that includes everything from underwriting to capital to research, but are there alternative methods that we're unaware of, of attracting more flow?

Or is this automated process get you into less liquid, less covered stocks, and that actually attracts the

?

Well, I think one of the things that drives more flow to us is just the structure of the way we've set up the business.

And that this scales very easily with very low costs. And to the extent that there is going to be increasing pressure on revenue margins, driven by the client side, there'll be more and more competitors who just find it unprofitable to prosecute the business.

Which is, I think, one of the reasons that's accounted for the success of the business to date, and will drive more share to us over time.

OK, I appreciate that.

Thank you. We'll take our next question from Ken Worthington from CIBC World Markets. Please go ahead.

Morning, Steve. With regard to the securities business in Europe, how is your pipeline across investment banking in Europe versus the U.S.?

And along those lines, what are you hearing from your bankers in terms of their clients growing this to raise capital and do deals in Europe?

And maybe how is that different than it is in the U.S.? And then, finally, what percentage of your revenues came from Europe this quarter versus last quarter?

Did you get all those?

Yes, I did, and I don't have a lot for you.

I would say Europe is a little bit slower than - than the U.S. And if you look at revenues, it's just really hard to - you know, with the nature of corporations, which are now global, you know, it's really hard to say where exactly the revenue came from.

But if you parse through it and look at how we do it internally, revenue contribution hasn't changed very much in terms of Europe versus the U.S.

OK.

And the market-making side, about what percent of your trading volume - your Nasdaq trading volume - is agency

principle right now?

That's not - we can look at that, that's not something we've been disclosing, though.

OK, great. Well thanks for the additional disclosure.

Sure.

Thank you.

We'll take our next question from Justin Hughes from Robertson Stephens. Please go ahead.

Good morning.

I wanted to ask you about your head count increasing in the financial advisers from quarter to quarter, at the same time that your overall head count is down slightly and

is very weak.

I'm just wondering what the strategy is there.

Interesting phenomenon.

What's happening really is not on the addition side. If you look at that, the number of brokers we've either hired or trained hasn't changed very much over the last couple of quarters.

What changed most significantly at fourth quarter, the first quarter, was we had less people leaving the business. And maybe one could argue that's an optimistic sign.

The model is set up so that people leave when they can no longer make the numbers work. And for whatever reason, last quarter we just had a lot fewer people leave the business entirely.

OK.

So it's not financial advisers that are coming over from competitors.

No it is not.

New classes coming in.

It's less departures.

OK.

Second broader question, what are the best opportunities for acquisitions that you see in the market right now? Obviously, across the business line, everything seems suppressed - depressed.

But are there any key areas where you see some good opportunities right now?

For ourselves?

Yes.

I guess we've actively looked at expanding our business across all product areas for as long as I can remember, and there are some areas we'd love to accelerate the growth of them and their market share position through acquisitions.

The problem is that most of the deals that have been done have been return-proof, and I'm not sure, even with equity prices being down, that that will change very dramatically.

So we'd love to find ways of expanding our business through acquisition, but one of the reasons I think you see profitability that's consistently higher here than elsewhere, is that we have not done acquisitions at large acquisitions premiums, which has a way of significantly diluting returns.

and those prices just still haven't come down enough?

There always seems to be somebody prepared to pay a strategic premium.

OK. Thank you.

Sure.

Thank you. We'll take our next question from Meredith Whitney from Wachovia Securities. Please go ahead.

Good morning. Promise no questions on compensation, but I do have some questions - you've always been helpful on your macro insight, and I was wondering if you could update me in terms of where you think we are in terms of the regulatory cycle, given this being an election year?

And then, secondly, where you think banks are in terms of the lending cycle? And when they're going to start making loan again?

When you say the regulatory cycle, Meredith, I'm sorry, you're talking about the Enron stuff?

Yes.

Yes?

Yes. And sorry, one last question, which is given the normalized

of paranormalized state of the bond market, your investment bankers are busy, but what's preventing companies from pulling the trigger?

OK. Just writing here. All right, on the Enron front, I guess the biggest thing that we are watching out of Enron is what implications it has for the securitization market.

That's a big business for us. It's a very big market opportunity, as well as an important risk management tool for us as a firm.

And so we're watching that legislation carefully. We're hoping that rational minds prevail. There's no reason to expect that they won't.

But your guess is as good as mind as to what the solutions are that people feel like they need to push through. That's the most important regulatory or legislative development we're watching.

On the bank front, again, at least with respect to the CP market, and being the backstop for corporate liquidity, we think that market's changed for good. And even when the economy returns, the banks have recognized the issues associated with that business, and they are moving away from it secularly.

So while they may be more prepared to lend, I think the nature of it will change, versus in past economy recoveries. And the trigger in terms of activity? I don't have a good answer for you there.

I guess it's just more confidence in the - in the level of economic activity.

There's still a couple of prominent economists talking about the risk of a double dip.

And until we see more certainty on that front, I think it's going to be hard for people to step up and try and do transactions.

OK, thanks.

I think we have time for one last question if there is any.

Thank you.

We'll take our final question from

from Dreyfus. Please go ahead.

Thank you and good morning.

I have two questions on the expense front.

First, excuse my stupidity, Steve, but can you just give us a better understanding for how this whole things work with the retail on the comp expense in terms of why that number bumps up with the environment that we're in? And, secondly, on the non-comp side, clearly, you've

a lot of the firm to reduce non-comp expenses.

How far along on the recognition of that are we in the income statement? Is there more to go, how long does that last?

OK.

On the retail front, not a dumb question at all.

What the issue there is as revenue declines, there a higher percentage of compensation which is fixed. And - unlike the institutional business, where much more of it is variable.

So as revenues decline fairly significantly between the first quarter of last year and the first quarter of this year, you see an increase in the expense ratio.

On the non-comp front, you know, we're always focused on the potential to do more.

I think right now, absent a change in our market view - which is that there is

recovery in the second half - plus or minus non-comp should be in this type of range for most of the rest of the year. But that's - as always, they also reflect overall levels of market activity.

So have we already seen the benefit of the actions taken over the last year?

Yes.

OK. And so, obviously, we'll stay at that level. OK.

Yes.

Thanks, Steve.

OK.

Thank you all and we'll see you next quarter.