摩根士丹利 (MS) 2007 Q2 法說會逐字稿

Welcome to the Morgan Stanley conference call.

The following is a live broadcast by Morgan Stanley, and is provided as a courtesy.

Please note that this call is being broadcast on the Internet through the company's website at www.morganstanley.com.

A replay of the call and webcast will be available through the company's website and by phone until July 20, 2007.

This presentation may contain forward-looking statements.

You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date on which they are made.

Which reflect management's current estimates, projections, expectations, or beliefs and which are subject to risks and uncertainties that may cause actual results to differ materially.

Factors that could cause actual results to differ materially from forward-looking statements include but are not limited to the underlying assumptions and expectations related to the spin-off of Discover Financial Services, proving to be inaccurate or unrealized.

For a discussion of additional risks and uncertainties that may affect the future results of company, please see "forward-looking statements" immediately preceding part 1, Item 1, competition and regulation, and part 1, item 1 Risk Factors, and part 1 item 1A Legal Proceedings and part 1 item 3, Management's Discussion and Analysis of Financial Condition and Results of Operations, in part 2item 7 in Quantitative and Qualitative disclosures about Market Risk in part 2, item 7A of the company's annual report on Form 10-K for the fiscal year-ended November 30th, 2006.

Management's discussion and analysis of financial condition and results of operations and risk factors in the company's quarterly report on Form 10-Q for the quarterly period ended February 28, 2007, and other items throughout the Form 10-K and the company's 2007 reports on Form 8-K.

The information provided today may also include certain non-GAAP financial measures, the reconciliations of such measures to the comparable GAAP figures are included in our annual reports on Form 10-K, our quarterly reports on Form 10-Q, and our current reports on 8-K, which are available on our website, www.morganstanley.com.

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 program over to David Sidwell for today's call.

Thank you, operator, and thanks everyone or joining us today.

As you have seen from our press release, we have achieved net revenues, profit before tax, income and earnings per share from continuation operations.

We're very pleased with these results, as they reflect execution of our strategic growth plans and strong trading performance and client execution in very favorable markets.

Markets were strong and provided good opportunities.

Concerns early in the quarter about whether issues in the sub prime market were going to spread dissipated.

Equity markets rose, credit spreads and emerging markets and other markets tightened, the dollar weakened against most currencies, and there was a high level of client activity.

Including in the M&A and financing markets.

These factors more than offset the impact of increasing rates around the world.

Let me begin with an overview of our firm-wide results which are outlined on pages 1 and 2 of the financial supplement.

Second quarter income from continuing operations was $2.6 billion, which is a record.

Record earnings per share from continuing operations was $2.45 per share, versus $2.40 in the first quarter.

Diluted earnings per share were $2.45, this compares to $2.51 in the first quarter, which included $0.11 per share in our discontinued operations line related to the sale of Quilter.

Return on equity from continuing operations was 27.5%.

Net revenues were a record at $11.5 billion, 5% higher than in the first quarter, which was our previous quarterly record.

Total non-interest expenses were $7.6 billion, up 7%.

The largest component, compensation and benefits expense, was $5.2 billion, up from $5 billion for a compensation to net revenue ratio of 45%.

Non-compensation expense was $2.4 billion, up 13%, driven primarily by higher professional services and marketing and business development expenses related to the high level of business activity across all business segments following the traditional seasonal slowdown in these types of expenses in the first quarter.

That noncompensation to net revenue ratio was 21% this quarter.

Year to date, the non-comp ratio is at 20%, a significant improvement over the 23% ratio for the same period last year.

Our year to date tax rate for continuing operations was 33%.

consistent with last year's normalized rate.

Now, let me discuss business segment specifics.

Turning to Institutional Securities, detailed on page 5 of the supplement, we were very pleased with our results for the quarter.

The strength and diversity of our franchise was evident in the quarter.

As a sequential drop in fixed income sales and trading was offset by record revenues in investment banking and equity sales and trading.

During the quarter, we moved the real estate investing business from Institutional Securities to asset management to reflect how we now manage this business.

Prior results has been restated for this change.

Real estate advisory and certain passive limited partnership interests remained in Institutional Securities.

Institutional Securities net revenues of $7.4 billion were a quarterly record, up 4% from our previous record in the first quarter.

non-interest expenses of $4.4 billion increased 4%, driven by the high level of business activity.

Profit before tax at $3 billion, also a record, was up 4% from the first quarter's previous record.

And the margin of 40% was flat with last quarter.

Finally, we achieved a strong return on equity at 35%.

Looking at page 6 of the supplement, investment banking revenues reached a record $1.7 billion, a 65% increase from the first quarter.

All categories were significantly higher versus last quarter and one year ago.

Advisory revenues increased 94% to $725 million, which set a record for the firm.

Our M&A backlog remains very strong, up sequentially and up even more significantly year-over-year.

Equity underwriting revenues were up 64% to $493 million.

Our second highest quarter ever.

Our equity backlog is up significantly from the first quarter and last year's second quarter, with a strong pipeline of equity offerings across geographies.

Fixed income underwriting revenues were a record at $486 million, up 35% from the first quarter, driven by M&A and LBO activity.

Our debt backlog also is up quarter-over-quarter, and year over year.

We continue to be optimistic about the prospects for investment banking and our ability to provide advice, capital, and distribution capabilities on behalf of our clients.

Also, on page 6 of the supplement, you can see that we had a strong sales and trading quarter with total revenues of $5 billion, down 9% from our record first quarter.

Please note that we've modified our disclosure by adding an "other" sales and trading category, the sum of equity, fixed income and other sales and trading equals the sum of principal trading, commission, and net interest income on the Institutional Securities income statement on page 5.

Equity sales and trading revenues of $2.2 billion were a record.

Slightly higher than our previous record last quarter, reflecting strong revenue growth across client businesses in all regions, which more than offset lower revenues from robust levels last quarter in principal strategies.

Cash equities revenues were up 20%, driven by rising stock market indices and strong client volumes across all regions.

Derivatives revenues increased 2% to a new record because of higher client flows and new deal activity across all regions.

Financing products increased significantly during the quarter, driven by increased seasonal activity in Europe, and growth in client business, given the favorable market conditions.

This was a record quarter in prime brokerage with revenues up substantially on both newer counts and the 17th consecutive quarter of growth in global client balances.

In fixed income sales and trading, $2.9 billion in revenues was our second best quarter ever, down 16% from our record first quarter results, which included favorable positioning in the sub prime mortgage market.

We saw healthy trading performance and good levels of client activity across our fixed income business, across regions.

Looking at the results by product carrier, interest rate and currencies were up slightly with record results in emerging markets.

Most emerging markets rallied and credit spreads tightened to historic lows during the quarter providing good trading opportunities.

In addition, there was significant revenues from structured transactions.

Credit products declined 24% from a record in the first quarter, which included record securitized products revenues driven by favorable positioning in the sub prime mortgage markets.

The decline this quarter was driven by lower volumes and volatility in the mortgage markets.

This decrease was partially offset by record corporate credit results, driven by large structured transactions and trading activity.

Commodities decreased 22%, driven by weaker positioning revenues in electricity and natural gas, and less revenue from structured transactions across all business lines offset somewhat by strong oil liquids performance that was flat with the first quarter.

Principal transactions investment revenues were $396 million, a $46 million increase.

The increase was primarily driven by markups of principal investments, real estate limited partnership investments, and the revenue gross up associated with certain employee deferred compensation and current investment plans to reflect the returns on such plans in both revenues and compensation expense.

Over the quarter, while we increased the level of risk, on average we operated at a lower value at risk level than last quarter.

Aggregate average trading and nontrading value at risk was down $5 million to $87 million, with decreases in equity and commodities risk and slight increases in foreign exchange and interest rate and credit spread risk, as well as reduced correlation within the portfolio, which increased the diversification benefit.

Period end aggregate trading and nontrading value at risk rose to $93 million as we increased risk exposure during the latter part of the quarter to balance the level of risk with our view of market opportunities and the needs of our clients.

Stress testing scenarios, which help us manage less liquid risk showed a similar trend over the quarter.

We continue to allocate more economic capital to our Institutional Securities businesses, which is another measure of our increasing risk, as well as the increasing scale of this business segment.

In the quarter, total loans and commitments rose by $26 billion compared to where we were last year at this time, total loans and commitments net of hedges, have increased by $34.4 billion or 167%.

Non-investment grade loans and commitments have increased by $25.3 billion.

We continue to see considerable opportunities to bundle services, providing solutions for clients' needs, including event lending, as we grow our leverage finance business.

The current marketplace to our strengths through the spectrum of services we provide to our clients including advising, structuring transactions, and distribution capabilities.

Now, turning to page 8 of the financial supplement, and our Global Wealth Management business.

This quarter represents our best quarter in terms of net revenues since 2000.

Revenues reached $1.6 billion, up 9% from the first quarter, and is our third best revenue quarter reflecting high commissions due to continuation of favorable markets, increased asset management revenues, largely from higher balances in fee-based accounts, higher net interest due to the growth in the bank deposit program, as well as gains from investments in memberships and exchanges.

non-interest expenses of $1.4 billion were up 7%, reflecting higher incentive-based compensation costs associated with improved performance, as well as higher professional services, marketing and business development costs from the seasonally lower first quarter.

Profit before tax of $269 million was up 17% and profit before tax margin increased to 16% from 15%.

Return on equity increased to 41%, reflecting the improved profit before tax as well as slightly lower capital requirements.

This business continues to build on its momentum, showing improvements in many areas.

On page 9, you can see this in a number of productivity measures.

Net new assets of $8.7 billion represented our fifth consecutive quarter of client inflows and the highest it has been since we started tracking this metric.

Assets in the $1 million-plus household segment increased to $33 billion.

Increased by $33 billion, excuse me.

And are 71% of our total client asset base, versus 65% at this point last year.

Total client assets increased to $728 billion, and fee-based assets represented 29% of the total.

Our FA headcount is up to over 8100 producers.

Average production increased to a record $814,000 per global representative, as we continue to attract and retain high quality producers.

Total client assets per global representative also reached a record high of $89 million.

Our bank deposit program continued to grow, ending the quarter at over $18 billion on track to achieve our goals of $20 billion by year-end.

We had another successful product launch in coordination with asset management, the Morgan Stanley emerging markets debt fund with sales of $1.3 billion.

Finally, the introduction of more lending products to our clients continues.

For example, our portfolio loan account, which was introduced in November, reached over $1 billion in credit lines.

Let me turn to our asset management business which now includes the results of our real estate investing business, formally reported in Institutional Securities.

We decided to move this business from our investment banking division, strategically aligning it with asset management, alongside our equities, fixed income, and alternative offerings to clients, as real estate has matured and become a primary alternative asset class.

For the asset management business overall, we posted $9.3 billion of positive flows for the quarter, our third consecutive quarter of positive flows, more than double the first quarter.

This positive trend in net flows, along with strong market performance, have contributed to our record assets under management of $560 billion at quarter end, up 7% from last quarter, which is evidence of the progress we're making on our key initiatives, and the momentum being built in the business.

As you see on page 10 of the supplement, net revenues of $1.5 billion were a record, and up 10%.

Income before taxes was $306 million, down 20%.

Profit before tax margin was 20%, and return on equity decreased to 23%, driven by an increase in expenses and higher capital usage.

Management and administration fees increased 10% to $844 million, largely driven by higher assets under management in our core traditional equities and fixed income businesses, as well as higher incentive fees in our alternatives business.

Principal transaction investment revenues of $588 million were 11% higher than last quarter, this quarter includes $308 million in revenue from real estate, and $183 million from private equity, with notable strength in our ongoing Asia private equity business as well as from the wind-down portfolio.

These numbers include the gross-up in due deferred compensation related to these businesses offset by an equivalent gross-up in compensation.

Principal transactions investment revenues will be a growing but lumpy in nature part of our revenue as we build our real estate, private equity and infrastructure businesses.

Expenses of $1.2 billion were up 22%, driven by a number of factors.

Higher compensation was a result of higher revenues, the continued investment in the business across core, alternatives, private equity and infrastructure, and the gross-up of employee deferred compensation plans.

In addition, there were increases in professional services and brokerage and clearing expenses driven both by the increase in asset management and administration fees, and the recognition of up-front costs associated with the launch of products in our fixed income and infrastructure businesses.

Our expectation for the 2007 full year had been for PBT margin to be around 20% as we invest in our strategic growth initiatives.

With the transfer of the real estate investing business to this segment, and the strong principal transactions investment revenues in the first half of the year, we believe the margin could come in a few points better.

Turning to page 11 of the supplement, you can see assets under management or supervision increased by $39 billion to end the quarter at a record $560 billion.

The alternatives category now includes real estate investing, private equity and infrastructure partners in addition to the hedge fund and other alternatives offerings previously disclosed in this category.

We had $9.3 billion in total net inflows, which marks our third consecutive quarter of net asset inflows.

Positive net flows were driven by strengths in the non-U.S.

channel with $4.1 billion of inflows, institutional liquidity with $3.5 billion, $1.8 billion in the Americas intermediary channel, and $1.3 billion in the U.S.

institutional channel.

Retail liquidity outflows were $1.5 billion.

Morgan Stanley branded retail flows were slightly positive in the quarter for the first time in six years driven by sales of $1.4 billion from our emerging markets domestic debt, closed-end fund.

The majority of which was distributed through our Global Wealth Management sales force.

In addition to the impact of positive flows across market channels, we saw the benefit of strong markets.

We continue to broaden our product offerings and launch an incubated 15 new products, including five in alternatives, six in equities, and four in fixed income.

We will continue to launch products to meet the needs of our clients.

For example, our recently launched FX alpha plus risk control funds, part of a new suite of alternative strategies, raised over $1 billion from European clients in the three months since launch.

In summary, we are pleased with the traction we are getting with our investments for long-term growth, including product expansion and alternatives, and the progress we're making in developing our private equity and infrastructure businesses.

Results for our Discover business are detailed on pages 13 and 14 of the supplement.

Financial information and statistical data follow on page 15.

Profit before tax decreased 10% to $333 million from last quarter while net revenues of $1 billion were up slightly, expenses of $702 million were up 8%, driven by the decrease in PBT -- driving the decrease in PBT.

Looking first at revenues, interest income increased 2% to $970 million, due to high interest spread.

The yield was up slightly from last quarter and the cost of funds was stable.

non-interest revenues increased by $39 million to $596 million, while fees were flat, gains on securitizations were higher as we did more securitizations than in the first quarter.

Net credit income was down 6% to $439 million.

The increase in interest income was offset by the provision for loan losses, which at $531 million was up 10%, reflecting an increase in charge-offs to 4.24% from 4.05% in the first quarter.

In addition, the reserve release of $6 million was lower than last quarter.

The consumer credit environment in the United Kingdom remains challenging.

During the quarter, we took a $60 million increase in reserves, related to implementation of higher minimum payment requirements on certain accounts.

In the U.K., the net charge-off rate of 6.5% increased 5 basis points from the first quarter.

Having said this, across the entire portfolio, 30-day delinquencies decreased to all-time lows and while there was a pickup in U.S.

bankruptcy filings during the last months of the quarter, filings still remain below normalized levels.

Consistent with the industry, our U.S.

bankruptcies have not returned to high levels as quickly as we had expected.

It is likely that Discover will finish 2007 at the lower end of the previously expected charge-off rate range of 4 to 4.5% for the full year.

Turning to expenses, non-interest expense increased 8%, driven by higher professional services fees and other expenses, including $20 million in spin-related expenses split equally between our U.S.

and U.K.

businesses.

And higher Visa and Mastercard litigation legal fees.

Discover anticipates an additional $30 million in expenses to be incurred as a stand alone company in the second half of 2007 related to the spin.

Marketing and business development costs, while flat relative to the first quarter are tracking up 8% for the first six months versus the same time last year.

Discover expects marketing and business development spending to be higher in the second half of the year, although full-year spend will be similar to 2006.

Period end receivables showed sequential organic growth for the fifth consecutive quarter due to increased net sales volume and stable payment rates.

In sum, our U.S.

business is performing well, with sales and receivables expected to continue to grow and strong credit performance expected to continue, although loan losses are expected to gradually increase as bankruptcies trend towards more normal levels.

In the U.K., we're working hard to limit the compact we're facing due to the adverse credit environment, which has produced a significant profit before tax loss of $64 million in the quarter, following a loss in the first quarter.

As I previously mentioned, and as discussed in its form Ken, Discover will incur higher funding costs and certain compensation costs, as it operates as a stand alone company.

Finally, regarding the spin-off of Discover, we're on track to complete the spin on June 30th with attributable capital of approximately $5.4 billion.

Beginning in the third quarter, Discover's June results will be reported in discontinued operations, and prior period results will be reclassified to that line.

Certain overhead costs previously charged to Discover in periods prior to the spin will be reallocated to the continuing businesses and restated in previously issued financial statements.

These charges are approximately $20 million per quarter.

Discover will be issuing a supplemental earnings release for the second quarter later today.

Finally, we expect Morgan Stanley's effective tax rate from continuing operations will decrease slightly and share count will be slightly higher following the spin.

During the quarter, Morgan Stanley repurchased approximately 18 million shares of its common stock for approximately $1.4 billion, and year-to-date we have repurchased approximately 33 million shares of common stock for approximately $2.6 billion.

With respect to the pace of repurchases, we evaluate and balance the needs of our business for additional capital to invest in organic growth and make attractive acquisitions with our objective over time of offsetting the dilutive impact of equity compensation to employees.

We have $3.4 billion remaining under our current board authorization.

Finally, the outlook.

The markets have generally remained very healthy despite recent interest rate hikes and weakness in U.S.

residential mortgage markets.

Global liquidity remains strong with large pools of uninvested capital and the capital markets continue to have a brisk level of activity.

I mentioned earlier that our investment banking pipelines across advisory, equities and fixed income are strong.

In addition, the level of client activity in our sales and trading businesses remains strong.

Obviously, results in our principal investment activities will depend on the overall level of the markets.

While I cannot predict our short-term performance, we will have very tough comparisons given the significant strengths we demonstrated in the first six months of 2007.

Any slowdown will lead to a tough sequential comparison.

In addition, the third quarter tends to be seasonally slower both on the retail and institutional side.

Having said that, we remain optimistic about the future for Morgan Stanley.

We continue to invest in the long-term growth of our businesses, and believe we are well-positioned to deliver value to shareholders as we implement our strategy to capture the substantial growth opportunities we see around the globe.

So that's the end of my formal remarks and I very happily take your questions.

Ladies and gentlemen, please stand by for the question-and-answer portion of today's presentation.

Thank you, your conference will resume momentarily.

This question comes from the line define of Guy Moszkowski with Merrill Lynch.

Good morning, David.

Good morning, Guy.

I was wondering if you could talk through the rationale on the funded and committed loan balances up 41% with the hedges up only 15% so your net position is obviously up considerably more, granted more of that growth in investment grade.

But again, maybe you can talk through the rationale for increasing your net unhedged exposure by quite a bit?

Okay.

Let me talk, provide the context which is really the business context.

As you know, we have been very focussed on building out the product offering for our clients and we continue to see very good opportunities to provide solutions to our clients and that would include advisory services, M&A broadly, as well as providing leverage finance and ultimately distribution.

That is really the context of this business.

If you remember, we've identified this as an area that we had not invested sufficiently in, and we have been making that investment.

We have been, as a result of that, growing the balances that are as a result of continuing that activity.

Obviously, to the extent that we can hedge the exposure, we do.

Obviously, we actively risk-manage the portfolio in terms of making sure that we maintain very high credit standards, we, in all cases understand how the extension of credit fits within the overall strategy for the client and the revenues we get from this bundled service.

And finally, we focus on our ability to distribute.

So this increase, while I know on paper it looks very significant, is part of what has been an essential part of continuing to develop the business in support of our clients.

Thanks for that.

Moving on to, more broadly, the employment in excess unallocated capital, obviously you brought that balance down, I guess on an average basis for the quarter, pretty meaningfully from about $5.1 billion to about $4.2 billion.

Maybe you can just comment at a very high level of how you think about the split between redeploying some of that in the businesses in the quarter versus sort of net share repurchase.

Okay.

There has been no change in philosophy, which I think is a good place to start.

I think you've heard me say a number of times that every quarter we look at the future expectation around the generation of equity, which is primarily through earnings as well as exercise of options, but it's primarily earnings, the uses of capital, which would include our dividend payments, and also both the organic and acquisition needs of our various businesses.

And obviously, as you say, when you look at the second quarter, you had a mixture of uses of capital across our institutional business and our asset management business as we did that.

So what we did each quarter is look at our expectations going out and determine amount of share repurchases that we feel comfortable with, and that determination also considers the price of our stock, so that we very actively manage our capital base and we actively manage our share repurchases within the context of the approval we receive from our board, which was to buy back $6 billion worth over the 18-month period till the end of June, 2008.

And David, just to follow up on that, in terms of how we should think about the reduction in excess capital that you achieved during the quarter, how would you divide that reduction of almost a billion up between the net share repurchase and redeployment into the business?

Well, actually, as you know, you know the amount we repurchased, you also know the amount that we paid in dividend, and the math is simple.

Actually, you can see that we deployed, for instance, in Institutional Securities, an additional on average, $2.8 billion.

We deployed an additional $400 million in Asset Management.

Okay.

I'm just -- I've just come into the idea though, that, trying to get to the idea that since the net reduction is less than those amounts, there must be sort of a calculus more or less as to --

Well, you've got the share repurchase and the payment of the dividend, those are the other ingredients you need to do the math.

Okay.

I won't beat the horse on that one.

The final question I'd have for you is can you just give us a sense for the international revenue contribution ex-Discover and perhaps if we could just drill it down to just the institutional business, too, what percentage would that be?

We have overall, as you know, our Discover business is primarily a U.S.

business.

And again, using our year-to-date revenues, which I think is better place to go, using our full firm 58% of our business is in the U.S., that is actually decreased from around 60, 61% in '06.

Europe has seen the increase, and Europe is around 30%.

It was around 26%.

And the balance in Asia is Asia, which has been around 12%, consistently in both time frames.

To be honest, I haven't done the math to take out the Discover revenues, but on balance they had revenues of just over $1 billion in the quarter.

So I don't think it changes these trends hugely.

Okay.

Great, thanks very much, David, appreciate it.

Sure.

Thank you, sir.

Our next question comes from the line of William Tanona with Goldman Sachs.

Hey, David.

Obviously investment banking was very, very strong this quarter and you highlighted how your record investment banking pipeline, but I guess, was there anything in this quarter that was of meaningful significance?

One or two deals that we should be thinking about?

And as we kind of look ahead for the next couple of quarters, I know it a record pipeline, but is it realistic to kind of just assume that this is a new run rate?

Well, I think I'd always make the caveat that the actual timing of when the pipeline shows up in revenues is always subject to the specifics of any deal.

I think the point I would make across all of the investment banking businesses, whether it was advisory, equity or debt, was the diversification and that would include across all of the regions did really very well.

I would say that the pipeline is also very well diversified.

Okay.

And then if we could switch gears a little bit and go towards the investment management business, I know you guys had been targeting people to low 20% margins, but I think that was kind of, you know, everybody's expectations was that would be prior to the reallocating of the business from securities into investment management.

So looking at that, I was surprised to see margins going down so dramatically, considering that you had some investment gains there and given the hedge funds that you had purchased.

And I know you kind of gave us updated guidance but why is the core business margins going down so dramatically, it appears?

Well, I think that -- and I hope we've been reasonably clear about this, this was why we had actually said that the margin would trend to 20% over the last couple of quarters when we're giving guidance, is because we are continuing to make investments not just in our private equity business, which, as you know, we're just in the process of building the team there and building out the team in our infrastructure funds business, but also given the nature of the arrangements on the acquisitions of some of the alternatives, I think we also indicated that the payouts would be higher compared with revenues in the near term as there were earn-out provisions in a number of those transactions.

So I think the -- our expectation was that margins were going to be lower.

I think you're right that the investment revenues have benefited from just the very robust market conditions, and that's why I said a little bit ago that we would expect the margins to potentially be a few points higher than the 20% guidance that we had given.

And that obviously includes the benefit of moving the real estate investing business into this business.

Okay.

And as you think about this business in a little bit of a longer term perspective, knowing all the investments that you're making, I mean, how long do you think it is before you actually start seeing industry-like margins, particularly as you move more into the alternative space?

I think we're talking three to five years.

I think that's what we said when we spoke at a conference a couple months ago and I think obviously we have actually received the benefit of these fairly significant investment gains and obviously by nature they're going to be fairly lumpy.

So the move from this sort of 20, low 20s margin to get to the high 20s, low 30, is definitely going it take some time.

Okay.

And then on the flow size, can you give us some color as to, how much of that came from alternatives?

And you mentioned a bunch of new fund launches and so just to get a perspective as to where those fund flows are coming by product?

Off the $9.3 billion, about a third was in real estate, and the other largest component was from core.

Great.

And then lastly, in terms of noncompensation expenses, I know historically we've always seen seasonality on the revenue side but also on the non-comp side with non-comp expenses being higher in the back half of the year.

What would be your kind of expectations for this year on the non-comp side?

Well, I think we have seen obviously extremely strong revenue environment over the first half of the year, and to the extent that that pace would continue, certainly many of the expenses are related to the level of activity, whether it's brokerage and clearing, whether it is in some of the T and E as people travel around the world to get the business.

I think that you're right, that the first quarter tend to be the lowest, and you see an improvement or an increase over the rest of the year.

We are trying to stay very focussed on having a non-comp to revenue ratio be a little better than it was last year, but I think what's important to realize is that we continue to invest in people in the space needed to house those people, the related technology, as we are very optimistic long term about the markets we're operating in.

That's helpful.

Thanks, David.

Our next question is from the line of Mike Mayo with Deutsche Bank.

Just to clarify, are your backlogs at record levels or just up from the first quarter?

They're up substantially.

To be candid, I don't have a long enough file back in history to make sure when I use the word "record," so they're up substantially both from this time last year and from the first quarter.

So in recent history they're a record at least?

They're very good.

And then another follow-up, your non-U.S.

42% outside the U.S., what was the growth rate of the U.S.

versus non-U.S.?

The growth rate was obviously higher in Europe than in the U.S.

As I said, Europe's about 30% of our business, the U.S., 58%.

So by definition, the growth rate is higher in Europe than in the U.S.

Link quarter was that true, in other words, your revenues were up about 5% link quarter, what were they up link quarter outside the U.S.?

Actually, looking at the six months, the trends were stronger in the first three months in the second half in terms of the growth in Europe.

But again, I just think that given the nature of our business and where we book trading revenues, I personally prefer to use the longest time series I can.

So I feel better with year-to-date data than single quarters.

And do you have any target where you think non-U.S.

might go especially with the spin of Discover, you're going to be close to half non-U.S.

Over time, we believe that the market opportunities in the emerging markets are very significant, and the pace of growth in those markets can be and are likely to be significantly higher than they are in the U.S.

and developed Europe.

Obviously, in the near term, the profit pools in the U.S.

and developed Europe, by definition, are much larger so you're going to see us continuing to invest in both the developed markets and the emerging markets.

So actually how this mix will change over time is really going to be a balance of the opportunities.

But we are, just so I leave no doubt here, we are intent on investing outside of the U.S.

and developed Europe, and I think you've heard us talk about the investment we're making in China, the investment we're making in India as we got out of our joint venture arrangement, the investment we're making in East Europe, and we continue to stay very focussed on Latin America.

Russia has been a very significant area where Morgan Stanley in Russia is a full-service firm, and feels and looks like a very full-service firm.

So we are very committed to developing non-U.S.

and non-developed Europe business.

And lastly, the brokerage business, obviously you're doing some things on your own, revenues were up.

But how's the environment?

It's actually, I think as the environment in wealth management really from two perspectives.

One is our business, and I think that if James was on the phone, he would say that the business is definitely stabilized, that when you think about the turmoil the firm went through, that obviously resulted in attrition of some very good people and difficulty to recruit talent.

As you saw from the fact that we increased our FA count to 8100, and that was an increase over the first quarter, that reflects both our success in retaining people, and in recruiting people.

That's very important.

The second aspect is that we continue to focus on developing the products that are of interest to our clients.

So the fact that when we launch this emerging markets debt product in the quarter, it was so successful with our wealth management client, demonstration with the types of things we're trying to do, as we target this million dollar-plus household range, it's going to be very important to offer them product they want.

The third aspect of environment is obviously the market at whole, and I think we have been very pleased that with the level of investor activity.

Also, I would highlight that in terms of the mix of our business, the amount of fee-based business as a proportion of the total is also higher than it's ever been, and that's a very important metric going forward.

Thank you.

Thank you, sir.

Our next question comes from the line of Douglas Sipkin with Wachovia.

Hi, good morning, how are you?

Hi, good morning, Doug.

Just a couple of questions here.

First off on the equity trading business, just hoping you can maybe shed some light on how big of a factor the sort of extension product, i.e., the 130/30s are starting to become and what sort of opportunity can that be for you guys on the prime brokerage side given that you're pretty much the leading firm in the world?

Well, prime brokerage, as I said, we had record results this quarter on the growth in both balances and new clients.

So prime brokerage is something that we view as a very strategically important business.

We think that we have a leadership position in the market and we're going to continue to invest in prime brokerage to support our clients.

But when you think about -- I mean, just 130/30s, is that a significant long-term opportunity for you guys or sort of an incremental positive?

To be honest, I'm sorry, I just don't have that detail at my fingertips.

Okay, no problem.

Just moving over to the resail segment, obviously you guys have made a lot of strides there.

Just looking for a couple of points.

One, margin 16%, can you just update us on what your targets are for that?

And two, given that you really have turned the business around 180 are you guys in a position, maybe you would start considering growing inorganically in that segment?

I think that, look, we're incredibly pleased with getting the margin to 16%.

I think what is relevant here is that it was 15% in the first quarter and we feel that we have reached a level of stabilization, which is important.

We continue to develop the product array to support our clients, and that includes new product offerings like the emerging market debt offering.

We continue to be very focussed on extending into products where we have not had very large balances like banking products, lending products, I mentioned one of them in my prepared remarks.

And we continue to stay very focussed on additionally penetrating the million-plus household range, both with new clients and increasing share of our existing clients.

To some degree, that would depend on further growth in people.

And so we're very optimistic with the headcount increases that we saw this quarter.

It's going to be a combination of those factors which is going to enable us to increase our margins over time.

We've had an extraordinary pace of improvement over the last 15 months since James joined.

I don't think the pace is necessarily going to continue as fast, although we remain very optimistic that we're going to get to where we need to get.

On the question of inorganic opportunities, I think we will consider -- continue to consider those opportunities.

I think you've heard me talk about our willingness to do that in the past.

And obviously now the U.S.

business is stabilized.

We are very focussed on developing our international private wealth management business, and -- wealth management business and would love to have a larger private bank, for instance, in Europe.

Okay.

And just finally, how should we be thinking about the potential change in the SEC rule or lack thereof around fee-based accounts?

How if at all will that impact Morgan Stanley's wealth management business?

The short answer is we don't believe it will have a significant impact.

Probably the major reason is that the clients that we have using this product, we believe that those clients will move their assets into different products.

And secondly, which is more defensive answer, it's a relatively small percentage of our assets, 5% would be enough a number for that.

Great.

Thanks for taking my questions.

Sure.

Thank you, sir.

Our next question comes from the line of Michael Hecht with Banc of America.

Hey David, good morning, how are you doing?

Good morning.

I know you're with us until the end of the year but congratulations on your announcement that you reached retirement.

Thank you very much, although I wouldn't retire if it was going to be these record results every quarter.

Right.

I just wanted to come back on the ROE.

I mean, on an overall basis this quarter, 27.5%, 34% for the non-Discover businesses, but I was just trying to think about the new continued ops ROE, given that Discover was only 16% ROE.

Do you have what the ROE was excluding Discover, kind of including the excess capital you guys have?

I can obviously do the math for you, which is basically if you allocate, which I think is the right way of doing this, all of the unallocated capital to the securities businesses, you'll see that that changes ROE by a couple of points.

So the 27.5 would move to 29.5.

Okay.

Great, that's helpful.

On the Asset Management business, do you have a run rate margin for that business excluding the investment gains and incremental expenses obviously you referred to, kind of stripping that out?

I'm sorry, would you repeat that question, please?

Sure.

On the Asset Management side, kind of a run rate margin excluding the investment gains this quarter?

We don't think of the business that way, I think is the right answer.

We-- as we have now focussed on building our private equity business, building our alternatives business, building our infrastructure business as well as moving in real estate, I think we recognize that there is going to be some lumpiness in the way those revenues come in.

And so I think that while we're very focussed on improving margins overall, we are doing that by looking over all as opposed to trying to pass the business into subparts.

Okay, that's fair enough.

Just to come back on the retail margins this quarter, I mean 16% this quarter versus 15% last quarter, it just seems they're tracking higher than we expected and even increasing kind of more quickly.

Should we be thinking about the first half margins here as more of a run rate and any change in terms of timing and longer term goals you have been thinking about in that business?

I think I would say that we would hope that 15 is a sort of new floor, is probably the way I think of it, that we would expect to do better than that.

But obviously we want to make sure we're making the right investment in the business.

So but we would obviously update you if we see anything that would impact margin from making additional investments.

But I think we believe that it should be possible at this point to have a margin higher than 15.

Okay.

Then just one more follow-up on retail.

Can you talk a little bit about the recruiting trends for brokers, how aggressive you guys are being today and any color just on the competitive environment you're seeing?

Well, part of the reason that our headcount has increased in wealth management has been that we've continued to match the pace of recruiting that we had been seeing in the first quarter, and also that we've continued to see a decrease in the level of attrition.

Obviously, we would expect to continue to recruit going forward, and we make sure that we feel comfortable with the compensation arrangements that we've made with the people that we bring on board.

Okay, that's fair enough.

Just last question, I wanted to follow up on Discover, the $30 million incremental expense you talked about second half, that's second half run rate, does that include allocation of Morgan Stanley overhead and funding costs or what's in there?

The 30 million is -- does not include that funding costs and is the incremental costs like consulting and other costs to do all the things they need to do to continue to operate as a stand alone company.

Okay.

I got it.

Thanks.

Not allocations from us.

Okay.

Thanks a lot.

Thank you, sir.

Our next question comes from the line of Meredith Whitney with CIBC World Markets.

Hi, David.

How are you?

Excellent, thank you, and you?

I wanted to ask you, all the way back to the beginning of the call and ask you a related question on Guy's comment and tie it back to last quarter's conference call when you were gracious enough to talk about the velocity of the loan balances.

If you could provide similar commentary this quarter and update if things have changed materially or if things are identical, that would be helpful.

Also you talked about the full product solution for your clients and it is remarkable in terms of the market shares that you and Goldman possess in global M&A.

Can you talk about how the ability to do this has solidified your market share in these businesses over the last even two years, some qualitative comments talking about the advantages of this strategy?

Okay.

That would be helpful, thanks.

Let me start with your first question which was about the velocity, and I would say there's not been from our perspective a significant change in that, that on balance, three months was the guidance I gave in the first quarter, and I'd say that that holds true today.

Obviously, our strategy here is to distribute this product.

In terms of how important these activities are to the M&A markets, they're extremely important.

Because if you look at where advice is being given, it is in the category that is then requiring financing.

So if we had not put resources against this sector, both in terms of client coverage in terms of the clients who are originating these activities and also make sure we were aligning the -- our advisory business and our leverage with that, I don't think you would have seen us be as successful as we've been over the last couple of years.

This was a very important part of our strategic growth initiative and to be candid, we would be nowhere near as well-placed in terms of the lead tables, and that would include equities, because IPOs tend to be the exit strategy.

Okay.

And then just one follow-up on that, which is you guys have a good reputation of risk management.

Can you talk about, then, if a larger commercial bank would want to come and attempt to offer the same type of packaging and full resource product offering that, let's say, you or Goldman would, what you're seeing in the marketplace and very decidedly what you are not doing versus what they are doing and getting into even some of the bridge equity commentary.

And then I'm done, I promise.

Okay.

That was a big question.

Look, these are incredibly competitive markets and the competitors, and you can see this from the lead tables, are clear, they include at the top of the tables, the commercial banks and then the investment banks are below the large commercial banks.

You obviously are competing with people who are providing advice, providing capital, and providing distribution in the way we are.

So a lot of this depends on your client relationship on your ability to structure transactions, and we believe that we are very good at doing that.

But ultimately what we believe is important in terms of what hits our balance sheet is making sure that we understand the credit and that we maintain very high credit standards.

And that is something that we are extremely focussed on doing.

Because ultimately what is important is the quality of the credit.

So then any commentary on the bridge equity?

I'm trying to answer it more broadly than just the market here, there's a market dynamic, and we are very careful about the credit that we participate in and those that we don't.

And I think there's been obviously a lot of commentary around credit standards, the documentation standards, the evolution of this market, and so I'm trying to answer in a broader way, saying that we will be very selective about where we participate to make sure it meets our standard.

All right.

Thank you so much.

Thank you, ma'am.

Our next question comes from the line of Roger Freeman with Lehman Brothers.

Hi, good morning, David.

Hi, Roger.

I guess, if we look at fee-based assets and the Global Wealth Management business, fee based assets as a percent of total client assets, looks like it declined a bit in the quarter essentially essentially, first time really in a while, at the same time, commission revenues as a percent of non-fee-based assets increased a little more than they have been.

Was there any mix shift that you can point to in the quarter in terms of retail clients becoming sort of more active on the trading front that would explain these moves?

No, I don't think there's anything there.

This is a trend, the trend actually I find that I stay very focussed on if you look at, for instance, the accounts with greater than $1 million, that increased to --

That's right, that one did increase.

So you know, I just think in any one quarter, you're always going to see some mix.

But I think the overall trend we feel very good about.

Okay.

And then I guess just to follow up on your commentary around the growth in FA's in the quarter, sequentially, that was up a fair amount more than the sequential increase in the first quarter.

I guess I was under the impression that the total for the year would remain relatively flattish, sort of net of attrition.

Is that not the way to think about this?

Is the second quarter jump an outsize one, maybe relative to incoming classes or something?

As I said in my prepared remarks, actually, you're absolutely right, we had targeted 8,000 as being the number.

When we looked last time at this.

But because of the fact that attrition has slowed down and we continue to recruit, I think that we would expect to see numbers higher than the 8137 that we had at the end of the quarter.

Got it.

Okay.

And then just more broadly speaking, in the -- with respect to alternatives, obviously you've been active in making some acquisitions in that area over the last few quarters.

Are you seeing any -- are you seeing increases in valuation?

Can you comment?

Obviously, some of the other large brokers have been bulking up in that area, too, from the demand side, is that starting to push valuations for these alternative asset managers up?

I think we feel extremely positive about the acquisitions and interest that we've taken, FrontPoint has gone extremely well.

Lansdowne is another example of something that's gone extremely well.

Obviously, the -- there's a huge demand for these assets in the marketplace, but we consider them asset by asset, look at the management team, look at the potential, and obviously price is one of the factors that we would consider.

But I think we feel very good about the transactions that we've entered into so far.

Okay.

And then lastly, you commented how fixed income benefited last quarter from or the of favorable positioning from a hedging standpoint in the mortgage area.

Would you characterize -- how would you characterize your positioning in the mortgage area, mortgage space in the second quarter?

Were you down just more as a function of sort of a decline in activity in the market in some marks or was there sort of negative positioning, i.e., betting the wrong way?

The first quarter we really did benefit from the market conditions in subprime.

As I mentioned, spreads didn't really move a whole lot during the second quarter, so there were lower opportunities.

We certainly did not lose money in this business.

Got it.

Okay.

All right, thanks a lot.

Thank you, sir.

Ladies and gentlemen, we do have time for one final question, and our last question today comes from the line of Steve Wharton with JPMorgan Chase.

I just have some specific questions on the Discover spin.

I happened to notice in your average equity, common equity that the capital allocated to Discover went from like $5.5 billion to $5.3 billion.

So when we think about this, is that the capital that will go away with Discover, is there a little bit of reduction in the capital?

I think the number is going to be around 5.4.

5.4.

Okay.

And then I just wanted to clarify, it's my understanding if they get a big settlement in this Visa/MasterCard exclusionary damages suit, like the first $700 million goes to you; is that correct?

My suggestion would be you look at the form 10 for all of the details of this.

What I was just trying to get at basically is that are you going to pay any of the ongoing legal costs associated with the suit or is that all going to be borne --

That I can answer.

That is paid by Discover, and is used in the -- will be used in the calculation of the proceeds that get available to be split between us and Discover.

I see.

Okay.

That was it.

Thank you.

Okay.

Thanks everyone very much, and we look forward to speaking with you in the quarter and if not, on the next quarter's earning call.

Thank you very much.

Ladies and gentlemen, thank you for your participation in today's conference.

This does conclude your presentation and you may now disconnect.

Have a wonderful day.