摩根士丹利 (MS) 0 Q0 法說會逐字稿

Good day, ladies and gentlemen, 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'ss website at www.morganstanley.com.

A replay of the call and Webcast will be available through the company's website and by phone until January 19th, 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.

For a discussion of the additional risks and uncertainties that may affect the future results of the Company, please see forward-looking statements immediately preceding part one, item one, competition and regulation, in part one,item one, risk factors in part one, item one-A, legal proceedings in part one, item one, Managements discussion and analysis of financial condition and results of operations in part two, item seven, and quantitative and qualitative disclosures about market risk in part two, item seven-A of the companies annual report on Form 10K for the fiscal year ended November 30, 2006.

Managements discussion and analysis of financial condition and results of operation and risk factors in the companies 2007 quarterly report on Form 10Q and other items throughout the Form 10K and the companies 2007 current reports on Form 8K.

The information provided today may also include certain nonGAAP financial measures.

The reconciliations of such measures through the comparable GAAP figures are included in our annual reports on Form 10, our quarterly reports on Form 10Q, and our current reports on 8K, which are available on our website at 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 copywrited and proprietary to Morgan Stanley.

At this time I would like to turn the program over to Colm Kelleher for today's call.

Please proceed.

Thank you, Operator, and good morning, everyone.

Before I go through the details of our results, John Mack has joined me and will begin the call.

John?

Good morning, everyone.

The results we announced today are embarrassing, for me, for our firm, this loss was the result of an error in judgment that occurred on one desk, in our Fixed Income area, and also a failure to manage that risk appropriately.

Make no mistake, we've held people accountable.

We're moving aggressively to make necessary changes.

This loss shouldn't be overshadowed -- the fact that the rest of the firm delivered really outstanding results for the quarter and for the year.

We had a record full-year result at Investment Banking, Equity, Sales and Trading and Asset Management.

Global Wealth Management more than doubled pre-tax profit for the year.

The fact is our core business remains strong and we're moving quickly and decisively to build on that momentum.

The strength of our business and our strategy is clear in the approximately $5 billion long-term investment we've announced this morning from CIC, a China Investment Corp.

This investment will help us further bolster Morgan Stanley's strong capital position while also building on our deep and historic ties and market leadership in China.

It also will insure we have resources necessary to pursue the growth opportunities we see in this region.

Across all of our businesses: Institution Securities, Wealth Management, Asset Management businesses, into '08 and beyond.

Now, before Colm takes you through this quarters results in detail, I've got a few things I'd like to say.

First, let's talk about the writedowns in our mortgage business.

We had a [lark].

Second, we have a strong performance across our other businesses.

And third, actions we've taken to address this quarter's loss and build momentum across the rest of the firm.

So let's start with the mortgage business.

Let me give you a quick recap of what lead to this writedown on our subprime trading position.

We had a large liquid trade on our books and a deteriorating credit market.

The early view was to hold a position rather than incur the cost of the unwind, as it was believed we had adequate hedges in place.

However, the hedges did not perform adequately and extraordinary market conditions of late October and November.

Subsequently, we -- given the illiquidity of the positions we're now writing it down to these levels.

We have moved aggressively to address these issues.

We've been as transparent as possible about our exposure.

Indeed, back in early November, we provided you details on the net exposure of the subprime trading position in our mortgage business.

We told you that as of October 31, we expected to take a $3.7 billion writedown of this subprime position.

We also made clear that our year-end marks would depend on market conditions.

During the month of November, the value of that position continued to deteriorate that lead us to writedown another $4.1 billion on the subprime trading position in the fourth quarter.

We were also taking a writedown of $1.6 billion on other mortgage-related assets that had suffered deterioration in value as a result of dislocations in the mortgage market.

And Colm will take you through that later on.

Virtually all writedowns this quarter was the result of trading by a single desk in our mortgage business.

But I want to be absolutely clear, as the head of this firm, I take responsibility for performance.

Let's go to our other businesses.

Beyond the loss of our mortgage business, almost every other business at Morgan Stanley continued to perform exceptionally well this quarter, and as I said earlier, strong for the year.

Our Investment Banking revenues were a record $5.5 billion this year, up 31% from last year.

We finished ranked number one in global completed M&A and number three in global IPOs.

Our Equity Sales and Trading revenues were a record $8.7 billion, up 38% from last year.

We had record results both in derivatives and prime brokerage where we continue to be market leaders.

Equity underwriting revenues were up 48% at a record $1.6 billion.

Our Global Wealth Management business has been dramatically reinvigorated.

Revenues were up 20% from last year.

We had a PBT of $1.2 billion, up 127%.

Margins at 21% in the fourth quarter, the highest quarterly margins since 2000, and a major improvement from the 2% margins this business delivering in early '06.

Our financial advisors are now the most productive in the industry with a record annualized FA productivity of [$853,000] and we had a strong client in flows of $40 billion this year.

Our Asset Management business also delivered its best year ever in '07.

We had record revenues of $5.5 billion, up 59% from last year.

We had a record PBT of $1.5 billion, up 72%.

We achieved five consecutive quarters of net customer inflows.

Our Asset Management business also reached a record high of $597 billion at the end of November, up nearly 35% from two years ago.

Our international business had never been stronger across Europe, Asia and the emerging markets.

We achieved record international revenues of almost $16 billion this year, up 44% from 2006.

In Asia, we finished the year ranked number two in IPOs overall and number one in China-related international IPOs.

In China, we have tripled our revenues over the past year.

We have secured a banking license.

We are now in the process of obtaining a securities license, a trust license, and an asset management license, which we will help -- which will help continue strengthen our Chinese business.

We're also building out our business in the Middle East as well, forming a joint venture with Saudi Arabia Securities Firm, Capital Group, and opening new offices in the region.

Those important investments have helped us increase our revenues about 90% in the Middle East since '05.

Now let me move to kind of the actions that we've taken.

While we've moved very aggressively, as you know, the issue raised by our loss in the mortgage business insure that we're well positioned to build on our business going forward, so we made some major changes.

We've put in place a new senior management team, with James Gorman and Walid Chammah as Co-Presidents, with Mitch Petrick as Global Head of Sales and Trading, and Ellyn McColgan as Head of Our Wealth Management Business, which we announced yesterday, I think it was in the press.

We've also made other changes to restructure our institutional sales and trading businesses.

We're further strengthening our risk management function.

It will now report to Colm, our CFO, and we will look to add additional talent to our risk management team.

We're also restructuring our [prop] trading businesses.

These businesses will operate under unified management reporting to Mitch.

Finally, as I mentioned earlier, we have further strengthened our balance sheet by raising approximately $5 billion in capital through the long-term passive investment made by China Investment Corp.

That investment grew out of our strong relationship in China, and I believe will help to strengthen our deep ties to this critically important growth market in the years ahead.

So as we move forward, I'm confident these actions of the new leadership team we put in place will help us adjust to the changing market conditions.

The near-term outlook is challenging.

The mortgage business is going to be dramatically reduced, credit and leverage lending will be on a lower basis as well, however despite challenging credit markets, we see opportunities at other parts of our Fixed Income business, as well as in Equities and Investment Banking.

We continue to have strong momentum in Asset Management and Global Wealth Management, and we remain bullish on Morgan Stanley's significant growth opportunities in our international and emerging businesses.

The fact is that we have a strong broad-based business.

We're positive about our business mix and we continue to believe diversification is a great strength of ours.

And despite the challenging market conditions we're facing, we're optimistic about the long-term prospects for this global growth financial services and for Morgan Stanley.

And with that I'm going to turn it over to Colm.

Thank you, John.

We have a lot of material to cover today and it will take some time, but I want to make sure that we provide you with all of the information you need for your analysis.

There will be plenty of time for questions and answers.

As you are aware over the past year our trading group decided to short the subprime market.

The traders were short the lowest [trench of] subprime securities with a value of approximately $2 billion.

The trade has decided to cover the cost of the negative care in the short position.

To do so they went longer approximately $14 billion at the super senior AAA or BBB subprime securities we refer to as mezzanine.

As the credit markets declined dramatically the implied cumulative losses in the subprime market cashed into the value of the super senior AAA trench we were notionally long.

As a result, notwithstanding the short position, the implied losses of the notional long generated a major net loss from the position with mark-to-market.

The loss was nonlinear with a decline of the relevant ABX index given the long/short structure of this particular trade.

Now, when I lost spoke with you in November, we provided risk management nonGAAP perspective on our U.S.

subprime exposure through October 31.

On page 15 of the supplement, you can see the updated schedule through November.

Our writedown reflected the impacts of November increased to $7.8 billion from $3.7 billion as of October 31, while our total net exposure decreased to $1.8 billion from $6 billion over the same period.

Using consistent valuation methodology, the fair value of these positions declined from October 31 to November 30.

Our valuation of these positions takes into consideration observable trades to continue deterioration and market conditions, the decline in the ABX indices, and other market developments including updated mortgage remittance and cumulative loss data.

The decrease in the fair value of our subprime exposures has lead to our first quarterly loss.

The trades we observed were those we executed in November as part of our effort to reduce our exposure.

The ABX deterioration in the class of super senior positions, mainly the BBB 061 vintage, were almost significant exposure rest was approximately 24% during November, which relates to 2005 collateral.

And in addition to the $7.8 billion in subprime writedowns, we also wrote down approximately $1.2 billion in other mortgage-related positions as a result of fair value declines in November, of which $400 million relates to CMBS for trades or executions as part of our balance sheet reduction, $180 million in Alt-A and other loans, where credit spreads widened and [remissions] data deteriorated, $175 million in first and second end loans meant for securitization on subordination changes by rating agencies and executed trades, and $450 million in European nonconforming loans on credit spread widening and executed trades.

We also took a $435 million writedown on the securities available for sale portfolio in our subsidiary banks.

We continue to see value in this portfolio, which is made up as exclusively of AAA-rated residential mortgage-backed securities when the portfolios contain no subprime whole loans, subprime residuals or CDOs.

This portfolio was redesignated as trading effective November 30 to preserve our flexibility with the portfolio and to align it with the accounting treatment of our other trading portfolios so that any mark-to-market will flow directly through the income statement each quarter.

These factors totaling $9.4 billion in writedowns drove the fourth quarter loss of $3.6 billion down from last quarter's $1.5 billion profit.

The EPS impact from these writedowns was $5.80.

Basic EPS from continuing operations for the quarter was a loss of $3.61 per share versus $1.45 gain per quarter last quarter.

Net revenues were a negative $450 million driven by the loss in fixed income revenues reflecting the writedowns I mentioned.

As John said, despite clearly disappointing results in our credit trading business within fixed income, many of our businesses produce record results and contributed to the second strongest year on record.

Let me now address other aspects of our firm-wide results which are outlined on pages one and two of the financial supplement.

Consolidated revenues for the quarter were negative $450 million and total noninterest expenses were $5.4 billion down 6% from last quarter.

The largest component compensation of benefits expense was $3.2 billion, reflecting an adjustment to the full-year payout.

Despite a quarter with significantly lower revenues, our compensation reflects strength across most businesses and our recognition of the competitive environment and the need to retain talent.

The full-year compensation to net revenue ratio is 59%.

As you know, next year's compensation is very difficult to forecast, particularly given on certain market conditions in 2008.

As of now, the best data point we can direct you to is our full-year 2006 comp-to-net revenue ratio of 47%.

We will provide you with updated guidance in the first quarter.

Noncompensation expense was $2.2 billion, which includes the $ 360 million reversal of the Sunbeam Coleman reserve that resulted from the recent Florida Supreme Court decision.

Excluding this reversal, noncomp expense throughout 21% driven by higher business development and professional service expenses.

Our full-year revenues decreased 6% from 2006.

Our effective income tax rate for continuing operations for the full year was 24.5%.

The decrease reflects the impact of lower earnings and lower tax rates applicable to nonU.S.

earnings partially offset by lower estimated domestic tax credits.

At this point we would anticipate that next year's tax rate will be closer to 2006 tax rate of approximately 33%.

The race depends on a number of factors including the level and geographic mix of our earnings.

Now, I'd like to discuss the details of our business segments results.

Starting with Institutional Securities which is detailed on page five of the supplement, the significant loss in fixed income sales and trading drove negative revenues of $3.4 billion in this segment down 169% from the third quarter.

Noninterest expenses of $3.1 billion decreased 12% driven by lower compensation expenses, excluding the $360 million from the Coleman Sunbeam reserve, noninterest expenses were down 2%.

PBT was $6.5 billion loss.

Full-year net revenues was $16.1 billion, down 24% from last year, yet still the second highest on record.

Full-year PBT decreased 89% to $817 million.

Our return on equity was 4%.

Page six of the supplement shows sales and trading reporting total negative revenues of $5.6 billion reflecting loss in our credit business within fixed income of the writedown and securities available for sale portfolio within other sales and trading.

These losses were partially offset by record results in equities and recoveries related to our leverage lending business.

The credit environment impact in our sales and trading results was partially offset by a gain of approximately $455 million from the spread widening at Morgan Stanley credit on some of our own structured notes.

Of this amount approximately $185 million was reported in fixed income sales and trading and $270 million in equity sales and trading.

In fixed income sales and trading we reported $7.9 billion in losses compared to $2.2 billion in revenues last quarter, reflecting writedown of our subprime-related assets.

For the year fixed income sales and trading revenues were $650 million, down 93% from our record results in 2006.

Forfeit credit and securitized credit trading, which includes our residential and commercial mortgage business, reported losses of $9.2 billion, down from approximately $260 million gain last quarter.

The majority of the losses were not U.S.

subprime residential business and will result in prior (inaudible) positions we took at the beginning of 2007.

The other mortgage related markdowns were driven by the November fair value deterioration I mentioned earlier.

Interest rates and currencies all were down 17% from our record third quarter continues to perform well in this environment reflecting strong customer flow, increased volatility and $185 million benefit from the impact of widening credit spreads our firm issued structured notes.

Commodities decreased 84%, driven by lower trading revenues across metals, oil, electricity and natural gas and the lack of structured deals this quarter.

Our client flow business performed well and was more than offset by poor positioning performance relative to opportunities in the market created by volatility across the most products.

Equity Sales and Trading revenues of $2.5 billion were 40% higher than last quarter and set a new quarterly record.

For the year, Equity Sales and Trading revenues were up 38% to $8.7 billion, our best year ever.

Looking at the quarter, strong revenues were driven by client flow and prime brokerage businesses, positive results in our comp trading strategies, the $270 million benefit from the widening of credit spreads on firm-issued structured notes and regional strength outside the U.S., especially in Asia.

NonU.S.

regions contributed to more than half of this quarters total revenue.

The cash business had record revenues with strong performance across regions including record results in Europe.

Derivative revenues decreased from a strong third quarter reflecting difficult market conditions, with full liquidity on even volumes.

Our Quantitive Strategies business recovered from losses last quarter have contributed healthy revenue gains more consistent with historical levels despite operating in a reduced risk and capital environment.

Our Prime Brokerage business produced the second best revenue quarter ever, with our average customer balances down slightly from the end of the third quarter.

Outside of the U.S., the business reported record revenues.

While client balances were down slightly, there was a significant increase in client balances in October, though sustained in November consistent with the recovery in the equity markets.

For the full year, this business produced record revenues and client balances in each region.

Other sales and trading was negative $202 million, driven by the writedown in our securities available for sale portfolio, offset by recoveries in our leverage to acquisition pipeline reflecting the improvement in liquidity that we saw in the quarter.

Loans and commitments details are on page seven of the financial supplement.

As we told you last quarter, our Leverage Finance business is subject to liquidity in the marketplace.

And this quarter we saw deals price activity begin to return to the market.

Total loans and commitments set of hedges declined $12.1 billion to $55.1 billion.

commitments including both investment and noninvestment grade are down 18% to $70.2 billion, through a combination of deal closings, renegotiations or deals going away.

We anticipate that our total loans and commitments will continue to decline in Q1, if capital markets remain deceptive.

Our noninvestment grade corporate lending commitments were $20 billion.

This includes $12.2 billion of commitments related to our leverage acquisition finance pipeline which is down from $31.3 billion.

Both across the quarter $4.4 billion of deals were withdrawn and $14.7 billion of deals have closed.

Of the deals closed, $6 billion have been funded that are included in the $10 billion of noninvestment grade [lists].

Looking at page six of the supplement, Investment Banking revenues were $1.4 billion, down 5% in the third quarter of '07.

Advisory revenues increased 17% to a record $779 million, driven by revenue strength across all regions.

Underwriting revenues were lower than last quarter in both equity and debt underwriting.

Sequentially, equity underwriting revenues were down 19% to $348 million, but up 37% from the fourth quarter of '06, with particular strengthen Asia.

Fixed income underwriting revenues were $236 million, down 32% from the third quarter, largely to reflect the decline in noninvestment grade issuance as investors grapple with the deterioration in the credit environment.

Partially offsetting this decline was the significantly increased demand for investment grade [debt] in the quarter especially during September and October.

The investment banking environment was mixed during the quarter.

Volumes decreased across products as uncertainty returned to the overall markets in November, except an announced M&A, where volumes remain healthy.

We maintain leading positions in our lead table standings for the calendar year-to-date through November.

We continue to lead M&A market shares in the number one rank in M&A completed with approximately 37% market share and number two in announced with approximately 33% market share.

Our ranking U.S.

IPOs is number one and we are number three in global IPOs.

We are number two in U.S.

equity and related issues and number five globally.

In the Bloomberg we're number two we're number two in global IPOs, number two in Asia-Pacific equity offerings, and number one in international China IPOs.

In debt underwriting our rank was number five with a stable share of the market.

Our ranking investment grade debt market is number four.

Our noninvestment grade rank was number nine.

Full-year advisory revenues increased 45% to a record $2.5 billion, 21% higher than the previous record set in 2000 and equity underwriting was up 48% to a record $1.6 billion, and debt underwriting increased 1% to a record $1.4 billion.

Our investment banking pipelines continue to be healthy.

Depending on market conditions, we remain cash usually optimistic about our M&A backlog, as there's a favorable flow of strategic activity even as we expect financial contracts to be down in 2008.

Our equity backlog is higher than the third quarter and fourth quarter of '06, with particular strengthen in Europe and Asia.

But our noninvestment grade debt backlog is down significantly, and investment grade backlogs are higher as capital raising needs remain robust.

(inaudible) transactions investment revenues were $496 million, up $279 million increase versus the third quarter and full year revenues increased 35% from 2006.

The increases were largely driven by higher investment gains in investor holdings in the fourth quarter and (inaudible) for the full year.

As John mentioned we are very focused on our risk management and VaR represents one of the key measures of risk.

Aggregate average trading and nontrading VaR increased $98 million to $91 million last quarter, driven predominantly by an increase in nontrading VaR.

Increase in nontrading VaR primarily reflects the the firms exposure to event loans that closed during the quarter and are currently in the process of being distributed.

Aggregate average trading VaR increased modestly to $89 million from $87 million.

Aggregate quarter end VaR decreased to $78 million from $81 million reflecting on active production in risk exposure which was upset in the VaR model by higher realized market volatility.

We have aggressively and thoroughly reviewed our stress test scenarios to insure that the market moves contained in these scenarios is severe enough in light of what's going on in the markets.

Over the past two quarters we have repeatedly increased the magnitude of market moves contained in our stress test scenarios reflecting increased levels of uncertainty and realized market volatility.

In the high levels of price volatility realized during this quarter we continue to pay close attention to our stress test scenario results for the most meaningful risk indicators with respect to rapid and dramatic market moves.

As John mentioned we are issuing approximately $5 billion of securities for the China Investment Corporation, CIC, that managed to reconvert into shares in August 2010.

This additional equity capital will build the firm's strong capital position and enhance our ability to pursue global growth and revenue opportunities.

Managing convertible securities we are issuing for CIC carry a yield of 9% and the after-tax cost is approximately 7%, because a significant portion of the yield that's tax deductible, therefore the after-tax yield of these equity securities is only 4.75% over our common dividend yield.

In return for these excess yield of these equity securities, [we take] the first 20% of appreciation of our stock price.

We believe the combination of paying less than 5% annual excess yield for only two years and seven months in return for 20% premium is attractive to our shareholders.

The 20% premium will be set above a reference price to be determined shortly.

The number of shares the managed comparable securities will convert into is based on our stock price at conversion.

At higher future stock price lowers the cost of the extra capital is the number of shares issued at conversion declines.

Given this feature and the tax deductability of the yield and the combination of regular capital eligibility and high equity trading from the rating agencies, we believe this is an attractive security to add to our capital base as we pursue growth and revenue opportunities in 2008 and beyond.

Turning to page four of the supplement in our current capital position, average unallocated capital -- economic capital was negative $400 million down from $3.5 billion since the last quarter.

The period end unallocates economic capital was a shortfall of $4.1 billion, however the firm continues to maintain total capital levels that significantly exceed regulatory requirements.

Over the course of the quarter, we assess and assign more economic capital requirements for our businesses, particularly Institutional Securities, while available capital decreased due to the writedowns.

Capital requirements for Institutional Securities increased mainly due to increased volatility in the credit markets and ratings and declines an underlying assets and credit businesses.

We also intend to strength tend to strengthen sheet and optimize the [flow] capital across our businesses.

For the moment we will maintain flexibility in our share repurchase program while we build up our capital.

During the quarter we repurchased approximately 9.2 million shares of common stock for approximately $516 million.

Year-to-date we have repurchased approximately 51.7 million shares of common stock for approximately $3.8 billion.

Even after reflecting the writedowns and losses in our fixed income business, and response to current market conditions, we reduced total assets on the balance sheet by $133 billion to $1.1 trillion.

This brought the adjusted leverage ratio down from 18.8 to 17.6.

These steps included in the investment by CIC will insure that Morgan Stanley has the resources necessary to pursue growth opportunities globally across our Institutional Securities, Wealth Management and Asset Management businesses into 2008 and beyond.

Page eight of the financial supplement describes our Global Wealth Management business.

Despite the market environment in the quarter, Wealth Management produced very strong results.

The fourth quarter was our best revenue quarter since the second quarter 2000.

As we announced earlier this week, Ellyn McColgan will be joining the firm to succeed James Gorman as President and Chief Operating Officer of GWM in April 2008.

Ellyn brings breadth and depth of experience that will enable us to build the momentum we achieve in this business over the past two years.

Revenues reach $1.8 billion, up 6% from the third quarter as the retail investor remained active during the quarter.

Commission and principal trading results was strong, which more than offset a sequential decline in Investment Banking revenues.

Noninterest expenses of $1.4 billion were up 1% from last quarter reflecting creases in business development expenses, the absence of the insurance recovery in the third quarter, and commission-based compensation reflecting a higher revenues.

We continue to focus on maintaining a cost discipline and believe that expense control can help fund our investment spending as we grow this business.

PBT of $378 million was up 32%, and our PBT margin increased to 21% from 17% in the last quarter.

The return on equity for this business was 52%.

2007 was our second best year ever with strong performance across the business reflecting higher financial advisor productivity, new in-house product offerings, strong client activity, and focused cost discipline.

For the full year, net revenues of $6.6 billion were up 20% and expenses of $5.5 billion increased 9%.

PBT totaled $1.2 billion, up 127% from 2006 on our PBT margin improved to 17%.

The return on equity for fiscal '07 was 41%.

On page nine of the supplement you can see the strong productivity metrics.

Net new assets of $10 billion represents our seventh consecutive quarter of positive client influence.

Assets of $1 billion plus household segment increased $29 billion in the quarter, increased to 72% of our total client asset base, as we continue to be effective in gathering assets in the high net worth segment.

Total client assets increased 3% sequentially to $758 billion, driven by both market increases of net new assets.

Fee-based assets represents 27% of the total, down from 29% last quarter.

This decline largely reflects the termination October 1st of our choice of fee in lieu of commission brokerage program.

Client assets in the Choice Program primarily moved to commission-based brokerage accounts or (inaudible) our clients the fee-based advisory programs including Morgan Stanley Advisory, a new nondiscretionary advisory account launched in August.

In addition we are developing a program that we believe will be attractive to former Choice clients.

Average production and total client assets for Global Representative were record levels in the quarter at $853,000 and $90 million respectively as our FA headcount increased at 8,429 producers.

We were achieving increased FA productivity while growing the number of FAs.

We continue to hire producers with higher production than those we lose.

While bank deposit program ended the year at $26.2 billion, exceeding our goal of $20 billion.

We launched another closed end from this quarter, PIMCO Income Opportunities Fund bring the total to five this year with over $4 billion in sales.

While there may be pressure on this business in 2008 if the U.S.

enters a recession, we believe that our more productive salesforce including new hires will mitigate the slowdown in retail activity.

We will continue to invest in technology and other infrastructure and continue to expand our U.S.

and international Private Wealth Management Business to grow our global footprint and capture the long-term growth potential of the business.

On page 10 of the supplement, we describe our Asset Management business.

The business performed well in the quarter.

Net revenues of $1.3 billion were down 8% in the third quarter driven primarily by $129 million of losses and securities issued by structured investment vehicles, SIVs and held by asset management.

Our total SIV exposure in our money funds as of today are $7.7 billion.

Off that, 92% is in lower risk SIVs that are sponsored by bank which have continued to support their SIVs.

Income before tax was $294 million, down 40% from the third quarter, driven by lower revenues and higher expenses including both compensation and noncompensation expenses.

PBT margin was 24% and ROE for quarter was 18%.

Looking first at revenues, our principal transaction revenues excluding the loss of securities on nonbank sponsored SIVs and held by asset management decreased 7% reflecting lower revenues from real estate investments offset by higher alternative investment gains.

Management and admin fees a key indicator of positive momentum in this business increased 6% to just under $1 billion driven by asset growth an a more favorable asset mix.

Noninterest expense of nearly $1 billion were up 10% for the third quarter, driven by higher compensation reflecting expenses associated with deferred compensation plans as well as increases in professional services and occupancy costs.

For the full year, revenues were a record $5.5 billion, up 59 % from 2006, PBT was $1.5 billion, PBT margin was 27%, and our return on equity was 26%.

This year we successfully built our management team and expanded our product array.

We had a very successful year for capital raising and our private equity Asia fund three, we have raised $1.5 billion including $350 million of commitments from the firm.

In real estate we raised [over] $15 billion in 2007 across our funds, most notably, international where we raised $ 8 billion and committed $1.6 billion of our own capital.

As you can see on page 11 of the supplement, we continue to show improvement in our key metrics.

Assets under management of supervision increased by $20 billion to end the quarter at a record $597 billion, primarily due to market increases in September and October.

We have $400 million in total net in flows as $5.6 billion of inflows in nonliquidity products were partly offset by $5.2 billion of outflows and liquidity products.

(inaudible) from net flows driven by nonU.S.

channels had $7.4 billion of in flows, the majority of which were from alternatives and Real Estate products.

U.S.

Institution and Americas intermediary channels had inflows of $800 billion and $400 billion respectively.

Van Kampen and Morgan Stanley branded retail funds showed outflows of $1.4 billion and $1.6 billion during the quarter respectively.

Institutional liquidity outflows were $2.9 billion compared to $12.4 billion in net inflows last quarter.

This quarters short-term outflows were driven by an expected $5.2 billion outflow gained in the prior quarter.

Retail liquidity outflows of $2.3 billion, primarily driven by additional bank deposit programs introduced in our Global Wealth Management business.

Our total net inflows for the year were $35 billion compared favorably to the $9.3 billion in net outflows we saw in 2006.

We launched and incubated 14 new products in the fourth quarter including six alternatives, seven in equities and one in fixed income.

For the full year, we launched 74 new products, 37 in alternatives, 25 in equity, and 12 in fixed income.

In summary we are pleased with the performance of this business.

We are focused on improving our margins and on product expansion especially in alternatives and widening our distribution capabilities.

In addition, we continue to develop our Private Equity and Infrastructure Investment Management business.

We continue to see investment opportunities generated from the firm's franchise and geographic footprint.

Our Global Real Estate business operates at a high level around the world and we continue to raise new funds to take advantage of the current market dislocation.

Real estate fundamentals generally remain intact although headwinds will increasingly get the down term -- given the downturn in economic activity and the fall back of debt financing.

We will continue to be focused on expanding our nonU.S.

footprint in both Europe and Asia as well as invest in our Morgan Stanley and Van Kampen brands.

On page three of the supplement you can see the regional revenue disclosure at the firm-wide level.

This year 43% of our revenues have come from the Americas, 36% from Europe, the Middle East and Africa, and 21% from Asia.

Year-over-year international revenues have increased 44%.

Our regional results in the second half of 2007 are skewed to favor nonU.S.

results for the majority of our trading losses which sustained in our U.S.

business.

If you were to exclude these losses, 55% of our revenues would be from the Americas, 29% from Europe and the Middle East and Africa, and 16% from Asia.

We continue to believe the pace of international growth will exceed that of the U.S.

Next, I'd like to review with you other mortgage-related assets on the balance sheet and briefly discuss the valuation methodology for each.

In nonsubprime residential mortgages, we are both balance sheet and net exposure to the U.S, Europe and Asia includes RMBS bonds, European mortgage loans, and to a lesser degree, residential Alt-A loans.

At the end of the fourth quarter we had $16.4 billion on our balance sheet with a total net exposure of $10.8 billion and a writedown reflected in our income statement of $800 billion at quarter.

These positions are valued based on subordination changes by rating agencies and executed trades and comparable instruments.

In CMBS, commercial [whole] loans, we had $31.5 billion on the balance sheet at the end of the fourth quarter.

During the quarter we significantly reduced our net exposure to these positions by more than half from $36.2 billion of the end of the third quarter to $17.5 billion by the end of the fourth quarter.

The writedown on the portfolio was $400 million, based on fair value in line with the observability market prices from our executed trades.

The majority of these assets are categorized as level two.

Our residual exposures of well diversified, approximately 2/3 were outside of the U.S.

As a result of the writedown in the quarter, the level of financial assets categorized in level three has decreased.

The movement of assets from level two into level three category was more than offset by losses within level three driven by corporate and other debt and derivative contracts.

In our 10K, netting amongst positions classified within the same level will now be included in that level.

And in our third quarter disclosure these positions were shown on a gross basis with a netting in the separate column.

This will be now more comparable to our peers.

Within this presentation change, our total asset position and level three at the end of the third quarter was approximately 7% of our total assets, and level three liabilities represents approximately 2% of total liabilities.

While we're still working on the fourth quarter disclosures, we anticipate that the total level three asset positions of total assets on the total level three liabilities position of total liabilities will remain approximately the same when we file our 10K.

Now, a bit on the outlook.

As I mentioned in August and again in November, we believe that the credit environment remains challenged.

It may take several quarters for a return to more normal market activity levels of credit extension and liquidity provision.

As we said last quarter, this affects not only trading but also customer flow and securitization.

Lending standards have tightened and we are seeing a return to more traditional credit analysis.

We expect many of the structured credit products to remain challenged for the extended period.

However, there continues to be opportunities in other areas within fixed income including interest rate, foreign exchange, commodity products and within emerging markets.

Volatility in the equity markets does not appear to be subsiding.

This creates opportunities in our Cash Derivatives and Prime Brokerage businesses.

Investment banking pipelines remain healthy across advisory equities and fixed income, and we are still cautiously optimistic.

Asset Management Global Wealth Management continues to provide strong results for the market turmoil and the positive momentum going into next year.

The near-term cyclical challenges do not change our view of the long-term secular growth opportunities, though we continue to allocate resources and capital into high growth areas globally and on our risk reward basis.

Thank you for bearing with me, and we will now be happy to take your questions.

Ladies and Gentlemen, please stand by for the question and answer session.

During the question and answer session you will hear a brief moment of silence.

Please stand by, and thank you for your patience.

And our first question comes from the line of Guy Moszkowski with Merrill Lynch.

Go ahead.

Good morning.

Good morning, Guy.

Can you tell us how you think we ought to think first of all about the roughly 100 million shares or obviously possibly less than that coming into the share count for EPS purposes over the next couple of years?

What's the time frame and what will drive the recognition of those shares in the fully diluted count?

Sure.

Well, they come in as you know in August 2010, so short-term , we will have a small charge up front which will dilute it or which will not put value down by a small amount, and then on conversion, depending on the strike price, we will have 9.9% of the Company will be represented

But as they come into or closer to the money, isn't there some gradual increment to the diluted shares as opposed to what happens to the book value calculation?

There will be, yes, there will be an impact as we come close to the money as it ratchets itself up from the threshold price.

Okay.

-- I have a schedule but what I'd rather do on that Guy, is after we've got the reference price and so on is come back to you with the schedule and show you the impact.

Okay, great.

That will be very helpful.

Thank you.

How do you think at this point about your tier one to assets ratio?

(inaudible) Yes, your tier one capital ratio with the $5 billion included.

Look, I mean, we were -- we felt we were pretty well capitalized despite the writedowns ahead of the equity in fusion, we obviously feel even more strongly confident about that post that.

And what is that ratio, because just to get all of the numbers in place and put it relative to your assets at the end of the quarter, what do you now view that that ratio is?

Look, well, I mean, all I can say at this stage because as you know, we're not in a position yet to disclose, is that we've met all of our minimum regulatory requirements on tier one and we feel we're adequately capitalized and we think we have a significant excess.

And, Guy, John Mack, also compared to our peers, we're more than adequately capitalized in our tier one.

At this time we just can't put out that number.

Okay, that's fair.

If I can then change the topic, could you talk just a little bit about the remaining $5.5 billion or so of subprime-related assets in the bank?

Did you actually -- did you just change the status to trading assets within the bank or did the bank actually sell the position to the broker dealer?

And if not, wouldn't it have been wise to actually do that to transfer it out of the bank?

Well, we've decided we've redesignated, so we've not sold the broker dealer, and the reason I've done this or we've done this is to be transparent.

Rather than taking temporary or permanent impairments through OCI, sorry, temporary impairments for OCI and then taking a charge for any permanent impairment, as we explained before, these assets are of very high quality, prices have been volatile in November, in some cases they went down to for instance [$93] and then re bounded to [$95] to [$96], we just felt that it was much clearer to redesignate these as mark-to-market securities.

Okay, that's fair.

Maybe you can help us understand what happened in the Asset Management unit with the SIV charges and what the interrelationship might or might not be between the SIV holding issues there and the net outflow to your liquidity products?

Well I don't think those net outflows are related, so we talk about the SIV exposure, and as I said, in our funds it's currently $7.7 billion, have that and to repeat 92% is in low risk SIV sponsored by banks, which have continued to support those.

The exposure is down from our peak in the quarter.

Our biggest risk was from four SIVs that were not sponsored by the banks.

And now just put this in context, the ABCP market at its peak was $1.2 trillion has shrunk to just around about $800 billion.

Many money-market funds owed this paper.

Of the four positions we had, one was fully paid off, one is approximately 2/3 paid off, one we have taken a charge against, which I described earlier, and the fourth one we are not unduly concerned about given the credit quality of that SIV.

I think overall, we feel that our exposure to SIVs we're comfortable with and we're committed to managing these funds for the folks on safety and liquidity.

And you brought those assets essentially out of the --

We bought one significant piece out of the money-market funds, one, material item, yes.

Okay, and then if I could just ask a final question.

Share repurchase obviously declined materially during the quarter because you were experiencing losses and obviously had a capital issue.

Should we assume that the share repurchase is probably suspended for some time?

I think that it's -- look, the Board gives us discretion to repurchase shares up to a cap as you know.

I think it's safe to assume for the time being that we will not be exercising discretion to repurchase shares until we have clarification about the general overall climate.

And also, Guy, as you know, we need to see what are the opportunities out there.

I mean, I think one of the things that's happening, yes, we've had this loss, but there are going to be some opportunities that could be very interesting for us, internationally and domestically, so the time being, we just want to see what is the best use of that capital, and until we get a better feel for that, I don't think it makes sense to start repurchasing shares.

Fair enough.

All right, thank you, gentlemen.

Appreciate it.

Our next question comes from the line of Glenn Schorr with UBS.

Go ahead.

Thanks very much.

From what I understand, the MSE gain ran through equity, I just wonder if you could help us just with the accounting and then maybe relative size?

And if that's it, meaning we're never going to see anything run through the P&L?

Well, it is a two-step process as you know, right, on MSCI .

In a two-step IPO, you don't recognize the gain.

It flows through the balance sheet.

That preserves the tax free nature of the spinoff itself and that treatment is pursuant, if you want to be techi, about this staff accounting bulletin 51, the sale of MSCI shares represents the first step in a broader corporate reorganization.

After that, the anticipated -- i.e.

the anticipated future tax free spinoff, any gain associated with the sale is required to be recorded as a capital transaction.

The impact is estimated to be both pre-and-after-taxation to shareholders equity of approximately $230 million.

Now, we obviously have options on MSCI as to whether there are other things we can do with that, but that's where we are at

So the $230 million was for the piece recognized, there's actually another slug that would eventually run through equity if that's what you decide to do?

Correct.

And that piece is a lot larger than the piece that you've already recognized, correct?

Yes.

Okay.

In -- on your CDS hedges and the things that you identify as hedges on slide 15, you talk at all towards counterparty, how you feel and I'm sure you won't tell us who it is, but I'll try, who it is.

You're talking about the subprime position?

Yes, I'm actually talking about the hedges that are backing up the subprime position, so I see you short ABS CDS in one or two places on that far right net exposure column.

I mean, they're broad-based CDS, I mean, that docket of hedges have markets observability on a highly tradable instrument with a broad range of counterparties.

Okay, so bottom line is it's diversified and not concentrated in any of the problem areas.

Not at all.

And then you mentioned earlier, I want to make sure I heard it right, is the net of the charges come to about $5.80, if you take that less the $3.61, you get to $2.19, you might take a reverse the Coleman reversal and the FAS 159 benefit.

Is that the best way to try to come to what was not a normal world, a somewhat normalized number?

-- you've got to comp effect that an also take into account the taxation, so I think you have to look at those.

Would the $5.80 not after-tax or are you saying tax affects the Coleman and 159?

It is after tax.

Oh, okay, great.

And then, finally, on the capital raise, it came after a quarter, in other words the book per share of [$28.56] that we're looking at?

Yes.

Is that pre the capital in fusion?

Well it is, yes, because the capital in fusion doesn't kick in.

For the time being, the capital in fusion will be a debt instrument on the point of conversion.

Okay, got it.

So no change on that.

And that's between, obviously, the way the rating agencies and your regulatory capital counts.

And when -- so how does that -- is it fully reflected on slide four then in terms of the unallocated capital position?

Absolutely not.

As of November 1st, we are showing what slide four is.

Okay, got it.

Let me just remind you what the unallocated capital is, there's some confusion, we obviously have a regulatory capital requirement and we are even before the capital in fusion in excess of a regulatory capital requirement, and the economic capital is an internal model we use for allocating capital for the businesses.

And that was a level of disclosure we gave, surplus or deficit that I think --

No, I mean, I get it, you're going to raise, if you're in a deficit on your unallocated capital that's a bigger driver than just whatever the regulatory capital requirements of a broker dealer are.

Absolutely.

Okay.

Cool, thank you.

Thanks, Glenn.

Our next question comes from the line of Prashant Bhatia with Citigroup.

Go ahead.

Hi.

Could you just help us reconcile the accounting impact of the $9 billion versus what the cash impact has been, so just realize versus unrealized?

In -- sorry, Prashant, in respect to what, sorry?

How much of this is just markdowns that you haven't been able to sell out of --

Okay, of the $9.4 billion, the great bulk of it is unrealized.

Obviously, the $400 million that related to the CMBS was realized, right?

But the great bulk of this was very much mark-to-market, if that's what you're asking

Right, okay.

So when we think about I think the $1.8 billion in exposure that's left is it fair to say that from where you're sitting, you probably just want to leave that exposure on and see how the cash flows end upper forming on some of these positions, or would you, if given the opportunity, liquidate at 1.8 billion?

I think that's a trading call.

What I'm doing with the $1.8 billion is showing you a net exposure that comes out of our valuation using consistent valuation methodology, and just to get it out, the $1.8 billion exposure.

Remember what I said on November the 7th, that is a function of assuming 100% default at zero recovery and all your shorts expiring worthless, within that you can't have some mark-to-market volatility.

Okay, and then on the CMBS side, it looks like you cut your exposure in half.

I mean, yes, I think I gave you the numbers.

We took our next exposure from August down from $37.2 billion to $17.5 billion.

Okay.

And does that reflect -- was it relatively easy to reduce that exposure at some point in the quarter, did you kind of hit the wall on the --

Well, the general point what I would say is, I gave a committment earlier in November to reduce my balance sheet to get the leverage ratios, or our balance sheet to get the leverage ratios back in line with the their quarter.

We have done a significant reduction on that balance sheet to maintain those ratios as you can see.

It wasn't easy.

Bits were easy -- bits were not easy and there were some frictional costs involved with that, but I would say that on the whole, we managed to get that done.

So --

Let me just add to that.

The majority of this is overseas, and as a result, we continue to distribute these positions out in anywhere from $100 million to sometimes $400 million to $500 million a week, so that's how that's taking place.

Now, have we, as Colm said, reduced the balance sheet?

Have we put some moral [suasion] out there that we get a lot more focus on and the answer is yes, and it's worked, so we continue to be active in that market.

Okay.

And then in terms of balance sheet size going forward, the $1.1 trillion, should we expect that to continue to ease down a little bit?

I think you should expect us to be judicious in our sizing of balance sheet with a very close eye to our leverage ratios.

Okay.

And then just finally on the Wealth Management side , your new Head of Wealth Management from Fidelity, does that signal in any way maybe more of a focus on either the mass affluent or the RIA channel

That's a continuation of what James has started and she plugs into that and continues to build that.

Okay, thank you.

Next question?

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

Go ahead.

Hi, good morning.

So just wanted to follow up on the mortgage exposure.

So it's fair to assume I think you said that the vintages are all '05, maybe early '06 in the CDO holdings, is that right?

No, I didn't actually give a ratio, but I am prepared to say that roughly 50% of the vintages are '05 and that's what caught us in November.

So but I guess the question would be if it's only about 50%, the mark seems kind of stiff if the remainder is later vintages where those ABX indices actually ended November roughly flat with October.

Can you just give us a little more color?

Sure, of course I can.

Well, first of all, we were absolutely confident that the valuation we gave as of 31 October was right using consistent valuation methodology.

Two things happened in November which changed the valuation which we had to look to as identifiable inputs.

One was the sell off as you know of the '05 collateral, which we described but two is in the risking this position we actually did execute observability trades which we have to calibrate to, and it was that calibration to external marks that has driven the valuations.

Okay.

And then in addition to that, you're aware that there's a lot of stuff going on in the market with other counterparties where circumstantially you're getting some evidence of pricing.

Okay.

I guess so is it possible that some of these actual transactions occurred closer to mid month as some of those other tranches were hitting their lows before they rebounded at the end of November?

That's right.

Okay.

I don't know maybe, John, you could comment on this.

Can you help us think about the changes that you alluded to in risk management?

I guess some of it is coming now, and, Colm, there's another piece going into Mitchell.

And can you just talk about what's actually changed specifically to how things were running and sort of what lead to the issues?

Well in the past, the way it was run that risk monitoring and risk management reported in to the President of ISG, so I'm just observing what's going on.

I think the right reporting line is not to the business unit head or the division head, but someone totally independent who reports directly to me and that's why we made the change.

Okay.

And what's the component that's going to report into Mitch Petrick?

Well, it's going to be Tom Daula, who is in our risk monitoring area who will work closely with Walid Chammah and his whole risk monitoring team, but it will be that team reporting to our CFO, and then Mitch Petrick, who has oversight for all trading and sales, will not have a direct report to Colm, but clearly will work very closely with him, but the key is that risk management now reports to someone outside of the division and reports to my CFO.

Okay.

And with respect to the Fixed Income business, if we back out the charges it looks like the run rate was something in the $ 1.1 billion range.

Can you the comment, a, on the impact in November specifically had on that, particularly a around client flows, maybe what you're seeing here in December?

I know it's not a great representative month, but then your thoughts about sort of the run rate going forward, i.e.

like could revenues actually be down year-over-year, not including the charges?

Well, I think John described accurately what's going on in the credit markets and that's where we have the greatest uncertainty.

There's no doubt that not just in the mortgage area but in our credit markets broadly, we seen relatively little activity.

Having said that, we just continue to see very much activity in our interest rate the and currency business, this was our second best quarter ever and that continues the pace and we see demographic trends that underscore that business and allows us to grow it, we see no fall off in activity there.

Secondly, our commodities business, I think I described the fall off was not a result of fall off of flow, but it was a result of poor trading and we feel pretty optimistic about that.

So in terms of the run rate on the Fixed Income business, and John described this very well, what you're looking at is certainly a few quarters of contraction in the credit businesses, until we can get some clarification on extension of credit and liquidity.

Okay.

And you think Investment Banking it sounds like you think that's going to be up next year --

Yes, the advisement I always give is that our Investment Banking pipelines are healthy.

Our M&A pipelines are healthy.

Our IPO pipelines are healthy, but the world economy could change, there could be contagins so --

Yes, but along with that, again, the sponsor business is a very active business not only for us but for the Street, and it slowed it down, there's just no question about that.

Right, okay.

All right thanks a lot.

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

Go ahead.

Hi.

Your super senior mezzanine, you have net $3.9 billion left.

Yes.

How much has that been written down?

I mean you had $11 billion a year ago so that would imply it's written down to like $0.35 on the dollar, but it was $14 billion when you took the position, so that implies $0.29 on the dollar, and we don't know if you sold any, so can can you give us some color there?

We have sold some, Mike, but the problem with giving you that ratio and I think it's best for you to calculate it yourself, is you're not looking at like-for-like instruments in the street.

And I'm not ducking the question.

All I can say is that we've used valuation methodology where we are comfortable with the valuations we've taken but these instruments have different attachment points, different vintages from house to house.

So you can work out the math if you think it's relevant, but what I can assure you is that what we've done is used the relevant inputs to get to the right valuation for this as at November 30.

Is that in the ballpark like using the $11 billion from a year ago though?

I mean, those are numbers that are correct numbers, so as I said, the proviso is, it's a function of the collateral tools that underlines them and it's a function of the attachment points.

I guess did you sell a lot or a little, I guess?

We didn't sell -- well, depends what your definition is of a lot or a little.

If we sold a significant enough increment to allow us to reprice our portfolio.

Okay.

And then just for clarification, with the new $5 billion of capital, there will only be a modest impact on book value until August 2010?

That's right.

And there will be no impact on fully diluted shares until then?

No, it starts accreting in depending on the threshold price.

So as I said to Guy before, what I'd like to do is that when we actually settle or get the reference price and so on, we will give you further details on that, Mike.

Can you give us any kind of ballpark way of thinking about this?

Well, I'd rather not until the deal is struck.

Is that fair.

Okay, and then lastly --

It will be shortly.

It will be shortly.

Yes.

And then lastly, I guess for John, what --

This is not a Marilyn Duke question is it?

What tone do you want to take on risk taking at the organization?

You can pull back on risk a whole lot across the board, and I guess the firm faced that at the start of the decade, or you can continue to take a lot more risk and potentially face more problems.

So where is the happy middle?

Well, look.

I think I've said this the day that I came back, that we're in a risk business and we'll be taking risks.

If you look at currency, the interest rates, you look at what we did in the equity trading businesses, they were really exceptional results.

Again, this is one desk who in my view took a risk that they made a misjudgment on, so in the short run, I'm going to be and this firm is going to be much more cautious in some of these larger bets.

So from that perspective, we're going to dial it back a little bit, but from putting risk capital into our trading positions and also into some of our proprietary positions, we will continue to do that.

But I think any time you have a situation like this and as we've changed reporting of risk monitoring, we have Mitch Petrick running the trading areas with more monitors working for him, until we get that really set up the way we want, I think that we have been sprinting and I think we're going to be kind of jogging right now for a while.

But we will still be in the market taking risks.

All right, thank you.

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

Go ahead.

Good morning, and good afternoon.

I wanted to thank you for your level of detail and ask you two follow-up qualitative questions.

If I look at the last couple of quarters obviously marred by the subprime meltdown, but also what struck me is in terms of challenged trading strategies within your commodity business.

And if you could just outline characteristically are there any similarities in terms of trading strategies, and then how you're going to manage risk, and then how you would look towards trading into commodities trading into '08.

And then my second question is related to compensation expense in the fourth quarter, really nice number for your employees is it fair to read the [TUEs] and say that you are there for optimistic towards 2008 and that -- or what does it say about your outlook for staffing?

Hi, Meredith.

I thought the first question was about five questions by the way.

You calling me cheater?

Look, I think our commodities issue is a very simple issue.

It was poor trading.

It's as simple as that.

It was a nothing -- structure or whatever.

We were badly positioned in our electricity, natural gas and oils, right?

And I think that easily remedied given the core preeminence we have in that business, and we've taken steps with moving people around to reenergize that DNA.

So I don't think there's any issue of risk management or anything wrong otherwise.

We think it's a business that will contribute significantly to our projections going forward.

On compensation, you're absolutely right.

We have to represent and repay the enterprise value of the firm.

The bottom line is, if you'd allowed back these losses to our businesses this would have been a great year for Morgan Stanley.

These losses just came from a small desk, proprietary trading desk and we didn't feel it was appropriate to punish the rest of the firm for that, but we also think, as John has said, we will have challenging times ahead of us, and there are going to be opportunities where we with our franchise can take real advantage and make money here, and we want to make sure we have the best people in place for that.

Meredith, it's John, let me add just a couple of things.

I think now with the changes, with Walid and James in, we'll take a much deeper dive into something that I've been a little frustrated with, is making progress on some of our noncomps.

And in the first part of the year, I can't announce it now, we have someone joining us who will have a couple hats on, and one of those hats will be specifically on some of our noncomp and some of the things we've structured that I think will be a lot more efficient.

So let me just put that into the mix of '08 what we'll be doing.

Okay, thank you.

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

Go ahead.

Great, thank you.

Just if we could ask you a question on the risk again.

I know everybody has been dancing around it, but I guess my question would be more, help us understand how this could happen that you could take this large of a loss.

I mean, I would imagine that you guys have position limits and risk limits as such.

It just behooves me to think that you guys could have one desk that could lose $8 billion.

Is that your own question?

Excuse me?

Bill, I --

I missed you.

Bill, look, let's be clear.

One, this trade was recognized and entered into our account.

Two it was entered our risk management system.

It's very simple.

It's very painful, so I'm not being glib.

when these guys stressed loss the scenario from putting on this position they did not vision in their stress losses that we could have this degree of default, right?

It is fair to say that our risk management division did not stress those losses as well.

It's as simple as that.

Think was a big fat tail risk that caught us hard, right?

That's what happened.

Now, with hindsight, can you catch these things?

We are not unique in being along these positions, right?

What is unique is that this was a trade that was put on as a proprietary trade and we have learned very expensive, and by the way, Bill, a humbling lesson, okay?

Okay, fair enough.

I guess the other thing I kind of would question too though is I'm surprised that your VaR, trading VaR, stayed stable in the quarter given this level of loss and given that I would suspect that these were trading assets.

So can you help me understand why your VaR didn't increase in the quarter dramatically?

Well I think VaR is a very good representation of liquid trading risk, but in terms of the nuts and bolts of that I'm very happy to get back to you on that analysis because I can't answer it as of the moment.

Okay, fair enough.

And then I guess a follow-up question in terms of the supplement, page 15.

Can you help me understand a little bit better in terms of reconciling the Statement of Financial Condition columns over on the left-hand side with the net exposure columns on the right hand side?

Well the real problem is that most of these positions are derivatives, right?

So that's the answer.

So the only reason we put in the Statement of Financial Condition initially was that one of our peers had done that, if you remember.

We clarified it by putting in P&L movement and net exposure, really the column you want to look at is the net exposure because it reflects the bulk of these positions, the super senior mezzanine, which I know you are very familiar with, are derivative contracts.

Okay.

So for the most part that's the one we should focus on the net exposure column.

And then I guess my last question, we obviously saw some ratings actions out of S&P this morning on these financial guarantors, I think probably the most significant one being on ACA moving that to a C from a A -- or CCC from an A.

Can you just tell us kind of what your exposure is to some of these model lines and if do you have exposure to these model lines?

Well I think everybody has exposure to these model lines of the business, but we think our lines exposure is relatively modest, right?

So in terms of what we have, you know what we own in the Utah Bank which is $1.54 billion.

We have $1.34 billion of municipal [wrapped model line bones] and we have approximately $130 million of other positions away from that.

In terms of counterparty exposure, we have a net exposure of $761 million.

And that's the aggregate for all model lines?

Yes.

Oh, okay, great.

Thank you.

I think that's pretty modest.

Yes, no, thank you.

Our next question comes from the line of Steven Wharton with JPMorgan.

Go ahead.

Hello.

I just wanted to follow up on the capital question again.

I guess I'm a little confused.

So I understand that the equity will accrete in the book value over time as we get closer to the conversion date, but I guess my question is do you get regulatory capital treatment for the mandatory convert?

Yes, we do.

You do.

We also get rating agency has different treatments for different pockets, but broadly this is a regulatory is treated as tier one and rating agencies given to a large extent full credit for the whole thing associating, depending on which rating agency, but this is very definitely seen as a capital add-on.

Okay, great.

That was my question, thanks.

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

Go ahead.

Hey, guys.

Thanks for taking my question.

I just want to come back on the comment on the level three assets.

I guess you mentioned it declined to about 7% of assets at the end of the quarter, so that would put them at about $82 million to $83 billion, if I'm doing my math right.

I don't want to do that number yet because, obviously, we're still finishing for the year-end, but you got to remember it's 7% also for reduced balance sheet.

Right, okay, and then so it sound like there was a bit of a mix shift within level three.

I guess what I'm trying to get a sense of is, will you guys have seen any marks as it relates to level three assets that maybe ran through the P&L this quarter?

And then if you could just maybe remind us what the biggest components is of level three because I don't think there's a lot of differentiation going on what's actually within that.

Well obviously there was one very big mark that ran through level three which we've just announced, right?

And in terms of if you remember in our Q last time around we gave a definition of level one, two, and three, and what the -- a pretty comprehensive idea or what the inputs were that define those.

I can send those to you, yes?

Okay.

No.

That's fine, that's fair, thanks.

That's all I have.

Thanks.

And our final question comes from the line of Douglas Sipkin with Wachovia.

Go ahead.

Yes, hi.

Good afternoon.

Two questions.

One, how should we be thinking about the mortgage asset class of going forward?

And then sort of following on that, how should we be thinking about sort of your acquisition sort of strategies given your investment in a mortgage company sort of the end for 2006?

Should we be thinking you guys are still very committed to that asset class and you'll commit capital to take advantage of opportunities on the trading side, or are you going to pull back on the mortgage business?

Thanks.

Well, we're not going to pull back on the mortgage business.

Clearly it's slowed down.

If you look at Saxon and the servicing, about 65% of what they did was servicing, so we're committed to it.

Without question though, on the origination side, that business is going to get smaller.

So we're still going to be active in it, and we're looking at some of the things that we've done internationally and making a decision there, are we going to take a different profile, and that's something we're discussing now.

And just to add to that I think I've said before that one of the things that we are looking at is we feel that the capital market distribution model in Europe needs to be looked at very closely, as John just said.

So we will come back.

Yes.

So I guess the events of Q3 and Q4 shouldn't impact your ability to continue to consistently provide liquidity and take advantage of opportunities as they arise both in the U.S.

and globally?

That's correct.

Okay, thank you.

Well listen, thank you very much, everybody for joining us.

I wish you all happy holidays, and we'll see you next year with follow-up.

Thank you.

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

That does conclude the presentation.

You may disconnect.

Have a wonderful day.