摩根士丹利 (MS) 2008 Q4 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 through January 17, 2009.

This presentation may contain forward-looking statements.

You're 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 additional risks and uncertainties that may affect the future results of the company, please see forward-looking statements immediately proceeding Part One, Item One, Competition and Regulation, and Part One, Item One, Risk Factors, and Part One, Item One A, Legal Proceedings and Part One, Item Three, Management's Discussion and Analysis of Financial Condition and Results of Operation, and Part Two Item Seven, and Quantitative and Qualitative Disclosures About Market Risk and Part Two, Item Seven A of the Company's Annual Report on Form 10-K for the fiscal year ended November 30, 2007, and other items throughout the Form 10-K, Management's Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors in the Company's 2008 Quarterly Reports on Form 10-Q and other items throughout the Company's Quarterly Reports on Form 10-Q and the Company's 2008 current reports on Form 8-K.

The presentation may also include certain non-GAAP financial measures.

The reconciliation of such measures to the comparable GAAP figures are included in our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, and our current reports on 8-K, 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 copyrighted and proprietary to Morgan Stanley.

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

Good morning, everyone, and thank you for joining us.

Today we will review our results and highlight how we are positioning Morgan Stanley for this rapidly changing environment.

The major equity indexes all fell for three straight months losing 30% for the quarter amounting to a loss of 40% or more for the fiscal year.

Financial stocks, which lead the way, were down 40% for the quarter, 60% for the year.

Emerging markets were similarly stressed.

Capital market conditions were extremely weak.

Volatility peaked across asset classes and deleveraging accelerated adding to the already severe asset price declines.

Hedging strategies became less effective as correlations broke down.

In addition, the market reaction over the purpose of TARP and the uncertainty of its use caused a repricing of fixed income assets in November to distressed levels that materially impacted market liquidity and the valuation of a broad range of financial instruments.

Despite these challenging conditions we had strength across several of our industry leading businesses, including commodities, foreign exchange, equity sales and trading including derivatives, advisory and Global Wealth Management.

We took leverage down substantially to 11.4 times at a gross basis at the end of the fourth quarter of '08 and significantly reduced our total assets by 33% sequentially to $658 billion, of which $128 billion is our liquidity pool at the end of the quarter, up again to $140 billion as of today.

We further strengthened our strategic alliance along with the successful $9 billion capital raise from Mitsubishi UFJ.

Along with eight of our peers, we received capital from the TARP, in our case it was $10 billion.

Within Institutional Securities we are engaged in a deliberate and focused reduction of balance sheet intensive businesses, including a resizing of Prime Brokerage, the ongoing exit of select proprietary trading strategies, the reduction of principal investments, and the closure of residential mortgage origination.

However, as stated before, we are targeting capital on a risk adjusted basis to our industry leading businesses, including flow trading, equity derivatives, foreign exchange, interest rate and commodities.

We are scaling back on risk and capacity but not capability.

Therefore, we expect to generate attractive risk adjusted returns when markets return to conditions that are more normal and clients reengage.

Global Wealth Management provides a stable earnings base, high ROE and attractive risk adjusted returns, although not immune to market conditions.

Our Asset Management business has been affected by poor performance this year.

This business remains a top priority and we are positioning it for profitability.

As announced, we are launching a retail banking group to grow deposits and banking products.

We've already announced the hiring of industry veteran Cece Sutton and Jonathan Witter and are looking forward to their arrival in January.

Under their direction we will leverage our existing retail banking capabilities and financial holding Company status.

We are developing our strategic alliance with Mitsubishi UFJ.

Now we have established a steering committee composed of the four most Senior Executives of both firms.

We identified and are pursuing more than 12 different initiatives, including corporate and investment banking, retail banking and lending activities which we expect to be finalized no later than June 30, 2009.

We have committed to cost reduction and have targeted $2 billion in cost savings for 2009.

Of this roughly $1.2 billion relates to lower compensation from our previously announced headcount reductions.

The remaining $800 million relates to a 10% reduction in our recurring non-compensation expenses.

Let me now turn to our results.

In the fourth quarter we reported a net loss from continuing operations of $2.2 billion or $2.24 per share.

Despite this loss this quarter, Morgan Stanley delivered three straight quarters of profitability and $1.8 billion from continuing operations for the full year.

For the quarter net revenues were $1.8 billion and total non- interest expenses were $5.2 billion.

Full year compensation expense was down 26% from 2007, driven primarily within Institutional Securities.

The compensation ratio excluding severance was 46.5%, as we manage compensation to reflect the low revenues and earning environment.

For the quarter non-compensation expenses were up 50% sequentially including $725 million of non-cash goodwill and intangibles impairment charge, primarily within Institutional Securities.

We reduced our balance sheet with total assets down 33% sequentially to $658 billion, largely driven by decline in Prime Brokerage and reductions in proprietary trading, interest rates and credit products.

Leverage was 11.4 times and our adjusted leverage was 8 times at quarter end, both down substantially from peak levels in 2007 or 32.6 and 18.8(Sic-see press release) times respectively.

Now we are expecting the absolute value of Level 3 assets to increase this quarter and they represent approximately 13% total assets.

The increase in the value is primarily due to the volatility seen in the derivatives market, especially given the widening of credit spreads.

The dramatic reduction in our total assets this quarter exacerbated the ratio of Level 3 assets to the balance sheet.

As we have previously said, there were offsetting hedges to these positions in the other levels of the fair value hierarchy.

As you can see in our Financial Supplement in Pages 16 through 18, we continue to systematically sell our Level 3 legacy assets whenever opportunities arise.

While there has been enormous mark-to-market volatility this quarter , Morgan Stanley operates and will continue to operate under fair value accounting rules using conservative assumptions.

Book value per share at November end was $30.24, relatively unchanged from last quarter and up 6% from a year ago, demonstrating our ability to preserve and grow book value in an extraordinary difficult operating environment.

Page four of the Financial Supplement highlights our current capital position.

While we are still finalizing our calculations, we estimate that our Tier 1 ratio will be approximately 18.3% this quarter under the SEC's interpretation of BASEL II guidelines.

The increase over last quarter was primarily driven by our new Tier 1 eligible capital.

Risk weighted assets declined sequentially to approximately $282 billion at November 30.

This decrease reflects the combined reduction in our total assets offset by an increase in credit risk charges due to the present environment.

Looking ahead we are well positioned to take advantage of market opportunities given our strong capital position, broad set of funding tools and lower leverage.

We successfully issued $6.6 billion of FDIC guaranteed debt over the month.

Given the market dynamic, we took the opportunity to repurchase $12.4 billion of firm issued debt, which resulted in gains of $2.3 billion this quarter.

This was predominantly recorded in other revenues within Institutional Securities.

Now let me turn to the specific businesses.

Starting with Institutional Securities detailed on page five of the Supplement, the business reported a pre-tax loss of $2.1 billion.

Revenues of $844 million reflected the difficult trading environment and asset write-downs.

Up to early November our revenues in Institutional Securities were encouraging.

A slated news beginning with the redirection of TARP, resulted in a step repricing of the market.

Extreme levels of negative sentiment are priced broadly across the credit market spectrum, including Investment grade loans -- investment grade loans on the ABX subprime index.

At that current market prices, CMBS triple A's implied unprecedented high default rates.

The CMBX triple A index as a benchmark currently implies a cumulative default rate of greater than 60% over the duration of the underlying bonds, assuming 100% loss severity.

Equity market volatility as reflected by the VIc more than doubled this quarter.

Principal investments revenues were negative $1.8 billion, the majority of which relates to write-downs of Real Estate Limited Partnership interests and other principal investments.

Non-interest expenses decreased 21% sequentially, largely reflecting lower compensation, which is partially offset by non-cash goodwill and intangible impairment charges of $694 million.

Turning to Investment Banking on page six, our leading Investment Banking franchise remained active, notwithstanding the challenging market conditions.

Revenues of $743 million were down 28% from the third quarter, in an environment with volumes down dramatically across products.

Completed M&A was down nearly 25%.

Global equity and debt reached down nearly 50% and the IPO market was virtually shut down in the quarter.

Despite these conditions we advised of several important transactions, including Northwest's merger with Delta, the sale of [H Boster Lloyds] and the sale of a stake in Fortus Bank to the combined governments of Belgium, the Netherlands and Luxembourg.

Significant underwriting transactions included equity follow on issues for Wells Fargo and General Electric and bond issues for IBM, Barrick Gold and Pepsico.

We're currently advising Verizon on the largest indicated financing transaction in the US this quarter.

On this transaction Morgan Stanley has been instrumental in working with Mitsubishi UFJ, another example of our burgeoning partnership.

Advisory revenues increased 32% sequentially on strength in Europe, even though activity slowed measurably in the quarter.

Equity underwriting revenues were down 72% from the third quarter of '08 of global equity and IPO volumes were at anemic levels.

Fixed income underwriting decreased 57% as issuance was down across all product and credit markets remain severely strained in the quarter.

Our pipelines are down given the secular downturn in global capital markets.

Investment Grade is one exception, as there is considerable pent-up demand.

We continue to maintain high levels of strategic dialogue with corporate financial sponsors and sovereigns and remain well positioned to take advantage of client activity when it returns to the market.

Equity sales and trading revenues of $1.7 billion were down 35% sequentially.

Trading in the quarter was at two extremes, with volatility in liquid trading producing strong revenues and credit and illiquid trading producing significant losses.

The revenue decline was primarily driven by losses of $729 million in proprietary trading.

The difficult market exacerbated losses on trades, as a convertible bond asset class collapsed and spreads widened.

Despite the losses this quarter, proprietary trading results were slightly positive for the full year, as gains from quantitative strategies offset losses from several other strategies.

We remain focused on quantitative strategies, including program driven trading and statistical arbitrage where we believe we can out perform.

Prime Brokerage revenues declined 50% from a record last quarter on lower client balances, which were down 37% when averaged from the previous quarter.

Cash equity revenues were up 8% from last quarter on strong performance in portfolio trading, despite lower commissions on lighter volumes in Europe and Asia.

Derivatives reported a strong quarter of continued volatility and increased customer activity and full year revenues were a record up 35% from 2007.

Equity revenues also included $685 million in gains from the widening of credit spreads of firm issued structured notes.

In Fixed Income sales and trading we reported negative revenues of $1.2 billion, down significantly from the previous quarter, reflecting the difficulty trading -- the difficult trading environment and further asset write-downs.

An area of strength this quarter was commodities, with revenues up 7% sequentially on strong customer flows across sectors driving broad based strength.

For the year commodities reported record revenues that were 62% higher than 2007.

Interest rate credit and currency trading revenues combined were down significantly from the third quarter of '08.

Interest rate products were lower as new client trading was offset by unfavorable positioning in Europe as a result of the November repricing.

Foreign exchange reported a record quarter and higher volatility and increased customer flows.

For the year, foreign exchange reported record revenues 56% higher than 2007.

Emerging markets recorded a loss driven by credit widening in Eastern Europe and credit trading generated a loss.

In addition to significant deterioration in consumer credit and related assets and further spread widening, our results included losses of $360 million from monolines.

Aggregate net exposure, net direct exposure to monolines increased to $4.3 billion.

This net exposure includes $700 million of ABS wrap bonds held by our securities banks, $3.1 billion of insured municipal bond securities and $500 million of net counterparty exposure representing gross exposure of $8 billion net of hedges and cumulative credit valuation adjustments of $3.8 billion.

The significant increase in our gross counterparty exposure reflects the current credit environment impacting the monolines.

We're managing this counterparty risk through a hedging program that utilizes both credit default swaps and transactions that effectively replace the potentially impaired component of underlying transactions, as well as credit valuation adjustments.

Fixed Income revenues also included $2 billion in gains from the widening of credit spreads on firm issued structured notes.

Details on pages 16, 17, and 18 of the Financial Supplement are our mortgage related gross and net exposures, which we further reduce this quarter.

On page 16, within the ABS CDO subprime schedule, you can see our total net exposure was slightly net short.

Of note on this schedule is the reduction of our super senior legacy mezzanine positions from $1.1 billion to $0.00, which was accomplished with a minimal P&L impact.

On page 17 within non-subprime residential mortgage, we reduced our gross and net exposures by roughly 20%.

These exposures include Alt A, which declined 27%.

Overall net write-downs were $900 million, including $650 million in Alt A.

On page 18 within CMBS commercial whole loans, we reduced our gross exposure to $17 billion, driven by nearly 40% reduction in CMBS bonds.

Net exposure declined over 60% to $2.9 billion.

Overall here, we recorded a net gain of $200 million.

Other sales and trading revenues are negative $1.1 billion, primarily driven by net losses of $1.7 billion in our lending businesses, which include leverage acquisition finance, relationship lending.

These net losses reflect negative market movements and write-downs of $4 billion, offset by effective hedges.

The five year cumulative implied probability of default in the cash and derivatives market for loans is now greater than 60%, much higher than the worse five year cumulative historical default rate of approximately 25%.

We continue to reduce our non-investment grade leverage acquisition portfolio, which is now $5.6 billion, as you can see in the footnote in page seven of the Financial Supplement.

During the quarter we added $420 million of new commitments and had $3.4 billion of reductions.

Also included in other sales and trading are losses of approximately $800 million from our subsidiary banks, driven by further deterioration of the investment portfolio, which is fair valued.

Offsetting these losses were derivative mark-to-market gains of approximately $1.1 billion following their de-designation as hedges of certain Morgan Stanley debt.

Total average trading and non-trading VaR decreased to $119 million from $128 million last quarter, reflecting a decline in our non-trading VaR.

This is primarily driven by a reduction in lending exposure.

Average trading VaR remained near flat from last quarter at $98 million, as higher spread and volatility levels were offset by a reduction in key trading risks.

As I mentioned, we continue to reshape our Institutional Securities business.

We've taken steps to exit select proprietary trading strategies and have de-emphasized our principal investing business in Institutional Securities.

We're exiting our remaining international mortgage origination businesses.

Within the US we are shifting origination activities to Global Wealth Management.

In addition, we are reshaping other businesses.

We remain committed to maintaining a premier Prime Brokerage franchise.

While this business is smaller it will benefit from the repricing of services.

As stated before, we'll no longer be market share driven, but rather a contiguous and strategic extension of our strategic client relationships.

We've repositioned research in an effort to coordinate analysts better with the businesses and leverage the intellectual capital more broadly throughout the firm.

We continue to develop and invest in our client driven and flow businesses where we see revenue upside.

This includes divesting in electronic delivery as markets move towards exchange like structures.

We're building out distressed credit trading and prioritizing risk analytics on the credit desks.

We are focused on reducing our infrastructure cost and geographic footprint at the margin by closing or relocating offices.

Now turning to page eight of the Supplement in our Global Wealth Management business, this business continues to produce strong underlying results with stable recurring revenues despite volatile market conditions.

Revenues of $1.4 billion decreased 9% from the third quarter reflecting write-downs of $108 million in option rate securities repurchased from clients recorded in principal transactions.

Revenues also included higher commissions on increased transaction volumes, offset by the lack of new issues effecting Investment Banking revenues and lower fees on declining market levels.

Overall revenues were offset by non-interest expenses that included an incremental provision of $256 million for the auction rate security settlement, as valuations have declined and repurchases are estimated to be higher than anticipated at the time of our initial announcement.

Excluding the provisions from both quarters, non-interest expenses were down 7% from last quarter driven by lower compensation.

As a result of all this, PVT was a loss of $55 million.

On page nine you can see the productivity metrics.

Total client assets decreased 23% as market levels declined sharply during the quarter.

Our client withdrawals driven by market volatility led to outflows of $3.9 billion.

They were less than 1% to total client assets.

Net new money for the full year was $34.5 billion, our second highest year and best-in-class.

The number of FA's was slightly down for the quarter.

For the full year FA's was flat despite a reduction of 233 representatives from the sale of our Spanish Wealth Management business.

We expect to continue to grow FA's and take advantage of market turmoil, particularly as the franchise has largely stabilized after a tumultuous September and October.

Our bank deposits, including client sweeps and client holdings in Morgan Stanley issued certificates of deposit, increased slightly over last quarter to $36.4 billion.

As of today our total deposits are $44 billion.

In 2008, we achieved double digit increases in a number of accounts using key banking services and there's a lot of room for future growth.

In support of the firm's goal of achieving 50% of funding from stable sources, including equity, long-term debt and deposits, we will further buildout our deposit base.

Our private Wealth Management Group continued to grow its global footprint of investment representatives and expanded into significant new markets, opening offices in India and Saudi Arabia.

Going forward, we are leveraging our high net worth franchise and focused on building a retail banking group, as I stated earlier, under the direction of Cece Sutton and Jonathan Witter.

Let me turn to Asset Management on page ten of the Supplement.

Asset Management recorded a pre-tax loss of $1.2 billion in the fourth quarter, primarily driven by principal investment losses and expenses related to Crescent.

Core revenues, which included traditional funds, hedge funds and fund to funds Asset Management, were down 87% sequentially and included a decline in management and administration fees resulting from lower average assets under management, losses of $261 million in alternatives in our core business, and losses of $187 million relating to marketing securities issued by SIVs held on balance sheet.

The carrying value of these assets is now down to $209 million at the end of the quarter.

In addition, total SIV exposure in our money funds as of quarter end was down to $100 million.

These are all bank sponsored and are maturing in January.

Merchant banking revenues were negative $454 million and included principal investment losses of $532 million in real estate including $113 million on Crescent financial assets driven by the continued deterioration in global real estate markets and $100 million in private equity and infrastructure funds, particularly our Asia portfolio.

Non-interest expenses decreased 3% of the third quarter, primarily driven by lower compensation expenses.

This decrease is partially offset by higher cost relating to Crescent, which includes an impairment charge on real estate assets of $243 million.

Approximately 90% of the Crescent portfolio is real estate assets primarily held at cost with quarterly depreciation.

These assets are subject to quarterly impairment review.

Our total real estate net exposure, which includes Crescent as well as our direct investments in real estate, private equity and infrastructure funds, was $5.3 billion at the end of the quarter.

This exposure does not include assets included in investments for the benefit of employee compensation or co- investment plans.

Turning to pages 11, 12, and 13 of the Supplement, you can see the assets under management and asset flow data.

Total assets under management decreased 30% to $399 billion, largely due to the extreme drop in global financial markets during the quarter, which had a broad impact across the industry.

We also recorded $77 billion in net asset outflows in the quarter, virtually all of them in our core business.

The primary driver here was money-market outflows of $51 billion, due to the dislocation of the industry.

As we mentioned in our third quarter 10-Q, nearly all of these outflows occurred in September, when credits and liquidity of markets were under severe stress.

During the quarter we purchased approximately [$25 billion] of these securities to fund the investor redemptions amidst illiquid markets.

We've reduced these positions substantially to $600 million at the end of November with no losses incurred.

The current balance is roughly $200 million.

Improving our financial performance in Asset Management is a top priority.

Asset Management faces significant headwinds in '09 from the decline in assets under management and a difficult environment for gathering assets.

Within core Asset Management we reduced net headcount by nearly 20%.

We are closing and consolidating non-performing subscale and overlapping products, as well as enhancing the efficiency of our technology and operations.

Despite the issues in Asset Management, this business remains a critical component of our strategy.

The diversified earnings into a high ROE business takes advantage of our distribution power and provides a channel to monetize our intellectual capital.

We are confident that we can drive this business to competitive advantage of profitability as markets improve.

An additional note I wanted to make you aware of is that our Board of Directors have approved our change to a calendar year reporting cycle, which will commence January 1, 2009.

In effecting this change we will have a one month transition period ending December 31, 2008, that will be reported along with our first quarter '09 results in April '09.

Now in closing I just have a few words on the outlook.

2008 was a very challenging year, yet Morgan Stanley delivered three straight quarters of profitability and was profitable for the full year.

While we do not expect the events of the fourth quarter to repeat, nor the dramatic falloff in client activity to persist, we do expect the near-term environment to be very challenging.

This recession has turned global in a relatively short timeframe.

Action is being taken to remediate the state of the markets on an non-precedented scale around the world.

Such moves will likely promote market stability near-term and economic recovery over the long-term.

We are expecting 2009 to be a year of transition.

There is no doubt that earnings power has been affected in the short-term and there is potential for further negative marks despite our reduction of risk positions and leverage.

Given the systemic reduction in leverage, we expect ROE to be low but still a healthy 12% to 15% over the cycle.

Clearly though, our ROE will improve over time as we expand Global Wealth Management, Asset Management, and Retail Banking to be a greater contributor to our business mix, as we have good opportunities to invest in these businesses.

Overall, we do not expect the volatility in the markets to subside untill at the very least the mortgage market and ultimately the housing market stabilizes.

However, we see opportunities amidst all the turbulence and market uncertainty.

For example, recent corporate new issuance activities an encouraging early step towards the normalization of conditions in debt capital markets.

We are seeing investment grade credit deals being completed.

In fact November was the second busiest month for European investment grade non-financial new issuance since March '01.

In the US, total issuances increased each month since the lows reached in September.

Even within high yield we're starting to see some activity, such as the $500 million El Paso transaction, which marks the reopening of the high yield market.

While limited, there have been select opportunities for issuance within the equity markets.

While we cannot control the difficult environment, we are committing to improving our operating performance by reducing non-compensation costs by 10%, continuing to reduce legacy assets as the markets allows, allocating capital on a risk adjusted basis for the client driven and flow businesses in our market leading institutional franchise, returning Asset Management to profitability, and as I've stated, maximizing our relationship with Mitsubishi UFJ.

Our leading client franchise and premium brand remains intact.

Morgan Stanley has been and will continue to be a premier global Financial Services firm.

We are confident that we will be well positioned to generate attractive returns when markets normalize and clients reengage in a more significant way.

We have successfully evolved and adapted our business across numerous business cycles in the past and we are doing so again today.

Thank you and apologies for the long intro and now I'll take

(OPERATOR INSTRUCTIONS).

The line of Roger Freeman from Barclays Capital.

Please proceed.

Oh, hi, good morning.

Roger.

I guess in listening to your commentary about risk positioning and appetite for principal investing going forward, how do you think about your approach to markets once they -- when we get to this eventual point where credit markets stabilize and we see increasing asset values again.

Are you going to be taking advantage of that?

I mean you clearly have excess capital given your really highest investment class Tier 1 ratio.

I mean, how do we sort of balance that versus the commentary here on the call?

Well, I mean, it is clear that we are very negative on these markets at the moment and have been for some time, Roger, as you know, right?

We are seeing client falloff and as I have stated in a number of occasions, where Morgan Stanley does well is when we have large client activity, because that is the benefit of our franchise.

When we see that pick up we will be there to commit capital to the markets and I think we're just ready to do that.

A combination of two things are interesting is we did have, obviously, legacy assets which we reduced, but what's interesting is they hurt us in the fourth quarter but not -- we've outlined to what degree.

Really, what's happening here was a broad based price destruction which is representative of what's going on in the markets, so I think we need to be prepared to commit capital as and when we see the market moving again.

Okay.

And then with respect to the balance sheet decline this quarter, can you help us think about some of the buckets there, because it was more than $300 billion decline in the absolute level.

Obviously a lot of markets were pretty illiquid.

Is it a lot of treasuries and agencies you are working out of?

No, you can see our adjusted leverage has come down as well so it was broad.

Obviously it's easier to reduce your match book, which we did, but if you think about it in terms of where we are, it was pretty broad based, but half the reduction came from a reduction in Prime Brokerage balances and the rest was pretty much spread out.

What we've done is we've continued to reduce legacy assets.

Okay.

And then on the proprietary debt that you actually purchased, can you give us a little more color around that?

What maturities did you buy?

Was it shorter term, longer term?

Do you still hold this?

And also the hedging, the re-designation of hedges there, do you actually actively hedge your debt in addition to the sort of the natural hedge you have around FAS 157?

Yes, we do.

We took the opportunity, given market dynamics, to repurchase some of our debt.

It was a broad range of maturities.

It was trading at very distressed levels.

Those repurchases, as I said, resulted in direct gains of $2.3 billion.

Now as you said, and I've just confirmed, we use swaps to hedge the interest rate risk.

In making those repurchases we are required to modify our hedging program.

So accordingly, a good number of those swaps were de-designated from being hedges of our debt and became mark-to-market instruments, so that's the $1.1 billion gain.

We know it's associated with de-designation reflects the mark-to-market change for these swaps when they are no longer considered to be hedges.

Now a full discussion off that hedge accounting is in more detail on page 14 of our August 31 Form 10-Q, if you want to have a look at it.

Okay, that's helpful.

Last question.

On the clawbacks with respect to compensation, how is that going to work?

Are there going to be specific clawbacks for each employee based on the amount of P&L that's at risk under them or (multiple speakers)?

No, I think -- really, it will be to the deferred cash part of their compensation.

It will relate to that and there will be various rules and we'll give you more color on that going forward.

It's only just been approved by the Board.

I have to go through it myself and I'd like to come back to you on that.

Okay.

All right, thank you.

Your next question will come from the line of Guy Moszkowski from Merrill Lynch.

Good morning.

Hi, Guy.

Wondering if you could, just to pick up on the clawbacks for a moment, wondering if you could give us a sense for whether that could result in lower expense recognition in year one of a bonus award, since it's not actually paid until certain future hurdles are cleared or would you go ahead and recognize all of it and there for it really wouldn't initially result in lower comp costs.

No.

There's no gain like that going on Guy.

It's going to be treated the same as equity.

We've kept those components the same as well, right, so we'll be amortized accordingly, So from an accounting point of view there is no arbitrage there.

Okay, I wasn't trying to imply that it was a game, just that (multiple speakers).

I know you weren't, but some people might think it was.

No what we're doing is we are just taking part of that deferred comp, which is now we will have the ability to clawback on.

It is the same proportion as normal.

And can you give us a sense for what happened to the compensation ratio within the institutional division in the fourth quarter?

Was there a meaningful comp, further comp accrual there in the quarter or was there either a very low accrual or indeed a reversal in institutional, as Goldman Sachs had for the whole firm?

Well what I will tell you is that in 2008, the comp to revenue accrual for the end of the year, for Institutional Security was 43.9%, ex-severance, 39.9%, and obviously that formulated on much lower revenue, so I think you can work out that it was a pretty drastic reduction in compensation.

Okay, that's very helpful.

Thanks.

On the ARS, are you still holding the majority of the assets that you've purchased over the last couple of quarters?

Yes, we are.

We are and, as you know, we're funding it through the facility, right?

But as of November 30, we'd repurchased 3.8 billion of eligible ARS, what we hold in our inventory.

We did take write-downs, which we described, of $108 million on that.

That was reflected as part of principal trading.

And additionally, during the fourth quarter, because as you know we have the ability to purchase up to $6.4 billion on returns for settlement, we took, because of the price deterioration that took place in November, we took an incremental provision of $256 million, right?

Right.

Which again is a provision and next quarter if there's been further negative variation, there could be a further charge which would be the equivalent of the $108 million this quarter.

Is that the right way to think about it?

Yes, correct.

And equally, if these things clear through the options and so on, there's a clawback so it works both ways.

Right.

Can you give us a sense for the carrying value as a percent of par, of what you have got currently on the books?

For the auction rate securities, let me just check.

Just give me a second.

Sure.

Yes, 75-80.

Okay.

And on the SIVs, you mentioned some that are maturing in January.

Now, is that all of what you're currently carrying that you've had to repurchase over the last (multiple speakers)?

No, sorry Guy.

I hope I didn't mislead you.

The $100 million maturing in January is what's actually held in the third party funds, which we have not taken on to our book.

That's just what's left in the various money-market funds.

They mature, they are bank guaranteed.

What we have written down, it's just over $200 million of written down SIVs, which were approximately about $680 million or something like that when we originally put them on the book.

Oh, okay.

So that's a very low holding value to par basically.

Yes.

And on the $2 billion of cost saves that you're anticipating or targeting for next year, should we realistically expect most of that to come to the bottom-line or is there a significant reinvestment of savings which you're anticipating?

I could say I'm trying to get an absolute saving to the bottom-line.

That's what I'm trying to do and that's what we've targeted and we've given you the component parts of that.

That's clearly our goal and we'll report to you quarterly on that progress.

Sure.

And is there a range of full year revenue that you're predicating that $2 billion on?

No.

This is independent of that.

This is synergies and efficiencies within the system.

Okay, great.

That's all very helpful.

Thank you, Colm.

Thanks Guy.

Have a good holiday.

Your next question will come from the line of Glenn Schorr from UBS.

Hi, Colm.

Hi, Glen.

Just to follow-up, I don't know if you've mentioned the face amount of the debt bought back?

I think I did.

It was $12.3 billion.

Okay.

And did you buyback any stock during the quarter?

Yes, we did.

I bought a small amount of stock back, obviously this was pre-TARP.

It was a combination of two aspects of the stock.

One, we have some employee related buybacks, which is the normal course of business and then in addition to that, in those brief periods when our stock was trading down very low, I bought back, let me give it to you.

I think I put it in the earnings release actually.

That's okay, I'll find it.

The bigger question is was that -- how much of the reduction in the average liquidity pool during the quarter was this versus just say calls on your liquidity from PB big leveraging?

No (multiple speakers)at all.

Let's talk about the average reduction in liquidity pool.

I think you've got to understand that our contingency funding assumes certain drains in our liquidity, right?

By the way, we repurchased 39 million shares only in our active repurchase early on in the quarter.

I think I had announced, by the way, just to finish that question, Glenn, on the third quarter earnings call on the Tuesday night I said I reserve the right to start -- .

I remember that well.

And then things sort of spiraled, as you know.

In terms of -- what was the other question, sorry?

Was that any contribution to the reduction in the liquidity pool or was that more PB (multiple speakers)?

No, no.

Not at all.

So let's talk about the liquidity pool.

Today I have got liquidity of about $140 billion.

I'm not sure it's as meaningful a number now that we're a bank holding Company and we have facility and we don't need -- have the sort of operational friction we used to have.

You have got to think about $140 billion in relation to my current balance sheet.

At the time of the third quarter, at the end of the third quarter when we felt the market was going to be very stressed, we had gotten that liquidity up, as you remember, to $179 billion and that obviously there was significant drain on liquidity for a period of time in that stress period but that was not part of this.

We've now rebuilt our liquidity through a number of actions and actually, if anything, we're probably in a more conservative place because the contingent drains in our liquidity are much less given the size of our balance sheet and certain aspects of our business.

So I guess when you look, you have $7 billion of unallocated capital and you have some really large Tier 1 ratio.

What do you, how do you balance it?

Because you bought back debt and it generated $3 billion of gains it produces equity, it reduces your debt load.

How do you draw the line between tapping into your precious liquidity pissing off the regulators and doing something economic?

I think we were, first of all, we were buying debt as part of a debt defense as well.

Secondly, it was at incredibly distressed levels, which is in the interest of our shareholders and thirdly, I think we're in a very strong liquidity position regardless, so it's basically comes out of our contingency funding plan.

We look at what we need to issue, what we need to cover our liabilities and as we've reduced the balance sheet, we clearly have less requirement for that funding.

And frankly, I think it was a good trading decision in the interest of our shareholders to buyback debt, which was at incredibly distressed levels and frankly, if I'd let sit out there, would have sent out a very bad signal.

I hear you.

And then so what point -- is that an implicitly a statement that leverage, considering where assets are, less the liquidity pool, is leveraged finally at a resting point or does it continue to (multiple speakers)?

I don't think leverage is going to go down anymore.

I think we've actually squeezed our balance sheet down to be prepared to take advantage of markets and dislocations, so I'm hoping we can take leverage back up but to do that, Glenn, we really need to see opportunities in the market and, frankly, I'm still reeling from what happened in November.

Me too.

And then maybe the last one.

Implicit in your comments about maybe 12% to 15% ROE over the course of the cycle, does that assume, I'll just put it in quotes, some normal cost of debt in the unsecured debt markets, in other words the funding pressures that are there today subside?

No, I've made assumptions about why, I don't want to get into details, but I've made some reasonable assumptions about where I think debt spreads are going to be, where I can refinance, but clearly within that, it does assume that we will have a normalized CDS spread than where we currently are, because frankly I don't think 460 over or 500 over or whatever, is a sustainable financing spread.

Got you.

Last one I promise.

That's okay.

How come book wasn't down a little bit more, meaning you lose $2.24, book goes down by about $1.00.

There's obviously a bunch of moving parts.

Well, getting back to one of your first questions we repurchased stock at below book value and we had certain transactions relative to employee stock awards that decreased our share accounts and they were accretive too, so really that's why.

Okay, thanks, Colm.

Thank you very much.

Your next question will come from the line of Mike Mayo with Deutsche Bank.

Good morning.

Hi, Mike.

Can you just talk about the balance between pulling back in proprietary trading and taking risk where you see some upside?

You had the proprietary equity loss this quarter, I think you said $700 million and this is one year after the big losses and you ratcheted up risk management and oversight and here we have another trading loss.

So how do you balance those two goals?

I don't think they are connected, Mike.

I think the losses in proprietary trading are all exiting businesses in very stressed markets, so I think it's actually because we have ratcheted up risk management, added a significant amount of hedges and so on.

What we did, and I've spoken to you about before in the previous few quarters, we've had a very analytical look at risk adjusted returns with better metrics.

I think this business was based upon a revenue driven model.

Frankly, I think a lot of these businesses on a risk adjusted return have been producing negative MPV, so we've made a decision to exit some of these businesses and there's a cost associated with those.

Now that cost has been exacerbated by incredibly stressed markets.

Within that, though, remember we're keeping our PVT business, our [con-strategy] business in equity because we believe it's a business that we have an alpha or an in flight on to.

We believe that where we have insight, like commodities, we can position risk of a proprietary nature on the back of those client flows and so on.

So I think to look at some of these losses, and they are winding down losses, is not, is perhaps misleading.

What we're doing is we're reallocating businesses on a risk adjusted basis to where we think we can generate alpha.

So these were not unexpected insofar as the market away from what the market did itself.

Okay, and then one separate question.

As it relates to equities being down, I think you said Prime Brokerage was down 50%.

Is anything else going on in that category?

In equities?

Yes.

In what sense, Mike, sorry.

Just in the decline in contrast to one of your competitors yesterday just didn't do as well, so I'm just wondering if there's any onetime factors there.

I think it's the prop trading you referred to a few minutes ago that covers the XG line item, I think if you would have normalized that I don't think we would be a million miles away.

It was a very strong year for us in equities.

Volumes were down in the fourth quarter, certainly, but I think that's probably the delta, Mike.

Okay, thank you.

Thank you very much.

Your next question will come from the line of James Mitchell with Buckingham Research Group.

Please proceed.

Hi, good morning.

Hi, James.

Can we just talk a little bit about fixed income?

I think I'm just trying to -- obviously, it was a tough quarter for credit, but if I kind of normalize for the mortgage related write-downs as well as the gains on debt, it looks like you had about a $2 billion loss in that line.

Was that all credit or was there -- you mentioned you had interest rate positioning was difficult as well.

Just trying to think through what maybe the major drivers were on the swing.

I think it was a broad based loss.

I stated earlier, going into November, we were looking pretty good in terms of our revenues and so on, but obviously there was a repricing of a lot of things, so obviously credit clearly got hit hard by just about any measure you want to look at.

But you had curve changes as well and bond swap spreads changed dramatically.

So in Europe, we certainly got hit on some European curve positions we had, but I think it was broad based.

I think to try and look at what happened in November, extrapolate from that is just very difficult because it was such a discrete event.

I hear you, fair enough.

Maybe switching over to Asset Management.

Were most of the flows, outflows you mentioned at least money-market was mostly in September-October.

Have you seen and maybe you could talk a little bit about in the equities and fixed income area and if some of those flows have stabilized of late?

Sure.

I think that's fair.

It was September-October, those flows have stabilized.

Obviously, it goes without saying that the major indices are down and that's affecting size of assets under management, but certainly for us it was primarily the money-market flows.

That started to stabilize?

Yes.

One last question.

The investments in the Institutional Securities, I think you gave us a number for the Asset Management business down to $5 billion or so.

Did you -- was that down meaningfully in the investment, I mean in the institutional business, can you give a number there?

What, the Private Equity investment?

Yes, exactly.

Not particularly, it's a relatively small portfolio.

It is about $3 billion, which is being written down, a loss is in there, I'd say it's about $2.6 billion or something like that now, $2.5 billion.

It's something that we've kept a close eye on.

That's it really.

That's a pretty substantial write-down, I guess you had $1.8 billion.

Yes, within that though remember, we have the LP interest in our commercial real estate funds is actually held in ISG and that was a big part of that write-down.

Right, right.

Fair enough.

Okay, thanks a lot.

Thanks.

Your next question will come from the line of David Trone from Fox-Pitt Kelton.

Please proceed.

Good morning.

A couple of questions.

If I heard you correctly, when you talked about the Prime Brokerage balances you mentioned a negative 37% delta.

I assume that was average.

Could you tell us the end of period?

Yes, end of period is about down 65%, but let me qualify that.

We've had a lot of balances wanting to come back, so what we're doing at the moment is we're looking at -- and also it's a function not only of balances that left, it is clearly a function of the downsizing of the hedge fund business at the moment as well.

But we have a number of balances that are wanting to come back and we are at the moment engaging clients in a strategic dialogue to decide where we are and what we want to do.

Okay, and through the period --

Can I just confirm one thing though, David.

Sure.

Remember, of the accounts that were closed, we only had 7% of the accounts that were closed, so you would expect a high rate of return because it wasn't a particularly stressed environment when a lot of those balances left.

Right, so what point during the quarter did that stabilize and what does December look like?

It stabilized pretty, I would say it stabilized probably post the closing of the Mitsubishi UFJ deal, but I'd have to confirm that.

But by then you had other dynamics in place and so far, I mean, we're in the midst, it's no longer about Morgan Stanley and Prime Brokerage or anybody else in Prime Brokerage.

It's about the hedge funds themselves at the moment so what we're certainly seeing is hedge funds wanting to move balances back towards in this market so I think we feel pretty encouraged about it.

What we're not too encouraged about is the overall state of the hedge fund industry.

Right.

Okay.

And second question on the bank deposit side, in the context of bricks and mortar, obviously an acquisition, A) what is too small to matter or should I say what is the right number where you start to have an interest in a property that might come up and B) how do the regulators feel about you doing that type of an acquisition?

Well, first of all let us explain that what we're saying about garnering bank deposits is that they have to fit into our existing strategy, our retail and high net worth strategy.

So in that sense there's no such thing as too small to matter.

It's got to fit into what we're going to do and I think the regulators, and we're in very close contact with the regulators, are very comfortable with our strategy, hopefully, and that's certainly the feedback I get.

What we're not talking about, at least to date, you never say never, is large strategic transactions.

I mean we're talking about garnering deposits that fit into a well defined retail strategy and that's why we've hired Cece Sutton and Jonathan Witter, who have been very successful in pursuing these sort of strategies at large money center banks.

So I think this will evolve as they join us.

Okay, great.

That's it.

Thank you.

Your last question will come from the line of Jeff Harte from Sandler O'Neill.

Hi.

Hi.

You talked about the size of the net real estate exposure within Asset Management, I believe you said it was $5.3 billion?

Yes, but remember there's some secured financing in that against Crescent, so you have to net that out as well.

So if you look at it, you've got Crescent is $3 billion of that $5.31 billion and the written, the residual net of secured financing is just under $600 million, so you would knock off $2.5 billion from those numbers.

Given how difficult hedging relationships in cash versus derivatives have been, that's a net number, can you give us a gross exposure number?

That is a gross exposure number.

Okay, I thought you were saying the net.

No, I gave you the gross originally, which is the $5 billion number and I said there is a secured financing against Crescent, which is secured financing so you'd take that out.

Okay.

Sorry.

Okay, thanks.

And looking at the debt repurchase gains this quarter and seeing that actually a transaction, I guess, would be realized and I am looking at the amount of structured note gains that you guys have been recording, it seems, quarter in and quarter out, is there the opportunity or have you actually been -- I mean, can you actually lock in and realize some of those structured note gains or have you yet?

We can.

I mean, DVA in -- I look at DVA slightly at debt, sort of what we call DVA, the structured note gains, slightly differently.

I think the trading of debt is real P&L.

It's a one-time gain.

We did it.

In stressed markets, one hopes that would never repeat itself.

Obviously DVA, the own credit spread, the 159 moves around.

You can to some extent lock it in by retiring debt that is associated with it.

But the way I look at it and say look, we are a fair value shop where mark-to-market, very conservative in the way we mark things, so the same way as we've been penalized for taking things at mark-to-market and let me give you an example of where we are.

CMBS bonds in the third quarter of '08, we had in the low 70's we now have them in the high 40s, senior commercial loans with the high 80s to low 90s, are now, they've been marked down as well to the high 80s, mez mid 70's to the low 60s, that is mez commercial loans, Alt A mid 30s to high 20s, we've actually taken some very significant marks here, so my view on our owned credit spread is it kind of, you've got to look at that in the round, if that makes sense.

So if you're trying to get a sense of what our core operating are, I think you would knock out the owned credit certainly as revenue that is maybe not the highest quality, but against that you would have to offset for legacy charges against it to get a sense of what the underlying is.

Okay.

And you mentioned an ROE maybe a target of the 12% to 15% over the cycle.

You're talking that's kind of your thought as to what the average would be over the cycle?

Absolutely, so I'm assuming that '09 is going to be a tricky year and come out of this.

And given everything that's gone on from becoming a bank holding Company and everything else, where would you historically have pegged that number?

I'm trying to get a feel for how much you think some of the changes we see come into effect this year may impact what you think your loss from ROE is?

I think I've addressed this before.

We've always been pretty consistent that we're in a world of reduced leverage and reduced leverage does mean lower ROEs.

I know there's some debate around that, but we think that that hair cut is 3% to 5%, but we can mitigate that a lot by much more efficient use of balance sheet and it's not that long ago that institutions had very nice ROEs at lower balance sheet.

We have got to get back to that world.

Okay.

Thank you.

Thank you very much.

Well, I just wish everybody a Happy Holiday and thank you for your time.

Ladies and Gentlemen, that concludes your conference call for today.

Thank you for your participation.