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Celeste Brown - IR
Good morning.
This is Celeste Brown, head of Investor Relations.
Welcome to our third-quarter earnings call.
Today's presentation may include forward-looking statements which reflect management's current estimates or beliefs and are subject to risks and uncertainties that may cause actual results to differ materially.
The presentation may also include certain non-GAAP financial measures.
Please see our SEC filings at MorganStanley.com for reconciliation of such non-GAAP measures to the comparable GAAP figures and for a discussion of additional risks and uncertainties that may affect the future results of Morgan Stanley.
This presentation, which is copyrighted by Morgan Stanley and may not be duplicated or reproduced without our consent, is not an offer to buy or sell any security or instrument.
I will now turn the call over to Chairman and Chief Executive Officer James Gorman.
James Gorman - Chairman, CEO
Good morning, everyone, and thank you, Celeste.
Our results and actions this quarter evidence progress and important milestones towards our long-term strategic plan, a plan we laid out for all of you several years ago.
In addition to executing on the long-term strategy, we also remain nimble and have demonstrated our ability to adjust tactically.
A key to our future is the increased contribution of Wealth Management to our revenue, profitability, returns, and funding stability.
This quarter we continued to move forward in two ways.
First, on the tactical front.
Our margin progress at 13% pretax margin, excluding nonrecurring expenses, provides increasing support of the strategy.
Second and of greater long-term significance, we purchased 14% of the Wealth Management joint venture while locking in the price and greater flexibility for the remaining 35%.
We are pleased to have clarity about our future and are closer to recognizing the full value of Global Wealth Management for the Firm and for our shareholders, value that goes beyond the short-term margin targets.
In addition, the revenue and profit contribution of MSAM, our Asset Management business, really rounds out the Wealth and Asset Management side of the Firm.
Also key to our future obviously is our long-term strategy in ISG, which continues to reinforce an integrated business that best delivers for clients, leverages our historic strengths, while optimizing capital.
Again on the tactical front, our objective this quarter was to demonstrate a recovery from the challenging second quarter, though acknowledging seasonality.
This was most clear in our Fixed Income results, which rebounded sharply even with the continued drag from CVA due to the timing of our credit spreads.
As discussed on our last earnings calls, clients did reengage with us at the end of the second quarter and continued to do so throughout the third quarter.
Evidence of progress across the Firm towards our long-term strategy is our strong Basel III capital ratio, which is now north of 9% as of September 30.
We've accomplished a lot over the last several years to position this Firm well for the future and the new regulatory landscape.
We have great confidence we'll translate this value into greater profitability for our shareholders and drive returns higher through sensible capital actions at the appropriate time.
Now I'm going to turn it over to Ruth to take you through our earnings in detail.
Thank you.
Ruth Porat - CFO, EVP
Good morning.
I will provide both GAAP results and results excluding the effect of DVA.
We have provided reconciliations in the footnotes to the earnings release to reconcile these non-GAAP measures.
DVA in the quarter was a loss of $2.3 billion, with a $1.6 billion in Fixed Income sales and trading and $641 million in Equity sales and trading.
Excluding the impact of DVA, firmwide revenues were $7.6 billion, up 14% sequentially.
Noninterest expense was $6.8 billion, up 13% versus the second quarter.
Compensation expense was $3.9 billion this quarter.
Non-compensation expense was $2.8 billion, up 19% from last quarter, reflecting nonrecurring expenses associated with the Global Wealth Management integration as well as higher litigation costs.
The effective tax rate from continuing operations for the third quarter was 35.4%.
Earnings from continuing operations applicable to Morgan Stanley common shareholders were approximately $535 million.
Earnings from continuing operations per diluted share were $0.28, after preferred dividends.
On a reported or GAAP basis, firmwide revenues for the quarter were $5.3 billion.
Earnings from continuing operations applicable to Morgan Stanley common shareholders were a loss of $1 billion.
Reported earnings from continuing operations per diluted share were a loss of $0.55 after preferred dividends.
Book value at the end of the quarter was $30.53 per share.
Tangible book value was $26.65 per share, reflecting a reduction of $0.58 related to the increased 14% ownership stake in the Wealth Management joint venture.
Turning to the balance sheet, our total assets were $765 billion at September 30, up from $749 billion last quarter.
Our liquidity reserve was $170 billion at the end of the quarter versus $173 billion last quarter.
Deposits were $71 billion, up again this quarter.
Although our calculations are not final, we believe that our Tier 1 common ratio under Basel I will be approximately 13.7% and our Tier 1 capital ratio will be approximately 16.7%.
Risk-weighted assets under Basel I are expected to be approximately $319 billion at September 30.
Subject to final rulemaking, our Tier 1 common ratio under Basel III was north of 9% as of the end of the third quarter, assuming full Basel III inflation of risk-weighted assets and zero benefit from future mitigation.
Let me now discuss our business in detail.
In Institutional Securities, revenues excluding DVA were $3.6 billion, up 26% sequentially.
Noninterest expense was $3.3 billion, up 21% versus the second quarter.
Compensation was $1.6 billion for the third quarter, reflecting a 45% ratio excluding DVA.
Non-compensation expense increased 27% from last quarter due to higher litigation costs of approximately $280 million.
The business reported a pretax profit of $345 million excluding the impact of DVA.
Including the impact of DVA, the business reported a pretax loss of $1.9 billion.
In Investment Banking, revenues of $969 million were up 10% versus last quarter.
According to Thomson Reuters, Morgan Stanley ranked number one in global IPOs; number two in global announced M&A; number three in global equity; and number four in US dollar investment-grade debt at the end of the third quarter.
Notable transactions included, in Equity underwriting, the $8.5 billion global IPO of Japan Airlines, which marked the second largest IPO globally this year and the largest airline float in history.
This transaction is also a great example of the power of our partnership with MUFG.
In Advisory, Porsche SE transferred the remaining 50.1% stake in Porsche AG to Volkswagen, valued at $8.9 billion.
And in debt underwriting, Blackstone's $650 million offering, its first-ever 30-year bond issuance, and its largest debt offering to date.
Advisory revenues of $339 million were up 29% versus the second quarter with increased revenues in all regions.
Equity underwriting revenues were $199 million, a 30% decrease from the second quarter.
Although equity underwriting volumes for the industry were up sequentially, they were more heavily weighted toward follow-on offerings and block deals versus IPOs in the second quarter.
Fixed Income underwriting revenues of $431 million were up 28% versus last quarter, reflecting increased revenue in high-yield and investment-grade issuance as well as stronger loan syndication fees.
Equity sales and trading revenues excluding DVA were $1.2 billion, an increase of 7% from last quarter.
Derivatives revenues improved despite seasonality due to a combination of more favorable market conditions and expansion of our client footprint.
Prime Brokerage revenues increased modestly despite reduced average hedge fund leverage in the quarter.
Hedge fund leverage picked up at the end of the quarter and continues to increase.
Revenues in cash equities were consistent with last quarter despite significantly reduced levels of market activity globally.
Results were supported by share gains across most markets.
Fixed Income & Commodities sales and trading revenues excluding DVA were $1.5 billion.
Revenues were up 89% versus our second-quarter results.
Revenues increased across most of our businesses.
CVA, net of hedges, was negative again this quarter due to the tightening of our credit spreads.
Year-to-date in rates, we have generated almost as much revenue as we did in the entirety of 2011.
In foreign exchange we delivered our best reported quarter since 2009.
Within our credit businesses, we have particular strength in our securitized products business.
Commodities results benefited from more favorable market conditions.
Others sales and trading reflects negative revenues of $164 million compared with negative $11 million last quarter.
Turning to VaR, we implemented a new VaR model this quarter which we have been running in parallel since 2011.
Our new VaR model has been approved by regulators.
The benefit of the new model is it is more responsive to current market conditions while also maintaining longer-term perspective.
The new model is aligned with Basel 2.5 requirements.
In our supplement, we provided VaR measures under both our current and previous and VaR model for this quarter, the prior quarter, and the prior year, and we will do the same for the fourth quarter.
Our average trading VaR for the third quarter was $63 million versus $76 million in the second quarter and $99 million in the prior year.
Turning to Global Wealth Management, revenues of $3.3 billion were flat to the prior quarter.
Asset Management revenues were down modestly versus the prior quarter, reflecting lower market levels at June 30.
Transaction revenues increased 6% from last quarter, consisting primarily of commissions of $521 million, which decreased 2% from last quarter, reflecting lower equity volumes; Investment Banking related fees of $199 million, which decreased 11% versus last quarter, driven by a slower equity issuance calendar; and trading revenues of $312 million, which were up 41% versus the second quarter, reflecting strong Fixed Income secondary trading as well as markups in our deferred compensation plans.
Noninterest expense was $3.1 billion, up 6% from last quarter.
Expenses included nonrecurring items of approximately $193 million related to the integration and the purchase of the 14% stake in the joint venture.
The compensation ratio was 61% versus 60% in the second quarter.
Non-compensation expense was $1 billion, up 14% versus last quarter.
Excluding the nonrecurring expenses associated with the joint venture, the PBT margin was 13%.
On a reported basis, the PBT margin was 7% with profit before tax of $239 million.
Total client assets increased to $1.8 trillion, reflecting the benefit of higher equity markets and positive flows.
Global fee-based asset inflows were $8 billion.
Fee-based assets under management increased to $556 billion at quarter end.
Global representatives were 16,829.
Bank deposits were $118 billion, with approximately $60 billion held in Morgan Stanley banks.
Asset Management revenues of $631 million were up from $456 million in the second quarter due primarily to principal investment gains in Merchant Banking and Real Estate.
In traditional Asset Management, revenues of $372 million were up 10% compared to the second quarter due to higher market levels.
In Real Estate Investing, revenues of $125 million were flat versus last quarter.
Due to the ownership structure of these funds, the majority of these revenues are passed to third-party investors in the noncontrolling interest line.
In Merchant Banking, revenues were $134 million compared with negative $3 million in the second quarter driven primarily by principal investment gains.
Compensation expense was $241 million in the quarter, up slightly from $214 million in the second quarter.
Profit before tax was $198 million, up from $43 million last quarter.
NCI was $50 million versus $23 million last quarter.
Total assets under management increased to $331 billion, driven by net inflows of $11 billion and market appreciation.
Turning to our outlook, we continue to see momentum in our businesses based on better market conditions and the strategic positioning of the Firm.
With respect to the market, both institutional and retail investor activity picked up on the back of the ECB's bold moves in August.
We believe the ECB's actions reduced the probability of a tail risk event in Europe, although challenges remain in Europe and globally.
With respect to the Firm's businesses, clients clearly reengaged with us post the ratings decision in late June and continued to do so throughout the third quarter.
We saw recovery in our Fixed Income results and continue to benefit from our cohesive sales and trading businesses.
Investment Banking volume industrywide remained muted relative to historical levels, but pipelines are healthy.
With our strong market share we are well-positioned if the fledgling economic recovery in the US persists and market stability in Europe is sustained.
We are increasingly benefiting from our Wealth Management business, including the advantages of being on one platform as well as our increased stake in the business.
We are also yielding results from our alliance with MUFG, with powerful market share gains in Japanese and cross-border M&A.
We continue to take the steps needed to realize cost savings through headcount reductions and cost-cutting, setting us up well for 2013 and 2014.
Specifically, by the end of the third quarter, we were close to our headcount reduction goal for all of 2012.
Our Office of Reengineering remains on track to achieve $500 million run-rate savings this year and $1.4 billion by 2014.
And the results of our cost initiatives in GWM are increasingly visible now that we are on one platform.
Looking forward, we remain confident about our path to ROE expansion based on the revenue, profitability, and capital strategies we have implemented.
Most notably, in Institutional Securities we have leading global businesses with momentum across the platform, enhanced by capital optimization.
In Wealth Management, we are already benefiting from our increased ownership, both because we are earning a return on the capital held against the 14% and the growing deposit base which will drive funding efficiency and revenue expansion.
Because of these and other steps we have taken, as well as the early signs of an improving macro environment, we look forward to the future.
Thank you for listening; and James and I will now take your questions.
Operator
(Operator Instructions) Howard Chen, Credit Suisse.
Howard Chen - Analyst
Hi, good morning, James.
Good morning, Ruth.
You both mentioned the impact of the CVA this quarter.
Can you tell us how meaningful that was?
And were there any hedges against that, as I think is your historical practice?
Ruth Porat - CFO, EVP
So, there are -- there were hedges against it, as is our historical practice and as we disclose in our filings.
The drag, just to try and help you size it, the drag from CVA this quarter was bigger than the period-specific items we called out last quarter in our Fixed Income business.
In addition, we had a drag in Equities, although it was smaller than in Fixed Income.
Howard Chen - Analyst
Great.
Thanks, Ruth.
Then, James, can you just update us on your long-term strategic vision for the commodities business, and how you see both the physical and the nonphysical segments of the business fitting within the regulatory framework as we go forward?
James Gorman - Chairman, CEO
Well, commodities has been a great business here at Morgan Stanley for a long time; continues to be an attractive business.
Obviously with the Dodd-Frank legislation there are potential limits to some of the activities that we can pursue in that business.
So it is incumbent upon us to explore all forms of different structures, appropriate structures, that can take us forward where we can get the benefits of the business but also meet the regulatory constraints that we operate under.
Howard Chen - Analyst
Okay, thanks.
Then on capital management, James, you have highlighted in the past, I think, about this capital management and capital [trend] as a sequential process.
So sequentially, you have retired legacy issues.
You bought the first 15% of the buy-in; crystallized the price for the rest.
And this Basel III Tier 1 common continues to improve.
So where we are now, how do you think about the potential ability to buy back your stock, restore the dividend, and/or maybe do the rest of the buy-in?
James Gorman - Chairman, CEO
Well, it's a good question, Howard.
Obviously, we have a CCAR process that we and the other financial institutions go through with our regulators, the Federal Reserve and the other regulators.
And in that process, one is in a position to pursue a range of capital actions.
The process is now conducted twice yearly.
The last couple of years it has been once yearly.
So there are opportunities going forward to put in place whatever plans we have in place.
We have made it pretty clear that our major strategic objective is to complete the acquisition of MSSB, of which we have a remaining 35%; and that would have a very modest capital implication for us, given the agreed-upon price and the goodwill we already hold against the position.
So I don't want to get ahead of ourselves and don't want to get ahead of our regulators.
We will address what and when other actions as we get to the CCAR process in January of next year.
Howard Chen - Analyst
Great.
That makes sense.
Then just finally for me, you noted the heightened litigation costs this quarter.
What specifically did those relate to, Ruth?
And how far would you say we are through crisis and post-crisis litigation for the Firm?
Thanks.
Ruth Porat - CFO, EVP
Well, it covered -- this quarter covered a number of items including the recent decision in one matter, but also expenses associated with other ongoing matters.
I think as you put it, litigation has been an ongoing cost for the industry; so at the end I think it will continue to be.
Howard Chen - Analyst
Thanks for taking the questions.
Operator
Roger Freeman, Barclays.
Roger Freeman - Analyst
Hi, good morning.
Just coming back to I think probably a couple things Howard asked, besides the CCAR process are there other things with respect to buying in the rest of the JV that factor into your decision-making?
What would cause you to accelerate that or not, separate from the capital allocation?
James Gorman - Chairman, CEO
You know, I will have a go and then Ruth can jump in.
But we agreed on a fixed price on the JV; and given that fixed price, the capital -- you can do the math on it -- the capital implications of buying the rest of it are pretty modest.
Roger Freeman - Analyst
Right.
James Gorman - Chairman, CEO
There are many advantages to pursuing that, obviously.
But again we've got to go through the CCAR process and make sure it's the right time to do it.
But there are advantages to pursue it, and we have made that very clear.
This is a strategic imperative.
Roger Freeman - Analyst
Got it.
Okay.
Then just maybe tied to that broadly, you have got to a 13% pretax margin excluding the charges.
Your target next year is midteens.
Can you just remind us what other milestones to be looking for?
You're obviously close to that number now.
Does this continue to, as you model it out, rise over the course of next year so you're at a higher level, above midteens by the end of next year?
Ruth Porat - CFO, EVP
We are still guiding to midteens margin mid next year, but two components I think to your question.
First is we are looking forward to the fourth quarter and beyond, a couple of items.
One, integration expense is running lower post the second quarter.
As we have talked about, it ran in the $80 million to $100 million per quarter area in the first half; and then we had budgeted for it to come down in the third and fourth quarters, which it did, running at lower levels, and then drops off again next year.
So the third-quarter margin did benefit from that drop in integration expense which will also benefit the fourth quarter, and then it goes down in 2013.
The second thing is that we will have a full quarter of the expense benefit associated with the charge that we took in the third quarter.
We had two of three months' benefit in the third quarter; so there was some impact on the 13% margin this quarter.
We get the full three months' benefit next quarter.
Obviously, we are always careful to say that PBT margin expansion is not a straight line.
For example, in the fourth quarter, we do tend to have seasonally higher expenses; but it is too soon to tell.
Then I think as we look forward, and really building on James's comment about the upside, whenever it comes, with the additional 35%, when we buy that in first and foremost we generate earnings on this capital that we are already holding against Citi's stake.
So that meaningfully improves ROE in the business.
But in addition to that, we get the benefit from adding about another $55 billion in deposits over time.
So not only do we benefit from efficient, stable funding but we also increase net interest income, which is higher-margin.
And then beyond NCI there is an earnings benefit from trading volumes that are now directed to Citi based on an order flow agreement.
That is eliminated when we own 100%.
So some contractual benefits that take it higher, and then there are certain other costs for managing a joint venture that drop away.
So midteens margin mid next year is the guidance, but just wanted to give you the path forward.
Roger Freeman - Analyst
Got it, okay.
Then just lastly on the Basel III Tier 1 ratio at 9%.
I think last quarter I think you said you were just under 8.5%.
There was some benefit from the MSSB transaction.
But also, is the 8.5% still a comparable number?
Because I know that NPR had just come out in June.
Didn't know if there were any revisions to the historical effect.
Ruth Porat - CFO, EVP
Yes, that is a comparable number.
The increase really starts with earnings; and as you know well, DVA is not relevant for the capital calculation.
So starting with earnings, there was a modest benefit from the new VaR model.
But I think very important, we continue to execute on our RWA plan, the risk-weighted asset plan.
Roger Freeman - Analyst
Okay, great.
Thanks a lot.
Operator
Mike Mayo, CLSA.
Mike Mayo - Analyst
Good morning.
Can you update us on your FIC risk-weighted asset reduction?
How much have you done and how much more do you have to go?
Ruth Porat - CFO, EVP
Hey, Mike.
Given we just laid it out at a conference recently, what I will say is we are very much on track for the targets that we laid out at the conference.
Mike Mayo - Analyst
Okay.
The increase in your Basel III Tier 1 ratio, was that helped out this quarter by the risk-weighted asset reduction, or is that to come?
Also, did the VaR change help out your capital ratio?
Ruth Porat - CFO, EVP
Yes, the three components that helped the capital ratio was obviously starting with earnings, and then I just mentioned that there was a modest benefit from the new VaR model.
And yes, we did continue to execute on the RWA plan.
That was part of the benefit.
Mike Mayo - Analyst
Why did you make the change in the VaR model?
Is it simply to get a shorter time series?
And if so, what time frame did you have before versus now?
Ruth Porat - CFO, EVP
Yes, the primary driver was to have a VaR model that is more sensitive to changes in market volatility.
So it is more weighted to one-year data.
As we've talked about in the past, our prior VaR model was really -- it was based on four-year data.
We have been running this model and the prior model in parallel since 2011, which gives us a high level of comfort from the model.
It has been approved by regulators.
It is consistent with Basel requirements.
In our disclosure what you have probably seen is we have provided the VaR measures under both models for this quarter, the prior quarter, the prior year; and we will be doing the same for the fourth quarter.
I thought it would be helpful for you to be able to see the trends under both models, which are the same.
VaR was down this quarter.
Mike Mayo - Analyst
You can appreciate the idea of changing a VaR model gets people's attention these days.
Is there anything else you have looked out at given what has taken place recently elsewhere in putting in place a new VaR model?
I mean, you put it in place firmwide; you ran it in parallel for what, a year and a half?
Anything else you can say to assure people?
Ruth Porat - CFO, EVP
Sure.
First and foremost it is part of the overall governance around risk management.
We have one centralized risk organization.
It reports to the Board Risk Committee.
The risk organization built the model.
It has been thoroughly vetted internally and, as I said, approved by regulators.
We have been running both models in parallel for an extended period of time.
And the other point is that VaR is just one of multiple measures of risk we use to assess overall risk in the organization.
We have talked in the past about our proprietary stress VaR model; that captures a longer time series and market liquidity and tail risk.
And we do constant scenario modeling, which stresses for volatility and price changes.
So it's part of an overall -- to your point, very good question -- overall comprehensive risk management, centralized risk management organization with multiple tools.
Mike Mayo - Analyst
Then last question, in Wealth Management, now that you're on one platform, I imagine you had many people working on that integration.
You said you're at your headcount reduction already.
So how many people were working on that integration?
And I guess they will be redeployed for more external activities, or elsewhere.
What kind of additional synergies can you get now that the integration is finally done?
Ruth Porat - CFO, EVP
As I indicated, the expenses were higher in the first half, but didn't drop off completely in the third and fourth quarter because we have continued to provide support.
We had built that into our upfront plan.
So you are right.
I don't have the numbers with me, but headcount does benefit modestly as we completed the platform and will continue to benefit.
Mike Mayo - Analyst
All right, thank you.
Operator
Glenn Schorr, Nomura.
Glenn Schorr - Analyst
Thank you.
Quickie on loan and loan commitments have been coming down.
They are actually down, like in half.
Is that a function of the environment or a little more a function of the Basel III/Dodd-Frank world that we are going to live in?
Ruth Porat - CFO, EVP
So, loans -- what I would like to point you to is obviously the difference between what is in our fair value book versus HFI.
As we have talked about several quarters ago, we were increasingly moving to HFI.
That is up again this quarter.
And overall, our loan book is actually up this quarter.
So I think that the change is in what is fair value versus HFI.
HFI is now over half of our total loan book.
Glenn Schorr - Analyst
Totally fair point.
I guess M&A performance is pretty good, but in general industrywide -- you scratch your head.
You look back and you say, wow, conditions actually should be pretty good for a heated M&A environment.
Yet, I think there's a lot of conversations, good pipelines, and not a lot of trigger pulling.
I am just not sure if you can think through the things that would maybe break up that logjam and what your expectations are next four or five quarters.
Ruth Porat - CFO, EVP
You're absolutely right.
Our view is that the conditions that we are seeing today, with lower volatility in the markets and low rates, so an attractive financing environment, if you look historically that should set up for or encourage a pretty robust M&A environment.
Pretty -- higher levels of activity.
And very much to your point, industrywide volumes continue to remain at very low levels.
What we are hearing anecdotally is that much of that continues to be the uncertainty about the environment, the concerns not just in Europe but increasingly here in the US, and that that is basically putting activity on the sidelines.
Conversation is ongoing and the pipeline is healthy.
But very much to your point, need to have more clarity about the environment and some of the changes that are forthcoming, in particular here in the US, for activity to move forward in a meaningful way -- is our expectation.
Glenn Schorr - Analyst
Excellent, thanks.
Last one, just more of a big-picture one.
I think everything you pointed out at the beginning of the call is spot on.
I think Fixed Income snapped back strong.
M&A, debt underwriting, Equities -- all good.
Wealth Management getting better.
You're going to own more.
Even if you do the math of you owning more and hitting your margin target, I am still coming up in a single-digit ROE range.
I just don't know if it is just waiting on a better environment.
Just curious if you, in your minds, have a path towards say a double-digit ROE, and what it takes to get there.
Ruth Porat - CFO, EVP
Sure.
We do have meaningful ROE upside and are unequivocally focused on driving returns in each of our businesses.
There was noise in the numbers this quarter.
I will let you model those in.
But taking you to the sustainably higher ROE and focusing on those drivers we have talked about -- revenue profitability, capital efficiency for the various businesses -- let me go into them in some detail.
So, in Wealth Management in terms of the revenue upside, we are continuing to increase our managed accounts businesses.
It is up above $550 billion this quarter; it's up 20% year-over-year, and that is accretive to returns.
And we are increasing our lending business.
We have $73 billion of deposits as of October 15, once the deposits came in from Citi associated with the 14% stake.
Those come in under the drag basis -- lag basis, rather.
So $73 billion of deposits.
We are increasingly moving that to higher-margin products, which will increase NIM even without any rate increase.
Then on the expense side, you have seen it in the third quarter.
The integration is complete, so expenses have come down and have more room to go, as I just noted.
And the cost-savings programs add to that even more.
Then on the capital side, as you said, when we own -- as we increasingly own more of the joint venture we generate earnings on what I have repeatedly called dead-weight capital.
We're holding this capital against Citi's stake and not generating earnings on it.
Notably, as we buy in the remainder of the Wealth Management joint venture, there is contractually significant revenue and profitability upside that I commented on.
Things like the order flow agreement, more deposits, so more upside beyond that contractually.
Then on the Institutional Securities side, starting with revenues, we have sizable operating leverage in our Institutional businesses and we are executing on our plan.
So we have a stellar platform in banking.
We have a strong M&A pipeline.
The same is true for equity new issuance, and both really play to our strength.
We have a leading franchise in institutional equities and we continue to increase share even with low marketwide volumes.
And on Fixed Income, we are on track to running an optimized returns business with a strong client franchise, putting risk behind clients with smart capital efficiency.
And we are pleased with the momentum in the business.
On expenses, we have very strong expense controls, comp and non-comp.
And on capital, we are benefiting from more efficient use of capital across the businesses.
On top of that, there would be upside from any return of capital and from an improving market over time.
But we are building to a healthy increase in ROE with revenue profitability and capital levers I have just gone through.
James Gorman - Chairman, CEO
Hey, Glenn, it's James.
You said at the beginning what -- an overall big picture on the ROE, and as Ruth has laid out all the components.
But just step back for a minute.
The first quarter the ROE was 9%.
Second quarter obviously we fell into a hole with the rating agency action, and there was -- clearly we wanted to demonstrate that we have bounced back from that, which I think we have clear demonstration.
You put all the pieces together, and it is not a terribly heroic assumption to get back to your cost of capital.
And that is clearly what our plan and focus is on.
We will be very, very, very focused on non-comp expenses.
We are very attentive to our overall capital plan over the next couple of years.
We are determined to make this GWM acquisition work.
And as Ruth said, we have huge operating leverage across Institutional Securities.
So, again, I am not sure what your math is looking like, but I don't think it takes a lot of heroic assumptions to get you to a reasonable ROE number.
And then obviously from then on, as the global macro environment improves, which I believe it is on the starting basis of doing, we take it up from that point.
Glenn Schorr - Analyst
Thank you, both.
That was great.
Operator
Kian Abouhossein, JPMorgan.
Kian Abouhossein - Analyst
Yes, hi.
First question is relating to risk-weighted assets again.
You mentioned at a recent conference second-quarter Group risk-weighted assets were about $500 billion.
Could you give us an update where we stand as of the third quarter with a 9% Tier 1 Basel III?
Ruth Porat - CFO, EVP
You know, given we just went through it at a recent conference, we are continuing to execute on the RWA plan; but I don't have it with me, because we are not updating it at this point.
Kian Abouhossein - Analyst
When will you give actually more details on your Basel III?
Because it's been industry-standard to just start, give a little bit more details.
When should we expect you actually to either have it in the press release or in any other form, that you give more details on capital as well as Basel III details?
Ruth Porat - CFO, EVP
Well, actually I think that with the delineation we gave on -- in particular in Fixed Income we have given quite a bit of granularity because we wanted to make it clear how we are thinking about this strategically, and we have laid out some pretty key milestones.
I think it might be helpful if I roll forward, based on that plan, where that gets you in '13 -- and you probably have already done this.
But based on our current interpretation of the rules, consensus earnings in the RWA reduction plan that we did lay out at the conference, the math will get you to north of 10% by 2013.
Kian Abouhossein - Analyst
Okay.
Moving on to funding cost, your funding cost is about 50 to 100 basis points higher than your peers.
I am looking at your balance sheet, and you have about $170 billion of long-term debt; but I'm sure there is other long-term debt that I am missing because of the way it is categorized.
How much long-term debt do you actually have, of what you categorize as long-term debt in your business?
And how does a 50 to 100 basis points higher CDS spreads impact your funding cost really going forward?
How should we think about how you fund your business and the impact on the ROE?
Ruth Porat - CFO, EVP
So, you've identified the long-term debt.
You've got the right number there.
In terms of funding, as I have said on many quarterly calls, the strategic moves that we have been making are benefiting our funding costs and our requirements.
So for example the growth of the deposit base, which is clearly consistent with our ongoing growth of the Wealth Management business, funds both our corporate and retail loan books and additional products in the bank.
And as we increase funding with deposits we reduce reliance on our unsecured funding.
With respect to the business mix, as we move more toward flow, which we have talked about quarter after quarter, from structured products, we are finding more efficiently through the secure channel.
And as a result of this and all that we have been doing with the balance sheet, this quarter alone our unsecured debt is down by $3 billion.
In 2012 year-to-date it is down by about $20 billion.
So in the aggregate, as a result of the strategic moves -- which is why I keep anchoring it back to that -- the strategy is actually yielding multiple benefits.
We have reduced our funding requirements.
We've increased the durability of our funding because we have more efficiency given the multiple funding sources.
Kian Abouhossein - Analyst
Okay.
That's actually quite useful.
In terms of the comp ratio, I get to an IB clean comp of 45 in the quarter.
You mentioned non-comp as an improvement area.
Most banks that I talked to are looking at more like high 30s as a comp target over the medium term.
How do you see your long-term comp ratio outlook, assuming no material changes in revenues?
Ruth Porat - CFO, EVP
Understood.
So in recent quarters with higher revenues, we delivered a lower compensation ratio, which evidences our philosophy and continues to drive returns.
As we have said many times, we're focused on appropriately rewarding those who drive returns, while improving ROE and earnings.
So this is not just about the compensation dollars.
We are also looking at headcount management, at location sourcing, at the overall expense management program, and looking at both comp and non-comp.
Kian Abouhossein - Analyst
But with this revenue environment is it fair to say we should still see low 40s as a number on comp?
Is it reasonable?
Ruth Porat - CFO, EVP
Well, I'm going to make two points.
The other important point to note is obviously ratios are not apples-to-apples across the Street.
And as I said, we're looking at ensuring that we get the balance right so that we can reward those who drive returns while improving ROE.
Kian Abouhossein - Analyst
Okay.
Last question on your VaR model.
Do you still use a Monte Carlo model, or historic now?
Ruth Porat - CFO, EVP
Historic.
Kian Abouhossein - Analyst
Okay, thank you.
Operator
Matt Burnell, Wells Fargo Securities.
Matt Burnell - Analyst
Good morning.
I have a follow-up question, I guess to Glenn's question about the businesses and getting to ROE.
Ruth -- and maybe you incorporated your comments on this -- but you didn't really focus on the Asset Management businesses.
You're currently running at about a 17% ROE this quarter, half that on a year-to-date basis.
Is there any meaningful benefit to ROE given the relatively modest contribution now that you see?
You mentioned ISG and you mentioned Wealth Management.
But is there anything that we might expect in terms of ROE benefit from Asset Management in the next year or two?
Ruth Porat - CFO, EVP
Well, you've identified, given it's already a high ROE business, there tends to be less of a question there.
What we have consistently been doing is bringing back seed capital and investing in the core business.
So again, that is accretive to returns in what is already an attractive return business.
Matt Burnell - Analyst
Okay.
Then you mentioned that there has been some greater sense of engagement from your clients post the Moody's downgrade, and that accelerated in the third quarter.
My presumption is that that is a comment basically focused on your institutional clients.
Can you give us a little more color as to the sense of the retail investor engagement over the course of the third quarter?
And any color you might want to provide relative to what has happened since the end of the quarter.
Ruth Porat - CFO, EVP
If I'm hearing the question correctly there were actually almost may be two points in there.
Post-Moody's we had -- we saw clients really reengaging, as you said, on the sales and trading side, in particular on the Fixed Income side which is the area that dealt with it the most.
There wasn't really a Moody's impact on the retail side.
So on the retail side, the focus has been much more about what is going on in the macro environment.
As I commented, one of the impacts and the drags in the business has been, with the macro as weak as it had been or as volatile as it had been, we had lower levels industrywide of equity new issue products.
So that affected the opportunity overall for retail product to go through the system.
But I think what you see in retail which is attractive is the consistency of revenues quarter after quarter.
James Gorman - Chairman, CEO
I would just add from observing that part of the business for over a decade that there are periods where retail investors are completely disinterested in the market.
There are periods when they are chasing everything that is moving.
And then there are periods when they are basically sitting on the sidelines.
If good product comes along, they engage.
If there is a better tone in the market, they engage.
And we're in that period.
We are definitely not in a fearful period.
We are in a period where the money is there, the flows are still positive, a lot of money is sitting in cash.
And when interesting product is coming along they are engaging; and when there is firmer tone, whether it is from here or Europe or anywhere else internationally, we see an uptick in activity.
So as Ruth said, it has remained enormously stable during a pretty depressed period.
And in my view it wouldn't take a whole lot for that revenue outlook to turn in a positive way.
Matt Burnell - Analyst
Okay.
Then finally, Ruth, you mentioned the hedge funds look like they are taking a bit more leverage this quarter.
Could you provide a little additional color as to if there are specific markets or products where they are willing to put on more leverage?
Ruth Porat - CFO, EVP
You know, I think it's a pretty broad-based statement that we are seeing.
Not -- I can't pinpoint it to any particular market as broader.
Matt Burnell - Analyst
Okay.
Thanks very much.
Operator
Brennan Hawken, UBS.
Brennan Hawken - Analyst
Good morning.
First, a quick one on CVA.
Are we done there?
Or is there more of that coming in subsequent quarters?
Ruth Porat - CFO, EVP
So you specifically asked about CVA, not DVA.
Obviously both are affected by movements in credit spreads, and so we don't forecast movements in credit spreads.
Brennan Hawken - Analyst
Right, but I think it was last quarter where you said that there was a big change because of the downgrade.
So I was more referring to the outsized move as it related to that, with the increased collateral.
Ruth Porat - CFO, EVP
Okay, sorry about that.
There were no -- there weren't more collateral calls this quarter.
So you are not -- we basically had the initial flurry of collateral calls post the ratings action in June, and it pretty much subsided even before we got to the second-quarter earnings call.
It was an initial flurry and that was it.
So you do not see an impact from collateral calls this quarter.
Brennan Hawken - Analyst
Okay.
Good deal.
Then sticking with the capital markets, nice to see a pretty solid bounce-back there in FIC and great to hear about clients reengaging.
Is that still -- is there still a tailwind coming there and still continuing to benefit to you?
Or do you feel as though everybody now is back and FIC is up to full speed?
In other words, do we have more coming, more benefit?
Ruth Porat - CFO, EVP
Well, we always want to be doing more with our clients, so I wouldn't put an end point on it.
I think that we were -- it helped to have the ratings action behind us and clients reengaged.
And you can see that in the numbers.
The moves by the ECB in the summer, as I noted, I do think helped bring clients back into the market more broadly.
That had been a big headwind as well.
But in our view, we've got a very focused approach to the businesses and are looking to continue to build share.
Brennan Hawken - Analyst
Yes.
Sorry if I wasn't more specific.
I just meant the reengagement post Moody's, if you felt as though at this point folks are now fully back and reengaged.
Ruth Porat - CFO, EVP
It is hard to disaggregate what is going on in the macro from any particular -- is there any particular lag.
Our sense is that clients have reengaged and we are continuing to work to build market share with them.
And it feels that it's pretty much been addressed.
But I was actually very, very directly saying that we are continuing to drive share and looking at that.
Brennan Hawken - Analyst
Cool.
Ruth Porat - CFO, EVP
So hard to be more specific.
Brennan Hawken - Analyst
Yes.
No, that's fair.
Aside from benefiting from the more favorable market conditions, as you highlighted, in the commodities business Goldman hit on weakness and specifically highlighted weakness there.
Could you give some more color on how that business went this quarter for you guys?
Ruth Porat - CFO, EVP
Yes, it was -- commodities was up meaningfully versus last quarter; but as we noted it was much lower last quarter, and that was due to a more favorable market environment.
It is still down year-over-year.
So I think some of the backdrop continued to be a bit challenging.
As we've discussed before, for us the business is a mix of flow and structured solutions for clients, and it can be quite lumpy.
Brennan Hawken - Analyst
Okay.
Then last one for me.
There was a good deal of noise made in the press on trends within FAs in Wealth Management.
You never know how much of that is noise versus something real.
So have you guys seen any uptick in defections post-integration?
Have you seen any tangible evidence of dissatisfaction?
I know the total FA headcount went up.
But sometimes there is junior brokers that get added and that can skew.
So if you could give maybe some color on that, that would be helpful.
Ruth Porat - CFO, EVP
Well, FA attrition continues to run at low levels.
In fact for the top two quintiles, which is what we typically call out, the attrition was lower in the third quarter than it has been for the last several quarters.
And if you look at metrics like annual revenue per financial advisor or assets per financial advisor, all of the trends are going in the right direction.
So there is always some movement in and out; actually this quarter FAs are down a bit, as it was between the first and second quarter.
But attrition is lower than it has been.
Or put it differently, retention is running at higher levels.
Brennan Hawken - Analyst
Great.
Thanks a lot.
Operator
Richard Ramsden, Goldman Sachs.
Richard Ramsden - Analyst
Good morning.
Thank you for taking the question.
I've got a question around Basel III again.
Given the uncertainty around the outcome of the final NPRs, as well as given some of the questions around the model approval process, is it possible to give a range of outcome for what your Basel III numbers ultimately could be?
Ruth Porat - CFO, EVP
Well, what we -- the way we approach the Basel III guidance is it's based on our, as I said, current interpretation of the rules.
What it does not include is the benefit of model approval, which is obviously a key part of the transition.
And we view model approvals as incremental upside.
So what we will do is layer that in as we get model approvals.
There are certain models that are kind of more foundational, like IMM.
But if you look at a CRM model approval, which we think a number of people keep coming back to, we don't include the benefit of CRM model approval.
So for example in the second quarter I mentioned that we estimated that our Tier 1 common ratio would be up about 40 basis points based on the book at that point in time.
And the reason we don't baked that into our guidance, our spot guidance, is as you know, even when you receive CRM model approval you have to wait a year to incorporate the benefit in the calculation.
So that by any -- under any set of facts would be an event at least a year out.
And given the (technical difficulty) changes and we are actively reducing it, the benefit changes as well.
So although we are working to get model approval we thought it was most prudent not to include the benefit of things like that in the guidance we give you.
And as we put it, kind of greater than 9%, and that gives us the room to take it up as we get model approval.
Richard Ramsden - Analyst
Okay.
So to be clear you haven't included CRM.
How about things like stressed VaR and the incremental risk charge?
Are those included in your number as well, or not?
Ruth Porat - CFO, EVP
CRM is not included.
But things that -- I will call them the kind of foundational models that move you from Basel I, then II, and through the various regimes like IMM or IRB are included.
It is just the specific models that are available and that we are clearly working on to take risk-weighted assets down as with the CRM model.
Richard Ramsden - Analyst
Okay.
What do you think is a reasonable time period in terms of getting full model approval from the Fed?
I.e., is this something that is months out, or do you think it could take longer than that?
Ruth Porat - CFO, EVP
Well, the reason we are not including it in our guidance is because we can't answer that question.
So we are working on it, and I think it will take -- they seem to -- there is obviously a lot going on with the various moves from I to II to 2.5 and III.
So I can't estimate the date, but we will provide updates as the models get approved.
Richard Ramsden - Analyst
Okay.
Then the second question I wanted to ask, can you confirm buying out the remainder of Smith Barney doesn't have a significant capital impact?
I think you have said that on a couple of occasions.
Given that, when we think about capital returns next year, should we think about buying out the remainder of Smith Barney versus buying back stock as an either/or decision?
Or do you think there is potentially room for you to do both?
Ruth Porat - CFO, EVP
Well, as I think James said, it is premature to judge the CCAR process.
We haven't even seen the rules yet.
But as you have seen from actions to date and James's comments, the first priority is the Wealth Management joint venture, the additional 35% or portions thereof, given the strategic value of the business.
So at this point it is premature to judge CCAR.
Richard Ramsden - Analyst
Okay.
All right.
Thanks a lot.
Operator
Ladies and gentlemen, that concludes your conference call for today.
Thank you for your participation.
You may now disconnect.