摩根士丹利 (MS) 2013 Q1 法說會逐字稿

Good morning.

This is Celeste Mellet Brown, Head of Investor Relations.

Welcome to our first-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 a 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.

Thank you, Celeste.

Good morning everyone.

We will review the progress we've made towards the six comprehensive steps we laid out in January, that will drive our return on equity and return on tangible equity, excluding DVA greater than 10% and 12%, respectively, assuming a flat revenue environment.

We'd like to update you on the progress we've made towards each goal during this quarter, and we remain committed to the targets as laid out.

First, on the first point number one, to acquire 100% of the Wealth Management joint venture.

As hopefully you know during the first quarter, we received a non-objection in the CCAP process to our request to use $400 million of our excess capital to buy in the remaining 35% of the joint venture from Citi.

We are now awaiting further approval from the Fed consistent with the process for the 14% purchased last year.

And we look forward to hearing from the Fed over the next several weeks or months.

Number two, to achieve Wealth Management margin goals through expense management, and to exceed them through revenue growth.

Due to better expense controls and a more robust revenue environment, we were able to drive another 17% margin result in Wealth Management to the first quarter, despite seasonally higher expenses.

In addition, our flows into managed accounts were very strong, at over $15 billion.

Long-term, we continue to believe this is an extremely attractive business for Morgan Stanley.

There is continued upside to profitability driven by a constructive environment and expense controls, a gradual shift back into equities by our clients, continued migration of managed accounts from commission based accounts, and finally, revenue and margin upside from earning 100% of Wealth Management.

Point three, to significantly reduce risk-weighted assets in fixed income and commodities.

We made good progress with our fixed income risk weighted asset reductions, ending the quarter at $253 billion, down from $280 billion at the end of 2012, and slightly below our year-end target of $255 billion.

Our progress was partially driven by passive mitigation with much of the decline driven by credit derivative contract expiry's.

Although we are pleased with our progress, we remain comfortable with our year-end target of $255 billion.

Point four was to drive expenses lower in 2013, 2014, and beyond.

Non-compensation expenses continued to come down sequentially, consistent with the progress we've made last year, and the targets we outlined in January.

In addition, our Firm wide and IC compensation ratios, excluding DVA and severance, were well below our full year 2012 ratios, while total compensation dollars were also below those from a year ago.

This largely reflects the significant headcount reduction we made over the past 12 months, across that business.

Point number five was to grow earnings through Morgan Stanley specific opportunities.

As we discussed when we reported the fourth quarter, we believe there is significant revenue upside and expense savings for both Institutional Securities and Wealth Management, as we more closely align those businesses.

Institutional Securities and Wealth Management launched their joint venture in September 2012 to increase collaboration between the businesses and there are currently over 40 initiatives in various stages of execution, we are already seeing the benefits in the first quarter and expect additional upside over the next several years.

For example, prior to 2013, the Firm had two separate groups focused on fixed income middle markets institutional clients.

In January, these groups were integrated under a uniform platform and leadership and are evidencing positive early results.

Revenue generated on these accounts was up despite aggregate market volume declines for the particular products in the same period.

During the quarter, we continued to deploy our excess bank deposits more efficiently.

Our mortgage lending was again higher and we made significant progress in regards to our PLA or portfolio lending efforts.

Where we expect to derive the majority of our retail lending growth over the next several years.

On the institutional side, we added two new initiatives to our bank suite platform in the first quarter and we are in the early stages of execution for commercial real estate and warehouse lending.

There remain significant opportunity for growing our bank, as we've previously discussed, our deposits will grow to approximately $140 billion after we acquire 100% of the Wealth Management joint venture.

And we have a prudent, disciplined strategy to deploy those deposits over the next three years.

Point number six, so how does all this add up?

While our 8% ROE and 9% ROT, both excluding DVA, are a solid start to the year, we expect that these levels will improve driven by the steps I've updated you on.

The consistency of our returns is as important as the absolute level of our returns and we have made progress in this regard, as well, particularly over the last several quarters.

In addition, we believe many of the regulatory headwinds facing the industry are already reflected in our results, such as the cost of subsidization and because our growth areas are those that are unlikely to be much impacted by further regulation, our path is clearer.

In closing, I'd like to briefly touch on our Japanese business before I turn the call back to Ruth.

It's top of mind because of the trip I made to Tokyo last week to meet with our partners.

I saw firsthand the impact of new monetary and fiscal policies on the markets there and the impact they are having on our business.

Our joint ventures with MUFG, Morgan Stanley MUFG Securities and Mitsubishi UFJ Morgan Stanley Securities are uniquely positioned in Japan to take advantage of what is a macro resurgence due to the global client network and capabilities of Morgan Stanley, and the domestic Japanese corporate and retail footprint of MUFG.

Combined, we have an unparalleled distribution intermediating invested capital flows into Japan and helping Japanese companies grow abroad.

In Japan, we have top three positions in equity and fixed income underwriting and M&A.

As Japanese domestic firms consolidate their IBD market share, our JVs are differentiated as a domestic firm with truly unique origination capabilities.

Outbound M&A volume was up significantly in 2012, and Japan became the number two acquire nation globally versus number nine in 2009.

We're also well positioned in sales and trading and have and will continue to benefit from cross-border flows in the Japanese equities, where we have a nearly 14% share in equity trading.

As we approach the third anniversary of the JV on May 1st, the financial contribution of Morgan Stanley continues to show positive momentum, which we expect to continue for some time, and was worth calling out at this unique point in transition in Japan.

Now, let me get back to the broader results and particularly the first quarter and turn it over to Ruth.

Thank you.

Good morning.

I will provide those GAAP results and results excluding the effects of DVA.

We have provided reconciliations in the footnotes to the earnings release, to reconcile these non-GAAP measures.

The negative impact of DVA in the quarter was $317 million, with $238 million in fixed income sales and trading, and $79 million in equity sales and trading.

Excluding the impact of DVA, Firm wide revenues were $8.5 billion, up approximately 13% versus the fourth quarter.

Non interest expense was $6.5 billion, up 7% versus the fourth quarter.

Compensation expense was $4.2 billion this quarter, which included approximately $132 million related to severance.

Non-compensation expense was $2.3 billion, down 6% from last quarter.

The effective tax rate from continuing operations for the first quarter was 21%.

Excluding discrete items, the effective tax rate was about 30%.

Earnings from continuing operations applicable to Morgan Stanley common shareholders excluding DVA were approximately $1.2 billion, earnings from continuing operations per diluted share were $0.61 after preferred dividends.

On a GAAP basis, including the impact of DVA, Firm wide revenues for the quarter were $8.2 billion.

Earnings from continuing operations applicable to Morgan Stanley common shareholders were $977 million, reported earnings from continuing operations per diluted share were $0.50 after preferred dividends.

Book value at the end of the quarter was $31.22 per share, tangible book value was $27.39 per share.

Turning to the balance sheet, our total assets were $801 billion at March 31, up from $781 billion last quarter.

Deposits were $81 billion, consistent with fourth quarter levels.

Our liquidity reserve at the end of the quarter was $186 billion, compared with $182 billion at the end of the fourth quarter.

$118 billion of our liquidity this quarter was parent and non-bank liquidity versus $111 billion at the end of the fourth quarter.

We increased our liquidity reserve to ensure we are well-positioned for the potential acquisition of the 35% stake in the Wealth Management joint venture.

With respect to our capital ratios, as a reminder, beginning this quarter, the definition of Basel I capital ratios reflect the implementation of the Basel Committee's market risk capital framework which is commonly referred to as Basel 2.5.

Although our calculations are not final, we believe that our Tier I common ratio under Basel I will be approximately 11.5% and our Tier I capital ratio will be approximately 13.9%.

For the fourth quarter, the pro forma Tier I common ratio under the new framework would be 10.6%.

Risk-weighted assets under Basel I are expected to be approximately $403 billion at March 31.

Subject to final rule making and reflecting our best assessment of the rules, our pro forma Tier I common ratio under Basel III was 9.8% as of the end of the first quarter.

Let me now discuss our businesses in detail.

In Institutional Securities, revenues excluding DVA were $4.4 billion, up 22% sequentially.

Non interest expense was $3.3 billion, up 8% versus the fourth quarter.

Compensation, which included severance of $113 million, was $1.9 billion for the first quarter, reflecting a 43% ratio excluding DVA.

Excluding DVA and severance, the compensation ratio was 40%.

Non-compensation expense of $1.4 billion decreased 6% from last quarter.

The business reported a pretax profit of $1.1 billion, excluding the impact of DVA.

Including the impact of DVA, the business reported a pretax profit of $830 million.

In Investment Banking, revenues of $945 million were down 23% versus last quarter.

According to Thomson Reuters, Morgan Stanley ranked number two in global completed M&A, and number three in global equity, at the end of the first quarter.

Notable transactions, included in equity underwriting, Zoetis, which raised $2.6 billion in its public offering, the largest IPO of a US company in almost a year.

In Advisory, Benckiser acquired DE Master Blenders for EUR7.6 billion and Morgan Stanley served as financial advisor and joint lead arranger on committed financing to the bidder group.

In Debt Underwriting, as joint book runner, we successfully priced $3.5 billion of senior unsecured notes for Intelsat Luxembourg to refinance existing indebtedness.

Advisory revenues of $251 million were down versus our strong fourth quarter results, due to lower industry wide volumes and timing of fee recognition.

Declines were primarily in the Americas.

Equity underwriting revenues were $283 million, up 19% versus the fourth quarter, driven by improved performance in the US and Asia, offset by declines in EMEA.

Overall, revenue mix for the market was less favorable in the quarter, with fewer IPOs and greater block activity.

Fixed income underwriting revenues reflected continued strong demand across products, although our revenues of $411 million were down versus our record fourth-quarter.

This quarter, the market was more heavily driven by high yield and leveraged loans, where our share has historically been lower, versus investment-grade where we have stronger positioning.

Equity sales and trading revenues excluding DVA were $1.6 billion, an increase of 14% from last quarter.

Equity revenues were up broadly across products, regions and client segments, versus the fourth quarter.

Client revenues were the highest levels in over a year, driven by market share gains and growth in prime brokerage balances.

Prime brokerage balance growth in fact out paced the overall market, due to greater balances from existing clients and from new business.

Strength in our core businesses was partially offset by the PDT spinoff that was effective January 1 of this year.

Fixed Income Commodities and commodities sales and trading revenues excluding DVA were $1.5 billion.

Revenues increased versus our fourth-quarter results, reflecting seasonal patterns, despite a period of challenging market conditions in March.

CVA, net of hedges, continued to be a drag this quarter, in part, due to the tightening of our credit spread.

Results in both macro and credit products, were up versus the fourth quarter driven by strong client activity.

In general, clients focused on higher yielding products.

Credit corporates were up significantly, as secondary trading volumes increased.

Securitized products results outperformed due to very strong volumes and several CMBS securitizations in the quarter.

Commodities sales and trading revenues continue to be challenged by cyclical headwinds, but were ahead of fourth-quarter results.

Other sales and trading revenues of $73 million compared with negative revenues of $34 million last quarter.

Average trading VaR for the first quarter was $72 million, versus $78 million in the fourth quarter.

Turning to Global Wealth Management.

Revenues of $3.5 billion were up 4% versus the fourth quarter.

Asset Management revenues were consistent with the fourth quarter, reflecting comparable market levels at the beginning of each period.

Transaction revenues increased 15% from last quarter, consisting primarily of commissions of $559 million, which increased 5% reflecting greater mutual fund activity, despite fewer trading days versus the fourth quarter, investment banking related fees of $274 million, which increased 32% versus last quarter, driven by strong, new issue activity for closed end funds.

And trading revenues of $298 million, which were up 22% versus the fourth quarter, reflecting the impact of deferred compensation plans and higher fixed income revenues.

Net interest revenue increased 6% to $413 million, in part driven by higher average BDP balances and more efficient deployment of our investment portfolio.

Non interest expense was $2.9 billion, up 4% from last quarter.

The compensation ratio was 60% versus 57% in the fourth quarter, reflecting seasonally higher compensation expenses in the first quarter.

Non-compensation expense was $808 million, down 6% versus last quarter, reflecting continued expense discipline and the roll off of platform integration expenses.

The PBT margin was 17%.

Profit before tax was $597 million, the highest level of absolute profitability since the inception of the joint venture.

Non controlling interest was $121 million, up from $103 million in the fourth quarter, reflecting stronger results in the joint venture.

Total client assets increased 6% to $1.8 trillion, reflecting higher market levels and inflows.

Global fee-based asset inflows were $15.3 billion, fee-based assets under management increased to $621 billion at quarter end.

Global representatives were 16,284, essentially unchanged from the fourth quarter.

Bank deposits were $126 billion versus $131 billion at year-end as clients began to shift back into the markets in January.

Approximately $69 billion is held in Morgan Stanley banks.

In Asset Management, we continued to benefit from the steps we have taken to strengthen the business.

With higher revenues and another quarter of positive flows into fixed income funds.

Which is an area of focus for us.

In addition, as of March, in excess of 76% of our long only strategies excluding liquidity outperformed their benchmarks over 3, 5, and 10 years.

Specifically, Asset Management revenues of $645 million were up 8% versus the fourth quarter, driven by higher marks and growth in management and admin fees.

In Traditional Asset Management revenues of $401 million were up from the fourth quarter, driven by higher global equity markets and continued positive net flows into the long only business.

Partially offset by outflows in our liquidity funds.

In Real Estate Investing revenues increased 24% versus the fourth quarter.

Due to the ownership structure of these funds, the majority of these revenues are passed to third-party investors in the non controlling interest lines.

In Merchant Banking revenues were down compared to the fourth quarter.

Expenses were $458 million, up 21% from fourth quarter on higher compensation expense, primarily due to DCT.

Profit before taxes $187 million, down 15% sequentially.

NCI of $51 million was essentially flat to last quarter.

Total assets under management increased to $341 billion driven by market appreciation.

In terms of our outlook, a number of factors continued to support our expectation for healthy activity levels notwithstanding the persistent structural issues that must be addressed globally.

In the US, positive economic data are encouraging, with monetary policies supporting momentum despite the negative impact of the Federal spending reductions rippling through the public and private sectors.

Strong liquidity inflows support both equity and credit market activity as evidenced, for example, by higher PB balances and the greater engagement by retail investors that was first evidenced in January.

In the Euro zone, there is work still to be done, however the market liquidity facilitated by the ECB has inspired some reentry by investors.

A modest up tick from the low market volumes in prior periods.

The Japanese market is clearly benefiting from a surge in investor and corporate activity on the back of the recent bold central bank moves there.

Notably, Japanese retail investors are still heavily in cash while many international investors are underweight the market, suggesting the potential for continued healthy activity.

On the corporate side, global M&A dialogue is active, though CEOs seem to require sustained evidence of economic strength to act.

The periodic setbacks, as evidenced in markets over the last several weeks are reminders that global economic recovery and market healing may not come in a straight line, even as major economies are clearly on firmer footing than just a year ago.

Against this backdrop, we are confident about the steps we have taken to enhance Morgan Stanley's business mix, benefiting from leadership positions within Institutional Securities, demonstrable upside in Wealth Management, and effective capital optimization.

Similarly, the Firm's balance sheet is a source of strength driven by our success in doubling our capital base since 2010 and fundamentally improving both the quantum and durability of liquidity.

Thank you for joining us and James and I will now take your questions.

(Operator Instructions)

Guy Moszkowski, Autonomous.

Good morning.

So, a handful of questions for you.

The first one is, I think we can see plenty of evidence of the cost management moving towards -- capturing your $1.6 billion expense targets.

But, what's the best way for us to track as we go through the year, your specific progress against the $1.6 billion?

So, on the $1.6 billion, that was based on the calendar year '12 actual compensation and non compensation expense, I think you know, through 2014 is predicated on a flat revenue scenario.

We do remain very comfortable with that target.

There is some quarterly seasonality.

I think as we go through the year, you will continue to see progress against the $1.6 billion.

Is there some way that, maybe starting with next quarter, you could actually track against those baselines what you've actually captured?

Well, we will try and highlight, so you can see the progresses we have in other areas where we've laid out a marker and it's continued to hit and exceed the goals.

Okay.

Great.

I think that would be helpful.

Moving on to just the whole question of the risk-weighted assets and what we saw happening in the Fixed Income business more broadly, in the quarter.

You called out rates and Commodities as contributing to the year over year decline in Fixed Income revenues.

But, while we did see the Commodities VaR come down quite a bit, if we measure year over year, the rates VaR was actually up pretty materially.

Can you help us square that with both the revenue momentum and with the decline that you called out in terms of the FIC RWAs that got you ahead of your year-end targets by the end of the first quarter?

Sure, obviously a couple of questions in that.

Within VaR, the interest rate line is obviously both an interest rate and credit line.

As you noted, it was up year over year, flat to the last quarter.

It's affected by a couple of things.

First and foremost, it's a measure of risk and not necessarily correlated with revenues.

It does take up the activity in credit, as you noted, I called that out as an area that was quite strong for us, both corporate credit and securitized products are mortgage business generally.

It's a function of the shape of the book and the volatility of the market, generally.

I think what we are looking at, when you look at the total line is pretty consistent with prior period, prior year.

I think you then had another question regarding risk-weighted assets?

Yes, I mean to the extent that risk-weighted assets are going to be driven, in some measure, by your stressed VaRs.

I was just wondering if you could try and reconcile for us the movement in VaR versus the decline in RWAs, and I guess the follow-up question on the RWAs is, if you already exceeded your year-end target, why stick with that, as a target, basically, for the end of the year, $2 billion more?

So, the reduction -- when we look at this reduction over the next period of time to 2016, it's ballpark 60% passive and 40% active.

This quarter, it was mostly passive, it benefited from the structured credit contract maturities, as James noted.

But, it also reflected a change in the shape of the book and some other changes, such as active mitigation and our view is that we are very confident that we will be at that year-end target of $255 billion, if not lower.

Given part of the reduction was the change in the shape of the book, we just built in some degrees of flexibility over the year.

As I said, we are confident we are going to at least meet that year-end target.

It may not be a straight line down quarter over quarter, just depending on the shape of the book.

It could be higher in the second or third quarters.

Again, we remain very committed to the reduction this year and taking it down to that sub $200 billion level by 2016.

Okay.

Thanks for that.

Then, just to sort of continue I guess along the same lines, you allocated a large part of the parent company capital down to ISG, $11 billion in the quarter, after holding a lot of that, really, at the parent for a pretty long time.

Can you talk about what prompted the decision?

Is there anything about that move that traps capital in the business in any way, if in fact, your RWA declines continue and you might otherwise free up capital?

So, the way we run the business, the way we look at capital, is we really run it with a Basel III lens.

As I think you know, we actually charge capital and liquidity down to the business unit level, the product level, so we can look fully loaded at risk adjusted returns.

The question then became, over the last year or so is, what do we do with parent capital, given the rules for Basel 2.5 and Basel III were still in flight and they hadn't been implemented.

Our view was that once the Basel 2.5 rules were implemented at the end of last year and so there was complete clarity on it, no guess work, and what was being charged to the various segments, it was the appropriate time to take that parent capital number and allocate it up to the businesses.

So, consistent with moving our Tier I common ratio to the Basel 2.5 metrics we allocated the parent capital.

Just to make sure it's clear, because it can be confusing given the nomenclature, it's still Basel I even though it's using the market risk rules under Basel 2.5, our fourth quarter '12 Basel I number was 14.6.

The Basel 2.5 for the fourth quarter was 10.6.

If you are looking at where our Basel I ratios were last quarter under an apples to apples basis, Basel 2.5 10.6 last quarter, going to 11.5 this quarter, consistent with reporting ratios that way, parent capital is allocated into the businesses.

To your very good question of does that mean that there is trapped capital, as we think about the businesses, we look at, again, a Basel III lens with that buffer, and then above that we believe we have degrees of flexibility with respect to capital return.

And we are continuing to build that Basel III ratio based on the capital accretion from earnings as well as the capital optimizations through things like the risk asset weighted reduction and so that does give us greater degrees of flexibility.

Okay.

That's a very helpful description.

Thanks.

I will just ask one more, which is the Moody's announcement and conference call a couple of weeks back, kind of puts into focus that Morgan Stanley still has a lot of its derivatives book held outside of the bank unit and I was wondering if given what they are talking about doing, that pushes you to try to move more into the bank, to the extent that you can?

Well, we've been focused on moving more into the bank.

We continue to write new foreign exchange derivatives in the bank, as we've talked about on prior calls, and move old foreign exchange derivatives into the bank and we do plan to write new interest rate derivatives into the bank this year.

Timing and speed is really a function of some of the regulatory processes.

I think more broadly on your question about Moody's, we feel good about the steps we've taken to position Morgan Stanley for greater quality and consistency of results and it sets us up well.

We've talked a lot about the changes to the business mix and funding on calls like this with plans and counter parties which really all go to the strength of our standalone credit profile and what we've done.

I think, also, when you look at the change in the business mix, for example, with Fixed Income, it's really moved more towards cash than derivatives.

So, that puts us in a good spot and obviously, the industry has changed as well in the past year with adjustments post the ratings action.

So it would mute the impact of anything that may be done on the ratings front.

I think the main thing is, we think that all that we are doing continues to build our standalone credit profile.

Great.

Thank you very much.

Thank you.

Glenn Schorr, Nomura.

Hello, just one quick follow-up on the RWA reduction in FIC.

It doesn't sound like it had much of an impact on revenues, I just wanted to make sure that I clarify that point.

Correct.

The majority of it was passive.

The active was P&L neutral and on the structured credit positions, there wasn't a P&L impact because we really hedged out the revenue and risk.

Okay.

Great.

Then, on Commodities, it's been a tough revenue backdrop for everybody, given the lower trending prices.

I just want to make sure that you still feel this is mostly cyclical trending, lower oil and things like that and make sure that there aren't any structural changes needed to the business.

Our view is that it is a cyclical headwind.

As you said, it's continued backwardation and it won't turn on a dime.

Cyclical changes can take time to turn, but it is cyclical.

It affects opportunities for us.

It affects opportunities for clients related to particular structured solutions, which benefited us last year, but we do view it as cyclical.

Got you.

In terms of the physical oil, you tend to hedge that at all times, correct?

Yes, we don't take outright positions.

We hedge our physical inventory.

Super.

Last one is, there was some -- not that big, but modest shifts of revenues and expenses in the reporting from last quarter from Wealth Management to the Institutional Securities Group.

It had a drop of effect of -- positive effect on the margin, but the real impact on the margin besides the good markets was a core drop in non-comp at Wealth Management?

I just want to see, is that a function of the systems integration costs running off?

And this is good run rate to run with?

A couple of things.

In terms of the International Wealth Management margin, you nailed it.

It's a small move.

You can, if you look at the supplement from the fourth quarter until now, it's about a 10 basis point different.

So, a small portion of the -- a small difference.

In terms of the overall margin, I think I'd highlight two points.

One was the strength of the new issue underwriting activity, in particular, closed end fund activity was very favorable last quarter.

That helped on the top line.

So, that -- you can't assume we are going to have the same volume in the next quarter.

That was a positive.

Expenses clearly -- we have remained focused on and the integration being done in rolling off was very much as planned and we are continuing to stay focused on the expense line.

I think if you're looking forward to the second quarter, assume expenses to pretty much hold at that level, notwithstanding the fact that we remain tight on expense discipline.

You've got the closed-end fund new issue activity, hard to forecast.

We do see new issue activity generally, a lot of that is outside the US and the real catalyst comes from the US.

At the same time, the S&P is about 10% higher than at the end of the first quarter, which benefit our fee based revenues.

I think those two revenue items sort of offset one another and so, at this point, we are holding kind of our margin expectation pretty much in the area where it is, although you can see we've got a number of levers that we are continuing to push.

Awesome.

Thanks, Ruth.

Thank you.

Howard Chen, Credit Suisse.

Good morning, James.

Good morning, Ruth.

On the remainder of the MSSB buy-in, what specific approval are you waiting for from the Fed regarding that?

So, we've gone through, obviously, the CCAR which is the capital approval and gotten the non-objection there.

The approval -- Dodd-Frank process approval, we did the same thing last year, when we did the 14% buy-in.

That approval, so it's process approval versus capital approval, that approval last year came in May which wasn't really as relevant for timing, because we didn't have the call until June and then we went through the arbitration process which took it out basically to the end of the summer.

I'm not suggesting that you can read anything into that May date but it's the only proxy we have for what that timeline was, at least last year.

Great.

Thanks for that, Ruth.

Then, James, speaking of the CCAR, to the test results came in a bit, your own test results came in a bit below that of the Fed.

I just wanted to get your thoughts on what you believe drove that difference, what's in your control to maybe bridge that gap going forward and how does it impact timing and quantum of the next stage of capital return post the buy-in.

Why don't I start in some of the technicals.

I think your point, in particular to our PP&R versus the Fed's, which you can see in the disclosure.

Our understanding is that the Fed has its own model which relies on historic data.

Given we've invested meaningfully to increase the quality and consistency of earnings there have been charges that have obviously been flowing through the P&L such as MBIA which are negatives in the historic financials but on a go forward basis, we've eliminated drag, improved the quality and consistency of results.

So, it's understandable there's a difference between the two, if one forecast is based on historic results and the impact and the other is looking at a fundamentally different business mix.

We don't know the extent to which those historic results in the Fed model were adjusted.

So, it's hard to know precisely how the models are different.

But, that in our view, is one of the key things that we're focused on, working on over the next period of time before the next submission to true the two up.

That being said, you know, if you just look at our fourth-quarter earnings and our first-quarter earnings, the first two quarters of the CCAR submission, that would add an additional 60 basis points to our ratios.

So, we will be focused on dealing with the PP&R differences and methodology.

We are continuing to accrete capital and we think that that does continue to give us degrees of flexibility.

And, I think, Howard, the difference between what we submitted and believe the models should throw out and what ultimately came out of the black box that is the CCAR process, was actually narrower -- the difference was narrower than what it was last year.

We've obviously got better at it and I think it was, relative to some of the other firms out there, was frankly not a very surprising result.

So we will play this forward, our focus now is getting the Smith Barney, which we got the capital approved.

Understood.

Thanks.

Quick numbers one, Ruth.

I realize you said that RWA reduction this quarter was P&L neutral.

What's driving the other sales and trading results?

It seems to be less of a headwind than it was in the past.

Well, it's a number of items.

It does move around and it's difficult to model.

It includes things like our long-term debt hedging program and our bank liquidity portfolio, our loan book, DCP.

It's kind of an aggregation of a number of different items.

Okay.

Thanks.

Finally, for me, it remains a pretty fragile environment for you and peers within the Institutional Securities business.

I was just hoping you could comment on overall attrition levels, both absolutely and relative to your expectations.

Thanks.

I think that the beginning of the year, having some departures is not in any way unusual.

We actually feel very good about the strength of the team.

We've got a very talented senior team.

Been together for many years.

We've hired, and think it's a great time at Morgan Stanley to be adding senior talent.

People are excited to join given the clarity of where we are going and the momentum moving in that direction.

So, it's kind of -- it's seasonal and we don't read anything into it.

More specifically, the attrition is actually tracking along exactly what it was last year.

I believe, and Celeste will correct me later, a little lower than what it was the year before.

Perfect.

Thanks so much for much for taking the questions.

Thank you.

Mike Mayo, CLSA.

Hi, I guess my questions could be grouped into the good, bad, and the ugly.

I will start with the ugly.

Financial Advisory?

If you look at it linked quarter or year over year, among the five largest US players, it looks to perform the worst, based on fees and you had some management changes there.

Can you reassure us that that franchise is still as strong as it's been historically?

Yes, it is.

The M&A lead tables are exactly the same as they were last year.

It tends to be lumpy in the first quarter, in particular, given the market environment with low activity levels and we are a consistent leader.

We have a very strong M&A franchise.

As I noted in my comments, part of it is just that lower volume and it tends to be lumpy.

And part of it is we had a very strong fourth quarter and there was some fee realization that was in the fourth quarter, so that partially explains it as well.

We feel very good about this.

I think if you just objectively look at the lead table this year, last year, it dulls throughout the year.

Then, in my bad category, the actions of buybacks.

I know you are not able to do that, but trading at such a big discount to tangible book, if you have confidence in the value of your balance sheet, which I assume you do, why wouldn't you take more aggressive actions to down size?

Why not be more aggressive with your FIC targets?

Why not take some other actions to shrink to move up that Basel III ratio even faster?

Well, I think, Mike, there are a couple of questions meshed together there.

I think the actions on reducing our risk assets in Fixed Income from, I believe it was $390 billion in the third quarter of '11 to $253 billion this year, we were a year ahead of schedule last year and we're at the end of the year's point already in the first quarter this year.

It would be easy to reduce it faster, but you would also destroy revenues and destroy good businesses.

So, our job is to balance sensible risk-weighted asset reduction without destroying revenues in parts of that business that we find very attractive.

We actually think we are being very aggressive bringing it down from $390 billion to a committed sub $200 billion by 2016.

If we see more sensible opportunities which don't destroy value, obviously we'd be all over it.

The capital buyback is a completely different topic.

You know, as we said at the beginning of the year, we adopted a very clear posture with our regulators, which was that our focus was on the strategic benefits of buying Smith Barney for two reasons.

One, it was an attractive business and B, we were already carrying the effective cost of the capital for that business, so we wanted the earnings from it.

At $600 million pretax a quarter, 35% is real money.

That was our focus.

We didn't want anything to get in the road of that focus.

We did not want to jeopardize that focus by prejudging where we came out on CCAR or prejudging how the beginning of the year would start.

The beginning of the year has started at $1.2 billion, significantly above where we were in the fourth quarter.

CCAR came out at 5.7, I think 5.6 net of the capital allocation list, so we are now awaiting for the Federal reserves to go through the application process.

When they do that, we know our number and as we go through the year, obviously the next question we open for ourselves is when and under what conditions we would pursue buybacks.

We are not going to react very short term on this.

We are trying to do, get this Firm back on the rails, which we've done over the last couple of years in a very deliberate path.

We believe we are now well on that path.

Then, the good category would be the brokerage margin which came in higher than what you guys had expected last quarter.

What is your brokerage margin target, is it still 15%?

It seems pretty low and you had one peer yesterday reported margin over 20%.

So, what are you really trying to achieve margin wise in that business?

Well, I have to take that one again, Mike, because I was the one who foolishly, a couple of years ago, went out with a 20% margin when we had then three years of zero interest rates following it.

So, I admitted to my mistake on that and we set a more conservative margin target for the middle of this year, which was 15%.

The fact we are ahead of it is good news.

We're certainly not going to turn around and reset margins based upon short-term impacts.

Our job is less around what is setting the margins is and is actually delivering them.

What I'm pleased about, is the fact that we are delivering those margins.

The competitor numbers, I'm not going to talk about, except to observe that they actually have a different business mix that comprises that ultimate margin number.

Was there anything unusual with a 17% margin this quarter?

Or can we consider that a base looking ahead?

No, there was nothing unusual.

As I said, the strength versus what is usually a seasonally lower margin, it's typically seasonally lower because compensation expense tends to be a bit higher in the first quarter.

But, what we had offsetting that, as I noted, was the stronger transactional volume, the new issue activity with closed end funds.

That really helped coupled with the ongoing expense discipline.

So, as we look forward, you're starting with a good base in the first quarter with that 17%.

Thank you.

Thank you.

Matt Burnell, Wells Fargo Securities.

Good morning, thanks for taking my questions.

Just a couple of questions.

First of all, on the deposits.

You saw about 4% decline in deposits in Wealth Management.

I think, overall, 3% down.

Was that largely seasonal?

Or was there something else going on there?

Deposits came off in December.

We saw some selling out of the markets.

We think it was primarily tax driven, by investors, as distinct from real concern about the market.

But, our expectation was that it would come back into the market in the beginning of the first quarter and it did.

So, it is really just positioning by investors at the end of last year, then coming back into the market and staying back in the market as they have.

So, no, there's not anything more to it than that.

Okay.

Then, just thinking about your debt underwriting business.

Given that there's obviously been pretty strong demand for that product over the last couple of years, you've admitted that you are a little bit sub scale in high-yield relative to some of your competitors.

Does that have any effect on your desire for 200 basis points of market share gains within Fixed Income, if that business continues to be relatively robust over the next couple of years?

No.

We've set a target of 2% market share increase, kind of 8% total market share for Fixed Income sales and trading.

We feel very confident with that, given the product set.

Our Fixed Income underwriting, which is actually reported -- those sales are reported in the Investment Banking line and we did have a record -- we had a record quarter last quarter.

This first quarter was actually the best ever first quarter that we've had.

What that ends up driving is the secondary sales and trading, as you know well.

What we feel very good about the, we remain very much focused on our share gains, equally focused on how we optimize returns, so it's really both of those, but no change.

Okay.

Then let me just confirm, finally, the 60% compensation ratio in Wealth Management.

You mentioned last quarter that we should think about that ratio being pretty unchanged for the next couple of quarters.

What would allow you to get that ratio down, presuming a steady revenue environment?

Is that something that we should be looking for towards the end of the year?

The 60% compensation ratio in the first quarter, is precisely the reason we had indicated that the margin tends to be seasonally weaker in the first quarter, we tend to have slightly higher comp in the first quarter on things like FICA and other factors.

So, it does tend to be a bit higher.

Coming down a point or so near-term is very -- it's a reasonable way to think about it.

The great -- the best driver of the comp ratio over time is really the growth of our lending product.

As we've talked about we are going to have deposits up to about $140 billion in the two years post buying in the rest of the Wealth Management business.

That's going to support growth in both Wealth Management lending product and Institutional product.

On the Wealth Management side, it's on a different compensation grid, relative to the formulary grid that generally drives that comp ratio and that is what really gives us meaningful operating leverage in the comp line.

That brings it down into the high 50%s.

Okay.

Thank you very much.

Thank you.

Jim Mitchell, Buckingham Research.

Good morning.

Just want to follow-up on -- you're sitting on about 23% of your balance sheet in excess liquidity.

Can you discuss where you are sitting in terms of the LCR?

Do feel like you're pretty comfortable for that, or do you need to build more?

On the LCR, we are over 125% and that really is given all that we've done terming out the secured book.

It's obviously just a 30 day test and we do triangulate, as we've talked about on some prior calls, with an outlook over a 12 month period of time in a stress environment.

One of the reasons liquidity is running at these higher levels, as I noted, is that we want to ensure that we have ample liquidity assuming we do acquire the 35% of Wealth Management, so there is a bit of flexibility thereafter.

Maybe just a follow-up, as you buy in the rest, should we -- what are the timing around the deposits and how quickly do think you can reinvest them, I guess, longer-term, do think that can help you bring down the excess liquidity and obviously help improve profitability?

So, the deposits, the way it works, is they come in over the two-year period of time.

We get about $14 billion of deposits within a few weeks of closing.

Then, $40 billion ratably over the following 24 months.

That will -- that's supports, as I just said, both retail lending as well as institutional lending.

I think the best way to think about it, is one, it gives us growth opportunities, because there's a suite of products within Institutional Securities that haven't grown as much as they could, because they would be funded with unsecured debt versus substantially more efficient deposits.

But they're still bank appropriate areas and areas where we have real expertise.

So, whether you're talking about project finance or commercial real estate, those are good examples of areas where we could have incremental growth opportunities, based on our competencies today and our clients today.

But, it would be funded with more efficient deposits in the bank.

Then, there are also areas where we will be able to move businesses from Institutional Securities into the bank and that enables us to do a dollar for dollar substitution.

Reducing unsecured debt and replacing that with deposit funding, which is more efficient.

So, yes, there is some efficiency that comes in in that way.

Overall, if the question is also and what does that do for liquidity, as those deposits, which are currently really supporting the AFS portfolio, go into support the lending product, the bank liquidity comes down as those are moving into support loan growth.

So we should see that excess liquidity start to come down as those deposits come in?

No, initial, yes, it's -- if you look over time, the answer to that is yes.

As those deposits come in, for example that first $14 billion of deposits --

Sure, right.

In the short term it could go up.

Right.

It goes up.

Then it goes into the AFS portfolio.

It's a positive carry on the AFS portfolio.

As it comes down again, because of supporting loan growth.

Yes, it does come down again.

But at a higher return.

Right, okay.

Thanks a lot.

Thanks.

Brennan Hawken, UBS.

Snuck in under the wire.

Good morning guys.

So, just a quick follow-up on FIC.

It was obviously pretty volatile in some of these markets here this quarter, is there any -- should we think about maybe the fact that revenue might have been a little bit lower than usual, just because there might have been some principal loss, given some of that volatility and that this is actually really a pretty lousy run rate?

The run rate we do think given the markets were more challenging, especially in March, just affected activity.

And, as I noted, rates were lower and then Commodities is dealing with the cyclical headwinds we've talked about.

So, I think it is very fair to say we don't view $1.5 billion of revenues, our revenues this quarter as a ceiling on what is attainable, even with quarterly seasonality.

I point you to the strength that we have in a lot of areas like credit and the mortgage product and foreign exchange.

We would expect that rates is higher.

So, we do think that given the strength of the client activity levels that there is upside from here.

I think an interesting way to even just look at client activity and volumes across the platform is just looking at the brokerage and clearing line, which is up, which really goes to client activity.

A long way of saying that we don't think that $1.5 billion in revenues is a ceiling and look forward to the continued activity.

But, were there any principal losses to specifically highlight, or was it mostly volume driven within the FIC line?

It was not principle losses, no.

Okay.

Great.

Thanks.

Then, on capital, once I understand that it's uncertain about when you get the green light on MSSB, but if we assume that that happens prior to midyear, is it too aggressive for us to think about, given where you guys are on the capital ratio front, and the fact that MSSB is already fully baked into Basel III, that you could be looking to take a second bite of the apple, here, with the regulators in a potential buyback with a new submission?

As James said, our number one focus is closing the Wealth Management acquisition, given the strategic benefit and the upside of promoting 100%, so we are just focused on closing that acquisition, which was our capital request.

We are accreting capital.

Your question is fair, but we want to get it closed before we think about anything else.

All right.

I figured I'd give that a shot.

Then, last one.

You know, it's the lending platform -- is there anything operationally that you guys are waiting on to get going?

Because, it seems as though you have excess deposits, currently.

So, it's not really a matter of funding and not having the right funding.

So, is there like a system investment process you need to go through in order to get everything up and running?

Or, is there any operational issues holding you back?

Do want have all of MSSB completely bought in before you really start more aggressively pushing the lending platform?

I guess I don't understand why it's been so slow to ramp so far.

In 2009, it became clear that over time we would be buying in the remainder of the Wealth Management business.

At that point, started investing in the systems, the risk management personnel, analytics, to ensure that at the point we ended up with the full $140 billion in place, we had the systems and infrastructure requirements there.

The gating factor is, and we've used this word so often in describing how we are building up the banking team and the banking effort within Wealth Management, it's prudent consistent growth.

There's no reason to rush it.

We want to make sure that we do it in a high-quality way and that we are leading with risk management.

So, it is better to do it prudently over time than to try and rush it and that is really the governor of the growth in that business.

We feel good about the strength and the build, as James said, it's both on the mortgage side and on the PLA side.

That's what we are continuing to do.

Okay.

I will note one other thing.

We said this, I think, last quarter.

That relative to our peers, we are under penetrated in the lending product.

So, what we're seeing is good take-up and we're just keeping it at a measured pace.

Okay.

At some point, after that book, assuming that you guys want to grow that book to a certain size, does that mean that there will be a transition to accrual accounting and we will start to see that level of detail for you all?

Well, so, we talked about the fact a couple of quarters -- I think over a year ago now, that we moved from fair value to HFI for our lending product.

That's most relevant for what we're doing on the institutional side.

At this point, about 69% of the book is on HFI.

So, that has been the approach.

That was very clear coming out of the CCAR process over a year ago, that that was a logical way to approach it and that's what we've been doing systematically.

Okay.

Thanks.

Thank you.

Great.

Thank you so much for joining us and we look forward to speaking to you in a quarter.

Ladies and gentlemen, thank you for participating in today's conference call.

You may now disconnect.