摩根士丹利 (MS) 2013 Q3 法說會逐字稿

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 the 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.

Thank you, Celeste.

Good morning, everyone.

Thank you for joining us.

In the third quarter, the fruits of our strategy were evident.

Despite a challenging quarter for Markets, our results demonstrated consistency and durability of our business model.

Our EPS excluding DVA and the charge for the Wealth Management acquisition last year was up sequentially in a seasonally weaker quarter and with higher legal expenses.

More important, however, we remain focused on our long-term objectives.

Starting with Institutional Securities our results underscore the power of our integrated model.

Our outstanding leadership and equity sales and trading again benefited us this quarter and we generated our highest revenues in the third quarter since 2008.

We continue to be first or second globally with our continued success driven by the focus on clients, sustained investments in technology and targeted investments in certain areas of the business.

In Investment Banking the focus we have placed on improving our wallet share in certain areas has paid dividends as growth in market share increases and debt underwriting offset lower market-wide advisory and equity underwriting volumes.

Cross-border activity continues to be a dominant theme and Morgan Stanley remains the number one ranked firm in terms of cross-border advisory activity benefiting from the strength of our global client franchise.

The cohesiveness of our model was illustrated by the Verizon deal, where we're leading one of the biggest M&A transactions in history, but also co-led the $12 billion bank loan syndication and the $49 billion senior note offering.

Our growing deposit base provided us with an important additional tool in this transaction.

We also remain focused on ROE and the fixed income and commodities business and continuously evaluate every aspect of what we're doing.

We stayed very close to home in regards to risk in the third quarter due to the liquid markets and this is evidenced both by our average and period end VAR.

We continue to reduce risk-weighted assets in the business, ending the third quarter at $213 billion.

Recall that this number now excludes the RWAs associated with lending; however, we are investing in other areas of fixed income that are core to our future including our people and technology.

Turning now to Wealth Management.

The third quarter was the first full quarter during which we owned 100% of the business and we're just beginning to see the benefits.

Despite seasonality and a relatively subdued trading environment, revenues were essentially flat and we improved our margins and profitability once again.

The revenues and margins were supported or driven by some of the benefits of the acquisition.

The elimination of the order flow agreement and continued growth in net interest income, both of which generate high incremental revenues and higher incremental margins, I should say, than our traditional advice and commission revenues.

In addition, we retained 100% of the earnings associated with the business, obviously increasing net income to the firm from Wealth Management, in this case by over 30% sequentially.

As we have discussed with you in the past, this business and the acquisition will continue to drive upside for the firm and its stakeholders as we prudently deploy the balance of the deposits from our former partner over the next several years in both Wealth Management and institutional securities.

We can generate attractive ROEs on the assets supporting the deposits in the retail institutional businesses even in the low rate environment and without reaching for risk.

This is due to the relatively low funding costs, the lack of bricks and mortar, and our embedded client base.

While we do not discuss Investment Management frequently, its earnings contribution continues to grow in absolute terms.

We've been very pleased with the investment in financial performance of our traditional Investment Management, Real Estate and merchant banking businesses.

The continued progress in regards to performance coupled with disciplined expense management drove the highest PBT in that business since 2010.

We remain focused on our expense programs more broadly and continue to make progress towards our goals although the results are less evident this quarter because of elevated legal expenses.

We expect to meet or exceed our expense targets excluding litigation.

In the meantime, however we will continue to reap the benefits of our strategy leveraging our world class franchises, upside from Wealth Management and deposit growth, intense focus on expense management and thoughtful capital allocation.

As you would expect, we began buying back stock in the quarter.

This is the first time since 2008, and we look forward to increasing Capital Returns to shareholders over time.

I'll now turn the call over to Ruth.

Good morning.

I will provide both GAAP results and results excluding the effective DDA.

We have provided reconciliations in the footnotes to the Earnings Release to reconcile these non-GAAP measures.

The impact of DVA in the quarter was negative $171 million with $141 million in fixed income sales and trading and $30 million in equity sales and trading.

Excluding the impact of DVA, firm-wide revenues were $8.1 billion, down approximately 3% versus the second quarter.

The effective tax rate from continuing operations for the third quarter was 25.3% inclusive of a discrete benefit.

Earnings from continuing operations applicable to Morgan Stanley common shareholders excluding DVA were approximately $983 million.

Earnings from continuing operations per diluted share excluding DVA were $0.50 after preferred dividends.

On a GAAP basis, including the impact of DVA, firm-wide revenues for the quarter were $7.9 billion.

Earnings from continuing operations applicable to Morgan Stanley common shareholders were $862 million.

Reported earnings from continuing operations per diluted share were $0.44 after preferred dividends.

Book value at the end of the quarter was $32.13 per share, up 2% versus the second quarter.

Tangible book value was $26.96 per share, up 3% sequentially.

Turning to the balance sheet.

Our total assets were $832 billion at September 30, up versus last quarter due primarily to the growth in our deposits pursuant to the contractual agreement associated with the acquisition of the remainder of the Wealth Management Business.

Specifically, deposits as of quarter end were $105 billion, up $23 billion versus Q2 of which $21 billion was due to on boarding of deposits from our former JV Partner and the remainder was from organic deposit growth.

Our liquidity reserve at the end of the quarter was $198 billion compared with $181 billion at the end of the second quarter.

The increase was also driven higher by the recently on boarded deposits, most of which have not yet been deployed thus resulting in elevated levels of bank liquidity.

Our non-bank liquidity level also remains elevated.

Turning to capital, although our calculations are not final, we believe that our Tier 1 common ratio under Basel I will be approximately 12.6%, and our Tier 1 capital ratio will be approximately 15.3%.

Risk-weighted assets under Basel I and including the final market risk rules are expected to be approximately $386 billion at September 30.

Reflecting our best estimate of the final Federal Reserve rules, our pro forma Tier 1 common ratio under Basel III was 10.8% as of the end of the Third Quarter.

Pro forma risk-weighted assets under Basel III are estimated to be $414 billion.

We estimate our pro forma supplementary leverage ratio to be around 4.2%.

This estimate reflects the United States proposed regulatory rules for the numerator and the denominator and is subject to change if rules evolve.

Our ratio was consistent with second quarter levels despite no longer reflecting the benefit of clearing as a deduction from the denominator and the increase in deposits in the quarter, which on a combined basis reduce the ratio by over 30 basis points.

We continue to expect to exceed the required 5% level in 2015 including an assumption for a greater return of capital to shareholders.

Turning to expenses.

Total expenses this quarter were $6.6 billion, down 2% versus the second quarter.

Compensation expense was down 3%.

Non-compensation expense was flat to 2Q, notwithstanding higher litigation expenses which have been elevated since last year and were higher in the third quarter than in each of the first and second quarters.

Let me now discuss our businesses in detail.

In institutional securities, revenues excluding DVA were $3.9 billion, down 8% sequentially.

Non-interest expense was $3.3 billion, down 2% versus the second quarter.

Compensation was $1.6 billion for the third quarter, down 8% versus the second quarter reflecting a 42% ratio excluding DVA.

Non-compensation expense of $1.7 billion increased 5% from last quarter driven by higher litigation expenses and a catch up for the Fed's SIFY assessment of approximately $25 million which covers all of 2012 and the first three quarters of 2013, partially offset by a decrease in activity-related costs.

The business reported a pre-tax profit of $542 million excluding the impact of DVA.

Including the impact of DVA, pre-tax profit was $371 million.

In Investment Banking revenues of $992 million were down 8% versus last quarter.

Results were driven by continuing strong debt new issuance activity and our integrated efforts across institutional securities.

More generally, according to Thomson Reuters, Morgan Stanley ranked number three in global completed M&A, number four in announced M&A, number three in global IPOs and global equity at the end of the Third Quarter.

In addition to Verizon, which James mentioned in his opening remarks, notable transactions included in advisory through our Japanese joint venture Mitsubishi UFJ Morgan Stanley, we acted as exclusive financial advisor to Tokyo Electron on its merger with Applied Materials, Japan's first all stop cross-border merger.

In equity underwriting Morgan Stanley acted as lead lap joint global coordinator for the $2.5 billion follow-on equity offering for Grupo Financiero Benorte, the largest Mexican stock offering of the year.

And in debt underwriting, Morgan Stanley served as joint active book runner on the General Motors $4.5 billion debt offering, its first major placement since emerging from bankruptcy protection, as well as sole book runner on the financing for the previously announced acquisition of Smithfield Foods.

Advisory revenues of $275 million were down 17% versus our second quarter results, driven by decreased revenues in EMEA.

Equity underwriting revenues were $236 million, down 28% versus the second quarter, driven by lower results in both the Americas and Asia Pacific.

Fixed income underwriting revenues were $481 million, up 15% versus the second quarter driven by investment grade and loan syndication fees.

Equity sales and trading revenues excluding DVA were $1.7 billion, a decrease of 5% from last quarter.

Results were strong across geographies and products, evidencing less seasonality than is typical for the third quarter.

Derivatives revenues increased sequentially as strong risk management offset the summer slowdown in certain products and brokerage balances remained relatively constant from the second quarter, also bucking the typical summer trend, although revenue was down due to seasonality in Europe.

Cash revenues declined modestly though held up better than industry volumes.

Fixed income and commodity sales and trading revenues excluding DVA were $835 million.

Revenues declined with broader market activity.

Client volumes, market liquidity and thus overall risk levels were generally low driven primarily by macro products.

CVA was also a drag in the quarter due to the tightening of our credit spreads and was a significant driver of sequential revenue change.

Credit products revenues increased despite the challenging environment.

Commodities revenues were up modestly driven by higher client activity.

Investment revenues of $337 million were up significantly versus the second quarter, driven predominantly by the sale of the insurance broker HUB.

Average trading VAR for the third quarter was $52 million versus $61 million in the second quarter, driven by low levels of risk taking throughout the quarter in fixed income and commodities.

Turning to Wealth Management.

Revenues were $3.5 billion in the third quarter.

Asset Management revenues of $1.9 billion were flat to last quarter reflecting the benefit of higher market levels at the beginning of the quarter but offset by lower deposit referral fees from our former JV Partner.

These fees declined pro rata with the deposits that were on boarded in the third quarter.

Transaction revenues decreased 4% from last quarter consisting primarily of commissions of $507 million, which were down 11% versus the prior quarter due to seasonality and generally subdued activity; Investment Banking related fees of $185 million, which were down 28% versus last quarter reflecting lower activity and closed end funds and partially offset by higher trading revenues of $317 million, which were up 42% versus the second quarter reflecting higher DCP as well as the benefit of elimination of the order flow agreement with our JV Partner now that we own 100% of Wealth Management.

Net interest revenue increased 11% to $493 million driven primarily by retiring a preferred security in the JV concurrent with our acquisition of the remainder of the Wealth Management Business, as well as growth in our lending product.

Other Revenue decreased sequentially to $75 million from $139 million.

Last quarter this line reflected revenue from the sale of a business, as well as ASF gains that did not repeat this quarter.

Non-interest expense was $2.8 billion, flat to last quarter.

The compensation ratio was 58%, flat to the second quarter.

Non-compensation expense was $796 million, down 5% versus last quarter due to the lack of expense items incurred in the second quarter in conjunction with the closing of the Wealth Management joint venture, as well as continued expense discipline.

The PBT margin was 19%.

Profit before tax was $668 million, another quarter of record profitability.

Total client assets were up versus the second quarter at $1.8 trillion.

Global fee-based asset inflows were $15 billion.

Fee-based Assets Under Management increased to $652 billion at quarter end.

Global representatives were 16, 517, higher than the second quarter.

Bank deposits were $130 billion, up versus the second quarter; approximately $94 billion were held in Morgan Stanley banks.

The third quarter was the first in which we did not have a drag from NCI from Wealth Management because we now own 100% of the business.

Investment Management revenues of $828 million were up 23% versus the second quarter.

In traditional Asset Management revenues of $369 million were down from the second quarter driven by lower performance fees and Asset Management and administration fees.

In Real Estate investing and merchant banking our revenues were up meaningfully, reflecting strong investment performance, favorable market conditions, and catch up of carried interest in two funds as we surpassed our hurdle rates.

Expenses were $528 million, up 3% from the second quarter driven by higher compensation associated with higher revenues.

Profit before tax was $300 million, up 88% sequentially.

NCI was $64 million versus $21 million last quarter.

Total Assets Under Management increased to $360 billion driven by market appreciation.

Turning to our outlook.

The impasse in Washington over the last several weeks was an unfortunate tax on the economy.

Assuming constructive steps are now taken, we expect US growth, as well as broader market activity, to resume the pace it was on prior to the events of the last several weeks.

Although our M&A pipeline has steadily grown over the course of 2013, an increase in transaction volume off of the recent lows hinges on CEO confidence about the economic outlook.

Clarity regarding a long-term resolution as distinct from a short-term fix is likely needed before there is meaningful pick up in new activity.

However, M&A revenues for the fourth quarter should not be affected to any notable extent by the recent impasse in the upcoming decision dates because revenues are associated with deals that have already been announced and are well on the path to closing.

Underwriting activity, particularly on the equity side, remains strong.

Institutional trading activity started off the quarter relatively subdued but may accelerate on the back of the recent temporary resolution.

Retail investors have been similarly cautious though they have not pulled away from the markets.

I will conclude by saying our results evidenced a stable and diverse business mix.

Our model weathered a slowing trading environment well but of far greater importance is one that is poised for greater upside with normalcy.

With our high margin, predictable Wealth Management Business such a significant percent of our portfolio, we have a significant shock absorber in weaker markets.

In addition, we expect that our earnings will be even more predictable with the ongoing execution of our bank strategy.

Morgan Stanley is well positioned from a resource perspective from a return to somewhat normal markets.

Our VAR is at the lowest levels in years and we are prepared to take risk on behalf of our clients when demand resumes.

Liquidity is high and we have a strong and high-quality capital base.

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

(Operator Instructions)

Glenn Schorr with ISI.

I heard your comments loud and clear on fixed income in the quarter.

I just want to make sure that the RWA shrinkage is on track at the same pace that you had laid out for us, and that there's no necessarily mindset change in structure, and still think that you can put up in the $1.5-billion- to $2-billion-a-quarter range in normalcy?

Our RWA reduction program is very much on track -- have not changed that.

The only thing that I did discuss at a conference in September is to provide greater clarity about our consistent path to reduce RWAs within fixed income.

We are breaking out lending from the RWA totals, so we're presenting just RWAs for fixed income.

So, in the second quarter when I said we had $239 billion of RWAs in fixed income, if you exclude the lending-related RWAs, that number is $219 billion.

This quarter we're down to $213 billion, and we've similarly reset our end state.

It was $200 billion; it's now sub-$180 billion.

So, very much on the same path -- no change there.

And then, as it relates to how we're looking at managing the Business overall, we have a very keen lens on driving to an ROE that is greater than our cost to capital.

We think that the reduction in risk-weighted assets is a core part of that; expense management is a core part of that, and that is the key driver.

We're looking at revenues, expenses, capital optimization; but the key lens is really on an ROE in excess of our cost to capital.

Fair enough.

On that front just -- I noticed, first is the Basel III ratio that you gave at 10.8%, is that standardized versus advanced, and curious on how we got 90 basis points growth in the quarter.

Earnings were okay, but risk-weighted assets were down 2.8%.

It's a big jump, so just curious how they got that.

That's -- on advanced, it's fully loaded and it is driven by two things.

One, earnings accretion, and then the associated reduction in numerator deducts under Basel III and the reduction in risk-weighted assets.

So, both numerator benefit and denominator benefit.

Not something we should be looking for every quarter though, right?

It's a big move.

I'm not going to -- I'll let you do the forecasting.

We're continuing to drive earnings, and we're continuing to reduce risk-weighted assets.

Okay, last one -- you're also -- on the loans and lending commitment, page 12, there is a wealth management loans and lending line that's been growing.

It's up 45% year on year; it was up 7% in the quarter.

Is that in any way a leading indicator for deposit deployment, or am I mixing apples and oranges there?

No, you're very much focused on where we're focused strategically.

One of the big benefits of the acquisition is on-boarding of the deposits.

The rate of on-boarding this quarter -- this past quarter, the third quarter, was unusually high.

We had a big slug come over immediately upon -- shortly after closing the acquisition.

And on a go-forward basis, we'll have $1.75 billion -- in that area of $1.75 billion coming over on a monthly basis.

So, we had a bigger on-boarding this quarter, but the focus really is deployment of those deposits to support loan growth both in wealth management and on the institutional security side.

And as we've talked about in wealth management, the real opportunity is we're underpenetrated versus our peers.

We've got about 5% penetration.

Our peers have about 10%, and we see very attractive growth opportunities both with PLA product -- that's our securities-based lending, as well as residential mortgages.

So, that's what you're seeing, and that's what we've been building towards since 2009 when we created the joint venture and we're executing on that.

Thank you for all that.

I just want to know -- are those commitments -- is that securities-based lending?

Because my gut is it's a tough environment while refi is dropping by 50% in the quarter.

Is that securities-based lending -- what am I looking at to see that kind of growth in commitments, because something good is happening.

So, PLA -- the securities-based lending PLA -- you are seeing strong growth in it.

Residential mortgage is where you have commitments, and we have had a strong pipeline of demand there.

So, even with the slowing environment, we have more demand than we're executing against, but the bigger growth is in PLA.

Excellent, thank you.

Howard Chen with Credit Suisse.

Just a follow-up on FICC -- slower quarter for everyone.

We can see that you de-risked.

I was just hoping you could discuss where returns are in the major FICC businesses today, so we can just track progress over time as the environment improves, and you do -- of what you want to do on capital and expenses.

It was lower volumes industry-wide.

I would note that, and I said this in my comments, given the tightening in our credit spreads, we did also have a meaningful negative swing in CVA sequentially.

If you exclude CVA in both quarters, our FICC results were actually down single-digit percentages.

But going through the products, as you ask, rates was challenging, risk remained low.

We continue to run risk at historically low levels there; did take risk down in May, as you may recall, we talked about that last quarter.

So, would look to see some upside in that business longer term as markets normalize.

Foreign exchange was down quarter over quarter; that was volumes and mix.

Electronic up better, but voice is lower and that's a higher margin, so that was a bit of a drag.

On credit -- on the credit side, as I noted, it was a bright spot; we were actually up quarter over quarter.

We had good performance across IG, distressed and high yield, and it was balanced across geographies.

That's been a consistent strong area for Morgan Stanley.

Mortgages was also quieter, and commodities was up a bit modestly but still running at lower levels.

So, overall, the net of it, you can see in the results, was a slower, quieter quarter, our risk was down, VAR was down in those areas, and we would expect to see some upside as markets normalize.

Okay, thanks, Ruth.

And switching over to the supplemental leverage ratio, can you discuss what the change in centralized clearing assumptions did to the model?

And is it simply earnings generation during the quarter that made up for that delta for that model change in the deposit inflows you mentioned, or is there something else that's going on?

In terms of clearing, in the second quarter I think the general industry read was clearing would benefit the denominator, and obviously in the second quarter the rules had just come out prior to the various earnings calls.

And we've now had time to assess -- clarify certain items.

There were changes in both the numerator and the denominator.

And in particular, with respect to central clearing, the rules clarified; clearing unto itself isn't a deduct.

It does facilitate compression trades, and we're still very focused on backloading.

And we have seen an acceleration in interest in compression trades by banks both in the US and in Europe because it's one of the few tools left to reduce exposures.

The other thing that changed quarter over quarter is the on-boarding of deposits that I mentioned.

We on-boarded $21 billion of deposits.

So, just those two was about a 30-basis-point reduction, and the offset to that really was in the numerator between earnings, and some of the numerator deducts was the offset.

Okay, thanks.

And then, you've been speaking to higher litigation expenses over the past few quarters.

James, you've talked about it more broadly to the investment community.

I was just hoping you could take a step back and just give us a sense of what inning you believe Morgan Stanley is in working through just crisis-related litigation issues.

Well, that's an interesting question how -- I think we are obviously fully disclosed all of the litigation risks that we have out there, and we're working our way through it.

I can't really tell you what inning.

We've been taking elevated expenses for a couple of quarters.

I'm sure there will be some of that will continue, but we're managing our way through.

We have, I guess, the good fortune to be one of the smaller dogs in this fight, as an institution.

And we obviously have less of the traditional mortgage exposure.

So, in some areas we are just not participants happily, but in the traditional -- in some of the litigation, we are.

Okay, thanks.

And maybe just a last follow-up to that one.

Ruth, how would you size the incremental litigation expenses this quarter?

And could you also just give us the size on the gain of sale of Hub as well?

Thanks.

Sure, so, litigation has been running about $200 million to $300 million higher per quarter than one would assume in the end state.

And to state the obvious, it's lumpy; it's unpredictable.

But we've got a steady march on the same set of issues associated with pre-crisis matters, and so it should come down when these issues are behind the industry, but it's been about $200 million to $300 million.

And then with respect to the gain on sale, it's part of the overall investments line.

There are a number of items in that, and I think on a go-forward basis if you look at prior quarter/prior year, that's probably more reflective of future run rates.

Okay, thanks.

Guy Moszkowski with Autonomous Research.

I just wanted to clarify a little bit the comment that Ruth made about the receipt but not really deployment of the deposits.

There must have been some impact on net interest income for GWM, and maybe more broadly for the Corporation from the receipt of those deposits, or is that not fair?

No, that is fair.

What I was trying to say is that with the on-boarding of deposits, we did have a big portion come over in this quarter, a lot still in cash, and we're deploying it into AFS and loan growth.

So, you do see, this quarter, some of the upside in net interest income and wealth management is due to growth in our lending balances.

The other benefit you see in NII is associated with the acquisition.

As part of the acquisition, we eliminated outstanding preferred with Citi, and the expense associated with it, so two drivers of net interest income.

But you're absolutely right.

There is upside this quarter in that, and we expect to continue to see more upside as we're deploying added cash into AFS and loan growth.

Great, okay, that's helpful, thank you.

And then, you gave a -- you told us that your [quarter one of] 10.8% for under Basel III was under the advanced basis.

Can you tell us what the calculation is on a standardized basis?

So, on a standardized basis, RWAs are a bit higher.

That's obviously -- the second test to establish a minimum, and if we are running greater than required, we are not required to report it, but we are above that minimum.

Okay, fair enough.

So, you're saying the RWAs are higher, and so the standardized ratio would be lower?

Yes, the standardized ratio would be lower.

I guess that's most relevant actually under CCAR moving to standardized for 2015 but, of course, the requirement under CCAR for standardized is 4.5%.

Right.

Goldman gave some comments on their investment banking backlog, and said that it was actually the best it's been in five years.

Can you give us a sense for -- your comment sounded a little bit more cautious in that regard, but can you give us a sense for the direction of your backlog relative to last quarter?

The backlog is up.

It's actually the highest it's been in years.

My comment with respect to, in particular, M&A is the backlog in M&A has been growing nicely throughout the year consistently, but the main factor really is what we've talked about on many other quarters, which is M&A is a proxy of CEO confidence.

And given the impasse in the last couple of weeks, and the fact that we don't have a final deal in DC, but it's kind of an interim step here, I just had a caveat that until there's confidence about the economic outlook, I wouldn't want to suggest that that growing pipeline actually goes through to announced and closed.

It's frustrating because all signs had been that GDP was improving, and confidence was up, and the pipeline was building accordingly.

And hopefully we get a resolution, and we actually see that work its way through.

The equity pipeline is also very strong -- the highest it's been in years.

And I think that we would expect to see more activity -- that moving through the pipeline.

The fourth quarter tends to be seasonally better than the third quarter given July blackouts in August, and it's a very strong high-quality pipeline.

Thanks, that helps.

And then final question is on FICC.

You have, as someone else had asked, identified in the past a minimum target revenue of $6 billion.

And I think the implication has been that, in order to exceed your cost of capital, you need to generate that kind of revenue level.

Year to date, on a cleaned-up, ex-DVA basis, you've done about $3.5 billion.

So, let's say that you're tracking for $4.5 billion-ish this year.

That's still well below the $6 billion.

Do you remain as confident as you might have been a couple of quarters ago that this $6 billion is a realistically achievable level?

And if not, are you making any incremental changes to your resource deployment?

We remain very focused and confident about the path to a higher ROE in fixed income.

And as I said, there are three major levers -- revenues, which is a function of the operating environment, among other things, and so we'll put that to the side; expenses; and capital.

And we are looking at all three levers, but the main thing is controlling that which we can control to drive ROEs greater than the cost of capital within fixed income.

And so, between expense management, some of the things that we've been doing there, continue to do, and capital optimization, we have a flight path to an ROE in excess of cost of capital.

And that's the real -- that is -- if there is one metric to stay focused on, it's the ROE.

That's the way we're managing the Business.

Got it.

So, it sounds like you feel that you might be able to achieve that cost of -- that return ahead of the cost of equity without necessarily achieving $6 billion in revenue, given the expense and other capital levers that you can use.

Is that fair?

Yes.

Okay, great, that's real helpful.

Thank you so much.

Mike Mayo with CLSA.

I just wanted to follow-up on your comment, James, that you're just beginning to see the benefits from the acquisition of the 100% of the joint venture.

Your branches are already down, your profit margin is up some, you have the deposits.

Aside from additional loan penetration to your customers, what other benefits are there still to be achieved?

So, I'll start on that.

There are quite a number.

If you just go through the items that we talked about that are the contractual benefit as a result of the acquisition, it will probably give you a sense of why we believe we're just beginning to see it.

So, one is the order flow agreement that -- we terminated that upon completion of the acquisition, and so, order flow that previously went down to our JV partner stays at Morgan Stanley.

That's in the principal trading line.

However, given industry volumes were lower in the third quarter, just with the overall market tone and seasonality, we had a more modest benefit, lower than we would expect on a quarterly basis and in a more normal environment.

So, upside there.

Net interest income I already commented on, but with continued loan deployment, that's a very important area -- additional upside in particular given the margin on loan products, so we see real upside in NIM.

There are a couple of other ins and outs -- the deposit referral fee and the FDIC fees smaller, and then obviously the elimination of NCI, which is below the line but does benefit earnings.

And so, again, a more normalized environment continuing to build out the loan book; the upside from that lending product all dropping to the bottom line.

And I think, Mike, I would add a couple of additional thoughts.

One is -- if you look at where the industry -- the wealth management industry now is, it's very concentrated.

And during the period of turmoil of the crisis, post-crisis, and then our acquisition of Smith Barney and the various staggered pieces that we've bought along the way, there was a lot of attrition, a lot of moving of people between different firms.

And that is a tax on the industry obviously, and it's inconvenient for clients in many cases.

But that level of turnover has dropped significantly, and we expect it to continue to drop.

So, that reduces your overall compensation cost because obviously recruiting deals can be very expensive, number one.

Number two, the strength of the old Smith Barney business at its core was its manage money program, and the strength of the Morgan Stanley business at its core was its capital markets capability, which is based up in Westchester.

And we are continuing to see each of those strengths populate the other side of the house, since now we're coming together as one Firm.

And that's why you're seeing so much growth in the managed money side, and you're seeing very good retail distribution of institutional underwriting.

So, I think just fundamentally it's a more robust business, and the broader industry structure is more accommodating to better performance over time.

As far as the outlook for the number of reps, the number of offices, how much you're looking to organically grow the business from here?

And also, how long will it take to deploy the new $20 billion of deposits that you took in?

So, in terms of FA headcount, it was up this quarter for a couple of reasons -- one, attrition.

It has been running at low levels for some time; it was even lower this quarter.

And then we had a higher number of trainees just with the quality of the training program and the time of year.

You could see that number going up a bit.

We're not managing it to a number.

We're still focused very much on FA productivity, and we just had a larger training program, strong trainees but just starting, so kind of in and around that level.

In terms of branches, you saw the number of branches come down this quarter.

The way we look at that is it's a function of really market-by-market analysis.

Leases roll off; the question is -- do you have completely fully staffed offices within any market, strong culture, no more room in the space, no need to consolidate or should you consolidate?

So, at this point, the big reductions that we've seen are really behind us, and now it's just market-by-market analysis.

And then, in terms of the deployment of deposits to support loan growth, you're really going to see that deposit deployment go not just into wealth management product, but also institutional product and, of course, the AFS portfolio.

And as we've consistently said, we're very much leading with risk management -- credit risk management.

So, there's nice growth near term, and we've been building that infrastructure, as I said, since we created the joint venture back in 2009.

But we're leading with risk management.

We are going to keep using the term prudent, steady pace, and you'll continue to see it deployed over the next continued steady pace.

Last follow-up -- which specific loan products by category?

Would it be a lot of mortgages, or what else in addition to that?

Well, the main thing is really this PLA product, the securities-based lending product, which is a more flexible product for our clients -- really enables them to retain their securities portfolio and continue to be invested in the market.

That's the primary one.

We're underpenetrated, as I said.

Residential mortgage is next on the list -- the next major category for our retail area.

And we continue to have strong demand because we're off of such a small base and, again, given the low levels of penetration.

And then on the institutional securities side, it's product very consistent with our strong areas within our franchise, to James's opening comments where we have strong client franchise, strong bankers that have built the incremental infrastructure required.

So, for example, in commercial real estate, in project finance, areas consistent with the businesses we're already in where we're already serving clients and we're now just expanding the suite of products.

So, it's growth in both areas.

Thank you.

Mike Carrier with Bank of America.

Ruth, just a follow-up on the SLR.

You mentioned some changes in thought process that you guys have gone through -- the proposal.

In terms of getting from the 4.2% to the 5% in 2015, can you just give us an update on that glide path?

I think in the past you said collapsing some trades, but anything that has changed based on further review of the proposal?

Certainly.

So, greater than 5% in 2015 -- we're very confident with the flight path there because there are opportunities with both the numerator and denominator, and very consistent with the strategy against which we've been executing.

So, we're not assuming any benefit from potential changes in the rules.

And starting with the denominator where we see the biggest opportunity, the first is with our focus on reducing risk-weighted assets in fixed income.

That leads to a reduction in the balance sheet, a reduction in the grossed up balance sheet because obvious relationship between RWAs and grossed up balance sheet.

So, that's number one, and very much on strategy.

The second is derivatives gross up, as I said, as can be reduced through compression trades.

We've been focused on that for some time.

We had not previous, as of the second quarter, hadn't quantified it or viewed it as an additional upside opportunity.

All that we've done in central clearing, our focus in particular on back loading, helps facilitate the pace of compression trades.

And just since the SLR was announced and the BIS proposal was announced, we've seen an interest in compression with banks both in US and in Europe.

And the total compression opportunity is greater than what we had assumed from clearing, so that is very much in the plan.

There's also numerator benefits from capital accretion and some of the numerator mitigation, so that the combined gets us to a strong glide path to greater than 5% in 2015.

And also important to note -- it includes the assumption that we have sizeable capital returns to shareholders.

Okay, that's helpful.

And then just on the asset management business, it seems like each quarter it comes in stronger than expected.

I guess just two questions on that.

On the traditional side, it seems like it's a little weaker.

You mentioned performance fees, so just trying to figure out how much that impacted it?

And then, when I think about the real estate, the merchant banking, just longer term, do you just want to try to gauge how much of that business you guys can still do, meaning its funds managed by others versus anything that you might have to shrink over time.

Just want to get an update on that.

Sure, so on the traditional asset management side, you identified it.

It was down due to both higher performance fees in the second quarter, and then we had higher waivers on liquidity funds this quarter.

And then on real estate and merchant banking, as I said, the upside was gains there.

We recently broke through hurdle rates on two funds, so we had catch up on carry for those two funds.

We are now close to the end of the catch up for those two funds.

We're earning carry on several other funds, but good performance, and had attractive catch up on carry.

And then, in terms of looking forward at those funds, we have strong teams in place, we're pleased with the returns there, and it's really a function of how much capital you have in those businesses.

Yes, I don't think there's any constraint or -- in fact, I think the businesses in some ways are more attractive because increasingly fee-based businesses because you have less capital at risk.

We're in private equity.

We're in mezzanine finance.

We're in real estate.

We're in infrastructure funding.

We have a pretty broad-based merchant bank, and a number of those groups are in fund raising right now.

And I think it's good teams, as Ruth said, good performance, limited capital, and that's a nice business model.

Got it.

All right, thanks a lot.

Brennan Hawken with UBS.

Just to follow-up there real quick on Mike's question -- is it possible to quantify the carry in the catch up that you guys had this quarter, just so we can understand how much is recurring and how much was more one-time?

No, we don't break that out.

We'll leave that to you.

No sweat, okay, figured I'd give it a shot.

And then, on asset management, just to sort of verify because I think there was a little bit of confusion before to the open on this, but you guys had a bump in your investments line in the investment management division, but it's my understanding that primarily washes out in NCI for that segment.

Is that right?

No, within investment management, we had carry catch up as indicated because we broke through the hurdle rate on a couple of funds.

And so, a majority of that actually is retained at Morgan Stanley, and NCI you can see it's smaller.

There's still NCI associated with the funds, but, no, we retained a large portion of that in-house.

Oh, okay, so that was the primary source of the carry, and then we've got to just basically come up with our own assumptions about how much is catch up and how much is repeatable?

Correct.

Okay.

And then, you gave some great color on the strength in the equities business -- a remarkably strong quarter really, especially looking at the US counterparts that have reported here to date.

It didn't sound like there were any kind of one-time components or things that wouldn't repeat, but just want to verify.

Is there anything that we should think about as one-time in nature in that number?

No, we've consistently -- I feel like quarter after quarter you talk about the strength in our institutional equities business.

It was another strong quarter across products and geographies.

And I've said that a number of quarters in a row here -- balanced across the franchise.

PB balances were very resilient, and that was notable given summer seasonality.

And cash equities, the market data indicates that we outperformed with industry volumes down; so, a strong quarter.

Typically the fourth quarter is lower in part with PB balances lower as managers go into year end, but nothing to note other than consistent, strong performance by the institutional equities business.

But one of the things that has been a determined move by the equities management has provided much more integrated approach across cash derivatives, prime brokerage to our clients.

And I think that's helping us gain market share, and obviously helps with the stability of the revenues.

Terrific.

Thanks.

And then, last one for me, just on the buybacks.

Is this the right pace we should assume, or should we assume some pick up here in 4Q?

And the buyback is approved through the first quarter, too, so we should carry that through to that, right?

Just want to verify my understanding there.

Yes, the approval processes for CCAR is through the end of the first quarter of 2014.

So, you should assume that we will use it no later than the end of the first quarter of 2014.

And is it okay -- is it right for us to assume that there is space for a pick up in the pace?

Well, the math would suggest that, given what we've used so far.

Thanks.

Fiona Swaffield with RBC.

Just a couple of follow-up questions on Basel III RWAs and deductions.

Firstly, on the deductions, they seem to have fallen quite significantly at $1.5 billion sequentially.

Could you explain what's driving that?

What kind of things, whether it's something to do with DTA or private equity funds, I'm not sure.

And then the second area is on the Basel III RWAs -- they've gone down outside of fixed income I think for the first time I remember it.

Are you doing something particularly outside fixed income as well on a Basel III efficiency basis?

Thanks.

So, in terms of Basel III RWAs, the main focus really is in fixed income, as you know, as you said, and I think it's just consistent with overall quieter market, lower volumes, the backdrop that we've been talking about.

In terms of the Tier 1 common and numerator and deductions there, obviously the buckets and waterfall of numerator deductions based on Tier 1 common levels.

And so, again, as we accrete capital, there are reduced deductions, numerator deductions is kind of the waterfall.

Okay, thank you.

Eric Wasserstrom with SunTrust Robinson.

Just two clarifying questions.

One back to the SLR glide path.

Does the continued on-boarding of deposits -- is that done sort of ratably over the period of time in terms of their contemplation in SLR?

Or is the end point somehow fully loaded in the current figure?

So, the -- two parts to that question.

The on-boarding of deposits was very large in the third quarter due to the -- that was the contractual nature of the acquisition.

One large tranche came on, as I said, a couple weeks after closing.

And then the balance of it is about $1.75 billion per month through the middle of 2015.

So, the big increase that we saw this quarter, you're not going to see on a go-forward basis.

That's the terms of the contract -- $1.75 billion per month through mid-2015.

And, yes, that is fully loaded into the estimate of greater than 5% in 2015.

Got it.

So, it's just that the influence of the incremental is just not so significant over the top?

Exactly.

And as you have deployment, you have greater earnings, so you have a couple of variables going on as well.

Got it.

And then just returning to FICC, it sounds like the most significant comment you made is that adjusting for some of the items, that your results quarter on quarter would have been down actually relatively little.

And so, I'm just trying to reconcile that with the -- and of course, it looks like there was a bit of share gain in credit, from some of your commentary.

I'm just trying to reconcile that with the continued reduction in RWAs to understand how it is that there is this group of assets that seem to have so little profitability associated with them.

That's precisely the problem -- they have so little profitability associated with them currently and on a go-forward basis.

So, the RWAs that we identified that we're reducing, structure credit, long-dated uncollateralized derivatives are a drag on the overall returns on the business.

And through passive and active mitigation, we are pleased to be shedding them at the fastest pace that we can.

You've seen that we've materially ahead of anything that we laid out.

We were at $390 billion on the old basis -- RWAs back in the third quarter of 2011.

It's been a lot of heavy lifting, and we're getting near to the -- there's light at the end of the tunnel given the pace of execution.

And with business leaders having the analytics, the dashboards to know how to reduce risk-weighted assets, that's helped the pace.

So, we're pleased to be exiting them, and it does help on the overall returns because it not only helps free up capital from fixed income, but I think that it's providing us with a more consistent, quality earnings base within fixed income, which is one of the key elements as we're thinking about how do we size any kind of capital return on a go-forward basis?

Great, thanks very much.

Roger Freeman with Barclays.

Back on the share repurchases, you commented I think earlier, greater share repurchases to hit the greater than 5% target, and obviously also as part of the ROE expansion.

Does that -- that doesn't assume anything sort of beyond the pace that you've been approved for?

Is that right?

I'm going to answer what I think your question was, and then let you have a follow-up if I missed it.

So, I was answering one question regarding the very small share repurchase program we're approved to do this year that ends through March and ends at the end of the first quarter.

And as we look forward, given all that we've done to build capital, given the greater consistency of results, the accretion of capital, we're building, in our view, increased flexibility to return more capital on a go-forward basis.

We are not going to judge CCAR or timing cadence, but it does build greater flexibility on a go-forward basis, and that's what I was trying to convey.

I'm not sure if I hit your question.

Yes, mostly.

I guess the point being that greater share repurchases as part of the path to hitting the 5%, and that's 2015 target, that kind of implies that you would expect to do higher than the small repurchase next year, because it only gives you a year.

We have certainly built in that, in providing this guidance of higher than 5%, but until we see the CCAR numbers, we have the capacity to do it, is what the greater than 5% means.

And my caveat -- we haven't seen the CCAR rules, the shocks, so we are not going to pre-judge CCAR.

It says that I'm not going to say what it will be next year, but we certainly have the capacity with the glide path to greater than 5% with much higher share repurchase even included in that number.

Okay.

And then just wanted to maybe get any updated thoughts you have on the physical commodities business.

Obviously, we don't have the final [Volcker] yet, but there's been a lot of obviously discussion in the industry and others have gotten out.

How do you think this stands for you strategically?

I don't think there's much change from what we've commented on previously.

It's been a good business for us for many years.

We want to be smart about what we do to drive returns in the business for the Firm overall, and so really no update at this point.

Okay.

And just a small one on -- back on the carry -- I know you are not quantifying the size, but what percentage of the way are you through the carry catch up?

Is it typical 80/20 in catch up?

Yes, probably.

I think a bit more than that.

So, what are you, 75%, 80% of the way there?

We've done a carry catch up this quarter, and we're almost through it.

And so, again, it's going to be a function of the market and the economy.

Okay.

So, there's a little bit to go?

Okay.

Right.

All right, okay, thanks.

Jim Mitchell with Buckingham Research.

One quick follow-up on the SLR.

Are compression trades and NOTC clearing -- are they in your guidance?

I thought it was excluding that.

It was just sort of the run-off what gets you the 5%, or did I misunderstand that?

So, the second quarter, as I said, the general industry read with the clearing would benefit the denominator.

Since then, it's clarified.

Clearing unto itself does not, so take that out.

When you take that out and you add the deposit growth, that's the 30-basis-point deduct that I mentioned previously.

However, what we have separately had the time now to do is go through and quantify the benefit from compression trades.

So, compression trades is distinct from clearing, reduced the denominator.

And it's really the pace of activity with compression trades, the volume that we're targeting with compression trades, is what helps -- is one component of what drives the leverage ratio higher.

The fact that we have been focused on central clearing for some time, and that we've been focused on backloading facilitates the pace of compression, but put those two as distinct issues and it's not the clearing itself but just compression.

But fair enough, but compression is in your guidance?

(multiple speakers)

Yes, compression is in the guidance.

Okay, thanks.

And then on the cost saves, can you give us some sense on where you.

You are targeting $1.6 billion net by the end of next year.

Where do you stand at this point?

We're very much on track for the expense reduction goals.

When we set out the goal, as you may recall, of $1.6 billion reduction, we set that out at the end of 2012, and said by the end of '14 we would be down by $1.6 billion.

But we were also very careful to say that that was predicated on revenues flat to 2012, and indicated that with higher revenues, which we expected, certain expenses would go up, in particular those that are activity-based.

But that we would measure progress based on overall expense ratios.

We were trying to hold for a number of different components.

And when you look at the components of non-compensation expense year to date, activity-related costs like brokerage and clearing, and transaction taxes are up, while non-activity-related costs like occupancy and market data are down.

And so, when you go through that math, take the 2012 revenues, deduct -- our expense ratio back then was -- I think it was 84%.

If you deduct the $1.6 billion expense savings we said we would get, that takes your expense ratio down to 79%.

We now have revenues up, some activity-related costs up, but net-net we're about at that level.

And if you exclude elevated litigation expense, we're ahead.

And our view is that litigation expense will be a cost for the industry for the near term, but we are improving our fundamental cost base, and we will get through that at some point.

So, very much on track for the expense program, ex-litigation.

Right.

I understand what you're saying that you had a targeted ratios, but revenues are up.

Where do you think they should be at current revenues, or I guess another way to say it -- do you think you're 50% of the way through it -- 25% or 75%?

Obviously, you must have some kind of thoughts on absolute headcount or things like that.

Just on the numbers given, we're already at the 79% expense ratio that was implied back in 2012.

One way to answer it would say that we're, excluding litigation, that we've achieved it, but we're only partially the way through executing it.

And so, we have the balance of next year -- fourth quarter, balance of next year to continue to execute on programs that we've laid out.

And for that reason, we say that the math would say that we're there, but we are continuing to execute on the programs that we identified back at the end of 2012.

So, we're feeling very good about our ability to continue to reduce the expense base.

I would just add that there is a culture of expense management across the Firm that we haven't seen for a long time.

Whenever I travel around the world -- local offices, sub-business groups -- everybody understands the program, everybody understands what we're doing.

We have a very well-coordinated program with 40 or 50 executives as part of it, so this is going to be a continuous process.

As Ruth said, on the percentage basis, we're already at the 79%, but that's -- honestly, that's not our focus.

Our focus is continuing to make the Firm more efficient by bringing it together as one Firm, which we did taking three platforms to one in wealth management, now bringing wealth management closer to institutional securities -- a lot of the electronic development within institutional securities.

So, there have been a lot of things that are going to be ongoing for the next several years, and I think we'll continue to add.

So, we've completed three of eight quarters, and achieved the target and the end state, and we are continuing to work.

Okay, thanks a lot.

Matt O'Connor with Deutsche Bank.

You guys have provided a lot of details on FICC RWAs, but have you talked about the total assets in that business?

We have not broken that out, no.

I guess if I can take a stab at trying to get to the opportunity of reducing those assets.

If we think about RWAs coming down by another $30 billion or $40 billion, and obviously there's a multiplier effect for the overall Firm, and I would think it's more for FICC, it seems like it might be in the $100 billion to $150 billion range in terms of total assets within FICC that might come down?

I'm not going to go through the math on the call.

If there's some technicals you want to follow-up with IR on, you can do that.

Okay, but it should be a multiple of RWAs, I would think, right?

So, we're looking at RWA reduction, we're looking at the grossed up balance sheet, and we're managing all of our businesses through a risk-based capital lens, a leverage-based capital lens, increasing an SLR lens.

Again, what we're driving is the strongest return in that business.

So, balance sheet is coming down as we've reduced -- and grossed up balance sheet is coming down even more as we reduce risk-weighted assets.

Okay.

And then just separately, as we think about the remaining $35 billion or so deposits coming in, and some of the benefit that you still get from what just came on, how should we think about the blended yield you can deploy that into?

Obviously, it's going to be a mix of retail loans, corporate loans, and some securities, but what's maybe a good blended yield to think about?

In a recent presentation, James actually laid out the return on cash, AFS, lending product.

And so we're continuing to deploy, as I said, added cash into AFS.

And then between both the wealth management and institutional book, and so, let you build out the growth there.

The components are in the presentation.

Okay, thank you very much.

Thank you so much for joining our third-quarter call.

We look forward to speaking to you again in January.

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

You may now disconnect.