摩根士丹利 (MS) 2014 Q3 法說會逐字稿

Good morning.

This is Celeste Mellet Brown, Head of Investor Relations.

And welcome to our third-quarter earnings call.

Today's presentations 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 www.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 instruments.

I will now turn the call over to Chairman and Chief Executive Officer, James Gorman.

Thank you, Celeste.

Good morning, everyone.

And, thank you for joining us.

Before I comment on our performance, I'll reflect briefly on where we are as a Firm and where we're going.

Management team here has been together for almost five years, and while we have accomplished a number of things, there's clearly more we can do.

In short, we do not think that this Firm is close to reaching its full potential.

The stability and cohesiveness of the team, significant depth of talent across the organization, commitment from our people, reshaping of our business model, all position us for significant growth.

At our core, Morgan Stanley is a client-focused firm.

Our philosophy has always been to do first-class business in a first-class way.

With the current regulatory paradigm, having a client-centric business model is key to sustainable success.

The opportunities in front of us are based on increasing client penetration and accelerating new client acquisition and may include building on our leading position in advising on cross-border M&A deals with particular success in Japan and our other strong banking franchises; the growth of our bank, both in Wealth Management and Institutional Securities; raising new funds in merchant banking and real estate, and the use of technology to improve the efficiency in which we serve our clients with a high-tech, high-touch approach across the entire franchise.

Those are just some examples.

Now, turning briefly to the quarter.

We grew our revenue and profitability quarter-over-quarter and year-over-year in both Wealth Management and Institutional Securities.

Firm-wide revenues, excluding DVA, were up 7% compared to the third quarter of last year.

In the Wealth Management business, our revenues grew 9% versus a year ago, driven by the continued execution of our bank strategy as well as revenue tailwinds from higher markets.

Notably, our margin improved to 22%.

Fee-based assets as a percent of client assets increased to 38%, up from 36% last year, and just 23% when we closed on the initial portion of the acquisition a few years ago.

Revenues in all of our major institutional businesses were up versus year-ago.

Investment Banking revenues were up 35%.

Fixed Income results, excluding, DVA were up 19%, notwithstanding continued reduction in RWAs.

Our Equity Sales & Trading revenues were higher versus last year, as we continued to execute across products and regions, and that franchise remains number one in the world.

The momentum of our businesses also drove continued improvements in our earnings and ROE.

EPS, excluding the tax benefit and DVA in this quarter and a year ago, was up about 40%, while our ROE on the same basis increased 180 basis points to approximately 8%.

We are not yet at acceptable levels, though we're making consistent progress.

For example, we have made progress in improving the returns and reducing the capital and expenses in Fixed Income & Commodities over the last few years.

We believe there may still be meaningful opportunities to optimize the remaining components of commodities beyond the recent TransMontaigne sale as we continue to drive for higher returns.

In addition, we're always vigilant with all our resources, especially the balance sheet.

A final thought.

We believe we remain well positioned for further capital actions given the magnitude of our fundamental strategic change and our improving earnings profile.

The CCAR process is ingrained in every aspect of our business.

I will now turn the call over to Ruth to discuss the quarter in detail.

Good morning.

I will provide both GAAP results and results excluding the effect of DVA.

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

The impact of DVA in the quarter was positive $215 million, with $132 million in Fixed Income sales and trading, and $83 million in Equity Sales & Trading.

Excluding the impact of DVA, firm-wide revenues were $8.7 billion, up 2% versus the second quarter.

The effective tax rate from continuing operations for the third quarter was 21%, reflecting a discrete net tax benefit of $237 million, or $0.12 per diluted share, primarily associated with the repatriation of non-US earnings at a cost lower than originally estimated.

Earnings from continuing operations applicable to Morgan Stanley common shareholders, excluding DVA, were $1.5 billion.

Earnings from continuing operations per diluted share, excluding DVA, were $0.77 after preferred dividends.

On a GAAP basis, including the impact of DVA, firm-wide revenues for the quarter were $8.9 billion.

Earnings from continuing operations applicable to Morgan Stanley common shareholders were $1.7 billion.

Reported earnings from continuing operations per diluted share were $0.84 after preferred dividends.

Book value at the end of the quarter was $34.17 per share, and tangible book value was $29.25 per share.

Turning to the balance sheet, our total assets were $814 billion at September 30, down from $827 billion at the end of the second quarter.

Deposits as of quarter-end were $124 billion, up $7 billion versus Q2.

Our liquidity reserve at the end of the quarter was $190 billion, compared with $192 billion at the end of the second quarter.

Year-to-date, we benefited from strong global demand for our credit enabling us to pull forward issuance from future periods, reflecting broad global investor participation.

Turning to capital, although our calculations are not final, we believe that our common equity Tier 1 transitional ratio will be approximately 14.3%, and our Tier 1 capital ratio under this regime will be approximately 16.1%.

Basel III transitional risk-weighted assets are expected to be approximately $415 billion at September 30.

Reflecting our best estimate of the final Federal Reserve rules, our pro forma common equity Tier 1 ratio using the Basel III, fully phased-in advanced approach was 12.6% at September 30, up from 12.3% in the second quarter.

Our pro forma standardized ratio was 11.7%, up from 10.7% in 2Q.

Pro forma, fully phased-in, Basel III advanced RWAs are expected to be approximately $423 billion.

We estimate our pro forma supplementary leverage ratio under the US final rule to be approximately 4.9% at September 30, up from 4.6% at the end of 2Q.

These estimates are preliminary and are subject to revision.

Turning to expenses, our total expenses this quarter were $6.7 billion, flat versus the second quarter.

Let me now discuss our businesses in detail.

In Institutional Securities, revenues, excluding DVA, were $4.3 billion, up 3% sequentially.

Non-interest expense was $3.3 billion, flat versus the second quarter.

Compensation expense was $1.8 billion for the third quarter, up 3% versus the second quarter, in line with the increase in revenues and reflecting a 41% ratio, excluding DVA.

Non-compensation expense for the third quarter was $1.5 billion, down 3% versus the second quarter.

The business reported a pretax profit of $1 billion, excluding the impact of DVA.

Including the impact of DVA, revenues were $4.5 billion, and the pretax profit was $1.2 billion.

In Investment Banking, revenues of $1.3 billion were down 6% versus last quarter.

According to Thomson Reuters, Morgan Stanley ranked number one in global IPOs and number two in global announced and completed M&A at the end of the third quarter.

Notable transactions included, in advisory, Morgan Stanley acted as sole financial advisor to Sigma-Aldrich, in the announced $17 billion sale to German Merck.

Morgan Stanley also acted as financial advisor to Dresser-Rand in the announced agreement to be acquired by Siemens for $7.6 billion in cash.

In Equity Underwriting, Morgan Stanley acted as joint book runner on the US $25 billion IPO of Alibaba Group, the largest IPO in history.

Morgan Stanley also acted as lead left book runner and stabilization agent on the $3.5 billion IPO for Citizens Financial Group.

The IPO represented the largest US bank IPO in history and the largest US financial institution IPO since 2007.

In Debt Underwriting, Morgan Stanley acted as lead left book runner for Tyson Foods on its $3.25 billion of senior unsecured notes in multiple tranches to finance its acquisition of Hillshire Brands.

This financing complemented our role as lead financial advisor to Tyson on its acquisition, lead left arranger for an $8.2 billion committed bridge facility, and lead left book runner and stabilization agent for the $2.4 billion offering of common stock and tangible equity units.

Advisory revenues of $392 million decreased 6% versus our second-quarter results, driven by lower results in EMEA and Asia-Pacific.

Morgan Stanley remains a leader in cross-border activity.

Underwriting revenues of $948 million decreased 7% versus our second-quarter results that were strong for a third quarter, driven by Equity Underwriting revenues of $464 million, which were down 5% versus the second quarter, reflecting lower volumes in the Americas and EMEA, partially offset by strength in Asia-Pacific.

Fixed Income Underwriting revenues of $484 million were lower versus the second quarter, primarily due to declines in investment grade and high yield bonds that were partially offset by higher revenue from loans.

Equity Sales & Trading revenues, excluding DVA, were $1.8 billion, flat compared to last quarter.

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

Solid client activity and the underwriting calendar drove cash revenues above second-quarter levels.

Derivative revenues also increased sequentially on higher client activity.

Prime brokerage revenues were lower, reflecting reduced activity in Europe.

Fixed Income and commodity sales and trading revenues, excluding DVA, were $1 billion, flat versus the second quarter.

Macro revenues were up significantly this quarter, most notably in foreign exchange, which benefited from improved market conditions with higher volatility.

Securitized products and credit products revenues declined on lower secondary client activity and less favorable market conditions.

Commodities revenues were meaningfully lower, reflecting lower client activity and a difficult market environment.

CVA was a benefit in the quarter.

Other revenues were $225 million, up versus $108 million in the second quarter, driven by a gain on the sale of TransMontaigne and the sale of a retail property space.

Average trading VaR for the third quarter was $42 million, down from $48 million in the second quarter.

Turning to Wealth Management, revenues were $3.8 billion in the quarter, up 2% sequentially.

Asset management revenues of $2.2 billion were up 5% versus last quarter, reflecting a higher market and positive flows.

Transaction revenues were down compared to last quarter, consisting primarily of commissions of $503 million, essentially flat to the prior quarter, investment banking related fees of $224 million, up 5% versus last quarter, reflecting a pick-up in closed-end funds, and trading revenues of $185 million, down 31% versus the second quarter, driven by -- primarily by lower marks in our deferred compensation plans.

Net interest revenue increased 4% to $601 million, driven primarily by higher revenues from our bank deposit program.

Other revenue of $112 million increased versus the second quarter, primarily due to the gain on sale of a retail property space.

Non-interest expense was $2.9 billion, flat versus last quarter.

Non-compensation expense was $767 million, effectively flat to last quarter.

Compensation expense was $2.2 billion, flat versus the second quarter.

The compensation ratio was 58%, down versus the second quarter, driven by revenue mix including ongoing growth in net interest income.

The PVT margin was 22.1%, up versus 20.6% in the second quarter.

PVT margin, excluding the benefit from the sale of a retail property space, was 21.3% in the quarter.

Profit before tax was $836 million.

Total client assets were $2 trillion.

Global fee-based asset in-flows were $6.5 billion.

Fee-based assets under management increased to $768 billion at quarter-end, representing 38% of client assets.

Global representatives were 16,162, essentially flat to the second quarter.

Deposits in our bank deposit program were $129 billion, up $2 billion versus the second quarter.

Approximately $116 billion were held in Morgan Stanley banks.

Wealth Management lending balances continued to grow, reflecting the ongoing execution of our bank strategy.

Lending balances increased $3.5 billion in the quarter.

Investment Management revenues of $655 million were down 5% sequentially.

In Traditional Asset Management, revenues of $456 million were up 5% versus the second quarter, driven by positive flows and higher markets and partially offset by lower marks in deferred compensation plans.

In real estate investing, revenues of $113 million were flat to the second quarter.

Merchant Banking revenues were $86 million, down 41%, driven by lower investment gains in the quarter.

Non-interest expenses were $467 million, down 4% from the second quarter, consisting of compensation expense of $253 million, reflecting a compensation ratio of 39%, and down versus the second quarter, driven by lower marks on deferred compensation plans and the mix of revenues in the quarter.

Non-compensation expense was $214 million, up from $196 million in the second quarter, primarily due to the settlement of a legal matter.

Profit before tax was $188 million, down 8% sequentially.

NCI was $18 million versus $7 million last quarter.

Total assets under management increased to $398 billion, driven by higher flows, though partially offset by market depreciation, driven primarily by foreign exchange.

In conclusion, our outlook is guided by the meaningful transformation we've made during the last five years and benefits from growth in our most annuity-like businesses.

First, our Wealth Management business continues to have momentum with growing profitability from the secular trend toward managed money.

We entered the fourth quarter with a modest tailwind from stronger equity markets at the end of Q3, and clients remain engaged as they assess evolving opportunities in markets.

Second, we continue to have earnings upside with ongoing loan growth in our bank.

This remains a differentiated contributor because we benefit from asset optimization on a growing loan book even without the benefit of rising rates.

As we entered the fourth quarter, the pipeline for loan origination remains strong in both Wealth Management and Institutional Securities.

Third, our Investment Banking pipeline remains healthy.

In advisory, it is broad-based across industry and geography and generates financing opportunities.

Ongoing market volatility may affect institutional results if it persists.

However, we view recent volatility as a repeat of a theme seen frequently during the last several years with growing activity levels across products and businesses building, only to be disrupted by macro events, then followed by a reset.

A reset could occur with recognition that stronger growth in the US may offset challenges in other economies.

Finally, our capital and liquidity position continue to be a source of strength.

Our healthy capital ratios on both an absolute and relative basis reflect a robust foundation and evidence our ongoing successful execution of our business and balance sheet strategy.

Thank you for listening.

James and I will now take your questions.

(Operator Instructions)

The first question will come from Glenn Schorr with ISI.

Hello.

Good morning.

Good morning.

Good morning.

Maybe just a quick one on the mechanics of this whole fair value of deferred comp that showed up in both -- in your comments, in both Investment Management and Wealth Management.

If I heard you correct, it hits both the revenue line and the comp line?

Correct.

And, can you just help us, when and why that happens?

It's a function of the assets in the deferred comp plan.

They move as the market moves, and it therefore flows through revenue and comp.

And, in this instance, you could see we went through the impact on both businesses.

Okay.

Do I need to care -- meaning are they comparable amounts on the revenue and expense line?

And, they net out to not a big impact?

Yes, although they -- by definition, therefore imply a higher comp ratio.

Yes, they net out.

Understood.

Okay.

Cool.

Moving on.

Curious, you definitely commented about how you've extended the duration of your book a little bit -- or a lot, I should say in the past.

Curious, marking to market, your thoughts on NSFR, impact on prime brokerage specifically in conjunction with the Fed's recent comments on short-term wholesale funding.

Just, how is it impacting?

It's an important business for you.

You're really good at it.

How is it impacting how you run the business and the profitability of the business.

So, taking the two rules, obviously, both of which are at this point preliminary, and we're looking forward to seeing the final rules.

On the Net Stable Funding Ratio, as you noted, we've frequently said that durability of funding is important, and it's the way we run the Firm.

And, as a result, probably not surprisingly, we think having a measure of long-term durability is appropriate, and we've spent a lot of time, as you noted, achieving this durability through proper ALM, and we've spent a lot of time walking everyone through how we've done that within our secured book.

The challenge in being more direct in answering your question is the rule is preliminary.

But, given all that we've done, we don't expect to make meaningful changes.

And, as I said, we very much look forward to seeing what the rule is.

And then, on the SIFI surcharge, the increase for short-term wholesale funding, somewhat similar given the Fed has only provided the broad contours of what the rule is going to be.

It's unclear how it's going to be implemented, and in particular, how it's going to be calibrated.

I think, obviously, the entire industry has some element of wholesale funding, and we've often said not all wholesale funding is created equal.

Very much to your question.

Our view is that logic would suggest that proper calibration would incorporate not just size but the quality and durability of funding.

In particular, given the Fed has recently published an article about durability in the industry -- one I noted in a recent conference, and it's just too early to know.

But again, given all that we've done and given the strength of our capital positions, we are not looking at changing what we're doing with our business here, and I guess the last point I would make on the wholesale funding is we would hope the rule is dynamic and does adjust as the industry adjusts to the new rule.

The big point is that given what we've done with our funding, with durability of our funding, and the way we're managing our balance sheet, we don't see it really at this point -- still waiting for the rule, leave that caveat -- but, really affecting the way we're running the business.

Last quickie is just your growth has been great as you noted in both the PLAs and the resi -- residential real estate loans.

Are the FAs being specially incented to drive that?

I know it comes at a higher profitability for the firm.

Is the offset of rates not going up for you?

Low rates actually helped drive the growth in those lending products?

There are a couple different questions in that.

As we've talked about, loan growth is not on the comp grid, on the formulaic comp grid.

It's what we call non-compensable revenue.

There is compensation on it, but it's not part of the formulaic grid.

What's really driving this is, we've talked about on some prior calls is, the take-up by FA, and what we're finding is we're having growth in the loans per financial advisor, growth in the number of financial advisors using the product.

As they use it, they see the value to their clients.

They see an ease of using it.

We've invested meaningfully in the infrastructure to support financial advisors, and so they're seeing the strength of this product suite.

And, we're also seeing higher drawdown on the securities-based lending that loans.

So, you have origination occurs, and then you have the drawdown over a period of time.

Really what this is, is increased penetration on what is a very sizable client base, and that's what's really driving it.

Okay.

Excellent.

I appreciate it.

Thank you.

The next question will come from Guy Moszkowski with Autonomous.

Good morning.

Good morning.

We've heard a lot of complaints from investors who are worried about the Street reducing the liquidity that it provides.

We heard a lot more about it in the last few weeks of the third quarter.

At the same time, in the third quarter, the [GSF] begin to have to make daily reports to regulators based on Volcker and liquidity regs.

Do you think this may have had an impact?

Just because it's onerous, and it puts in your face every day the impact of inventory and hedging?

Or, is the issue more broadly structural in your view?

We think it's more structural, and it's really the combination of other regulatory requirements.

We don't think it's as a result of the Volcker reporting.

People have been working on that for quite some time.

As you said, it has now starting to be submitted to regulators.

When you look at the combination of the supplementary leverage ratio with the other various tests -- whether it's CCAR or for some firms, it's the LCR.

There are a number of factors which are really changing dynamics in the market and liquidity in the market.

At a recent conference I put up a slide that looked at the extent to which balance sheets have come down on the one hand and liquidity requirements have increased on the other hand, and by definition, that's squeezing the amount of balance sheet available for trading activity.

So, we do view that as a structural change in the industry driven by regulatory change in the aggregate.

And, is there a way that you're actually seeing in which this leads to fundamentally better spreads?

Well, the gapping that you saw this week I would say -- I wouldn't view that as a positive for the market.

I think that one of the things that has been concerning is the increase in Treasury sales, which I think initially were attributed to the SLR, and there was a view that potentially there would be a readjustment in markets.

But, in fact, through the course of the third quarter even before the last couple of weeks, the trend line was up even when market volatility was low.

And, I think that is a concern.

And actually, if you don't mind, can you comment a little bit on the early going in October?

Obviously, we're only a couple weeks in, and they've been an unusual couple of weeks.

But certainly, JPMorgan commented earlier this week that their markets' businesses had seemed a lot more mixed over the last couple weeks.

As you said, the macro environment, the trading markets are really the key issue, and it has been a challenged quarter to date.

As you appropriately noted, two weeks isn't a quarter.

As I said in my opening comments, we've seen this through the last several years, choppiness in markets and then a reset.

It's tough to gauge when it resets.

So, it has been a choppy, early start.

But, when you look, again, across the franchise, the investment banking pipeline is strong.

You've seen continued issuance throughout this period.

Yes, a sustained downdraft wouldn't be constructive, and it could affect the timing of deals.

But, at this point, the pipeline continues to build.

In fact, a lot of deals that we may have thought would close in the fourth quarter -- were pulled into the third quarter.

Were executed earlier, and the pipeline has replenished which really goes to the strength of the dialogue across banking franchise.

And, similarly in Wealth Management, what we're seeing -- I appreciate you're asking about trading markets -- but as we look across our franchise, what's quite relevant is just the consistency we're seeing in Wealth Management as well.

Thanks.

You mentioned the SLR, and thanks for giving us the figure.

Is there still a [SACCR]-type benefit that we should be looking for?

Well, there has been no update on the rule.

We do still expect that SACCR will be a part of the standardized risk-based capital calculation, and as proposed, based on the third-quarter number, that would be about a 30 basis point benefit to our standardized ratio.

On the SLR, it's unclear if the rule would include SACCR as part of it.

If it would include it, we would expect a modest benefit there.

Thanks.

I have a question on Wealth Management.

As you pointed out, the fee-based asset in-flows at $6.5 billion were quite a bit lower than in either of the reference quarters.

I think you were $12.5 billion last quarter and $15 billion a year ago.

I was wondering if there is any color you can provide there?

Any special factors that we should pay attention to?

No special factors.

We've seen the same strength in the business.

In our view, it just reflects timing.

As you noted, we had strong flows throughout the year.

As we're looking at it year-to-date, we had strong flows, and there are timing issues.

You talked about the discrete tax benefit because of being able to repatriate more attractively than you had expected in terms of your tax provisions.

How unusual an event is just the repatriation itself?

And, can you give us a sense for the order of magnitude involved?

And, I guess what I'm looking for is a signal as to what we're looking at in terms of potential capital return?

So, in terms of the repatriation as I noted, it was due to some non-US earnings that were at a cost lower than originally estimated.

I think we look at requirements in geographic markets throughout the year.

This one just happened to be with a benefit.

And, can you tell us what the gross amount was that you repatriated?

We indicated the tax benefit here.

I don't have more than that with me.

Fair enough.

Thanks for taking my questions.

I appreciate it.

Thank you.

The next question will come from Matt O'Connor with Deutsche Bank.

Good morning.

Good morning.

I was hoping just to follow up on your comment about further capital actions given strategic changes.

I don't know if that's just referring to the CCAR process.

Earnings are higher.

There has been more stability, so think about higher payouts.

Or, was there something else that you're referring to maybe related to selling the commodities business, freeing up capital, things like that.

Why don't I take that.

I think we're just pointing out that in the context of all the things going on at this firm, we're obviously building pretty solid capital buffers.

That said, we live in a dynamic regulatory environment with potentially new G-SIFI buffers coming out.

We feel strongly about where we are with our capital base, and we feel strongly about where we're going coming into the CCAR process.

We certainly expect to continue to return capital to shareholders in increasing amounts over the coming years.

And then, have you disclosed either the assets or revenue related to the commodities business?

Either what you sold, or just the entire unit?

No, we haven't.

Okay.

And then, just separately, there was an article in the paper a couple weeks ago related to the dividend arbitrage that some clients are using that US broker dealers and global broker dealers are helping.

Just wondering how big of a business is that for you?

And, remind us of the seasonality around that?

And, thoughts on, I guess, just the business going forward?

Well, as we have said repeatedly, our equity business is strong, diversified across products and regions, and that's what drives it.

We don't break out particular pieces, and there are seasonal patterns throughout the year.

Okay.

Is that an area that you think you and others will pull back a little bit, given just that it's being highlighted and maybe scrutinized a bit more than in the past?

It is one of a number of services that we provide clients, and it's really based on client activity.

Okay.

And then, just lastly, the non-comp -- expenses overall actually came in pretty good this quarter in general.

The non-comp, in particular, has been managed down quite nicely.

Is there anything -- I guess from here, is there more that you can do?

Or, should we think about this as a pretty reasonable run rate?

Our view is that we -- there is more to do.

We remain very focused on expenses overall and if you go back to 2012 when we first laid out our expense reduction goals, we had an expense ratio at that time of about 84%, and we indicated by the end of this year we'd get to 79% or lower.

Year-to-date, we're at 77%.

But, the process of going over the last couple of years is really to provide the analytics, the tools, the dashboards to the businesses to ensure that ingrained throughout the organization is a real focus on expenses and expense management, and we view that as an ongoing part of the way we run the business.

As I talked about at a recent conference, we divide our expenses into what we call, run the bank and change the bank.

And, we've been able to extract savings and run the bank to fund what we call change the bank requirements, which include both regulatory requirements as well as ongoing innovation in the business, investments to ensure we're enhancing client experience and applications and across the platform.

So, again, we've got a very strict lens on that because it does create incremental capacity as well, and we think it's the appropriate way to run the overall franchise.

Okay.

Thank you very much.

Thank you.

The next question will come from Jim Mitchell with Buckingham Research.

Thanks.

Can you just update us on the FIC RWA this quarter?

And, maybe just more strategically as we think outward if there is more pressure from regulators with a SIFI surcharge on top of a surcharge focused primarily on repo and other aspects of the Fixed Income business, do you think that, that -- there could be some changes in trying to push the RWA lower over time?

Thanks.

So, risk-weighted assets in Fixed Income are $191 billion this quarter, down from $192 billion last quarter.

We just had less roll off this quarter.

And, we remain very comfortable with the $180 billion target for Fixed Income which was originally end of 2016.

We pulled it forward to end of 2015.

As I indicated at a recent conference, we want to make it clear, though, that there's not a -- just as with the non-comp expense question, there's not a line in the sand on a particular date where activity stops beyond the $180 billion.

There is about $25 billion of incremental risk-weighted assets that run off over time in areas like structured credit and long-dated uncollateralized derivatives which generate a negative ROE because we have to finance positions -- legacy positions.

As we exit, we take those from a negative ROE to neutral, and as we redeploy them, you shift to a positive ROE.

And, we're already generating strong ROEs in a number of our businesses within Fixed Income like credit and securitized products.

So, we have an opportunity to reallocate to get a higher return on those.

That's really the way we're looking at what we're doing within Fixed Income.

As it relates to changing regulatory requirements and the potential surcharge, I would note that our ratios are very strong.

The transitional ratio at 14.3%, and even fully phased in as we're talking about, 11.7% standardized, 12.6% advanced.

What we're really looking at is how to best optimize within each business to drive the ROE within each business.

We believe we've got room to really use a number of different levers to do that.

That's helpful.

If you think about the $180 billion, there's $25 billion that's runoff beyond that, but you might be reinvesting depending on the environment?

Is that the way to think about it?

Yes, depending on the environment and client activity.

Because we have the opportunity already resident within a number of products within Fixed Income to generate an attractive return.

So, depending on requirements, there's ample capacity.

Okay.

Great.

Thanks.

Thank you.

The next question will come from Mike Mayo with CLSA.

Hi.

What inning are you in, in redeploying the deposits that you achieved from the joint venture?

So, we are -- what inning.

Frequently, do ask the inning question.

I think we're well on our way, and I think -- let me give a couple of parts to that.

The early days -- I guess you would say even pre-game -- was building the infrastructure required to support the growth when we were able -- once we closed out the acquisition and started on-boarding the deposits.

That was a very important element of really the set-up.

Ensuring that we had the infrastructure, the risk management, the bankers supporting the financial advisors so that as the deposits started on-boarding, we could have positive growth, a good experience for our financial advisors as I've already addressed, and see the kind of roll-off that we've had.

The other thing is we've emphasized repeatedly that our focus is on prudent loan growth.

Prudent loan growth within Wealth Management and Institutional Securities, and we have two broad franchises that enable us to have strong demand, but what we've been focused on is really prudent loan growth.

And so, we have ample capacity beyond here.

We've been closing the gap versus the industry average, but still believe we have ample capacity beyond here to grow.

And, that is just with the contractual on-boarding of deposits where as you've seen this quarter there's organic on top of the contractual.

We view this as the opportunity to have the tenth largest depository embedded within Morgan Stanley that creates substantial incremental opportunity in a flat rate environment or a rising rate environment, and I'm going to give it to James because he tends to like cricket matches and they last a lot longer, and that's the way we view this bank.

It's got a long way to go.

I'm not sure you're asking about cricket innings.

But, if I were to put a number on it, I'd say we're somewhere around the bottom of the fourth in baseball and at the afternoon tea session on day two of a five-day test match.

(laughter) Okay.

How much do interest rates help if they increase?

And, how much do they hurt if they don't increase?

Some of the more traditional banking peers will actually quantify this for us, and you haven't done that.

Can you help size the benefit or the harm?

Yes.

I'm glad you asked that question because it's an important one given the way we see the outlook for the bank.

So, overall, rising rates are a good thing.

They do benefit the bank if we deploy deposits into lending and AFS.

And second, it should signal an improving economy which would increase activity levels across the franchise.

But, the main point and tried to indicate that in the opening comments is that the main driver of NII growth is deposit deployment, and you can see that in our year-over-year numbers.

We're benefiting from deploying these legacy Citi deposits, and with more coming on board, we have a positive impact even without rates rising.

And so, you take that, that to us is a really differentiated advantage.

We're pleased to see the ongoing growth in NII again even without rates increasing.

Now you flip to the other side.

At some point, rates will increase.

And, for modeling, a couple of the key points.

I guess first is that the reason we've gone through the giving you contractual deposit on-boarding -- what the schedule is and what the current asset mix and what the target asset mix is, is so that you can model the rate impact whenever you do expect it to occur.

The other components in modeling that we think about is, one, what's the impact of higher rates on deposit outflows, and the data suggests that for Morgan Stanley that would be de minimis because our deposits, our working capital in client accounts, so very sticky.

We've talked about that in some prior calls.

In terms of deposit pricing, we model that based on historic data for both Morgan Stanley as well as for retail deposits at regional and large money center banks.

Notwithstanding the fact that as I said, our deposits do behave very differently than those retail deposits, and our analysis and our model would reflect about a 45 basis point increase in deposit pricing with the first 100 point -- basis point increase in rates.

We do believe that is conservative, given the nature of our deposits and structural changes in deposit alternatives, but it's what we would assume as something to put into a model.

Fed funds is the most relevant rate for our business.

The last point is that the average duration of our bank assets is about 1.5 years, so rising rates do benefit us quickly.

The way we look at is in a flat environment there's upside given NII growth but it's all about asset optimization.

In a rising rate environment given the factors I went through and the cost structure of our bank, no bricks and mortar, the investments have already been made.

Any rise in rates does drop nicely to the bottom line.

Just two quick follow-ups.

The deposit beta of 45% seems somewhat low compared to many traditional banks.

Are you sure about that?

It's not a whole lot of sensitivity there.

When we look at the data that we've looked at over time, and again, given the nature of the deposits as I indicated, our view is that that's appropriate, given the nature of the business.

And as I said, we're talking about the first 100 basis points.

So, it moves over time.

And then, low rate, if it stays lower for longer, what impact does that have on your refinancing of your debt?

You issued a lot of debt when your credit spreads were blown out a few years ago, and now they have many come in.

Can you take advantage of that?

We can, and we have, because we've started refinancing debt that as you noted was -- came on in the 2010, 2011 period.

We do realize the benefit over time given the weighted average maturity of our unsecured debt is about six years, so we would leg into any benefits over time.

But, at this point, we're refinancing debt we issued post-crisis, and there is a benefit.

All right.

Thank you.

Thank you.

The next question will come from Brennan Hawken with UBS.

Good morning.

A quick one first.

The $141 million gain that you laid out?

Was that only on that real estate sale?

Or, does it also include the gain on TransMontaigne?

No, it's just on the real estate.

Okay.

Is it possible to quantify the TransMontaigne gain?

Was that significant?

We don't break that out.

That's included within the other revenue line.

And, just as a reminder, that also includes the contribution from our joint venture with MUFG.

It's where the real estate is TMG, and there are a dozen line items in that one.

Given the fact that you broke it out would imply that you didn't view it as a material number -- it wasn't material enough to break out?

Is that fair?

It's included, as I said, within the other line.

All right.

Thinking about the rest of the physical business and the potential sale to Rosneft, what are the next steps if that doesn't go through here by year-end?

Can you start to shop the asset now?

Is there any change that can be made proactively on that front?

Well, as you noted in the way you framed the question, the terms of the contract are such that if the deal doesn't close by year-end, the contract expires.

So, we're considering alternatives if it doesn't close.

Okay.

Is it possible also while on the physical commodity front to think about what growth rates might have been if we exclude either the TransMontaigne component of the physical commodities revenue out of FIC or physical commodities overall?

Just given that it's getting shopped?

TransMontaigne wouldn't have -- would have been immaterial to the results, and as we indicated, commodities overall was very -- it was very low.

It was down meaningfully year-over-year and quarter-over-quarter.

So, it wasn't much of a contribution across commodities generally.

Okay.

So, is it possible that the growth rate might have even been higher if we ex out the physical business?

Oh, yes.

If we ex out commodities.

Right.

And then, one last one.

Just when we talk about the loan book, a lot of times we focus on the Wealth Management end of it.

Just kind of curious.

You've disclosed that at least 50% of the loan growth is going to be coming from the institutional side.

How should we think about the NII from those loans flowing through your P&L?

And, generally, how should we think about the spreads on those loans versus the loans in your Wealth Management business?

Is there a way to frame how to think about that side of the loan growth?

Yes, it's a fair question because, as you know, in ISG, in the Institutional Securities business, NII is a function of a number of factors.

So, it's not as easy to parses through as in Wealth Management.

Just to give you some loan growth numbers, though.

In Wealth Management, I think I indicated securities-based lending is up $2 billion.

Residential is up $1.5 billion.

Institutional Securities, we were up $1.5 billion on the quarter, primarily in commercial real estate, and we are focused on continuing to build a diversified portfolio.

Our focus is on lending in areas where we have strong client franchise, strong domain knowledge, so the other element of it is it's enhancing our overall client experience within Institutional Securities.

It's in addition to what we're already doing with key clients.

And so, it's reflected there as well.

In our view, accretive to the overall relationship.

We have some slides that we've used in prior conferences that give you yields on a blended basis.

Okay.

And, when we think about those yields and how that yield -- those yields play in.

My guess is -- or my sense would be that the level of competition in those markets probably a bit more intense than you would see on the retail side?

Is that a correct assumption, or is that off-base?

Well, again, as I said, part of it -- on both sides, Wealth Management and Institutional Securities, what we're doing is really focused on our client base.

And, in Institutional Securities, it's adding on to what we're doing within our key franchises.

So, we view all of our businesses as competitive.

We don't take anything we're doing with any of our clients for granted.

But, we've got, in our view, a strong opportunity, and what we've said repeatedly is that we're focused on prudent loan growth.

It's not as though we're looking to create, to originate volume -- merely to originate volume.

There's a substantial opportunity within our client base on both sides of the house, and the key lens is -- you've probably heard us say it too many times.

It's prudent loan growth, and it's driven with the tightest lens on risk management.

That's what is key to the way we're looking to build the bank here.

Thanks for the color, Ruth.

Thank you.

The next question will come from Michael Carrier with Bank of America.

Thanks a lot.

Ruth, just on some of the regulatory ratios.

Any update on the bank SLR or the LCR?

So, the bank -- given we capitalize the bank to support the loan growth that I'm pleased that we've within talking a lot about on this call -- we're in a strong position on all the various capital ratios.

LCR, SLR, and again it's because we capitalize the bank to support what we expect will be ongoing loan growth.

Okay.

And then, small items, but just in terms of the tax outlook?

And then, also, the CVA, just wanted to find out -- significant this quarter?

Or, kind of an average level?

In terms of the first part of your question, over time given our business mix, the tax rate should be around 30%.

And then, on CVA, it was positive this quarter.

It was a drag last quarter and last year.

But, one point that is worth noting is Fixed Income excluding commodities was up quarter-over-quarter and year-over-year, and if you exclude CVA, that same trend would apply.

So, the business -- Fixed Income products broadly excluding commodities up quarter-over-quarter and year-over-year, excluding CVA.

And then, just on trading.

On commodities, anything in the quarter that you would say was like a one-off versus environmental, and that's more going into the fourth quarter and next year?

And then, I guess same thing on equities?

Just given the relative strength, anything that you would say was especially strong that you wouldn't expect to continue?

No, so starting with commodities, nothing specific to call out.

And so, our view is that what we're looking at appears to be structural headwinds in certain commodities markets, and as a result, the key question is how to best maximize returns if in fact these are structural headwinds.

But, there was nothing specific there.

And, similarly, in equities, we had broad-based strength again across products and geographies, just given the leadership in that business.

We did benefit from a strong global underwriting calendar, but I would say that's core to the overall franchise and the strength of what we're doing in Equity Underwriting generally.

And, the Equity Underwriting calendar remains strong, but nothing specific to call out as broad-based strengths, again.

Thanks a lot.

I guess just to add, one of the things to note is that we have seen in the past that if challenging markets result in overall poor performance, you'll often see reallocation.

But, overall, I think that one of the key things is typically activity slows as you go into the end of the year, in particular with prime brokerage clients.

We've seen that in prior years.

Thanks.

The next question will come from Fiona Swaffield with RBC.

Hello.

I just had two questions.

Firstly, was on just understanding the compensation ratio sequentially a bit better.

Because you took out the gain in your analysis on the pretax margin so I assume we should also do the same on the comp ratio.

And, if we do that, it obviously has improved less.

Could you also explain this issue of the employee deferred comp, and how that would affect the comp ratio sequentially?

And, the second question is on the SLR.

Could you talk a bit more about the balance sheet -- or the denominator?

It obviously seems to have gone down which is helping, and is there more prospect of that continuing?

Thanks.

Certainly.

So, starting with the SLR, 4.9% versus 4.6% last quarter.

We had a contribution from both the numerator and the denominator.

The benefit on the denominator was actually primarily from mitigation of the gross-ups.

So we've been talking for quite some time about the number of work streams against which we've been executing including the net long CDS sold, the pick-up in compression activity, the reductions in Fixed Income RWAs over time.

And, that was the bulk of the benefit that we saw on the denominator.

As you noted, we also had a decrease in our GAAP balance sheet, but the other items were a bigger contributor to the benefit from the denominator.

And then, on the numerator, beyond earnings, we did have a pref issuance this past quarter.

Those two drove the numerator higher.

In fact, the split between the numerator and the denominator was about two-thirds of the benefit came from the numerator, one-third came from the denominator.

Thank you.

The next question will come from Christian Bolu with Credit Suisse.

Thanks for taking my questions.

Just a quick one on FVA.

A number of your peers have now implemented this adjustment to the derivatives books.

Curious on your latest thoughts on where Morgan Stanley stands on this?

So, FVA, referring obviously to fair value adjustment refers to the potential implied financing cost for uncollateralized derivatives.

Only to the extent that those are observable.

We do continue to evaluate it.

As you noted, there is a lot of industry discussion.

There has also been a lot of academic discussion on the topic.

In our view, transparency continues to be lacking so there's no basis to take the adjustment.

Quickly, on VaR, that came down.

Particularly interest rates, credit line.

I assume there was more client activity during the quarter.

Just curious if you could parse out the decline there between positioning versus volatility.

It has come down, I think, in line with overall activity levels coming down.

You can see it, and you noted one line -- I would say that in commodities it also came down.

Its was really just more in line with client activity.

Got it.

Thank you.

Thank you.

Your final question will come from Steven Chubak with Nomura.

Good morning.

Good morning.

James, I appreciate your comments on your CCAR focus internally.

And, clearly you've made considerable progress delivering stronger returns over the last four quarters.

One thing I was a little bit surprised by, just looking at your latest Company-run, mid-year stress tests is that your PPNR forecast of $8.3 billion wasn't meaningfully different than your prior Company-run submissions.

I was wondering whether this merely reflects increased conservatism on your part in an effort to maybe match the Fed's historically conservative view of your PPNR profile?

Given the progress that you've made over the last 12 months, assuming no meaningful changes to the CCAR guidelines, would you expect to see a better result this coming year?

Why don't I just take it at the top line for a minute on the better results this year.

We didn't ask for something that we didn't get last year.

It's not like we've been restricted.

We have behaved according to what we thought was the right balance for the business and the right balance for our capital actions.

Yes, as we're accreting earnings, which we've been doing throughout this year significantly, and we've met the capital ratios which we expect to meet.

And, we're entering the CCAR process with a reasonably high degree of confidence again for -- I think it's our sixth go-around.

We would expect to have further action on the capital side.

So, it's not like we asked for something, didn't get it last year.

We're just proceeding on a plan that we've been on for several years.

Certainly wasn't suggesting that.

It's more a focus on the -- I guess your perception of the PPNR progress that you've made, and it's probably the one area where one could argue that the Fed has been overly conservative.

Or, at least that's certainly something that we've heard from other market participants as well.

It's a fair comment, and I think I'll let Ruth take you through where -- how we're thinking about it this year.

We would agree, it's obviously premature to comment on 2015 CCAR since we haven't seen any of the rules yet.

But, we would agree.

We think the PPNR calculation was very counterintuitive last year, and our view is that another year of evidence to the benefit of the change in business mix logically should help.

Last year was the completion of the most strategic transformation with the acquisition of the final piece of the Wealth Management business, and you've seen we've substantially increased the quality and consistency of earnings with the acquisition.

So, our view is that this is an iterative process that improves.

All parties have improvements throughout the course of time.

It was counterintuitive.

We're working hard to highlight all that we've done and the benefit of the earnings stream.

And so again, that's been the key focus.

You've identified it.

We did think it was counterintuitive.

Thanks.

That commentary is extremely helpful.

Just switching over, just one quick question on preferreds.

You issued the additional $1 billion as you noted in the quarter.

It appears that you're at least fast approaching the 150 basis point of RWA target others have contemplated and has been mentioned by Basel.

Just wondering at this juncture, do you feel as though you're full on preferreds at the moment?

Or, should we anticipate additional issuance going forward?

We have no plans for more preferred issuance this year.

Over the past two years, we've been optimizing our capital stack, as you said.

Prospectively, I'm not going to close the door permanently, but at this point, no plans for preferred issuance this year.

Understood.

Okay.

Thank you for taking my questions.

Thank you.

Thanks so much for joining us for our third-quarter conference call.

And, we'll speak to you again in 13 weeks.

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

You may now disconnect.