摩根士丹利 (MS) 2017 Q2 法說會逐字稿

Good morning.

This is Sharon Yeshaya, Head of Investor Relations.

During today's presentation, we will refer to our earnings release and financial supplement, copies of which are available at morganstanley.com.

Today's presentation may include forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially.

Please refer to our notices regarding forward-looking statements and non-GAAP measures that appear in the earnings release.

This presentation may not be duplicated or reproduced without our consent.

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

Hi, good morning, everyone.

Thank you for joining us.

In the second quarter, we achieved a 9% ROE, reflecting the stability of many of our businesses, which offset a relatively difficult trading environment.

In many ways, this quarter provided a robust test of our business strategy.

Whilst many trading businesses were affected by benign markets characterized by low volatility and the absence of meaningful macro events, other business lines demonstrated resilience.

Investment Banking showed continued strength, reflecting diversity of our global M&A and capital markets franchises.

Investment Management saw asset inflows and solid performance across alternatives.

As a result, this business saw improved revenues and returns.

Wealth Management performed at the high end of our 2017 target, achieving a 25% pretax margin and a record profit before tax of over $1 billion.

It is worth noting that in the first year after the acquisition of Smith Barney, Wealth Management generated approximately $1 billion of pretax profit annually.

Compensation expenses are in line with our stated targets, and higher accruals year-to-date reflect higher revenues.

Non-compensation expenses included one notable item, which Jon would take you through in a moment.

Given the obvious headwinds this quarter, we are pleased to have generated respectable returns for shareholders, albeit at the bottom end of our target range.

Of course, with the firm now on solid footing, performance could still materially improve in the years ahead, assuming constructive markets.

In addition, there are 3 tailwinds worth calling out, each of which has the potential to impact our long-term performance in a material and positive way: capital, tax reform and interest rates.

On capital.

This year, through CCAR, we asked for and received approval to buy back up to $5 billion of stock and increase our dividend to an aggregate of $1 per share annually.

While we intend to invest in our business as opportunities present themselves, we're determined to use any excess capital to continue to reduce our share count.

Much has been talked of adjustments to some of the Dodd-Frank rules that were put in place over the past 8 years.

It is fair to say that now is the time to make some practical changes to the multitude of regulations.

These changes would allow U.S. banks to be greater engines of economic growth.

Second, U.S. corporate taxes are too high.

If the administration and Congress can achieve a sensible realignment of tax rates with other major developed economies, then that would be a clear positive for our business and corporate America in general.

Finally, as a major U.S. depository, we have endured historically low interest rates for a very long time.

Each move in hiring rates, assuming a measured path, should benefit our business.

In summary, in the second quarter, we showed resilience in a challenging market.

In a more favorable environment, we should see better results.

More interesting to us, though, are the long-term impacts of some of the changes just described.

We've built meaningful operating leverage in our business.

While we remain cautious in the near term, we like our business mix and remain bullish on the long-term outlook for the firm.

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

Thank you.

Thank you, and good morning.

The optimism that characterized the first quarter was replaced with a more subdued tone amongst clients for the majority of the second quarter.

Activity was more sporadic, and market-sensitive businesses, particularly within Fixed Income, were impacted.

That said, we supported our clients when market opportunities presented themselves.

Equity Sales & Trading and Investment Banking produced strong results.

Wealth Management and Investment Management both witnessed continued growth and stabilized our headline performance.

Firm revenues were $9.5 billion, down 2% compared to a strong Q1.

PBT was $2.6 billion.

EPS was $0.87, and ROE was 9.1%.

Non-compensation expenses were up approximately $138 million or 6% quarter-over-quarter.

Well over half of the increase was due to a provision that we recorded as a result of a self-identified item relating to VAT on intercompany services provided to our U.K. operations.

We also saw some seasonal increase in professional services, marketing and business development and higher volume-driven expenses.

We continue to exercise compensation expense discipline, which led to a 1% sequential decline in total noninterest expense.

On Project Streamline, virtually all identified projects are in flight, and we are on track to complete the target outlined at the start of last year.

Compared to the same period in 2016, our 2017 year-to-date revenues have increased by over $2.5 billion.

In the same period, our non-compensation expenses have increased by about $300 million and total expenses by approximately $1.3 billion in the same comparison.

As a result, our year-to-date efficiency ratio of 72% is approximately 300 basis points lower than the same period last year and remains well inside the 74% target for the full year.

That said, we recognize that expenses in any one quarter may be impacted by business mix, geographical mix, seasonal patterns and other factors.

During the remainder of 2017, our focus will be on completing all remaining initiatives and making sure that the culture of cost discipline, represented by Project Streamline, remains best practice.

This will help ensure that the savings achieved to date remain permanently out of the expense base.

Now to the businesses.

Net revenues across Institutional Securities businesses of $4.8 billion were down 8% sequentially.

The trading environment slowed from the first quarter.

Market-moving events were episodic.

Volatility in many asset classes hit multiyear lows, and activity was sporadic.

Despite the quarter-over-quarter decline, revenues across ISG were strong.

Non-compensation expenses were $1.7 billion for the quarter, up 6% sequentially, driven by the U.K. VAT expense as well as higher execution-related costs due to a shift in business and geographic mix of client activity.

Compensation expenses were $1.7 billion, with the compensation to net revenue ratio of approximately 35%.

In Investment Banking, both advisory and underwriting performed well.

Revenues of $1.4 billion were unchanged versus the first quarter.

This result contributed to an exceptionally strong first half of the year.

Advisory revenues for the quarter were $504 million, up 2% sequentially.

Broadly, M&A volumes remained healthy.

The fundamental drivers of activity, including challenging organic growth, remained in place, encouraging client engagement.

However, we have seen a decrease in larger transformational deals on a year-to-date basis compared to 2016 as the current market environment is impacting management's decision to act.

Additionally, uncertainty over taxes, regulatory reform and the broader political landscape will likely weigh on activity.

As such, we remain cautious as we look towards the rest of the year.

Turning to underwriting.

A continuation of stable capital markets with low volatility and range-bound credit spreads contributed to another strong quarter for underwriting.

Overall equity volumes continued to recover from the weak level seen last year, particularly in Europe.

The market was receptive to both IPOs and follow-ons.

We generated equity revenues of $405 million, up 4%.

We expect activity levels to remain healthy, although near-term issuance windows may be impacted by macroeconomic uncertainties and the typical summer slowdown.

Fixed Income underwriting revenues decreased 5% sequentially to $504 million.

A market-wide decline in volumes relative to a strong first quarter was partially offset by market share gains across both investment-grade bond and high-yield financing.

Our Sales & Trading performance was solid.

The postelection excitement that began to slow towards the end of the first quarter did not reassert itself for most of the second quarter, predominantly impacting our Fixed Income franchise.

However, activity saw a notable uptick towards the end of the period as rates held off.

This contributed to our overall performance and underscores the strength and resilience of our franchise.

In equities, we retained our leadership position and expect to be #1 globally with revenues of $2.2 billion, up 7% sequentially.

Strong prime brokerage revenues, aided by seasonal factors, contributed to the sequential increase.

We continue to witness growth in client balances, positioning us well in this business.

Derivative revenues remained solid.

These gains were partially offset by lower cash revenues driven by lower volatility.

Once again, our diversified strategy and global footprint benefited from pockets of regional strength.

In the quarter, we saw a very strong European activity as well as increased results in Asia.

Fixed Income revenues in the second quarter were $1.2 billion, down 28% versus a very strong first quarter and 4% versus a year ago.

Historically, low volatility, a rally in interest rates over most of the quarter and fewer market events contributed to a slowdown in overall performance.

While the revenues showed a sequential decline, given the market backdrop, we are pleased with the results.

In our credit businesses, revenues were down quarter-over-quarter, driven by lower levels of activity.

Our securitized products business also witnessed a decrease in revenues compared to last quarter as the frequency of larger transactions slowed.

Within macro, our rates businesses were negatively impacted by low levels of volatility.

This was partially offset by foreign exchange in emerging markets, where discrete geopolitical events and pockets of volatility led to stronger revenues.

Commodities saw a sequential decline as there were fewer structured deals in the quarter.

While the environment did weigh on the results, this quarter, revenues underscores the progress the business has made over the last 18 months.

Since we restructured our business in 2015, we have experienced various market backdrops, clearly some had been more favorable than others.

We are encouraged by the consistency of recent results and are critically and credibly sized to service our clients as the backdrop evolves.

Average trading VaR for the period was $51 million, up versus $44 million last quarter.

We deployed capacity to support accretive client opportunities.

Now turning to Wealth Management, which reported another record quarterly revenue and pretax profit result.

The revenue and margin achievements underscore the business' ability to benefit from the scale of the platform.

These results were achieved despite a normalization in activity, following a strong first quarter, as retail sentiment reflected the same uncertainties faced by our institutional clients.

Second quarter revenues were $4.2 billion, a 2% sequential increase.

The PBT margin of 25%, slightly above our full year 2017 target range, reflected growth in fee-based revenues and operating leverage.

Client assets grew 2% to $2.2 trillion.

Fee-based assets increased 4% to $962 billion or 43% of total client assets.

While the Department of Labor's fiduciary rule has contributed to these fee-based flows, the majority of the movements had been from non-retirement accounts, reflecting clients choosing the enhanced service levels provided by this offering.

We saw strong fee-based asset flows of $20 billion.

Higher asset levels and positive flows contributed to asset management revenues of $2.3 billion, representing 5% growth relative to the first quarter.

Net interest income of $1 billion was up 2% over last quarter.

The benefit of higher rates and lending balances was partially offset by lower deposit levels.

This reduction in deposits reflects both typical seasonal client tax payments and deployment of cash into the markets.

NII was further negatively impacted by higher prepayment amortization.

Wealth Management lending in the U.S. banks grew by about $3.5 billion in the quarter, or 6%, as clients drew on their SBL lines to manage liquidity needs, a trend we often witness in the second quarter.

Year-to-date, our NII of $2 billion is up approximately $340 million or 21% compared to the same period last year.

While market expectations for additional rate hikes have lessened, we remain comfortable with the full year NII guidance provided in Q1.

In particular, we expect to continue to benefit from further lending growth.

Transactional revenues of $766 million were down 7% from Q1.

While clients deployed cash into the market, the frequency of trading captured in brokerage accounts decreased from the previous quarter, again mimicking the pattern witnessed in the institutional space.

Lower mark-to-market gains on our deferred compensation plans were also a driver of the sequential decrease.

Total noninterest expenses were essentially unchanged versus Q1, highlighting the operating leverage in the scale business.

Lower compensation expenses were offset by seasonally higher marketing and business development and professional services expenses.

The compensation ratio was below our full year target of 56%.

Looking forward, we remain optimistic about the outlook for this business and the value of its contribution to the firm's business mix.

Annuitized revenues continue to grow with fee-based assets and increased loan balances.

Additionally, our investments into improving our digital capabilities will enhance future productivity and provide more operating leverage to the franchise over time.

Investment Management witnessed a solid quarter, with strength across both asset management fees and investment results.

Total net revenues were $665 million, up 9% quarter-over-quarter.

Overall, AUM grew 3% to $435 billion, driven by investment performance, with particular strength across our active equity strategy.

We also saw positive flows across our equities, fixed income and alternative businesses, with strong capital raising internationally.

On the back of higher AUM, we saw a commensurate 4% growth in asset management fees to $539 million.

Investment revenues were up 28% to $125 million, driven by gains in our infrastructure and real estate funds.

Despite the 9% revenue increase, overall expenses were up only 3% quarter-over-quarter.

Turning to the balance sheet.

On a sequential basis, total spot assets of $841 billion were up $9 billion, and average assets were up $12 billion, reflecting continued support of client activities within the Sales & Trading businesses.

Our pro forma fully phased-in advanced RWAs are expected to be up approximately $22 billion versus the first quarter to $381 billion, driven by higher-market RWAs, consistent with the increase in VaR metrics over the quarter.

As a result, our pro forma fully phased-in Basel III advance Common Equity Tier 1 ratio decreased approximately 70 basis sequentially to 15.9%, which remains in line with our pro forma fully phased-in Basel III standardized Common Equity Tier 1 ratio.

We continue to expect the 2 ratios to remain relatively close in the near term.

Our pro forma fully phased-in supplementary leverage ratio for the quarter remained at 6.4%.

During the second quarter, we repurchased approximately $500 million of common stock or approximately 12 million shares.

Our tax rate in the second quarter was 32%.

We continue to expect our tax rate for the remainder of the year to be in the 32% to 33% range.

This quarter's results reaffirm that our strategy is working.

As James said at the outset, this quarter represented an important test of our model.

Notwithstanding a challenging trading environment, we achieved the 9% ROE on account of our balanced business mix and the resiliency of the franchise.

However, investor psyche remains fragile.

The same questions that lingered around timing and achievability of the administration's policy initiatives at the end of the first quarter remain unresolved as we enter the third quarter.

In addition, the market continues to grapple with mixed economic data and questions around the timing and pace of monetary policy tightening.

This dynamic may continue to weigh on activity and sentiment in addition to typical seasonality in the summer.

At the same time, we should not lose focus on the broader macroeconomic issues that could have a materially positive impact to our business.

After years of headwinds for the industry, we are finally starting to see some tailwinds that can be promising for our business in the long term, including the potential for tax reform, sensible regulatory change and a rising interest rate environment.

We are confident that we will achieve our stated goals.

With that, we will open the line to questions.

(Operator Instructions) And our first question comes from the line of Glenn Schorr with Evercore ISI.

First question, on Wealth Management.

I noticed the deposits down 7%, I think.

Sometimes, there's seasonality and then sometimes it's cash deployment.

I'm just curious how you attribute some of that.

And also, if there's just rate competition and what we should expect on deposit beta, if there are more rate hikes.

Sure, Glenn.

I think, as I mentioned in the script, it was a combination of both.

Clearly, we normally see in the second quarter BDP deposits going down because of tax season.

We also saw continued deployment into the markets.

I don't think we've seen a lot of deployment into other cash products.

So again, from a competitive dynamic, I don't think it's a rate story.

I just think it's an opportunity story.

We've started, a couple of quarters ago, initiating some other strategies around the deposits, including a premier cash management product and some CD products, and we've got a couple billion dollars in those products.

So we feel good about the overall deposit franchise and the overall ability to fund that business as we continue to see growth in the asset side.

So maybe bluntly, if we get a couple more rate hikes, do you capture the majority of it?

What -- even without the -- as you said, a rate story, do you have to hike along the way?

Are the clients looking to participate in that move up?

I think the best indication of sort of how we feel about that is really looking at the NII line, which has, as you know, has been a very good story for us.

All right.

Back in 2012, we had $1.6 billion of NII in the Wealth business.

Last year, it was $3.5 billion, grew more than $500 million.

In February, we talked about what we thought we would see, and we thought we would continue to see good growth in the NII line, albeit at a slightly slower pace.

Year-to-date, we're at $2 billion, which is up over $340 million over last year.

So again, we feel very confident about that story.

It is reliant on the lending growth, which we saw good growth across all the products this quarter, so we feel good about that.

I think the composition is a little different.

Your comment about betas, generally, the betas have lagged what we've modeled.

So that's been a positive.

We've also -- if you go back to the first quarter, remember what the curve looked like, I think we've gotten rate hikes faster than we thought back then.

On the other side of the ledger, as you just mentioned, the deposits are down.

So we brought down the liquidity pool in the banks as well as started to use other savings and deposit products as well as some wholesale funding to support that business.

And then lastly, we clearly didn't model any prepayment acceleration that we saw in the second quarter as rates went down.

So on balance, we're very confident with where we are on NII, and it's been a good story, but the composition has been a little different.

And our next question comes from the line of Brennan Hawken with UBS.

So first, on FIC, really, again, encouraging to see the sustained stability.

Say that a few times fast.

And now that we're clearly -- we've demonstrated -- you've demonstrated some stability here after the repositioning, has there been a shift in mix?

Can you give us a sense for the different business lines now that the business has been adjusted?

And can you also -- I know you mentioned, Jon, that commodities were down sequentially.

But was this quarter extraordinary from your perspective?

We've heard some mixed things from some of the competitors, so additional color there would be great.

Sure, I'll try.

I think the way I would look at it is the results clearly just reflect the environment that we were operating in.

If you look over year-over-year, the results are pretty flat.

So when we look at the individual product mix, as I did mention, our rates business, given the low volatility, is down, yet our FX did a little bit stronger, particularly in the emerging market areas.

Credit sort of hung in there.

Less movement in credit spreads this quarter, but again, comparable type of results in light of the fact that the year-over-year results were essentially flat.

So we feel good about the business.

Commodities, also down a little bit, less activity, a tighter trading band there.

But the results reflect the moves and the changes that we made, and the results reflect that the business is really starting to come together and gelling.

And I think we feel pretty good about the results in light of the environment.

Right.

But -- so I guess, from your perspective, paraphrasing, you saying that commodities were tough but not necessarily extraordinarily difficult or remarkable in that way?

Yes.

Listen, the commodities business that we have has been totally reshaped and resized, more traditional Sales & Trading supporting our client base.

It's a smaller contributor for us, so the movements are not that dramatic.

And our next question comes from the line of Steven Chubak with Nomura Instinet.

So wanted to start off with a question on Wealth Management pretax margin.

Certainly encouraging to see that you guys eclipsed the 25% target for the quarter.

I'm just wondering, as we look ahead to the second half, given a number of favorable trends for the business that, Jon, you had cited, whether it's strong fee-based conversions, healthy loan growth and NIM expansion, I'm wondering, barring any exogenous market shocks, whether you can sustain margins above that 25% target for the remainder of the year?

Listen, I think you highlighted what we think is driving that margin.

Right now, with rates and higher markets, those are good trends that will drive our asset-based fees as well as our NII.

The lending growth has been solid.

I think the one area of potential volatility or softening is around transactional.

We are heading into the summer months.

But again, I think the tailwinds for this business are very good.

We saw really nice operating leverage here.

We saw really nice growth across all products in the lending book, and we feel very good about the results.

I mean, the PBT at $1 billion plus is obviously a record, and it's a really important contributor to the overall franchise.

And just one follow-up on capital.

You guys had outlined a couple of the potential benefits that -- to your business in terms of capital relief that were outlined in the treasury white paper.

One of the areas that's gotten quite a bit of focus is this notion that -- or the prospect for cash and liquid assets to be excluded from the SLR denominator.

And I'm wondering, given that 4% -- the Tier 1 leverage constraint in CCAR of 4% appears to be your binding constraint for the moment, it's not clear whether that carve-out is going to apply to that measure.

I didn't know if you had any feedback from regulators as to whether they were considering that possibility and what might that mean for you guys in terms of capital relief?

On the first part of the question, I think, clearly, the reform around SLR would be helpful for a variety of reasons.

Whether or not it's our binding constraint this quarter or next quarter is certainly not a foregone conclusion.

So there could be some benefit from that, but we also think there's just general benefit with that calculation in terms of what it means for the overall Sales & Trading businesses.

But I do think there are several changes that have been discussed or that are being discussed that would clearly help our position, including around the balance sheet and how you think about capital actions going forward.

So I think it's a little early on 2018 CCAR to sort of have a prediction.

But clearly, we were pleased with the results.

If you look back a year ago where we were versus what came out of the report a couple of weeks ago, with 100%-ish payout and a 33% increase in capital return and a clean report, we're very pleased.

I would just add on the leverage ratio.

Specifically, we have argued for a number of years and presented to regulators for a number of years that the fact that a balance sheet grows during a time of financial stress is hard to understand how that happens.

Assets depreciate.

Assets run off.

New business is not gathered.

It would be hard to imagine factoring the crisis in the years following and our own balance sheet obviously shrank dramatically, but through our actions and through market activity.

So the leverage ratio constraint is made more acute by the fact that the denominator is growing at, I think, it's about 4%, 4.5% a year for the 9 quarters.

There's been quite a lot of sympathy to that view.

But if we should look not at some blanket growth rate, but what the actual experience was during the crisis and during other periods of financial stress, and I think that experience would largely hold up that balance sheets shrank.

So if you just held our balance sheet flat for that time period, that would have a material impact on our leverage ratio.

So I think there's certainly a good dialogue going on through the treasury white paper and with the regulators on that topic alone.

(Operator Instructions) And our next question comes from the line of Guy Moszkowski with Autonomous Research.

Just looking at the VaR and the RWA metrics, which you talked about and floated up on an average basis, I guess, 7%, 8%, depending on which one you look at.

Could you give us a sense for, given that those are average daily, I guess, metrics, what we look like at on a spot basis towards the end of the quarter?

Should we be expecting that these things will float down again?

Sure.

A couple of things.

So on the VaR metric, we obviously -- the $51 million was the average for the quarter.

If you have the Q, it was actually $57 million at period end at March 31.

So that actually came down over time, and has actually continued to come down, and the spot will be -- spot period end will be lower than the $51 million that we said.

On your market -- excuse me, on the RWA comment, actually, some of the calculations are daily average volumes, some of them are 12-week averages.

And the VaR metrics are important in those calculations, so I think that the same trends that we've seen in the VaR would be consistent in terms of how we finished out quarter-end in that metric.

With the ratios that we have at CET1, even at the 16% or 15.9% level, we're still obviously very, very strong in terms of our capital position.

Great, that's helpful.

And then just my follow-up question is more targeted on FIC specifically.

Given the success that you've had in generating revenue even in a period like the one that we've just had, which was certainly weaker, characterized by low vol, et cetera, all the things that you've said, would you consider raising your quarterly average expectation from that $1 billion number that you've been talking about for quite a while now?

Guy, I'm surprised it took so many -- these many questions to get to "let's raise the targets" discussion.

We dodged one on the pretax margin a few questions ago.

I think the short answer you know, and it's no.

We've been pretty consistent.

We've set these targets for proof of business model for this year.

We're going to stay with them.

We think -- listen, we were -- recall third and fourth quarter 2015, we were doing $500 million, $600 million in FIC.

First quarter of '16, I think, if memory serves me, it's about $800 million.

A $1 billion number on a steady run rate basis is a good number with 25% less people, much smaller organization, much more focused organization.

If we consistently do better than that, then that's terrific.

But I don't think -- the point of setting the target was to establish what we needed to prove to ourselves on an average run rate for the business to justify the expenses and capital balance sheet that we put behind it at that level.

Everything we do better than that with the same expenses, capital and balance sheet is obviously a gift.

And our next question comes from the line of Jim Mitchell with Buckingham Research.

Maybe just a follow-up on the SLR and the treasury report.

If we assume that both the Tier 1 leverage ratio and the SLR are treated similarly by accepting cash and maybe short-term treasuries, how do you think that impacts the business?

I guess I think a lot of people are asking the question of, is this a revenue opportunity to kind of re-expand the balance sheet, whether it be repo or other businesses?

Or is it really more of an excess capital story?

Just trying to get a sense of -- if you think business has been held back by the SLR.

Let me start with that.

Jon might want to add to it.

First and foremost, this is a capital question.

We believe we are overcapitalized.

There were good reasons for that several years ago as we're coming out of the financial crisis.

We had a dividend of $0.05 a quarter.

We've now raised that 4 years in a row to $0.25.

Our initial buyback program was 0, then went to $500 million, and it's now all the way up to $5 billion over a 5-year period.

And our payout ratio is closing in on 100%.

So we clearly believe that we're overcapitalized and for good reasons.

We were coming out of the crisis, and we needed to shore up our defenses.

There is plenty of opportunity for business expansion with the amount of capital we have today.

The more fundamental issue is, what is the right level of capital this firm should hold?

Are we holding too much capital because of the way the leverage ratio has been constructed?

What is the right denominator for the SLR?

In fact, what is the right ratio?

In Europe, it's 3% of the balance sheet, in the grossed-up balance sheet.

In the U.S., they took the -- our GAAP balance sheet ratio of 5% and attached it to this SLR balance sheet from Europe, so we sort of ended up with a fairly draconian answer.

I think let's start with, number one, if the treasury and other type securities can be taken out of the SLR, that obviously makes sense.

Number two, to not gross up the balance sheet under the GAAP core leverage ratio makes sense.

And I think we'd have capacity at that point both for further capital distributions and for sensible business growth.

You saw the RWAs bounce a little bit this quarter.

That was consistent with sensible business growth.

There was opportunity.

Clearly, our Tier 1 capital ratios are not a constraint or nowhere near it.

So that -- the RWA constraint is not there for this firm at the moment.

Okay, that's helpful.

And maybe as a follow-up, on just the treasury report generally.

Is there any other aspect of the proposals that you feel would be particularly helpful for your business?

I'm trying to remember all the aspects of the report, which I actually can't do it off the top of my head.

I think, clearly, I think there's a general recognition from the regulators all the way through to the treasury that the Volcker Rule, as it played out over time, strayed a fair bit distance from what Paul Volcker initially envisaged, which was a simple restriction on the amount of capital put into proprietary investing, proprietary trading and became frankly constrained on the ability of institutions to make markets and effective market liquidity.

So I think the treasury report spoke about that.

There was reference to the fact that banks are required to continue their payouts, notwithstanding they're in a period of financial stress for 9 quarters.

No bank board would authorize continuing a buyback program during a financial crisis.

That clearly wouldn't happen.

You could argue holding the dividends static, but certainly, the buyback shouldn't be, and that would have a material effect on the institutions.

So our approach has been, and we've talked about this somewhat publicly recently, let's focus on a few things that don't require major legislative change.

Let's leave the basic architecture of Dodd-Frank in place.

Let's focus on some sensible changes because we've now had 8 years of experience to digest and see what worked and what didn't.

And the cumulative effect of a lot of these regulations, in some cases, end up, if you will, with a double counting.

And I think the spirit of the treasury report reflected that.

I think they are focused on sensible, pragmatic change.

They're not focused on trying to redo the whole legislative agenda.

And I think that's the right approach.

And our next question comes from the line of Devin Ryan with JMP Securities.

Maybe first here, just in Wealth Management.

You recently outlined the digitization strategy, which was very helpful.

And with respect to the robo offering, it sounds that you're now going to be able to focus on the children of existing clients and some lower balance accounts, which it does seem smart just with this generation of wealth transfer coming here and where the money is going to be over the next several decades.

So as we think about that process, how do you protect against maybe some cannibalization of existing business as clients look at the lower price point?

I guess the question is, is the revenue opportunity here just much more than offset?

Or do you just not think this is something that would appeal to some of your existing higher net worth clients for a portion of their account, it's just a different bucket?

Yes.

I think that your description of what we're doing on the digitalization and the robo strategy is pretty accurate.

Listen, we have a business that is built to cater to clients with wealth.

Those wealth clients want advice.

They want personal advice.

We're seeing it as we see the brokerage fee-based flows coming out of brokerage into the fee-based accounts.

Obviously, digital is going to be an important part of that strategy.

But the digital-only client is not someone right now that would generally be interested in the types of products and services that we have.

We think the digital strategy is going to be both important for both revenue opportunities longer term, but also optimization and efficiency around what happens in a branch and how we free up people's time to spend more time with their clients.

So overall, it's a strategy that's going to be built for the longer term, but the thesis of our business is around providing people with personal advice around their wealth and their planning.

I'd just like to add to that because it's an important question.

We actually saw this movie once before in 1999 when the direct players came out and the big fear was cannibalization.

That would only have held true if people actually didn't value the financial advisers and advice that we're getting from those advisers.

And it didn't play out that way.

The reality is the marketplace has different segments based upon consumer preference.

And I think the digital strategy makes all the sense in the world.

That is clearly a segment.

Whether they change their behavior as they become wealthy remains to be seen, but there's clearly a segment that wants to deal digitally, just as there's a segment that wanted to deal through direct brokerage trading and so on.

But on the price sensitivity, it's interesting.

If you look at the -- and I think I'm right in this.

If you look at the average basis points paid from the various robo platforms, they range, in general, I think from something like 20 to 40 basis points.

If you look at the average basis points for a full service advisory like ours, just divide our revenue into our assets, including everything, you get somewhere in the 70s, low-70 basis points.

So the value added of a financial adviser, the institution behind it, the research, the product offering, the new issue calendar, you could argue is being put out there for 30 to 40 basis points.

It's not clear to me that, that is such an expensive gap that that's going to lead to the cannibalization issues.

I think it's more that we just need a very compelling digital platform to deal with clients who want to deal with Morgan Stanley, but want to deal with us digitally and don't want to deal through a traditional wealth management advisory relationship.

That's an exciting opportunity for us, frankly, given our brand and our technology capability.

Okay, great.

That's great color.

Looking forward to seeing it.

Maybe in equities trading here.

We're 6 months away or within 6 months of MiFID II in Europe.

I'm sure there's a lot of preparation at the firm right now.

So just curious with respect to expectations there, is this something that you feel like it will weigh on the research fee pool, but you'll pick it up in trading market share, or just Morgan Stanley is going to take market share of the overall equities pool?

I'm just curious, kind of how you'd frame your expectations right now just as we're getting pretty close to the implementation?

Yes.

Well, I think, as you know, we've been preparing for a while both in terms of dialogues with clients, but also systems and technology-related investments that we needed to make.

But I will tell you, it's going to be very hard to estimate what the impact of this is.

Anytime you have a change of this magnitude where you just sort of flip a switch, we would expect the potential for disruption to be pretty high.

How it affects longer-term structural markets is still up in the air.

We've got clients -- global clients who are already doing this.

We have global clients who are going to probably adopt it in all the markets, even though we don't expect it to be adopted in the U.S. We have some clients who are walling off their European operation.

So how it all plays out is certainly unclear.

But given the fact that we are #1 in the world in this business and we have a full-service platform and intellectual capital and product, if there is consolidation in a number of counter-parties, we would expect to participate in that.

But I think it's a little early to make a call here, and trying to estimate the impact is also probably a little early to make the call.

And our next question comes from the line of Chris Kotowski with Oppenheimer & Co.

I mean, recognizing the excellent outcome that you had in the CCAR capital return process, I have to say I was surprised the week before when the DFAS results came out that, that still shows Morgan Stanley as being the most severely impacted by the severely adverse scenario.

The Fed's booklet shows you losing 8.4 percentage points of capital against the median of 2.8.

And given all you've done in derisking your balance sheet, I would have thought that we would have seen more progress in that.

Can you tell us what it is that the -- in the Fed's methodology that seems to cut against you so disproportionately?

Listen, again, we were very pleased with the results.

We had the same issue last year around DFAS, and people are sort of concerned with our outcomes at about 100% payout ratio, continued increased capital return, part of our core strategy.

We clearly have derisked the balance sheet.

Our RWA density is lower than basically every other firm out there, which is why you see some of that disparaging percentages.

If you look at the tier-based -- excuse me, the leverage-based ratios, you get a slightly different picture.

We clearly have derisked.

We've gotten -- you've seen that through the dollar amount of losses that we've seen over the last coming -- last several years have come down.

We have met our strategic objective of increasing capital return.

We still think we're capital sufficient.

When we came out in January of '16 with that statement, we said we were capital sufficient.

We did not want to grow our equity base.

We have grown our equity base a couple of billion dollars, but we've also supported our businesses and grown our balance sheet by $50 billion.

So we've increased capital return, and we've increased the size of the balance sheet, and we feel very comfortable with our capital position there.

And we don't -- Chris, we don't have complete access to the Fed model, as I think you know.

The construction of operating risk capital, the various stress losses that are in there, counter-party risks, how the trading book is managed, how you derive your PPNR, there's a hell of a lot of stuff that goes into this.

Our own submission was 45,000 pages.

So -- and frankly, looking back at this point, I don't think that's going to be very valuable.

Although the regulators and treasury are all focused on how to make both the models more transparent, the process more transparent, and to make some sensible adjustments for it.

So I don't -- honestly, I mean, not to be flip about it, but I sort of don't care what the past was.

What I do care is that our distribution this year approved is about $6.8 billion; and 5 years ago, it's $400 million.

So let's start with that one.

And number two, let's see what changes come through.

We may all be pleasantly surprised.

We may be in the same place we're in, but we're operating now currently with about 100% payout.

So I'd let this one play out a little bit and see what comes out of the treasury efforts.

Okay.

And I mean, I guess, the thing is like, just again, if you look at the old way of doing it, right, if you needed 5 after the stress and you were losing 8 or 9, and you need 1 for a margin of safety, that would suggest you need a CET1 ratio on a -- 14%, 15% on an operating basis.

I mean, is there an outlook for, like, operating at less than that?

I think you're torturing yourself by looking backwards.

Honestly, I wouldn't do it.

Focus on the big picture here, buddy.

The big picture is we distributed $400 million 5 years ago.

We're distributing $6.8 billion now.

And there's a full review of the whole capital process being undertaken right now.

And our next question comes from the line of Andrew Lim with Societe Generale.

Can I press you a bit more on your claim of excess capital?

As things currently stand, your SLR, on a severely adverse scenario, I mean, that's 3.2%, so maybe slightly above the 3% minimum.

So you're kind of maxing out your capital return here.

So your claim of excess capital is rather contingent on changes coming through from the treasury, or as you say, the Fed being more lenient on how the leverage exposure pans out on a severely stressed scenario.

So I mean, can you give a bit more color in there?

I'm really not sure what else I can say.

We have consistently increased our capital payouts while the test has become consistently more severe.

We are now at 100% payout.

So by definition, any excess capital we have from the gating constraint with the leverage ratio this year, and we were above the gating constraint after we did our distribution, so by definition, we're carrying excess capital.

And our view is that the way we calculate our capital needs to run our business, we continue to have excess above that, but we're waiting for the outcome of the white paper and the various efforts from the regulators to see what changes take place.

There are clearly going to be changes.

How favorable they are and to what extent they affect Morgan Stanley remains to be seen.

It's not going to be productive to try and guess that.

Right, understood.

And just a follow-up question.

You've got the FTRB (sic) [FRTB] lurking in the background.

We hadn't heard anything on that for a long time now.

But just on the guidance, when we might get some disclosure on the impacts on capital ratios or the timing?

Yes.

I don't think we have much more visibility than anyone else in this area.

I think the thing that sometimes people fail to recognize is we obviously have this white paper out.

And if you think about it, we are actually going to enter a period of refinement and adjustment to regulations versus where we were a year ago, where our expectation was incremental regulation for periods and periods and periods of time to come.

We're clearly going to be in a better place.

Now how that plays out and what time frame and what the actual changes are, it's very hard to predict.

But we are clearly entering a different period going forward that we have been in the last 8 years.

And our next question comes from the line of Gerard Cassidy with RBC Capital Markets.

Can you guys share with us, once we get into a more normalized return of capital environment that we see in the future, what kind of dividend payout ratio are you guys comfortable with as we look further out?

I don't think it probably serves us well to get ahead of that discussion with the regulators and others.

We've -- I think the current regulatory environment anticipates for the G-SIFI banks a payout ratio of something like 30%; and for some of the smaller institutions, I think they've gone higher than that, maybe up to 40%.

Whether that changes post all the work being done, I don't know.

We're not at the 30% at this point.

I think we're close to it.

So one way to think about our business, which is -- I've thought about it for a while, the Wealth Management business is almost like a yield stock.

So you can imagine the dividend coming out of Wealth Management earnings.

And obviously, the institutional businesses are more volatile over time, so they're more capital distribution businesses or capital investment businesses.

But I don't know, Gerard, that we want to change what the targets that are currently being given to us by regulators are.

Okay, great.

And then second, in the supplement package you gave us, on Page 5, you gave us the total loans of the organization.

And could you share with us some color on, and I may have missed this, and I apologize if I did, why the corporate loans were down 37% or so year-over-year?

And a little color behind that really good growth you're seeing on the Wealth Management side where those loans are up 20%?

I'm just flipping to Page 5. Give me a second here.

Okay.

I mean, I think the changes in the corporate book are really around the event -- size of the event book and sort of the event activity as well as some just overall management of the relationship book.

The real story for us is, as you mentioned, has been in the wealth business as we continue to increase the penetration of our client base with lending products.

The growth has been very good across all of our 3 core products: the SBL, the mortgage and the tailored lending.

And we feel like we've got good momentum.

The growth last quarter, $3.5 billion, was pretty balanced across the businesses, a little bit more skewed towards SBL and tailored versus mortgage, given what happened in rates.

But again, that lending story, we feel very good about.

Our levels of penetration of how many of our clients have lending products is still probably a bit below peer level.

So we expect -- or feel good about the ability to continue to grow that.

And that's been a real key driver to our wealth business.

And our next question comes from the line of Christopher Wheeler with Atlantic Equities.

A couple of questions on Wealth Management.

I think during the quarter, we've had the news that I think yourself and a couple of your big competitors are now stepping back from hiring away experienced financial advisers.

And obviously, in doing that, obviously, reducing the cost of amortizing the forgivable loans that are part of hiring senior producers.

I'd like to perhaps understand how that's progressing?

What -- how are you getting on with that?

Because obviously, it's a big change.

And then perhaps to sort of link it up with the end of the Smith Barney payouts, but talk about what you think this might do to your pretax margin?

Because I think, at one stage, you said it might add, once the Smith Barney payouts -- the retention packages run out, I think, next year, you might be adding 1.5% percentage points to your pretax margin.

So a little bit of color there would be helpful.

I'll go first on the second part of your question.

So the retention payments conclude in first quarter of '19.

Obviously, it's a function of numerator and denominator.

But a 1.5% increase is a reasonable approximation.

And obviously, that will drop directly to the bottom line.

In terms of the attrition and the recruiting that we've seen, it's clearly slowed down, and that is obviously helpful both in terms of just ins and outs.

There's the expense associated with bringing in new FAs.

But also, when an FA leaves, generally, their book goes with them or a good chunk of their book goes with them.

So just lower levels of recruiting and lower levels of attrition has been overall helpful to the business.

And I mean, just kind of decide whether do you think your competitors are holding the line?

Because it does seem it's a beneficial move, but there are 1 or 2 players out there, of course, who are still sort of quite keen to take away some of your senior people.

Listen, this is -- these are big organizations.

The -- our major competitors each have, I don't know, 10,000 to 15,000, 16,000 advisers.

If you have 1% attrition, that's 3 people a week.

So it's not like these -- you're not going to have movement.

You'll always have movement, Chris.

I think what's changed structurally with the industry is, frankly, there are fewer competitors.

If you think of Morgan Stanley, Morgan Stanley is now a composite firm that includes Dean Witter, Reynolds & Co., Robinson Humphrey, Legg Mason, Smith Barney, Shearson, Hutton, and there are probably some that I'm missing, all of which used to compete against each other and recruit against each other.

So it's a consolidated industry that the big and small firms continue to recruit.

There are fewer numbers of them.

I think the deal structures have become, shall I say, more sensible.

There was a bit of a crazy period there.

So yes, but there'll always be some recruiting, and that makes sense.

I mean, people have a right to go and work where they want to work.

And our next question comes from the line of Brian Kleinhanzl with KBW.

Maybe just a first question on equity sales and trading.

I think this is probably the third or fourth quarter now you called out strength in prime broker.

As a driver of those revenues, can you maybe give us a little bit more color as to what's driving that strength?

Is it by region?

Is it client -- existing clients being more active?

Is it client growth?

The simple answer is yes to all of those things.

Very strong quarter.

The growth was across all the regions, particular standout being EMEA, given some of the seasonality there.

Balances were up.

We continue to invest in the balance sheet.

And so again, it's been a very good story for quite some time.

It's the full service platform, and our clients have been very responsive to that.

And then second question.

Can you give us an update of kind of where the banking pipeline stands, especially for M&A?

It seems like there's been a pickup in activity thus far early in the third quarter.

I mean, how did the pipeline stand at the end of the second quarter versus first quarter?

I would say that, first of all, it's very early in the third quarter, point number one.

I would say that the IBD pipeline is clearly healthy into the third quarter.

I think if we look specifically at advisory, it's probably down slightly.

But overall, the equity and underwriting and debt underwriting remains healthy.

IPO's backlog is healthy and broad.

That activity has picked up really nicely here.

So again, a healthy environment.

We're going into the summer months, so we'll have to see how that impacts us as well as all of the sort of policy uncertainty that we've talked about in the past.

But right now, pretty healthy.

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

That concludes the program, and you may all disconnect.

Everyone, have a great day.