摩根士丹利 (MS) 2018 Q1 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.

Thank you, Sharon.

Good morning, everyone.

Thank you for joining us.

2018 began on a very strong footing.

In the first quarter, firm revenues and net income were a record, $11.1 billion and $2.7 billion, respectively.

The ROE of 14.9% comfortably exceeded our targets, albeit in what is typically a seasonally strong quarter.

Importantly, the quarter's performance demonstrated our inherent operating leverage in an attractive market environment.

Results across all businesses were consistently strong.

Our Sales & Trading businesses performed exceptionally well against the backdrop of heightened volatility and client activity.

Equity Sales & Trading benefit from strong volumes across all regions.

Return volatility in rates and FX markets provided clients with an opportunity and a catalyst to rebalance their portfolios.

This activity, combined with the rise in U.S. interest rates and changes in inflation expectations, contributed to strong Fixed Income results.

We remain appropriately sized to take advantage of active markets when they present themselves.

Investment Banking demonstrated sustained strength, despite new issue markets being punctuated by periods of elevated volatility.

Wealth Management remained solid.

For the quarter, a combination of continued advisory growth supported by secular trends and the business' scale-driven operating leverage produced record pretax profit of $1.2 billion.

This represents an almost 20% year-on-year increase in PBT with a margin in the range we set to achieve over the next 2 years.

At the same time, we continue to actively invest in the business, building out our digital offerings, banking products and technology capabilities more broadly.

Investment Management, again, witnessed net long-term inflows over the quarter as the team continues to produce strong investment returns across both alternatives and public markets.

We expect attractive returns from Investment Management in the years ahead, particularly as we take advantage of our global platform.

In the quarter, we closed the Mesa West acquisition and made several key hires.

We've often said that Wealth and Investment Management give us ballast and our other businesses make up the engine that drives this firm forward in more active markets.

That is exactly what we witnessed in the first quarter.

For the past several years, a lot of focus has been put on the importance of the stability that Wealth Management has brought to our firm.

This focus has been appropriate.

Margins of 26.5% on revenues of $4.4 billion would have been unthinkable just 3 years ago.

However, what has not been discussed as often is our continued commitment to strengthen the Institutional Securities businesses.

In Institutional Securities alone, the dominance of equities, the strength of Fixed Income and the breadth of Investment Banking generated over $6 billion in revenue.

Along with the rest of the industry, we recently submitted our 2018 CCAR plan.

As has been widely reported, this year's scenario is more severe than previous years.

Of course, we don't have full transparency into the Fed models, but over the years, we've seen a reasonable degree of variability.

Therefore, we are prepared for range of outcomes this year.

More importantly, beyond this year, the Federal Reserve has recently requested comments on several proposed rulemakings.

We expect that we, and the U.S. financial sector more broadly, will benefit from more sensible and less complex regulation.

We believe we are sufficiently capitalized and expect to maintain our attractive capital return profiles over coming years.

As we look forward, our objectives remain the same, to execute on our strategy and deliver on the medium-term goals laid out at the beginning of this year.

I'm confident that given our business model mix and the competitive strength of our global franchise, we're very well positioned.

I'll now turn it over to Jon to discuss the quarter in detail.

Thank you, and good morning.

The first quarter's results were strong across businesses and regions.

Global markets were active.

Our Institutional Securities businesses benefited from increased trading volumes and a return of healthy volatility across many asset classes.

Our Wealth and Investment Management businesses delivered solid results, weathering softer asset prices.

Revenues were up 17% sequentially to $11.1 billion, a firm record, after excluding the impact of DVA in prior periods.

PBT was $3.4 billion, EPS was $1.45, ROE was 14.9% and return on tangible common equity was 17.2%.

Total noninterest expense was $7.7 billion, up 10% year-over-year.

The increase was driven by a combination of higher compensation expenses and execution-related costs associated with higher revenues and business volumes, respectively.

Continued investments into technology also contributed to the increase.

Over that same period, revenue growth was 14%.

In the quarter, the firm efficiency ratio was 69%, with all segments contributing to strong operating leverage.

The gross-up impact of the new accounting guidance on revenue recognition was not material at the firm level.

The details are more fully described in the quarterly supplement.

Now to the businesses.

Institutional Securities generated revenues of $6.1 billion.

This represents a 35% sequential increase and the best performance for the segment as a whole since 2007.

Investment Banking, Equities and Fixed Income all contributed to the results.

Non-compensation expenses were $1.8 billion for the quarter, a 6% increase, driven by higher execution expenses.

Compensation expenses were $2.2 billion, representing a compensation to net revenue ratio of 35.4%.

In Investment Banking, we generated revenues of $1.5 billion, a 5% increase over a strong fourth quarter.

The results reflect the combination of increased advisory revenues and stability in underwriting.

All regions demonstrated strength.

Advisory revenues for the quarter were $574 million, up 10% sequentially.

Announced M&A volumes have had a strong start to the year.

Notably, there has been a pickup in both larger and cross-border transactions.

Clients remain engaged, and pipelines are healthy.

Turning to underwriting.

New issue market conditions were more challenged during periods in the quarter.

Despite bouts of heightened equity volatility, rising interest rates and wider credit spreads, results remained solid.

Equity underwriting revenues of $421 million were up 1% sequentially.

The market backdrop impacted our ability to convert some of our IPO backlog, but follow-on activity remained robust.

Regionally, we witnessed strength in Asia and the Americas.

We also saw issuers take advantage of higher volatility through increased convertible issuance.

Fixed Income underwriting revenues increased 4% sequentially to $518 million.

A decrease in high-yield financing was offset by increased investment-grade issuance.

This was supported in part by event-driven activity, including one large financing we provided together with our partner, MUFG.

Overall, Investment Banking pipelines remain healthy and diversified across products, regions and sectors.

However, as demonstrated by recent market dynamics, future activity may be impacted by regulatory, macroeconomic and geopolitical factors.

Our Sales & Trading businesses produced revenues of $4.4 billion, up 64% quarter-over-quarter.

Increased market activity, strong client engagement and more favorable bid-offer spreads, particularly during the first half of the quarter, drove the improvement in results.

In Equities, we retained our leadership position and expect to be #1 globally.

Revenues were $2.6 billion, up 33% sequentially on strength across all products and all regions.

Derivatives had a very strong quarter as episodes of volatility created significant trading activity and strong client demand for hedging solutions.

A combination of higher client balances and increased engagement generated a sequential rise in prime brokerage revenues.

And cash revenues also saw a quarter-over-quarter increase, benefiting from strong volumes globally, particularly in Europe and Asia.

Fixed Income was also strong.

Revenues in the first quarter were $1.9 billion, more than doubling fourth quarter results.

While seasonal patterns were a contributing factor, the sharp rise in interest rates in the early part of the quarter, heightened volatility levels and the rise in inflation expectations aided activity and our performance.

Our macro business performance was solid, driven by improved sequential performance across rates and FX.

The credit businesses performed well.

Our securitized product group had one of its best quarters in close to 4 years, driven by strength in Europe and a more active trading backdrop.

Deepening our institutional lending footprint has aided this revenue stream.

Commodity revenues were also strong.

The results benefited from both an increase in flow activity and more structured transactions, which can be episodic.

Fixed Income results demonstrate the operational flex in the business and the segment's ability to service clients in a range of market environments.

Average trading VaR for the period was $46 million, up from $38 million in the fourth quarter 2017.

The increase was driven by higher market volatility and facilitation of increased client activity.

Turning to Wealth Management.

Revenues of $4.4 billion were down 1% quarter-over-quarter, as continued growth in asset management was offset by the impact of mark-to-market on deferred compensation plan investments.

Despite lower sequential revenues, the segment produced record pretax profit of $1.2 billion, resulting in a PBT margin of 26.5%.

The 40 basis points of sequential margin increase and the 250 basis point uplift compared to last year's first quarter demonstrates the operating leverage in this scale business.

On a year-over-year basis, non-compensation expenses are flat, despite an 8% growth in revenues.

Total client assets was essentially unchanged at $2.4 trillion, reflecting softness in domestic and international equity indices.

Fee-based assets continue to be a source of long-term organic growth for the business, supported by both conversions from brokerage and net new asset flows into the firm.

Net fee-based asset flows of $18 billion were strong.

As a result, fee-based assets reached a new high of $1.1 trillion or 45% of total client assets.

Asset management revenues were $2.5 billion.

Positive flows and last quarter's higher asset levels were partially offset by the effect of fewer calendar days in the quarter.

Net interest income was $1.1 billion.

Higher average balances and yields were offset by an increase in funding costs, driven primarily by higher rates on our deposits.

Lower sweep deposit balances also impacted NII, as retail clients have continued to deploy cash into the market.

Cash in our clients' accounts remains at historical lows, and equity allocations remain at historic highs, hovering around 54% of client assets.

On a year-over-year basis, net interest income is up 8%.

This has been driven primarily by an increase in Wealth Management lending in the U.S. banks.

Loan balances are up $6.7 billion or 11% with growth across both SBL and mortgage.

In the quarter, loans grew by 1% to $68.3 billion.

The more modest pace of sequential loan growth was driven by rise in rates, steepening paydowns and a lower level of mortgage production as we transition to our in-house origination platform.

Retail engagement was strong in the quarter as investors actively reposition portfolios and responded to market volatility.

However, total transaction revenues of $747 million was down 5%, driven principally by the impact of mark-to-market on deferred compensation plans.

This quarter's results underscored the stability of the segment.

Despite gyrations in equity markets and our pace of investment, pretax profit reached new highs.

We continue to pursue enhancements to our digital capabilities, and we are continuously introducing new applications to the organization.

Over time, we believe that these advancements will enable our advisers to provide better advice and service and broaden their client relationships.

In Investment Management, revenues were $718 million, up 13% sequentially, driven by higher asset management fees and the absence of last quarter's impairment charge.

Total AUM of $469 billion was down 2% quarter-over-quarter with long-term AUM of $312 billion, up 2% quarter-over-quarter.

Although we saw outflows in our liquidity business as clients manage their cash balance needs around the turn of the year, our long-term strategy saw continued positive flows.

In the quarter, we also closed the Mesa West acquisition, adding private real estate credit capabilities to our platform.

Asset management fees of $626 million were up 9% sequentially on the back of higher average AUM for the quarter.

We continue to see stability in fee rates earned on our long-term assets.

Investment revenues were $77 million, down by 31% relative to last quarter, impacted by lower market performance in certain private equity-related funds.

Total expenses increased by 2% quarter-over-quarter, largely driven by the revenue recognition gross-up related to the segment.

Turning to the balance sheet.

On a sequential basis, total spot assets of $860 billion was essentially flat.

As a result of higher lending commitments supporting relationship and event activity in the quarter, our standardized RWAs grew by approximately $12 billion to $389 billion.

Our Basel III standardized common equity Tier 1 ratio is expected to decrease to 15.6%.

Our supplementary leverage ratio is expected to remain relatively unchanged at 6.3%.

During the fourth quarter, we repurchased approximately $1.25 billion of common stock or approximately 22 million shares, and our board declared a $0.25 dividend per share.

This morning, we announced a share repurchase plan with MUFG.

As part of our regular repurchase program, we will make pro rata purchases directly from MUFG.

This will help ensure compliance with their passivity commitments to the Federal Reserve by maintaining their ownership below 24.9%.

This will not impact our strategic alliance.

Our tax rate in the first quarter was 20.9%, reflecting the reduced U.S. corporate tax rate and benefits associated with share-based payments.

Our guidance for the full year remains at 22% to 25%.

Since the vast majority of share-based award conversions took place in the first quarter, we expect the tax rate for the remaining quarters to be at the upper end of this range.

This quarter demonstrates the strength of our franchise and the benefit of our global business model.

As we look forward, we remain confident that we are well positioned to execute the medium-term strategic objectives that we laid out earlier this year.

In the year -- in the near term, we are aware of the fragility of market sentiment.

We have emphasized the importance of open and functioning markets as it relates to our performance.

This quarter results demonstrate that increased levels of activity and client engagement are broadly beneficial to our business.

With that, we will now open the line to questions.

(Operator Instructions) Our first question comes from the line of Steven Chubak of Nomura.

So I was hoping to just unpack, James, on your comments surrounding the recent proposed changes to capital regime.

As we think about the capital constraints that you're looking to manage to longer term, historically, you've been a bit more leverage-constrained.

We now have this enhanced SLR and SCB proposals that are out there.

And there's some expectation that risk-based ratios could once again become a bit more binding.

And just based on the new proposals as outlined and your initial read, which constraints are you now more focused on in terms of what informs, not just future payout capacity, but also how you're thinking about your balance sheet strategy longer term?

There's -- well, there's a -- the bunch in that, obviously.

I think the first point, just to reiterate, is acknowledgment that this year's CCAR test, at least the economic scenarios, which are driven by the 10% unemployment requirement under Dodd-Frank, and when your unemployment is currently around 4%, 4.1% in this country, you need some very severe shocks to hit 10%.

So it's sort of -- it's an academic approach, if you will, to achieve an outcome, which then generates models, which are very severe.

So this year will be kind of interesting to see how it all plays out.

We obviously believe we're well capitalized, but we can't anticipate how all these -- the test this year will play out.

So what we're really focused on is 2019 ongoing.

And you're right.

The SCB buffer comes into play.

Historically, you're right.

Our constraint has been our leverage ratio.

It's been -- I think our constraint on every test going back -- maybe not the first one, I can't remember exactly, but I'm pretty sure.

And it will remain, the constraint, under the traditional CCAR model.

Under the SCB proposal, I think you're right.

The likelihood is that this CET1 ratio would be the constraint, rather than the leverage ratio.

For Morgan Stanley, I don't think that's unfriendly news.

Where it comes out, and we're in a comment period at the moment that the Federal Reserve has asked for responses to the multiple rule changes, and Jon may have something to add to these comments, by the way, but the Fed has asked for comments on that.

And where that comes out remains to be seen.

But I -- I've always found it slightly surreal that the binding constraint would be the balance sheet -- GAAP balance sheet, irrespective of the content of assets that comprise that balance sheet.

Having capital as a leverage ratio of cash or treasuries or other forms of government securities versus highly illiquid high-risk securities, seems to me that kind of thing one would want to differentiate against.

So always in my mind, leverage ratio should have played a -- should have been a secondary ratio to the core capital ratios.

That's been my -- just my personal view because it leads to a very bizarre outcome that in order to -- if your constraint is leverage ratio, it might cause you to be very aggressive on the risk-based assets because, frankly, they don't matter if leverage ratio is your constraint.

That's clearly not an outcome that regulators here or anywhere in the world would want.

So I'm kind of welcoming the shift to the SCB model.

I think if it translates to Morgan Stanley, which I think will, the constraint being core capital, I think that's more sensible from a regulatory perspective.

And I don't think we're going to be -- let me just add, I don't think we're going to be worse off under that scenario than we are today.

Whether and how much better off, I don't want to prejudge that.

All right.

That's a very comprehensive response.

I'll switch over to the business side, specifically Wealth Management.

It's certainly encouraging to see continued robust fee-based flows, improvement in pretax profitability.

Probably, the one area that maybe fell a bit short of our expectation was NII, driven in part by slower loan growth.

I know you've spoken to some of the factors, including the migration of mortgage originations in-house, but how should we think about the outlook for loan growth in the coming year?

And maybe against the backdrop of rising funding cost, how does it inform your outlook for the NIM trajectory from here?

Sure.

So I would say that the NII results and lending results were actually in line with our own expectations.

I think what we've talked about coming into the -- throughout last year as well as coming into this year was a couple of factors that we suggested that would slow down NII growth in this segment.

And that's what we obviously saw this year -- or this quarter, excuse me.

We still do believe that we'll have good loan growth, and that will be a driver of the NII growth going forward.

Last year, we grew loans by about $7 billion or $8 billion.

Our portfolio is now about $70 billion.

So we'll grow probably at a slower pace for the reasons you highlighted, the transition and sort of rising rates.

But we still think that's healthy growth on a $70 billion portfolio.

We still feel like there's opportunity within our client set.

If you look at penetration numbers and whatnot, that will continue to grow that line, but at a slower pace.

We also told you last year that we thought that the deposit deployment strategy that we had in place was going to play out.

And we were planning on diversifying our deposit and liability structure, which we obviously have done.

What we have seen, and we talked about this last quarter and again this quarter -- or excuse me, last year, our clients are deploying more cash into the markets, and they're putting it into different types of investments.

The good news is that we still capture those assets when they go into advisory accounts and other transaction-related accounts.

But it has brought down our sweep accounts, and we've replaced those with higher-cost deposits.

And you're seeing that on the net interest expense line item.

The other point I would make just quickly or briefly is that we have seen a very receptive network, if you will, to our new products, particularly around some of the CDs and savings promotions that we've been running.

So we have been able to raise $10-billion-odd deposits in the -- since last summer, albeit at a higher price.

So I think this is actually playing out as we expected.

And it is going to be growth, but it will be slower.

Our next question comes from the line of Brennan Hawken of UBS.

Just wanted to ask another question here on the lending and such.

Jon, you highlighted that the institutional lending supported -- or lent some support to the VIX trading results here this quarter.

We certainly saw strong growth in the institutional balances here.

Is some of this funding that you're doing for CDs being used to fund some of the institutional loan growth?

What's the plan for how long that would stay on the balance sheet?

And does this provide a pipeline for some DCM activity here over the coming quarters?

So a lot of questions in there, and I would basically say yes to all of them.

But let's just quickly tick off.

So if you look at our disclosures, I think on one of the pages in the supplementary deck has the U.S. banks.

You'll see that the -- as you mentioned, that the institutional lending has increased.

A lot of that has been in our FID secured business or our warehousing businesses, which have been very active.

There's good velocity in those facilities.

We've seen really good strength actually in Europe, as we help finance some of our clients buy some of these portfolios that the banks have been selling.

So that has been a good business for us, good velocity, good yield.

And that is actually financed in the bank.

You don't see that in the net interest income that we talked about in Wealth Management because it shows up in the ISG lines.

So there is good asset sensitivity and good growth in that line item.

It's just embedded in some of the Fixed Income and Sales & Trading line items.

So good growth in that area.

We continue to see -- or have the ability to invest in that area and grow that business, and it's been a good source of revenues for us -- stable revenues.

Terrific.

So the follow-up would be, then, I'd expect that, at least -- while certainly, volatility supported some of the trading strength here this quarter, there's also some annuitized component to some of the revenue strength here in trading that sits on the balance sheet.

And another component, which you might not touch upon, so I want to try and get at it in a different way, is the CD -- or -- is the CDs being used to fund this?

And are those deposit costs being born in the NII and wealth, but not necessarily getting the benefit of the NII, and so it's just a geography issue?

So we're all going -- we all might focus on the wealth NII, but you really are generating the economics.

It's just not flowing through that line.

So yes.

I mean, again, within Fixed Income, there are lots of businesses, macro, micro, corporate trading, commodities.

But within our SG -- our SPG business, a larger percentage of that line item, over time, will be coming from these lending activities.

And we've seen good growth in that area.

Again, the bank -- the primary funding sources for the bank are deposits.

And they are being used, whether that's the sweep deposit savings at that time as well as some of the other external sources that we have, to fund the institutional part of the lending program.

So again, you are right that it is a growing part of that segment, but it's still relatively small to the overall pie.

It does give us some stability.

And we like the credit characteristics and the yield characteristics of that business.

And we'll continue to try to grow it going forward.

Our next question comes from the line of Glenn Schorr of Evercore.

Just a question.

Historically, the whole industry, but Morgan Stanley specifically, had big seasonality in the first quarter.

I thought a chunk of that had to do with the physical commodities business, which is no longer there.

But putting aside that this was a more active first quarter, in general, you talked about securitized products.

You also talked about some structured transactions in Commodities.

I know it's an impossible question, but should we be expecting seasonality of the past given that the higher activity levels in those specific components this quarter?

I'm glad you prefaced that by saying it's an impossible question, which means that, actually, I'm going to go back to Brennan's question because I realized I didn't answer the second part.

And then Glenn, I'll get back to you.

But on the NII comment, obviously, we transfer price across segments.

So some of the benefit of those deposits is being born in the NII of the banks, clearly.

And how it falls within the segment is ultimately a function of usage and activity level.

And now to Glenn, in terms of seasonality, we did exit many of our physical Commodities businesses that I would say added to the seasonality because we were generally owners of commodities and oil.

And during the winter, with the weather, you saw different seasonality components to that business.

It's obviously now a smaller component of it.

And generally speaking, though, if you look back over 5, 10 years, the first quarter has generally been seasonally strong, particularly in ISG Sales & Trading.

And whether that's just because people have new money to invest or they're repositioning for the year or the start of the measurement period in terms of their performance, but there generally has been real seasonality in Sales & Trading.

We clearly saw that in the first quarter this year.

If you look at the wallets, at least based on some of the early data, it suggests that the Equity wallet is up.

Fixed Income wallet is also up.

But I think, also, if you look certainly quarter-over-quarter or year-over-year, Equity wallet would be up.

And it looks like Fixed Income is actually quite balanced.

I just make an observation that, yes, historically, the first quarter has been the seasonally stronger quarter across Wall Street.

But you've got to also take into account what the business mix is.

10 years ago -- or 12 years ago, when I started here, I was running Wealth Management, I think our revenues in Wealth Management were at $1.

25 billion a quarter.

And our pretax at that point was around 3% or something in that order.

Obviously, we're in a very different planet now.

So at $4.4 billion, plus or minus, a quarter and pretax over $1 billion, you add wealth -- the way think about it is, I add Wealth and asset management together and say we start off every quarter at $5 billion in the bank.

And then if you think about Equities and Investment Banking have historically -- it's been a long time, I think, since we've had an Equity's quarter below $1.5 billion and quite a long time since we've had a banking quarter much below $1 billion.

I mean, there have been, I think, some in the high 900s.

So I think of $2.5 billion pretty much in the bank from those , so every quarter kind of begins with roughly $7.5 billion.

The flex is obviously how strong the markets are reflecting in the new issuer calendar, which pumps up the banking, reflecting equity activity, depending -- the (inaudible) season, what time of the year it is.

And then obviously, Fixed Income.

And as you correctly point out, the tail that wagged the dog for a while in Fixed Income was the big physical commodities and some of the very large multiple structured trades we did.

A lot of that has gone away, so Fixed Income won't have the huge ups that we had in 2006 and '07, most of which we gave back, by the way, but it won't have -- it's unlikely to have the kinds of downs that we had before we got rid of the physical stuff and restructured the business.

So I think of the range of this firm is kind of a worst-case scenario without the market completely imploding around $7.5 billion a quarter.

That was not the case 10 years ago.

And it was not the case 5 years ago.

So that's what we're playing for is this sort of ballast and then the speed.

Obviously, in a good market, the seasonally strong market and active market, all of which we had in the first quarter, slightly lower tax rate, slightly lower preferred that we have every other quarter, then you're going to be at the highest end of -- or towards the higher end of your ranges.

Our next question comes from the line of Guy Moszkowski of Autonomous.

James, I think I got the gist of what you were trying to say at the outset when you talked about this year's CCAR and being prepared for a range.

But I think you were trying to send some messages there, and I was just hoping that you could elaborate a little bit on what you mean by that versus how you might view future CCARs.

Well, very simply, Guy, and I appreciate that follow-up question there.

Very simply put, we have increased the dividend, I think, 4 years in a row and increased the buyback 4 years in a row.

We've gone from $0.05 and $0.5 billion to $1 and $5 billion.

And this test is -- I mean, this is a hard test.

If you have to generate a 10% unemployment number, and unemployment is currently at 4.1%, you have to provide some pretty extraordinary shocks to hit it.

That's just mathematical.

That doesn't -- I'm not saying people actually believe that's what's going to happen.

In a scenario, it's certainly much worse than what happened in the financial crisis of '08.

But that's a reality of the Dodd-Frank legislation and the outcome that has to be generated.

We obviously -- the firm has not materially grown in any way that would suggest we need more capital.

The firm is more profitable than it was, so it's accreting more earnings.

The firm is operating with a tax rate nearly 10 points below what it was a year ago.

The firm has more earnings coming out of Wealth Management, which are more stable.

So on any objective assessment, you would say that there's -- we are approaching 100% payout last year.

I think we're in the high 90s, if memory serves me.

You would expect us to be paying out certainly anything that we accretes and some.

That would be any objective assessment would say that.

I'm just saying against the backdrop of the way the particular models of this test is spitting out for 2018, and I don't think this will be the case for 2019.

So I want to really separate those discussions.

I'm saying it's less clear.

I mean, we're pretty confident and will ask for what we think we should be getting and what I think our business throws off.

Obviously, that's between us and the Federal Reserve until the results are outlined.

But I've seen -- over the years, I've seen our PPNR numbers come out at $6 billion and at $400 million.

That's a $5.5 billion swing.

So I've seen some pretty unusual results over the years.

And I just can't predict exactly how it's going to play out.

But I'm prepared -- and I've said it very deliberately, which you picked up on, prepared for a range of outcomes for 2018.

Okay.

That's helpful clarity.

The other question I just wanted to pick up on that was something that Jonathan mentioned in his remarks was the concept of the bid offer, which was up very strongly in the early part of the quarter, I guess, across a wide range of products.

And I'd just be interested in a little bit more color on what you saw, where you saw it and in terms of products and areas and to what extent should we think that this is probably normalized already.

Just before he does that, I just want to be clear.

We are highly confident in this firm's capital position.

If it was strong last year, it's stronger now.

And that's where we stand as a firm.

So there is nothing that I'm trying to suggest or indicate that would imply that we don't feel very strongly about our capital.

We were capital sufficient last year.

By definition, every dollar you accrete from then on, you would either give back to shareholders or put to good use.

So we're highly confident about that position.

What I am anticipating is I've have been around this track long enough and been through enough of these tests and seen enough variability that when you dial this scenario up to the level it got dialed up, it can lead to unintended consequences.

Jon -- Jonathan?

And I would add, you heard, Guy, that we repurchased $1.25 billion.

This quarter, we have a $5 billion authorization that James referenced.

And it's our intent to use that authorization in the second quarter.

In terms of the bid-offer spread, it really -- anytime you see heightened volatility in the equity markets around some of our market-making activities, you generally see that spread widen out, and it's really just a function of volatility.

So as the volatility changes, you'll see changes in that bid-offer spread.

I think it's as simple as that.

And our next question comes from the line of Mike Mayo, Wells Fargo Securities.

This question might go in the category of, "No good deed goes unpunished." But you have the biggest gap between your return on equity and your targeted return on equity.

So the fact that you're not raising estimates or targets yet, I guess, it could be because it's seasonal or you don't want to extrapolate some of the results because of something you see or because you compete away the tax benefits or you just want to be supersafe, especially after your first couple of years as CEO, James.

You got started, but you missed a couple of targets.

And now you're exceeding them and you're exceeding them by a wide margin.

So why not increase targets?

Well, Mike, I'm glad you asked the question.

And not to correct you, but I will.

But actually, we had a bigger gap between our return targets and our performance, and that was when we generate 2% ROEs.

And we had a 10% target, which, if memory serves me, you reminded us of pretty frequently on these calls.

So yes, it's a happy gap in the other direction.

But seriously, we -- this isn't all science.

There's -- there are these things called the markets that operate here, and we build our business models to function well in bad markets.

If Morgan Stanley's strategy could be defined simply, it would be that we will do fine when the markets are tough and we will do well when the markets are good.

There are others who might do better when the markets are good.

That's fine.

What I care about is how we do when the markets are tough.

So when we put in a target range, we don't anticipate -- firstly, we would never change it after one quarter, and you wouldn't expect us to.

It's a -- it think we call it a medium-term range.

So think about that for a couple of years.

So it would be kind of silly to bounce around after one quarter.

But putting that aside, just philosophically, the target range is supposed to represent a normal set of outcomes under kind of tough market environment and a good market environment.

This was a very good market environment, as we said right at the outset.

Not perfect.

We can definitely do better.

The underwriting calendar was not phenomenal.

Wealth Management transaction activity is extremely light.

We had very few gains in the investment portfolio.

We're managing expenses strongly, but not ruthlessly.

So there's things we could do clearly to drive returns higher, putting aside revenue growth.

But what we're focused on is how we're going to do in a difficult market environment.

So seasonally, just add in the extra preferred, bring the tax rate up to the sort of 23%, 25% range that Jon talked about and the returns for this quarter probably dropped from 14.9% to, rough math, about 14%.

So think of it as starting basis is 14%.

Yes, the high end of our target was 13%, but as I said, a very good environment.

If we go to the end of this year, and we were consistently above 13%, then I will come back to you and I'm prepared to renegotiate our goals at that point.

Fair enough.

And one follow-up in terms of environment.

Now that you have $70 billion of loans, up almost 20% year-over-year, how do you reassure investors that the loans will stay of good quality?

Again, I think, from the overall credit quality, there's a couple of components.

One is obviously mix.

A good portion of that -- or the vast majority of the Wealth Management loans, virtually all, are secured in one way, shape or form, whether that be by a house or our bigger portfolios around the security-based lending, where we have good LTVs, good -- and good protections.

On the mortgages, I think you know our portfolio has been very, very clean.

And then on the institutional side, again, all of that lending is secured.

The warehouse business has good structural protections and good haircuts.

Our commercial real estate portfolio also has performed nicely in terms of its LTVs and whatnot.

But again, we are in a pretty good credit environment.

I would suspect, at some point, we'll get into a credit cycle and you will see more losses from that portfolio.

But at this point, it's been very clean.

It's been a good risk-return profile with healthy yields and very strong credit characteristics.

Our next question comes from the line of Gerard Cassidy of RBC.

Jon, can you share with us your thoughts on -- you talked about the mortgage production and moving it in-house may have contributed to some of the slower growth, but I know it's early, but your clients tend to be obviously higher-net-worth type of clients.

Have you seen any evidence yet that the SALT issue, when it comes to the state and local taxes and that restriction is impacting people's borrowing habits on mortgages yet?

To be honest, the answer is no.

And I know there was a lot of discussion about people moving and -- particularly out of places like California and New York, but we haven't really seen any activity based on that dynamic.

We did -- obviously, our provider was PHH.

They've changed their business model, so we had to bring -- change ours.

So we brought it in-house, and we purposely slowed down that production to make sure that we have the right infrastructure and level of client service required for our clients.

We still think there's opportunity to grow.

As rates rise, we'll also see presumably less runoff.

But again, we feel good about where we are in terms of the lending growth, slower first quarter, but as expected.

Very good.

And then just pivoting to the trading area in equities.

Obviously, you have made a meaningful commitment to technology in low-touch trading versus the traditional high-touch trading.

Can you share with us how those trends are moving?

Is the high-touch trading falling fast and it's really becoming more of a low-touch trading environment, which you guys, of course, are one of the leaders in?

Yes.

I think there has been a multiyear trend of more electronic trading versus voice trading.

And we've seen that quarter-over-quarter.

We benefited obviously this quarter, as we've seen that transition.

The volumes have gone up dramatically, so although there's different pricing dynamics around price versus -- excuse me, voice versus electronic, we've been making up a lot of it in volume.

But there is clearly pressure on the voice trading part of the business.

Our next question comes from the line of Michael Carrier of Bank of America Merrill Lynch.

Jon, you guys generated good operating leverage in the quarter.

Your comp ratio lower.

Just on the non-comp side, we expected some lift with just the activity, but maybe just some color on what's being driven by activity versus what you guys mentioned some of the investments in Wealth Management, like what we should be expecting?

Is more ongoing?

Yes.

Again, I think, based on sort of our expectations and budgets, we actually were right in line with sort of what our expectations were on sort of the nonrevenue-related items.

And then we saw a clearly increase in BC&E, which shows up in the BC&E line and increase in transaction taxes, increases in U.K. bank levy and some of the other things that would show up in the other expense line.

So where we expected the increases, we had a little bit of increase in occupancy as we knew we were renegotiating some leases.

We've got some expenses related to some of the planning we're doing in Brexit.

So again, all the expected slight increases that we thought we'd have, we saw.

And then the real increase in expenses was virtually all related to the Sales & Trading and revenue-related activities.

Okay.

Got it.

And this a follow-up on the capital ratios and the stress capital buffer, just wanted to get your take.

Given that it will be more variable or volatile going forward, do you expect some more transparency in either the calculation or the test?

And if you get that, then can you better manage, like, the current kind of portfolio and the business to maybe navigate that better over the next few years?

And I know it's early, but I'm just trying to understand.

Yes.

Again, I would say it's very early.

I would say there have been a couple of announcements.

And Vice Chairman Quarles testified yesterday -- or day before and made some comments.

I think there is clearly a trend towards simplification.

There's a trend towards more transparency.

There's a trend towards more bespoke regulation based on your own individual firm risk profile.

And there is an element of recalibration 10 years after the fact.

And I think transparency, for us, that might lead to better stability would really be transparency around the actual scenarios.

We've seen this test get harder year after year, as James mentioned, the 10% unemployment rate.

But also, every year, when we get the scenarios and the upfront market shock and the past, there's always a couple of things in there that surprise us, and to be fair, are not necessarily 100% consistent with how we see the world and what would happen in a scenario like that.

So anything around transparency, around the scenarios and that's one of things that we're going to comment, and I think Vice Chairman Quarles mentioned something about putting out the scenarios for comment.

I mean, any of that would be helpful for us to plan our business because we look at things for the longer term and to get surprised year after year based on sort of the scenario.

It does obviously inhibit that -- some of that long-term strategy planning.

Our next question comes from the line of Jim Mitchell of Buckingham Research.

Just a follow-up on that.

You guys -- James, you said you built more stable -- you think stable kind of revenue-producing business model.

Yet, when we look at the stress test, you get hit the hardest in terms of starting point to stress minimum in terms of the loss rates.

That seems -- doesn't seem to jive with what you built.

And just, therefore, you get hit hardest in the SCB even though you have plenty of capital.

How do you -- is there anything we can -- you think about or going forward that you can sort of help the Fed or help yourself kind of reduce that?

Is that higher losses that they attribute to your firm?

How do we think about offsets going forward?

Or how do you think about it?

This is -- I'll try to take a chance.

Again, the transparency in their models and one of the uncertainties this year is they are continuing the sort of 2-year phase-in transition on some of their PPNR models.

As James mentioned, we think we've created a much more stable revenue base.

Yet, in the stress cases that they prepared, our PPNR has been wildly unpredictable and wildly low.

Some of that, this year, is going to be a function.

As you know, our -- a significant portion of our revenues in Wealth comes from our fee-based flows.

And if your markets are down 65% and they don't ever recover, that obviously has an impact on our business.

The other thing you should know is all these tests, we're not allowed to do -- make any sort of management actions.

So we just watch all of this go on and have no ability to react to it.

So we do have a high reduction.

Also some of that has to do with just our RWA density is lower than everyone else's.

And that, while it intuitively means that we have less risk, doesn't seem to benefit from the test, which is also one of the reasons why I think -- and I think Vice Chairman Quarles mentioned this yesterday, we do think that a recalibration of the GSIB methodology, particularly MiFID II, would be helpful.

Our derisking strategy has led to a higher GSIB buffer, which does -- intuitively doesn't make sense.

And we've got a pretty big gap between the MiFID I and MiFID II.

And so those are some of the types of things that we'd like to comment on going forward in this process.

And just specifically, on us, historically, as we said, the constraint was leverage ratio.

And if -- as the models and the Fed have done, you grow your balance sheet, then that's highly punitive.

I think it's been growing 4.3%, 4.5% a year.

So -- and I've said this publicly, and I've said it privately, I don't -- I can't anticipate a scenario where your balance sheet grows during a time of financial distress and deflation of financial assets, unless you're acquiring other institutions.

It just is illogical.

And I've seen no empirical evidence to support balance sheet growth during that time period.

And I think that view has started to resonate.

And I think Vice Chair Quarles talked about some of that in one of his speeches recently, as they're considering moving to the stress buffer model.

But I think, in fact, our experience was, I think, our balance sheet shrank, if memory serves me, 29% post-crisis.

So under that, we would be wildly overcapitalized from a leverage ratio perspective.

Now I'm not suggesting that, that's appropriate to model out in that regard because, obviously, we took very draconian steps because we had to.

And a stronger institution might take less draconian steps, and we believe we're a stronger institution now.

But the bottom line is we have always had the constraint leverage ratio.

If you took away the balance sheet growth and just kept it flat, we wouldn't even be having this discussion.

Right.

Absolutely.

And then maybe a follow-up on there's been an awful a lot of chatter about the Volcker Rule.

I don't know if you -- when you talk to your traders, has the uncertainty and complexity of that rule kind of hurt them in any way?

Did they feel like some greater simplicity would help a lot or just a little?

I mean, is it more of an expense issue?

Just trying to think through if there's any kind of material impact, where the revenue and expense is from some simplicity in the Volcker Rule.

Yes, I'd probably -- it's probably going to take too long to pull apart all the aspects of the Volcker Rule for this call.

So just given the time, I won't go into it.

But clearly, what Paul Volcker was trying to do was restrict deposit-taking institutions from putting their own capital at risk in proprietary trading or investing and then morph into something, which is far more complex, requires a lot of attestations.

And many people's view is -- has impinged on market liquidity and moved from -- focused on proprietary activity to principal trading activity.

I think the regulators are obviously very aware of the industry response on this.

And this is an opportunity where they're taking a hard look at it.

I do not expect the Volcker Rule to be removed.

I'm not sure it should be removed because I'm not sure banks should put large parts of their capital at risk in proprietary trading or proprietary investing positions.

So the essence of what Volcker was trying to do, I personally agree with.

The way in which it was executed left -- well, some revision would be appropriate.

Our next question comes from the line of Christian Bolu of Bernstein.

On the Wealth Management side, just want to follow up on NII questions.

I guess, just to wrap it all up, how should we think about sequential quarter progress going forward?

Should we be thinking about growth off a Q1 base?

And also, if you have the deposit -- the brokerage deposit number for the quarter, that would be helpful also.

Sure.

And again, the way I would describe this is, first of all, I think you've heard James talk a lot about this business being ballast.

So it's not going to move quarter-over-quarter sequentially very much.

That's why we like it a lot.

It sort of grinds it out.

If you look over the year-over-year comparison, NII is up 8%, driven by very nice loan growth.

And I would say, going forward, we've -- I've tried to highlight in this call that the loan growth would be at a slower rate than last year.

We're also off of a bigger base.

And we're also not going to get the benefit of sort of the lower betas -- or the betas -- actual betas sort of below -- sort of the predicted model betas of 50%.

I think we're going to start seeing the betas.

And we already have crept up towards that 50% type of level.

So again, we do expect NII growth.

It will be slower than we've had over the last 5 years.

I mean, we've tripled our loan portfolio in 5 years.

We clearly can't continue at that clip, as we started with a lot of new products and a lot of new strategies.

But we will continue to see growth just at a slower pace.

Okay.

Just -- sorry, the growth is sequential or year-over-year growth.

That's -- I guess, that's what I'm trying to know.

I'm sorry.

When we talk about NII growth, we're talking year-over-year.

So if you look at -- historically, we've been growing NII year-over-year, on average, $500 million.

We're clearly telling you that we're going to grow NII in '18 versus '17, but it's going to be at a slower pace.

Our next question comes from the line of Kian Abouhossein of JPMorgan.

Yes, it's Kian Abouhossein.

Securitized products, you mentioned, it's one of the best performances you have seen over the last 4 years.

And I'm just wondering why that is because I wouldn't expect that looking at industry data.

And you particular highlighted Europe in that context as well, which, historically, is a very small part, at least, if you look at dialogic data in terms of revenues -- issuance revenue.

I'm just wondering what is driving that for you.

It looks like you're gaining market share.

So I want to understand what you're doing in -- globally, but also in Europe, in particular, in this area.

Again, I would say, broadly, Fixed Income was strong.

There weren't a lot of elephant-type transactions in the quarter.

So it's really just sort of small outperformance in a lot of places across the globe, number one.

In terms of SPG, and one of the things that we highlighted, Europe is, again, in this -- in our warehouse business.

We've been very active supporting clients as some of the larger banks have been getting out of real estate portfolios, as they continue to deleverage.

And we've been providing financing for European clients.

That's been a very good business for us.

We obviously -- some combination of both syndicating out that exposure, but also securitization activity on the back of it has been very good for us.

So again, I called out SPG just because if you look at percentages, it did sort of outshine, if you will, the other areas with both fixed -- excuse me, FX and commodities.

But it wasn't -- it was just a little bit better in a lot of different places all over the world across products and geographies.

Our last question comes from the line of Brian Kleinhanzl of KBW.

Just had a quick question on the Wealth Management space.

I saw that the reps were down 1% year-on-year.

I mean, going forward, is that just the right way to think about your advisers in that business as there's going to be a declining base from here?

Or will there be some point we can actually see growth in advisers?

Yes.

I mean, I think generally, the attrition has been pretty low.

1% is a relatively small number given the size of the franchise with the ages and retirements and some people still leaving.

What we've seen, to date this year, is actually a significant slowdown in the number of people who have left.

Generally, the size of the production of the people who have been leaving has been quite low.

We have deemphasized recruiting.

We've only recruited a handful of people over the first quarter.

But I think, generally speaking, flattish.

And plus or minus 1%, I sort of bucket into the flattish category as sort of how we see this certainly in the near term, as we continue to invest in our current franchise, our current FAs and our current infrastructure.

Yes, I'd focus on total assets and assets per adviser more than the number of advisers.

But you won't see radical shifts in numbers.

We're at the last question.

I know there are other people on the line.

I'm sorry about that.

We went a little longer on some of these questions early because they were a little more dense.

So if you need to course your own, then please do, and we'll answer everybody's questions offline.

Thank you so much.

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

That concludes the program.

You may all disconnect.

Everyone, have a great day.