摩根士丹利 (MS) 2018 Q3 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.

Thanks, Sharon.

Good morning, everybody.

Thank you for joining us.

Over the last several years, we've focused on a number of things.

Firstly, taking actions necessary to fix the obvious and immediate problems that we faced.

Secondly, putting a strategy in place, the right strategy, which was focused on a balanced business with more effective risk controls.

And thirdly, meaningfully investing in our culture to ensure we remain an employer of choice for top talent and manage our business with professionalism with whatever challenges we face.

These strategic choices were designed to ensure that as much as we can control, the firm does well in a strong market environment and demonstrates stability in a seasonally or structurally more difficult one, and that is exactly how 2018 is shaping up.

The first half of the year was characterized by a strong market environment, and increased levels of client activity.

Commensurate with that backdrop, we delivered returns above the top end of the ROE target range of 10% to 13% of that first half period.

The third quarter, of course, was impacted by the traditional summer slowdown and a more fragile trading environment.

Even so we delivered an ROE of 11.5% and an ROTCE of 13.2%.

These are comfortably within our target ranges and firm revenues of $9.9 billion.

In prior periods to 2008, when we delivered revenues of $9 billion to $10 billion, we had a leverage ratio of 30 to 40x.

Obviously, we have dramatically changed the way we conduct our business.

What was most pleasing in Q3 was the stability across the whole franchise.

Though we can clearly have aberrations in any 1 quarter, we believe that we have set a floor while at the same time created significant upside potential.

Investing in our talent and building out our leadership team is an essential ingredient to what we see as an exciting path forward.

Our ability to attract talent from across the Street, relatively low attrition levels, and high employee satisfaction are all hard evidence of a strong culture.

Our challenge is to make sure this is not for weeks, months or even years, but for decades to come.

With Q3 now behind us, we look forward to spending more time discussing growth opportunities in the months and years ahead.

In the meantime, we remain confident and optimistic about the near-term prospects for a strong finish to 2018.

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

Thank you, and good morning.

Results in the third quarter demonstrated strength despite the typical summer slowdown.

Our performance illustrates the resiliency of our business model and the ability to perform across an array of market environments.

We reported revenues of $9.9 billion and PBT of $2.9 billion.

Diluted EPS was $1.17, ROE was 11.5% and ROTCE was 13.2%.

Institutional Securities performed well.

Investment Banking benefited from continued strategic activity and new capital formation globally.

Compared to historical third quarters, equities results were strong.

Fixed income showed stability despite seasonally slower client flows and the lack of larger transactions.

Wealth Management delivered another solid quarter and Investment Management saw continued positive long-term net flows, although investment results were impacted by weaker emerging markets.

We continue to benefit from the inherent operating leverage of our business model.

On a year-to-date basis, our efficiency ratio was 70% and almost 200 basis point improvement compared to the same period last year.

Increased expenses have primarily been driven by higher compensation and execution related costs associated with the higher revenues.

Our discipline around discretionary spending has allowed us to continue to make investments across the firm, especially in technology.

Although we typically see a seasonal increase in expenses in the fourth quarter, we remain confident we will hit our full year efficiency ratio target.

Now to the businesses.

Institutional Securities generated revenues of $4.9 billion in the third quarter.

Year-to-date revenues of $16.7 billion are up 17% versus the same period last year, benefiting from active global markets, increasing revenue pools and stable to improving wallet share.

Non-compensation expenses were $1.7 billion for the quarter, an 8% sequential decrease, driven primarily by lower execution related expenses.

And compensation expenses were $1.6 billion, bringing the year-to-date compensation to net ratio revenue to 34.5%.

Investment Banking reported revenues of $1.5 billion, down 14% relative to the second quarter, reflecting a normal seasonal slowdown in activity.

Notably, this is our best third quarter in over a decade contributing to record year-to-date revenues.

Advisory revenues for the quarter were $510 million.

M&A volumes remained at historically high levels, supported by larger strategic transactions and cross-border activity.

Pipelines remain healthy and dialogues are active.

New issue market conditions remained favorable in the quarter supporting strong underwriting results.

Equity underwriting revenues were $441 million.

Activity remained healthy across products and regions with particular strength in IPOs.

Americas was strong throughout the quarter, while Asia and Europe saw some seasonal slowdown in August before a strong September.

Fixed income underwriting revenues were $508 million, increased results and investment-grade issuance partially offset a slowdown in high-yield financing relative to a very active second quarter.

Event-driven transactions remain a significant driver, supported by the active M&A backdrop and our ability to leverage our global franchise to provide holistic client solutions.

Investment Banking pipelines remained constructive across products and regions.

For the remainder of the year, strategic activity should support both our advisory and underwriting businesses.

Of course, client activity could be affected by continued or new macroeconomic and geopolitical uncertainties.

In addition, protracted periods of heightened volatility may impact issuers' financing plans.

In Equity Sales and Trading, we retained our leadership position and expect to be #1 globally.

Revenues were $2 billion, down 18% quarter-over-quarter.

Sequential revenues declined across each business line as the quarter was characterized by low market volumes and more subdued volatility compared to the first half of the year.

Still, activity remained robust across products relative to historical third quarters, particularly in Europe and Asia.

Prime brokerage had a strong quarter benefiting from our investments in our global client footprint, and derivative results were also strong aided by a diversified product set and client mix.

Fixed Income revenues of $1.2 billion were down 15% versus the second quarter.

Seasonality and low rate volatility in the quarter impact at Europe in particular, which contributed to the sequential decline.

Overall, revenues remain solid and are up 8% year-to-date.

In our macro business, we saw strong client activity in FX, supported in part by idiosyncratic events across emerging markets.

Rates was negatively impacted by range-bound yields and low volatility globally.

Our Credit business saw a sequential decline on lower client activity across product areas.

Our institutional lending franchise continues to demonstrate good balance sheet velocity.

In Commodities, revenues were up as client activity remained robust.

The results were supported by macro movements within the energy complex.

The Fixed Income results reinforce that this business is well positioned.

Despite seasonal headwinds this quarter, our revenues remained solid.

Turning to Wealth Management.

Organic growth drivers of the business remain strong.

In the quarter, we saw net fee-based inflows, higher fee-based assets and a continued increase in lending balances.

The growth in these metrics supported higher asset management and net interest revenues, contributing to the 2% sequential increase of total quarterly revenues of $4.4 billion.

The business continues to demonstrate significant operating leverage.

On a year-to-date basis, revenues of $13.1 billion are up 5%.

Non-compensation expenses are up only 1% over the same period and total non-interest expenses are up 3% resulting in PBT growth of 11%.

In the quarter, the margin exceeded 27%.

Total client assets of $2.5 trillion is up $85 billion or 4% compared to last quarter as market showed gains and clients continue to add new money to their accounts.

Net fee-based flows also remained strong at $16 billion contributing to 3% growth in fee-based assets, which now stand at $1.1 trillion or 45% of total client assets.

This quarter represents the 12th consecutive quarter of Fee-Based Assets growth.

Asset Management revenues for the quarter were $2.6 billion, up 2% on the higher asset levels.

Net Interest Income was $1.1 billion for the quarter, up 3% sequentially.

Higher NII was primarily driven by increased earning assets, as higher asset yields were offset by higher funding costs.

This includes the impact of the cash sweep program redesign.

Wealth lending in the U.S. banks grew by $1.1 billion to $71.1 billion with increases across each major product line.

Year-over-year, loan growth stands at approximately 7%.

While the transition to our in-house mortgage platform impacted production earlier this year, we're currently in line with pre-conversion levels.

We saw growth in the mortgage portfolio for the first time since this transition.

In addition to the tradition decline in retail engagement during the summer months, we saw clients continue to focus more of their fixed income investing into shorter-duration products at lower commission rates.

However, due to the impact of positive mark-to-market on deferred compensation plans, total transactional revenues of $698 million remained essentially unchanged.

It is worth noting that the contribution of transactional revenues have steadily declined.

On a year-to-date basis, transactional revenues represent approximately 16% of total net revenues versus 22% in the same period 3 years ago.

This quarter's results once again demonstrate the stability and health of our wealth business.

Segment revenues grew supported by annuitized revenue drivers and pretax profit reach new high.

Year-to-date results demonstrate that we can steadily grow this business, while continuing to make investments into tools to support asset growth, increase client engagement and improve cost efficiencies.

In Investment Management, we saw continued positive long-term flows, $3 billion in the quarter supported by strength in overseas distribution.

Total net revenues were $653 million, a 5% decline relative to last quarter.

Asset management fees of $604 million were essentially flat sequentially.

Increased fees on higher average long-term AUM were offset by lower fees and liquidity primarily driven by the wealth management cash sweep redesign.

Our overall fee rate in this business remains stable.

On a year-to-date basis, asset management revenues are up 13% on strong investment performance and positive flows particularly in our active fundamental equity strategies.

Investment revenues were $40 million, down 27% sequentially impacted by continued market volatility in FX and emerging market equity performance.

Overall, expenses of $451 million were essentially unchanged.

Turning to the balance sheet.

On a sequential basis, total spot assets of $866 billion are down $10 billion.

Our standardized RWAs of $370 billion decreased by $17 billion over the quarter, driven primarily by lower Credit RWAs on reduced lending and commitments to syndications and pay downs in the quarter.

As a result, our Basel III standardized common equity Tier 1 ratio is expected to be approximately 16.7%.

Our supplementary leverage ratio remained flat at 6.4%.

During the quarter, we repurchased approximately $1.2 billion of common stock or 24 million shares.

Our Board declared a $0.30 dividend per share and our tax rate in the third quarter was 24.4%.

As we look ahead to the fourth quarter, we are cognizant of the seasonal headwinds, but we are encouraged that we are off to a good start.

Strong volumes and increased client engagement associated with the recent pickup in volatility have benefited the franchise thus far.

Of course, while bouts of volatility can support revenues, sustained volatility can erode confidence and close market access.

We have not seen that to date.

We believe that the economic backdrop is strong characterized by broad global growth.

Assuming these macro conditions persist, clients are active, and markets remained open and functioning, we will press our advantages and look to continue to get wallet share.

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

(Operator Instructions) Our first question comes from Brennan Hawken with UBS.

My first one is on deposits.

They have been definitely in focus for the Wealth Management side.

And I know you gave some comments on that, Jon, thanks for that.

But we had the first wave, I believe of CDs -- your CD program that were scheduled to mature over the summer.

So it would be great if you could maybe let us know what sort of customer behavior you've noticed with that money?

What portion of that cash are you retaining?

And what kind of products are customers are moving into with that cash?

Sure.

So as you mentioned, we did have some CDs mature during the period.

What we generally have seen, although this is all new for us since we just got into the products over the last 18 months, is that a good amount of those dollars going to the investment accounts of those clients, while some portion gets retained in the savings products.

So while it hasn't been retained in the bank, it's been retained in the system.

Those dollars continue to go on in to both equities and fixed income.

We have seen a little bit more of a shift into the fixed income investing than we did probably what we saw in 2017.

But all in all, it's been sort of both a nice way to supplement liquidity in the bank, but also bring in new assets to the firm.

Perfect.

And then on the equity side, your guys' trends and the share gains have been really impressive.

I know this might be somewhat of a high-class problem, but do you have any thoughts or insights how your customers are thinking about concentration risks?

Are there any limits to thinking about further share gains, particularly in the financing side of the business?

Listen, Brennan, as you mentioned, we've gained significant share over the last 4, 5 years.

I think what we're benefiting from now is more of a stable share in a growing market.

The equity product this year is up pretty dramatically over last year, and it's been down for a couple of years in a row.

So this is a good positive play.

And I think we do believe that we can continue to grow share, although at slower paces.

We continue to invest in the franchise, particularly around both product, people, geographies, international footprint and technology.

So I would say that we feel very comfortable with our share.

We feel very comfortable to be able to maintain that share, and there are pockets where we continue to believe that we can grow that share, but it would be at a slower pace than we've seen in the last 5 years.

Our next question comes from Mike Mayo with Wells Fargo.

Could you just elaborate a little bit more on the deposit strategy and growth?

And it just seems to be getting a little bit more competitive with more of the banks pursuing a national digital banking strategy.

What are you seeing, and at what point would you pivot your strategy based on what you're saying?

And then a separate question.

I don't recall, do you disclose a net interest margin?

And if you do, what has it done?

And what do you expect it to do?

I'll go with the second one first.

The answer is no.

Again, we try to focus on the net interest income in the wealth business and you can see that, in that business, the NII has grown about 4% to 5% year-to-date.

On the first question, it's a good question, Mike.

We continue to make investments in the liability structure.

We've talked about professional CDs and savings.

We're working on new premier cash management products, and we continue to enhance our digital strategies around both payments and deposits for our client base.

We're at historical low levels of cash in client accounts, and our deposits are really more impacted by sort of our client's asset allocation than actual rates.

The betas on our deposits have actually outperformed our models and continue to outperform our models.

But what we have seen, whereas cash levels have been sort of 8% to 10% for quite some time, they are now down at about 6%.

And what those do after or in light of some of the market volatility is really a question that we'll have to see, as the markets evolve, but we have been a prolonged bull market, if you will, and we have seen the cash levels go down.

So at this point, I don't think we're thinking about changing the strategy.

We're continuing to invest in the product suite.

You can see that we have grown deposits a little bit.

Quarter-over-quarter, our clients are very open to the products that we've been offering.

And when we run promotional products and rollout new offerings, we seem to see very good take up.

So again at this point, competitive business, but we feel good with our position.

And then just one follow up.

That's interesting about the cash levels from 8% to 10% down to 6%.

What's been the range of those cash levels like over the last 5 or 10 years?

I think over 5, I would say, 8% to 10%.

But now down to 6% on 10%, I don't have the data, but it's in that 8% to 10% range for a while.

Our next question comes from Matt O'Connor with Deutsche Bank.

Revenue obviously was strong this quarter.

It's been strong year-to-date.

It sounds like it is off to a good start this quarter, but if you look at the stock, it's obviously been under a lot of pressure this year.

And I think it's a concern over the sustainability of revenue.

Actually thinking about the cost side, can you just talk about how much flexibility there is to bring in cost if the revenues come in weaker, or to say, next year than you expect?

Matt, it's James, and I think I'll take that question, because I too have been wondering about the price action on the stock.

It's interesting.

The ROE and ROTCE are up 40% year-over-year.

Revenues on an annualized basis are up 12%.

We're hitting a little bit of pretax margin numbers that we said.

We're above the ROE range, we said.

We're comfortably within the range that we talked about below 73% on total compensation and the stocks down at least premarket this morning, it was down or last night 7%, 8% year-to-date.

So it's kind of a little bewildering against the backdrop of a very strong U.S. economy and we're overweight the U.S. and gaining share across each of the institutional businesses.

So I guess, there are smarter investors than myself out there who got this figured out.

But to me it seems like with the ROE up 40% and the revenue trend that we've got so it's a little hard to reconcile with the stock being down.

So what I care about frankly is the long term of positioning of the firm.

This firm is positioned for resilience through cycle.

That's exactly what we have demonstrated in this quarter to deliver $9.9 billion of revenue in the summer quarter, that was unheard of a couple of years ago.

And look at some of the metrics of where the resilience are, just looking at the numbers this morning, the assets that are in wealth management sitting inside the $10 million-plus household.

And many of those households are many multiples of $10 million.

Back in 2009, that number was slightly over $400 billion.

As of today, it's well over $1 trillion.

And that money is not going to go away.

That's very sticky stable money.

Then the next segment of $1 million to $10 million the same.

So you look at the share question that came up about particularly the prime brokerage part of equities, I mean, the reason we gain share in equities is, it's hard to make money if you're not in the top 3. The industry is consolidated.

In fact, those with superior technology and great franchises have gained share because clients want that.

Far from being a concentration risk, clients have wanted to be with 2 or 3 players and we have obviously been a huge beneficiary because we have, in my humble opinion, the best-in-class equities business across the street.

So back to the sort of near term on your question, if the turns, we respond.

We do what we needed to do on the expense side.

We obviously have some cushion given we're running with an ROE currently of 13.1% year-to-date.

So I'm very confident about the outlook.

I'm confident about our ability to respond if the market turns.

If we go into a complete major crisis environment, which I did not expect at all, then obviously we'd be affected along with everybody else.

But in a normal downtick in the market, yes, we'd pick up some more volatility and then overtime revenues would trail off a little bit, but the fundamentals are very strong.

I think the other concern obviously is the capital deployment and the results from 2018 CCAR.

But it seems like you're addressing that or trying to building capital.

I don't know that was simply the what's going on in the market or specifically the response to the CCAR results, if you comment on that?

And if there is still further optimization that you can do to the CET 1 after going up 90 bps this quarter?

Well, it's obviously kind of apart from, where goes the market from here, the second question is, what is likely due to evolve in the regulatory front, not just in 2019, but over the next 3 or 4 years.

And if you look at what we did last year, obviously we did a distribution equivalent to what we did -- what we're approved for the previous year.

Since then, year-to-date, we've accreted $6.9 billion net income to common.

By the way, full year last year was $6.6 billion.

So through 3 quarters, we're at $6.9 billion.

Our capital distribution should go up.

I mean, why wouldn't dividend is still below a reasonable payout ratio, I think, it was in the low 20s, 23% or something.

$0.30 a quarter.

So that's about 20.

Frankly, we're making too much money to keep holding it there.

Now at the same time and good news is the stock is trading at $43.

You're buying back a lot of stock with that distribution.

Now overtime, if the stock trades back to where I think the values is reflected in the ROE performance then you've got different strategic choices as to how you distribute the capital.

But I can't imagine the scenario of the next several years where we don't have significant buyback programs, just because we're accreting so much capital and unless you can find ways to invest that in the business to generate those kinds of returns.

So I think it shareholder-friendly to have a strong dividend, have strong buyback and make the appropriate investments to build growth into the business, but we can kind of do all 3 when you're producing nearly $7 billion in net income in 9 months.

Our next question comes from Mike Carrier with Bank of America Merrill Lynch.

This is Sameer Murukutla on for Michael Carrier.

Just a quick question.

And one of your peers highlighted the increased competitive environment in ISG.

I think specifically in FICC with tighter spreads.

Can you let us know what you're seeing?

Is this the usual strong players competing more aggressively, given the lower volatility?

Or are you seeing somemore reinvigorated competition from maybe the European peers?

Well, I would just -- again I don't know if this quarter is any different than any other quarter.

ISG across the complex of FID, Equities and Investment Banking is very competitive.

It's always been competitive.

And we continue to either maintain our share or grow our share.

In the Fixed Income space we picked up share over the last several years since the restructuring, which is why we're so confident that the position of the businesses in such good shape.

We're probably running 10% to 12% share when we used to run 6% to 8%, and we've seen our ability to grow that share even though the pool of revenues are not really growing.

As I mentioned earlier, in Equities, a very competitive business, but we have a comprehensive business and offering.

And as James mentioned, best-in-class, and we continue to maintain our share and capture a growing revenue pool.

And then in banking, the global footprint and the stability of our franchise has led to some really strong results, and we picked up share in banking.

So again, a very competitive environment.

We expect to continue to maintain or grow our share given the stability and the momentum in the franchise and it's always going to be a competitive market.

I guess, as a quick follow-up.

Given the volatility that we're seeing in like the EM and Asian markets start 4Q.

Can you give us an update on how this impacts your business, maybe specifically in IM with like the investment line?

Sure.

As I mentioned earlier, the investment line was impacted this quarter because some of the volatility in both the rates and emerging markets.

As you know, some of our alternatives and equity strategies are in Asia.

So I think it will continue to see some impact from that, but I think again that's sort of the tail on the dog, the primary driver of revenue growth for us in that business is going to be around the fee-based assets.

And we continue to see continued good flows into our long-term assets.

The last 7 quarters, we've seen $20 billion of inflows and active management -- active strategies are working for us.

So again it will have some impact, but we feel very good about the overall health of that business, and we've seen very stable fee rates here too, which is another reason we feel good about that.

There was a comment in your press release on Institutional Securities that the other sales and trading net losses were down a quite a bit versus a year ago reflecting lower net funding costs.

I was just wondering number, it's a big enough of a number that it's meaningful and it sounds like great thing.

How do you reconcile that with higher interest rates?

So you read our press release I'm impressed.

So listen, there are a lot of things in that line.

Some of which is the hedging activity and other things that flow through that.

We also have some assets in that business.

Basically, the businesses have been optimizing their balance sheet and the funding and that sort of collectively the net result being the statement we made in the press release at the net funding costs are down.

It's really based on usage not rate.

And is there any sustainability to that?

Or just in terms of well funding cost?

Or it's that just something that was helpful this quarter?

I think it was helpful this quarter.

That number is going to be volatile, because there are a couple of things in there that sometimes offset each other, sometimes they don't.

But really it's a function of how much liquidity the businesses require and how we optimize the balance sheet.

And again, that has some variability to it.

So I wouldn't necessarily bank on it.

Our next question comes from Glenn Schorr with Evercore ISI.

Further on the conversation of stability, Wealth Management and Investment Management are half the firms revenues.

Considering 45% is in fee-based accounts and your lending efforts and deposit efforts, the comp trends, the only offset I see is the lower transaction.

I mean, this is markets business obviously, but can pretax in that combined business grow in a flattish market environment?

Yes.

I mean, it depends on how you manage the business.

I mean, as you pointed out a lot of the revenues come from non-market-related activities.

And secondly, there is shift in market-related activities.

So money moving from transaction accounts plus the transaction revenue, but as it moves into managed by asset management account, it improves the revenues.

So the net is actually net gain on the switch of assets as they occur as the clients move out of transactions into managed money.

So there is a lot of stuff going on in that business and obviously next year we're seeing the recruiting deals coming off, which relating to the merger with Smith Barney and we've also been doing just less big ticket recruiting for the last several years.

So the annual to cover the deferred recruiting expenses is coming down each year.

So yes, I would say, I mean, modestly I wouldn't, there isn't some massive jump likely across wealth and asset management in a flat market environment, but they're definitely operational improvements that can be made.

Okay.

Believe it or not, I also read the press release.

There was something in there in the Institutional business on a modest gain on the sale of the business.

Just curious on how big and what business that was?

That was a deal that was announced, I believe, in the second quarter and closed in the third quarter.

We were an owner of the business called the Municenter, and it was a good, just trying to see the line item, it was a good percentage of that line item.

It was about $60 million, $61 million, $62 million.

Our next question comes from Steven from Wolfe Research.

I want to start over the question on equity market sensitivity.

James, it was interesting to see your perspective on some of the factors going on the stock and some of the underappreciated revenue stability.

It appears to us that one of the big concerns is your higher sensitivity to movements in equity markets and equity market declines, which certainly comes to mind, given the latest move.

I was hoping if you can give some of the insight about how do you think about earnings resiliency in a sustained market correction and given some of the commentary around the movements in cash balances, how much of an offset do you think that could provide if equity market weakness persists.

I mean, listen, we had a more challenging third quarter both from market activity in just seasonal volumes, and we delivered an ROE of 11.5% in that environment.

So tax adjusted that's probably 10% to from what would have been last year.

The best we've done up until then was on an annual basis was 9.4%.

So that's in a pretty subdued trading market and not definitely not a robust equity market environment.

I think though if you look across the franchise they're still M&A transactions get done.

The Prime Brokerage business is very resilient.

There is still trading across the Fixed Income businesses whatever is going on equities and as we have improved our share in the macro space, we've always been a little stronger in the micro.

And then in micro, SPG and the other credit businesses we are well positioned.

So we're not as correlated to equity market moments as I think is sort of believed.

If you actually look at the stability of the franchise across each of the businesses.

Clearly if you have a sustained correction call it 20% over a year I mean, I'm not naïve about it.

But as we just saw in the quarter, which wasn't a great equity market quarter, we had $9.9 billion of revenue and we've only ahead 2 quarters of more than $10 billion of revenue and they were over the first and second quarter of this year.

Thanks for that color, that's very helpful.

And may be just follow up on operating leverage.

You clearly demonstrated strong expense discipline in the quarter, 200 bps of efficiency improvement year-on-year.

It seems like the Street is contemplating some revenue growth from here in line with GDP, but numbers suggest that there is some skepticism that it will translate into positive operating leverage.

Just wondering from your perspective how do you think about balancing the need to continue to deliver margin improvement versus some of the higher investment needs as you look at other growth opportunities?

I honestly, I think you're raising a very good point.

And I don't know if that's a view of some people on the street.

I don't understand that view.

I mean, there is obviously operating leverage in a business that has the scale that we got across wealth management across the primary space.

The core lines in the investment banking business, the incremental dollar of revenues coming on at a much higher rate than the embedded dollar revenue across all of our businesses.

So unless you get -- yes, we're going to have to invest, but that's part of what's call the incremental of dollar revenue to come on 30% margin rather than 50% margin.

That's part of the investment profile, but the assumption that you would not generate operating leverage with revenue growth, it just doesn't add up to me.

And it just hasn't been the experience.

We've had year-to-date 12% revenue growth and the expense ratio has dropped from 73% to 70.3%.

We haven't done anything to consciously reduce expenses.

We haven't shut businesses.

We haven't sold businesses.

We haven't had a major riff.

In fact, we had huge investments.

We just opened another fusion center in Singapore, I was out there a couple of weeks ago, we continue to invest in the cyberspace.

We're continuing to invest across all of our technology platforms, in automation, in AI, in big data, cloud computing, digital, the whole digital initiative across wealth management, expansion across the asset management businesses and building out new platforms, raising new funds.

All of these are investments that we're making continuously.

And we have been hiring talent.

So there is just no way if we produce another $3 billion of revenue, that you're not bringing on at a higher margin than the existing margin.

That is just not going to happen.

Our next question comes from Jim Michelle with Buckingham.

Maybe just following up, James, on the stability of earnings and revenue and how that translates to capital.

Because I think, I guess, one of the issues I've struggled with and investors have struggled with is you have sort of the biggest drop in the stress test in CET 1, and that obviously could have an impact if and when we move to the SCB.

So how has the dialogue gone?

How do you convince or think about the stress test and how that impacts your ability to return even more capital given that your ratios are dramatically higher than your peers?

Yes.

Jim, it is the question, and I'll start and we should spend some time on it, and I want Jon to weigh in on this because he has been pivotal to over discussions we had in with our regulators.

First question is, are you capital sufficient?

And that was addressed squarely last year with notwithstanding the results of the test under what most would suggest were unusually stressful scenarios.

Let me just put it that way.

But we and other banks were all committed to distribute the same level of capital that we distributed in 2017.

So that basically says, check, you're capital sufficient.

The second question is are you accreting capital above what you need to support the investments of the business, whether it's investments you're making, whether it's growing sheet in different parts of the business.

And as I said, with net income this year, already at $6.9.

Billion, we're heading for an $8 billion-plus net income, the record I believe was $6.6 billion last year.

So clearly, we're accreting capital about what our investment needs are.

The third question is, what will be our regulatory environment, the rules permit you to do.

We're in a transition period.

We're growing from a pure CCAR structure for an SCB structure.

I don't believe that change impact.

I'm sure, that change is not going to happen for 2019.

So 2020 on it will.

It remain several open questions.

How do you calculate -- so on just the more narrow, sort of 2019 CCAR, will there be changes to the scenarios that would generate a different kind of outcome from 2018, in other words was 2018 the high watermark in terms of scenario severity.

I believe it was, but until we see the scenarios, I don't know.

I mean, we don't have access to that information.

But I would suggest that it's highly likely that we have seen the high watermark.

And by the way, that high watermark translates into us suffering losses many times the size of what we actually did during the crisis.

So it is a high watermark.

The second is then how did the model apply themselves to the particular makeup of individual firms and that translates into your stressed losses, PPNR, et cetera and again, I don't want to prejudge that.

I'd like to just sort of see that play out, but worst case is we will not be worse than last year.

And with a greater more there than last year.

So by definition, we should be in a better position than last year.

The more interesting has been 2020 on, will there be a countercyclical buffer put in someone suggested, I doubt it.

Is the stress test buffer, the SCB buffer likely to remain at the initial levels that we put out, that remains to be seen, it could come down a little bit to be more consistent with what the European and firm banks are dealing with.

So I guess, my simple summary and I'll turn to Jon is, we've hit the high watermark in terms of stress scenarios.

And at some point, you can stress anything.

You could have capital equal to the size of your balance sheet, and have a leverage ratio one-to-one, but obviously you'd shut down your economy.

So at what level do you pass the infection where you're doing, you're affecting economic growth rather than generating it.

And I think we've picked it, that's my gut.

And in this transition, it will play out that we will -- as we accreting at this level, we should be able to increase our capital distributions.

Exactly how much?

We will have to see how the models produce.

Jon?

Yes.

I think James actually was pretty comprehensive.

I do agree that we're in this transition period.

We've been encouraged by the comments regarding tailored supervision.

We've been encouraged by the comments by both Chairman Powell and Governor Quarles around the industry being appropriately capitalized, which we have said since 2016, we believe we're sufficiently capitalized.

And we're starting to accrete more capital and currently in the forward 12 months going to pay out less than 100%.

So overtime, we will continue to either invest in our business, while return that capital.

So again we think we're capital sufficient.

We think the regime is going to go through some changes, and we believe we'll be able to continue to offer our shareholders an attractive capital return profile.

And the last thing I'll just add to that is 2 bugaboos that I've had for a very long time and communicated very directly is it's hard for me to imagine a scenario where your balance sheet grows during a time of financial stress and deflation of financial assets.

And secondly, I don't understand why Boards would continue to do a full capital distribution for 9 quarters after an economic crisis, financial crisis has occurred.

Under the current thinking around the SCB structure, balance sheets would not grow, that obviously makes both intellectual and intuitive sense.

And secondly, I believe that the capital what you would be required to continue to distribute would be just the dividends for 1 year.

Now these rules are in some state of development and comment period.

So I don't know where it's ends up but both of those things would suggest that the constraint that is been most powerful for Morgan Stanley, which has been our leverage ratio because our balance sheet grows -- if your balance sheet is not growing, that opens up a whole different kind of discussion and as you pointed out at the beginning we get back to CET 1 or total capital ratios and our numbers are phenomenal.

So we've got to see how these things plays out, but bottom line I believe we hit the high watermark and moved past it.

That was comprehensive.

I appreciate it.

If I could just maybe ask one thing, unrelated to capital, just on the, I think, there's been a lot of concern about NII growth from here.

Is your sense that at least could you update us on kind of the pickup in yields in growing the loan book versus the securities portfolio, as you kind of see that loan growth.

Should we expect a margin can continue to move a little higher?

I think that's the right characterization, I think last quarter, we mentioned that we saw NII growth in the 4% to 5% range for the year.

We're still comfortable with that.

We also said that it would be driven by average earnings growth or loan growth and that's really what's been driving it.

If you look over year-to-year, average earning assets are up about $7 billion or $8 billion and that's really primarily driven by the loan growth and that's primarily driven -- driving the NII growth.

We have seen healthy increase in asset yields but as we mentioned earlier, that's really been offset by the change in mix of our liability structure, not data per se.

But if you go back in time, we used to have one product, which was a sweep product.

In the third quarter of '17, that presented closer to 90% of our deposits.

Today, it represents closer to 75% of our deposits.

So that increasing asset yield has been sort of absorbed by the increase in the liability costs.

And therefore, average earning asset growth will be the primary driver, and we're still pretty comfortable with our ability to grow loans in our wealth business.

In the last couple of quarters, we have been growing at $1 billion to $2 million a quarter that feels healthy to us and that's also sustainable.

Our next question comes from Devin Ryan with JMP Securities.

I guess, a follow-up question here on the growth strategy on outlook and wealth management I know some of the things you've highlighted are gaining more wallet from existing customers in the high net worth channel, which are obviously growing, to banding relationships with younger customers through technology and then marketing to the stock plan participants.

So I was wondering if you could maybe touch on all those channels in terms of the longer-term potential, and then any anecdotes that maybe is making you feel good about where you are with some of the newer initiatives like the younger customers or penetrating the stock plan, just as I'm assuming that's where we've also growth accelerated as well.

I think you've done a nice job of articulating where we're going to get growth from in the business.

And really I think the biggest opportunity long-term, and these are all medium- to long-term, is really around asset aggregation and our ability to do attract incremental assets from our customers.

We know they have a lot of money outside of the firm, and some of the encouraging anecdotal stories as we roll out some of these new strategies is that our clients are much more open to sharing their financial information with us.

I think years ago, it was sort of -- you know you didn't want to aggregate all your assets at one firm.

I think we're seeing a little bit of a shift in that.

And that and as we rollout asset aggregation and the next best action and some of the programs that we have been rolling out to the FA community, we're all seeing good take up in that.

I would say the stock plan growth and the younger client growth, both of those are also sort of in their infancy in terms of the strategies and the implementation.

And they should long-term be attractive ways to aggregate assets.

Remember, a lot of the young clients don't have as much wealth as our older clients.

It's going to be a slow build but we continue to make the investments in the digital strategies and the stock plan program to be able to position ourselves to bring in more assets over time.

So I think the most immediate opportunity is really trying to attract incremental assets from our existing client base.

Okay, great.

And just to follow up here maybe good to get a little more perspective on just the investment banking activity levels in the various businesses.

And then clearly, some concern in the market just on kind of a being late cycle.

And so I'm just curious if you guys are actually seeing those kind of a normal signs of late cycle activity, whether it be overextending on deals or overpaying or just indiscriminate buying.

Is there anything that would tell you that we're kind of late cycle in those businesses?

Other than the fact that it's late in the cycle, we actually haven't really any real indications.

The healthy -- the pipelines are very healthy.

If you look at the pace of announcements in M&A, they haven't slowed down.

The capital markets are open.

Our IPO and debt underwriting backlogs are healthy and we're bringing things to market.

Now if we get into a period of prolonged volatility that might close access, but we haven't really seen it yet and the leverage loan market has been liquid and orderly.

You know that's a cash flow-driven market and cash flows are quite healthy.

So a lot of activity in that space.

There has been some repricing, but deals are still getting done inside of flex.

And for good deals, we see a lot of good support.

So other than we're late in a cycle, we haven't really seen any real indications at least from our business perspective.

Our next question comes from Gerard Cassidy with RBC.

I apologize if you guys addressed this, I had to jump on and off your call, but the first question is how quickly do your customers in wealth management expect to see higher interest rates passed on to them?

I know you mentioned, Jon, that I think cash is down about 6% of everybody's portfolios, but how quickly do they expect, when the Fed funds rate is raised, do you have to raise your rates within days of that to keep them satisfied?

Again, I think you got to think about these deposits for what they are.

And historically, these are really transactional.

People have them in the bottom of their investment accounts to transact To buy and sell securities, to have a little extra liquidity.

What we've seen as an investment thesis the percentage of cash that people are holding is lower and that what we have seen reflected in the system.

In terms of rate rises, we're very competitive with our primary competitors in this space.

We have our betas have outperformed our model betas.

So it's really not as the rate sensitive, if you will, it's really asset allocation sensitive.

And as people reduce their cash amounts, we continue outflow.

That being said, we're in a prolonged market rally here and historically, if we go into a different market environment, we have seen people pull cash out and put it back in their account.

It's very similar to sort of checking accounts.

I mean, it's the same sort of dynamics.

So the answer is betas have outperformed, and it's really an asset allocation versus a rate sensitivity.

Very good.

And then the second question is more of a qualitative question from what you guys are seeing out in the markets.

Clearly, credit quality across the banking industry is very strong today.

Your consumer wealth management area is high-quality, you don't have much trading risk anymore with the var being where it is.

But what are you guys seeing?

What are you folks telling you that they're seeing in the so-called shadow banking sector, the leverage lending area.

We're hearing that there seems to be some aggressive underwriting going on.

Is that a concern for you folks, 12, 24 months down the road?

Or just any color you can give us on what you guys are seeing out in the markets?

I mean, Jon is going to say something.

We're going to have to wrap up in a couple of minutes.

My gut is if other people want to engage in dumb practices, God bless them, but we're not and that's what I'm focused on.

So there is the always somebody out there always doing the marginal deal.

What I care about is and that's not going to blow up the market, but what I care about is overall asset bubbles or not and we're not in one and then how we're participating.

Yes.

I think specifically, I agree with James.

Specifically, in our portfolios, we've actually seen improving metrics in the ISG credit quality.

We've got good velocity there.

So we have been very active securitizer of some of our product.

And then on the wealth side, you said it's been very very stable.

We have not been impacted by some of these unfortunate hurricanes that we've seeing across the country and very, very stable metrics for us.

Our next question comes from Brian Kleinhanzl with KBW

Follow up question on the corporate lending -- it looks like the noninvestment grade exposures are down quite meaningfully.

Year-on-year and also your some drop downs during the commitments sequentially.

Are you actively derisking in the loans and lending balances in the Institutional Securities business?

The answer is we're not actively derisking.

We saw a couple of dynamics in the September numbers.

We were fronting some deals, which is why it looks like that we had a much higher exposure to noninvestment grade when in reality we didn't really have those exposures because they were syndicated across the bank lending, excuse me, the bank syndicate.

And then on the derisking point, we saw a lot of activity around the event book.

And as I mentioned earlier, we're also active in the commercial real estate securitization market.

We skewed more of our business in that area towords securitization versus held for investment just given the profile and where we are in the cycle.

So again we have been very disciplined around it.

That was really a function of just a lot of activity in the third quarter, and we expect to continue to sort of rebuild those pipelines and be active in those markets.

And then just one follow-up real quick.

You mentioned that clients are moving fewer providers in the equities business.

And I thought that trend started a few years back for the Prime Brokerage business.

Is it still early innings with a cash business as well as in the derivatives business?

Again, I think we are the #1 provider of those services.

We've got a very strong franchise there.

We have seen a little bit of consolidation with MIFID going into places, people reduce the number of counterparties they deal with.

But I think that the general comment was generally that the top providers, top 3 or top 4 or top 5 depending on the market, or the product, have generally been gaining share and we expect that, that trend will continue.

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

You may all disconnect, and everyone have a great day.