摩根士丹利 (MS) 2019 Q4 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, financial supplement and strategic update, 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 and strategic update.

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

Within the strategic update, our reported results for 2014 have been adjusted to exclude several significant intermittent items, which were highlighted in our 2014 annual report on Form 10-K.

Likewise, our reported EPS and ROTCE metrics for 2019 have been adjusted to exclude the impact of intermittent net discrete tax benefits.

These adjustments were made to provide a transparent and comparative view of 2014 and 2019 operating performance against our strategic objectives.

The reconciliation of these non-GAAP adjusted operating performance metrics are included in the notes to the presentation.

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.

2019 was a strong year, representing one of the best in our history.

Results were within our target ranges with contributions from each of our business lines.

Jon will discuss the details for 2019 in a moment.

But first, let me take you through our annual strategic update presentation.

Please turn to Slide 3. I think about our firm's transformation in 5-year increments.

Over the first 5-year period, we worked aggressively to clean up the issues from the financial crisis, stabilize the firm, integrated Smith Barney into our franchise and reset our strategy.

Over the next 5 years, we made significant investments in our business around digitalization, technology, talent and the balance sheet.

We grew revenues by 20%, while we managed expenses tightly, doubled net income and materially increased capital return.

Our ROTCE now stands at nearly 13%, and EPS has more than doubled, excluding intermittent discrete tax benefits.

Today, we will discuss the next phase of our evolution.

The goal continues to be to shift our business further, emphasizing more durable sources of revenue within Institutional Securities and from Wealth and Investment Management.

The continuation of this evolution should, by design, help support a base level of profitability during periods of market disruption.

Drilling a little deeper into this, throughout this decade-long journey, we defended and expanded our Institutional Securities footprint, which we show on Slide 4. Our brand is closely tied to our institutional presence and leading integrated investment bank.

Our premier institutional franchise remains a key competitive advantage, which has allowed us to take share and grow revenues despite a shrinking wallet.

At the same time, the contribution from Wealth and Investment Management continues to grow, as shown on Slide 5. Over the last 5 years, we've increased the profitability of our Wealth Management business, while still making investments in the U.S. banks and our Modern Wealth Platform.

Of particular note, on nearly 100% of business days, we have revenues greater than or equal to $60 million, nearly 3x that which it was 5 years ago.

We also invested in our Investment Management platform.

We put together a new growth-oriented leadership team and focused on clients, solutions and new products.

We highlight the growth in long-term net flows, which reflects strong long-term performance.

With combined revenues of approximately $21 billion, our Wealth and Investment Management businesses are among the largest platforms in the world, and now we have an untapped opportunity to further scale our Wealth Management channel through our workplace offering.

Meeting these ambitions for future growth would not be possible without a strong culture and a cohesive team.

On Slide 6, we describe our culture and the tenure of our leadership team.

We have an 8-year track record of stating and meeting various public goals.

We continue to invest meaningfully in our culture and diversity efforts to ensure we remain an employer of choice for our top talent.

And further, Morgan Stanley has been at the forefront of sustainable finance.

We founded our Global Sustainable Finance Group over a decade ago with the mission to accelerate the adoption of sustainable investing across capital markets.

I want to spend most of my time providing a bit more detail about the future opportunities we're excited about and that we see across our franchise.

Across our segments, we have platforms with scale benefits, and we're positioned for growth.

Let's start with Institutional Securities on Slide 7. Our institutional footprint and franchise is extremely strong.

In the face of a declining wallet, we've gained share over the last 5 years across our institutional businesses, and we have reason to believe these gains are sustainable.

Our business has benefited from the stability of the leadership and commitment to a global client footprint.

We expect to continue to hold and gain share across the division.

On Slide 8, we take a deeper look at Wealth Management.

2020 marks a new chapter in our Wealth Management strategy.

The significant investments we're making in the digital space and the acquisition of Solium position us to efficiently service the mass affluent population and capture new clients and assets through the workplace.

Moreover, we can leverage the corporate relationships we have built through our institutional offering as we look to add new corporate clients.

We've completed the Morgan Stanley @ Work offering to expand beyond just Shareworks by Morgan Stanley, our stock plan administration platform.

We're enhancing and investing in our financial wellness and retirement offerings.

This more fulsome suite of products allows us to deliver services to an even larger base of employees.

And this will help ensure that our touch points are not limited to stock plan participants.

As illustrated on this slide, we're continuing to win new mandates.

The combination of the state-of-the-art Shareworks platform and the Morgan Stanley Wealth Management capabilities is being very well received in the marketplace.

We expect to fully convert all of our existing corporate clients to the Morgan Stanley @ Work model by the end of 2021.

To date, nearly 40% of those plans on the legacy Morgan Stanley system have been transitioned to Shareworks.

And the remainder will be accomplished by year-end 2020.

Then by the end of '21, individual employees of our corporate clients will gain access to financial coaching, exclusive educational content and our self-directed brokerage offering, providing them with an introduction to our Wealth Management services.

Over the next 5 to 7 years, we expect to convert over 1 million employee participants to either wealth management digital or advisory channels, adding to the more than 3 million client relationships we have today.

We'll be able to provide a compelling offering for all our relationships, servicing the ultra-high and high net worth segment with financial advisers and more mass affluent clients with our virtual adviser or digital solutions.

Moving to Slide 9. We've been clear that we believe that supporting advisers with cutting-edge technology and enabling them to deliver unique product and set of services to clients will be our competitive advantage going forward.

The investments we made with our digital initiatives have been embraced by our advisers.

And anecdotally, these tools are supporting asset consolidation.

Additionally, of course, we've seen over $250 billion of assets flows in advisory over the last 4 years and continue to believe that at least half of our client assets will migrate to advisory over the medium term.

Let's talk about Investment Management on Slide 10.

The asset management sector is both very large and extremely fragmented, lending itself to opportunities for growth in areas where we believe we can deliver differentiated value to our clients.

And to me, one of the most exciting things we've done to capture this opportunity is product innovation, illustrated by the number of new products we have developed.

These products have broadened our revenue base, made us more relevant across the client spectrum and translated into material revenue and asset growth.

Since 2016, we've launched many new products successfully, leveraging our global client franchise.

We've already seen significant contribution from these products, generating $90 billion of incremental assets under management and almost $500 million of incremental revenue in 2019 versus 2016.

These strategies, continued new product launches and investments in our client franchise more broadly will be a very important component of future growth.

Another key driver of growth is our existing diverse alternatives client franchise.

As you can see on Slide 11, our alternatives client platform is at scale, and there is strong secular growth in private alternatives.

In addition to new private alternative product launches noted on the prior page, we're seeing strong organic growth in our existing high-performing private funds.

For example, our infrastructure #3 fund, which closed in the fourth quarter, is over 50% larger than infrastructure 2, raising $5.5 billion of institutional capital versus $3.6 billion, respectively.

Further, we continue to see very strong organic growth in our premier institutional core real estate strategy.

Our alpha products across both private and public markets as well as our world-class global solutions capabilities will be critical contributors to Investment Management's revenue growth.

And our public active equity strategies have strong performance, and global client footprint has driven robust net flows.

We believe we ranked #1 in organic growth since 2017 among the top publicly traded active equity managers.

So let's turn to Slide 12.

We expect that these and all our other growth initiatives, along with expense discipline, will drive further ROTCE expansion.

In 2015, we communicated that we believe we were capital sufficient.

And since that time, we've continued to deploy our capital to meet our strategic objectives.

We look forward to the transition to the new capital regime and expect Morgan Stanley will be able to return excess capital to shareholders while continuing to invest for future growth.

Our robust capital position will enable us to pursue opportunities to invest in the franchise and return capital.

We're confident in our ability to deliver 2-year ROTCE expansion of 13% to 15%.

I'll conclude with our updated strategic objectives.

The targets we expect to achieve in 2021 as well as our longer-term aspirational targets are shown on Slide 13.

We have meaningfully and with intent transformed this business into what it is today.

As we execute on the next phase of the firm's journey, the objectives listed here, assuming a normal market environment, should result as a natural consequence.

We believe that in 2021, Wealth Management will be a 28% to 30% pretax margin business and will exceed 30% over time.

This business has compelling scale benefits between our core competency of serving ultra-high and high net worth individuals and our near expansion into the workplace, there is clearly room to grow from here.

Beyond Wealth Management, we're making numerous investments across all of our platforms to enhance the digitalization of our firm and overall technological capabilities, given our scale and other efficiencies.

We have largely been able to self-fund these investments.

Between this and revenue growth, we expect to achieve an efficiency ratio of 70% to 72% in 2021 and below 70% in the long term.

As a result of these and all the other efforts, we expect our return on tangible common equity to rise to 13% to 15% in 2021.

And over the long term, we aspire to have a return on tangible common equity of 15% to 17%.

Given our established track record, our competitive positioning and our continued investment into our business, we're confident in our ability to achieve each of these objectives.

I will now turn the call over to Jon, who will discuss our fourth quarter and annual results, and then together, we will take all of your questions.

Thank you.

Thank you, and good morning.

The firm produced a record level of revenues in 2019.

We had strong momentum through the quarter and finished the year on solid ground.

In the fourth quarter, firm revenues were $10.9 billion, increasing 8% sequentially, contributing to full year revenues of $41.4 billion.

Fourth quarter PBT was $2.7 billion, and EPS was $1.30, resulting in an ROE of 11.3% and ROTCE of 13%.

In the fourth quarter, severance expenses of $172 million related to a December employee action and intermittent net discrete tax benefits of $158 million largely offset each other.

For the full year, ROE was 11.7%, and ROTCE was 13.4%.

Total noninterest expenses were $30.1 billion for the year.

Noncompensation expenses were essentially flat to 2018 at $11.3 billion, demonstrating our ability to self-fund incremental costs related to absorbing and integrating Solium and increased technology investments through continued discipline over our more controllable expenses, particularly marketing and business development and professional services.

We continue to actively review efficiency opportunities, including optimization of our global workforce through reduced dependence on contingent workers and leveraging our global in-house centers.

We also see opportunities for vendor consolidation across the firm over time.

This focus will result in continued momentum to control our noncompensation expenses and help us achieve the objectives that James just discussed.

Compensation expenses increased 7% on a full year basis.

This rise included severance charges and significant movements in deferred compensation plans as well as increased revenues.

Our full year expense efficiency ratio was 72.7%, below our 73% target.

Now to the businesses.

Our Institutional Securities business reported revenues of $5.1 billion, marking the best fourth quarter in over 10 years.

Results were driven by strength in investment banking, especially advisory.

Additionally, we did not see the seasonal slowdown in Sales and Trading or underwriting typical of a fourth quarter.

For the full year, ISG revenues were $20.4 billion, slightly below last year's record level.

The compensation ratio for the quarter rose to 40.7%, reflecting $124 million of severance related to the December action and the impacts of movements in investments associated with employee deferred compensation plans.

After considering the impact of these items, the fourth quarter compensation ratio was approximately 36%.

And looking at the full year, again, after considering these adjustments, the compensation ratio was under 35%.

DCP creates some volatility in this ratio, but as we have said many times in the past, it has a very limited impact to the bottom line.

Investment Banking had the strongest fourth quarter in a decade, generating revenues of $1.6 billion.

The sequential increase was driven by strength in advisory and seasonally robust results for underwriting.

Overall, pipelines are healthy across products.

The pace of M&A remains strong, and we would expect the period of activity to extend.

The global equity pipeline remains robust as many issuers target capital raises in the first half of 2020, particularly across health care, consumer and technology.

As we said before, the conversion from pipeline to realized remains dependent on market condition.

In Equity sales and trading, we retained our leadership position and are #1 globally for the sixth consecutive year.

Fourth quarter revenues were $1.9 billion, down 4% sequentially.

Strength in the Americas was offset by declines in EMEA and Asia.

In cash, we continued to expand our share across regions, which partially offset the impact of lower global market volumes.

Prime brokerage performed well as client activity rose during the quarter, with equity markets trending higher.

And derivative revenues declined sequentially as lower volatility weighed on results.

Fixed Income sales and trading produced revenues of $1.3 billion, down 11% from a robust third quarter.

We continue to deepen our relationships with our client base.

Results were driven by strong performance across the credit complex.

Micro produced another solid quarter with well-diversified performance.

Healthy levels of client engagement supported results.

We continued to invest in our secured lending businesses, which performed well and witnessed increased client interest from commercial real estate products.

Balance sheet velocity remains a focus in this business and on a full year basis, improved from the prior year.

Macro results declined versus the third quarter due to lower client activity.

Commodities revenues also declined sequentially.

However, client activity and further geographical diversification of the revenue mix supported results.

On a full year basis, Fixed Income was up 11%.

Strong performance in micro outweighed the decline in macro, where a difficult environment weighed on results in FX and rates.

Turning to Wealth Management.

We reported fourth quarter revenues of $4.6 billion and pretax profit of $1.2 billion, resulting in a PBT margin for the quarter of 25.4%.

Strong revenues were offset by higher seasonal expenses as well as a $37 million severance charge, which had an 80 basis point impact on the margin.

On a full year basis, the PBT margin was 27.2%, representing a 100 basis point expansion over last year.

The business continues to illustrate the benefits of scale.

While investing in this business and absorbing the Solium expenses, noncompensation expenses declined 3% from 2018.

Transactional revenues were $829 million, up 39% sequentially.

Results were principally driven by gains in investments associated with employee deferred compensation plans as well as improved retail engagement.

Asset management revenues were essentially flat versus the prior quarter.

On a full year basis, asset management revenues were also flat as the large market decline in Q4 2018 impacted first quarter results.

Total client assets of $2.7 trillion increased 5% sequentially and 17% versus the prior year, reflective of broader market movements.

Over the last several years, we have seen net new assets of approximately 4% of beginning period client assets.

While these flows are an indicator of the health of the business, we continue to believe fee-based flows are a more relevant driver of near-term results.

We had $25 billion of fee-based flows in the fourth quarter, a record.

The shift towards advisory continued, and fee-based assets now represent 47% of total client assets, up from 45% last year.

Loan growth continues to be strong across products.

Lending balances increased to $80 billion or 11% versus the prior year.

We continue to see strong receptivity in our lending offering.

Our investments into technology have better enabled our advisers to identify clients who would benefit from our lending product suite.

This has been especially effective in securities-based lending.

We expect to continue to see strong receptivity, resulting in loan growth of mid-single digits in 2020.

Total deposits rose 5% sequentially.

Within our bank deposit program, we have seen stable deposit levels since May with a seasonal uptick in the fourth quarter.

We continue to invest in new banking products, and our high-yield savings product has also continued to gain traction.

Our new money savings campaign has raised close to $14 billion since it's March launch.

Net interest income was in line with last quarter.

On a full year basis, NII was up slightly, [excluding] (corrected by company after the call) the impact of prepayment amortization.

Over the next year, we would expect the full impact of 2019's 3 rate cuts, the realization of the forward curve and the continued diversification of our deposits to offset the benefit of our lending growth.

As James discussed, we will continue to invest in our workplace offering and also build out our U.S. banks to drive further growth.

That being said, we would expect the margin to rebound nicely in Q1 from its fourth quarter seasonal low.

Investment Management reported revenues of $1.4 billion in the fourth quarter.

For the full year, revenues were $3.8 billion, representing a $1 billion increase from the prior period.

Total AUM rose 9% to $552 billion, of which long-term AUM was $356 billion.

We continue to generate strong positive net flows across major, high-conviction active strategies.

Long-term net flows were $6.7 billion, the strongest in 8 years.

And we had another strong capital-raising year, capped off with the close of our $5.5 billion infrastructure 3 fund.

Asset management fees of $736 million grew 11% versus the third quarter.

Recall, a significant amount of performance fees are recognized in the fourth quarter.

Performance fees for the quarter were driven by strong results in our core real estate strategy, and management fees increased on higher average AUM.

On a full year basis, asset management fees increased 7% to $2.6 billion.

Investment revenues were up $565 million in the quarter and $1 billion for the year.

This line is primarily driven by carried interest, which is earned from clients who are invested in our private funds.

The increase this quarter and year was primarily due to an underlying investment, IPO, subject to sales restrictions within an Asia private equity fund.

This event generated a significant amount of accrued interest revenue, the ultimate realization of which will depend on the monetization of the underlying position in the fund.

As we have previously said, this line is lumpy.

Other revenues were impacted by an impairment of a legacy equity method investment in a third-party asset manager.

Total expenses increased 52% sequentially.

In particular, higher compensation costs are reflective of higher accrued carried interest compensation, which was primarily related to the event I just discussed.

Noncompensation expenses were driven by higher BC&E expenses related to the launching of new products and reflecting our continued investment into this business.

This business continues to grow, and we expect it will be an increasingly meaningful contributor to total firm earnings.

We continue to look for organic and inorganic opportunities to grow this business to -- and to effectively meet the needs of our clients.

During the fourth quarter, we repurchased approximately 31 million shares or $1.5 billion of common stock, and our Board declared a $0.35 dividend per share.

After considering $158 million and $348 million of intermittent net discrete tax benefits, our tax rates were 21.4% and 21.3% for the fourth quarter and full year, respectively.

We expect our 2020 tax rate to be slightly higher or approximately 22% to 23% and will exhibit some quarter-to-quarter volatility.

Taken in full, we are pleased with the firm's results this year.

We entered 2020 with asset levels at new highs, healthy pipelines, constructive markets, engaged clients and a right-sized expense base.

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

(Operator Instructions) Our first question comes from Glenn Schorr with Evercore ISI.

Just curious, within your 2-year objectives, what -- particularly on the ROTCE, what capital return assumptions are incorporated into that?

Is that steady state now?

Or any changes from what we've seen the last couple of years?

Well, again, just from a technical standpoint, as we haven't seen the new proposals, which we think are forthcoming, it's sort of hard to say what the future return profile looks like other than it will be consistent with what we've done prior until we have more information.

Okay.

Fair enough.

On the gain in that Investment Management, I guess, IPO out of a private equity fund, I'm assuming there's a standard lock up and illiquidity discount.

Can you tell us what that company is so we can track it, so we don't have surprise ups and downs every quarter?

I'll give you some more information on that.

But first, I'd clarify there's no illiquidity discount there.

The company is public, and it's marked to the stock price on a daily basis.

And you mentioned, it is in the Asia -- one of our Asia P/E funds.

It was an investment we made more than 6 years ago or the fund made more than 6 years ago into a China consumer products company.

The company has been quite successful and grown quite nicely.

And it went public in the fourth quarter on the Hong Kong exchange, and the IPO has performed quite nicely.

To give you some sort of context around the round numbers, the investment that we made was less than $50 million, and the current investment value is approximately $2 billion.

So we have not only the carried interest, we also have a small LP investment in the fund.

And so the ownership and carry is going to be fluctuating until we have the underlying investment monetized.

So as of today, we're comfortably above the preferred return threshold in that fund.

But as I said before, it's an unrealized gain.

So we'll have more volatility if there is volatility in the stock price.

So just to sum up, given the size and given that it's public, we would expect a little bit more volatility in that investment line in IM.

And we would also expect corresponding volatility in the IM compensation line as the investment team has about half of the carry typically.

Our next question comes from Christian Bolu with Autonomous.

Maybe a question on Wealth Management.

I believe you made -- you recently made some changes to the comp grid that should be beneficial to Wealth Management margins certainly next year.

I think longer -- the question is longer term, can you keep pulling the comp lever?

And I guess as I look at the industry and what's happened over the last decade, whether it's warehouse consolidation, the demise of the broker protocol, more client stickiness because of lending and technology, it feels like you can do that, but be curious to get your thoughts on using the grid to drive margins over time.

Well, listen, I'll take that.

We're not using the grid to drive margins.

We use the grid to drive behavior to help us do a better job with our clients.

So most of the changes of the grid over the last decade have been designed to do exactly that.

They have supported asset-based accounts, supported working with more sophisticated complex clients.

They have supported larger producers who have been growing their business.

So I don't think of the grid as an expense item.

I think of the grid as, frankly, what really reflects what we're trying to do with the business, and the best advisers embrace that.

And we've had great stability among the top advisers as a result of that.

So Christian, the changes this year were modest and -- but within the changes, sort of under the covers, there are more significant changes as you move -- compose effectively from one set of behaviors to another.

And ultimately, the goal is to continue to professionalize the financial adviser workforce, which is a fantastic group of people, and being transformed in the last decade from producing something like $300,000 revenue to over $1 million revenue per person.

And the grid's got to be aligned with their interest as well.

And that's something Andy and the team are very focused on.

Okay.

Maybe just to get back to the question I think Glenn asked earlier on.

Because the ROTCE target does stand out, the 15%, 17%.

It is -- it does catch one's eye.

Can you just maybe just help clarify like what level of capital you assume?

Do you assume like the absolute dollar of capital level will go down over time, and that's how you get to 15% to 17%?

I just -- it would be great to get that sort of like clarification.

Yes, I'm probably going to disappoint you, Christian, and not give you exactly what you'll need for your model to produce that answer.

We run the business based upon a myriad of things that we see from global economic growth to market share we have in each of our businesses, to the capital we're using to prosecute our earnings in those businesses, our ability to drive efficiencies across the group net of investments that we're making.

And we're currently running an ROTCE around 13%.

And so the 2-year objectives feel like it's -- there's no compelling reason why we'd go below that in any individual quarter.

Of course, these things bounce around, as you've seen in our numbers over many, many years.

But over that time period, we think that 13% to 15% is a very reasonable expectation.

And assuming normal market condition, we will deliver on that.

The longer-term aspirations are really speaking to where we see embedded scale we have in our various businesses, what the longer-term growth projection looks like, our ability to manage our expenses.

You'll see our noncomp year-over-year were essentially flat this year, which -- and modestly, it's pretty impressive given that we're investing in a lot of parts of the business.

So if you just roll the math forward and make reasonable capital assumptions, you'd get to those ROTCE numbers of 15% to 17%.

There is, as always, through the CCAR and the capital process, a kind of wildcard.

How much do you ask for?

What's the stock trading at when you're doing your buybacks?

Do we increase the dividend?

Are we going to make other acquisitions or investments along the way?

There are a lot of things that drive the longer term.

But what we're trying to set when we set longer term is what do we believe the potential for this business is.

Many, many years ago, when our Wealth Management margins were around 10% or 11%, we set a target of 15%.

And I'd said publicly, I thought they could get to 20%.

And obviously, we exceeded that, and the whole transformation of the business helped on that.

Many years ago, we set an ROE target of 10% when I think our ROE was around 2% or 4%.

And we were constantly asked on this call, "When are you going to get there?" Like the kids in the back seat in the car saying, "When are we going to get there?

When are we going to get there?" And we kind of got there.

And our feeling now is there's no compelling reason with normal economic growth and good discipline around expense management and the embedded scale in our businesses and the strength of the culture why these returns shouldn't be achievable over a longer-term period.

Our next question comes from Brennan Hawken with UBS.

Question on the pretax margin target here in wealth over the next 2 years.

Good to see you guys expecting a nice step up.

Could you talk a little about the market and revenue assumptions embedded within that target?

And at this point, you guys seem to have implied generally, especially with your comments just a minute ago, James, that about noncomp flattening out here in 2019 that we should be expecting self-funding of investment and a more stability in the noncomp as opposed to the growth of prior years.

Is that fair?

There's a couple of questions in there.

I think when we think about our budgets, we generally use a sort of consensus views on markets and rates.

And that's what we've done here.

The 28% to 30% margin target, as you said, is a nice improvement and continues to trend.

It also gives us the flexibility to continue to invest in this business, which we will continue to do around our Shareworks platform and the Morgan Stanley @ Work.

We've done a lot of work around the digitalization, which James talked about, which is critically important to the customer experience and the client experience, and we'll continue to make investments there.

And so I don't think there's any outsized expectations around markets or rates.

Just what we see in the consensus view going forward.

Yes.

I think, Brennan, we're -- I think that we finished the year at 27.2%.

Obviously, fourth quarter -- and somebody will probably ask us about it, so I'll address it right out, was 25 and change.

There is some seasonality.

We had some severance expenses in there, DCP and other stuff.

So as I said before, these things will bounce around quarter-to-quarter.

I can't guarantee where the first quarter is going to be, the second quarter, third quarter.

But over a full year, we're at 27.2% with normal economic growth.

What we've done with the business, I think that 28%, I'd be disappointed if we're not at that.

I'll just put that out there.

Can it be higher than that?

That's why we put a range on it.

Do we think it's going to be over 30% in the next 2 years?

No, we do not, and I think we've got to be responsible when we set these targets about what we think is a likely outcome, not a 3 standard deviation outcome.

What is the likely outcome.

And coming off a 27.2% margin, 26.2%, I think, the year before, approximately -- it's kind of grinding higher.

Why is it grinding higher?

Well, as you bring incremental revenues in, the incremental margin on the incremental dollar of revenue is higher than the embedded margin, so we're grinding higher.

Sure, sure.

That makes a lot of sense.

Clearly, the Solium should also -- the Solium acquisition and integration should also help, too.

Appreciate that.

I think you made reference, James, in those comments, too, what the underlying margin might have been in the fourth quarter.

I know -- I think, Jon, you said 80 basis points from severance and wealth.

So that gets you to 27%.

There was some DCP, but I don't think you talked about what impact that would have had on the Wealth Management margin.

If you could please let us know that?

And just a request, maybe -- I know it doesn't impact the bottom line, but the DCP creates some noise around some of the underlying metrics, which makes it -- it can blur investor visibility into the underlying trends.

It'd be really helpful if you could disclose that or consider disclosing that going forward.

Yes.

So just -- I appreciate the comment, and we continue to give further thought to that.

But we do give a reasonable amount of disclosure in the K around that.

We try to highlight it to you when it's a meaningful contributor based on meaningful swings in the marketplace across all the businesses.

As I said before, the PBT impact is not material.

Generally speaking, $1 of revenue versus $1 of comp expense.

Your fourth quarter comment, though, we generated 25.4%.

I think you said with the 80 basis points, we'd be at 27%.

Obviously, we'd be at 26.2%.

And then by definition, when you look at all of these ratios, they are negatively impacted by that dynamic.

It's effectively 1 for 1. It's not precise, but that's what we, to simplify, have been using.

And again, I appreciate the comment, and we'll give it some thought.

But we obviously feel very comfortable with the new targets that we laid out at 28% to 30% on that margin.

Brennan, you make a good point.

It creates noise.

I mean, I remember the old days when we used to have to deal with DVA on these calls, which would move -- I think, 1 year it moved $6 billion and sort of bizarre impact it had on our financials.

Fortunately, we got -- we managed to clean that up.

The DCP, I mean, the funny thing is it's kind of a good news story, right?

You actually want it to be messing with the numbers like this in a positive way because it means the stock has done well, which people are invested in and the markets are doing well.

This was a year where -- what was the S&P?

It was up 25%.

And the stock was up 28%, 29%.

So pretty unusual year.

And that's why I think we're seeing the outsize on this year.

I wouldn't -- I'd be -- I mean, listen, if that happens in 2020, I'll be delighted.

And I don't mind the noise if we get that outcome.

But I'll leave it to the accounting and controlling team to figure out what the right disclosures are, but that's where we are.

Our next question comes from Steven Chubak with Wolfe Research.

So appreciated some of the additional disclosure on the Wealth Management conversion targets from Sharework.

Certainly, that's an area where there's significant interest post the Solium deal.

I recognize it's a 5- to 7-year goal, so you certainly have a lot of time to execute on that conversion target.

I was just hoping that you can maybe help us frame how we can think about either the incremental revenue or even just AUM growth opportunity over that horizon if you ultimately execute on that goal.

And just separately, do you expect the pace of on-boarding to be somewhat linear?

Or is it going to be more back-end loaded?

Let me try to answer that.

I mean, a couple of things.

One, first of all, we had -- Solium was only in our results for 8 months this year.

I think we've mentioned before that it was dilutive to PBT, so obviously, dilutive to margin.

We'll have the full effect of the acquisition this year, which will also be dilutive to margin and to PBT, and then we would expect it to turn potentially PBT neutral or positive and then to build over time and improve the margin.

The conversions are -- there are several stages, as James mentioned.

There's just making sure that we get all of the corporate clients onto the Shareworks platform.

That's accelerating.

That should be done this year and then integrating it into the Morgan Stanley @ Work platform will take another year.

I think we'll see sort of an acceleration, a slow build, if you will, of converting our Morgan Stanley @ Work clients into either the digital or advisory channel, but we think 1 million incremental customers on our current base would be quite attractive and a real nice growth engine.

Obviously, the potential for the different dynamics around the size of that client, i.e., whether it's mass affluent versus ultra-high net worth or high net worth will have an impact to asset levels and cash levels and net new assets.

But again, incrementally, if we think we can bring on another 1 million customers in 5 to 7 years on top of our current existing base, it's why we're so excited about the opportunity.

Got it.

And just one follow-up for me.

I was hoping you could speak to some of the underlying assumptions, just specifically on the macro and maybe industry fee pool outlooks, particularly on trading in IB, just supporting some of the near- and long-term return objectives.

I'm sorry, trading -- what did you say?

Just Investment Banking fee pools as well as just some of the underlying macro assumptions underlying some of the return targets.

Yes.

Again, so I think that we'll obviously have to see where the pools come out this year when everyone finishes reporting and we get the data.

It looks like pools are pretty stable.

I think from a budgeting -- I think, from a budgeting standpoint, we generally think about those types of pools growing with sort of GDP, so sort of very limited or sort of a couple of percentage point type growth in the pool.

And then we couple that with our view on investment dollars and share points.

So that's generally the macro backdrop that we use for the budgeting, which we'll obviously track consensus views on GDP and U.S. growth and so on and so forth.

I'd just add.

I mean, we don't talk, ironically, as much about the Institutional Securities business, which has sort of been our core and our lineage since our founding 85 years ago.

But in each of the -- we have a slide in there that shows in each of the 5 businesses, debt underwriting, equity underwriting, advisory, M&A, equities and fixed income, they were able to gain share over that 5-year period.

And this year, they delivered their fourth consecutive $5 billion revenue quarter.

And we'd never had a year where we've had 4 $5 billion quarters.

I mean, what this business has been characterized by at least one and sometimes 2 pretty volatile and difficult quarters each year.

Now we can't -- and it's obviously more vulnerable to market swings.

But I think what the team has done in balancing out the business, Ted and the group have made it a much more stable organization, I think, within Fixed Income, the way that's been turned around with stability to Sam and his team.

I see it -- it gives us more comfort that we've got a lot more stability embedded in the business from prime brokerage financing through to the M&A, which remains very stable.

Obviously, you're going to have volatility, but we think these shares are sustainable.

Some places, we could grow share.

But it's really a function of stability is what I'm very focused on for this business because the capital on the balance sheet, shall we say, is stable.

It stays there.

So we need the revenues to be stable, and that's what they delivered.

Our next question comes from Mike Mayo with Wells Fargo.

I'm wondering if your minimum targets are high enough.

Slides 7 through 11 highlight what you expect in Institutional Securities.

The 5-year share gains would continue.

Wealth Management, you increased clients there by 1/3, albeit over a longer time frame.

Investment Management, you have new products, you have digital initiatives, noncomp is flat.

It's all going well, and you reported 13% ROTCE last year, and you look for a minimum ROTCE of 13%.

So why not raise that minimum floor?

Mike, we now go back a long way, and I'd have to say you're a model of consistency.

I think I'm not sure we've ever had a call when you haven't ask for higher targets.

And it's hard to feel defensive when we're talking about wealth management margins above 28%, efficiencies at 70-plus percent and ROTCEs at 13% to 15%.

Listen, our job is to be as transparent and realistic as we can.

These targets have one significant caveat, which is the markets.

If the world collapses, they will be very difficult to meet, and we will not be the only financial institution struggling with meeting whatever public targets they have out there.

We don't run this place on the basis the world is about to collapse.

And we have no evidence that 2020 is going to be a difficult economic year.

Difficult politically, potentially geopolitically, but certainly, the economic outlook remains very, very stable.

So when we do the math and put the targets together, we do it based upon a balance between what is that downside in a normal scenario, and what is a realistic upside over the near term.

Longer term, that's great.

That's sort of -- it's fun, and it's interesting, and it's sort of saying what could we deliver aspirationally.

And that's probably where your head is, in the longer term, part of that chart, the right-hand side.

But in terms of running the business and in terms of thinking through our capital deployment, our dividend strategy, our compensation, our -- all of our investments that we're making, we really focus, frankly, on the 2-year objectives.

And what I've always tried to do with these targets is set a range where the bottom of the range is what we should be able to deliver in all normal circumstances.

The top of the range is obviously a little more sporty.

So listen, I would love for us to deliver on your more aspirational views each year, but we can't reliably project that.

So I don't think we should reliably project it.

And if you folks want to model in different numbers, that's obviously your decisions, but we've got to do what we think is right.

And then just to follow-up Slide 7 and 8. One is the expectation to continue to gain share.

I get the share gains from the European banks, but your expectations is for that to continue.

And then on the Wealth Management side, going to the mass affluent, you're going down market to the teeth of the Schwab 0 commission for wealth and after a number of years of kind of moving back from the lower-end clients.

So just if you could address those 2 specific areas.

Yes.

Well, I think the word we used was sustainable share.

We certainly don't see our share going backwards in these businesses.

And there is clearly -- in different parts of the institutional business, we think we can gain share in certain regions in the world where we're looking forward to getting our full China license there and continuing to grow out our Asia presence, for example.

So I feel good about these share numbers.

You point out that there are different parts of the industry that are going through larger transitions now, those kinds of things we were doing several years ago.

So there is potential share upside.

No question about that.

We can't model that because that would be pretty aggressive, but you can certainly -- we certainly affirm that the share we have now is stable, normal market environment growth.

That obviously translates into higher revenues, and we think there's some upside on share.

On the going down market, I think about it differently.

And for sure, commission pricing has been going to 0 in small trades for a long time.

And there have been examples of that in the digital space for years.

I think the move that Schwab made just accelerated what was something that have been happening for a long time.

And their business models are not built around their secondary commission revenues, that I -- you and I understand.

I don't think about this so much as going down market.

I think about it as opening up a new segment to Morgan Stanley.

There are basically 3 ways in which people have their wealth managed: One is through some sort of advice whether it's full service, private bank, trust bank, independent financial plan, our financial advisers and so on.

And we are very dominant in that space.

The second is direct digital, and there are a whole set of new platforms.

But there are some very established, at-scale players in that space.

And the third is the workplace.

And the workplace remains -- there are certain players who've been very dominant in it, but we think this is also a very interesting space.

Solium gave us a leg into it.

We see a lot of financial wellness, financial advice, financial planning that can be brought to employees.

If they're into a default digital account, when their stock plans vest, for example, that's sort of -- that's relatively easy for us to drive on a digital and direct platform.

So I see it less sort of characterizing as going down market and more characterizing as just expanding the universe of clients.

There are a lot of people out there, working companies making good money through these share plans.

They do not want or need one of our large financial adviser teams, that's for sure.

But that doesn't mean they can't have access to what Morgan Stanley can deliver.

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

I realize you don't want to give all the details on the expense adjustments related to deferred comp, but I guess I'm trying to get a sense of the kind of full year efficiency ratio of 73%.

As I think about kind of getting to 70%, 72%, it would be helpful if you could give us kind of the clean base for this year either now or I guess, it's probably coming in the K, but it will be helpful just to get that base.

And I guess my question is, if you don't want to that, really just as we think about the efficiency improvement, can you just elaborate a bit on the drivers?

Obviously, it's a little bit of revenue growth, as you talked about, a little bit of growth in wallet and some of the efforts in wealth.

But just maybe elaborate on, is there opportunity to bring the comp rate down?

And on the noncomp, is it about keeping it flat?

Or maybe some opportunities to cut on an absolute basis?

Yes.

So I think I've given the comment, and we've given the comments and we hear you on the DCP.

So I'm just going to focus.

You can see from our targets that we've lowered the efficiency ratio.

We had a little bit of severance in there.

And again, the DCP adjustment would be -- would also impact that ratio slightly.

But I think when we think about expenses,and expense discipline, we're talking about expense discipline across all categories of expenses, both comp and noncomp.

We allocate resources at the firm level, which is why we have a firm efficiency ratio target.

Some of these ratios get a lot of attention to them when they are -- if you think about the comp ratio within ISG, that's only 40% or less than 40% of our comp versus the totality of the firm.

We constantly have been focused on being disciplined on comp and noncomp.

What we will say is that we have been disciplined on comp.

If you -- the only things that we continue to try to do and we have done quite successfully is to pay our people competitively across all of our businesses, and we try to attract and retain talent.

But we're disciplined across all those categories.

When we get to the noncomps, we've been very focused on professional services as we've grown our businesses, and we've grown some of the digital and technology and digitalization of the firm as well as complying with the regulatory agenda.

We relied on sort of contingent workers and consultants to help us build out this practice.

And as all of that has matured and turned more into BAU.

We've been able to rely more efficiently on employees, which is why you've seen the headcount grow even after the December action.

And so we've been able to take out some expenses there and optimize the workforce.

I mentioned vendor consolidation.

We've done data consolidation in the past.

So we're constantly looking for opportunities in the noncomp space to continue to self-fund and drive efficiencies.

And those types of categories are the ones that I would just say that we'll continue to focus on in the future.

And we all -- and we have finally seen some productivity gains around the significant investments that we've made in technology and digital, and that's led to some of the actions we've taken as well.

I would just say something about the comp ratio, and I think it's important to say it.

Years ago, when we started on this journey, the ISG comp ratio was 62%, I think, if memory serves me.

And Wealth Management, I forget what is, but it was well in the 60s.

And we had a long-term aspiration to get, I think, Wealth Management down to 55%, 57%, and ultimately, ISG to 40%.

We -- the last time we publicly set a comp ratio goal for ISG I think was in 2015, which was 37%.

And we've managed in the last 3 or 4 years to be under that, sometimes 34%.

This past year was a little higher, and we had some stuff going on, as we've all talked about.

But we also have started moving -- we've had a lot of contractors and contingents around the world working for us, tens of thousands actually.

And we've decided, as part of our restructuring and offshoring, we've moved some of those folks in as permanent employees.

More stability with that.

We've preferred, for a lot of reasons I don't need to go on, on this call, that then becomes part of the comp pool.

So we -- I don't want to be tied to a comp ratio when we're really managing the firm for overall expenses.

That's what we're going to manage for.

And there's a reason you're not seeing new comp ratios in these numbers, but you're seeing a pretty aggressive efficiency ratio.

We want the ability to manage the firm for shareholders on best basis, and that's to have the best people working most efficiently.

So you will not see -- you're never going to see comp ratios in the 40% in ISG again.

That's just -- we're not going to do that.

But we just want to maintain flexibility to run the business and not do goofy stuff, like not make contingents employees because of worry that it will affect the comp ratio when, in fact, it brings down the noncomp ratio.

So that's -- we're going to run business on that basis.

And we've been doing that for a couple of years, but I just want to be explicit about it.

Our next question comes from Michael Carrier with Bank of America.

Just a quick one for me.

Just in Investment Management, so you guys have done well from product development and kind of growing that business.

It does seem like on the private side, it's more of your assets.

We can see it in the performance fees, in the carried interest.

I don't know if you can quantify maybe how much of the AUM now has the potential to generate carrier performance fees.

It's just something that's obviously hard to model, but you also probably don't get much credit for it because we don't have kind of have the magnitude of that.

So any more clarity around that would be useful.

I would -- again, the different categories that we break out, obviously, the alternatives generally are where we're going to have carried interest or performance fees.

Let me try to give you some more information on that in a second.

Again,

it's hard to model because, as we said, there is some lumpiness to it, but we've had some really good performance across all of the strategies within IM.

We've also seen stable fee rates across the platform.

So as AUM has grown, we've seen that fee-based revenue number grow.

As, again, a year-over-year comparison, that was up 7%, which is quite healthy in this industry, given what you're seeing across the complex.

So again, we tried to give you the information to do it.

But as -- even with perfect information, these things are very difficult to project and model out.

Our next question comes from Gerard Cassidy with RBC Capital Markets.

This is Steven Duong in for Gerard.

Are there any products, product areas within your businesses that you'd like to complement with acquisitions?

Yes.

I don't think -- I don't know that we can really talk about products and acquisitions.

I mean, the -- most of the product gaps we have, we try and fill organically.

Acquisitions, we tend to do for broader strategic reasons: either build scale in the business, open up a new vertical, expand geographically.

Rarely would we do a significant acquisition or even a small acquisition on a pure product.

It's more a platform or a business unit.

So I think the short answer is no.

All right, understood.

And just last question.

We appreciate your targets for the next couple of years, recognizing that you guys have changed considerably since the last time we've had a sustained bear market.

Can you share with us the tools that you'd use to mitigate revenue shortfalls that are likely in a bear market to try to help reach these goals, should a bear market occur in the next 2 or 3 years?

Expenses.

I mean, basically, that's your tool, right?

Good news is with a bear market, your stock's low.

You're buying back more shares.

Your EPS is growing because your share count is down.

Our share count peaked at about 2 billion, and we're around 1.6 billion now.

So we bought back nearly, I think, nearly 100 million net shares last year when the stock was trading around $38 a couple of months ago.

So that was a little gift that God gave us.

So I think it's very hard to fight the market.

If you're in a sustainable bear market, you've got to restructure your organization to reflect that.

You become smaller, more nimble and more efficient.

And we and all our competitors would have to go through that.

You can't plan the business based upon a bear market, obviously.

You've got to plan the business based upon a normal market, not a bull market.

And that's where we set our goals from.

But as I've been very clear, and I'll finish on this note.

These goals are always subject to a normal market environment.

If we have an abnormal market environment one way or the other, then the numbers will be what they'll be, but they probably won't be what's on this page.

Thank you.

Ladies and gentlemen, this concludes today's conference call.

Thank you for your participating.

You may now disconnect.