摩根士丹利 (MS) 2020 Q3 法說會逐字稿

Good morning.

I will be reading a statement on behalf of Morgan Stanley.

Today's presentation will refer to Morgan Stanley's 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.

Good morning, everyone, and thank you for joining us.

For a decade now, we've been rebuilding Morgan Stanley from the depths of the crisis to a firm positioned to withstand whatever comes our way.

Our performance this year has validated that approach, and third quarter revenues were $11.7 billion, the second highest quarterly result in our history.

The balanced business mix continues to deliver consistent results and high returns.

We reported an ROTCE of 15% with a year-to-date ROTCE of 14.3%.

On October 2, we closed the acquisition of E*TRADE.

And last week, we announced our intent to acquire Eaton Vance, which serves as the latest strategic step in our transformation.

We added these acquisitions from position of strength, and we have strong momentum across each of our businesses.

Institutional Securities has been pivotal to our performance in 2018, '19 and again in '20, year-to-date, extremely strong.

This quarter, ISG reported over $6 billion of revenues and $2 billion of pretax.

Strength in Asia, Equity Underwriting and Fixed Income Sales and Trading and our overall Equities business powered our performance.

Asia had its best quarter in nearly a decade as we continue to see the benefits of the investments we have made in that region.

Fixed Income delivered the highest third quarter revenues in 10 years, excluding DVA.

ISG revenues to date are $19 billion, up 24% over last year, and we continue to believe our Institutional Securities business has meaningful organic growth opportunities.

Wealth Management continues to grow, both organically and inorganically.

On a year-to-date basis, fee-based flows have been exceptional at $53 billion, with $24 billion in this quarter alone.

Lending balance growth was a quarterly record of $6 billion.

Versus the prior year, lending balances have increased nearly 20%.

While we did not own E*TRADE in the third quarter, it is important to note how they performed, delivering strong client activity and asset growth in the quarter as they have all year.

With E*TRADE, our total client assets are now $3.5 trillion.

That is up from $600 billion approximately we oversaw before we bought Smith Barney a decade ago, representing an increase of nearly 6x.

Our Investment Management business serves as the third leg of the stool and produced over $1 billion of revenues on its own this quarter.

Assets under management reached a record $715 billion.

Important to note that, that is compared to $460 billion of assets under management we had less than 2 years ago.

Assets under management growth has been powered by long-term net flows with over $10 billion in the third quarter, fueling, of course, fee revenue growth.

While generating this strong organic growth, our recent announcement allowed us to transform our Investment Management business, giving it scale and several incremental growth engines at one time.

Frankly, it was too good of an opportunity to pass up.

For years, we've viewed Eaton Vance as the perfect partner.

We will bring together 2 high-performing asset managers with great business momentum.

And through this partnership, we will now manage $1.2 trillion in assets under management and generate a combined $5 billion in annual revenues.

And to cement October 2020 as one of the most important months in our history, we received an upgrade to A2 from Moody's, the only GSIB to receive an upgrade during the pandemic.

Their recognition of the firm's clear and consistent strategy to shift our business mix towards low-risk, recurring, profitable revenue streams in Wealth and Asset Management, together with our Integrated Investment Bank, is a further codification of our transformation.

So what do the next 6 to 12 months hold?

One, we will make material progress on the integration of E*TRADE.

Two, we will close and commence the integration of Eaton Vance.

Three, we will reinstitute our capital distribution plan in 1Q 2021, assuming, of course, we have clarity from the Federal Reserve.

It is worth noting that our CET1 ratio, following the additions of E*TRADE and Eaton Vance, is expected to be 300 basis points above our SCB requirement of 13.2%.

Four, we will focus on driving organic business growth while managing expenses.

And five, we will ensure our culture remains firmly client-centric and grounded in doing the right thing.

This includes operational resiliency, meeting all regulatory expectations and maintaining the risk profile we enjoy today.

I will now turn the call over to Jon to discuss the results of the quarter.

And together, we will take your questions.

Thank you.

Thank you, and good morning.

In the third quarter, firm net revenues were $11.7 billion with net income applicable to Morgan Stanley of $2.7 billion.

We reported an ROTCE of 15%.

Our year-to-date revenues reached a post-crisis record.

Institutional Securities is having an exceptional year capturing the elevated client activity and managing risk well.

Wealth Management is delivering stability while the underlying indicators continue to position us for future growth.

And Investment Management is delivering growth through industry-leading long-term net flows.

Our bankers and financial advisers are supporting our clients as they remain intensely engaged.

Expense management remains a priority.

On a year-to-date basis, our firm efficiency ratio was 71%, down approximately 90 basis points from the prior year.

We remain focused on our more controllable sources of spend while continuing to support our growth initiatives, employees and communities.

Non-compensation expenses increased on higher volume-related expenses and higher unfunded credit provisions, which were partially offset by a meaningful decrease in Marketing and Business Development expenses.

Compensation expenses increased on higher revenues.

Now turning to the businesses.

Institutional Securities had the strongest third quarter in a decade.

Equity Underwriting, Corporate Credit and strength in Asia underpinned the results.

Clients remained engaged through the third quarter as risk assets continue to rally through August and capital markets remained active.

From a regional perspective, Asia had its strongest quarter in nearly a decade, with contributions from each of the businesses.

Heightened activity and interest in China, which saw particular strength in IPOs and equities, drove results.

Year-to-date 2020, Asia revenues are higher than all of 2019.

Investment Banking generated revenues of $1.7 billion, decreasing 17% from the prior quarter.

While Fixed Income Underwriting subsided and Advisory revenues remain muted, Equity Underwriting buoyed results with particular strength in IPOs.

Advisory revenues were $357 million, reflective of lower completed M&A industry volumes.

Equity Underwriting continues to be extremely active with revenues of $874 million.

Results were driven by IPOs, which nearly doubled versus the prior quarter, offsetting declines in Convertibles and Blocks.

Fixed Income underwriting revenues were $476 million.

Results were impacted by the lower levels of event-related activity in the quarter.

The Equity Underwriting pipeline remains healthy.

We expect issuers to continue to access the market and remain opportunistic.

The Advisory pipeline is recovering, as evidenced by the recent increase in announced activity, and we have seen the pickup in both sponsor and corporate activity.

Equity Sales and Trading revenues were $2.3 billion.

We are #1 in this business both for the quarter and year-to-date.

Results were particularly strong in Asia as well as the Americas, consistent with client interest in higher-growth regions and momentum names, respectively.

While volumes declined from historic levels of the second quarter, activity remained robust.

Both Cash and Derivative revenues were elevated for a third quarter.

Prime Brokerage results were strong.

Average balances increased as market levels rose and certain clients relevered, with spot balances closing above 2Q period-end levels.

Fixed Income Sales and Trading had the strongest third quarter in a decade, excluding the impact of DVA, driven by the strength in micro.

Revenues were $1.9 billion in aggregate, with most products declining from an exceptionally strong second quarter.

Activity levels were healthy as clients remained engaged throughout the summer months.

From a geographical perspective, results were broad-based, and year-to-date, Fixed Income has now generated over $7 billion of revenues.

Micro continued its robust performance.

Bid-ask spreads remained elevated though lower than the prior quarter, benefiting results.

Performance was supported by continued strength in Securitized Products and Credit Corporates.

Macro was impacted by lower sequential revenues in rates and foreign exchange as spreads normalized and volatility declined.

Foreign Exchange and rate markets continue to be range-bound.

Commodities results reflected lower activity but were supported by strength in metals, highlighting the diversification of the business in recent years.

Our ISG loan portfolio continued to perform well.

As a reminder, over 90% of our ISG loans and commitments are either investment-grade or secured.

The sequential decline in results across Other Sales and Trading and Other Revenues primarily reflected lower gains, net of hedges, on our Held-for-Sale portfolio due to less spread tightening compared to the prior quarter.

Our funded ISG loans declined by $2.3 billion from the prior quarter driven primarily by paydowns in our corporate loan book.

Our funded ratio of corporate loans now stands at 15%, down from 18% in the prior quarter and well below the 1Q peak at over 25%.

We added to our reserves modestly in this quarter.

Our provision for loan losses was $66 million, down 70% from the second quarter.

We had approximately $23 million of net charge-offs, primarily from one commercial real estate loan that was troubled pre-COVID.

Our allowance for credit losses on loans and lending commitments increased to $1.1 billion, of which our allowance on loans now stands at $806 million.

The increase was primarily driven by COVID-related sectors.

COVID-related sectors continue to represent just 10% of our total ISG lending exposures, and the substantial majority of these exposures are either investment-grade or secured by collateral.

Our allowance for corporate loans increased to 4.8% and for CRE remained stable at 3.1%.

Across the entire Held-for-Investment loan portfolio, our total allowance rose to 1.9%.

Turning to Wealth.

Third quarter revenues were $4.7 billion, broadly in line with the prior quarter and up approximately 5% excluding the impact of DCP.

Pre-tax profit was $1.1 billion.

Our reported margin was 24%.

Merger-related expenses and a regulatory charge impacted the margin by almost 200 basis points.

The underlying indicators of this business remain robust, including record net new assets, continued strength in client engagement, fee-based flows, loan originations and net recruiting.

Fee-based flows were exceptionally strong at $24 billion in the third quarter, contributing to a year-to-date fee-based flows of $53 billion.

Total Client Assets ended the quarter at $2.9 trillion, 11% higher than the prior year.

In the third quarter, Transactional revenues were $880 million.

Including the impact of DCP, revenues increased sequentially, exhibiting seasonal strength driven by capital markets activity.

Asset Management revenues increased 11% sequentially to $2.8 billion, reflecting higher starting asset levels on higher markets and fee-based flows.

Importantly, asset management fees are $8 billion year-to-date, a 6% increase over 2019.

Lending growth remained strong with balances exceeding $91 billion.

On a year-to-date basis, balances have grown by $11 billion, with record quarterly growth of $6 billion in the third quarter.

Growth was broad-based across the portfolio.

We saw strength in Securities-Based Lending, which was driven by strong engagement from ultra-high net worth clients and by adding resources to our lending businesses.

The loan portfolio continues to perform exceptionally well.

We had only $2 million in net charge-offs in the last 7 quarters in this portfolio.

Forbearance continued to decline.

Mortgage forbearance fell by more than half, representing less than 1% of our portfolio, and 90-plus day delinquencies declined to 20 basis points.

Forbearance on commercial real estate loans in our tailored lending book declined by approximately 40%.

Net Interest Income was $889 million, declining 14% sequentially.

Higher lending and BDP balances helped to partially offset the impact of prepayment amortization and tighter deposit spreads.

Prepay was more meaningful in the quarter, accelerating in the latter part of September as rates declined.

Nearly half of the sequential decline in NII was attributed to prepayment amortization.

Total U.S. Bank Deposits were $238 billion, and third quarter BDP balances were up $7 billion despite delayed tax payments.

Total expenses were $3.5 billion, in line with the prior quarter.

Investment Management results were very strong as the business continues to demonstrate meaningful momentum.

Long-term net flows and strong investment performance has supported AUM growth, which is translating into higher fee revenue.

Revenues of $1.1 billion represented the second highest quarterly level in over a decade, increasing 19% from a robust prior quarter.

Total AUM rose to a record-high $715 billion, representing over $200 billion of growth since last year.

Long-term net flows were $10 billion driven by continued strong investment performance in global equity strategies.

Being global remains critical.

Our investment team in Asia began sub-advising a newly established ESG global equity fund in the third quarter.

It was one of the most notable fundraises in Japan in the last 20 years and at quarter end, had more than $5 billion in assets under management.

Inflows across all regions led to an annualized long-term growth rate over 10% for the second consecutive quarter.

Total net flows were $13 billion as liquidity inflows moderated and investors pivoted away from money funds.

Asset Management fees of $795 million increased 16% sequentially driven by higher management fees consistent with strong growth in AUM.

In the third quarter, we did see an increase in fee waivers on certain money market funds as a result of the rate environment.

And we expect to see the full effect of this trend in the fourth quarter.

Investment revenues were $258 million in the quarter.

We saw broad-based gains across the portfolio with sequential increase primarily driven by gains in Asia private equity funds.

Total expenses were $741 million.

The increase was driven by higher compensation on higher revenues as well as higher BC&E expenses on higher average AUM.

We are very excited about the future of this business and to be partnering with Eaton Vance.

We expect to close the transaction in the second quarter of 2021.

We look forward to advancing our partnership with Eaton Vance and further enhancing our Investment Management platform.

Turning to the balance sheet.

Total spot assets declined to $956 billion as funding levels declined from the highs of the second quarter.

Our Standardized RWAs declined by $5 billion to $411 billion.

And our Standardized CET1 ratio rose 80 basis points to 17.3% compared to our SCB of 13.2%.

Our Board declared a $0.35 dividend per share.

Excluding $113 million of intermittent net discrete tax benefit, our tax rate was 24.3%.

We continue to expect our full year 2020 core tax rate will be approximately 22% to 23%.

On October 2, we closed the acquisition of E*TRADE.

As a function of the closing, we issued 232 million shares and $11 billion of common equity.

Our assets increased by approximately $77 billion and RWAs by $12 billion.

We created approximately $8 billion of goodwill and intangibles, of which $3 billion will be amortized over approximately 15 years.

And our CET1 ratio increased by approximately 40 basis points.

Tangible book value per share declined by approximately $4, and our book value per share was essentially flat.

As you would expect, in the fourth quarter, we will start to see merger-related expenses as we begin the integration of E*TRADE.

We will start to break these charges out in our disclosures in January when we report year-end results.

As for the operating outlook, the dispersion of potential macro outcomes remains high.

And while we are cognizant of the seasonal patterns of the fourth quarter, we are encouraged by client engagement across all 3 businesses in the first few weeks of the quarter.

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

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

Curious if we could talk about flows in Wealth Management.

You mentioned a couple of things, but I'm curious what you would attribute year-to-date to recruiting versus consolidation of wallet share.

And while we're on it, if you could talk about the Wealth Management loans being up almost 20%.

Is that a combination of mortgage and SBLs?

Just curious what's driving that within Wealth Management.

Sure.

In terms of the flows, listen, this is a long-term secular trend that we continue to see, that people want to pay for a managed account and one fee.

And we've seen this for the last several years, and we now approach about 50% of the assets we manage are in fee-based accounts.

It's really a combination of multiple factors, and I think you mentioned many of them.

One, we've seen more cash come into the network, and that cash is being deployed, although there's still a significant amount of cash on the sidelines within our network.

But we have seen more come in, and more of that's being put into the market.

Number two, your comment about net recruiting.

We're seeing Morgan Stanley become the destination of choice for financial advisers.

Recruiting has been quite strong, and we brought in bigger teams over the last -- course of the last 9 months.

And with them, they are bringing their assets, which are being deployed into the fee-based accounts.

So really, a combination of those 2 things.

And then lastly, we've seen attrition drop significantly.

So we're not losing many assets.

So a combination of all those 3 things.

And again, we think that's a long-term secular trend that will continue, and we'll continue to see good flows into our fee-based accounts.

And then I think the lending growth is really, as you mentioned, those 2 products.

The SBL product, we saw a significant pickup, about $4 billion this quarter.

Predominantly, about 70%, 75% of that came from our ultra-high net worth client base.

We've continued to invest in the platform.

I think we've gotten better at using data and analytics.

We've added some more support to the field, and we've seen real receptivity around that product with our client base.

And then lastly, mortgage continues to do quite well.

Interestingly, we had about 45% purchased this quarter, which was nice to see as that has picked up as well.

So it's really -- both those products have been quite strong within the footprint.

I would just add, Glenn, sort of observing it now from a little distance because I'm not directly involved in it, this is the healthiest I have seen this business in the 14 years I've been here in terms of client flows, both fee-based flows and absolute flows, which we historically don't break out.

There were a lot of movements during the year with tax payments and the like, but it's extremely healthy.

And the attrition numbers, very low, as Jon said.

So net recruiting, better client penetration and a lot of very wealthy clients validating the model.

And you add to the E*TRADE franchise, which has also seen very strong flows this year.

It's -- for me, it's very exciting to see it.

I appreciate that.

Maybe just one follow-up on the expense side.

First, maybe with the core expense, you mentioned activity levels are up so obviously, expenses are elevated, but marketing and T&E has been down.

Maybe if you could start with how to think about that for the go-forward on expenses.

And then I know that we have to wait until January for your integration thoughts on E*TRADE dollar-wise.

But maybe you could talk a little bit about what you actually have to spend money on, on the integration of E*TRADE so we can just start putting together our thoughts on models.

Sure.

Just broadly on the expense base, what we've obviously seen given the elevated volumes is elevated brokerage and clearing expense that goes with the trading volumes as well as transaction taxes.

As I mentioned, Asia has been very strong, so we've got a little bit more of a skew towards transaction taxes.

And those will continue to remain elevated, assuming that the volumes remain elevated, and those generally ebb and flow -- or they do ebb and flow with the volumes.

We've done a really nice job of also managing our professional expenses.

We continue to try to drive those numbers down.

And then the marketing, business development expenses has really been driven by just the lack of travel, the lack of conferences, things being converted to virtual, and we would expect that to remain muted for a while.

But ultimately, those expenses will start to tick up as we start to see movement around the globe.

In terms of E*TRADE, as you know, in February, when we announced the transaction, we talked about $800 million of integration-related charges that we would incur over a 3-year period.

As I just mentioned, that will start in the first -- this current quarter.

In the fourth quarter, we'll start to break out those disclosures so you can see exactly what they are.

We closed the deal about 10 days ago.

We're extremely confident about both the funding and cost synergies that we laid out.

And we also think there's significant revenue opportunities as we get into the integration here.

So you'll start to see that this quarter.

We'll break it out.

And as you said, we'll give you some more thoughts around that in January.

Our next question comes from Steven Chubak with Wolfe Research.

So James, I wanted to start off with a question on capital.

The accretion has been considerable, as you noted, since the pandemic started, and you're clearly significantly overcapitalized.

You also noted that you plan on returning the excess, possibly as early as 1Q next year, subject to regulatory approval and removal of the buyback moratorium.

How should we be thinking about the pace and cadence of buyback and your comfort initiating payouts in excess of 100% of earnings?

And just separately, how does the dividend target evolve alongside that?

A few questions tucked in there, Steve.

Very artful.

Listen, we're overcapitalized.

I mean that's the bottom line.

We were overcapitalized before we went through CCAR last time, and our SCB numbers actually were lowered by the Fed, reflecting the change in the business model.

It's something that we thought -- we felt for a long time, and it's starting to be recognized.

And even if you look at the PPNR models where we continue to argue, I think entirely appropriately, that financial adviser compensation is a variable, not fixed expense so it would come down as revenues come down, our PPNR numbers would actually be healthier than they're currently showing.

Eventually, I think that argument will prevail.

I hope it will prevail.

But even without that, with the accretion from the E*TRADE transaction, we're making $2.5 billion a quarter net.

And we're paying our total dividend, I think, of about $2.2 billion, looking at Jon, maybe slightly higher.

So we're clearly accreting a lot of excess capital, about probably $7 billion net without doing buyback on a base where we're 300 basis points above the minimum requirement.

We'll always keep a buffer.

I don't know what that buffer should be, 100 basis points probably, something like that.

I'm looking at our CFO here to see if he disagrees with me.

He's sort of shaking his hand sideways, like he's probably a little plus on the 100.

I'm probably a little minus on the -- oh, he's a little minus.

Okay.

We're all happy.

Let's see.

On buybacks, there is absolutely no reason, given Morgan Stanley's current condition, the shape of our balance sheet, our liquidity profile and the mix of the businesses, why we wouldn't be distributing capital except that for right now, it's the right thing to do for the broader community as we work through this pandemic exercise and the Fed does its pandemic stress test, which is going on right now.

I'm highly confident we will come out of that showing we have significant excess capital.

I'm hopeful we'll have those results before we get into next year, but obviously, that's not within my purview.

Given that, I would expect us to be back doing buybacks in the first quarter.

Obviously, if the economy completely tanks between now and then or the results are less positive than I expect them to be, then all bets are off.

But that's -- you've got to run the business as you see it likely to be, and that's my likely scenario.

How much do we do?

You could do -- by definition, you could do above 100% payout.

Why not if you -- otherwise, we'll never eat into the 300 basis points.

At some point, we have to do something with this capital.

Our shareholders rightfully who own the company are entitled to generate a decent return on their capital investment in the company.

We have to do something with it.

Buying Eaton Vance was a tremendous opportunity to use some of that.

It's going to hit our CET1, I think about 90, 100 basis points.

But we've accreted 90 to 100 basis points in the meantime.

So we're sort of back to where we started but we own a new company.

That's a nice thing.

So you can tell I'm a little animated on the subject.

If you look at any of the global G-SIFIs in the U.S., I think it's fair to say we are carrying the most capital surplus.

And I don't think there's any rational reason why, once we get through the COVID stress test, if you will, that, that would perpetuate unless we get a result which is adverse, which I don't expect.

And maybe just a question for Jon on the NII outlook.

You beat on virtually every line item.

I think NII was the lone exception.

You were not alone this quarter as prepay started to accelerate even towards the end of the quarter.

So just curious, given the strength in loan growth that was cited in Glenn's earlier question, I want to get a sense as to how we should be thinking about the NII trajectory from here, whether we should expect things to start to stabilize and maybe even grow as we look out to 2021.

Yes.

Well, I think you're right.

We did get hit with prepayments at the end of the quarter.

I think absent that prepayment level, we generally came in where we thought and where we had guided you to, probably a little light as we saw some contraction in deposit spreads.

I think on a go-forward basis, if we were just ourselves, I would say we're pretty stable at this point.

We obviously have reinvestment risk as the investment portfolio turns over, but we're generally offsetting that with the growth we're seeing in the portfolio.

But as you know, we did close E*TRADE.

E*TRADE comes with a large low-cost deposit base and a very highly liquid, high-quality investment portfolio.

So from a quantum perspective, next quarter, you'll -- or this quarter, you'll see the dollars of NII go up as about half of the revenues generated at E*TRADE were from NII.

And then we're going to start optimizing their portfolio as we laid out in February.

We're -- we'll give you a better sense of sort of what the sensitivities are around that, but we're highly confident we can get the funding synergies that we outlined in February.

And that contribution of NII probably ticks up, but still is going to be sort of, again, relative to others, about only 25% of the Wealth business, which again is a much smaller part of the overall company.

Steve, just back to your capital question.

I mean it's important to note that -- let's assume just mathematically, I don't know, we're carrying 20% excess capital right now, 300-plus basis points on 13.2% requirement.

If that's the case, then we're still generating ROEs of 13%, ROTCE of 15%.

So with that excess capital, we're generating these kinds of returns.

So I think shareholders would -- could sensibly look through that and project what the returns would be on the capital we're actually using to run the business.

And obviously, they're higher than where we are now.

Our next question comes from Brennan Hawken with UBS.

Wanted to start with one on expenses.

So at the beginning of the year, James, you provided some targets, 2-year targets, that focused on efficiency ratio and pretax margin in wealth.

But I seem to recall that they were based on -- this was before all the deals, so I think they were based on what I'll refer to as legacy MS, not pejoratively but just for clarity.

So not trying to be nitpicky here.

I just wanted to try and understand.

Is there a way we're going to be able to track your progress in your legacy business towards those targets?

Or is the idea that now that you've got so many of these like strategic integrations that are continuing your transformation, that that's sort of trumping the work that you had previously laid out on efficiency and therefore, it's just more important to focus on the integration there and not the efficiency push?

Just want to try to understand how to think about that.

Sure, Brennan.

I think there are sort of 3 elements to looking at this.

One is what is the -- as you described, what the legacy business are going to generate in terms of efficiency ratio.

And right now, I think this year, we're slightly over 70%.

We were less than that in Q2.

We're higher in Q1, and we are right -- I think right on the button this quarter.

Our 2-year objective was 70% to 72%, so meeting that.

Our long-term aspiration was under 70%, and we are very close to meeting that.

So sort of check the box on legacy.

Number two is what do the new acquisitions do to our efficiency ratio.

If you look at the pretax margin on the E*TRADE business, it's -- let's see, it was -- it's sort of in the 40-ish percent range, maybe a little below that with what's going on with net interest income.

And if you look at the Eaton Vance business, it's closer to 30%.

So by definition, if you simply added 1 plus 1, your efficiency ratio would actually be lower.

But the third bucket, of course, is what are the integration costs.

Well, they don't start on Eaton Vance until we close that, which Jon said should be Q2 of next year.

We have actually -- we had a small number of integration costs already in E*TRADE in the last little bit, and that will build.

And I think we put out a projection of $800 million over 3 years.

I personally would like to accelerate that.

We will probably identify it as a below-the-line number.

So just for cleanliness and for your models, we'll show -- you'll be able to see an efficiency ratio with and without it.

But clearly, we'll talk to our accountants about the right way to report that.

But we're not going to hide the ball here.

We're highly confident that absent integration costs, our efficiency numbers, there's no reason why they don't stand.

Okay.

Great.

And then I know that -- Jon, I think you mentioned that your plan is to lay out some more specifics around E*TRADE with the fourth quarter call, which makes a lot of sense.

But what's your early read on how you're thinking about some of these changes that are likely to happen on the back of this integration?

Is the plan that the E*TRADE bank sub will be folded into the -- one of the Morgan Stanley bank subs?

Are you planning to integrate the BDs?

And really one of the great assets that E*TRADE brings, the stock plan business, has sort of a different focus, more of a public plan focus.

And so the strengths are very different, but offer a nice kind of yin and yang with the Solium, which has a strong private offering.

So how do you plan to bring those platforms together?

Or is the idea that in order to fully capture the broad strength, keeping them separate is a better approach and so it -- maybe the full integration is not going to be realized in order to maintain those various strengths?

Sure.

I mean broadly, the answer, Brennan, to that question is yes.

But I think the way we're thinking about it, first, we've got to integrate the systems.

We want to capture the cost and the funding synergies that we laid out.

We want to do it in a way that doesn't disrupt the customer experience and ultimately enhances the customer experience.

And then as you said, I think we believe there are significant opportunities across all 3 channels to generate growth and revenue growth.

And whether that's in the stock plan business and trying to get our cash capture numbers up to the E*TRADE numbers -- when we did the deal, they were running about 15%.

They're now running north of 20%.

Our numbers were dramatically lower than that.

So if we can bring the combined business together and get that to a higher level, closer to theirs, that's a significant synergy.

Clearly, they are generating lots of new clients.

Some of those clients are ultimately going to want advice.

And so there are lots of opportunities across all 3 channels, and we'll start to see those as we get these systems integrated.

As we mentioned before, that we'll keep the E*TRADE brand for the self-directed business line.

But we're going to bring these companies together slowly.

This was not a deal about costs.

It was about revenue opportunities ultimately, just like the Eaton Vance deal was.

And we're going to take our time, integrate them well and bring the cultures and companies together.

But -- and to be clear, nothing has changed in our view of E*TRADE.

If anything, it's got better.

The integration plans we've been working on for 6 months with Mike Pizzi, CEO of E*TRADE, who's joined our operating committee, very well-thought-through plans, great detail.

We'll stage the various businesses, as you highlighted, the workplace, the banks, et cetera.

And then the actual E*TRADE trading business will retain a separate identity because it has a very powerful brand in the marketplace.

So we are highly confident we're going to get the cost synergies.

It's just -- and I think we gave you that $800 million number in January or February, I guess, when we did the deal.

And it would be fair to say that it's probably not -- we're -- we tend to be conservative with numbers like that.

So I doubt we're going to be spending more than that.

And the pace of the spend will be just run with the integration plan.

So it's going exactly as we hoped it would go, but even a little better, frankly.

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

First, just institutional had a very strong year and a few years for that matter.

And James, you mentioned upfront you still see some good organic growth opportunities.

Just given your leading share in some of the areas, can you provide maybe a little color on just where you see some of the attractive organic growth in that business and if that can maybe offset some of the expected moderation in the business?

Yes.

Well, firstly, doing deals in the institutional space is a little fraught.

You're unlikely to want to do balance sheet type deals.

I don't think anybody would be sending up balloons if we did that.

And there are obviously advisory businesses around the world that you could acquire, small ones, boutiques, if you like, but we haven't found anything that really excites us yet.

So if we look at the organic growth, I mean, just look at Fixed Income.

And still the gap between what our Fixed Income business is doing, which is phenomenal, by the way, from where they've come from, it's truly phenomenal.

And credit to Sam Kellie-Smith and Ted Pick overseeing our institutional business for that turnaround in the last couple of years, just phenomenal.

But they clearly have capacity to grow in that business.

Our Equities business, we lost the #1 mantle for a quarter.

We didn't like that.

We got it back.

Clearly, Prime Brokerage should continue to consolidate.

There's growth across Prime Brokerage.

Our capital markets business in Asia, particularly China-bound Asia, enormous.

We have an incredible franchise there.

I think there are parts of banking we could be stronger in.

We have some segments where we're very dominant, health care, tech and then some other industry groups we could get even stronger.

So I think in DCM, we've made progress.

I think we're #5 or -- 5 or 6 in DCM underwriting, Jon, and -- well, 4 actually he's pointing to me.

I think the gap there with some of our competitors, there's no particularly rational reason why there should be a gap there.

I think there's just -- it's nowhere near -- we're nowhere near what we could be as a potential.

The question is, can we get there with the kinds of returns we want and expect from the business.

So we're quite judicious.

We're not just throwing balance sheet at it.

Look at the trading var.

I think our trading var this quarter was $60 million a day, and that was materially lower than our major competitors.

So we're quite judicious about it.

But a series of small steps rather than big swings is the way I would describe the institutional business, and they've delivered.

I was -- I made a point of saying in '18, they had a record, '19, and again in '20, they're delivering.

So I think there's a lot of upside.

And obviously, it's also framed by the competitive landscape and what the European banks are doing or not doing, et cetera.

Jon, I don't know if you want to add to that.

Yes.

No, I think you've summed that up well.

And I think Asia is really a bright spot for us.

As I said, year-to-date, the revenue generation from that business in ISG is now bigger than Europe.

We see that as a real growth engine, and we'll continue to make investments there.

All right.

And then just given the recent M&A, whether it's E*TRADE involved or Eaton Vance in Investment Management, I think both make sense.

Just curious on timing.

Is it, obviously, you have the excess capital?

Or are you seeing something from an industry dynamic?

And then more importantly, both of those businesses are putting up good growth.

So just what do you think that business does with these transactions, obviously not over the next 6, 12 months, but maybe 2 to 4 years?

Yes.

I think the question was around the timing of those transactions.

Here's how I think about acquisitions.

There are at least 4 things that matter.

One is strategy, two is culture, three is price, and four is timing.

Strategy is like the high table, if you will, the Holy Grail.

You've got to have strategic intent.

It's got to be a logical fit.

It's got to be building on something which you already have confidence in.

It's not a swing for the fences.

It's not new ground.

It's something we know well, we're good at.

And that's -- the perfect strategic opportunity comes when you get that, and we got that with E*TRADE and then with Eaton Vance.

Culture is very important, particularly in the Finance industry, where a lot of deals have gone bad because of cultural -- bad cultural fits, including, by the way, in the Asset Management space.

And there's a fairly high skepticism probably from all of you about large asset management deals.

We talked through that a lot.

Eaton Vance has been around 94 years.

We're the biggest distributor of their product.

We know them extremely well.

Parametric has been an absolute home run in our system, the Calvert funds and what they've done in sustainability space, the Fixed Income combined with our Fixed Income business, their core equity funds.

There's so much to like about it and about their leadership team.

And I would point out that they have -- they had an internal voting shareholder structure, and all 25 of their internal voting shareholders voted in favor of the deal, unanimous.

So it wasn't just the Board, it was the management.

So culture, I feel really good about.

Price is price.

You don't buy quality assets cheaply.

Timing is the thing least in your control.

And I'm sure if we didn't do this transaction with Eaton Vance, somebody else might have.

We didn't want to do it before we had the E*TRADE thing completely done.

On the other hand, we wanted to get moving as assets -- quality assets don't sit on the shelf for very long.

They were interested in Morgan Stanley.

We were interested in them.

So timing is just -- timing is the thing you've got to give most on.

It may not be the ultimate convenience.

It certainly came hot on the tail of E*TRADE.

We didn't want to communicate, all of a sudden, we're trying to do an acquisition a week.

We're not.

We didn't control the timing.

So we -- if we got the first 3 right, then timing is the least important.

What it does in the COVID thing, I think, is your broader timing issue with what's going on with the economy.

Listen, their business is growing.

They've had great growth.

As I said, the Parametric product has done incredibly well since it was created a few years ago.

They're seeing great growth across the whole platform as is our Asset Management business.

So we really think we're putting together 2 strong, growing businesses.

And the investment market is not going to go away whatever happens in the election, whatever happens politically.

So I'm not worried about that over the next couple of years.

Our next question comes from Mike Mayo with Wells Fargo Securities.

Well, to coincide with your upgrade of your credit rating, congratulations, my question is on risk.

In the...

I thought you were about to upgrade us, Mike, when you said upgrade.

You have disappointed me, man.

Well, first, 3% quarter-over-quarter loan growth is well above the industry.

So just wondered about the risk related to that and how you're getting what others are not.

Second, on the E*TRADE acquisition, the spread revenues for E*TRADE seem like they'd be quite a bit lower.

So updates on revenue thoughts with that acquisition.

And then third, with Eaton Vance, $7 billion for a firm that's earning about $360 million.

You'd have to double the earnings just to get over a 10% ROE.

So in terms of risk, loan risk, E*TRADE risk with the spread revenues and Eaton Vance risk with just really getting your full money's worth.

Well, I'll let Jon talk about the credit risk, but I would observe that we are not in the unsecured credit world.

We do not do small business lending on any scale at all.

We tend to loan against people's owned portfolios, so we have collateral and we have total visibility on the consumer side.

And on the institutional side, we're very careful about what sectors we've been in.

We're not overexposed to some of the more troubled sectors.

And we have a lot of really good clients who've been really loyal to us, have great businesses that we want to support during this period.

So the fact that our credit is performing differently from some other institutions is completely irrelevant.

I mean it entirely depends on who you're lending to and on what terms and conditions.

So on the E*TRADE business, yes, with the NII, obviously, that business is affected by that.

On the other hand, the account openings, the positive asset flows, the opportunity for us to provide those kinds of mortgage and lending products to their clients, the opportunity for us to provide the alts -- put the alts platform on their system, the fact that we're not spending $200 million a year building out our own digital platform, there are so many positives before you even get to the workplace business, where their conversion rate, as Jon said, is something like 20-plus percent.

Ours has been about 3%.

So I just think that we certainly -- we are eyes wide open on what's going on in the interest rates in this world.

I don't expect that to be a permanent state, but it's certainly not something that makes me shy about the attractiveness of this acquisition.

The underlying benefit and flows in the business have been phenomenal.

And the one thing that is actually changing people's behavior even more than what's going on in the last 5 years is the increased use of digitalization, whether it's their health services, financial services, obviously shopping, et cetera.

So I think we couldn't have been more blessed than to have got E*TRADE at the time we got it.

On Eaton Vance, listen, Mike, I'm not that smart.

One of your colleagues on the call said that even if we paid $1 billion excess for it, as a $90 billion company, it's like, yes, it's -- I'm not ashamed to say it's fully priced, but this is a quality asset.

And I look at the growth rate in the asset.

I don't look at a static position.

We will get the expenses out of this.

We will consolidate this.

We will generate the revenues from it.

It fills out our Fixed Income asset management business in a way that we couldn't have done otherwise, and it provides us some real growth endurance, as I said, with their core equities platform with Parametric, with Calvert funds, the Atlanta fund.

They've got so many businesses that work for us.

They have very little international distribution.

We can take them internationally.

We have trouble getting our product distributed domestically because we don't have a strong wholesaling sales force as others do.

They do.

They have a world-class one.

So will that deal deliver?

I'm positive that deal is going to deliver.

And if we overpaid by a couple of hundred million dollars -- people said we overpaid Solium by a couple of hundred million dollars.

Some people said we overpaid Smith Barney by a couple of billion dollars.

So I take a very long-term view on acquisitions.

Just one more follow-up.

As we pull back the lens even more, I mean, over the last 10 to 20 years, you're right now reversing some of the actions that you took.

You sold off Van Kampen, and now you go ahead and get an asset manager.

You got out of the kind of the mass market wealth management, and now you're back with E*TRADE.

Can you give us kind of your big-picture strategic thoughts on why the long-term reversal here?

I totally disagree with what you just said.

We've not had a long-term reversal.

We sold Van Kampen, which I regard as a mistake.

I said a couple of years later I wish we hadn't done it, but we did it.

And I said on a call a couple of weeks ago, if Marty Flanagan was listening, I regret that, but God bless him.

He's a friend of mine, and I wish him well.

We haven't got out of the mass market.

And by the way, E*TRADE is a combination of a workplace business, an active trader, options, derivative business and a direct business.

We have always provided financial services, since we merged with Dean Witter in 1997, to the average investor.

We happen to have a lot of very, very wealthy investors in addition, but we have millions of people with hundreds of thousands of dollars to invest, not tens of millions of dollars to invest.

So this is not a change in strategy at all.

This is about getting scale in the businesses we want to be in.

The one thing we did differently, which I would have done differently, I've said repeatedly, is Van Kampen.

But you look at some of the other stuff we did.

We got out of mortgage servicing, Saxon.

We got out of shipping, storage and -- oil storage and shipping, Transmontaigne and Heidmar.

We got out of the PDT business, Peter Muller's business, because it was a prop business.

So we shut down FrontPoint, our hedge fund.

We got out of Discover, which was a credit card business to the mass market, unsecured credit.

We have fundamentally over -- and that happened before my tenure obviously, but fundamentally changed the profile of this company to focus on originating, distributing and managing capital for individuals, governments and institutions.

That's what we do, and this is entirely consistent with that.

And Eaton Vance sits squarely in that square.

Our next question comes from Jim Mitchell with Seaport Global.

Maybe just a follow-up on E*TRADE.

If we look at their results in the first half, as you pointed out, James, are very strong, adding 650,000 retail accounts, up 14%.

Cash balance is up 50%.

I guess 2 parts to the question.

I guess first, on the flip side, you have lower rates.

So how do you think about the accretion targets, given the growth we've seen versus the interest rate declines we've seen since you announced the deal?

And then secondly, I mean, how do you -- what's driving -- I mean, obviously, the markets are volatile, but do you think that kind of account growth can continue?

And is that a big surprise going forward?

Well, let me start, and then I'm sure Jon will add.

Listen, we're on day 10 or something here.

And I know everybody wants to fill out your models, so I'm sympathetic to that.

Sharon has already told me that's what everybody is looking for.

And I'd love to be able to do that for you, but we're not going to do that today.

They have had unbelievable growth.

I think their record new account number before this year was 93,000.

And they're over 300,000 in the first quarter; second quarter, a couple of hundred; this quarter, well over it.

They've had incredible asset flows into the business.

So will that continue?

I think it will stay elevated.

It won't continue at this level.

There will certainly be net attrition because some of these accounts that were opened will close that were smaller accounts, but they also brought in a lot of large accounts.

So I think the answer is, Jim, it will slow.

But they've reached -- I would -- I believe they've reached a new baseline above where they were previously because of all the engagement around the markets.

How their P&L then plays out based on that and based on some of the mortgage and alts product and other stuff that we put in their system and some of the expenses that we're able to take out and the funding benefits, Jon can address that.

But we'll certainly do a full update at year-end once we have an actual quarter of them sitting inside Morgan Stanley.

Jon?

Yes.

I think stay tuned for January.

But when we announced this deal in February, we told you it would be dilutive in year 1, breakeven-ish in year 2 and accretive in year 3. And we still think that that's the general framework, and we'll give you more information in January.

We're just -- we just started on this path.

We still have high confidence in the funding synergies, the $400 million of cost savings and the broad outline that we outlined in February.

Our next question comes from Devin Ryan with JMP Securities.

First one is just around the acquisitions.

And I appreciate that you guys have your hands full and the message is nothing big coming soon or at least it sounds like.

But if we take a step back, you've added many millions of new retail customers to Morgan Stanley's ecosystem over a short period of time, whether that be through Solium, E*TRADE or Eaton Vance.

And so if we think about products, are there any big products or services that you're not touching yet at the firm level that could really make sense to plug into this broader retail consumer base?

Or is it really now just more about cross-selling existing Morgan Stanley?

I think we've got a very full plate right now.

And I think the biggest opportunity is probably putting mortgage product to high FICO score clients with good assets at E*TRADE and putting the banking product through the Morgan Stanley system, the digital banking to go with our already -- the 2 banks that we have.

I think they are the 2 obvious ones, Devin, but I'm not seeing a specific product gap.

And as always, we have total open architecture.

We'd take anybody's best product, including from all our competitors, because if that's what's right for the client, then that's the right thing to do.

So I'm not seeing a product gap.

Okay.

Terrific.

And then just a quick follow-up.

I just want to make sure I'm following what's happening on the wealth side, on the adviser head count.

So this is the first quarter of net additions in over a year.

It's the best addition quarter in 5 years.

And I heard the comment that -- Morgan Stanley as a destination and also benefiting from lower attrition.

But is this quarter kind of a one-off in that evolution?

Or is this something that we should maybe focus on as a shift occurring and maybe the backlog could back that up?

So maybe just curious kind of what the recruiting backlog looks like and if we should start to think about head count growth again on the financial adviser side.

I mean Jon may have a comment.

But -- it's hard to project, but the trend is definitely our friend.

And if you look at the net recruiting numbers for the last several quarters, I don't have them on hand, but I think the gap has been closing.

We've now turned positive.

It's a -- we're in an interesting inflection point with that business.

It's got great momentum.

That's all I've seen.

The attrition, part of it, Devin, is that people aren't leaving.

Then, by definition, you're going to be growing.

But Jon, do you...

Yes.

I think that's right.

And the pipeline for recruiting, certainly in the near term, is strong.

We're attracting attractive teams with good business -- books of business.

As James said, the number of advisers, if you go back, in the JV was dramatically higher.

The attrition rates are quite low.

And on a net basis, we're seeing sort of flat to slightly growing numbers.

But more importantly, the assets and the revenues that the new advisers are bringing with them is going to be additive in future years.

So it's a really nice position to be in right now.

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

Jon, you touched on the Prime Brokerage results were strong in the quarter.

Average balances, I think you said, increased as the markets improved and you -- more clients became relevered up or engaged more.

Can you share with us what's going on with winning new clients, particularly in other geographies outside of North America?

Is that also driving these numbers?

So a couple of things.

We did have a nice quarter in PB.

You're right, balances are up from where they were.

They're still below the peak levels.

We have seen the long, short hedge funds relever.

Quants still haven't relevered as much as the volatility in the equity market still remains reasonably high.

We continue to see a nice pipeline of new launches that adds to the growth dynamic -- excuse me, add to the growth dynamic, and it's been pretty broad-based.

So we continue to believe if the markets remain constructive, if volatility comes down, we'll continue to see growth in the PB balances, which will drive revenue growth in the future.

Very good.

And then as a follow-up, I think, James, you talked about the strength in the institutional business.

We've been very pleased with the numbers in 2018, '19 and year-to-date.

You cited some of the competitors overseas aren't as strong.

Is there any evidence yet that they're kind of getting back up on their feet and so we have a more competitive environment as we look forward?

Or do you think they are still struggling?

Well, I don't think I said that, Gerard, to be fair.

I just said there might be opportunity depending on what some of the international competitors' strategies do.

And clearly, some of them have chosen, over the last 2 years, to shrink their balance sheets and go back to their core traditional banking businesses more.

It's hard for me to predict.

I mean these things wax and wane a little bit.

So I don't want to comment on their strategy except to observe what's happened.

And that clearly provided the opportunity for some of the U.S. banks, but that could change.

Our next question comes from Andrew Lim with Soc Gen.

So a question for you, James, on M&A strategy, please.

So you talked a few weeks ago about your disappointment that MS has been trading like a bank with a P/E ratio from 9 to 10x.

And I can see how buying Wealth Management and Asset Management businesses might try and change investors' perception of that.

But I'd like to discuss it from a different angle.

Why isn't it a better strategy to divest CIB?

It's not obvious to me that CIB has synergies with Asset Management and Wealth Management.

You could have the CIB trading at 9 to 10x and then Asset and Wealth Management trading at 20x.

On top of that, you'd have the bulk of the excess capital with Asset and Wealth Management, and that could be returned freely to shareholders without restriction from the Fed.

So I was just wondering what your thoughts are on that as a strategy to maximize shareholder value.

That's not going to happen.

That's my thought about that.

We have an integrated model for a reason.

We have the ballast from Wealth and Asset Management.

We have the engine room.

We generate -- originate product in our institutional business that helps provide enormous opportunities for our clients across the other side of the house.

There are so many synergies, Andrew, that it's just not -- that's not even remotely close to where we think about this business.

Thank you.

And ladies and gentlemen, this concludes today's conference call.

Thank you for participating.

You may now disconnect.