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Morgan Stanley (MS) Earnings Report: Q1 2016 Conference Call Transcript


The following Morgan Stanley (MS - Get Report) conference call took place on April 18, 2016, 08:30 AM ET. This is a transcript of that earnings call:

Company Participants

  • Kathleen McCabe; Morgan Stanley ; Head of IR
  • James Gorman; Morgan Stanley ; Chairman and CEO (Australian)
  • Jon Pruzan; Morgan Stanley ; CFO

Other Participants

  • Michael Carrier; BofA Merrill Lynch; Analyst
  • Devin Ryan; JMP Securities; Analyst
  • Matt O'Connor; Deutsche Bank; Analyst
  • Guy Moszkowski; Autonomous Research; Analyst
  • Brennan Hawken; UBS; Analyst
  • Mike Mayo; CLSA Limited; Analyst
  • Glenn Schorr; Evercore ISI; Analyst
  • Steven Chubak; Nomura Securities; Analyst
  • Fiona Swaffield; RBC Capital Markets; Analyst
  • Christian Bolu; Credit Suisse; Analyst
  • Eric Wasserstrom; Guggenheim Securities; Analyst
  • Matt Burnell; Wells Fargo Securities, LLC; Analyst
  • Jim Mitchell; Buckingham Research; Analyst
  • Kian Abouhossein; JP Morgan; Analyst

MANAGEMENT DISCUSSION SECTION Kathleen McCabe (Head of IR): Good morning. This is Kathleen McCabe, Head of Investor Relations. During today's presentation, we will refer to our Earnings Release and financial supplement, copies of which are available at 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. James Gorman (Chairman and CEO (Australian)): Thank you, Kathleen. Good morning, everyone. Let me get straight into it. Obviously, 2016 got off to a difficult start. markets were challenging, equity issuance was effectively non-existent, and retail activity was extremely subdued, reflecting the many uncertainties with which investor grappled. These included negative interest rates internationally, questions around the pace of Fed activity in the US, the growth rate of the Chinese economy, and growing concerns about geopolitical issues like the migration crisis and potential [breks-it], among others. The securities businesses were exposed to a number of these factors, which led to a more challenging revenue environment than what we have come to expect in the first quarter of the year. That said, all was not lost. M&A was robust, equities once again delivered a strong performance, and wealth management generated a pre-tax margin greater than 21% despite market headwinds and fewer trading days. We made real progress in our expense discipline ahead of our broader initiative called Project Streamline which, as we said, will play out over the next two years. So where are we now? Though it's impossible to predict the future, we're seeing a slightly better turn in markets, certainly in comparison to what was evident of the start of the first quarter leading into the early days of February. The M&A pipeline is strong and some green shoots suggest the equity underwriting calendar may open up. The S&P level at the end of the first quarter will help with asset pricing in our wealth management business where we continue to grow our lending book and see flows into managed accounts. Importantly, fixed income, notwithstanding the 25% cut in headcount, improved sequentially. By no means can FIC be considered strong but the business is showing some resilience in this difficult environment. In January, we laid out our strategic goals for 2016 and 2017. While we've yet to see the revenue growth we anticipated it remains early days. In a minute, John will take you through the progress we've made to date. It must be said that if these markets were to continue as is, our goals would be extremely difficult to achieve and we would therefore take additional appropriate actions. We obviously accept a degree of volatility in the revenue environment that has led to lower revenue pools although we do not expect this as a permanent state. We also recognize that we cannot control the environment in which we operate but we are focused on what we can control, such as expenses. As part of Streamline, we are reshaping our expense base and have embarked on an aggressive evaluation of our global infrastructure costs, reviewing each product, business, and geography globally to convince ourselves that we need our footprint as it is currently configured. We operate under a multitude of capital tests and requirements. In January, we discussed our belief that we have sufficient capital for our business mix and risk profile, and we are taking actions that should result in longer-term reduced capital requirements. For SLR and CET1, we are well in excess of the requirements in which we will be subject to in 2018 and 2019, respectively.

Financials Conference in June. So let me now turn it over to Jon to walk through the quarter in greater detail. Thank you. Jon Pruzan (CFO): Thanks, James. Good morning. As James said, the beginning of 2016 got off to a challenging start as negative sentiment and volatility prevailed in the global markets, undermining the traditional strength in client activity we have typically seen at the start of the year. Concerns about global growth, China, commodities and interest rates resulted in divergent performance of global indices and mixed results across international markets. Against this turbulent backdrop, we remain focused on delivering for our clients and helping them navigate these difficult markets. We continued to demonstrate strength in our equities and M&A businesses and stability in wealth management.


For the quarter, we reported revenues of $7.8 billion, essentially flat versus fourth-quarter 2015 when excluding DVA for the fourth quarter. During the first quarter, we early adopted the accounting guidance that requires that DVA be presented in accumulated other comprehensive income as opposed to net revenues. Results for previous quarters shown in the supplement were not subject to restatement under the guidance. In my remarks, the prior-period amounts exclude DVA. Non-interest expense for the quarter were $6.1 billion comprised of $3.7 billion of compensation expense and $2.4 billion of non-compensation expenses. We remain focused on reducing expenses and, as James mentioned, Streamline initiatives have begun to take shape. Some of the areas we are focused on in Streamline include, first, our workforce strategy. We continue to remix our global workforce and have approximately 40% of our infrastructure employees in our centers of excellence around the world. We are targeting to increase the number of employees deployed by 10% to 15% and are actively working toward achieving this by year-end 2017. Many of the initiatives involve leveraging best-in-class technologies. For instance, we are adopting virtualization and private cloud computing to increase agility and asset utilization, while achieving a significant reduction in our data center expenses. We are building the next-generation wealth management desktop and mobile suite for both our financial advisors and clients, while optimizing and automating our operations and work flow. We are also partnering with incumbent technology companies and emerging start ups on a number of initiatives to improve efficiency and lower costs. And, lastly, we are focused on rationalizing our footprint and infrastructure to insure we are as efficient and productive as possible. In particular, there are opportunities across our institutional securities and wealth management businesses where we have the ability to drive efficiencies while improving collaboration. Turning to institutional securities, revenues were $3.7 billion, up 5% quarter on quarter. Non-compensation expenses were $1.4 billion for the quarter, down 13% versus the fourth quarter, driven by a decline in professional services. Compensation expenses were $1.4 billion, reflecting a 37% ISG compensation ratio. In investment banking we saw continued strength in our M&A business offset by a tougher backdrop for our underwriting businesses. IPO volumes were down 82% quarter on quarter and high yield volumes were down off of already low levels in the fourth quarter. For the quarter we generated $990 million in revenues, down 18% sequentially. Advisory revenues for the quarter were the strongest post crisis at $591 million, up 15% as the deals announced last year continue to close. Equity underwriting revenues were $160 million, down 55% versus Q4, driven largely by the significant decreases in IPOs.


Fixed income underwriting revenues were $239 million, down 31% versus the fourth quarter, reflecting a slowdown in high yield and leverage loan markets. In equities we saw continued leadership with revenues of $2.1 billion, up 13% sequentially.

Prime brokerage revenues were higher this quarter as we work closely with our clients and continue to focus on the efficiency of our balance sheet and returns. Derivatives revenues were up sequentially, driven by increased client activity as clients try to navigate volatility and hedge risk exposures. And cash equity revenues were down versus Q4 against a backdrop of lower global equity markets and a limited new issue calendar. And we continue to show leadership in our electronic products suite. Fixed income and commodity sales and trading revenues were $873 million, up 59% versus the fourth quarter, although down 54% versus the first quarter of 2015 when we had a very strong commodities quarter, both in our oil merchanting business which we sold in Q4 last year and our commodities trading businesses. Throughout the quarter, we saw a continuation of the challenges experienced in the second half of 2015. This translated into ongoing muted levels of client activity across our fixed income and commodities business. Despite these headwinds and the 25% reduction in headcount we maintained our client focus and improved results from the fourth quarter. We saw some improvement quarter over quarter in corporate credit with strength in investment grade and we saw continued weakness across commodities. Fixed income RWAs were down $4 billion in the quarter to $132 billion. And our SLR balance sheet was down approximately $9 billion to $345 billion. While revenues for the quarter were up sequentially, they are not where we ultimately want them to be. We are focused on driving execution and bringing our sales and trading businesses together to leverage synergies across the platform. Other sales and trading revenues were down quarter over quarter driven by hedging losses for our relationship lending book. Other revenues were down versus fourth quarter driven by an increase in our allowance for loan losses for our held-for-investment portfolio. In the quarter, we have continued to see pressure on the energy complex and have seen some credit migration and some bankruptcies. Our loan loss provision on our HFI portfolio of $127 million this quarter was predominantly against our energy portfolio. As a reminder, 40% of our approximately $15 billion funded and unfunded energy exposure is fair value or held for sale where we mark to market daily and have taken markdowns this quarter. Our energy exposure is down about $1 billion from last quarter and, importantly, we have not seen any meaningful signs of contagion. Lastly, average trading VAR for the fourth quarter was flat versus last quarter at $46 million. Wealth management revenues for the first quarter were $3.7 billion, down 2% versus the fourth quarter reflecting muted client activity in an unfavorable market environment, as well as fewer trading days. Our PBT margin for the quarter was 21.4%, up slightly versus Q4 2015, reflecting the stability of the business. Bright spots for the quarter were continued momentum in our lending strategy and the ongoing secular trend to managed accounts. Flows for the quarter were approximately $6 billion with decent pick up in March. The NII

In investment management revenues were $477 million, down 23% quarter over quarter. Revenues from asset management fees for the quarter were $526 million, up 5% versus Q4, reflecting the steadiness of this revenue line. And AUM was essentially unchanged at $405 billion.

Investment revenues in the quarter were a loss of $64 million driven by volatility and particular weakness in emerging market investments, resulting in markdowns and some reversal of carry. Overall, expenses were down 13% quarter over quarter driven by compensation, which was down 23%. Turning to the balance sheet, total assets were $808 billion at March 31, up from the $787 billion at December 31. The increase reflects a low fourth quarter spot asset level given lower client activity at the end of the year, as well as higher levels of liquidity in the first quarter. Our average balance sheet, however, was down to $802 billion in the quarter from $814 billion in Q4. Pro forma fully phased in Basel III advanced RWAs are expected to be approximately $386 billion, down from $395 billion in the fourth quarter. Our pro forma fully phased in Basel III advanced common equity Tier 1 ratio increased to 14.5%. Our pro forma supplementary leverage ratio for the quarter was 6% up from 5.8 in Q4. During the first quarter we repurchased $625 million of common stock, or approximately 25 million shares, and our Board declared a $0.15 dividend per share. Lastly in the quarter, as you'll see in our supplement we modified our segment common equity allocation disclosure to base it on fully phased in regulatory capital, as the market has focused more on these ratios than the transitional ratios. As we've said in the past, we look at capital through multiple lenses so this is not a totally new view for us. Capital is allocated based on risk-based and leverage-based requirements under both business as usual as well as stressed scenarios. This resulted in a reduction in parent equity from $21 billion to $6 billion, and the resulting $15 billion is allocated across the segments. We will now allocate equity to our segments only at the beginning of the year and it will remain fixed throughout the year. Turning to the outlook, across sales and trading we do not believe that the back drop we saw in the first quarter will become a permanent state and have already seen some improvement in market conditions. However, given the numerous uncertainties across regions we would expect to see some uneven markets and client activity. We are engaged with our clients and focused on delivering content, liquidity and solutions. In banking, M&A pipelines are healthy and client dialogues remain strong but we would expect a slowdown from last year's elevated pace. We are cautiously optimistic that equity underwriting volumes will improve after a very muted first quarter, probably more weighted to the second half. We have seen IPOs in the US and EMEA starting to come to market. How these transactions are received will be important to confidence going forward. In debt underwriting we would expect the investment grade markets to remain stable, and are seeing signs of life in the non-investment grade markets, although still selective at the bottom of the capital structure. In wealth management we would expect to see the stability and trends seen in the last several quarters to continue. And in investment management we expect asset management fees to remain stable and expect potential lumpiness in the investments line. We will continue to focus on Project Streamline and managing our risk profile. With that, we will open up the line to questions. QUESTIONS & ANSWERS Operator: (Operator Instructions) Michael Carrier with Bank of America

Good morning, Mike. I think, first of all, the targets are, as you point out 2017 targets, and they did have in them, they were driven in part by three efforts. One was Project Streamline and the ability to take out $1 billion of compensation and non-compensation expenses, assuming a flat revenue environment. The second was modest revenue growth of 3% to 5%. And then, of course, our continuation of our capital plans. I know we're going to get a lot of calls on this because that's the perils of putting out a target, is you get asked about it every time, every quarter, until you finally get there. But we did put it out for 2017. I think that it's very early days here. This was, as we said, an unusual backdrop, I think everybody would acknowledge the calendar was very weak. As we said, retail investors were very skittish. We still had some clean up in the investment management area. So it was an unusual backdrop. So, we're not aren't really at the stage...