Morgan Stanley MS
Q2 2013 Earnings Call Transcript
Transcript Call Date 07/18/2013

Celeste Mellet Brown - IR: Good morning. This is Celeste Mellet Brown, Head of Investor Relations. Welcome to our Second Quarter Earnings Call.

Today's presentation may include forward-looking statements, which reflect management's current estimates or beliefs and are subject to risks and uncertainties that may cause actual results to differ materially.

The presentation may also include certain non-GAAP financial measures. Please see our SEC filings at morganstanley.com for a reconciliation of such non-GAAP measures to the comparable GAAP figures and for a discussion of additional risks and uncertainties that may affect the future results of Morgan Stanley.

This presentation, which is copyrighted by Morgan Stanley and may not be duplicated or reproduced without our consent, is not an offer to buy or sell any security or instruments.

I will now turn the call over to Chairman and Chief Executive Officer, James Gorman.

James P. Gorman - Chairman and CEO: Thank you, Celeste. Good morning, everyone, and thank you for joining us. We will again review the progress we've made towards the six strategic priorities we delineated in January that would drive our return on equity and return on tangible equity excluding DVA to greater than 10% and 12% respectively.

We're pleased with the progress we've made during the quarter and we met or exceeded several of the goals. Let me just go through them quickly. First was to acquire 100% of the Wealth Management joint venture. As you know, we closed on the final 35% of that joint venture on the last business day of the quarter. As we've taken through the benefits numerous times, I'm not going to spell them out again. Suffice it to say however, the deal was a game changer for this firm and for our shareholders now and for decades to come.

Secondly, we've put out a goal to achieve Wealth Management margins through expense management and to revenue growth. In addition to owning 100% of the business, one of the key drivers for ROE upside is the revenue and margin upside in the Wealth Management business, both were higher this quarter. The margin of 18.5% represented the fifth consecutive quarter of margin improvement excluding non-recurring costs associated with the integration in Q3 2012. We've reached our highest margin level since the first quarter of 2008.

In addition, we increased our margin goals for Wealth Management business at our Financials Conference in June to 20% to 22% by the end of 2015, without the benefit of high rates or markets and more than 23% if markets or rates increased. Why the increase? The margins reflect the simple math of the upside from a 100% ownership with ongoing investment in the business, using the first quarter of 2013 results as a base.

Our third objective was to significantly reduce RWAs in fixed income and commodities. We continue to make progress regarding our fixed income RWA reductions ending the quarter at $239 billion down from the first quarter. We continue to expect fixed income RWAs to be below $200 billion by the end of 2016.

Our fourth goal was to drive expenses lower in 2013, '14 and beyond. We are on track to meet our expense reduction targets, and Ruth will take you through these in more detail. As you can see clearly see, our expense ratios have improved as we said they would with revenue growth.

Our fifth point was to grow earnings through Morgan Stanley specific opportunities. We recently received approximately $16 billion of deposits in the initial wave due to us now that we own 100% of Wealth Management. The team is executing against our plan to prudently deploy those deposits in support of loan growth in both Institutional Securities and Wealth Management.

Now that we own 100%, we can execute on more of the initiatives we have in place to better align Institutional and Wealth Management, including a deeper partnership between the businesses and their trading desks. Because order flow is no longer split with their former partner, we expect deeper and more efficient markets for both our institutional and retail clients, as well as greater revenue opportunity for fixed income, in addition to the order flow benefit we discussed to you for Wealth Management. We are also looking forward to launching new products and increasing the efficiency of firm funding.

So, our sixth point asks, what did it all add up to? Well, despite difficult markets, our results this quarter evidenced strength and resilience. Revenues in all of our major businesses were up double-digits year-over-year with Institutional Securities excluding DVA up 40% and Investment Management up 48%.

In addition, we're pleased to commence the share repurchase we announced this morning, which will offset some of the dilution relating to employee stock programs and also benefit ROE. We recently received a non-objection from the Federal Reserve to returns 1% of our Tier 1 capital and we will execute on the buyback in the forthcoming quarters.

We've on a long journey to generate stronger, more sustainable, long-term returns with businesses that balance each other in volatile markets. With the acquisitions of 100% of Wealth Management that business model is solidly in place. Our Wealth Management business complements our leading Institutional Securities business and the adjacencies across the entire platform would drive upside for all of Morgan Stanley. We've strengths across areas of fixed income and are consistently in the top three in equity underwriting and M&A league tables with increasing momentum in fixed income underwriting.

Our Investment Banking franchise is a leader globally. And we demonstrated the power of our footprint with important cross-border deal announcements in the quarter.

I'd now like to draw particular attention to our Institutional Equities franchise, which consistently ranks top two globally in market and wallet share. In the second quarter, we continued to execute extremely well against challenging markets. In the cash product, we benefited from a hybrid voice and electronic model centered around integrated client coverage. We approach this business with the delivery of research driven content, market insight and state-of-the-art trading technology to a wide variety of client types. Our electronic offering spans cash, synthetic cash and derivatives, and has more than doubled market share over the last three years.

In equity derivatives, our team is capitalizing on the investments we have made over the last several years, driven by the breadth of our client reach, deepening relationships and partnerships across the firm, and ongoing strong risk management.

Last, but not least, in prime brokerage with significant balances we have a practice focused on market access, service excellence and innovative solutions for clients, all leading to an outstanding performance by Institutional Equities this quarter.

With Morgan Stanley's global reach, we are confident there is continued upside for this business and for the firm.

Thank you. I will now turn the call over to Ruth and look forward to your questions later on.

Ruth Porat - EVP and CFO: Good morning. I will provide both GAAP results and results excluding the effective DVA. We have provided reconciliations in the footnotes to the earnings release to reconcile these non-GAAP measures. The impact of DVA in the quarter was $175 million, with $114 million in equities sales and trading and $61 million in fixed income sales and trading. Excluding the impact of DVA, firm-wide revenues were $8.3 billion, down approximately 2% versus the first quarter.

The effective tax rate from continuing operations for the second quarter was 31%. Earnings from continuing operations applicable to Morgan Stanley common shareholders, excluding DVA were approximately $720 million, which included a negative adjustment of $152 million related to the acquisition of the remaining 35% stake in the Wealth Management joint venture.

Earnings from continuing operations per diluted share excluding DVA were $0.37 after preferred dividends. EPS included a negative adjustment of $0.08 per share from the acquisition of the remainder of the Wealth Management joint venture. On a GAAP basis, including the impact of DVA, firm-wide revenues for the quarter were $8.5 billion. Earnings from continuing operations applicable to Morgan Stanley common shareholders were $831 million.

Reported earnings from continuing operations per diluted share also inclusive of the negative adjustment of $0.08 were $0.43 per share after preferred dividends. Book value at the end of the quarter was $31.48 per share. Tangible book value was $26.27 per share, reflecting a reduction of $1.49 due to the completion of the acquisition of the Wealth Management joint venture partially offset by earnings.

Turning to the balance sheet, out total assets were $806 billion at June 30, essentially flat versus last quarter. Deposits were $82 billion, basically unchanged from the prior quarter. Quarter end deposits did not reflect the first tranche of deposits that are transferred to Morgan Stanley in conjunction with the acquisition of the remainder of the joint venture. The initial deposits come in on a lag basis with $16 billion transferred this week. We will receive the remaining deposits on a monthly basis through the middle of 2015.

Our liquidity reserve at the end of the quarter was $181 billion compared with $186 billion at the end of the first quarter. The decline was driven by a reduction in bank liquidity as we deployed excess liquidity to support loan. Although our calculations are not final, we believe that our Tier 1 common ratio under Basel I will be approximately 11.8% and our Tier 1 capital ratio will be approximately 14.1%.

Risk-weighted assets under Basel I and including the final market risk rules are expected to be approximately $404 billion at June 30. Reflecting our best assessment and expectations of the recently received Federal Reserve rules, our pro forma Tier 1 common ratio, under Basel III was 9.9% as of the end of the second quarter. We note that this ratio reflects our best interpretation at this time and is subject to change as we further study the new rules.

We estimate our pro forma supplementary leverage ratio to be 4.2%. This estimate reflects the most recent United States proposed regulatory rules for the numerator and denominator and is also subject to change as study the guidelines. We have a clearly identified path to exceed in 2015 the 5% regulatory requirement.

Turning to expenses; total expenses this quarter were $6.7 billion, up 2% versus the first quarter with compensation expense down 3% and non-compensation expense up 11%. Relative to the expense reduction targets that we articulated in January, we remain on track as best evidenced by our expense ratios relative to our 2014 target. Recall that we expected that some of our expense reduction efforts to result in $1.6 billion decline from 2012 reported expenses to 2014 full year expenses. Our $1.6 billion target was set based on revenue, consistent with 2012 levels, notwithstanding our expectations for growth. Thus, we further indicated that on higher revenues our variable expenses would grow, but that our overall expense ratios would improve.

Our revenues excluding DVA were up 8% in the first half while our expenses were up 5%. Excluding higher litigation costs our expenses would have been up 2%. Our $1.6 billion cost reduction target on flat revenues imply an expense ratio of approximately 79% for the firm for 2014. We are at that level in the first half of 2013 and would be even better than 79% without higher litigation with still more expense savings to be realized over time. As a reminder, our targets are two-year targets and expenses have and will likely continue to vary from quarter-to-quarter.

Recall that we had some non-recurring expenses in the second half of last year. In addition, we had severance in certain Wealth Management items in our results in the first half of this year. Our targets include an expectation for continued elevated legal expenses, but of course, those tend to be (indiscernible) and difficult to forecast. We continue to work through our cost cutting programs and they will drive operating leverage through the end of 2014.

Let me now discuss our businesses in detail. In Institutional Securities, revenues, excluding DVA were $4.2 billion, down 5% sequentially. Non-interest expense was $3.4 billion, up 3% versus the first quarter. Compensation was 1.8 billion for the second quarter, down 7% versus the first quarter reflecting a 42% ratio excluding DVA. Non-compensation expense of $1.6 billion increased 16% from last quarter, driven by increased litigation expense as well as revenue and activity related costs. The business reported a pre-tax profit of $785 million excluding the impact of DVA. Including the impact of DVA, the business reported a pre-tax profit of $960 million.

In Investment Banking, revenues of $1.1 billion were up 14% versus last quarter with strong growth in EMEA. According to Thomson Reuters, Morgan Stanley ranked number two in Global Completed M&A; number three in Announced M&A; number two in Global IPOs and number three in Global Equity at the end of the second quarter.

Notable transactions included; in advisory, Morgan Stanley acted as lead financial advisor for Kabel Deutschland on the proposed EUR10.7 billion takeover offer from Vodafone. In equity underwriting, Morgan Stanley successfully priced the $4 billion IPO of Suntory Beverage & Food Limited. Morgan Stanley acted as joint global coordinator and lead left book runner on the international tranche. Our JV partner MUFG also acted as joint book runner on the domestic tranche. And in debt underwriting, Morgan Stanley acted as an active book runner on Petrobras jumbo $11 billion six tranche senior notes offering as well as Chevron's $6 billion four tranche senior notes offering.

Advisory revenues of $333 million were up 33% versus our first quarter results, driven by cross-border activity and improved performance in EMEA and the Americans. Equity underwriting revenues were $327 million, up 16% versus the first quarter, driven by a significant increase in IPO activity and the highest level of sponsor-related activity in several years.

We had strength in the Americas and Asia, particularly Japan. Fixed income underwriting revenues were $418 million, up 2% versus the strong first quarter, driven by loan syndication fees.

Equity sales and trading revenues, excluding DVA, were $1.8 billion, an increase of 13% from last quarter. Equity revenues were up broadly across products, regions and client segments versus the first quarter. Client revenues were the highest level in over a year, driven by higher market volumes, increased volatility and greater prime brokerage balances.

In cash equities, the revenue increase was driven by continued strong market share and volume growth, in particular, in the Americas. Derivatives revenues were up versus last quarter, with strength across regions, particularly in Japan and the Americas and in part driven by higher volatility. Prime brokerage revenues also increased driven by increased activity during the European dividend season and higher client balances which increased with overall market levels.

Fixed income and commodities sales and trading revenues excluding DVA were $1.2 billion. Fixed income revenues decreased versus the first quarter due to higher volatility that resulted in lower client activity. However, reduction in our risk levels during this period helped offset price volatility.

FX delivered its fourth consecutive quarter of revenue gains, benefiting from ongoing strong contribution from the firm's electronic trading platform. Commodities' results were up meaningfully versus the first quarter benefiting in particular from increased client activity in North American power and natural as well as precious metals volatility. Generally, however, the oil liquids market which over time has been the most important driver of our commodities business, continues to operate at historically low levels. Finally there was a modest CVA benefit in the quarter.

Other sales and trading negative revenues of $57 million compared with positive revenues of $73 million last quarter. Average trading VaR for the second quarter was $61 million versus $72 million in the first quarter driven by a reduction in risk in May in fixed income and commodities.

Turning to Wealth Management, we achieved revenues of $3.5 billion in the second quarter, a record level. Asset management revenues of $1.9 billion were consistent with the first quarter, benefiting from higher market levels that were offset by lower deposit referral fees due to a rate reset late in the first quarter.

Transaction revenues decreased 7% from last quarter, consisting primarily of commissions of $567 million, which were flat to the prior quarter; Investment Banking related fees of $258 million, down 6% versus last quarter, reflecting lower new issue volumes; and trading revenues of $223 million which were down 25% versus the first quarter, reflecting the impact of lower activity due to difficult market conditions in June.

Net interest revenue increased 8% to $446 million driven primarily by growth in our lending product. Other revenue increased to $139 million in the quarter, primarily due to a gain on the sale of our global stock plan business and our investment portfolio gains. Noninterest expense was $2.9 billion, flat to last quarter.

The compensation ratio was 58% versus 60% in the first quarter, reflecting a higher level of net interest income and higher non-compensable revenues in the other revenue line. Non-compensation expense was $834 million, up 3% versus last quarter due to a number of expense items incurred in conjunction with the closing of the Wealth Management joint venture, including software write-off, branch consolidation and increased advertising expenses.

The PBT margin was 18.5%. Profit before tax and the PBT margin benefited modestly from the net impact of the unusual revenue expenses in the quarter.

Profit before tax was $655 million, the highest level of absolute profitability since the inception of the joint venture. We reported non-controlling interest of $100 million in the quarter, reflecting a full quarter of earnings. Prospectively, we will not have the NCI deduction. Total client assets were basically flat to 1Q at $1.8 trillion. Global fee-based asset inflows were $10 billion. Fee-based assets under management increased to $629 billion at quarter end. Global representatives were 16,321, up slightly from the first quarter. Bank deposits were $127 billion, effectively flat to 1Q. Approximately $70 billion were held in Morgan Stanley banks. As mentioned previously, we received the first wave of deposits associated with the final 35% ownership this week.

Investment Management revenues of $673 million were up 4% versus the first quarter. In traditional asset management, revenues of $490 million were up from the first quarter, driven by higher performance fees and asset management and administration fees. In real estate investing, revenues decreased 11% versus the first quarter and the firm realized strong principal investment gains. Due to the ownership structure of these funds, the majority of these revenues are passed to third-party investors in the non-controlling interest line.

In Merchant Banking, revenues were up 31% compared to the first quarter, driven by higher principal investment gains. Expenses were $513 million, up 12% from the first quarter, reflecting a change in revenue mix. Profit before tax was $160 million, down 14% sequentially. NCI was $21 million versus $51 million last quarter. Total assets under management increased to $347 billion, driven by net inflows of $9.8 billion.

In terms of our outlook, in the U.S., positive economic data suggests that headwinds are abating. Improving employment, signs of strength in discretionary consumer spending, a healthy outlook for housing, and a declining deficit are encouraging signs for our clients and our businesses. Recent Federal Reserve guidance is also constructive, in particular, its emphasis on interest rate policy. Institutional clients are repositioning in response to the Fed comments. Equity activity in the U.S. remains strong with U.S. equities viewed as a relative safe heaven. Our M&A pipeline remains healthy with corporate clients increasingly focused on executing strategic priorities ahead of potential rising rates and our retail clients remain engaged in the markets.

In the Eurozone, our outlook for GDP remains subdued. We expect to see higher activity levels, but only relative to anemic lows in recent periods. Japanese markets remain strong and we are well-positioned given our partnership with MUFG.

In short, we benefit from our leading positions globally. Our franchise momentum continues. And we are increasingly leveraging strengths within business units to the benefit of the entire firm.

Thank you joining us. James and I will now take your questions.

Transcript Call Date 07/18/2013

Operator: Mike Carrier, Merrill Lynch.

Michael Carrier - Bank of America Merrill Lynch: Maybe first question just on the Wealth Management business. So, you're hitting the margins. You do the buy-in. Just the one area that it just seems like that business still looks a little bit on the low side would just be on the returns, and granted this quarter there's a lot of charges and you don't get the full benefit. But it just seems like even on an adjusted basis it might be in that 7%, 8%. Just going forward, like what's the driver there of improving those returns. I mean, obviously, as the margins pick up, that's going to benefit it. But just what's the long-term opportunity for the return in the Wealth Management business?

Ruth Porat - EVP and CFO: Well, a couple of points. Given there was an acquisition, there is goodwill associated with this. So, the return on tangible equity in the business is about 30% today. We do see the profitability, the profit margin and the returns on that business increasing. So, up nicely, year-over-year increased versus the last quarter and that really reflects the ongoing strength on the revenue line, the benefit of the cost moves that we've made on the expense line. I did call out that there were some higher expenses this quarter, but fundamentally, the benefit on the expense line and we do see longer-term upside as we continue to execute on the lending products. So, again, upside from lending. We revised our target to 20% to 22% by the end of 2015. And again, to be clear, that was with no assumption about higher equity market levels or rate changes and we expect that we would be above 23% with the benefit of markets and rates. The other thing I'd note is that this quarter we did take the charge associated with buying in the balance of the Wealth Management business. That's $152 million charge. So, the return on equity excluding that's 10%. But again, I'd focus you to the return on tangible equity given the acquisition.

Michael Carrier - Bank of America Merrill Lynch: Then maybe just as a follow-up on the capital side. So, you gave the color on the leverage ratio and the outlook in terms of 2015. In terms of – how do you get there? What are the different leverage points that you have, and then any impact on the revenues of the business? And then probably more importantly, given that you got the buybacks this quarter and for the rest of the year, how do you think that plays in? Because obviously the earnings power is improving, the leverage ratio is lower, but you are getting some buyback opportunities. And when we think about buybacks going into '14 and '15, just any view on that just given the different dynamics?

Ruth Porat - EVP and CFO: So, let me start with the leverage ratio. As I indicated, we estimate we're spot at about 4.2% this quarter and as I said, we expect to be above 15% in 2015. We do see opportunities with both the numerator and the denominator, and most important, they are very consistent with the strategy against which we've been executing. So starting with the denominator, where we see a big opportunity, there are a couple things to note. First, with our focus on reducing risk-weighted assets in fixed income, this is not model approval, but passive and active mitigation, and as a result, we're taking balance sheet down because there's a relationship between risk-weighted assets and gross balance sheet. So that's the first point. As we repeatedly said, we're taking risk-weighted assets down in areas that are not accretive to revenues. So we don't see that is impacting the business. The second is our focus on central clearing. We've talked about that on many calls. We've invested meaningfully in central clearing. We're well-positioned to increase the volume of our derivatives through central clearing and back-loading old trades leads to an elimination of the gross up in the denominator. We're obviously accreting capital, which benefits the numerator. So when you incorporate both items, $500 million share repurchase we've talked about and an assumption that we do continue to return capital in the future, that takes us to this glide path to above 5% in 2015. Now, to be clear, on top of those items, we do believe there are additional opportunities to reduce the denominator, but it's too early to quantify. So, a couple of examples. With banks on both sides of the Atlantic focused on reducing balance sheet, we believe there could be lower derivative notionals by compressing offsetting trades between clients and counterparties for non-clearable derivatives. A second opportunity is more upside in central clearing. In our calculation, we only incorporated our expectation for the amounts to be cleared in the next 12 months. We didn't go beyond one year. This is an important area and so we do see, again, upside in the reduction in the denominator from the amount that's centrally cleared. And then finally, consistent with all that we've been doing to optimize capital, business unit leaders have the analytics to optimize their returns. We've talked about this in the past. We look at – we charge them for the capital balance sheet and liquidity needed to support their business and when you look at the way we are organized with our bank resource management effort, we've talked about that in the past, BRM. It's a centralized resource governance structure. We are well-positioned to make appropriate resource allocation adjustments. So, we do feel good about the strength of our capital base, which we baked in and returning more capital into that calculation and I would note that we're already above 6% at the Bank.

Operator: Guy Moszkowski, Autonomous Research.

Guy Moszkowski - Autonomous Research: It was very encouraging to see the buyback. Can we assume that that was something that was approved as part of your approvals process with the Fed just ahead of the joint venture buy-in?

Ruth Porat - EVP and CFO: So, just to break it down, in the 2013 CCAR, the only request we put in as we've talked about on prior calls was for the Wealth Management acquisition given how strategically important that is and there is a provision though within CCAR once you have capital approval, you can apply for an additional 1% of Tier 1capital for capital action. So, upon closing it, I think this is where you are going, but just to make sure I'm very clear on it. As we went to the final closing of the Wealth Management acquisition, we put in the request to use this incremental 1% of Tier 1 capital for capital actions. We thought it was the logical next step and are pleased to have the approval no objection and to be commencing the share repurchase – it hasn't yet started. We just got approval for it, so it gives us the ability to use it as James said in his opening comments.

James P. Gorman - Chairman and CEO: Yeah. I think, Guy, that the key, as we've said consistently, is to focus on the strategic platform, get Morgan Stanley in the shape that it needs to be in for the next decade and more and then the financial management through buybacks and other capital actions, obviously follow from that. So we were very careful to make sure we got the deal done even though it was modest capital outlay of four hundred and some million before we started anything on the capital action and we've taken this first step and obviously we are pleased to do it.

Guy Moszkowski - Autonomous Research: But just to follow-up on it then. As we think about the platform and the capital that's needed in it, I look at the capital allocations that you give for the different business units, which is as I told you before a very, very helpful disclosure, which a lot of people don't do, so thanks for that. I noticed that you brought the capital in ISG down this quarter by a little over $1 billion and with the accumulation of retained earnings you brought the parent unallocated capital up by a little over $2 billion. Are we supposed to read or can we read anything into that into what you think you need for the different business platforms and how much you might be accumulating for ultimate return?

Ruth Porat - EVP and CFO: Well, let me first clarify what's in the allocation of required capital. So, you are absolutely right. The parent capital number went up. The allocation is based on the final Basel I, Basel I plus 2.5 if you want to call it that. And with the reduction in risk-weighted assets in fixed income that we require less capital in fixed income which is why the ISG number went down and the parent number went up, accretion of earnings plus the reduction of capital required in the business. Now, the way we are managing the business is with the Basel III lens as we've talked about and we will shift to this table to Basel III as soon as we are – the industry is reporting on the Basel III basis completely. But fundamentally what you see here is that we are continuing to accrete capital. That's why we said we believe we are increasing our degrees of flexibility that's reflective in our Basel III Tier 1 common ratio and in particular, the clarity we think we have with the execution path on the leverage rations. So, directionally, yes, and then the numbers would change a little as it moves to Basel III.

Operator: Howard Chen, Credit Suisse.

Howard Chen - Credit Suisse: On the core clients fixed franchise, it's been a challenging backdrop, but I think you've expressed some level of disappointment on an absolute basis and the results somewhat lag the peers. As you look at broader FIC franchise performance, what do you attribute the underperformance to and what's within your control from here to improve those results and the trajectory of it?

Ruth Porat - EVP and CFO: Well, it was a tough quarter. We reduced risk in May given our concerns about the potential market volatility within the fixed income product. You can see that when you look at VaR. We ended the quarter with VaR down about 15%. And as I noted, risk-weighted assets were down, down to $239 billion. In our view, it does set us up well going forward to support higher client activity, and we do think that we have upside in quite a number of the product areas and we are continuing to benefit from the leadership positions across our franchise given the benefit of adjacencies.

James P. Gorman - Chairman and CEO: I would just add, Howard. There is a little bit of an obsession in comparing for size. We don't frankly compare for size. We have a different structure business from a lot of other institutions for very important reasons. We're not a global commercial bank in the traditional sense. So we are always going to have smaller foreign exchange and rates businesses. But we focus on our returns. We've been through a period where we had to cleanup a lot of stuff that we had. We did that going back to MBIA and longer. We had to then build out a footprint, which we've been doing over the last couple of years. And now the business is aligned the way we like it. We're now working on each of those parts as we laid out at the last analyst call getting to their individual returns. The sum aggregate obviously gives us a decent return for the business. So we're much more focused on returns than on size.

Howard Chen - Credit Suisse: Then switching gears over to GWM. Ruth, asset administration fees grew, but maybe not as much as we expected with the lag pricing dynamics. So I was just hoping you could walk through the dynamics of the moving parts of the referral fees this quarter and any other notable trends ex the referral fees that you might have seen through the business?

Ruth Porat - EVP and CFO: Well, you went right to the key point which was the referral fees. That referral fee is set on an annual basis and it's based on rates at that time. It was reset late in the first quarter. So this is the first full quarter of the lower deposit referral fees. It gets reset again next year and the deposit referral fee, just like the higher FDIC fee from City as well. Both of those roll off as the deposits rolls over to Morgan Stanley.

Howard Chen - Credit Suisse: Then my final question, thanks for all the thoughts on the supplemental leverage ratio. Just, if I heard you correctly, it sounds, Ruth, like most of the mitigating actions you could take are mostly on fixed income and I guess when I take a step back I inherently think of your sales and trading franchise, equities being inherently more levered business than fix. So, how do we kind of marry that with you having fantastic equities results with that inherently being higher leverage business with you achieving the glide path, does that makes sense?

Ruth Porat - EVP and CFO: So a couple of things. One, we are managing a leverage-based capital, looking at both leverage-based capital and risk-based capital and our portfolio actually when you manage those two results in the highest overall return. Second, on the gross up, in terms of the gross up for the balance sheet, the areas that we're running down are areas entirely consistent as I said with the strategy we are executing upon. So, back to James' comment that we are not focused on fixed income size for size sake. We are looking at the returns on the business and so the run down in risk-weighted asset enables us to focus on the areas that are core to our client franchise where we are continuing to put risk behind client and the reduction in denominator is associated with the move to central clearing. Again, we've repeatedly said on calls that we believe that central clearings is not only good for the market, because it increases transparency and standardization, but it does play to Morgan Stanley strength, because it's less about competing on size of the balance sheet and more about content and service and execution. So we were moving in that direction in any event and the opportunity to backload all trades into central clearing and thereby reduce the denominator, again, consistent with our ability to have a right – a focused fixed income business that plays to our strengths and again, benefits from all that we are doing across the franchise.

Howard Chen - Credit Suisse: Maybe just one follow-up on that. I guess what I'm asking is, it doesn't sound like there's a high level of concern that this supplemental leverage ratio and mitigating to that will disrupt these great results, share gains that you've all made in the equities business over the last few years?

Ruth Porat - EVP and CFO: No. As I said, the – I think with the elegance of the rundown to 2014, if that's the right word to use, is it is consistent with the strategy that we've already articulated and against which we're executing. And our equities franchise is a stellar franchise, continued strength across products and geographies, balanced across the franchise and so again, we're able to continue to execute.

Operator: Mike Mayo, CLSA.

Mike Mayo - CLSA: I just wanted to clarify, Ruth, when you said getting the leverage ratio of 5% that has an assumption for return of capital in the future, what did you mean by that?

Ruth Porat - EVP and CFO: We included an assumption, but I don't want to prejudge where 2014 CCAR comes out and given the flexibility that we have as I enumerated the various items that further reduce denominator, we've built in levels of flexibility so that, again, it will be based on where is CCAR at the end of this year and managing the mix of levers that we have. I noted it because $500 million is a good first step in terms of a share repurchase and it is a tool that we believe we've built flexibility to use on a go-forward basis but don't want to prejudge 2014 CCAR by putting a number out there.

James P. Gorman - Chairman and CEO: I'd just point out though. Since the last CCAR, we've had earnings of, round numbers, $800 million (to $1.2 billion) and $900 million. So, we're obviously accreting reasonably healthy levels of capital quarter-by-quarter.

Mike Mayo - CLSA: To stay on the topic of capital, the ROE is about of half of where your target is. Any general thoughts on how you are going to improve the ROE from where it is in this quarter?

Ruth Porat - EVP and CFO: Yeah. So, James laid out in January the six point ROE plan, and as you said, we've already made progress – substantial progress on a number of the items. Completing the Wealth Management accusation is obviously a key step. The earnings this quarter don't have the benefit of that incremental 35% we closed on the last day of the quarter that starts July 1. The revenue and margin upside we've delivered, but as we indicated we think there's more upside there. The reduction in risk-weighted assets and fixed income, we're very much on track, if not ahead of track and we do believe that there's upside in that business. We're continuing to execute on the expense ratios. Expenses were a bit higher this quarter as we noted. Litigation was a bit higher, and again, we're on a good trajectory to have tighter expense ratios as we go through the 2014. We're executing on the bank strategy, which again gives us some upside and capita as well. So the ROE this quarter was obviously also depressed by the charge associated with buying in the Wealth Management business, but when you roll those items together, excluding the charge about 6% and then we see upside from the six items that we've consistently taking you back to.

James P. Gorman - Chairman and CEO: Mike, I would just say there's nothing that we have seen in this quarter, the changes. Our view on what we've laid out on our ROE projection, we stand by them.

Mike Mayo - CLSA: You mentioned backlogs a little bit, but could you elaborate a little bit more?

Ruth Porat - EVP and CFO: Sure. The pipeline does remain healthy. U.S. activity is the strongest, I did note Europe is up, but that's versus a very weak prior 12-month. Japan continues to be strong. Our emerging markets are mixed. China is slow, Brazil has a big pipeline, but as challenged. We think that's on pause for – at least for now, but we are seeing greater opportunity in Asia Pacific. So it's a very country-specific. I think the intriguing element is this backlog in M&A, which has been sitting for quite some time, and I've said on prior calls; we attribute that to CEO confidence. But what we are increasingly hearing is reassessments of timing, in particular of Fed comments are that any moves are data dependent and where there are signs of improvements in the economy, that isn't inspiring it in conjunction with concern about higher rates and what that means is there's a delay. So, we are hopeful to see that backlog start moving through the execution. The drivers to-date on activity have been more cross-border, as I noted, in the sponsor and activist related activity. The equity pipeline is stable. It's skewed more towards the U.S., Mexico and Japan.

Mike Mayo - CLSA: Two more small ones. Litigation, how much was it this quarter and where do you expect that to go and what's normal?

Ruth Porat - EVP and CFO: So the second quarter was up 140 relative to the first quarter. It's proven to be an ongoing cost for the industry associated with all the pre-crisis matters. It's proving to be lumpy. Tough to forecast, but we called it out in terms of the expense comparison, because at some point the financial crisis is behind the industry and these start to abate. And just to give you a sense, first half this year versus first half last year we're up $250 million.

Mike Mayo - CLSA: Then lastly, your VaR was down; at some others, it was up. Is this – what is that? Is that just the more cautious risk profile or is this just temporary?

Ruth Porat - EVP and CFO: Yeah, the VaR was down in particular on the interest rate and credit line, and that really goes to my comment that we reduced risk in May given concerns about potential market volatility within fixed income product. And the team did a good job managing that, but it does set us up well to support client activity this quarter going forward. We have capacity there.

Operator: Brennan Hawken, UBS.

Brennan Hawken - UBS: So, a quick one on leverage. Does the new rule change your view on moving derivatives over to the Bank sub?

Ruth Porat - EVP and CFO: That's a great question, because I indicated that we're above 6% at the Bank now. The way we're looking at it, it's obviously just come out and is still in the proposal stage. But if we move derivatives to the Bank, we get a dollar for dollar benefit because we're not obviously funding it with unsecured anymore, but with deposits. So, there is some optimization there and I think the way we're thinking about it is, client preference, efficiency, logic of it, how the market is evolving. We have some capacity in the Bank. We have a clear flight path for the holding company. So, it's much more about looking at the specific asset classes and assessing it, and it's too early to actually answer it more specifically than that.

Brennan Hawken - UBS: So, switching gears then, I guess, as you guys continue to work to improve margins in Wealth Management, is there a way we should think about FAA headcount going forward?

Ruth Porat - EVP and CFO: FAA headcount is up a bit this quarter. We continue to be very focused on FAA productivity, which as I noted is at a record high. Kind of in and around this level, it is logical, and again, our focus is primarily on FAA productivity. So it's not a line in the sand here.

James P. Gorman - Chairman and CEO: Yes. It will bounce around a little bit quarter-to-quarter. Honestly, I wouldn't think about it too much.

Brennan Hawken - UBS: But really productivity is probably the bigger driver and the way that we should think about it more so than actually the number of heads?

Ruth Porat - EVP and CFO: Yes,

James P. Gorman - Chairman and CEO: By far.

Brennan Hawken - UBS: Then last one from me. As NII becomes sort of more important to you all and the asset leverage increases paying a lot more attention to that. So, this question is a little dated, but I had kind of not paid as much attention to NII for you guys for a while. It seems as though NII in ISG has been really weak since 2008. What's been behind that? Is there any way to think about that or what are the drivers there?

Ruth Porat - EVP and CFO: No. I think your opening comments actually answered it. NIM is much more a banking book than a trading book concept and so it's much more relevant for the Wealth Management business and it has been improving nicely and should continue to as we deploy deposits. So, really it's less relevant in the trading business.

Brennan Hawken - UBS: On that the latter business than the Wealth Management business, we have seen kind of a move here in the two and three-year treasury. Is there any benefit that we can expect down the line for you guys from that move or is the deposit investment far shorter and we only really like the six month LIBOR would have an impact?

Ruth Porat - EVP and CFO: Yeah. We've indicated that it really is – we focus on the much shorter end. So the first 150 basis points in Fed funds is it's about $1.1 billion in PBT for the business. To the extent, we're seeing rising rates because there is improving economic activity that constructive for all of the businesses, but the guidance that we've provided was really anchored at the short end.

Operator: James Mitchell, Buckingham.

James Mitchell - Buckingham Research: Could I just ask a follow-up question on the derivatives business as you move to central clearing. We talk a lot about the numerator benefit, but have you done any work, trying to figure out what the – if any capital benefit would be on a Basel III basis and going – moving more and more of the derivatives to the centralized clearing platform?

Ruth Porat - EVP and CFO: It's still too early.

James Mitchell - Buckingham Research: But is it at least in your guidance – makes sense that you get some benefit or there is just no way to tell it all?

Ruth Porat - EVP and CFO: No, our assumption is there some benefit. There is benefit to it and trying to quantify it for our callers, it's too early. Our assessment is there will be capital too early.

James Mitchell - Buckingham Research: Just to follow-up on the spread question on the deposits. As you pool in $55 billion over the next 24 months, how do we think about – you talked about your leverage more in the short-end, but in the near-term I assume you are putting it mostly in AFS portfolio and with the backup in yields in the intermediate bond area, would you get some benefit? I know your target was 1% spread before the rate spike, should that – should we be assuming a little bit better than that?

Ruth Porat - EVP and CFO: We are still fairly short and it's been our philosophy given we've been in the low interest rate environment is to keep duration short given the inevitable rise in rates would prove to be a financial drag and I think that was the right thing to do.

Operator: Roger Freeman, Barclays.

Roger Freeman - Barclays Capital: I guess just on the FIC business. You're talking about risk having come down in May. With markets more normalized this sort of the level of liquidity provision gone up. Was the decline in May just the volatility? Or I know you had some management changes too, but I'm not sure if that's factored in there?

Ruth Porat - EVP and CFO: Well, there were concerns from the team about potential market volatility and just thinking of that it was prudent risk management to bring risk down in the business given that concern and we're pleased that they did.

Roger Freeman - Barclays Capital: And so market normalcy has returned, from your perspective, so far this quarter it seems like. We’re hearing that from others.

Ruth Porat - EVP and CFO: It does seem that way, yes.

Roger Freeman - Barclays Capital: And just back on the buyback and CCAR, I know you've probably said what you can. But just thinking about the 1%, is that sort of a mechanical outcome of this provision to be able to apply for that and kind of not to read into that one way or another as to the Fed's thinking on improving capital – stock buyback requests with, say, your leverage ratio where it is against the target? I mean, are they kind of separate issues?

Ruth Porat - EVP and CFO: Well, there is a provision that you have the opportunity to apply to use 1% of your Tier 1 capital. But it's still an approval. And so, we were pleased to have received the approval, no objection and to be able to proceed.

Roger Freeman - Barclays Capital: I guess the only other one on the clearing rollout, how is that in the swaps businesses, how is that going from your perspective? It seems like we're hearing from others there is no real impact on customer volumes. Are you finding the same thing?

Ruth Porat - EVP and CFO: Yes. I mean, the big event was obviously category too. The move went well, clients were ready. We didn't have operational issues. We do think the staggered rollout of clients was constructive between category one and category two. At this point it's premature to judge, I think, the impact fully on market activity, because there were so many other exogenous events, but it went well and we still are well-positioned.

Operator: Fiona Swaffield, RBC Capital Markets.

Fiona Swaffield - RBC Capital Markets: Two things. Firstly on the Basel III., Can we look through the 9.9 versus Q1? I don't' know if you could talk about the numerator and the denominator, because the RWAs keep on going down in fixed income, but I think there seems to be something offsetting it is kind of the first question. And the second question was the total exposure number. So the supplementary average ratio exposure and the move to the full. If we look back, and you have that big reduction in FICC Basel III RWAs, I mean, could you kind of tell us where the exposure would have been or the leverage ratio would have been into the bottom, just to kind of workout what the correlation is potentially?

Ruth Porat - EVP and CFO: So, on the first question, the Basel III firm-wide RWA are $426 billion. Some of the movement between the first quarter and the second quarter, obviously, there is earnings accretion, there was obviously the charge associated with the Wealth Management acquisition and then just finalization of the rules gets you to the 9.9%. And then could you repeat the question regarding the leverage ratio?

Fiona Swaffield - RBC Capital Markets: I'm just trying to understand the moving parts on the total exposure because you've obviously seen the fixed income RWAs come down a lot in the last 18 months and you are kind of getting more towards the end of that process. So how much of the total exposure going down, is it really due to the fixed income? Is this total exposure number would have been much higher before you started reduce in the fixed income book?

Ruth Porat - EVP and CFO: It would have been much higher before we started reducing the fixed income book. And I think the two bucket that I broke out, one, the RWA reduction. I mean, RWAs in fixed income were $390 billion at the peak. They are down to $239 billion and most of that really is in areas that are relevant to the gross up in particular, our structure credit, credit correlation business. So, yes, we've absolutely benefited from what we are doing and we continue to be on an execution path to take it down even more, which is what gives us the confidence we can continue to do so. And then similarly, we've moved – already moved quite a bit. We were early in central clearing and so we're already seeing some benefit in the denominator and the move to central clearing and look forward to continuing to execute on that portion.

Operator: Matt Burnell, Wells Fargo.

Matthew Burnell - Wells Fargo Securities: Thanks for taking my question. I appreciate the disclosure particularly specific to Wealth Management loans on Page 12. I guess I'm just curious as to if there was any dollar target or growth target of those loans, now that you've got deposits obviously flowing in from the MSSB transaction given your ongoing statements about trying to grow the spread revenue within Wealth Management?

Ruth Porat - EVP and CFO: So, I may give you a somewhat unsatisfactory answer because I'm not going to be able to quantify it by buckets and the reason is, we've said consistently that we are leading with credit risk management and that it will be a prudent build-out of the portfolio and that is how we are continuing to build it. So, the deposits are going to continue to grow and support growth and lending product both for Wealth Management and Institutional Securities. And on the Wealth Management side, the biggest growth is on the securities-based lending and secondarily on residential mortgages. We have 5% penetration of our clients relative to our peers who have 10%. So, our view is that there is tremendous upside. We've got a tailwind there, but we're again leading with prudent steady growth and that's going to be the continued philosophy around it. And then on the institutional side, that's also how we are going to be utilizing some of the deposits. We do get a funding benefit when we move dollar for dollar funding benefit, when we substitute unsecured debt with the more efficient deposits. So, certain product does move to the bank and obviously, our relationship or maybe not obviously – our relationship about lending is in the bank and then we have an attractive opportunity growing bank appropriate product in the bank. So areas where we already have very strong teams, domain expertise, client base, like commercial real estate lending, asset-based funding, project finance. We can grow the lending suite, an area we hadn't heretofore been focused on. So, it is a real diversified portfolio of assets supporting growth on both Wealth Management and the Institutional Securities businesses that we'll build over time and we'll be sharing more about the bank and the bank strategy over time given the growth that we are seeing there.

Matthew Burnell - Wells Fargo Securities: Then just switching gears a little bit, James, maybe a question for you in terms of how you are thinking about the long-term total payout ratio of the firm, given that you've taken a big step towards that with the announcement of the 500 million share buyback?

James P. Gorman - Chairman and CEO: Well, as I say, journey of the 1,000 miles begins with a single step and we've had our first step, that's really what mattered. We don't want to get ahead of that obviously. It's what payout ratios are. It's going to be a function of where absolute earnings are and managing against the changing regulatory environment. But what we wanted to do is put ourselves in a position where we could launch a buyback and begin that process which is what we did. Celeste Mellet Thank you so much for joining our second quarter call. We look forward to speaking to you again in October.

Operator: Ladies and gentlemen, gentleman, that concludes your conference call for today. Thank you for your participation. You may now disconnect.