Morgan Stanley Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
July 13, 2022

There are 13 speakers on the call.

Operator

Good morning. Welcome to Morgan Stanley's Second Quarter 2022 Earnings Call. On behalf of Morgan Stanley, I will begin the call with the following information and disclaimers. This call is being recorded. During today's presentation, we will refer to our earnings release and financial supplement, copies of which are available at morganstanley.com.

Operator

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 Sir, James Gorman.

Speaker 1

Thank you, operator. Good morning, everyone, and thank you for joining us. We're doing the call a little differently this time. I'm in London, so it's in New York. So if we have any logistical gaps for a second or 2, Please understand, but I think we'll be just fine.

Speaker 1

The firm delivered a very solid quarter against obviously what is a more challenging backdrop. Our business has proved resilient, reflecting an important aspect of our strategy and that is to, as we've said many times, deliver stable performance In a difficult environment while remaining well capitalized. The integrations of E*TRADE and Eaton Vance continued to expand our opportunities to reach new clients, Grow assets and support the firm's overall stability. Net new assets in Wealth Management of over $50,000,000,000 despite The volatility and clients' tax related withdrawals in the quarter underscored the scale of our business and its power to attract assets. And in the face of a sharp decline of equity markets, Wealth Management delivered a strong PBT and improved margin supported by the benefits of rising rates.

Speaker 1

Investment Management benefited from its diversification and we saw continued momentum in private alternatives, parametric customized portfolios And the counter cyclicality of our money market business. Finally, in Institutional Securities, our strong franchise in equity and fixed income Helps materially counter what everybody knows to be limited activity across Investment Banking. Our results this quarter also reflected 2 notable headwinds that are worth calling out. First, we saw a significant movement in the investments related to deferred cash based compensation plans. While the marks on these investments, substantially offsetting compensation expense, They created significant drag on top line revenues in the quarter across the firm, particularly in Wealth Management, where the impact to revenues exceeded $500,000,000 Secondly, the quarter results also included the legal costs of $200,000,000 that reflects the likely resolution of regulatory investigations by the SEC and the CFTC regarding employees' use of unapproved personal devices and the firm's record keeping requirements.

Speaker 1

This has been the subject of industry wide scrutiny.

Speaker 2

Our

Speaker 1

Excluding integration expenses for the deals that we've done was 14.3%, down 20% in Q1 and from last year. As I said at the outset, our objective to demonstrate resilience and balance in a more difficult economic cycle was achieved this quarter, Helped in part by the acquisition of E*TRADE and Eaton Vance in what was otherwise a challenging environment. Finally, the Fed stress test further affirmed our differentiated business model. Our diversified business mix as well as our strong capital position Provide us the flexibility to invest in future growth and support our robust capital return program. As such, we increased our quarterly dividend by 11% and announced a $20,000,000,000 multiyear buyback program.

Speaker 1

Having a dividend that's aligned to the more stable earnings from Wealth and Investment Management is a leading priority of this firm. And by the way, today's stock price, the current dividend has a yield of approximately 4%. With the buyback, We wanted more flexibility than an annual fixed commitment allows. Given the nature of our business model, it's especially appealing To have this additional flexibility to deploy capital at what we believe to be attractive valuations. I'll now turn the call over to Sharon.

Speaker 1

And as always, at the end, we'll take your questions.

Speaker 3

Thank you, and good morning. The firm produced revenues of $13,100,000,000 in the 2nd quarter. Our EPS was $1.39 and our ROTCE was 13.8 Excluding integration related expenses, our EPS was $1.44 and our ROTCE was 14.3%. Our results reaffirm the stability of the franchise against the challenging backdrop and the benefits of a balanced business model. The Integrated Investment Bank continues to serve clients' evolving needs in a dynamic environment.

Speaker 3

Wealth Management benefited from its scale and rising rates. Despite the decline in global asset prices, our expanded product set Investment Management proved supportive to that business. The firm's year to date efficiency ratio excluding integration related expenses With 70%. This includes the $200,000,000 legal matter related to the firm's record keeping requirements that James discussed. Given the broader market uncertainty and inflationary environment, we are focused on discretionary spend, while balancing continued investment initiatives and ensuring the right controls are in place to support future growth.

Speaker 3

As a management team, our priority is to diligently address what we can control given the market We will continue to review incremental spend as we regard efficiency as a critical performance objective. Now to the businesses. Institutional revenue of over $6,000,000,000 demonstrates the power of our balanced franchise Against the difficult market backdrop, revenues declined from the exceptionally strong prior year, while the backdrop was challenging for Investment Banking, Particularly underwriting, fixed income and equities led the strength of the quarter as clients navigated volatile markets. Investment Banking revenues were $1,100,000,000 down significantly from the prior year. Heightened volatility led clients to delay strategic actions and new issue activity.

Speaker 3

Advisory revenues to $148,000,000 Results were in line with global equity volumes, which fell meaningfully versus the prior year. Fixed income underwriting revenues were $326,000,000 also down compared to the prior year, As bond issuance was muted across both investment grade and non investment grade companies, the investment banking pipeline remains solid. Conversion to realized will largely be dependent on market conditions and corporate confidence. Equity revenues were $3,000,000,000 reflecting the strength of our business against a volatile backdrop. Prime Brokerage

Operator

Please standby as we reconnect our speakers.

Speaker 3

I understand the sound just dropped, but they'll reconnect now.

Operator

Please continue.

Speaker 3

Our revenues declined versus the prior year and reflected a loss of $413,000,000 Mark to market losses on corporate loans held for sale, including event loans, offset by gains on hedges were $282,000,000 This reflected the widening of credit spreads. Notable declines in deferred cash Based compensation plans compared to gains in the prior year also contributed to the decline. Turning to ISG Lending. As a reminder, over 90% of our ISG loans and commitments are either investment grade or secured. Our institutional securities group credit Our funded ratio on corporate loans stands at approximately 11%, In line with pre pandemic levels and well below the Q1 2020 peak of approximately 25%.

Speaker 3

Turning to Wealth Management. By several measures, performance was Strong despite the volatile backdrop. We reported revenues of $5,700,000,000 Results were meaningfully impacted by movements in DCP, which reduced revenues by $515,000,000 in the quarter. Excluding the impacts of DCP, Revenues increased 6% from the prior year to $6,300,000,000 a new record. The decline in DCP was substantially offset by a reduction in compensation expense.

Speaker 3

Excluding integration related expenses, PBT was robust At $1,600,000,000 and the margin increased to 28.2%. The margin resilience in a turbulent market environment serves As evidence of the strength of the franchise and the benefits of our business mix, including the growth of our banking offerings. Transactional revenues were $291,000,000 Excluding the impact of DCP, transactional revenues declined 17%. Lower revenues reflect a moderation of client activity from last year's elevated levels and limited new issuance. Self directed daily average trades remained well above E*TRADE's pre acquisition high.

Speaker 3

Asset Management revenues of $3,500,000,000 We're up modestly versus the prior year, driven by strong fee based flows realized over recent quarters. Fee based flow assets were $29,000,000,000 in the quarter and fee based assets now represent 50% of our advisor led assets. Total net new assets were $53,000,000,000 in the quarter, bringing year to date NNA $195,000,000,000 representing a 6% annualized growth rate, tax outflows were roughly double that of recent second quarters. And yet asset generation remains strong and balanced. NNA was driven by existing and new clients in the advisor led channel, stock plan vesting events, positive net recruiting and self directed channel inflows.

Speaker 3

Bank lending balances grew $7,000,000,000 in the quarter, Driven by securities based lending and mortgages, we continue to expect full year loan growth of $22,000,000,000 Deposits declined $12,000,000,000 in the quarter to $340,000,000,000 The decline was associated with seasonal tax outflows and Employment of rate sensitive cash. The outflows were largely in line with our expectations. The average rate of deposits increased to 28 basis This was driven by an increase in saving account rates and deposit mix. Net interest income was $1,700,000,000 up notably from the prior year driven by higher rates and continued strong bank lending growth. Looking ahead To the Q2, NII is now a more reasonable exit rate going forward.

Speaker 3

While the magnitude of rate hikes is not Certain, if the forward curve is realized and our model assumptions materialize, we estimate $500,000,000 of incremental NII to be spread over the upcoming 2 quarters weighted towards the 4th quarter. Turning to Investment Management. Revenues were $1,400,000,000 Against the challenging public market environment, our results demonstrate The benefits of our diversified product mix, particularly with strength in our portfolio solutions led by Parametric Customization And Private Alternative Funds as well as our liquidity offering. We have built a portfolio that provides balance across various market environments. The benefits of these efforts were apparent in the quarter.

Speaker 3

Total AUM was $1,400,000,000,000 Long term net outflows of $3,500,000,000 primarily reflect recurring headwinds in Equity Strategies, All were partially offset by strong demand in alternatives and solutions, particularly in Parametric Customized Portfolios. Collaboration with our Wealth Management business as well as other U. S. Wealth Management platforms is a driver of strength of our customized offerings. Liquidity net inflows exceeded $30,000,000,000 We have invested in our liquidity business in the past And related fees were $1,300,000,000 The impact of lower AUM was partially offset by higher liquidity fee revenue as rates came off of a zero bound.

Speaker 3

Performance based income and other revenues were $107,000,000 in the quarter. We saw broad based gains in our private alternatives portfolio with particular strength in infrastructure and the energy sector investments. The decline versus the prior year was driven by movements in DCP and markdowns on public investments. Overall, our integration with Eaton Vance continues to progress well. We have seen early success in leveraging our global distribution across our combined businesses.

Speaker 3

Turning to the balance sheet. Total spot assets declined 4% from the prior quarter to $1,200,000,000,000 Our standardized CET1 ratio was 15.2%, up 70 basis points versus the prior quarter. Standardized RWAs notably decreased to $461,000,000,000 from the prior quarter As we manage our exposure efficiently across our businesses amid a market decline, the result was a reduction in RWAs of $40,000,000,000 OCI related to our available for sale securities portfolio reflected an increase of unrealized losses of $1,100,000,000 While this should be earned back over time, it reduced our CET1 ratio by approximately 20 basis points in the quarter. Our supplementary leverage ratio was 5.4%. During the Q2, we completed our $12,000,000,000 buyback plan that we announced Last year, the most recent stress test results further reaffirmed our durable business model, And we announced a dividend increase of 11% and a $20,000,000,000 multiyear repurchase authorization.

Speaker 3

Looking ahead, while the second half of the year remains difficult to predict, we are focused on our underlying business drivers. Lower asset values will impact revenue in both Wealth and Investment Management. However, in Wealth Management, rising rates Are already driving NII higher, supporting performance and net new assets remain healthy in Investment Management. The diversification across fund strategies should continue to support results. What we do not know is How much volatility we will see in the coming months and how it will impact our institutional securities business.

Speaker 3

However, our competitive positions remain strong And we remain close to our clients while they assess current valuations and the overall environment. With that, we will now open the line up to questions.

Operator

Thank you. We are now ready to take Then we'll move to the next person in queue. Please stand by while we compile the Q and A roster. We'll take our first question from Christian Beaulieu with Autonomous.

Speaker 2

Thank you. Good afternoon, James, I guess, and then good morning, Sharon. Maybe start on the macro. James, it's a very confusing time on the macro front and there are some positives, but a ton Headwinds. I'm not allowed to say this quarter was unusually noisy for Morgan Stanley, and I think you kind of put up your lowest ROE in almost 2 years.

Speaker 2

So Just curious how you were thinking about the macro backdrop? How is MS positioned for that backdrop? Maybe how you think about your pathway to achieve some of your longer term targets in the current backdrop? Thanks.

Speaker 1

Sure. Thanks, Christian. I think you hit on the head, the environment. If I had to use one word to describe it, it would be complicated. We have the Russian invasion of the Ukraine, obviously, at historic occasion, we have historically low rates with Very significant rate increases going around the world.

Speaker 1

We've got the tail of COVID. We've got obviously the fears of inflation and Actual inflation, we've got enormous political change just here in this country, the UK, where I am at the moment. They had a leadership change a few days ago, Supply chain issues, China U. S. Relations, etcetera.

Speaker 1

So yes, very complicated. I think it's important to say though, it is not 2,008 complicated. This is a different type of financial stress in the system. And frankly, the banking sector is much stronger Than it was going into the last time we went through a major reset in 2007, 2008 Morgan Stanley is in particular, I won't speak for others, but We're specifically in much better shape. We're along the U.

Speaker 1

S. In our businesses largely because wealth management is almost entirely U. S. And the U. S.

Speaker 1

Is It's almost entirely U. S. And the U. S. Is yet again sort of a great region to be in the world.

Speaker 1

And yes, while we might head into Some form of recession and I, like many of others, have tried to handicap it, but we're frankly guessing at this stage. But I think It's unlikely to be a deep and dramatic recession, at least in the U. S. I think Asia is a little behind. It depends how COVID rolls out, And it's sort of reemerging a little bit in some countries.

Speaker 1

And then Europe is obviously the is fighting the hardest Right now, because of the war in the Ukraine, because of the pressure on gas and gas prices and so on. So when I look at Morgan Stanley, just sort of We did exactly what we wanted to do this quarter. Yes, it's the lowest ROE for a couple of years after, I think 3 consecutive record years, but hey, this is the most difficult environment we've been in decades. So I'm okay with the lower ROE, Particularly when it has a 10 handle on it. We have CET1 capital ratios 200 basis points above our requirement.

Speaker 1

Our RoTCE was nearly 14%. If you look at the Wealth Management margins, We did a 27% margin including integration this quarter, 28% without it. Those numbers were unheard of a few years ago. So you add it all together, the environment very complicated, lots of uncertainty. But frankly, for our business model, I think we fare relatively well.

Speaker 1

And evidence of that is our confidence in the future. And I'm sure we'll talk about that in terms of capital and so on.

Speaker 2

Okay. Thank you, James. Maybe Sharon, some more specifics around the buyback. Just thinking about how you're thinking about buybacks in the second half of the year. I mean, your CET1 did grow quarter over quarter, but I think a lot of that RWA declining.

Speaker 2

It looks like actually CET1 dollars are still falling, have been falling for a while. So I don't know. Can you maintain the sort of $2,700,000,000 ish buyback per quarter going forward? Or any more specifics around how long it will take to exhaust that 1,000,000,000 in buybacks, you announced?

Speaker 3

Well, multiyear obviously means more than 1 year. So sort of just To put that in perspective, but I think that the most important thing about the buyback, and also the capital more broadly is we've been very prudent and efficient around our I think that we've always said that capital is very much tied to strategy. They're 1 and the same, and so we think about them holistically. When we think specifically about the buyback and the concept of a multiyear repurchase plan, right, two points. 1, we did complete our old authorization, so therefore, We had announced a new authorization.

Speaker 3

And in addition to that, the point is we provide ourselves with tremendous flexibility in an environment such as this one Where there are, as James said, multiple macroeconomic factors, but also a commitment to continue to return capital Those shareholders, be that both in the evidenced by the increase in the dividend. And I think that what we're looking for is really Is flexibility around this capital, the capital repurchase plan?

Speaker 1

Yes. I just want want to add something. I mean, it was an important move, the $20,000,000,000 number. And we said multiyear for a reason. Obviously, we're not We're going to do that in 1 year, but we have enormous flexibility quarter to quarter now, And that's really important.

Speaker 1

And with 200 basis points of capital excess, we can use some of that flexibility. Listen, the stock is trading, I don't know what This morning, dollars 72 or something. It was $109 a couple of months ago. I like buying the stock at $72 And by the way, every time you A share at $72 you're retiring dividend with $3.10 So there's a sort of virtuous circle. If we bought back, We're averaging about 6% of shares outstanding, net we're buying back plus a 4% dividend, shareholders getting great return without getting out of bed.

Speaker 1

So this is a statement of confidence of A, our capital position and B, the resilience of our business model.

Operator

Thank you. We'll take our next question from Glenn Schorr with Evercore.

Speaker 4

Hi, thanks. Maybe just a follow on on the buyback convo and broaden it out. When you look across all the big GSIBs, lots have higher GSIB buffers coming, Capital deficiency to their targets and don't have the access that you have. So I get it, buyback cheap stock is great. Are there any other options that you ponder like maybe using that capital to grow Share in any parts of the business or just save a rainy day, like I'm curious on how that dynamic works being one of the only ones with the excess position.

Speaker 1

Well, it's Glenn, this is sort of the ultimate question. We've built through a decade of, Frankly, hard work and discipline, a great excess capital position. Not for nothing, along the way, we did 2 major acquisitions. So we're using it on deals and 2 small ones, Solium and Mesa West, you recall. The majors, of course, e trade Eaton Vance.

Speaker 1

We've taken the dividend. Last year, we doubled the dividend. And this year, we took it up Another 11%. It wasn't so long ago, our dividend was $0.05 a quarter. The incremental change this year is $0.075 a quarter.

Speaker 1

So we've used on that. We're investing in the business everywhere, particularly around the workplace, retirement space. We've invested in the digital bank and building out the wealth space. We've invested in asset management and our capability and we're going to be doing more of that taking Eaton Vance Funds internationally, expanding the Parametric program and then we're investing in banking. I mean, obviously, the banking calendar has been terrible The last few months, but that's not we're interested in the next 10 years, not the last few months.

Speaker 1

So the only thing we haven't done with excess capital is do a special dividend. And that's something I'm just personally not a fan of. I just don't I think it's like giving shareholders a problem and saying, we don't know what to do with that money. Here you take it. So what we like to do with our money, invest it in the business check, give you a smart dividend with a 4% yield check And do buybacks and have flexibility around it when the stock is trading.

Speaker 1

At the beginning of the year for every Ex dollars we spent, we got 4 shares retired, now we're retiring 5 shares. I like that.

Speaker 4

I appreciate all that James. Follow-up on Wealth Management. Sharon, thank you. You gave color on new money coming into which types of accounts and new clients. I'm curious, what are they doing with it?

Speaker 4

In other words, is it sitting in cash? Are cash positions higher than they usually are? What products are they going to? And then Thirdly, you're the largest gatherer of alternative assets. Has this market brought any noticeable impact to that opportunity on the wealth channel?

Speaker 4

Thank you.

Speaker 3

Sure. Let me start with the last. No change in opportunity. I think we continue to actually work very closely With different alternative managers, as we go forward and think about educate FAs, educate FAs to educate their clients And use that relationship to continue to create the right products for our clients all based on education through both channels. In terms of what are they doing with that money, I think what you do see is a lot of the money ends up moving into fee based over time, right?

Speaker 3

So look at the fact We aggregated all these net new assets over recent quarters that first often does come into the system as cash when they're brought over And then that cash is then deployed into various types of fee based asset accounts. I think it's worth noting and just repeating Those fee based assets are now 50% of our advisor led channel and those assets, which is a big move from those somewhat 40s, low 40s that we had seen In previous years. In terms of very specifically what we've seen over the course of the first half of this year in terms of different types of products, We were sitting at the end of the 4th quarter, with cash levels at around 17% to 18% around the self directed And the advice based channel, we're now at around 21%. Of course, that could be reflective of some of the equity The values and the other asset values coming down to increase, but there is somewhat of there is a pause. I think people are waiting and observing in certain markets To deploy that cash, and I think that's just you can see that in the transactional coming down a bit and DARTs coming down a bit.

Speaker 3

But I don't want To suggest that the engagement isn't there because we still are at levels where our engagement as thought about buys a most DART And just what we've seen in transactional, it's still higher than levels where we were from a pre pandemic basis. So people are engaged, people are active and they are seeking advice from their FAs.

Operator

Thank you. We'll take our next question from Steve Chubak with Wolfe Research.

Speaker 5

Hi, good morning. So I wanted to ask a follow-up question on the deposit outlook. As you noted in the prepared remarks, Just lots of crosscurrents this quarter on the deposit side, tax seasonality, cash sorting and maybe some offset from higher market volatility. And given the NII guidance, Arun, that you had laid out, I was hoping you could speak to what you're assuming for deposit betas And the deposit growth trajectory given the myopic focus on cash sorting and recognizing that you already laid out some pretty explicit guidance on the loan growth

Speaker 3

I think what you just noted at the very end is very important because all of this is weighted Into that NII forecast, right? Deposit betas is just one piece of that conversation, the behavior and then also how we continue to build And in aggregate, be it new assets through NNA and also various types of, as you call it, cash sorting, but the movements of cash between products And that behavior of deposits. Specific to your question around the beta, as we've said, we are informed by the last rate hike cycle. And it does have to do with the weighted beta at 50, which I had noted last quarter and we'll just reiterate again this quarter. It really has to do with the deposit composition mix that we have.

Speaker 3

So we have obviously still accumulated very increased levels on those Smaller accounts with smaller account levels. And we might have other accounts where we've seen larger inflows into Larger accounts, right? So account balances that are higher might also have gone up over time. And that helps to explain the deposit beta, which we see now Based again, as I said, on that deposit composition mix, it will not just be though, of course, around deposit data. A lot that is embedded into the forecast, as I That has to do with how we see those deposit behavior moving over time.

Speaker 3

And again, a lot of that is informed by what we saw in the last rate hike cycle.

Speaker 5

Very helpful color, Sharon. And maybe just a follow-up on the earlier discussion on organic growth. I mean the 4% number, which considering the more pronounced tax seasonality, elevated market volatility was certainly an impressive result. If the market volatility persists, should we view this as a reasonable floor on organic growth? And I was also hoping you could just speak to the cadence Flows from April to June, just to give us a sense as to how organic growth is projecting over the course of the quarter?

Speaker 3

Well, the cadence is obviously, you're not going to you've seen more in the 2nd two quarters I mean, you've seen a different mix, right, in the second 2 months than the 1st month because you had a tax Outflow season. So that kind of gives you the change in those two numbers. I think what we have seen is a continue you have a lot that comes in From a flow base basis, it's just if you think about workplace, you're going to see that development and continue as people have exercised their options, they continue to move forward. So there are various types of offsets. I think what's important as we look forward in terms of where is the floor, Look, we've said historically we don't expect to be in that very low single digit range, which we were before the acquisition of E*TRADE.

Speaker 3

We said that 11% was too high. So that kind of gave you that middle range. Exactly how it will pan out, what I can say to you is that it does look it's Still healthy and we're still we still feel well positioned. As it relates specifically to other indicators that you might think about, for example, recruiting, When the recruiting pipeline remains healthy and what we often see and tactically anecdotally is when those recruits Come over, they will be they could be in a market volatility event actually be quicker to begin to bring those assets that were held away into the channel. Why?

Speaker 3

Because they're seeking to be with their SA through that advice led channel more immediately. So as you called it, there are crosscurrents And I think they're important to bear in mind in this environment.

Operator

Thank you. We'll take our next Question from Dan Fannon with Jefferies.

Speaker 6

Thanks. Good morning. Wanted to follow-up on Investment Management and the fee outlook. You have Obviously, beta working against you and some of your higher fee products, but you have fee waivers coming off on the money market side. So as you think about mix And client behavior going forward, how do you think about the fee rates in that business longer term?

Speaker 3

It's a great question. I'm sure you'll see the disclosure also that will come out in the Q specifically for this business. But just to give you a sense, the fee rates themselves haven't changed. What changes what has changed is the mix of the actual flows So we've seen a decrease over the course of the last two quarters in some of those equity accounts, for example, Which as is disclosed could be higher can have higher fees, but what we have seen is an increase in balances And things like liquidity, we're now not seeing the fee waiver since we've moved off that 0 band floor. We had given you previous guidance of $200,000,000 That we expected to see as an incremental fee positive over the course of the year as those waivers went away because rates came off of that zero bound.

Speaker 3

We stand behind that guidance and you've continued to see that flow into the numbers. I think that what is important is obviously where could you see things Change is the liquidity balances, right? It's a rate times balance question, as I've said before. And the balances in this case, I think it's a testament To the amount of time and the investment we've put into this business to find relationships also across the Integrated Investment Bank where we've worked with Partners in institutional securities, for example, to help forge relationships that will help bring in some of those deposits into those money market products.

Speaker 6

Great. Thank you. And then just as a follow-up, given the backdrop we're in where revenues are a bit more challenged or uncertain, As you think about non comp expense and you highlighted being focused on this area and being efficient, but have you proactively started to make Decisions around spend and cutting back or as you think about that flexibility in the back half of the year, is there a way To quantify levels of growth or lack thereof in any changes.

Speaker 3

The first point that I would highlight to you is that ex integration, our efficiency ratio is at 7 And that includes the legal charge that James mentioned this quarter. So I think we have shown and continue to demonstrate discipline Around our expense base, very similar to the way we think about capital. Resources, we think about it very holistically and part of our strategic As we walked into the Q2, we were aware that the environment was Changing and we all had been seeing the same events that we've all witnessed together as it relates to the geopolitical front and the macro side. And we came in and we took a look, a hard look and we continue to do so individual product by product, investment by investment, project by project To understand where are the potential growth in expenses coming from, how are we thinking about balancing, as James said, that near term investment, making sure That we need to get done certain things. We always need to ensure that as we invest also with a longer term horizon, the right controls are in place As we continue to grow the business efficiently, but are there projects that can be delayed that we might be doing on the margin?

Speaker 3

So I'd say that that work Is in flight, has been in flight. It's not new information and it's certainly something that we're keeping our eyes on.

Operator

Thank you. We'll take our next question from Ebrahim Poonawala with Bank of America. Hey, good morning.

Speaker 7

Good morning. Just one follow-up on the institutional securities business. So You talked about market share opportunities, which you clearly have. Would love to hear your thoughts around just the health of One, how is the plumbing in the capital markets functioning? We saw a bunch of headlines around hung deals, etcetera, during the quarter.

Speaker 7

So just how are clients holding up on the institutional side? And given how strong the franchise already is on the prime brokerage side, is there more opportunity there? I realize that was a big driver of the growth this quarter. So I'd love to hear your thoughts.

Speaker 3

From basically in terms of the capital market functioning, As James said, this is not we're not in a position of the same kind of stress we've seen in other necessary cycles. We're still seeing functioning markets. You can see that in just some of the funded balance points that I made across the ISG portfolio In terms of funded balances being at 11% versus even in the pandemic, we have seen those balances up to 25%. So I would certainly say that you see institutions that are in a good place. I also think from a corporate perspective, it is worth noting that many came into this From an environmental perspective, in a much better position than they have before because they did issue and were in a good spot.

Speaker 3

From a balance sheet perspective, in the period of low rates that you saw over the course of last year, of course, there are days where it's More difficult to come to market. That is very clear as you see that in the underwriting results. So just to provide that balance, Of course, it's not the same thing as having a green screen every single day. But I think that, you are seeing Both institutions and corporations etcetera taking advantage of days where the market is open and they are able to do that and from that perspective the market is functioning. As it relates to prime brokerage, we've been very balanced in that business.

Speaker 3

I think we've been a tremendous leader in that business. And we continue to effectively look for the relationships that we're well suited for both in this environment that makes sense to partner with clients. You see that on the balance side. You see that on the revenue side. And you see that the mix also matters to us.

Speaker 3

And so from that perspective, We've been very focused on the equities business more holistically for over a decade now.

Speaker 7

Thanks for that. And just on the fixed income, so appreciate that you all right sized the business a few years ago. Like given the capital constraints at your peers, Does it make sense, maybe James or Sharon to like lean in and revisit areas where you could actually pick up share on the fixed income side or no?

Speaker 1

Listen, there's always opportunities to an environment where you can try and pick up share. We're in a bit of an uncertain world As I open with, I don't think this is the time to be overly aggressive personally. I like the fact we have excess capital. I like where our CET1 ratio is. Obviously, as you drive up RWAs, you eat into that.

Speaker 1

We actually brought up RWAs down by 40 b in this quarter. I think the institutional team in both fixed income and equities We're very prudent and appropriately so. So listen, if the option is to trigger another 50 basis points on the See, B will generate another, I don't know, dollars 100,000,000 $200,000,000 in revenue. That for me is a very easy call right now. I like the 50 basis points That we haven't had to trigger that some of our competitors have.

Speaker 1

So listen, we'll be eyes wide open, but We're not trying to win the game right now. There's a the fixed income business has gone from Doing I don't know what they were doing $500,000,000 $600,000,000 a quarter in the back half of twenty fifteen and we're consistently You know, it's somewhere between $1,750,000,000 $3,000,000,000 They've done a phenomenal job. They've materially gained share. I think we're around 10% share, up from 6 Sandler Lower in those days, stable business, great leadership. So yes, we'll be opportunistic, but we're not going to be greedy.

Operator

Thank you. We'll take our next question from Brennan Hawken with UBS.

Speaker 8

Good morning. Thanks for taking my questions. I wanted to follow-up on Steve's questions on deposit beta, but Rather talk about the balance side of things. So the brokerage sweep deposits declined by about $30,000,000,000 this quarter. Sharon, I think you referenced that it that was driven by both tax payments, but also some yield seeking.

Speaker 8

Could you maybe Break that down a little bit or do you have a sense about what that attribution would be just so we can kind of level set and think about how much further Potential deposit, yield deposit loss there could be from further yield seeking?

Speaker 3

Yes. I think the better I mean, I think that 1 quarter would be a little bit difficult to kind of draw those conclusions. I think the way I would think about it, Brennan, is a little bit Which is some of the questions I know we've received are, well, why didn't your beta come down, because You had E*TRADE. And so those balances should be in a position where you should have an average weighted beta that's lower over time. So I think the best way to kind of answer your question a little bit more head on, in terms of where the underlying crux is, is We have seen balances also increase in the higher account level.

Speaker 3

That's built into the model. It's built into our expectations. It's Built into the NII forecast and we've said, as I said directly in my remarks, we also saw deposit behavior very much in line with what we And so it is working in terms of that predictability. But why is the beta then higher? Some of that beta just has to do with you have some Higher balances, why?

Speaker 3

Because you accumulated them likely at periods of time where yields were lower and there was excess cash that was sitting in position. And so some of that higher balanced amount begins to leave seeking out higher yielding payments. So I think that can help give you a little bit of construct In terms of what's going on from the balance perspective to more directly, I think, answer the question rather than just look at 1 quarter's behavior.

Speaker 8

Sure, sure. Okay. That's fair. Thank you. And then when we think about the SBL Book, you flagged the $22,000,000,000 of continued loan growth.

Speaker 8

So it seems like you're expecting loan growth in the back half to be about half of what you saw in the first half, a little More than that, but not by much. So that and it makes sense, it would slow. Can you talk about What we've seen from an LTV perspective in the SBL book, and whether or not some of that Slowing loan growth is going to reflect some maybe some SBL pay down or is there the potential of some SBL reduction just because LTVs are getting high and so there's going to need to be some of that just mechanically and maybe also how you manage Those LTVs in these choppy market environments.

Speaker 3

Yes. So the LTVs are very well managed. No, it's okay. It's okay. I'll just try to remember it all.

Speaker 3

So from the LTV perspective, as you would We're very much actually in line with where we've been from historical years. And the reason for that is it is a very well managed book And why any uptick at all as you would expect? Obviously, the value of the underlying has gone down. But from a historical basis, We've always been within that we've sort of given a 40 range, a low 40 range. We're in that range and we're very much like I said in line over the last couple of years.

Speaker 3

Now as it relates directly to what we're looking forward and seeing, I think what's important here is that From a mortgage perspective, you might see some slowing, just obviously given where rates are. Now why would the SBLs come down? You just might not have as much interest or engagement in the product with lower asset values. So I don't look at it in terms of, oh, there's Management issue, rather that is a very well managed portfolio where we haven't seen issues in a lot of different market environments With the calls from an operational perspective more broadly, etcetera, but rather just the engagement from that relationship side, Is this the right product to be using now? You might not have those conversations as much with the asset values coming down.

Speaker 3

So very practical answer to the question that you gave.

Operator

Thank you. We'll take our next question from Mike Mayo with Wells Fargo Securities.

Speaker 9

Hi. Just a follow-up on the loan growth. The $20,000,000,000 loan growth target from the start of the year, it looks like you're still looking at that. But How are you thinking about loss rates on those new loans given perhaps a new economic forecast? We note that Provisions for wealth losses are already tripled the level of last year.

Speaker 9

Kind of what's the risk in that portfolio? And It

Speaker 3

doesn't make sense to have

Speaker 9

a loan growth target. It's always easy to make loans. It's just tough to get paid back sometimes. Thanks.

Speaker 3

Yes. I think that the loan to repurchase is, I mean, just in terms of it's more of an expectation to help people And with NII, I would have called it a target. To the point that was read by Brennan, obviously, the expectations On a quarter over quarter basis, it's come down. So we did see some pull forward and that's all we're reflecting in that. As you look at the provisions themselves, they're still Very on a relative basis to other provisions across various both institutions and even our institutional securities franchise is quite low.

Speaker 3

In terms of what drives that, as you know, it is based on the CECL concept and the life of loan concept. And as you also know, it is a complicated idea between both qualitative and a quantitative scenario. For us, as we disclosed in our Q, the factors that we look at that are most important is really around GDP. We did see a degradation in the GDP expectations, very consistent with what's And with what's going on in the macroeconomic outlook, and we are expecting the recession that we've talked about, the probabilities are in the fifty-fifty range, and that's Very consistent with also what we've said publicly.

Speaker 9

And so did you have any extra CECL provisions This quarter?

Speaker 3

No. We feel appropriately reserved for where we are right now.

Operator

Thank you. We'll take our next question from Gerard Cassidy with RBC Capital Markets.

Speaker 10

Thank you. Good morning. Sharon,

Speaker 11

in the workplace channel, you guys had some good growth in the number of participants On a year over year basis, it was up 17%. The unvested asset values It declined about 33%. Can you give us a little color? Was it primarily just market conditions bringing that down? Or is there something else there?

Speaker 3

It's a great question. And you draw an interest of a good point distinction. No, those are just the value it's just the value of the assets themselves have gone down That those holders have. Now the increase in participants has a lot to do with the fact that we just continue as we continue to We mandate, we've seen that increase the number of participants. What I would say in terms of just an opportunity in terms of engaging with those Obviously, it is a difficult time and environment for some of those individuals.

Speaker 3

And we do we continue to educate and use financial wellness as a tool, Especially in these environments, they explain the advice driven model and provide us with an opportunity actually in this kind of environment to discuss What financial advice and what financial wellness is specifically as people see different declines in their potential portfolio.

Speaker 11

Very good. And do the assets skew to more new start up companies that might be tech orientated versus a more Traditional industrial company or a stable company in those plans?

Speaker 3

SKU, there are there is a good portion, I would say, of technology companies that would be in that sector that you can As you see, those asset values declined. But there is a balance on the other side of different types of companies. And as we win mandates, it's not just On the tech side, we're winning mandates across different institutions, especially as people better understand that financial wellness offering.

Operator

Thank you. We'll take our next question from Matt O'Connor with Deutsche Bank.

Speaker 12

Good morning. Appreciate all the details on Slide 11 here, the allowance for credit losses, maybe you've had it before, but more relevant now in good detail. If you had to kind of guesstimate in a moderate recession that $1,200,000,000 of total ACL, Where does that

Speaker 3

go? I think that is a very difficult question to answer. I think that what you can look at and think about it is Obviously, the economic scenario makes sense, the GDP makes sense, the size of the where the growth actually comes from and goes. And then there is some extension of duration that you can see dependent on the rate rise expectation.

Speaker 12

Okay. Any way to frame the double or triple? Obviously, a lot of the loans are in wealth management, which is just not going to You would think have as much loss content, but any way to frame numerically how high it could go?

Speaker 1

Yes. I would I

Speaker 3

mean, you know what I would do, I would say is why don't you think about it as it relates to COVID, right? You can think about where we were from a COVID perspective. And so let's talk ISG specifically. The provisions this quarter are 82%. It was almost 4 times that when you think about where we were from a COVID perspective.

Speaker 2

Okay. That's helpful. I would

Speaker 1

just point out that sorry, I'd just point out that the wealth management piece ACL percentage is 0.1%. These are very different kinds of loans from traditional consumer banking loans. So you're just not going to see, at least for that part of it, a major, major move. For the others, I think it's Just you can't project. I mean, who knows what kind of recession the recession might be, how long it might be and so on.

Speaker 1

But we manage this business Conservatively, and we don't have a big traditional middle market small business loan book. We just don't have that kind of business.

Speaker 2

That's helpful.

Speaker 12

And then just a clarification question. The total DCP for the firm, you mentioned $515,000,000 revenue impact in wealth, but what's the firm wide revenue and expense impact please?

Speaker 3

It's not material per business line, which is why we don't call out the number.

Speaker 1

The reason we called it out in wealth, just to be clear, was wealth actually had a great quarter. Revenue growth, New money growth, fee based growth and margins year over year the same at 27% in a very difficult environment. So We thought it was kind of raining on the party a little bit that the DCP took $500,000,000 off the top line number even though it comes out of the comp expense Number almost dollar for dollar, not quite. So that's why we called it out there. Ordinarily, we wouldn't call out DCP.

Speaker 1

We don't make a big deal of it. It's kind of it's an accounting issue. It's not a business issue. So we're not often that excited about it, but we just thought given you'd all be interested in how the retail Investor was behaving right now and what was going on in that business and how panicked they were, the short answer is not very, behaving well, business stable,

Operator

We'll take our next question from Jim Mitchell with Seaport Global.

Speaker 10

Hey, good morning. Maybe just on the RWA decline, was that a deliberate reduction or is that more market driven? And if somewhat, some deliberate actions, can you kind of give us a little more clarity on what those actions were specifically and if that can continue?

Speaker 3

Yes. It was both is the way I would answer it. There are obviously market That had to do with it as well. But this was a very thoughtful use and thought approach around efficient uses of RWAs. And where does it make sense from a business perspective given the uncertainty?

Speaker 3

And I think there is a very as I said, the same way when we think about the It's about being efficient and thoughtful and very prudent and flexible with all of that environment. So It's both of those things that were taken into account when thinking about, the RWA decline.

Speaker 1

Listen, I want to make an important point here. We regard our capital ratios as sacrosanct. These are a big deal for us. We've spent a decade building them. We like having excess capital for exactly this environment we're in now.

Speaker 1

We can buy back up to $20,000,000,000 and A bunch of what we're going to be doing hopefully in the low 70s. So making sure we give ourselves that flexibility, Demonstrating discipline in a tough environment, I think Ted and the ISG team did a phenomenal job in driving that number down. And obviously, it's driven in part by in the market, so things outside of their control, but this is something that we should and we'll try and control as best as we can.

Speaker 10

Right. Maybe as a follow-up on that, James, I think you've talked about hoping the change in the mix of your business over time would push your DFAST losses and SEB Down slightly this year is probably a pure victory relative to what some happened to your peers, but do you think there's still room to see that come down over time given You're changing

Speaker 7

mix.

Speaker 1

Absolutely. Look at the PP and R number was materially up. Our Stress losses were also up. Not surprisingly, the test was incredibly demanding in this environment, but notwithstanding that we increased the dividend and we still came out at 13.3 think versus 13.2%, we're very focused on the SCB buffer not getting away from us. The change in business model, the growth in the asset management business, The growth in the workplace retirement business, all of these things which frankly are very capital friendly, yes, that number is going to keep moving.

Speaker 1

Then we have An argument we've been not an argument, I won't put it that way, but let's just say a different point of view with the Federal Reserve about how they treat financial advisor compensation during a time of stress. And we have argued for a long time The financial adviser compensation is obviously variable, so that expense comes down when revenues come down. The Fed has not yet seen it our way, but we're continuing to push that argument strongly. When it does, we believe that will free up another bunch of capital.

Operator

Thank you. We'll take our next question from Mike Mayo with Wells Fargo Securities.

Speaker 9

Hey, James. You've talked about variable expenses for variable revenues and The revenues were down and comp was down. But at what point do you pull the lever on kind of plan B? I mean, you said fifty-fifty on a recession. And Sharon talked about maybe delaying some projects.

Speaker 9

But when it comes to resource allocation, headcount, More aggressive moves to prepare for a difficult environment. You said yourself that it's uncertain. It's not the time to Take too much extra risk, push for market share, but is it time to go to plan B or more recession like Scenario in terms of your resource management?

Speaker 1

No, it's not. We're overwhelmingly in the U. S. We had 6% revenue growth in the Wealth Management business, produced ex integration 28 Margins, this is a business we definitely don't want to harm in this moment. And we are managing, I mean, I guess it's quasi plan B, managing the RWAs as we just said in the balance sheet, Reflecting more stressed environment.

Speaker 1

We met as a management committee last September, I think, and I spoke to the management committee about I felt there was much more downside risk to the market. The magnitude of it, I didn't have a strong feeling for, but I thought it was somewhere between significant and Really significant and I think we're in the sort of significant phase of it right now. So we started pulling back Mike at that point. We've got A very clear handle on headcount growth and where that growth is. We've also got a lot of regulatory obligations we've got to continue to fulfill As all the banks do, but right now we're definitely not in a sort of crisis mode at all.

Speaker 1

I mean that's why if we were, we wouldn't be Buying back $20,000,000,000 increase in the dividend 11%. On the other hand, balance sheet growth will be very measured. I think we'll pick up share by banks coming back to us, not necessarily us having to move forward. And as I think Shiron articulated very well, we're doing a pretty systematic review of the prioritization of all the projects Going on around the firm, listen, in a big company like this with 60B in the revenue, we have a lot of stuff going on and we have choices as to when we do it. So I call it a sort of plan A minus, not a plan B, if you will, but that's a mindset we're in.

Speaker 1

However, if things get worse and in my career, I've seen A lot of recessions, a lot of crises, a lot of damage done to the environment. If things really deteriorated, Particularly in the U. S, then we take a much more aggressive position and we obviously have the ultimate weapon, which is comp.

Operator

Thank you. There are no further questions at this time. Ladies and gentlemen, this concludes today's conference call.

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Earnings Conference Call
Morgan Stanley Q2 2022
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