Morgan Stanley Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
April 19, 2023

There are 13 speakers on the call.

Operator

Good morning. On behalf of Morgan Stanley, I will begin the call with the following disclaimer. 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. Today's presentation may include forward looking statements that are subject to risks and uncertainties that may cause actual results to differ materially.

Operator

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

Speaker 1

Good morning, everyone, and thank you for joining us. The Q1 of 2023 was very eventful for our industry, But not so eventful for Morgan Stanley. Firm delivered strong results with revenues of over $14,500,000,000 net income of 3,000,000,000 ROTCE of 17% and net new asset flows of $110,000,000,000 At the same time, We bought back $1,500,000,000 of stock, while maintaining a CET ratio of 15.1%. In many ways, it was an excellent test to Morgan Stanley and the opportunity to show the strength and stability of our business model. Let me just touch briefly on the turmoil in the banking sector.

Speaker 1

In my view, we are not in a banking crisis, But we have had and may still have a crisis among some banks. I believe strong regulatory intervention on both sides of the Atlantic Led to the categorization of the damage. I consider the current issues as not remotely comparable to 2,008. I was pleased that Morgan Stanley along with the other large U. S.

Speaker 1

Banks became part of the solution by providing an uninsured deposit line of $30,000,000,000 First Republic Bank. Someone who lived through the darkest days of 2,008, where Morgan Stanley was seen as part of the problem, It's indeed rewarding to be here 14 years later as part of the solution. Turning back to our own While the performance of the overall business was strong, the results reflected the impact of the environment. In Wealth Management, positive flows of 110,000,000,000 Very strong result reflect continued growth in the model together with applied to quality. This obviously gives us a good start to our 1 trillion every 3 years target.

Speaker 1

Diversified management also benefit from diversification as long term outflows moderated And we saw strength in Parametric and also in the liquidity product. Overall margin in the Wealth Management business was 26 percent impacted by modest increases in credit reserves, slightly lower growth of NII versus forecast and ongoing integration expenses. We continue to focus on the levers within our control with an eye towards expense management. In ISG, underwriting and M and A remained very subdued. As I've said previously, these are revenues delayed, not dead.

Speaker 1

Already, we're seeing a growing M and A pipeline and some spring like signs of new issuance emerging. That said, it largely remains a back half 2023 and full year 2024 story. On the positive side, our fixed income and equity trading teams performed very well in managing through some historic rate moves. Total trading revenues were solid. I expect the markets to remain choppy through this earnings season and for the next several months.

Speaker 1

However, absent any geopolitical surprise or limited progress in bringing down inflation, I think 2023 is likely to end On a constructive note in most areas, Morgan Stanley is very well positioned not just for 2023, But for several years ahead, as we see significant growth opportunities across all three of our client platforms. I'll now pass it over to Sharon for more details on the Q1.

Speaker 2

Thank you and good morning. The firm produced revenues of $14,500,000,000 in the first Our EPS was $1.70 and our ROTCE was 16.9%. The firm's results demonstrated the durability of our business model, evidenced by the resilient ROTCE, robust asset consolidation and wealth and our stable capital and liquidity levels. In Institutional Securities, Fixed Income and Equity supported our clients while navigating volatile markets. Wealth Management showcased $110,000,000,000 of net new assets and Investment Management continued to benefit from the investments we have made to diversify our offerings.

Speaker 2

The firm's 1st quarter efficiency ratio was 72%. Deferred cash based compensation plans negatively impacted our firm's efficiency ratio by approximately 60 basis points. Ongoing technology and marketing and business development investments as well as higher litigation costs Increased operational expenses versus the prior year. Given the broader market uncertainty and the inflationary environment, Expense management remains a priority, although we continue to prioritize investments in our long term goals. Now to the businesses.

Speaker 2

Institutional Securities revenues were $6,800,000,000 an 11% decline from the very strong prior year. Fixed income and equity results partially offset weakness in banking as we helped our clients intermediate markets through this period of heightened uncertainty. From a regional perspective, Asia delivered its 3rd highest quarter ever with strength in areas of both fixed income and equity, aided by the policy dynamics in Japan and the China reopening. Investment Banking revenues decreased year over year to $1,200,000,000 Solid revenue and advisory supported results, While ongoing market volatility continued to pressure equity and non investment grade underwriting. Advisory revenues were $638,000,000 benefiting from the completion of previously announced transactions.

Speaker 2

Revenues were down versus the strong prior year on the back of lower announced volumes in 2022. Equity underwriting revenues were $202,000,000 down 22%, largely as a result of depressed IPO activity. While IPO and follow on activity remained muted, issuers selectively accessed market windows. Fixed income underwriting revenues were $407,000,000 Results were supported by an open investment grade market and opportunistic loan activity. Clients are engaged as we help them navigate an uncertain backdrop And our Investment Banking backlog is building.

Speaker 2

Financial sponsors continue to look for opportunities to invest. Within underwriting, we are encouraged by the issuance activity during constructive windows.

Speaker 1

Of

Speaker 2

course, Further conversion from pipeline to realized is predicated on clarity around macroeconomic conditions, stable financing markets and increased corporate confidence. Equity revenues were $2,700,000,000 a solid quarter against uncertain and volatile backdrop. We continue to be a leader in this business and the results reflect our global and diversified footprint. Cash revenues decreased versus the prior Q1 on lower global volumes. Derivative results were solid compared to a strong quarter last year as we helped clients navigate challenging markets.

Speaker 2

Prime Brokerage revenues were down as equity market levels declined. Clients remained engaged and balances increased steadily throughout the quarter. Fixed income revenues of $2,600,000,000 were strong, though lower versus the prior year's elevated result, which was impacted by the beginning of the Fed rate hiking cycle and the start of the war in Ukraine. This Quarter's performance was driven by rates and credit. Macro revenues were down modestly year over year with relative strength in rates versus foreign exchange in the comparison period.

Speaker 2

The volatility created by varying expectations around Global Central Bank Policy Aided Results Across Regions. Micro results were up versus the prior year, supported by client engagement. Commodity revenues moderated meaningfully compared to the robust results in the previous Q1, largely due to reduced volatility in European markets and the mild weather in the U. S. Other revenues of $245,000,000 improved versus the prior year, largely driven by higher revenues on corporate lending activity and gains related to DCP.

Speaker 2

Turning to ISG lending and provisions. Our allowance Credit losses on ISG loans and lending commitments increased to $1,300,000,000 In the Quarter ISG provisions were $189,000,000 and net charge offs were $70,000,000 The increase in provisions was driven by the higher recessionary probability and worsening outlook for commercial real estate. The charge offs were substantially all from a handful of specific loans. Turning to Wealth Management. Revenues were $6,600,000,000 Movements in DCP positively impacted revenues by approximately $100,000,000 compared to a negative impact of nearly $300,000,000 in last year's Q1.

Speaker 2

Net new asset growth of $110,000,000,000 It was a standout as we continue to execute on our long term strategy. Pre tax profit was $1,700,000,000 and the PBT margin was 26.1%. The margin reflects a more favorable revenue mix, offset by higher credit provisions and an increase in expenses as we continue to invest in our business, inclusive of integration related expenses. Credit provisions were $78,000,000 including those that impacted revenue and the integration related expenses for the quarter were $53,000,000 in line with our expectations. Forward growth drivers remain robust.

Speaker 2

Net new assets were very strong at $110,000,000,000 for the quarter, representing a 10% annualized growth rate of beginning period assets. While N and A will be lumpy and should be looked at on a full year basis, the results illustrate our ability to attract assets and the payoff of our investments to support growth. We saw contribution from all channels with notable strength in the advisor led channel, particularly amongst existing clients. The events in March and the rising interest rate environment over the past year impacted client behavior. Clients increased their allocation to cash equivalents such as money market funds and U.

Speaker 2

S. Treasuries by over 60% versus last year. At the same time, deposits declined in the quarter by 3% to $341,000,000,000 We believe investable assets stayed within Morgan Stanley as our clients worked with advisors to help navigate the volatile markets. Today, advisor led assets invested in cash and cash equivalents stand at a peak of 23% Compared to historical average of approximately 18%, over time we believe clients will reinvest these balances across more assets when the market outlook improves. In the interim, given our broad product offering, clients are choosing to invest in cash with Morgan Stanley through the cycle, positioning us to provide them with more reinvestment choices down the road.

Speaker 2

Net interest income was $2,200,000,000 up 40% year over year. Results reflect the impact of higher interest rates And lower sweep balances. Feebase flows of $22,000,000,000 were strong. Asset Management revenues were $3,400,000,000 down 7% versus last year, reflecting lower market levels. Transactional revenues were $921,000,000 Excluding the impact of DCP, revenues were down 12% versus last year due to fewer new issuance opportunities and reduced activity levels compared to the beginning of 2022.

Speaker 2

Lending balances declined this quarter to 100 And $44,000,000,000 led by pay downs in securities based lending, reflecting the higher interest rate environment. Importantly, our strategy is working and we are seeing channel migration from workplace to advisor led. Advisor led flows originating from workplace relationships reached $28,000,000,000 in this quarter alone, double versus this time last year, and this compares to the approximate $50,000,000,000 we saw annually over the past 3 years. Furthermore, almost 90% of these flows were from assets held away, also consistent with what we have seen historically. Our strategy remains in place to best serve our clients and support the firm's path to reach $10,000,000,000,000 in client assets.

Speaker 2

Moving to Investment Management. Revenues of $1,300,000,000 declined 3% year over year, Primarily on lower AUM due to the decline of asset values and the cumulative effect of outflows over the prior year. Total AUM ended at $1,400,000,000,000 Long term net outflows were $2,400,000,000 as equity outflows moderated in the quarter. In fixed income, outflows in floating rate loans were partially offset by high yield and emerging markets. Finally, alternatives and solutions delivered strength, driven mostly by demand for Parametric's fixed income customized portfolios as well as inflows into private credit.

Speaker 2

Liquidity and overlay services had inflows of $13,900,000,000 Positive liquidity inflows of $37,000,000,000 We're partially offset by outflows related to a single client relationship. Asset management and related fees decreased versus the prior year to $1,200,000,000 due to lower average AUM, partially offset by higher liquidity fee revenue. Performance based income and other revenues were $41,000,000 Results were supported by gains in our Private alternatives portfolio reflecting the diversity of the platform. Integration related expenses were $24,000,000 in the quarter, in line with expectations. A key focus area remains maximizing our global distribution capabilities and we continue to see momentum internationally, particularly from the Eaton Vance fixed income team.

Speaker 2

Our investments Across a broad array of strategies and capabilities, including active ETFs, Parametric Customization and alternatives Turning to the balance sheet. Scott assets were $1,200,000,000,000 largely in line with the prior quarter. Our standardized CET1 ratio stands at 15.1% and SLR at 5.5%. Standardized RWAs increased quarter over quarter, primarily on client activity consistent with seasonal patterns. We continue to deliver on our commitment to return capital to our shareholders, including buying back $1,500,000,000 of common stock.

Speaker 2

Our tax rate was 19.3 percent for the quarter. The vast majority of share based award conversion takes place in the Q1, Creating a tax benefit. We continue to expect our full year tax rate to be approximately 23%, which will exhibit some quarter to quarter volatility. As James discussed, the fallout resulting from the events in March is not indicative of the systemic stress that the industry faced during the global financial crisis. Our clear and consistent strategy allowed us to enter this environment well positioned.

Speaker 2

The outlook for the remainder of this year is difficult to predict. We are keenly aware that opening and functioning markets and economic stability are integral in aiding confidence moving forward. In the interim, we remain focused on supporting our clients and attracting assets to our platform. With that, we will now open up the line to questions.

Operator

Thank you. We will pause for a moment to assemble the queue. We'll take your first question from Daniel Fannon from Jefferies.

Speaker 3

Thanks. Good morning. Just thinking about the environment and the opportunity, can you talk about advisor recruitment? I assume retention is high, but as you think about the opportunity given some of the fallout with some of the regional banks in the current environment, Maybe talk about how you're positioned and maybe how that differentiates versus say a year ago?

Speaker 2

Certainly. The advisor recruiting pipeline remains healthy. We continue to see assets aggregated from all channels. As I mentioned, both recruiting, advisor led and workplace. And when we compare it to a year ago, I think that what we continue to see Is that we remain a destination of choice, not only for new advisors, but also obviously as we stated From the assets held away that we continue to aggregate in both the net new assets from existing and from new clients.

Speaker 3

And then just as a follow-up, with NII, generally probably a little more challenged versus Where we were last year, how do you think about wealth management margin expansion in this environment? And maybe specifically, can you talk to the NII trends as you think about This year and how we should think about that given some of the deposit dynamics you mentioned as well as the current rate environment?

Speaker 2

So first, let's take NII. As we said, what we've been looking at is we've been thinking about it in terms of modeled client behavior. Obviously, March itself had a different modeled client behavior than we probably would have expected for other months within the quarter. When we look ahead, we're currently not expecting expansion of the quarterly NII as we go forward. Now as that relates to the margin, a 26% margin, obviously still impacted by certain things such as integration related expenses.

Speaker 2

We mentioned also litigation, and we continue to really invest in the model as we go as we have and also as we go forward. All of that being said, our eyes are still on the 30% goal that we have set forth, and we will continue to achieve as we move through time to progress to those goals.

Operator

We'll hear next from Glenn Schorr from Evercore.

Speaker 4

Hello, thanks. Maybe we could follow-up on that conversation. I'm just Curious, you mentioned that interesting stat of 23% sitting in cash and cash equivalents up from 18% historically. If we weave that into normalizing over time, but also deposits were down 3% and cost of funds is up A bunch. As we go through the year, do you anticipate the normalization of the cash component at the same time, deposits can still use continue to come down and migration continues to be yield seeking like Ken, I guess my question with all that ramble is, can the margin get back into that range While we have these cash seeking and yield seeking behaviors happening?

Speaker 2

So I think that for us to predict exactly what the behavior will be, obviously, if we think about what happened in March, that's a very difficult thing to predict. But I think what you're highlighting in your question, Glenn, as I parse out the very beginning of it is right now cash and cash equivalents are at a higher level, A higher level than we have ever seen historically. As we begin to see those assets be deployed into different types of products, That ability and that advice will obviously be accretive. It will also help us as you see asset levels rise. So there is a pull push factor as you think about those things.

Speaker 2

In addition to that, as we continue to aggregate assets, We will gain from scale. The more assets that we see, the more we will see in balances, the more that will probably help as you think about What the cash balances are more broadly because assets are being attracted to the platform. And in addition to that, we will gain for the longer objectives of what that might mean for the margin and for the Wealth Management business more broadly.

Speaker 1

If I could just add and excuse my voice over chest cold. Glenn, on the simple math, to take the margin in that business from 26% to 28% is about $120,000,000 Obviously, we're still absorbing some integration stuff relating to the platform that will be done this year. We had slightly higher reserves. We've been investing pretty aggressively in the business and frankly, I think appropriately. The payoff is $110,000,000,000 which is a net new asset organic growth of 10%.

Speaker 1

So, I'll take that any day long. Yes, it sustained the building. So, yes, we have a lot of levers to push that margin around a couple of percent points. That's not frankly A source of great anxiety to me at this point. And I think you'll see us probably We'll shift fuel those levers as we get through this year and certainly next year.

Speaker 1

So, the trade off is, I think we all want to Keep investing for growth. We see a real window here. This $10,000,000,000,000 target is for real. The TRY in every 3 years is 300 and Whatever it is, dollars 3.30 million a year, dollars 3.33 million, I guess, and starting off with $110,000,000 I think we have pretty good visibility So, it's a balance, but as we get through this integration as it's finally completed, some of those costs roll off. We'll get a little tighter in the expense management in the wealth business.

Speaker 1

I know Andy and his team are already focused on that. So, and then the deposit stuff will it's of going to be what it's going to be depending where rates go and what the Fed does.

Speaker 4

Appreciate that and thank you for fixing my question. The follow-up, I have a simpler on commercial real estate. Can you just help us just dimensionalize the portfolio? What exposures you have and how do we Get comfortable that this isn't a gift that keeps on giving like I'm sure there's details within the provision that you took that could help us. Thanks.

Speaker 2

Absolutely. I think what's important about that portfolio is that it is diversified. In addition to that, we have been reducing the exposure In the ISG Direct CRE portfolio over the course of the last year or so, so obviously, we keep our eyes on it. As you know, CECL is a life of loan And so as you see economic deterioration, you do need to account for that. And the same goes for what we're seeing in the commercial real estate market.

Speaker 2

So I think that those are the 2 main points I would point you to is that it is diversified and we have been continuing to reduce that direct exposure.

Operator

We'll hear next from Ebrahim Poonawala from Bank of America.

Speaker 5

Good morning. I guess just first question wanted to follow-up. James, the comment you made about I think, expecting 2023 to end on a constructive note. I was wondering if you can elaborate on that just in terms of A lot of this is tied to macro. How do you think the economy is playing out in terms of the Fed's fight against inflation, Damage it does to the economy and the markets and as you think about ending 2023, where do we think where do you think We'll be on all these fronts by the time the year ends?

Speaker 1

Well, our house call up for the markets went about flat From where they started at the beginning of the year and I certainly support that. I think the 2 wildcards out there are geopolitical risk, which We can't really handicap. My gut is that the unit U. S.-China relations, While having their moments of tension remain overall stable through this year and global trade remains stable, the second risk Of course, is that the Fed's actions doesn't bring down inflation. Well, the evidence so far is it is bringing down inflation, but they're probably not done.

Speaker 1

I It's likely we'll see at least 1 more and possibly 2 more rate increases. That gets you to sort of high 5%, 6% Type interest rates, which is not shocking. And if we get through that, again, many people are calling for a modest recession. It might be. I don't know, obviously, but my gut is whether it's a modest recession or we dodge that bullet Sort of doesn't matter that much.

Speaker 1

What really would matter is if inflation is not tamed, it has to go much higher than people are expecting, you go into a much deeper recession. That's certainly not the likely outcome at this point. So, that's why I said, I think I used the words constructive. For Morgan Stanley, if the sort of green shoots we're starting to see, again, I don't think there are Q2 Type event, but back half of the year and next year in banking and underwriting. We just had a global risk committee yesterday discuss some of this stuff and certainly underwriting calendar looks like it's picking up a little bit through the back half of the year.

Speaker 1

I think the wealth management, what Sharon pointed to the 23% in cash like securities moving into active investments, that will happen. I mean, through the long history of this business, people don't hold a quarter of their money in cash. They just it's not real. So And I suspect once we pass this sort of inflation Fed action, there will be a long pause would be my gut Followed by some rate cuts starting in 2024. I do not expect that this year.

Speaker 1

So, when I put it all together relative to sort of other periods that I've been through my career, I think it feels given the land war, given the geopolitical stuff, Given the inflation surge, given COVID, it actually feels surprisingly benign from what it could have been. Now, that's not denying there are clear stresses. The commercial real estate that I think Glenn just asked about across the banking sector, what's going on Some of those banks with very idiosyncratic portfolios that frankly didn't match duration interest rate risk well is were issues. There are parts of the world that are still having solid growth. So, it's not a perfect kind of reminds me of the Rolling Stones song, you can't always get what you want, But you get what you need and I think about Morgan Stanley coming out of this and we're kind of getting what we need.

Speaker 1

We're getting a 15% CET1. Beginning at 17% ROTCE, decent revenue, decent earnings, obviously opportunity to take some costs out. And I think very well positioned on a go forward basis. So that's where the word constructive came from.

Speaker 2

That's so true.

Speaker 6

Sorry, it's my

Speaker 2

long answer

Speaker 1

for one word.

Speaker 5

No, no, I appreciate the color. And just as a follow-up, when we think about capital return in terms of, 1, the pace of buybacks given the macro Any perspective there? And just opportunistically, do you see this as creating opportunities inorganically M and A wise for Morgan Stanley as we look forward?

Speaker 1

We've maintained it's a very good question. I'll deal with sort of what the capital position is now and what the opportunities are for On the capital position now, CT1 is running at 15.1%. We obviously have control over that dial to a large extent. So, and we have tilted conservative. I think it's fair to say, I haven't seen all the numbers, but I'm pretty sure we're at the top of or above all of our competitors' set again and we've been that way for quite a while.

Speaker 1

So, On current capital requirements with the last stress test, we're at 13.2%, I think or 13.3%, somewhere around there. So, 15% is a very healthy buffer, but we've got a new stress test coming out. So, many people feel that's going to be a little tougher than what it was Last year, it might be and we obviously got plenty of capital for it, so I don't expect any issues whatsoever. And then we have Basel III coming out in, I think, So the late May, June type period where and again that will be implemented probably 2025, it looks like earliest. So again, it's time for the banks to adjust their capital position.

Speaker 1

So we will have much better visibility As to what we're dealing with by say July 1. And again, I don't I suspect it might drive some changes in We run our balance sheet, but I don't think it's going to involve anything particularly draconian. Now given that, We like to maintain a healthy buffer. We have done obviously the deals we did in the last couple of years, e trade and e advance, which I'll just say that I couldn't be more happy with both the timing of those deals, the pricing of those deals and the performance of the businesses. And when we see a really robust market environment, you'll see that even more so in spades.

Speaker 1

We've had a very healthy dividend yield. I think it's over 3.5% shown something like that now. We believe in the dividend, I've said for years and I think of the Wealth Management business as a dividend stock and we're clearly making more money in that business than we're paying out in dividend. And we're buying back. I mean, we dialed the buyback down a little bit, I think to $1,500,000,000 We're probably running $2,500,000 at that peak last year On a quarterly basis and we did that just it was an interesting environment.

Speaker 1

I mean, let's just say, you had 2 of the biggest banks fail in the last 15 years. So, being a little prudent, little conservative watching that going on, you don't want to be too grabby is my attitude. So, I think we have lots of flexibility. There is no doubt we can and over the years will do more acquisitions in my mind. There is no doubt about that whatsoever.

Speaker 1

And it will be in the wealth and asset management space and we constantly keep a list of who's attractive and who would be a good fit. But Obviously, I couldn't say if there was something imminent, but there's nothing imminent. But it's something we focus on. So, Again, I'm sorry, I'm giving long answers this morning. It must be this cold I've got.

Operator

We'll move next to Steven Chubak from Wolfe Research.

Speaker 7

Hi, good morning. So I wanted to start off just unpacking the NNA flows that you saw in the quarter. I mean 10% is really an impressive result. The fee based flows continue to lag brokerage and just wanted to better understand what you see as a sustainable fee based flow rate. And just as we try to evaluate the durability of the 10%, how much of the quarterly inflows were from FRC where you're clearly a destination of choice First, some of those are Triton Advisors.

Speaker 2

I'm going to try and remember all of your questions, Steve, in order so if I forget one, Just remind me, the first point on FRC, I'll take first. In terms of the regionals more broadly, as I mentioned in the prepared remarks, I believe, We had about $90,000,000,000 that came in without any relationship to those regionals. And so that shows cases to you that's well above the average that we've seen. So I think it just continues to show that the investments That we have made are really working as we move forward. So that's sort of point number 1.

Speaker 2

The second point that I mentioned and I think you asked where are those assets Coming from it's really in this particular quarter was in that advisor led space, both from existing accounts and new clients. To me, what was most remarkable when I was going through the diligence materials really was what we're seeing from existing clients. So the idea that we continue to be A destination of choice for our existing clients and attracting assets held away, again, speak to all the conversations that we've all had Over the course of the last 7 years or so, talking about investments to give our advisors more time to service their clients as we move forward. Then the final question that you asked around the fee based flows, actually a very strong fee based flow number, to be honest, from our perspective. In an environment where individuals, as we think about it, cash and cash equivalents are high, you're thinking about putting your money into managed Kind of accounts associated with from that fee based concept, you're unlikely to do that in a period of time where you think that cash and cash And so that is in fact the drive outer that we have It over time could move into the fee based assets.

Speaker 2

So I think it's actually a strong number given the environment that we have on the backdrop.

Speaker 7

Really helpful color, Sharon. And just for my follow-up, with on sweep deposits, Those are now running below 4% of AUM. That's historically been a strong support level for transactional cash within the advisory space broadly. I was hoping you can give some perspective on how we could think about where sweep cash could potentially bottom? And have you seen any continued mix shift into Sweep or deposit pressures in April so far?

Speaker 2

As it relates to April, I talked a little bit, in one of the earlier questions is about modeled client behavior. And then what we did see is that in March, we really deviated from some of that modeled client behavior. Now in April, we have been more in line with modeled client behavior. So that does speak to your point of maybe we are in a position where from a transactional patch level, We're there. But again, as James said, it is an uncertain environment.

Speaker 2

And so from that perspective, we'll have to wait and see how we move through time from here.

Operator

Moving next to Brennan Hawken from UBS.

Speaker 8

Good morning. Thanks for taking my questions. I'd actually love to follow-up on that last question from Steven. So April is more modeled. April is typically a tax payment month, which is a headwind.

Speaker 8

So are you seeing Where is that cash getting funded from? Are you seeing some of the taxes, tax payments coming out of both sweep and The other higher cost deposit sources, is it more biased to the higher cost? Could that provide some relief? And when we put all that Into the mix and think about NII going forward, should we be thinking about stable NII? We know it's not growing, but Funding this funding cost elevation maybe could lead to some downside.

Speaker 8

So curious how we should be thinking about that?

Speaker 2

I think that your question in terms of April in terms of where it's coming from, The exact breakdown is challenging to see in terms of exactly where it's coming from, from all of the deposits perspective because there's could as you know, Cash is fungible, so you could take something and then move it into a different security or a different asset. So to parse that out is challenging. I do think that what's more important as you highlight is that it is tax season and so to not see an acceleration is obviously one of the more optimistic Signs that you are moving through more modeled client behavior. Now what it means from funding, we obviously have many funding different places. I don't think that Funding is a concern.

Speaker 2

As you mentioned, it does matter from an NII perspective, but it will be a function of 2 things, Brennan. As you know, rate expectations have also changed since January. And so our NII forecast and predictions are based on Models client behavior in terms of cash, sweeps, etcetera, and also where interest rates are and where the forward curve is for Fed funds. And so as you begin to see if that changes, that could change your NII forecast. We are still, if you look at model of client behavior, asset sensitive.

Speaker 2

So from that perspective, I think that gives you a few different pieces to put together in terms of how to think about the forward look based on different assumptions.

Speaker 8

Okay. Thanks very much. Obviously, a lot of uncertainty, so appreciate that color. And then one more on the net new asset Component, you guys have an offer for promotional offer and it's tied to Higher yielding cash alternatives. What percentage of the net new assets came in to from that promotion this quarter?

Speaker 8

And In the past, you've spoken about how when you bring that cash in, a majority of it stays in the system. Do you have any more granular Statistics on what portion of that stays in the system, it's obviously good that it comes into the system, but kind of curious when we think about

Speaker 2

So the best way to think about the stickiness within the is actually NNA, right, because you're going to see the outflows would be a net negative to the NNA more broadly. And so the consistent growth over time, if you look at it all the way back even to when we saw promotional levels back, I remember we Spoke about this in 2018 and I think it was 2017 2018 in those early years that was still seeing net new asset inflows over time. So For me, the most important thing is, well, what's the net? The net continues to be positive and continues to ramp higher. In terms of the CD exact offerings and what that would mean from NNA, it's considered NNA if it's brought out from outside of the firm.

Speaker 2

And again, what's important here is that we continue to see more in the advisor led space and that over time, again, think about the channel migration from workplace into the advisor led space. What's important here is that when people begin to see money into advisor led, We actually see more money from assets held away. So I know that doesn't answer your question directly, but I think it's important to highlight As people begin to work with an advisor, what we said to you is 90% of the assets that then come are from assets held away outside the building. So just again another proof point that once they understand what the advisor has to offer, it helps aggregate new assets into our system.

Operator

We'll hear next from Gerard Cassidy with RBC Capital Markets.

Speaker 9

Thank you. Good morning. Sharon, can you share with us when you guys talked about, I think James said around 25% of your wealth management Customers' assets are in cash or cash equivalents, which is high, of course. What interest rate do you guys sense, Meaning, do rates have to fall 100 basis points or 200 basis points for that money to move back into more traditional assets?

Speaker 2

So I don't actually know that it's the absolute value And I will answer it in 2 different ways. First, you have to remember that the events in March didn't make people I mean, we all read the popular press And most individuals begin to think about what is the most risk free asset, that being U. S. Treasuries. So one should not be surprised if they begin to move assets into U.

Speaker 2

S. Treasuries. So I do think that it's a function also of uncertainty and not just the absolute level of where interest rates are or aren't. Now as I said, we have these moments that are opportunistic, both when you think about the corporate activity and then when you think about the individual activities, so both for ISG and in Wealth Management. And that was evidenced last August, last October and then earlier in January February that When markets become calm that you begin to see movements into asset classes and further activity as evidenced by our self directed channel as well.

Speaker 2

So I don't know that there is an absolute level of rates, but I would say it's related to confidence in the system more broadly and the belief in asset levels being in a place that will bottom and then potentially will rise as we go forward.

Speaker 1

I totally agree with that. I think, Gerard, if people can get a 4 ish percent return in a very uncertain environment, that's not a bad thing to have in your portfolio, at least for 25% of their portfolio. As they get better visibility, as we all get better visibility of when the Fed stops moving And did we go into this recession that some are fearing or not or if it's modest, then I think you start seeing more engagement. I mean, it's just We've all been through this. It's human behavior.

Speaker 1

We've had a pretty significant shock to the system in the last few months, which thankfully The world kind of the financial world got through, but could have turned sideways and higher rates came at a time of increased Uncertainty, so it's entirely rational that people would take advantage of higher rates and increased uncertainty by packing in cash, but they're not going to stay in cash At 4% forever, that's not going to happen.

Speaker 9

No, thank you. I appreciate that. And then just as a follow-up question, Sharon, you talked about The credit, the provision and linking into commercial real estate, of the total loan portfolio, What percentage of that is in commercial real estate mortgages? And are there any construction loans in that portfolio?

Speaker 2

As it relates specifically to the construction loans, I don't know about the exact construction I'm certain that somewhere there could be a construction loan. But more broadly, I think the absolute level, we do disclose from the ISG side Around that $10,000,000,000 and that was in our filings from last quarter.

Operator

Devin Ryan from JMP Securities, your line is open.

Speaker 10

Thank you. Good morning. I guess, I want to start just on market share opportunities that Maybe you're accelerating here. You touched on some on

Speaker 11

the call.

Speaker 10

But one of your peers highlighted Private banking in Europe, just on the heels of some of the banking stress, or potentially even just opportunities Where you're going to get paid more for committing capital when your capital is becoming more scarce in the system. So just love to maybe think about some of the things that you're seeing just over the last month or so that might be Sustained going forward.

Speaker 2

On capital opportunities in Europe, sorry, could you repeat what's the question?

Speaker 10

Yes. The question is just where there's opportunities to take market share kind of on in the wake of The banking turmoil, so one peer had highlighted private banking in Europe as one example, but just whether there's others as well here just on the yields of The recent stress?

Speaker 1

Yes. Devin, let me have a go at that because it probably builds up the capital discussion and where we'd invest. We do not have an appetite for Private Banking Europe. In fact, we sold our Private Banking Europe to Credit Suisse several years ago. It's one of the first things I did because We'd had an unhappy experience.

Speaker 1

We'd owned the business for 21 years and we'd lost money for 20 of them. And I kind of took a fairly simple view that if you lose 20 out of 21, You've probably got to lose us. So, we got out. You need scale and frankly, it's not a good fit, I believe with the current regulatory structure that we operate under. So, much more interested in the U.

Speaker 1

S. And Asia And Tom in LatAm, the U. S. Business, it's just going to be an asset gathering monster. To bring in $110,000,000,000 in 1 quarter and a trillion over the last 3 years, there aren't many companies in the world that have a trillion assets under management.

Speaker 1

So, I think we've got to keep our eye on the prize here and not get distracted by going down some rabbit hole Because somebody else is in stress, maybe somebody else is in stress because it's not a very attractive rabbit hole when you get down inside it. We know what we've got here and it's a killer machine. Asia is growing nicely. Again, LatAm some, But the workplace conversion is a massive opportunity now that we're focused on. Obviously, we're attracting financial advisors from I was seeing somewhat of a safe harbor, I guess, across the industry.

Speaker 1

And our organic flows, if you compare them to our traditional competitors, the warehouses or The online brokers, our organic flows, I think are on an annualized basis high significantly higher than the traditional players And higher than anybody in the industry. So, that's how we think about it. Again, Asia more interesting, Europe Not interesting. LatAm, a little bit interesting and U. S.

Speaker 1

Definitely interesting.

Speaker 10

Got it. Okay. Thank you. Helpful. Just a follow-up, it sounds like you're starting to see Maybe a little bit better momentum with financial sponsor clients.

Speaker 10

So I'd love to maybe just touch on those specifically and kind of what the appetite is To do deals or to sell assets and kind of what the you think the trigger point is to kind of engage them further?

Speaker 2

Certainly. I mentioned this actually when I spoke at a February conference this year, which is that when you think about financial sponsors, They may be in a different position than what we would consider traditional M and A, I. E, they are faster to market, They are in a position where you might not have the same level of activity from a Board. And because of the size, you might have different regulatory restrictions. And so from that perspective, we would expect that they might be first before we see really traditional activity open up and that is that remains kind of the view that we have.

Speaker 2

And also as the pipeline begins to build, that's also what we're seeing. In order for that to move forward and become realized, It's really about the opening of the markets in terms of the financing activity. As we have seen some of the backlogs clear, that's

Operator

We'll move next to Mike Mayo from Wells Fargo.

Speaker 12

Hi. What is going so right in Asia that it's your 3rd best quarter in an environment like this? And then what is going so wrong in Investment Management? Since you closed Eaton Vance, the first full quarter was Q2 2021, if I have that correctly, Investment Management revenues are down almost 1 fourth. So shout out to certainly E*TRADE, well, Doing well, but in terms of investment management, like it just looks from the outside like Eaton Vance isn't panning out the way you expected, but first the positive on the Asia was Right.

Speaker 12

And then the negative one, what's not going right in Investment Management?

Speaker 2

Certainly. So let's take Asia first. What we saw over the course of the quarter was China reopening, obviously supporting us from the equities side and perspective in terms of client engagement. And what's going right also from Asia has been, the what we have a franchise that we've really built in Japan. And in an environment where interest rate dynamics change, such as what's going on within Japan, that certainly helped us from the macro perspective and the macro Given the macro business within fixed income.

Speaker 2

So I think that we're that's very important and critical is that it speaks to the global perspective and it speaks to our global franchise. Why that is important when you think about Investment Management and I will tie the 2 together is that You have to invest more broadly to be able to create an environment of diversification. And so Asia might be asleep. Japan, for example, could be asleep for many years, then all of a sudden, central bank activity picks up and you're there to support your clients with that global franchise. Think about Investment Management quite similarly.

Speaker 2

What we're doing is we continue to build a franchise where we're able to have diversified products That are there to capture our client assets. You highlighted what's going on within Investment Management. Well, asset levels are down tremendously. However, since we've purchased and we announced the deal associated with Eaton Vance, look at Parametric. We've raised over $45,000,000,000 in that product alone, again, diversification of the portfolio, diversification of product To be there in a period of time where you see activity, that's what we're trying to do and build.

Speaker 1

Yes. I mean, I'll just add, I wouldn't frankly render a judgment On the Advance deal, I think it's a little soon through a challenging market environment. I'll tell you, I'm personally thrilled with it. And I'm highly confident that 5 years from now, we're going to look back and be thrilled with a lot of people said the Smith Barney deal was a dumb idea. A lot of people said E*TRADE was a dumb idea and a lot of people said we overpaid for Solium and these things have moments of sort of settling, if you will.

Speaker 1

It's like Good House, its foundations have to settle and in a very challenging environment, I think the business is holding up great. So, I'm very happy with that transaction. Great people, great company, some fabulous brands. And I think, Mike, if you come back I'll ask that questions in 3 years' time. Hopefully, you won't reverse the questions, but maybe you'll say what's going right with Eaton Vance And Asset Management, what's going wrong in some other place, because I'm sure as I said in the Rolling Stones on, you can't always get what you want given the environment something won't be working.

Speaker 1

But yes, I'm pretty relaxed about that one.

Speaker 12

I appreciate the answer. Just a short follow-up, it looks like you're not getting any NII guide or if you did, I missed it. And we just want some help with our models here, if you want to kind of guide us in a certain direction. I mean, clearly, Funding costs have gone up to the industry.

Speaker 1

I mean super hard, but I'll be bumpy. We sort of guided a little higher on growth in the Q1 and Came in plus 1%, which I guess is better than most, but just super hard. So, let's get through I think let's get through this quarter. We'll learn a lot Tax season, as Sharon said, it's kind of the numbers have reverted back to what we're modeling, which is good. We'll see that.

Speaker 1

We'll see how much of this cash starts moving. We'll see whether there's further deposit Outflows or not, I mean, it's just super hard to guide right now. So I don't think I know it's sort of I don't know if it's fair or not, but it makes your modeling harder, which I appreciate. But also, I don't want to give guidance that we don't really have And intellectual basis or fact basis we're doing it. It's just too hard.

Speaker 1

We're not stressed about it. That much Guidance I will give you, but I just don't want to put numbers on a sheet of paper at this point.

Operator

We'll move next to Matt O'Connor from Deutsche Bank.

Speaker 6

Good morning. Can you talk about the sustainability of the Strong fixed income trading revenues, obviously, on an absolute basis, very good, down from a really strong year ago level. And benefited from rate volatility, but at the same time advisory and DCM was sluggish. So how do you think about this kind of not just 2Q, but the next several quarters in the kind of environment that we're in and maybe some improvement in IB? Thanks.

Speaker 2

So our business has done, I think management has done a phenomenal job in really transforming this business to be a client centric model, Focused on velocity of assets, focused on supporting our clients, the deeper we've gotten into that, the more we've been able to grow our wallet Share more broadly, and we've been able to be in and around this 10% number. So that's clearly based on the activity that we've Now to your point, should we see an opening up of markets? Could there be greater activity? That would also obviously support the wallet more broadly, But we would expect to be there to continue to gain our appropriate share of that client activity.

Speaker 6

Okay. And then maybe just broadly speaking, like as you think about prime brokerage in both state and equity, like what's your thought there in terms of Committing capital kind of on an incremental basis like providing more or less from here or not really any change?

Speaker 2

We continue to invest in that business more broadly. You can see that even on the technology side. We're really proud of the Equity franchise and business and the transformation that's had for well over a decade being a market leader. Clearly, as we think about committing capital, it's also again about our clients being active in that market. As we see and I highlighted this in my prepared remarks, as you see client balances increase, We've obviously been there to support our clients and we are looking for the appropriate risk adjusted return as we continue to invest in that

Speaker 1

Yes. I'd just add, if you step back from this sort of over a 5 year view, firstly, just take hats off To the team led by Ted and Sam Kelly Smith and then Jay Hellick and Jacob Porter in Fixed Income, It's come a long way from I think a 6% share. I think we troughed out, I don't even know, blow after crisis, it might have been much lower, but Sort of 6 ish percent share for half of the last decade and then steadily moved up to now 10% and pretty Stable. It's kind of what we wanted. I mean, and on the equity side, you can buy share for sure More, but you want to be in the part of the prime brokerage business that we want to be in.

Speaker 1

We don't want to be in sort of the broker of last resort. So, But if you step back from it and what you've really got is kind of an oligopoly type structure emerged out of the financial crisis, where a smaller number of institutions Have the global capability for global sales and trading and we're now one of them and that was probably not a given 10 years ago, it certainly wasn't a given. And you've just seen obviously Credit Suisse has been merged and that business Lots of parts of that business I suspect disappear relating to the trading side and the prime brokerage. So, our position gets stronger, not weaker. All that said, we are pretty careful about how much balance sheet we want to use to grow aggressively on the margin because we simply have good options in terms of Wealth and Asset Management businesses.

Speaker 1

So, it's a balancing act, but I think the team has done a great job and I feel really good about

Operator

We'll hear next from Jeremy Sigee from BNP.

Speaker 11

Thank you. Just a quite a specific one actually. I thought comp costs So a bit heavy in wealth and in investment management. And you mentioned the deferred comp plans linked to investment performance. Is that heavier deferred comp cost, is that something that stays with us throughout the year?

Speaker 11

Or is it does it move around? Is that a 1Q Perfect. Or is that stuck with us for the rest of the year as well?

Speaker 2

No, Jeremy, as you remember, that moves around with You'll see both on the revenue line and the expense line. And so you should look at them together, and that's why we've enhanced the disclosure so that you can think about them from both sides, understand both the margin and the comp ratio, both historically and as we move forward.

Operator

There are no further questions at this time. Ladies and gentlemen, this concludes today's conference. Thank you everyone for participating. You may now disconnect.

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Earnings Conference Call
Morgan Stanley Q1 2023
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