Morgan Stanley (MS) Earnings Call Transcript & Summary

All right. But thank you very much, everybody, for being here. I'm absolutely delighted to welcome Ted Pick, Morgan Stanley's Co-President to the European Financials Conference, and of course, to our fireside chat. Ted, thank you very much for being with us today.

It's my pleasure. Thank you for having me. It's our 19th, yes?

It is our 19th, yes.

So congratulations, and thank you to the Morgan Stanley team, some of whom have been at this for 19 years. And let's hope this goes well because I'd love to do a 20. So here we go.

Very good, very good. And it's a promise that we both had. So before we start, let me just go through our disclaimers here. So this discussion may include forward-looking statements, which reflect Morgan Stanley's management's current estimates and are subject to risks and uncertainties that may cause actual results to differ materially. Morgan Stanley does not undertake the obligation to update the forward-looking statements. This discussion, which is copyrighted by Morgan Stanley and may not be duplicated or reproduced without their consent, is not an offer to buy or sell any security.

Okay. I guess, we're done with that. Ted, a lot of things are going on. Markets going up and down. There are kind of -- there's kind of question marks around what is happening in kind of U.S. regional kind of banking as well. So let's start top down. Can you talk about the overall economic environment and how we got to where we are today?

Magdalena, 15 years ago, we had the great financial crisis, and what came after that was a period of ultra-low interest rates, low growth, low everything, what we called financial repression. And as you know, during that heart of financial repression, which looked a lot like Japan after the 1980s, there was reasonable question that we were asking, which is, would we have lower forever.

Yes, particularly in Europe.

Europe, U.S. even, low rates, low inflation, low growth, and then some things happened. We had the first pandemic in 100 years, COVID. And to beat COVID, which we finally did after 3 years, we needed to inject a tremendous amount of fiscal and monetary stimulus, 3 years to get to that. Then we had the first land war in Europe in 75 years, humanitarian crisis and one that also exported inflation into Europe and the world through the energy product just at the moment when we were seriously thinking about energy transition. So 2 phenomena that we're clearly on their own inflationary. And then the bubbling of inflation itself began to kick in. And by the time we got to last summer, we really had the basis to have a conversation around hot versus cold, the old Robert Frost paradigm of hot being inflation, in this case, and cold being the threat of recession. And we felt that, that hot and cold battle would be one that would be waged over 12 to 18 months, and that, that was a necessary battle to slay inflation, the first inflation now that we've seen around the world in 40 years. But that once having done that, we would get to what comes next. Having beaten the pandemic, having seen that the war, again, while devastating in Ukraine, is contained as a global economic matter that this battle over containing inflation before inflationary expectations cement would be the critical battle that the Fed and other central bankers would have to wage for us to get to the next era. And of course, what we've seen over the last year, since we talked about that, is the Fed raising rates by the better part of 500 basis points, other central bankers following. And now as we speak, that battle between fire and ice, which we think we're about halfway through.

And in that context, how do you think about the developments over the last week kind of given us the overall? But how do you think about what's going on now?

Right. So we go from 15 years to 1 week.

Yes, totally, as we do, in markets.

So the 15-year history lessons, nice. But then there's reality, and the reality is when you move 500 basis points in 1 year, that is a real adjustment to the system for investors, for the corporate community, for the consumer, 500 basis points in 1 year. There will be a reaction function to that, and the reaction function manifests itself in situations that when I think of Dornbusch, the economist who gets quoted in moments like this, why did it take so long to happen? And then when it's happening, how can it be happening so quickly? And that phenomenon is what we're seeing this week, which is we knew that the story of our time would that we would have to slay the inflation dragon and that the Fed, as part of its dual mandate, would have to raise rates, and other central bankers would follow, but that there would be a delay in the effect of that transmission. And that when there would be events that would be responding to that, like we saw with the mini crisis in the LDI community in the U.K. last year, like we're seeing with the 2 banks being taken over this past weekend in the U.S., that this is part of the process of the not being turned to tighten financial conditions, to make sure that we are on our way to normalizing in a higher interest rate world, but that there might well be surprises, there might well be reactions in a world where, after 15 years of the financial crisis, the notionals of all assets are much bigger, where we are all instantaneously connected to a Bloomberg machine. The reaction function time is immediate. And so that these incidences, these examples of reaction to a higher interest rate environment, they're going to be real. They are going to be, in some cases, rather unpleasant. And it will be, of course, absolutely critical for all the great and the good and policymakers and stakeholders to address each one of them thoughtfully as they come up. But I guess, my answer in part, Magdalena, would be that this week, in some respects, is indicative of what happens when you're in the throes of that battle between fire and ice. You have the knob being turned to try to fight against inflation. And then the question is, do you stop turning the knob? How hot is the CPI print going to be in a couple of hours? Can the Fed continue to turn the knob to try to get inflationary expectations down? Or given what's happened this week, the reaction function, to higher interest rates, do they need to either slow the knob down or turn the other one? That is this week, which is the fire and ice right before us. And I think it's something we should expect over the next 6 to 12 months.

And when you think about those kind of various kind of layers of complexities, how -- what does it mean to -- for Morgan Stanley's institutional business this year, how does that global backdrop impacts the Sales & Trading business, underwriting advisory business for us?

So Magdalena, let's start with the trading businesses. We like to say in the trading community that volatility is good until it's not. So when there is a reasonable amount of volatility because, again, our clients are trying to either monetize or navigate hedge this new paradigm, the shift from what was financial oppression to the normalized error to calm, they are going to be market making. They are going to be trading interest rates, foreign exchange, equities -- equity derivatives that are going to be putting on and taking off leverage, depending on how things feel. And for our Equities and Fixed Income businesses, that is a healthy environment. It is not as strong an environment as we saw in the first quarter of last year, in part because that first quarter had the tailwind of the commodities moment when the world was just kicking in. But I'd say for the whole, the markets businesses have actually held up very nicely, both Equities and Fixed Income. Clients are engaged. They're very much following not just the paradigm shift, but they're following the moment to moment, and we're in there helping them intermediate markets. The banking business understandably is slower because the C-suite decision-making process at the strategic level is governed by some belief that conditions have stabilized. And what I'm describing, of course, is a period where we will continue to see a reasonable amount of uncertainty. Now I am increasingly bullish on the return of the mergers product as one that is going to be part -- a big part of the next cycle because we've had 3 years, thanks to the pandemic, where a lot of the scaling activity did not take place, where we had a heck of a lot of regulatory uncertainty. Now we have something that feels like a partial decoupling, which is now being factored into supply chain mentality, into doing business with other companies that maybe friendly to a certain way of executing a scaled plan. So the identifying of merger partners is something that's been happening. You have the sponsors community that is, through the last 15 years of financial repression, become institutionalized. So they have plenty of dry powder. And I think, while there's regulatory uncertainty and that will continue, while there will be this fire and ice debate that will go on, I think, for another 6, 12 months, I think we will begin to see some real M&A activity. The pipelines are growing. It will be across sectors. And yes, there will be regulatory risk around that given the sensitivities of geopolitics today, but I think we're going to see mergers and particularly cross-border mergers start to kick in. The IPO product, I think, is going to take a bit longer. We had the blow-off of the profitless group going into the height in mid-2021. That's going to take some time to reset. The leverage lending event calendar has generally been absorbed. A lot of it has been burned off, but I think investors and underwriters are adjusting to not just what the right spread is, but what the right new base rate is. So I'd imagine the financing of LBOs, while they're going to come back, that's going to take some time as we continue to navigate the uncertainty. So in sum, I think the banking numbers will continue to be pretty anemic relative to what we saw pre-2022, so in line with what we've been seeing over the last number of quarters. But I would hope, this time next year, we're going to see that coming back strongly.

Now maybe a little bit more kind of strategically because you've been running various divisions of the Institutional Securities group pretty much since the financial crisis. Where have you focused your strategy since leading this business?

Well, after the financial crisis, we were focused on rebuilding equities, which requires an enormous amount of CapEx on an ongoing basis. It is really a technology-driven business. There are 3 competitors that are able to generate returns above their cost of capital, and we have aggressively invested in that business, in the cash business through electronic trading, the Prime Brokerage business and the derivatives business. So we're 1 of 3 that have about 60% of the total available wallet to the big players. Our Fixed Income business, in '15, '16, we took the view that we're not going to be lower forever. Some day, interest rates would be higher. Some day, people would care about foreign exchange. Maybe it would be more automated. Maybe it would be more equitized, electronically traded. So maybe we could take some of our equities technology kit and migrate it over to fixed income. And that clients, given the size and scale of the debt stack, would care about our having a large credit and securitized products group. That's turned out to be the case. So in the fixed income suite, we went from 6 share to 10 share. I like that positioning. Kind of the way I think about, Magdalena, is we have 20 share of Morgan Stanley in the equities piece. We have 10 share in the debt capital markets and fixed income piece, and then we have about 15 share at the top of the triangle, which is the investment banking piece. That's the piece that I'm now focused -- our team is now focused on growing. We want to grow that business. We call it the integrated investment bank. As you know, there's historical tribalism between the 3 divisions. People in equities, traditionally, maybe are nervous about working with people in fixed income. And people in fixed income think that they're probably a little brighter than people in equities. And people on equities and fixed income both agree they really don't want to deal with bankers. So it's kind of a classic case. And what we've done is we kind of have a laugh about that because we've mobilized people in those 3 divisions into each other's pond. So of course, by the time you're in the new -- you were in the new tribal outfit, after 6 months, you're like, "Wow, the equities guys are a heck of a lot smarter than I thought. And the fixed income people are actually interested in working with clients. And actually, the bankers have a great high-margin product." So it works if you have a group that, as we have, our management team has an average length of service of 25 years with the firm, and that is a long time. 80% to 100% of their career is at the firm. And I think that's important. We have 1 capital statement, 1 income statement, 1 partnership group. And a lot of the team has mobilized across geographies and across different products. So it allows us to be able to generate returns for clients based on the client saying, "You're really good at this equity product. You're pretty poor in this fixed income product. You're actually quite mediocre in this banking product." And given the client is giving us that 1 report card, we can sort of get after it holistically.

Yes, yes. And then -- so let's maybe talk about kind of Europe and Asia, more of our global business. So how do you think about the relative attractiveness of Europe as a place to do business as a global firm? And of course, particularly over the last couple of years, we've dealt with the impact of Brexit fragmentation. Could you tell us about that, too?

Sure. It's an interesting thing to be thinking about forward plans at a moment like this. But because the firm has a strong capital position, because the firm has strong liquidity, because the firm has a stable and diversified funding, this is a quite different firm than 2008, as you know. It's 15 years in the making. And while we're all navigating what higher interest rates mean, we also have a stable deposit base. So you put that all together in the context of the moment, and you start thinking where are the places where we can grow our business, beyond where the firm has doubled down, which is the U.S. via Smith Barney, E*TRADE, Eaton Vance. And I like the continent. We have the better part of 9,000 people in -- effectively in U.K. plus. We're migrating some folks on to the continent. We have terrific businesses already in banking and in markets, but largely banking driven in places like Iberia and Scandia and Italy. But it wasn't until Brexit and the war, neither of which, of course, the content wanted that the continent has been put in a position where it needs to think about itself as its entity, as its economic entity. And we have, for reasons that are defensive, given where we were coming out of the financial crisis, we kind of kept Europe as a nice niche business that needed to make the capital nut, and that was a reasonable place to be for a business that was self-helping and where our business strategy was being reoriented. We're 15 years late. And whether there's going to be a recession in Europe in 3 months or 6 months or 12 months, it's much less interesting to us than whether there is rule of law, high levels of education, sectors that appeal to the qualities of the high end of the consumer, forward science, liquidity possibilities. And as asset managers and investors, broadly, move on to the continent and the regulator moves with them, so too does incremental banking human capital. And now we're increasingly able to bank the European client base out of Paris, out of Frankfurt and Munich. And we are on our way to, I think, building forward a European business in investment banking and in the broader institutional securities context that, I think, only a global investment bank can really get after. And much like in other parts of investment banking, we really have 2 main global competitors. And obviously, in Europe, you have a bunch of national champions who are superb in their home market. But I think getting after the cross-border M&A opportunity, the interest rate or foreign exchange hedge, the carve-out or the rights offering, as a global investment bank that has reliable sales and trading capability onshore, proper regulatory hygiene and the investment banking intellectual capital to get in the Boardroom, I like that. And I like it particularly at a point where people are a little more negative about Europe's economic forecast the next 6, 12, 18 months. We are investing there. We're investing, particularly in France and Germany.

Perfect. And we're also kind of starting to have a conversation about Asia. Of course, the kind of China reopening theme as well, of course. Where do you see the particular opportunities for Morgan Stanley?

I think people would give their laundry list of Asia. They'd go through Hong Kong as the gateway to China given all that's going on. Hong Kong never having lost its position as a hub, having gone several times since during and now post-COVID, the mask finally gone a couple of weeks ago. But I think a lot of that is well known. People know about the opportunity in India. What I like to talk about is Japan for us. Japan is something -- Japan is a place where Morgan Stanley is differentiated. We have a 22% owner in Mitsubishi. This usually, as you all know, with strategic partnerships, especially those sort of done in the heart of a crisis, after a dozen years, they tend to sort of melt away. There is a real desire on both sides to actually engage even further. And why is that interesting right now in Japan? Well, it's interesting because they have their own geopolitical concerns. They have their own energy transition issues. And the population is both getting older and not keeping up on a net basis with its birth rates. So there are challenges there. But very, very important, back to my earlier conversation post-pandemic, post-war, inflation, real interest rates, they're going to come off the 0 barrier. Japan coming off the 0 barrier means that 1989, that is almost 35 years of Japanese financial repression, is going to come to an end. When it comes to an end, I think that will be one of the great wealth management opportunities in the world and is one where we can bring our expertise to the Japanese depositor who has been yen denominated, plus real estate. And hopefully, we can bring tools and knowledge to that base. And then, of course, Japanese being deposit-rich, as we all know, are starting to engage in substantive corporate reform. We know that every financial sponsor is in Japan right now trying to find new opportunities to -- not only to raise capital, but to actually benefit from the high-quality education, again, rule of law. I think the opportunity in Japan coming at it from always, with our differentiated really spectacular partnership with our friends at Mitsubishi, is something that we think is going to be a gem item for us over the next 10, 15 years.

Perfect. And on the kind of longer term, the next decade conversation, when we talk about the firm, we talk about delivering growth and kind of across the -- across our businesses. How is the firm positioned to deliver that growth in your mind?

The growth story is borne out of a store stability. James has been giving his strategy deck every January for the better part of a decade, and he talked about the ballast of wealth and asset management. We integrated Smith Barney after the crisis. We bought a small company in the stock planning business in Canada called Solium. We then were able to get E*TRADE done at the outset of COVID and then Eaton Vance. The ballast has $4.5 trillion of AUM in wealth and the better part of $1.5 trillion in asset management. The engine is the integrated investment bank. We have 14 share on $175 billion revenue wallet for the [ 9 ]. We're 1 of 3 global leaders. You've heard that we want to expand that share largely in the investment banking, intellectual capital driven, less pure financial capital-driven products. So you put those together, you've got the ballast and the engine. The one twist to this, though, it occurred to me thinking about this theme of growth, is actually the ballast is showing real engine qualities because we've gone now from -- we talk about the funnel and wealth. We've gone from the advisory model and self-directed to really getting after the corporate client base. It -- there is one corporate stock plan and it's got Morgan Stanley's name on it as it does for now we're approaching 40% of the S&P 500. That is a mandate business forever. You're in with the CHRO. You're doing all of the stock planning business, which eventually is a feeder into broader wealth management. That is an engine like business. And then for people who say, "Well, what about the investment bank? Can it please give us predictability? Can it give us the durability that we like to see in the wealth business?" Investment banking, the trading businesses are always going to have more volatility, but there are elements of that business that we are managing to enhance durability. The Prime Brokerage business, some of the lending businesses within securitized products, some of the flywheel inside investment banking and the hedge management around that for corporate clients, a lot of that business is taking on an increasingly ballast-like field. So I like that, that the engine starts feeling more ballast-y, and that the ballast starts having an element of engine, such that in some years, it will be 50-50 revenue split. The returns will be roughly comparable. But in other years, 2 years ago, it shifted more towards investment banking, procyclically. And I would think in the next year or 2, it will be shifting more towards wealth and assets.

So probably to follow up from the earlier comments, how do you see literally the group businesses interact across the firm? And how do you monetize the mix of those businesses?

I think we benefit from having had a tough history, idiosyncratically. We had a merger in '97 that was problematic, that many of you are familiar with. And anyone that worked at the firm knows that, that was a tough moment where we had a retail firm and an investment bank. So people have remembered how that did not work great. We have endeavored to do better. We also then came within a hair's breadth of the abyss during the financial crisis. So the interesting part of watching the wealth business particularly grow has been the engagement of the investment bank and securities business to try to be part of that and for the wealth business to be able to attract itself to the gem of the investment bank. So version 1.0, I call, getting to know you. Here's a reference. This is someone who runs a family office, there may be some investment banking business. Here is a company that just went public, they need a wealth manager. Getting to know you. 2.0, monetization opportunities. Let's create a program where we are going to formalize some of the referrals where we're going to have pockets of people that are scones to each of the divisions. Version 3.0, creative design, creative design. We have a fund services platform inside of equities, the only one left inside of a major investment bank, which is effectively the statementing, the administration or your NAVs and other data. Critical, if you are an alternative asset manager, a hedge fund to distribute through LPs. Well, why not take that kit and migrate it into wealth management, rather than buying it or rebuilding it and make it the base infrastructure for your outsourced CIO product? Because that hedge fund manager is now a wealthy individual running a family office who expects the same feel and service. And so we've migrated that. Very powerful, interconnected. The Parametric product, which is a jewel inside of Eaton Vance, which is part of investor management, why not take Parametric since the whole world, and very much in the U.S., the attention is given to individual taxes, why not have that product migrated throughout the wealth platform? And why not have it migrated inside of investment banking discussions where the discussions now with the CEO as opposed to with our company? How about when we do a directed share program and an IPO where we're offering up shares to friends and family and other interested parties, we do that on the E*TRADE platform. That kind of creative design, of course, brings together the entire group of people. And what I'd say also is necessarily going to happen if you've moved people around. I just want to sort of reemphasize that point. If you have folks that know each other well and they get along, and the incentive structure is collegial, it should work. But it's never going to work as well as if people are moved through the system. You, Magdalena are running this financials conference. You will soon be running the entire Asia research product, right?

Very much looking forward to it.

That's the deal. So you do this job very well. And then you do the next job such that you've taken on a management role, and you're taking that management role on in a different region. And then when you come back to the U.S. or to Europe, you say, "Okay, now, how can I scale that wisdom, that experience across the entire plant?"

Thank you very much for that. Thank you.

Congratulations.

No pressure.

Maybe an applause. I know that's usually the case. Am I going to look at what the stock is doing? Is that okay?

No, no, no.

I want one of those.

But -- so before I open to questions, just a couple of kind of yardsticks. How would you quantify the firm's growth potential? What would you like people to...

Back on the growth question.

Yes, yes.

Round 2 of the growth question.

I know your numbers.

I'm an investor in Morgan Stanley. I want to see that this firm can generate 15% to 16% returns on tangible when the environment is tough, as it was last year, which is what we did. And I want to own it for 20% returns on tangible. That's the name of the game, durably. That's what we did in '21, and that's what the management team is focused on for our shareholders and for the entire team. How do you get there? The way you get there is to continue to expand the funnel inside of wealth to make sure that you're growing assets at roughly $1 trillion every 3 years on the $4.5 trillion of wealth and the better part of $1.5 trillion in asset management, and you get to a number of $10 trillion through compounding, 5% a year of higher asset prices, 5% a year by getting assets elsewhere in the system. In a week like this, assets begin to work to the consolidating players. There are 10 trillion of identified wealth assets away from us, and we're trying to get to 10 overall over a number of years, 1 trillion a year every 3 years at 30% margins. You can do the math. Everyone has done the math on that path, the ballast that has an engine quality. And then on the engine that increasingly has a ballast capability, top 3 global investment bank, 14 wallet, the wallet should grow between 1 and 2x GDP. What comes in the new cycle? I think what comes in the new cycle is additional volatility, but I would hope it also comes real interest rates, real inflation and real growth. And therefore, you should be able to achieve something that is a real number on 1 to 2x GDP. 14% wallet on $175 billion total of revenues, again, high-margin business, focused very much on returns on capital to grow that business via operating leverage. Where does that operating leverage come from? It comes from holding 20 and 10 share in equities and fixed income, respectively. Frankly, if we can grow them in both equities and fixed income, very much want to grow. The business plans are in. It's just a question of whether they are price makers. It's a question of whether the implied investing return sharp against that wealth business is something that all the stakeholders want. So we would want to grow the markets business judiciously, but the available TAM is growing. The available market to our equities services, prime brokerage, cash equities, derivatives and our ability to service on interest rates, foreign exchange, commodities and the credit spectrum, there's a lot of it to the markets business itself or to investment banking, which becomes the core from which a lot of this markets business would come out. You should have excellent returns put together with our global asset and wealth manager.

Perfect. And on that high note, we'll open up for questions. I think there are microphones right at the back.

Ted, I'm going to do the less-friendly question. All these things sounds very good, but there is a constraint on capacity in general. So I mean, how do you see these events? Because obviously, the large banks like you, well capitalized, well funded. You're going to be winners of business across the board, it's pretty obvious. But the regulation across the system has to tighten. So how do you think about the 2 going forward, your capacity to take business because clients are going to take more confidence with you versus how much you think they're going to tighten?

Excellent question. We need to be thoughtful about the value of mandate business, about being able to grow through the cycle. We have in place capital program, which, as you know, has taken our dividend from script up to $0.775 a quarter, $3.10 a year. We take the dividend very seriously. As a shareholder, I guess I've reached an age in my life where I am a lover of dividends. I'm a dividend guy, and I know that's how the management team feels. So we care about that a lot. Your point is an excellent one with respect to regulatory uncertainty, with respect to Basel III end game, a tougher CCAR test, everything that's happening as we speak. We have to let that play out. Are we doing a lot of modeling, a lot of studying, a lot of sort of careful consideration? Sharon Yeshaya, our CFO, and her excellent team and the broader management team about what the potential capital implications of all of that are, yes, we're spending a lot of time on that. You are suggesting that there is a trade-off between capital return, the need to potentially for the system have more capital that we are compelled to hold and that capital, which we wish to distribute. We are coming from a position of strength, but you are right. We need to be very careful about how we prioritize that because, of course, the worst thing you could do is to undertake to a segment of the client base or a segment of the organizational stack that you're going to go expand the business. And then 6, 12, 18 months in, say, "Well, we've had a regulatory headwind, Basta reversal. That's not the program. We go at it thoughtfully. I think part of the reason you're hearing me thread so much of the investment banking piece to the institutional securities piece is because, all things being considered, I would hope that would be a more asset-light way for us to continue to build moats. And then to the extent we have business that is either balance sheet, GAAP or risk-weighted asset intensive, that is business that we would take on in the context of offering solutions for clients thoughtfully. So there's a lot of prudent modeling and business strategy consideration that's taking place right now. But to be clear, the intention is that we will continue to grow, and we will continue to grow via the ballast and the engine.

We probably have time for one more question. If anyone -- the gentleman on the right.

You mentioned potential for M&A, especially cross-border and even cross sector. Could you be a bit more elaborative on the financial sector and banks more specifically? We've seen both SVB, but the solutions are more domestic. Do you expect to see more cross-border activity in the banking sector?

Well, I know for Morgan Stanley, we are quite happy with the perimeter we've got, having executed 2 of the largest M&A transactions since the financial crisis and all the work that went into getting those right. That doesn't mean that we ourselves would not be interested in potential opportunities as tuck-ins to wealth and asset or into the integrated investment bank. But I'd say we've done what we're going to do, all things being equal, barring the unexpected. You've heard the business strategy, and the plan is largely and predominantly an organic one. With respect to whether there might be cross-border activity in the space, either as a function of scaling or as a function of sort of pockets of dislocation, I think some of that is a function of what the situation actually is, what the terms of trade are. My guess is that the environment that we're in today is one where the buyer is probably not going to get a lot of relief for whatever is inside of the new entity. So I think there is going to be some hesitation. But there may be, and there probably will be, examples where folks who are going to be able to grow through this period of uncertainty, to scale given some of the ongoing capital requirements, given the reality that some of the tightening that we're seeing right now may erode margins, and that the cost base via inflation to run a financial institution will continue to be more expensive. So there might be that opportunity. Certainly, there are bankers at every firm that are out there working those opportunities. But you have to take into account the regulatory approval process as we know, is complicated on pending bank mergers that we are all aware of and the reality that you have to know what you're getting given the uncertainty that we're living in right now.

Perfect. Ted, thank you very much.

Thank you so much. Thank you, all. Thank you very much.

We appreciate it. Thank you very much.