Morgan Stanley (NYSE:MS) Q4 2023 Earnings Call Transcript

Morgan Stanley (NYSE:MS) Q4 2023 Earnings Call Transcript January 16, 2024

Morgan Stanley beats earnings expectations. Reported EPS is $1.13, expectations were $1.05. Morgan Stanley isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

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 supplements, 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. Please refer to our notices regarding forward-looking statements and non-GAAP measures that appear in the earnings release and strategic updates. Within the strategic update, certain reported information has been adjusted as noted. These adjustments were made to provide a transparent and comparative view of our operating performance.

The reconciliations of these non-GAAP adjusted operating performance metrics are included in the notes to the presentation or the earnings release. This presentation may not be duplicated or reproduced without our consent. I will now turn the call over to chief executive officer Ted Pick.

Ted Pick: Good morning, and thank you for joining us. It is a privilege to be with you. Today, I will deliver the annual deck that was a hallmark of James Gorman’s 14-year tenure, both to affirm Morgan Stanley’s strategy and to provide a level of transparency on our progress that you have come to respect. Let’s turn to the slides. Turning first to Slide 3, over the last 15 years, we have transformed the firm’s business mix, scale, profitability and returns. If you compare various historical periods, you can see our business evolution. Each period faced its own challenges. In 2009 to ’14, Morgan Stanley was a classic self-help story. Transformation began with the acquisition and integration of Smith Barney. The investment bank was reset, and the firm survived the near triple credit downgrade and the euro crisis.

In 2015 to ’19, we weathered the years of financial repression, resizing our fixed income business and pressing ahead to the top slot in institutional equities. During this period, we also acquired Solium, which was a step toward leadership in the corporate stock plan space. Then in 2020 to ’22, the COVID years, we achieved incremental scale in both wealth and investment management with the acquisitions of E*TRADE and Eaton Vance, giving us a leading self-directed platform and pushing forward in investment solutions. During this period, each of the two major business lines — wealth and investment management and institutional securities generated operating leverage and high returns. Transformed Morgan Stanley today has tripled client assets in its durable businesses with significant opportunities for further growth.

Notwithstanding 2023’s geopolitical, macroeconomic and industry challenges, the firm’s business model generated consistent results. In 2023, firm revenues were $54 billion with $12 billion of PBT, double the averages of 2009 to ’14. Our return on tangible common equity was a solid 13%, inclusive of notable items that reduced returns by over 100 basis points. Last year’s return profile was tripled the post crisis years. Combined earnings from wealth and investment management generated 60% of the firm’s top line and PBT, and our category of one asset gathering strategy sets the stage for continued durable growth. The institutional securities business also grew over the transformation years with an eye to investing in its leading franchises. The objective has been to create an integrated investment bank of investment banking, equities and fixed income to serve leading institutions around the world.

Taken together, the Morgan Stanley business portfolio of today has well higher and more stable profitability. The actions we have taken over the last 15 years, organic and inorganic, were all within our core strategic footprint. At its center is acting as a trusted advisor to clients, helping them raise, allocate and manage capital. It is what we do. We are a global leader and we are really good at it. This will not change. Turning to Slide 4, since 2010, revenues and wealth and investment management have more than doubled, and today we are number one in the world among our peers. During the same period, our client assets have more than tripled to $6.6 trillion. We see continued opportunities to drive growth and are steadfast in our goal of reaching $10 trillion in total client assets.

In wealth management, we have established ourselves as a leading asset gatherer by expanding our business model across three channels — advisor led, self-directed and workplace. The business generated $1 trillion of net new assets over the past three years, and we are relentlessly focused on sustainable growth. We expect NNA growth to continue to vary quarter by quarter, given seasonality and even year to year given market tone and the cadence of migrating workplace assets and attracting assets held away. We are nevertheless confident in our ability to continue to grow and deepen our 18 million relationships with the breadth of our wealth management offering. Over time, our ability to track, deepen and retain client relationships with our differentiated platform allows us to drive revenue growth and operating leverage, enabling 30% margins.

Given some of the recent macro headwinds in our continued investments for growth, it’s reasonable to expect reported margins to consolidate in the mid-20s range over the near term. The underlying business has achieved 30% margins before, and we intend to deliver that return profile again in the long term against a higher base of revenue. Our wealth platform is complemented by investment management, where we’ve added a number of new capabilities to our strong public market alpha engines. This business is well aligned to key areas where we see secular growth, including customization such as parametric, private markets and value add credit. At a holistic level, the wealth and investment management business has achieved the kind of scale which enables us to invest in what matters most to clients and to take further market share through cycles.

Turning to Slide 5. Morgan Stanley’s Institutional Securities Group, our Integrated Investment bank is a preeminent global franchise. Our capability set, extensive client footprint and premier brand put us in a position to be the trusted advisor to every important corporation, public or private, asset manager and asset owner. Our teams across geographies, businesses and client segments position us at the center of global capital allocation and formation. Over the last decade, we have advised on nearly $9 trillion in M&A transactions, raised nearly $13 trillion of capital for clients and as indication of our market’s presence. In a single trading session last month, our equities business transacted roughly $250 billion of notional value. Our leadership position outside the U.S., acting as a true global investment bank, is critical for the Morgan Stanley franchise.

After more than five years managing our integrated investment bank, I’d add that it is clear from client visits around the world that the barriers to entry to becoming a global investment bank are real. Today, there are fewer competitors, and we are one of those very few who can provide the full breadth of capabilities. We expect the next economic and financial cycle to be led by corporate finance activity which will drive investment banking growth, and as such are particularly focused on expanding our 15% world share in that advice driven business. Turning to Slide 6. When you combine our wealth and investment management platform with our leading institutional franchise, you see the power of what we will call the integrated firm. Our capacity to source new client opportunities efficiently facilitates the flow of capital and deliver Morgan Stanley’s firmwide Solutions has never been stronger.

Looking at the right side of the slide, more specifically, our premier corporate franchise spans every business segment, with clients at the center of everything we do. We cover their broad range of needs, from advising the C suite on strategy, to helping them raise capital and hedge risks, on through to advising the broader employee base through our workplace offering. Second, we have a unique capability to serve individuals who range from self-directed, up through to the ultra-high net worth set and small institutions who sit between the traditional segments. We can deliver best-in-class institutional capabilities paired with sophisticated wealth management solutions in an integrated service model. Third, we continue to invest in our ability to deliver investment and client solutions as we are at the center of financial innovation and growth.

Our global integrated investment bank is core to our ability to source and structure customized opportunities for corporations and financial sponsors. Our structuring capabilities are augmented by scaled distribution channels, extending from the largest institutions through the individual retail client set. With a central focus on our clients, we see significant opportunities in delivering the integrated firm. Turning to Slide 7. Ultimately, the firm’s success relies on our human capital and maintaining a differentiated partnership culture. With James as Executive Chairman and together with Andy Saperstein and Dan Simkowitz as our Co-Presidents, our highest priority is delivering the integrated firm to our clients. Our shared Morgan Stanley experience, having all lived through the 15-year transformation, gives us a lens into where we come from and where we are going.

The intentional mobility of our leadership, engineered by James over these many years, is particularly important. Andy, in his expanded role as head of both wealth and investment management, is well situated to leverage his deep knowledge of retail distribution and products to drive client opportunities across the business. Dan, having successfully revitalized investment management for nearly a decade, is returning to lead institutional securities, where he spent 25 years, will play a critical role in connecting the firm around sourcing opportunities, structuring financing and distributing capital for our clients. Both these gentlemen have burnished the brand and successfully integrated acquisitions. To have James, Dan, Andy as partners to open 2024 speaks to the enduring strength of our culture.

Our broader leadership team has worked together since the financial crisis through the strategic transformation and today are unified in advancing toward our goals. The operating and management committees of the firm each have an average tenure of more than 20 years. Long tenure is one element that maintains the strength of a learning culture of serving clients in a first-class way. In addition to backing the Morgan Stanley experience set of our longstanding leaders, we’re enhanced by the injection of some key lateral hires and joiners via our acquisitions. Our businesses are supported by a world class technology and infrastructure organization, and by 2,320 talented Managing Directors, 155 of whom we promoted to the partnership last week. Our 80,000 people are what makes Morgan Stanley’s culture and drives us to be excellent on behalf of our clients, to be prudent fiduciaries of capital, and to maintain a keen awareness of the road we have traveled to achieve the firm we have today.

Turning to Slide 8, in addition to one — the performance of the business, two — driving an integrated firm and three — maintaining our culture, we are four highly focused on the state of our financial capital. Given our deliberate growth and durable earnings over the last several years, our capital position is strong, going to the finalization of Basel III Endgame. Our regulatory requirements, as ventured within our stress capital buffer, have steadily come down since 2020, reflecting the improved resilience of our businesses. With respect to Basel III Endgame, we continue to believe after fulsome industry comment and further evaluation of economic and competitive impacts, that the final rule will result in a well more constructive outcome than originally proposed, particularly as it pertains to matters that are driving our estimated RWA inflation.

Looking ahead, we remain committed to the dividend as it is at the core of our business model’s durability. While we will toggle among opportunities to support our clients, grow our businesses, and repurchase our stock, the core strengths and strategic decisions of the last 15 years are reflected in our quarterly dividend, which we have grown from $0.05 to $0.85 per share. The continued sustainability of that dividend is paramount. With the firm coming together, we will drive toward our performance goals. Slide 9 reiterates our confidence in them. Our strategy and long-term value proposition remain intact. The four firmwide goals are in place, hitting $10 trillion in client assets, achieving a 30% wealth management pretax margin, a 70% firmwide efficiency ratio, and achieving 20% returns on tangible equity.

Our management team is steeled to execute against our priorities to reach these goals. We enter 2024 with confidence, and our base case for the coming year is constructive. There are two major downside risks. The first is geopolitical, that global conflicts intensify and conflagrate. The second is the state of the U.S. economy over the course of 2024. The base case is benign, namely that of a soft landing. But if the economy weakens dramatically in the quarters to come and the Fed has to move rapidly to avoid a hard landing, that would likely result in lower asset prices and activity levels. On the other hand, if inflation in fact has not been beaten back and continues to challenge consumers and supply chain, that could result in a stickier fed and the resulting higher for longer will have to be absorbed in the way of a higher-than-expected cost of capital and the dangers of a bifurcated economy.

These risks, the geopolitical and that of the U.S. economy, present some uncertainties as we start 2024. Nevertheless, as we have discussed this morning, the Morgan Stanley of today is meant to perform through the cycle, and based on the evidence we see, our building M&A and IPO pipelines, improving boardroom confidence, and an increasingly positive tone from our retail and institutional clients, we remain constructive on the year ahead. We will execute on our clear and consistent strategy. We have a global business, a world class wealth and investment manager alongside a leading investment bank. The growth opportunities are extraordinary, especially given how our businesses and regions intersect and support the business strategy. We will continue to lead with asset consolidation across wealth and investor management, and remain committed to growing high quality share in institutional securities to consistently deliver our integrated firm to clients around the world.

In so doing, we will continue to execute towards our key objectives and to deliver for shareholders. I will now turn the call over to Sharon, who will discuss our fourth quarter and annual results, and then together we’ll take your questions. Thank you.

A – Sharon Yeshaya: Thank you and good morning. The firm produced revenues of $54.1 billion in 2023 and ended the year with fourth quarter revenues of $12.9 billion. For the full year, ROTCE was 12.8% and EPS was $5.18, and for the fourth quarter ROTCE was 8.4% and EPS was $0.85. The full year efficiency ratio was 77.2%. A number of factors impacted our annual and quarterly results. The full year results include nearly $900 million of notable items. Over half of these items were reflected in the fourth quarter. A $286 million FDIC special assessment charge and a legal settlement of $249 million were both realized in the fourth quarter. In addition, the full year results include $353 million of severance expenses, primarily related to a May employee action.

The combination of these three items negatively impacted full year EPS by $0.44, ROTCE by 105 basis points and the efficiency ratio by 164 basis points. Total integration related expenses for the year were $293 million, nearly 70% of which was related to E*TRADE. With the E*TRADE integration now complete, we remain focused on continuing to manage our expense base, supporting our long-term efficiency goals while still investing in growth. Now to the businesses. Institutional securities’ full year revenues were $23.1 billion and quarterly revenues were $4.9 billion. Full year results were impacted by the weak investment banking environment that began with the onset of the hiking cycle and geopolitical events in early 2022, and persisted through most of the past year.

Fourth quarter revenues reflected stronger investment banking results and prudent risk management across fixed income and equities. Investment banking revenues were $4.6 billion for the full year. Lower completed M&A transactions followed a dearth of announcements in the back half of 2022 and early 2023, which weighed on results. However, optimism began to rise midyear followed by a notable increase in Morgan Stanley’s announced volumes starting in the third quarter and continuing into the fourth quarter. Fourth quarter revenues were $1.3 billion. Results were supported mostly by fixed income underwriting as the investment grade market remained open for regular way issuance and was supported by event driven activity. Advisory revenues have begun to recover versus recent quarters, and were roughly flat year over year.

Equity underwriting revenues were also flat as activity remained muted. As we enter 2024, we are positioned to capitalize on the opportunity set, while downside risks are linked to the consumer with the rate path and geopolitics as two key determinants, we expect the US will lead the recovery globally. Corporate confidence will ultimately drive the cycle forward and we are encouraged by signs the CEO and boardroom optimism is growing, evidenced by the build of our advisory and IPO pipeline. Our integrated investment bank is well positioned to capitalize on the recovering backdrop, particularly where the institution works across the businesses with CEOs, CFOs and Treasurers on corporate solutions. Strength and sentiment should support broad M&A and new capital market issuance, and eventually feed through to the broader market activity.

Equity full year revenues were $10 billion, reflecting lower revenues across regions. Tempered client engagement was reflective of broad market uncertainty. Revenues were $2.2 billion in the fourth quarter. Prime brokerage revenues in the fourth quarter were solid. Results reflected narrower spreads and the geographic mix of client balances. Cash results declined versus last year’s fourth quarter, reflecting lower volumes, particularly in Asia, ex-Japan. Derivative results were up versus last year’s fourth quarter as the business continued to grow the client base. Fixed income revenues were $7.7 billion for the full year, declining from 2022 strong results. The full year decline was driven by lower client activity in foreign exchange and commodities, which were impacted by greater uncertainty around the rate outlook and less volatile energy markets.

Quarterly revenues were $1.4 billion. Macro performance was down versus the prior fourth quarter. Results reflected fewer monetization opportunities, particularly in Asia compared to heightened engagement in the region last year. Micro was down year over year, driven by lower revenues in credit corporates which was negatively impacted by movements in credit spreads on the back of geopolitical events. Results in commodities were up versus last year’s fourth quarter, primarily reflecting improved performance in the power and gas business. Turning to wealth management. For the full year, wealth management’s revenues were $26.3 billion and the pretax profit was $6.5 billion, which resulted in a PBT margin of 24.9%. Reported results reflect the complex macro backdrop as well as several idiosyncratic events.

The unprecedented rise in the absolute level of interest rates were particularly consequential as the subsequent shifts in client behavior impacted the revenue mix and margin. In addition, there were several expense items that impacted the margin including integration related expenses, the FDIC special assessment, severance charges and the impact of DCP, which saw meaningful swings compared to last year. Taken together, these four items impacted the full year margin by over 250 basis points. Total client assets ended the year at a new high, reaching $5.1 trillion of assets. Full year fee-base flows were $109 billion. These flows and associated fees offset the market levels and changes in interest mix of client portfolios, supporting the year-over-year increase in asset management revenues.

Fourth quarter revenues were $6.6 billion, and the reported PBT margin was 21.5%. The aforementioned notable expenses negatively impacted the fourth quarter margin by over 400 basis points. Asset management revenues in the quarter were $3.6 billion, up approximately $200 million from the prior year’s fourth quarter. Quarterly fee-based flows were strong at $42 billion, underscoring the value clients are seeing in our advice-based model. Client allocations to higher yielding cash alternatives remained elevated, and clients continue to deploy monthly inflows into equity markets from sweep balances. The eventual return of the new issuance calendar and improved retail sentiment should provide a tailwind as clients look to redeploy into broader asset crosses.

Net new assets of $282 billion for the year represented 7% annual growth rate of beginning period assets. Fourth quarter net new assets were $47 billion. For the full year, net new asset growth was driven by the advisor led channel across existing clients, new clients and net recruiting. Transactional revenues in the fourth quarter were $1.1 billion. Excluding the impact of DCP, transactional revenues increased slightly year-over-year as clients invested in structured products and fixed income products. Bank lending balances of $147 billion remain roughly flat, consistent with the environment. Total deposits increased 2% quarter over quarter to $346 billion, driven by continued demand for our savings offering from our wealth management channel and a modest increase in sweep balances.

Net interest income was $1.9 billion in the quarter. The sequential decrease was primarily driven by the mix of average deposits and the blended deposit cost in the quarter. Looking ahead to the first quarter of 2024, the deposit mix will continue to be the primary driver of net interest income. The modest sequential build and sweeps was promising and suggests we are nearing a level of frictional sweeps and client accounts. Assuming that the forward curve holds and that our assumptions around client behavior materialize, we would expect NII in the first quarter to be roughly in line with the fourth quarter. Our asset led gathering strategy remains unchanged, and we expect it to deliver margin expansion over time. The path is clear and includes the following objectives — First, increase relationships through our channels.

Second — migrate assets to advice. Third — deepen existing client relationships with enhanced capabilities including new products and solutions, and finally, realize scale benefits of our investments over time. These efforts are well underway. In the year, we grew client relationships by over 600,000 across the franchise. This was led by success in the workplace channel, as we continue to win corporate plans and add participants in stock plan. In the prior three years, we saw an average of $50 billion of workplace assets migrate to the investor led — the advisor led channel on an annual basis. This year, client migration was up 25% year-over-year despite economic headwinds, and on the product side, our financial advisors are offering clients investment opportunities such as private credit, private equity, and all their other alternatives.

Bringing wealth and investment management closer together will create greater opportunities for ongoing product creation. As we move forward and transition from integration to optimization for client experience, we expect to see greater scale benefits from our investments over time. Investment management reported full year results of $5.4 billion and fourth quarter revenues of $1.5 billion. AUM increased year-over-year to $1.5 trillion, supported by higher asset values. Long-term net inflows of approximately $7 billion — excuse me, long term net outflows of approximately $7 billion were driven by headwinds in our [MSIM] active equity growth strategies. Within alternatives and solutions, we continue to see demand for parametric customized portfolios across both equity and fixed income strategies as more retail clients seek customized solutions.

Liquidity overlay services had outflows of $6.6 billion. Weaker institutional liquidity flows were partially offset by demand for parametric’s overlay product and the combined parametric brand, inclusive of overlay and its retail offering had net inflows of over $5 billion again this quarter, underscoring the strength of our differentiated customized offering. Fourth quarter asset management and related fees of $1.4 billion increased slightly versus last year. Quarterly performance based income and other revenues were $61 million. Gains in U.S. private equity and infrastructure offset losses in real estate, reflecting the benefits of diversification in the franchise. Turning to the balance sheet, total spot assets were $1.2 trillion. Standardized RWAs increased by $13 billion sequentially to $457 billion, as we actively supported clients.

We prudently managed our capital profile and ended the year with a standardized CET1 ratio of 15.2%, while focusing on our strategic priorities, including our commitment to return capital to our shareholders. Utilizing the flexibility of our repurchase authorization, we were opportunistic at the start of the 4th-quarter, and we bought back $1.3 billion of common stock. The full year tax rate was 21.9%, reflecting the realization of certain tax benefits earlier in the year. The fourth quarter’s tax rate was 26.5%, primarily reflecting the tax implications of a specific legal matter. We expect the 2024 tax rate to be approximately 23%, consistent with prior years, we continue to expect some quarterly volatility. A number of idiosyncratic and macro headwinds added complexity to the backdrop over the last year.

Notwithstanding these challenges, we ended the year better than where we started. We now have $6.6 trillion of client assets, and we successfully completed our E*TRADE integration. As it relates to capital markets, boardroom confidence is rising and our calendar is building. We approach 2024 with optimism, keenly aware of the dynamic environment we operate in, as we continue to drive towards our performance goals. With that, we will now open the line up to questions.

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Q&A Session

Operator: [Operator Instructions] We’ll take our first question from Dan Fannon with Jefferies. Your line is now open. Please go ahead. It looks like we lost Dan, we’ll move to Glenn Schorr with Evercore.

Glenn Schorr: Hi, thanks very much. I love how you laid out the picture on the wealth management margin potential. And I do like that sweeps have settled in. So I’m curious, in the big picture, has FA and client behavior changed a bunch on the cash management front such that, that’s a potential driver of margin potential and why you’re leaning towards that mid-20s near term versus the 30% where we were kind of hanging out when rates were lower end deposits were higher. Is that the primary driver of the margin thought? And do you think behaviors changed like permanently?

Sharon Yeshaya: I can’t speak about behavior permanently. But I appreciate the question, Glenn. If we take a step back, it was always an idea, the premise of a sustainable growth in margin was really about ensuring that we continue to see growth in fee-based assets, and we see growth in that migration towards the advice-based channel. And in fact, that is what you’ve begun to see — look at our fee-based flows this quarter alone and think about the fee-based flows that we’ve had over the course of the year. We continue to educate our clients. So when we think through the funnel, we have more participants, we begin to see more assets and then those assets will, over time, migrate to advice. What you point out as we think about the cash and what some might call cash sorting, et cetera, is that we still have that 22%, 23% sitting in cash equivalents, so not necessarily BDP, but rather cash equivalents, that don’t necessarily earn a fee, right?

Money markets think of a savings product over time, et cetera, that you might see as individuals begin to take that money and deploy it in the markets or deployed into fee-based that will be accretive to the margin over time. And that, to your point, is a place where you should begin to see a margin build and something that becomes more sustainable as we both grow our asset base and grow the advice and the client migration towards advice in those fee-based assets.

Glenn Schorr: Makes sense. I appreciate that. Maybe just a follow-up in wealth, if I could. It certainly doesn’t show in your flows this quarter. So I guess I know where you’re going to go with this, but you’re definitely hearing a lot more from the bank-owned wealth management companies that are turning up the heat a little bit on recruiting and a lot more on their intent to better penetrate their banking while clients wallet. So I’m curious if you feel any of that in your franchise, any of that where you compete and whether or not that impacts your thought process on your ability to attract some of the trillions of dollars held away that is always part of the growth story.

Sharon Yeshaya: So the first point I would say is it’s obviously always a competitive market, but we’re very well positioned given the tools that we’ve given to our advisers. A couple of points that I would make to you. The first is when we look forward into the first quarter, that recruiting pipeline is healthy. So when we think about January and what we’re seeing, we see the recruiting being healthy. The second point that I’d mention is what I find to be most encouraging when you look under the M&A data, is that we’re seeing new clients from the Morgan Stanley. So it’s not just attracting assets all the way but rather you’re actually getting new clients from those participants. And then you’re seeing conversion. So when you think about some of the statistics that I gave you around workplace and we’ve talked about these statistics, the workplace assets that move over you have 80% of those assets are actually assets that are coming from outside the institution.

So you’re bringing new clients in, and then they’re bringing their assets that are sitting away into the institution. So I think we’re well positioned to capture those opportunities. Final point that I’d make is on your banking products, actually, this idea of the E*TRADE integration, right? And we talked about, we’ve completed the integration, and I said we’re looking towards the forward of the front office integration, some of that will be around banking products, et cetera, as we think and we look ahead over a multiyear journey.

Operator: We’ll take our next question from Dan Fannon with Jefferies. Your line is now open. Please go ahead.

Dan Fannon: Thanks. Good morning. Congrats on the new role, Ted. I was hoping you could elaborate on the current environment and a little bit more and maybe what you see as the biggest opportunities for growth as you look to make progress against the longer-term targets that you’ve outlined?

Ted Pick: Thanks for your question. I think we — as you heard from my comments, we’re generally constructive about what 2024 brings and it should be beneficial to both arms of the firm. Some of the reorientation of cash equivalents, whether they be in money markets or treasuries and the like that Sharon referred to and redeploy by our wealth clients into the markets, given increasing sense of stability, clearly good for FAs and for the wealth channel. In the investment bank, we’ve had a decade’s long route in IPOs slowest volume we’ve seen in decades. As you know, we’ve had very light M&A calendar. So that also has been at a trough sort of early cycle type activity from our highest margin products inside of the investment bank, specifically inside of investment banking, we think, in order to our benefit to.