Morgan Stanley (MS) — Q2 2024 Earnings Call Transcript

Good morning and thank you for joining us. The firm generated $15 billion in revenue, $1.82 in EPS, and a 17.5% return on tangible capital in the second quarter. Solid earnings and demonstration of operating leverage complete a strong first half of 2024 with $30 billion in revenue, $6 billion in earnings, and an 18.6% return on capital. In institutional securities, we're beginning to see the benefits from our continued focus on our world-class investment banking franchise, with revenues up 50% year-over-year, including a 70% increase year-over-year in fixed income underwriting. In institutional equities, we are back with a $3 billion quarter. In wealth management, we posted margins of 27%, and across wealth and investment management, we've now grown total client assets to $7.2 trillion on our road to over $10 trillion. Together, we delivered strong operating leverage. Further, following the annual stress test results, we announced that we will increase the dividend by $0.075 for the third year in a row to $0.925, reflecting the growth of our durable earnings over time. During the quarter, we built $1.5 billion of capital, and at quarter end, our CET1 ratio is 15.2%, 170 basis points above the forward requirement. Our capital position provides us the flexibility to continue to support dividend growth, support our clients, and buy back stock opportunistically. The quarter also showed continued balance in both top-line and profitability across the major segments. Wealth and institutional securities produced $6.8 billion and $7 billion in revenue respectively, with earnings also roughly split between our institutional businesses and wealth and investment management. Our businesses are working closely together to maximize adjacent opportunities across the integrated firm. Across the investment bank, navigating changes in the cycle means being deliberate around risk management and, given geopolitical uncertainty, where we spend our time to deliver client solutions and capture share. In wealth management, we continue to focus on aggregating assets and delivering strong advice. In investment management, we are investing in secular growth areas, including customization and real assets. Year-to-date, annualized growth in net new assets in wealth management is over 5%, with another strong quarter of over $25 billion in fee-based flows. Strong fee-based flows support daily revenue, which on average continues to be about $100 million each day this year and show the stability and continued growth of the wealth franchise. We are well navigating the uncertainty around forward rate paths, geopolitics, and now the US political cycle and expect those to be the themes for the balance of the year. We remain focused on our best-in-class talent and building out best-in-class infrastructure to support ongoing growth across wealth and investment management and institutional securities. I wanted to reiterate our strategy, which is clear: to advise individuals and institutions around the world in raising, managing, and allocating capital. World-class execution demands that we deliver strong earnings and returns through the cycle, that we do so while maintaining robust capital levels, and that we deliver on a durable growth narrative across the segments. That's it in a nutshell. And finally, in reflecting on this weekend's assassination attempt, we share in the hope that in the months to come, we will as Americans, find ways to unify and preserve our better selves. With that, Sharon will now take us through the quarter in greater detail. Thank you.

Thank you and good morning. In the second quarter, the firm produced revenues of $15 billion. Our EPS was $1.82 and our ROTCE was 17.5%. Results highlight the power and scale of our integrated firm. The resilience of the US economy and a more stable near-term outlook on rates supported conviction among clients. Institutional securities drove performance, led by strength in equity and a pickup in investment banking. Wealth management also delivered on our established strategy, reporting record durable asset management fees and strong fee-based flows. Together, improved confidence and higher client engagement along with our focus on prioritizing investments yielded operating leverage and profitability. The firm's year-to-date efficiency ratio was 72%, benefiting from scale and reductions in our expense base. Year-to-date expenses benefited from lower litigation expenses, the absence of back office integration related costs and severance, as well as our dedicated effort to prioritize our current spend. On prioritization, we remain committed to client and asset growth, technology, and targeted investments to ensure robust infrastructure that supports growth and addresses ongoing regulatory expectations. Now to the businesses. Institutional securities revenues of $7 billion increased 23% versus last year, capturing the strengths of the integrated investment bank across US and international markets. Higher activity in Asia contributed to results. Strong performance in institutional equity, as well as debt underwriting, demonstrate the breadth of our client franchise. In our markets business, opportunities unfolded on the back of global political events and macroeconomic data. Investment banking revenues were $1.6 billion. The 51% increase from the prior year was broad-based. We continue to invest in investment banking across talent and lending, broadening and deepening our global coverage footprint in key sectors, including financials, healthcare, technology, and industrials. These investments are beginning to have an impact as capital markets improve and activity picks up. Advisory revenues were $592 million, reflecting an increase in our completed M&A activity versus the prior year. The pre-announced M&A backlog continues to build and suggests diversification across sectors. Equity underwriting revenues of $352 million improved versus the prior year, driven by increases across most products, but remain below historical averages. From a geographical perspective, we brought a number of transactions to market in Europe and Asia, demonstrating the importance of having a strong global market footprint. Fixed income underwriting revenues were $675 million, well above five-year historical averages. Results reflect a meaningful pickup in non-investment grade loan and bond issuance, as tighter spreads and strong CLO issuance provided opportunities for refinancing. The investment banking backdrop continues to improve, led by the US, and the advisory and underwriting pipelines are healthy across regions and sectors. Inflation data has continued to moderate, which has helped stabilize front-end rates and support boardroom confidence and sponsor reengagement. As buyers and sellers make progress to close the valuation gap, we expect that we are still in the early innings of an investment banking rebound. Subject to changes in rate path expectations and geopolitical developments, our integrated investment bank is well-positioned to service our clients. Turning to equity, we continue to be a global leader in this business. Equity revenues of over $3 billion, up 18% compared to last year, reflect strong results across business and regions. Higher client engagement, dynamic risk management, and strength in Asia all contributed to performance. Prime brokerage revenues were strong and increased from the prior year as client balances reached new peaks. Regionally, we witnessed higher client activity in Asia and seasonal patterns in Europe. Cash results increased versus last year, reflecting higher volumes across regions. Derivative results were up versus last year's second quarter as client activity was higher and the business navigated the market environment well. Further, the business benefited from corporate activity on the back of convertible issuances, additional evidence of the integrated firm at work. Fixed income revenues of $2 billion increased year-over-year. Macro performance was up versus the prior year. Despite lower realized volatility, clients were engaged around elections and political events in the quarter. Micro results improved year-over-year, driven by the growth of our more durable revenues as we continue to support our clients with financing solutions. Solid results in commodities were in line with the prior year. Turning to ISG lending and provisions. In the quarter, ISG provisions were $54 million, driven by certain individual commercial real estate loans. Net charge-offs were $48 million, primarily related to two commercial real estate loans for which we had previously already taken provisions. Turning to Wealth Management. Wealth Management generated strong results generating revenues of $6.8 billion with record asset management fees. Our PBT margin continued to make progress towards our goal, demonstrating our ability to grow and generate operating leverage through the cycle. We are delivering on our differentiated, scaled multichannel asset-gathering strategy. Wealth Management client assets reached $5.7 trillion. Moving to our business metrics in the second quarter. Pretax profit was $1.8 billion up year-over-year with a reported margin of 26.8%. DCP negatively impacted our margin by approximately 100 basis points. The margin demonstrates the inherent operating leverage of our asset-gathering strategy. We are improving the efficiency with which we run the business. Asset management revenues of $4 billion were up 16%. That is more than $500 million in fees versus the prior year. It's driven by higher average asset levels and the impact of cumulative positive fee-based flows. In the quarter, fee-based flows of $26 billion were strong, marking the seventh consecutive quarter of over $20 billion, bringing the year-to-date fee-based flows to $52 billion. We are seeing a steady migration of assets from adviser-led brokerage accounts to fee-based accounts, evidence that investments in our client acquisition funnel are paying off. Fee-based assets now stand at $2 trillion. Net new assets were $36 billion reflecting headwinds from seasonal tax payments. Year-to-date, net new assets are $131 billion representing 5% annualized growth of beginning period assets. Net flows will be lumpy in any given period of time and impacted by both the macroeconomic environment and business-specific factors. We believe both tax-related outflows and increased spending, particularly among high net worth clients, impacted flows this quarter. Still our first half net new asset growth remains solid. Transactional revenues were $782 million. Excluding the impact of DCP revenues were up 5% versus last year. The increase was primarily driven by higher equity-related transactions. Bank lending balances grew by $4 billion to $151 billion evidence that as the macroeconomic backdrop stabilizes, our lending capabilities can meet our diversified client needs. Total deposits of $343 billion remain stable, with sweep deposits down approximately $10 billion sequentially mostly offset by growth in CDs. Net interest income was down modestly to $1.8 billion reflecting the decline in sweeps, which was largely attributable to the seasonality of tax payments. The Wealth Management business continued to perform well, aggregating assets, generating fees and benefiting from scale and our differentiated offering, consistently earning approximately $100 million a day. In the third quarter, we intend to make changes to our advisory sweep rates against the backdrop of changing competitive dynamics. The impact of these intended changes will be largely offset with the expected gains from the repricing of our investment portfolio. Therefore, third quarter NII will be primarily driven by the path of sweeps, and NII could decline modestly in the third quarter. Importantly inclusive of these pricing changes, the rate path and our expectations around client behavior, we believe that NII should inflect higher as you look out into next year. Our Wealth Management strategy is predicated on gathering assets, meeting our clients' lending needs and offering advice. Asset management fees, the core of our Wealth Management strategy, continues to produce strong results reaching a record this quarter. Taken together, we delivered a strong margin, and we continue to work towards 30% margins over time. This quarter, we reached approximately 19 million relationships across our three channels, and we continue to invest in order to deepen engagement. AI tools are helping advisers grow, and Wealth Management's partnership with institutional securities is increasing connectivity around our workplace offering. These investments have supported flows to our adviser-led channel, where average client duration is nearly 15 years and growing. The steady progress supports our journey towards over $10 trillion in total client assets. Turning to Investment Management. Revenues of $1.4 billion increased 8% from the prior second quarter, supported by higher asset management revenue. Asset management and related fees were $1.3 billion up 6% year-over-year, reflecting higher average AUM. Total AUM ended the quarter at $1.5 trillion. Performance-based income and other revenues were $44 million as gains were driven primarily by our infrastructure, US private credit and US private equity funds, reflecting our investments in secular growth areas. We recorded long-term net outflows of approximately $1 billion. We continue to see strong momentum across areas of strategic focus, namely Parametric. Consistent with current industry trends, we saw outflows in our active equity strategies. Our business is well-positioned given strength in areas of secular growth, such as customization, direct indexing and private alternatives. Our continued focus on global distribution combined with our deep structuring and product creation capabilities should support incremental growth. Turning to the balance sheet. Total spot assets decreased $16 billion from the prior quarter to $1.2 trillion. Our standardized CET1 ratio was 15.2%. Client activity was strong and markets were open. We actively supported clients with a focus on velocity of resources. We also grew our CET1 capital by $1.5 billion, reflecting strong earnings and continued capital distribution. The most recent stress test results reaffirm our durable business model and strong capital position. For the third year in a row, we announced a quarterly dividend increase of $0.075. Having generated over $3.85 of earnings per share and an 18.6% ROTCE year-to-date, we enter the back half of the year from a position of strength, with a robust capital base to support clients. Investment Banking pipelines are healthy and diverse, dialogues are active and markets are open. In Wealth Management, strong fee-based flows and the realization of operating leverage continue to demonstrate that our strategy is working. As capital markets become more active, we see opportunities for retail clients to engage and over time deploy their cash and cash equivalent balances into fee-based products.

Hi, there. Thank you.

Good morning, Glenn.

Good morning. Sharon, I appreciate your insightful comments on NII and Wealth. I would like to delve deeper into your previous statements. If you have $2 trillion in client assets under advisory and they maintain a small percentage in cash, the adjustments you are implementing regarding the interest rates on advisory account deposits could result in significant financial gains. Could you clarify what you mentioned about the NII for 2025? Also, what did you specify as the offset concerning the NII? Thank you.

Sure. Thanks, Glenn, for the question. The portion of the sweep balances that are affected are, as you mentioned, the sweep on the adviser-led channel, which is actually a small part of the overall BDP that we disclose. So it’s a small part of that overall stack. The increase in pricing is largely being offset by the repricing of the investment portfolio. As things mature and that investment portfolio reprices, it’s that change in the quarterly amount that will offset it when we look ahead.

Is there a particular reason why you only need to focus on repricing in this smaller portion compared to the adviser-led channel?

Certainly. Yes, what I would note there is that when we think about sweeps, broadly is mainly in transactional accounts. And in those transactional accounts, we have a wide range of choices and products for our clients. And so therefore, they have a lot of options as they think about their transactional accounts and brokerage.

Hi, good morning.

Good morning Ebrahim.

Good morning, Ted. Sticking with net interest income and more importantly, pretax margin, you had an extremely strong quarter. The stock is weaker this morning, which is related to the net interest income impact on wealth revenues and margin. So Sharon, based on your visibility into net interest income, with many factors affecting client behavior, and potential interest rate cuts, can you give us an idea of what history suggests about client behavior in response to rate cuts? Or is there cash to assets data that reassures you about the possibility of net interest income stabilizing after the third quarter? Please go ahead.

Yes. So why don't I take that, and then you can ask your second question. So you are pointing at a great point Ebrahim, as we look ahead through time, which was the second point of my guidance, is that when we look over the next year, we’re seeing and we expect that we should see an inflection in NII. And that is predicated on the points that you mentioned, which is that as you see rate cuts, we would expect those balances to stabilize. Remember, outside of the tax quarter this particular quarter, we had been seeing a stabilization in those sweep deposits. So it's important to recognize that, that has been happening, reaching that frictional level of transactional cash. So that would likely continue. And then over time, you would also begin to see a benefit as rates to be cut, that BDP could actually see inflows, which you've seen from a historical perspective. But in addition to that, you have two other factors. One is the repricing of the portfolio, which I've also already mentioned. And the second piece has to do with lending. We look to continue to support our clients with lending products, and you are beginning to also see that potentially reach an inflection. This is the first quarter that we've seen this type of lending growth since the interest rate hikes began. We've seen now use of SBL products rather than just it being offset by paydowns. So those are all encouraging signs when we look ahead over the course of the next year for NII.

That’s helpful. And I guess my second question was just talking to investors, when we look at the 30% pretax margin target, the question is whether this is aspirational, whether the bar is set too high given how competitive the business is. So remind us in terms of your comfort level on the 30% pretax margin to the extent you can, the timeline of when we get there? And when we get there, should that be a sustainable pace for the business? Thanks.

Thanks, Ebrahim. I have a high level of confidence. If you take a step back, there are three components to the Wealth Management line: asset management, transactional, and net interest income. In terms of asset management, these are fees associated with fee-based accounts and advisory services. Those figures increased by 4% sequentially and 16% year-over-year. Last quarter, we saw net new assets of $26 billion in that category, which continues to be a growing part of Wealth Management. The second component is transactional, which has been relatively weak due to overall capital market activity. However, our positive outlook on corporate finance in the investment bank will positively impact transactional results over time. The third component is net interest income, which is expected to improve over the next year. When you combine these elements—the scale of our business, the revenue funnel, and our increasing processing of $100 million in revenues daily—we are on track to achieve operating leverage. It's straightforward. We are investing in E*TRADE and in traditional advisory services, while also focusing on workplace opportunities, which we believe are significant across our corporate and sponsor base. In January, I mentioned that achieving a 30% goal was our aim while we were in the mid-20s range; we just reported 27% GAAP and 28% excluding CPE. This is a core objective for us. It will take some time to reach, but we are committed to achieving it as we continue to grow our assets and scale the business.

Hi, Ted, you've said this and Sharon repeated this that the industry is only in the early innings of an investment banking rebound. I have to say we've heard that for a couple of years and there now is this time, why is this time real? Do you expect the rebound to continue through the normally slow summer period before the election? How many years? What gives you confidence that this is for real? And how much is your backlog up quarter-over-quarter?

It's an excellent question because you're exactly right that a number of folks have been calling for this and it has been sort of a delayed shoots, if you will. But I think now we are seeing some tempering of the inflation prints and some normalization of rates. We are also beginning along with that to see the market broaden out. You of course have seen that over the last number of weeks. And I think, we can now expect broader corporate finance activity to quicken, whether that is across the corporate community or sponsors or other institutions. The early sign of this kind of activity can be seen in the convertibles product. Global convertibles activity is up significantly. And as you know, on the margin ladder, it typically goes converts, IPO, and then M&A. In the context of bake-offs and the like, in some spaces we are seeing bake-offs running at triple plus the year-over-year rate for sectors and for some of our client groups. We've been seeing now the launch of traditional IPOs and we are seeing the M&A pipeline kicking in. So the corporate community, sponsor community, cross-border community, I think we are in the early stages of a multi-year investment banking-led cycle. If you believe the economy is going to hold up led by the US, you should expect then to see that if there is some regulatory normalization too across a whole bunch of the sectors that are typically most active. So we are quite convicted on this call.

And just one pushback, I mean with interest rates, you know, so much higher than they've been in the past. Don't you think that could get in the way when people are looking to borrow money for deals and the like? Is this a matter of simply waiting for rates to go lower? Or that's not going to get in the way?

I mean it's a fair question. You've written about this in the context of what was the normal before financial repression, right? And I would take the view that in the context of the last 15 years, even some normalization, because I don't know that we are going to go into a full-blown rate cycle to your point, some normalization of rates will still have you at 3% or 4% on the front end and even some steepening potentially. So now we are just back to the old weighted average cost of capital of mid-90s in most normal economic periods. And the game will have to go on because there has just been some activity that has been suppressed by any kind of measure percentage of asset stock percentage of market cap. And the stickiness that we are seeing in the sponsor community, too needs to unglue. There is an enormous, as you know, multitrillion-dollar stockpile between the two sides of sitting on inventory that needs to be released and then dry powder that's been raised. That will act as a competitive weapon against the competitive bid from the corporate community that has to contend with the reality of a smaller world with real sovereign risk and real cost of capital differences from one jurisdiction to another. So in short, unless you were to tell me we are going to go into a full-blown recession, which none of us can call, and that even if we saw rates normalize to something that is along the lines of the historic 4% on the front end, I think you will see over the next number of quarters and really over the next number of years, a resumption of more normalized M&A activity, with the key difference being that the financial sponsor community has now institutionally come of age. They have global reach. They can work the entire capital structure. They will work in concert with corporate partners, as you know. They don't actually have to act as lone wolves, and they can work with us to finance the package. So it is not just the straight M&A advise or the straight IPO, it would also be bespoke offerings in the private public space, interest rate and foreign exchange hedging and the other ornaments on the investment banking tree that a couple of the leading global investment banks can bring. And this is really why, over the last couple of years, the extent we've done a so-called front-office hiring, it really has been to target several very high-quality investment bankers who typically have spent their entire careers at one firm and have decided to come to the Morgan Stanley platform. And we are seeing the fruits of that across industries. So I am quite bullish on it. Certainly take your point that it has been a number of quarters on sort of on the promise. But I think as we get into 2025 and the election coming and then the election behind us, we should see that activity continue at a sustainable pace.

Thanks good morning. I was hoping to get a little bit more color on the flows in the quarter within Wealth, maybe the breakdown from the channels and contribution. Last quarter, I think we saw a Family Office be an outsized contributor. But hoping to get a little bit more color on where the flows were sourced in Q2.

Certainly. We continue to observe a broad range of sourcing for these assets. In this particular quarter, the main challenge has been from taxes. We still see contributions from workplace accounts, advice-based accounts, and self-directed accounts. What I find particularly interesting is that in the advice-based channel, contributions are coming not only from existing clients but also from new clients, some of whom are sourced from workplace relationships. It's important to consider not just the source of the contributions but how these channels interact with each other, as this reflects the strength of our differentiated platform. When a client seeking more specialized advice for self-directed accounts consults with an advisor, that advisor can attract new clients and bring in more assets, contributing to our acquisition funnel and ultimately to fee-based services. Therefore, it's essential to focus on the entire ecosystem rather than just one individual channel.

Workplace plays a crucial role because it allows me to achieve success within the corporate and sponsor community, which influences the wealth at those institutions and potentially leads to other products. This can create an indirect sale where we're not directly approaching the prospective client through the financial advisor, but instead engaging potential clients through the established effect of the workplace. We excel in educating about financial wellness and effectively position ourselves by managing incentive compensation through the Morgan Stanley Solium product. By successfully fulfilling an MS at work mandate, which is a long-lasting and valuable asset visible to the entire employee base, we can begin to connect with senior executives.

Good morning Ted. Thanks for taking my question. I'd like to just drill down a little more to give the second follow-up here on the repricing change that you mentioned in your prepared comments, Sharon. So the repricing that we've seen in the securities book has been slow. So I'm just kind of curious as to why you think that will help offset the repricing actions that you are taking on the deposit side. Is that because it will be a phased repricing, and therefore there is an ability to have the phased benefit in the asset side offset? And then just a nitty-gritty question on it, is the switch going to be to money fund sweep rather than higher yielding deposits, and then that way you can just slowly replace that funding as you see fit?

So thanks, Brennan, I'll take that question. No, all the changes that we'll make are expected to happen in the third quarter. And so those different changes will be made, and they'll be based on various competitive dynamics.

Okay. Got it. Is this going to focus on the advisory relationship like we've seen from other wirehouse competitors? Are the changes announced by Wells and Bank of America what you mean by competitive dynamics, or is there something else I'm not aware of?

That's exactly as I stated it, and it will just be limited as you said, to the sweeps that are dealt within the advisor-led channel.

Great. Good morning Sharon and hi. The first question, just on another one on the GWM flows. Sharon, you mentioned tax season is a factor, which you completely get. But then you also mentioned increased client spending. And I just wanted to drill into that, just whether that's something that could continue, whether it was seasonal or influenced by inflation? Just trying to understand that component of the impact on flows.

Yes, that's an interesting question. We've observed that higher net worth individuals are increasing their spending. This is evident in the data through various purchases such as homes and tailored investments. This group is utilizing their cash and investments in diverse ways, which is an intriguing trend. Others have also noted similar observations in their portfolios, and it's something we are clearly seeing in our data.