Highlights from Morgan Stanley's (MS) Q409 Conference Call; Misses on Top and Bottom Line

Morgan Stanley (NYSE: MS) reports Q409 EPS of $0.29, 7 cents worse than the analyst estimate of $0.36. Revenue for the quarter was $6.8 billion, which compares to the estimate of $7.81 billion. Shares are down 1.64% today.

Highlights From MS's Q409 Conference Call:

• James Gorman - President and CEO:
  • We raised $6.9 billion in common equity and sold remaining interest in MSCI enhancing our capital structure. We issued total of 13 billion dollars in ongoing senior unsecured debt, including fourth quarter 1.5 billion euro raise, our first non-U.S. dollar unguaranteed issuance of 2009.
    
    
  • We closed the Morgan Stanley Smith Barney joint venture earlier than expected, creating the industry leader with more than 18,000 financial advisors and 1.5 trillion dollars in client assets.
• Colm Kelleher - EVP, CFO, and Co-Head of Strategic Planning, and Ruth Porat - Joining as CFO:
  • Negative revenue of approximately 600 million from narrowing of the firm debt related credit spread lowered earnings per share by 27 cents. Firm wide revenue 6.8 billion non-interest expenses 6.2 billion for the quarter.
    
    
  • We exceeded our annual cost savings target of $800 million by over 30%. Excluding expenses related to Smith Barney, option rate security and goodwill impairment from both years recurring savings totaled over $1.1 billion. The effective tax rate for the quarter was benefit of 11% reflective of the geographic mix of earnings, domestic tax credit and utilization of state net operating losses.
    
    
  • We continue to keep significant portion of our balance sheet in cash and equivalents. Our capital ratio demonstrate strength of our balance sheet. While we are still finalizing our calculations we believe on the Basel 1 tier 1 ratio 15.4% and tier 1 common ratio will be 8 at any time 2%. Risk weighted assets expected to be approximately 301 billion at December 31. Level 3 assets were in the mid-$40 billion range at December 31, representing approximately 6% of total assets.
    
    
  • Revenues 3.2 billion included approximately $600 million negative impact from tightening credit spreads as discussed earlier. Noninterest expense were $2.8 billion in fourth quarter of 2009, down 25% from the third quarter on lower compensation. Excluding the negative impact of the improvement in Morgan Stanley's debt related credit spread the compensation ratio in this business was 39% for the quarter and 40% for the year. This business reported pre-tax profit of $464 million.
    
    
  • In the quarter we led Comcast 14.4 billion joint venture with General Electric and for the year we advised eight of the top 10 announced transactions, more than any other firm.
    
    
  • Fourth quarter investment banking revenue 1.5 billion up 42% sequentially.
    
    
  • Advisory revenue increased 90% up across all regions of completed M&A activity. Equity underwriting revenue in fourth quarter of 2009 were $627 million, highest disclosed quarterly revenue.
    
    
  • ...underwriting revenue increased 7% from first quarter and higher indication fees and high yield activity.
    
    
  • Equity sales and trading revenue $722 negatively impacted by 221 million from the narrowing of debt related credit spread on firm issued structured loans.
    
    
  • Fixed income and other sales and trading revenues of $963 million included losses of 380 million from the narrowing of credit spreads on firm issued structured notes.
    
    
  • Revenues were lower across all products due to Senate, lack of market volatility and tighter spreads.
    
    
  • Total average trading and nontrading VAR increased 187 million from $168 million primarily reflecting modest increase in fixed income and equity trading. However, methodologies must be examined when comparing VAR measures across the industry as they are not standardized. Morgan Stanley uses full-year market data series, therefore our VAR has tendency to maintain higher volatility assumptions with modestly increasing trend on the current market conditions.
    
    
  • This quarter marked second full year of consolidated Morgan Stanley Smith Barney results. Revenues were up 4% sequentially to 3.1 billion in higher fee-based revenues and were in line with the overall retail environment. Noninterest expenses were 2.9 billion and included 146 million of integration costs. Full year Morgan Stanley Smith Barney integration costs were $218 million. For 2010 we expect integration cost of approximately $450 million, mostly relating to rationalization of real estate and IT. Full year closing cost related to joint venture 221 million and mostly related to FA replacement of awards. The business reported pre-tax profit of $231 million, on pre-tax margin of 7%.
    
    
  • Total client assets increased 2% to 1.6 trillion on higher market levels. The number of FAs remain relatively unchanged 18,135.
    
    
  • Total firm wide deposit at quarter end 62 billion dollars. Deposits in our bank deposit program increased to $112 billion of which 54 billion is held by Morgan Stanley banks.
    
    
  • Merchant banking revenue of 153 million up from the third quarter of 2009 driven by gains in principle investments. Asset management noninterest expense 565 million decline slightly from third quarter of 2009 on lower compensation expenses.
    
    
  • Real estate gross asset exposure reflected on the statement of financial condition was 2.2 billion at the end of the quarter, down from 4.4 billion at the end of September. Including 1.5 billion of contractual commitment and other arrangement with respect to real estate investment total exposure 3.7 billion, down from 6 billion at the end of September. This exposure excludes assets and investment for the benefit of certain deferred employee compensation of co-investment plans.
    
    
  • [Outlook]Global economic conditions are improving in the financial markets are healing. The global economy likely trust in 2009 and is recovering. We expect short-term rates to remain low for the time being and expect tightening of monetary conditions thereafter.
    
    
  • Global equity markets reasonably healthy and open across industries and geographies. Public credit markets are functioning normally and bank lending remains slow. Global M&A activities improving as funding becomes available and corporate confidence recovers. IPO activity returned to a more normalized level and momentum on completed offerings and filed backlogs are encouraging for 2010. We do believe real estate markets continue to be challenged and rising foreclosures may threaten prices on the availability of credit. We expect the industry cyclical and structural changes to continue for sometime. This industry is on the path of regulation and expect higher liquidity requirement. We are well positioned for this, although concerned about the apparent lack of international coordination. Industry consolidation, better pricing of risk and stronger growth in emerging markets present opportunities to gain market share and maintain spreads globally.
• Q&A Session
  • (Q)First a question on the trading side of the business. You act as CBA, you had other benefits last quarter from spreads tightening within the derivative business. Just curious in the current thick results, were there reversals in this quarter or was it just a weakness across the board on both the client side and lower volatility across products? (A)CBA itself was not much issue at all this quarter. Spreads have normalized, mike. Also, I'm somewhat skeptical about pulling CV a out of the business because I don't believe you can run derivative without it being an integrated part. We disclose it in the Q. The story was one of subdued activity for us this quarter, as you know, spreads didn't do too much during the quarter itself and I think the large footprint you have, the more you will benefit and I think what you saw there was reduced by activity in our case. There was no one story that I can point to other than reduced activity.
    
    
  • (Q)And then just on the comp side, you gave the adjusted numbers on the institutional business. 39% for the quarter, 40% for the year. What you are seeing for the industry, is 40% comp ratio going to be more like the new norm? Obviously it depends on activity levels and competitive environments, but obviously down significantly from the 50% that we're used to in the past. (A)Generally I've said on a number of cases comp generally will come down at the industry. We are an environment where forecasting compensation is difficult for a number of reasons, including market pressure and regulator oversight. We have to pay our people competitively and retain and attract the top talent. The market is still competitive itself, but obviously the structure of compensation is changing and on that measure Morgan Stanley was first to introduce pull back, we strengthened those provisions and gave high degree of deferred compensation to all employees, the operating committee specifically getting high level, 75%, and I think that is a trend you will see continue.
    
    
  • (Q)James we heard about long-term goals for institutional securities and global management, can you share your thoughts on plans for the Asset Management business and maybe long-term time line for getting there? (A)There is a five or six point plan we are working on. The first was to integrate fund to funds business, which we did by merging gray stone and AIB, which we expect to be significantly larger than that, given distribution capability. The second was to sell our retail asset management business to keep equity stake option which we did with the Invesco. We will restructure our Asset Management business which we are doing with outsourcing and state street and hiring portfolio managers and focusing attention on the institutional liquidity space. The fourth is to look at all of the hedge fund stakes we have and that is something Greg Flemming has coming into core Asset Management and will be looking at including stakes across how we manage front point and various stakes in (inaudible) and then finally to work with our merchant banking side in rolling out more funds across private equity we have a mezz fund just raised for looking at the stress fund, potentially commodities and on the real estate size measure of 7 over 5 billion fund waiting term to invest. Obviously we've had traumatic couple of years in terms of initially fund performance and in terms of actual investments in the merchant bank and problems in our portfolio. We believe the vast majority of that is behind us with Crescent being important chapter closed. We are looking forward to Greg's arrival and prosecuting that strategy.
    
    
  • (Q)Given what we know so far about Basel 3, shouldn't we expect that some of that will be allocated back into some of the lines of business, especially institutional? You're small in terms of allocated capital relative to some of your peers and obviously you are rebuilding footprint there. (A)First of all, Guy, one of only a few institution to show economic capital model in all fairness. So given that we do that, I'm not sure we're comparing like for like. But yes, I totally agree the bulk of our capital will be absorbed in the institutional securities business in the light of the BCBS recommendations we saw on December the 17th. And that is why I refer to the capital, there is no doubt that we could not operate a business with $17 billion dedicated to our SG&A unless people thought significant amount of capital behind that and regulatory issues will force that issue.
    
    
  • (Q)First a follow-up for the 250 to 400 employees that you hired. How will you know if you are getting return on investment and whether you have hired too many or if you should is be hiring more, how are you going to measure that? (A)We have a number of measures and metrics and we've done this before. Certainly in the 90s we had hiring plan and were able to measure the effectiveness of those employees through a number of measures. You know whether it is just revenue for employee on accrued measure you look at return on assets and look at velocity of balance sheet and so on. We can work that out and have internal metrics to allow us to do that way.

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