Morgan Stanley Q4 2023 Earnings Call Transcript

Participants

Corporate Executives

• Ted Pick, Chief Executive Officer
• Sharon Yeshaya, Chief Financial Officer

Analysts

• Glenn Schorr, Evercore ISI
• Dan Fannon, Jefferies Financial Group Inc.
• Ebrahim Poonawala, Bank of America Co.
• Steven Chubak, Wolfe Research
• Devin Ryan, JMP Securities
• Christian Bolu, Autonomous Research
• Brennan Hawken, UBS Group AG
• Mike Mayo, Wells Fargo & Company

Presentation

[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, Chief Executive Officer at Morgan Stanley]

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 conflict rate. 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.

[Sharon Yeshaya, Chief Financial Officer at Morgan Stanley]

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 MSUM [Phonetic] 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.

Questions and Answers

[Operator]

We are now ready to take in questions. [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've lost Dan. We'll move to Glenn Schorr with Evercore ISI.

[Glenn Schorr, Analyst at Evercore ISI]

Hi. Thanks very much. So, sure, I love how you laid out the picture on 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 and deposits were higher. Is that the primary driver of the margin thought? And do you think behaviors change like permanently?

[Sharon Yeshaya, Chief Financial Officer at Morgan Stanley]

I can't speak to 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 and 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 shorting, etc., 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, etc., that you might see. As individuals begin to take that money and deploy it into markets or deploy it into fee base, 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 makes sense.

[Glenn Schorr, Analyst at Evercore ISI]

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 clients' wallet. So, I'm curious if you feel any of that in your franchise, any of that and 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, Chief Financial Officer at Morgan Stanley]

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 advisors. 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 NNA data, is that we're seeing new clients come to Morgan Stanley. So, it's not just attracting assets held away, 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, etc., as we think and we look ahead over a multi-year journey.

[Operator]

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

[Dan Fannon, Analyst at Jefferies Financial Group]

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, Chief Executive Officer at Morgan Stanley]

Thanks for your question. I think, as you heard from my comments are 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 or the like, that Sharon referred to and redeployed 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 decades long drought in IPOs, the slowest volume we've seen in decades. And 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 that we think in order our benefit too, so we quite possibly could have a dynamic where if we are in this soft-landing zone, we could see increased activity. Ultimately, we are in the tickets business by activity based in both channels, and benign economic conditions auger well for both wealth and investment, but also for the investment bank.

And part of the reason I wanted to talk about the integrated firm today was because the two segments are working together will bring inevitably additional growth opportunities inside the firm. We have folks that have mobilized around the enterprise and are now in a position to talk to clients across the product spectrum and to bring in additional business.

We have a big business, as you know, in Europe and in Asia. So, if economic conditions are better than the expected, which is that Europe will struggle and China might as well, if we do any better than that, we would expect to see some increased activity coming out of those regions, too. So, it's not just a U.S. proposition but a global one as well.

[Dan Fannon, Analyst at Jefferies Financial Group]

Great. Thank you. And you mentioned margins and within the wealth channel or wealth segment will consolidate around the mid 20s here in the near term. Can you maybe unpack some of the inputs that will drive that outcome?

[Sharon Yeshaya, Chief Financial Officer at Morgan Stanley]

Certainly. I worked through that, I think, Dan, when I actually tried to explain it in the script. So, the premise in terms of a growing wealth management margin, again, is about the conversion to the advice-based model over time. Of course, individuals will have different pieces, right. But we have three different channels that we've talked about. We've talked about self-directed, we've talked about workplace, we've talked about advice. The self-directed side, we will continue to attract those clients, and those that might be interested in advice will see it as we have different ways to give people a sense and a connection to FAs. So, we've talked about that.

On the workplace side, we continue to get new participants, new corporate relationships, and that as we educate people with the wellness offering, etc., and we've seen evidence of this to bring people yet again to that advice driven model. And the fee-based flows, as you see those, will help us grow the asset management line. Then you can break it down again, the transactional line, we've talked about, you're going to have new products and you're going to have a deployment of this cash that's been sitting on the sidelines, that we've talked a lot about, the dry powder that could impact either the transactional line or the asset management line. And again, we're encouraged by the signs that we're seeing in NII. That too suggests that we are seeing, as of right now, it looks like that cash, that frictional level of cash is stabilizing. I think you have the drivers in each of those lines. As we think about the revenue side, and then as you think about the expense side, we are looking for place to invest and gain from the scale of those investments, and that will be as part of the objectives that Ted laid out when you see $10 trillion of assets.

[Operator]

We'll move to our next question from Ebrahim Poonawala with Bank of America. Your line is now open. Please go ahead.

[Ebrahim Poonawala, Analyst at Bank of America]

Hey, good morning and welcome, Ted. Maybe just going back to the strategic update, going to slide 13, where you sort of lay out very nicely the transformation over the last 15 years. As we look forward over the next three to five years, I was wondering if you can help fill in the blanks around strategically M&A has been a key pillar of this transformation. As we think about both organic and inorganic one on the M&A side, give us a sense of just where you see deal making happening over the next few years. We saw a big private asset deal being announced on Friday, so we'd love some perspective there. And then I think the second thing you mentioned in terms of wallet share on the investment banking side, if we can unpack that a little bit in terms of how you expect to achieve a greater wallet share. Thank you.

[Ted Pick, Chief Executive Officer at Morgan Stanley]

Thanks. Good to talk with you. It's an interesting question. You're effectively asking, what will the slide look like three, four years from now? We believe that the revenue mix will toggle around. There could be periods like in 2020 or '21 where the investment bank is really firing in all cylinders, again early economy type of activity, and that could grow again towards 50%, and we could have other periods where as we continue to invest in the wealth and investment management piece of the firm, that could expand further. I think where we are right now is a revenue and profitability matter where 60% of the firm is in wealth and investment management is not a bad place to start.

I think the main message I'd want to convey today is that while there's a change in leadership, after 14 years of James' stewardship, there's not a change in strategy. We have undertaken and integrated, if you really go back into time and then include Mesa West, five different acquisitions, and I think the view inside the house is that's good for now. We can execute our business with the growth plans in front of us and it feels organic. Now that having been said, there are ideas that come across the transom [Phonetic] and we naturally would take a look. But I think for the next period, the view that I would have is that we really work to grow the organization and to do so organically and efficiently.

I think on the margin, one comment might be that we could work on sweating the income statement a bit more. There's a little more work to be done post integration on where there could be inefficiencies along the income statement, and I think we are much focused on looking for those efficiencies without giving up any of the strategic investment that we want to make on our way to 30% PBT margins in wealth and 70% efficiency of the firm.

The way I've articulated the strategic goals is to effectively reiterate we will achieve those goals, but along the way we will invest, and that investment opportunity exists on the current portfolio in an exciting way. And that is why for me, the most important message we wanted to send out to folks today was this concept of the integrated firm. Now we have the portfolio of businesses together. We have a unified partnership culture. We have the two halves of the firm. It'll toggle by 5 points or 10 points on revenue or profitability given a period of time. But now we can scale that organically and hit the numbers and work the income statement a little bit.

[Operator]

We'll move to our next question from Steven Chubak with Wolfe Research. Your line is now open. Hi, good morning.

[Steven Chubak, Analyst at Wolfe Research]

Hi, good morning. I wanted to start off with just a question on incremental margins and comp leverage in a lower rate backdrop. We know NII is going to be a source of drag in the coming quarter, certainly if the forward curve manifests. But fees should see improved momentum from equity market tailwinds, stronger fee base flows, a better IB backdrop. But the street is modeling comp dollars flat, revenues up about $2 billion. I'm just trying to get a sense as to how we should think about incremental margins as revenue momentum improves, but the growth is coming admittedly from more compensable areas.

[Sharon Yeshaya, Chief Financial Officer at Morgan Stanley]

So, you obviously did hit the nail on the head in terms of the different pieces, right? So, you can't look at the different line items the same way. You're going to have a comp ratio change as FAs get compensated as you would expect on the grid associated with those fee-based revenues. As it relates to NII, yes, that was non compensable, as I just told you, the expectation on a quarter over quarter basis, if client behavior remains unchanged, you are sitting in a position where you're beginning to better understand what that behavior is, and that NII will be roughly in line with where it was in the fourth quarter, at least for the first quarter.

So yes, the comp itself might change, but the actual growth in the ability to see the fee-based assets grow is higher. There are also other offsetting factors that we have to think about as we look back into the last year. Remember that what I highlighted was you had negative implications associated with mix of revenue in those asset management lines because of the fact that we saw investors invest in safe fixed income products. You had market dynamics associated with billing, etc., so there are rather places that you can see growth in the asset management line. Yes, they will be compensable, but we would see benefits of scale both from the asset side and hopefully from the market side as you see different pieces being invested as you move forward. I hope that helps to frame the answer to your question.

[Steven Chubak, Analyst at Wolfe Research]

Yeah, that's really helpful. And just for my follow up, I was hoping you could just speak to the sensitivity to lower rates. It's a big area of focus for investors. You benefit from having the majority of your deposits in premium savings, where admittedly you have bigger pricing flexibility. At the same time, the asset side is still very sensitive to the short end. So, I want to get a sense as to how you expect NII trajectory to unfold as the Fed begins easing and whether there's any appetite on your side to extend duration to maybe lock in some higher yields.

[Sharon Yeshaya, Chief Financial Officer at Morgan Stanley]

That's a great question. And the answer is fully premised on what we see first with deposits, right. So, your sort of first order condition as you look ahead into 2024 is what happens to the deposit mix? What I said on the call is that we're encouraged, and in my prepared remarks, we're encouraged by what we've seen to date as the beginning of January. If you were to assume that that were to hold, the next question is what is the pace of the interest rate cuts that we see? If you see an instantaneous shock, we disclosed to you what that means, right. So, an instantaneous 100 basis point shock lower will be negative, around $600 million, right.

However, if it was more gradual in nature, which is similar to what you might see in the forward curve, you will have offsets associated with the reinvestment of the portfolio. So that will offset the rate decline, right. Will largely offset those rate declines, but it will depend -- first order condition is are deposits stable? Is the mix stable? And that's what we've seen so far. So, let's see if that holds. And then second, what is the pace of the cuts over the course of the year?

[Operator]

We'll move to our next question from Devin Ryan with JMP Securities. Your line is now open. Please go ahead.

[Devin Ryan, Analyst at JMP Securities]

Thanks so much. Good morning, Ted and Sharon. Sharon, maybe just start with a question on investment banking, and good to hear about the tone improvement there. Sponsors have been less active than corporates, at least from the data we track. And we know sponsors have record dry powder, but higher interest rates, current valuations have been a little bit challenging for them. So just -- the question is whether they're in a position of return in force over the next year. I think that's probably going to be necessary for full normalization in investment banking. And then just what you're seeing when you talk about the pipelines that you have, which are good. What are sponsors doing in those pipelines? Thanks.

[Sharon Yeshaya, Chief Financial Officer at Morgan Stanley]

Sure. Overall, the pipeline is more diversified than we've necessarily seen in historical years. We expect to see continued momentum in energy that we've seen over the past year. We see optimistic signs in real estate, and we see optimistic signs in technology. As it relates to sponsors, we would expect sponsors to come back. That will obviously take time, and I do think it will likely take a couple of potential prints in certain places, and other things that will be encouraging will be on the equity IPO side. What I'd say is we've moved from a period of time that was window driven, and that market is beginning to build momentum. And so, the juxtaposition between the outlook for '24, I think in '23 is important there as well.

[Devin Ryan, Analyst at JMP Securities]

Okay, terrific. And then a question for Ted. So, I think you're pretty clear here. The strategic trajectory is not changing dramatically, but we often get the question around stylistically what's changing. And so, you have a different background than James. I think everyone has their own management style, and you've run some big businesses very successfully from Morgan Stanley. So, I'd love to maybe just hit on briefly how you would characterize kind of your style and just the ability to leverage your experience, and what may change as a result of that? Thanks.

[Ted Pick, Chief Executive Officer at Morgan Stanley]

Well, that's a great question. James and I are much more similar than not. He brings to the table a positive mojo to the business from the time that he took over as CEO, when things were in, as, you know, pretty rough shape. And for now, in his 15th year of leadership as exec chair, he brings that positive spirit to every single interaction that we have, whether it's our operating and management committees, our risk meetings, these calls, client interactions, cultural work with our newbies and folks that are looking to get promoted in the organization, I think that spirit of positivity is something that has been contagious in the organization, is something that I'm a big believer in and has worked well inside of the trading businesses, inside of investment banking. And I think you can feel it throughout the firm. So, the reaffirmation of our partnership, our core values, and this articulation of the integrated firm, which is the next step now, because we went from trying to build our way back to generating the kind of enhanced scale and deeper modes through these gutsy acquisitions that brought us to a place now where we can kind of look around and see how we can bring the firm closely together.

I think the tone is one of determination. I've been at this place for more than three decades, and we had our moment sort of before the abyss in '08. And I think it's fair to say that the entire senior partnership, James, but also the folks that came through the organization, like myself, we are determined to not revisit anything that feels like those days. So, the calling card here is durability, is consistency. We want to put up consistent results. Part of what you see in the strategic deck in the back page, those are very clear numbers, and we will hit them. We will hit those numbers. It will take time. We will have to do all of the three yards and a cloud of dust work associated with thoughtfully working our way to those numbers, such that when we hit them in a normalized environment, which will be part of the next arrow on page three, in the years to come, we will have done so in a way where we can achieve full valuation on it, because the view will be that they are not only achieved for a moment in time, but sustainable.

And that obviously is also the calling card of James' tenure, which is that of consistency and durability. So, if the first is this positive mojo and the second is this ethos of consistency, rigor, durability, I think the third, at the end of the day, has been to believe in what Morgan Stanley can aspire to for clients, and that is this integrated firm, that we are something differentiated in our two channels. We're very clear on what we do and what we don't do, and that the cycle is very much a tailwind for us.

[Operator]

We'll move to our next question from Christian Bolu with Autonomous Research. Your line is now open. Please go ahead.

[Christian Bolu, Analyst at Autonomous Research]

Good morning, Ted, and welcome to the call. Good morning, Sharon, as well. Maybe, Ted, for you on the trading businesses, Morgan Stanley has suffered some share loss over the last couple of years, and your peers have been aggressively allocating capital to that business and gaining share. So maybe curious on how you're thinking about opportunities to grow those businesses, and any plans to either invest more capital or resources into that business.

[Ted Pick, Chief Executive Officer at Morgan Stanley]

Thanks for the question, Christian. Good to hear your voice. I think we know that we have achieved the top three position in the institutional securities business over the last number of years, but as you say, on the margin, we have lost share to the number one and number two. And I think our view has been that that is a trade that we've been willing to make both to continue to toggle the organization to the kind of revenue and profitability mix that you see today, but also importantly, the preservation of capital, which allows us today, irrespective of where we are in Basel III Endgame, to have a CT1 ratio that is well above 15%.

As you've heard, I am with team much focused on the durability of the dividend. And so, there's been a real focus on what shareholders want and what the business model ought to be for folks that want a durable Morgan Stanley. Now that having been said, what you saw in 2020 was that we can be quite agile about getting capital resourcing to the client base if the tailwinds are there. Part of the proposition of being a global investment bank is that if, for example, balances start working in the prime brokerage context towards their '21, '22 highs, where we're about 10% away from those figures, well, then perhaps capital needs to be put towards equities, namely the prime brokerage business in behalf of clients. There may be other periods where the event space, which was an allusion made on the previous question with respect to activity around financial sponsors, that that activity may come back because, of course, at some point these large assets need to trade and the sponsor community is dependent at some level on the street to engage in velocity.

So, there is no strategic decision at all to withdraw from the investment bank. I think what we would say in 2024 is that it's not really a choice between wealth and investment management or the institutional securities business. We will engage in both activities, but we will not be looking to chase the ball simply to have wallet share. The name of the game is to have an income statement that demonstrates operating leverage in each of the two businesses and ultimately to get to holistic returns. So, we are much focused on what the durability of that capital put to use is, and where we can serve clients over a long period of time. We're paying attention to it very carefully. And what I'm most excited about, Christian, is that the cycle that's coming, the investment banking led cycle is coming at a time when we spent years putting together, and I know you've met some of these folks, our so-called integrated investment bank. What is differentiated about this place is that we have bankers, equities people and fixed income folks who work together. They work together on client solutions.

What I'm proposing on our behalf is now we extend that proposition to the firm where in the wealth business, the investment management business, and inside the investment bank, we can work together around clients ultimately to generate operating leverage and returns. And that is for me the most exciting part of the next chapter, which is we've got the team, we've got the excess capital. But again, I like the excess capital because it's part of what has differentiated us from the group, and allows us to weather whatever comes through on Basel III endgame.

I would add, if in fact the Basel III endgame outcome is more favorable than perhaps what the street expects, we will adjust accordingly. But we have tools, and part of that's the dividend, part of that's investing in the business, part of that, obviously, is buying stock back. But ultimately, having a real capital cushion is something that shareholders have come to expect from James, and that's something they should continue to expect from me.

[Christian Bolu, Analyst at Autonomous Research]

Awesome. Very clear, Ted. Thank you. And then maybe another one on wealth management margins, unfortunately, maybe for Sharon. I kind of hear you, Sharon, very clearly, that you think higher revenues will drive margins over time. But if, I guess if I look at the business 2019 versus today, wealth management revenues are up 50% versus where they were in 2019, but your margins have compressed. And again, I know there's one-time items in the quarter or in the year, but it doesn't seem to me like bigger revenues have driven operating leverage. So, what gives you confidence that going forward, revenue growth will drive meaningful operating leverage.

[Sharon Yeshaya, Chief Financial Officer at Morgan Stanley]

Really, around the conversion, that's why I keep talking about the conversion, Christian. We brought the statistics up last year. We brought the statistics up again this year in terms of seeing conversion from workplace, about seeing net new assets coming in and then seeing those assets migrate, new clients, giving FAs time. All of those things are able to give us more durable asset management-based revenue as we move forward.

So, to your question, and I think Steve asked a similar question, the NII will fluctuate, obviously, based on rates and on consumer and customer behavior. And so, the goal, while that has been something that we say, don't forget the bank, don't forget the margin that you'll get from that. Over time, the goal is to have a more sustainable trillion dollars of assets coming through both wealth and investment management. Those assets will earn fees to some portion of it, and we see the migration into fee based right. We have 50% of advisor led assets sitting in fee-based accounts. That's the ultimate proposition from seeing an expanded margin and seeing the benefits of scale. And we have invested in workplace, we've invested in getting new channels and getting new participants. The time is now to begin to see conversion, and we have evidence -- factual evidence that I've pointed to on this call to show you that we're making progress towards those goals.

[Ted Pick, Chief Executive Officer at Morgan Stanley]

What I'd add, Christian, is again, all goals being equally important, we will hit that $10 trillion number. So, part of it is to allow for some of this latency, if you will, on assets held away, on assets working their way through workplace. It's a space that we are a leader in. It's a space that is relatively embryonic in the wealth business.

And we will allow for some time for those assets to convert. But the key, of course, is to have them in house and then as well to see that folks who are our new workplace customers have assets held away in other existing brokerage accounts that they bring them to the firm as well.

[Operator]

Due to time constraints. We'll take just one question and no follow up going forward from analysts. Our next question comes from Brennan Hawken with UBS. Please go ahead. Your line is now open.

[Brennan Hawken, Analyst at UBS Group]

Good morning, and congrats Ted on the new role. Since I only get one shot at this, I will ask on the long-term targets. So, there was some slight changes here. We lost some pluses and we lost a less stand on the efficiency ratio, although in fairness, we gained a plus on the client assets. So was that a reflection of -- these are long term targets, so I'm guessing it's not really a reflection of the current environment. So, what drove the tweak there to maybe signal some reduction in some of the upside scenarios? And you've referenced the fact that you need the environment to normalize. How should we be thinking about progression towards these targets, and what specific non environmental actions you can be taking in order to move the ball there?

[Ted Pick, Chief Executive Officer at Morgan Stanley]

Yes, excellent question. And a lot of time given to consideration on pluses and the like. This, for me, was sort of an easy call. The page is one that we all own, and getting to 30% margins is a number that we want to achieve. And at that level, having hit something that is approaching $10 trillion assets, we're going to be in a really great place. And that would be a reasonable time to say, hey, how about more? And we'd say, okay, well, clearly we're going to continue to grow assets because the asset number away that TAM is gigantic. James has mentioned $20 trillion at one point. There are client assets that will keep us busy for many generations to come.

Whether the pretax margin of wealth should go about 30% at that point before or not, I'd like to get to the 30, and I want to get there durably and thoughtfully. And the mid 20s is a range that you've seen us trade at the business to work well at, and we believe we can when economic conditions normalize, as Sharon described, and as new assets get put to work, some combination of money markets and T bills coming into the market again, workplace coming through the funnel, all three channels working on the back of increased transaction activity and new issues and the like. We should slowly and durably work our way back to 30.

The efficiency ratio, as you know, is just another way of saying 30% margins for the enterprise. Now, by definition, the investment bank, which has more capital and more underlying risk should have margins that exceed 30% over time. So, it's fair to say that if we're hitting 30% margins in wealth management, we certainly should be at an enterprise efficiency ratio of one minus 70, 30% as well.

So, 30% plus could be a way of thinking about it. But I wanted to set up numbers where the team knew that they are specific and that we needed to hit them. And then finally, with respect to returns on capital, this gets to the importance of our being stewards of that capital. What we pay out in the form of dividends, what we buy back, and durably, how we run the place. So, we thought that 20% ROTCE, which is something we hit during the COVID years, but of course, those were against macroeconomic conditions, which were unusual and highly favorable, that we can do 20% in a normalized environment. So, this may be on the margin, and James liked it too, when we talked about it. Stylistically, my view was, and the team shares it, that $10 trillion of client assets, we should get there and just keep on going. But the other three, effectively, in removing the pluses, it's simply reaffirming that those numbers will be hit. We will hit 30% pretax margins and wealth, 70% efficiency ratio for the firm, and 20% ROTCE. It will take time. There will be -- the challenges you would expect in making that happen. And, of course, we need economic conditions to line up in a favorable way. But over time, those are the firmwide goals, and we wanted to be very specific about that for you.

[Operator]

We'll take our last question from Mike Mayo with Wells Fargo Securities. Please go ahead. Your line is now open.

[Mike Mayo, Analyst at Wells Fargo & Company]

Hi, Ted.

[Ted Pick, Chief Executive Officer at Morgan Stanley]

Hey, Mike. Nice ink. Enjoy the story.

[Mike Mayo, Analyst at Wells Fargo & Company]

Okay. Well, it looks like you have a heavy lift after following James Gorman's shoot path. What is your message to the wealth managers and investment managers? That half of the company that you haven't run in the past. So, you've proven yourself in the half of the company. That's clearly cap markets and Wall Street banking. But what's your message to the other half of the company at a time when they've had a step down in their growth rates, new asset flows on wealth and outflows in investment management?

[Ted Pick, Chief Executive Officer at Morgan Stanley]

Well, thanks for the question, Mike. The wealth business is actually in my blood. My dad and my father-in-law were both brokers once upon a time, and I grew up studying that business as a kid. And I think it is absolutely that which has differentiated Morgan Stanley during this 15-year period. The ability to integrate Smith Barney and build out something that is truly special has been existentially, as you know, better than most, but also thematically, exactly what the firm has needed. In no way has it actually worked to the disbenefit of the investment bank. As you know, the history of our merger from '97 was largely about social issues. But the industrial idea wasn't necessarily off at all. To build a world class wealth manager would be something that would have enormous barriers to entry and have run well and run in a first-class way, could deliver value to clients in a differentiated manner. And what we have done, thanks to the leadership of Andy Saperstein with Jed Finn, and then the investor management business with Dan Simkowitz now moving over the investment bank, and Ben Huneke and Jacques Chappuis, running investor management today is we've got effectively the full funnel. We've got the soup to nuts, self-directed, the traditional advisory channel, and this new channel workplace working as one.

I've spent time working some of the Chairmans and hitting a branch here in midtown, and spending some time with folks that are actually making the engine work. And I think it's fair to say that we at one point were calling the wealth and investment management business the ballast, which is the right word, because we wanted to convey durability. But I'd submit to you, Mike, and hopefully you'll appreciate the spirit in which I say this. I think it's actually the engine. I think this will be the engine for further Morgan Stanley growth. If opportunities were to come before us in the years to come, of course we could staple them on and do something inorganically, as James alluded to. Perhaps that would be outside the U.S., where I've spent a whole bunch of time. But in running the actual organic business as it currently stands, we're truly a group of one. And as you know, having spent time inside the knitting of MS, what we're most excited about, Mike, you, as a student of corporate culture and these investment banks, I think what you'd be most excited about is just how well we all get along.

There is zero friction in the leadership ranks across infrastructure, across wealth and investment management, and across the investment bank. So, the beauty of where we are today is that all of us as shareholders and custodians of the Morgan Stanley idea and the Morgan Stanley culture of first class business in a first class way, are very much focused on growing both pieces of the firm, and this leading wealth and asset manager has a lot more room and will grow, as I said, to the $10 trillion of assets. And at the same time, I don't see any reason why we can't continue to pick up high-quality, durable wallet inside the investment bank and generate operating leverage in that business too.

[Operator]

That concludes our question-and-answer session for today. [Operator Closing Remarks]