Morgan Stanley (MS) Q3 2020 Earnings Call Transcript

Morgan Stanley (NYSE: MS) Q3 2020 earnings call dated Oct. 15, 2020

Corporate Participants:

James P. Gorman — Chairman and Chief Executive Officer

Jonathan Pruzan — Chief Financial Officer

Analysts:

Glenn Schorr — Evercore — Analyst

Steven Chubak — Wolfe Research — Analyst

Brennan Hawken — UBS — Analyst

Mike Carrier — Bank of America — Analyst

Mike Mayo — Wells Fargo Securities — Analyst

Jim Mitchell — Seaport Global — Analyst

Devin Ryan — JMP Securities — Analyst

Gerard Cassidy — RBC Capital Markets — Analyst

Andrew Lim — SocGen — Analyst

Presentation:

Operator

Good morning. I will be reading a statement on behalf of Morgan Stanley.

Today’s presentation will refer to Morgan Stanley’s earnings release and financial supplement, 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. This presentation may not be duplicated or reproduced without our consent.

I will now turn the call over to Chairman and Chief Executive Officer, James Gorman.

James P. Gorman — Chairman and Chief Executive Officer

Good morning, everyone, and thank you for joining us. For a decade now, we’ve been rebuilding Morgan Stanley from the depths of the crisis to a firm position to withstand whatever comes our way. Our performance this year has validated that approach and third quarter revenues were $11.7 billion, the second highest quarterly result in our history. The balanced business mix continues to deliver consistent results and high returns. We report an ROTCE of 15% with the year-to-date ROTCE of 14.3%.

On October 2, we closed the acquisition of E TRADE, and last week, we announced our intent to acquire Eaton Vance, which serves as the large — latest strategic step in that transformation. We added these acquisitions from position of strength, and we have a strong momentum across each of our businesses.

Institutional Securities has been pivotal to our performance. In 2018, ’19 and again in ’20, year-to-date, extremely strong. This quarter ISG reported over $6 billion of revenues and $2 billion of pre-tax. Strength in Asia, equity underwriting and fixed income sales and trading and our overall equities business powered our performance. Asia had its best quarter in nearly a decade as we continue to see the benefits of the investments we have made in that region. Fixed income delivered the highest third quarter revenues in 10 years, excluding DVA. I see revenues today at $19 billion, up 24% over last year, and we continued to believe our institutional securities business has meaningful organic growth opportunities.

Wealth management continues to grow both organically and inorganically. On a year-to-date basis, fee-based flows have been exceptional $53 billion, with $24 billion in this quarter alone. Lending balance growth was a quarterly record of $6 billion versus the prior year, lending balances have increased nearly 20%. While we did not own E TRADE in the third quarter, it is important to note how they performed, delivering strong client activity in asset growth in the quarter as they have all year. With the E TRADE, our total client assets are now $3.5 trillion. That is up from $600 billion approximately we oversaw before we bought Smith Barney a decade ago, representing an increase of nearly 6 times.

Our investment management business serves as the third leg of the stool and produced over $1 billion of revenues on its own this quarter. Assets under management reached a record $715 billion. Important to note that is compared to $460 billion of assets under management we had less than two years ago. Assets under management growth has been powered by long-term net flows with over $10 billion third quarter fueling of course fee revenue growth.

While generating the strong organic growth, our recent announcement allowed us to transform our investment management business, giving at scale and several incremental growth engines at one time. Frankly, it was too good of an opportunity to pass up. For years, we’ve viewed Eaton Vance as the perfect partner. We will bring together two high performing asset managers with great business momentum. And through this partnership, we will now manage $1.2 trillion in assets under management and generate a combined $5 billion in annual revenues.

And to cement October 2020 as one of the most important months in our history, we received an upgrade to A2 from Moody’s, the only G-SIB to receive an upgrade during the pandemic. Their recognition of the firm’s clearing consistent strategy to shift our business mix towards lower risk recurring profitable revenue streams and wealth and asset management, together with our integrated investment bank is a further codification of our transformation.

So what do the next six months to 12 months hold? One, we will make material progress on the integration of E TRADE. Two, we will close and commence the integration of Eaton Vance. Three, we will reinstitute our capital distribution plan in 1Q 2021, assuming of course we have clarity from the Federal Reserve. It is worth noting that our CET1 ratio following the additions of E TRADE and Eaton Vance is expected to be 300 basis points, above our SCB requirement of 13.2%. Four, we will focus on driving organic business growth while managing expenses. And five, we will ensure our culture remains firmly client-centric and grounded in doing the right thing. This includes operational resiliency, meeting all regulatory expectations and maintaining the risk profile we enjoy today.

I will now turn the call over to Jon to discuss the results of the quarter, and together, we will take your questions. Thank you. Thank you and good morning. In the third quarter, firm net revenues were $11.7 billion with net income applicable to Morgan Stanley of $2.7 billion. We reported an ROTCE of 15%. Our year-to-date revenues reached the post-crisis record. Institutional Securities is having an exceptional year capturing the elevated client activity and managing risk well. Wealth management is delivering stability, while the underlying indicators to continue to position us for future growth. And Investment Management is delivering growth through industry leading long-term net flows. Our bankers and financial advisors are supporting our clients as they remain intensely engaged. Expense management remains a priority. On a year-to-date basis, our firm efficiency ratio was 71%, down approximately 90 basis points from the prior year. We remain focused on our more controllable sources of spend while continuing to support our growth initiatives, employees and communities. Non-compensation expenses increased on higher volume-related expenses and higher unfunded credit provisions, which were partially offset by a meaningful decrease in marketing and business development expenses. Compensation expenses increased on higher revenues. Now turning to the businesses. Institutional Securities had the strongest third quarter in a decade. Equity underwriting, corporate credit and strength in Asia underpinned the results. Clients remained engaged through the third quarter as risk assets continue to rally through August and capital markets remained active. From a regional perspective, Asia had a stronger quarter in nearly a decade with contributions from each of the businesses. Heightened activity and interest in China, which saw particular strength in IPOs and equities drove results. Year-to-date 2020 Asia revenues are higher than all of 2019. Investment Banking generated revenues of $1.7 billion, decreasing 17% from the prior quarter. While fixed income underwriting subsided and advisory revenues remain muted, equity underwriting buoyed results with particular strength in IPOs. Advisory revenues were $357 million, reflective of lower completed M&A industry volumes. Equity underwriting continues to be extremely active with revenues of $874 million. Results were driven by IPOs which nearly doubled versus the prior quarter, offsetting declines in convertibles and blocks. Fixed income underwriting revenues were $476 million. Results were impacted by the lower levels of event-related activity in the quarter. The equity underwriting pipeline remains healthy. We expect issuers to continue to access the market and remain opportunistic. The advisory pipeline is recovering as evidenced by the recent increase in announced activity and we have seen the pickup in both sponsor and corporate activity. Equity sales and trading revenues were $2.3 billion. We are number one in this business both for the quarter and year-to-date. Results were particularly strong in Asia as well as the Americas consistent with client interest and higher growth regions and momentum names respectively. While volumes declined from historic levels of the second quarter, activity remained robust. Both cash and derivatives revenues were elevated for a third quarter. Prime brokerage results were strong. Average balances increased as market levels rose and certain clients re-levered with spot balances closing above 2Q period end levels. Fixed income sales and trading had the strongest third quarter in a decade, excluding the impact of DVA driven by the strength in micro. Revenues were $1.9 billion in aggregate, with most products declining from an exceptionally strong second quarter. Activity levels were healthy as clients remained engaged throughout the summer months. From a geographical perspective, results were broad-based and year-to-date fixed income has now generated over $7 billion of revenues. Micro continued its robust performance. Bid-ask spreads remained elevated though lower than the prior quarter, benefiting results. Performance was supported by continued strength and securitized products and credit corporates. Macro was impacted by lower sequential revenues in rates and foreign exchange as spreads normalized and volatility declined. Foreign exchange in rate markets continued to be range bound. Commodities results reflected lower activity, but we’re supported by strength in metals, highlighting diversification of the business in recent years. Our ISG loan portfolio continued to perform well. As a reminder, over 90% of our ISG loans and commitments are either investment grade or secured. The sequential decline in results across other sales and trading and other revenues primarily reflected lower gains, net of hedges on our held for sale portfolio due to less spread tightening compared to the prior quarter. Our funded ISG loans declined by $2.3 billion from the prior quarter, driven primarily by paydowns in our corporate loan book. Our funded ratio of corporate loans now stands at 15%, down from 18% in the prior quarter and well below the 1Q peak at over 25%. We added to our reserves modestly in this quarter. Our provision for loan losses was $66 million, down 70% from the second quarter. We had approximately $23 million of net charge-offs, primarily from one commercial real estate loan that was troubled pre-COVID. Our allowance for credit losses on loans and lending commitments increased to $1.1 billion, of which our allowance on loans now stands at $806 million. The increase were primarily driven by COVID-related sectors. COVID-related sectors continue to represent just 10% of our total ISG lending exposures, and the substantial majority of these exposures are either investment grade or secured by collateral. Our allowance for corporate loans increased to 4.8% and for CRE remained stable at 3.1%. Across the entire held for investment loan portfolio, our total allowance rose to 1.9%. Turning to Wealth. Third quarter revenues were $4.7 billion, broadly in line with the prior quarter and up approximately 5% excluding the impact of DCP. Pretax profit was $1.1 billion. Our reported margin was 24%. Merger-related expenses and our regulatory charge impacted the margin by almost 200 basis points. The underlying indicators of this business remain robust including record new net — new — excuse me, record net new assets, continued strength in client engagement, fee-based flows, loan originations and net recruiting. Fee-based flows were exceptionally strong at $24 billion in the third quarter contributing to a year-to-date fee-based flows of $53 billion. Total client assets ended the quarter at $2.9 trillion, 11% higher than the prior year. In the third quarter, transactional revenues were $880 million. Including the impact of DCP, revenues increased sequentially exhibiting seasonal strength driven by capital markets activity.

Asset management revenues increased 11% sequentially to $2.8 billion reflecting higher starting asset levels on higher markets and fee-based flows. Importantly, asset management fees are $8 billion year-to-date, a 6% increase over 2019. Lending growth remains strong with balances exceeding $91 billion. On a year-to-date basis, balances have grown by $11 billion with record quarterly growth of $6 billion in the third quarter. Growth was broad-based across the portfolio. We saw strength in securities-based lending, which was driven by strong engagement from ultra high net worth clients and by adding resources to our lending businesses. The loan portfolio continues to perform exceptionally well. We had only $2 million in net charge-offs in the last seven quarters in this portfolio. Forbearance continued to decline. Mortgage forbearance fell by more than half representing less than 1% of our portfolio and 90-plus-day delinquencies declined to 20 basis points. Forbearance on commercial real estate loans in our tailored lending book declined by approximately 40%. Net interest income was $889 million, declining 14% sequentially. Higher lending in BDP balances helped to partially offset the impact of prepayment amortization and tighter deposit spreads. Prepay was more meaningful in the quarter, accelerating in the latter part of September as rates declined. Nearly half of the sequential decline in NII was attributed to prepayment amortization. Total US bank deposits were $238 billion and third quarter BDP balances were up $7 billion despite delayed tax payments. Total expenses were $3.5 billion in line with the prior quarter.

Investment management results were very strong, as the business continues to demonstrate meaningful momentum. Long-term net flows and strong investment performance has supported AUM growth which is translating into higher fee revenue. Revenues of $1.1 billion represented the second highest quarterly level in over a decade, increasing 19% from a robust prior quarter. Total AUM rose to a record high $715 billion, representing over $200 billion of growth since last year. Long-term net flows were $10 billion, driven by continued strong investment performance in global equity strategies. Being global remains critical. Our investment team in Asia began sub advising a newly established ESG global equity fund in the third quarter. It was one of the most notable fundraisers in Japan in the last 20 years and at quarter end, and more than $5 billion in assets under management. Inflows across all regions led to an annualized long-term growth rate over 10% for the second consecutive quarter. Total net flows were $13 billion as liquidity inflows moderated and investors pivoted away from money funds. Asset management fees of $795 million increased 16% sequentially driven by higher management fees consistent with strong growth in AUM. In the third quarter, we did see an increase in fee waivers on certain money market funds, as a result of the rate environment, and we expect to see the full effect of this trend in the fourth quarter. Investment revenues were $258 million in the quarter. We saw broad-based gains across the portfolio with sequential increase, primarily driven by gains in Asia private equity funds. Total expenses were $741 million. The increase was driven by higher compensation on higher revenues as well as higher BC&E expenses on higher average AUM. We are very excited about the future of this business and to be partnering with Eaton Vance. We expect to close the transaction in the second quarter of 2021. We look forward to advancing our partnership with Eaton Vance and further enhancing our investment management platform.

Turning to the balance sheet, total spot assets declined to $956 billion as funding levels declined from the highs of the second quarter. Our standardized RWA has declined by $5 billion to $411 billion, and our standardized CET1 ratio rose 80 basis points to 17.3% compared to our SCB of 13.2%. Our Board declared a $0.35 dividend per share. Excluding $113 million of intermittent net discrete tax benefit, our tax rate was 24.3%. We continue to expect the full year 2020 core tax rate will be approximately 22% to 23%. On October 2, we closed the acquisition of E TRADE. As a function of the closing, we issued $232 million shares and $11 billion of common equity. Our assets increased by approximately $77 billion and RWAs by $12 billion. We created approximately $8 billion of goodwill and intangibles, of which $3 billion will be amortized over approximately 15 years, and our CET1 ratio increased by approximately 40 basis points. Tangible book value per share declined by approximately $4 and our book value per share was essentially flat. As you would expect, in the fourth quarter, we will start to see merger-related expenses, as we begin the integration of E TRADE. We will start to break these charges out in our disclosures in January when we report year end results. As for the operating outlook, the dispersion of potential macro outcomes remains high, and while we are cognizant of the seasonal patterns of the fourth quarter, we are encouraged by client engagement across all three businesses in the first few weeks of the quarter. With that, we will now open the line to questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Glenn Schorr with Evercore. Your line is now open.

Glenn Schorr — Evercore — Analyst

Hi. Thanks very much. Curious, if we could talk about flows in wealth management. You mentioned a couple of things, but I’m curious what you would attribute year-to-date to recruiting versus consolidation of wallet share. And while we’re on it, if you could talk about the wealth management loans being up almost 20%, is that a combination of mortgage and SPO? Just curious what’s driving that within wealth management?

Jonathan Pruzan — Chief Financial Officer

Yeah, sure. In terms of the flows, listen this is a long-term secular trend that we continue to see that people want to pay for a managed account and one fee. And we’ve seen this for the last several years and we now approach about 50% of the assets we manage or in fee-based accounts. It’s really a combination of multiple factors, and I think you mentioned many of them. One, we’ve seen more cash coming to the network and that cash is being deployed. Although there is still significant amount of cash on the sidelines within our network, but we have seen more come in and more of that’s being put into the market.

Number two, your comment about net recruiting, we’re seeing Morgan Stanley become the destination of choice for financial advisors. Recruiting has been quite strong and we brought in bigger teams over the last — course of the last nine months and with them, they bringing their assets, which are being deployed into the fee-based accounts. So, really a combination of those two things. And then lastly, we’ve seen attrition dropped significantly. So we’re not losing many assets. So a combination of all those three things. And again we think that’s a long-term secular trend that will continue and we’ll continue to see good flows into our fee-based accounts.

And then I think the lending growth is really, as you mentioned, those two products, the SPL product. We saw a significant pick up about $4 billion this quarter, predominantly about 70%, 75% of that came from ultra high net worth client base. We’ve continued to invest in the platform. I think we’ve gotten better at using data and analytics. We’ve added some more support to the field and we’ve seen real receptivity around that product with our client base. And then lastly mortgage continues to do quite well. Interestingly, we had about 45% purchase this quarter which was nice to see as that has picked up as well. So it’s really both those products have been quite strong within the footprint.

James P. Gorman — Chairman and Chief Executive Officer

I would just add Glenn sort of observing that from a little distance, because I’m not directly involved in it. This is the healthiest, I have seen this business in the 14 years I’ve been here. In terms of client flows, both fee-based flows and absolute flows, which we historically don’t break out. There are a lot of movements during the year with tax payments and the like, but it’s extremely healthy and the attrition number is very low as John said. So net recruiting, better client penetration and a lot of very wealthy clients, validating the model and you add that to the E TRADE franchise, which has also seen very strong flows this year. It’s — for me it’s very exciting to see it.

Glenn Schorr — Evercore — Analyst

I appreciate that. Maybe just one follow-up on the expense side. First, maybe with the core expense, you mentioned activity levels are up, so obviously expenses are elevated. But marketing and P&A has been down. Maybe if you could start with how to think about that for the go-forward on expenses? And then I know that we have to wait till January for your integration thoughts on E TRADE dollar wise. But maybe you could talk a little bit about what you actually have to spend money on, on the integration on E TRADE, so we can just start putting together our thoughts on models? Thanks.

Jonathan Pruzan — Chief Financial Officer

Sure. Just broadly on the expense base, what we’ve obviously seen given the elevated volumes is elevated brokerage and clearing expense that goes with the trading volumes as well as transaction taxes. As I mentioned, Asia has been very strong. So we’ve got a little bit more of a skew towards transaction taxes. And those will continue to remain elevated, assuming that the volumes remain elevated and those generally ebb and flow or they do ebb and flow with the volumes.

We’ve done a really nice job of also managing our professional expenses. We continue to try to drive those numbers down. And then the market and business development expenses has really been driven by just a lack of — the lack of travel, the lack of conferences, things being converted to virtual, and we would expect that to remain muted for a while, but ultimately those expenses will start to tick up as we start to see movement around the globe.

In terms of E TRADE, as you know, in February when we announced the transaction, we talked about $800 million of integration-related charges that we would incur over a three-year period. As I just mentioned, that will start in the first — this current quarter and the fourth quarter. We will start to break out those disclosures, so you can see exactly what they are. We closed the deal about 10 days ago. We’re extremely confident about both the funding and cost synergies that we laid out, and we also think there are significant revenue opportunities as we get into the integration here. So you’ll start to see that this quarter we will break it out, and as you said, we will give you some more thoughts around that in January.

Operator

Thank you. Our next question comes from Steven Chubak with Wolfe Research. Your line is now open.

Steven Chubak — Wolfe Research — Analyst

Hi, good morning.

James P. Gorman — Chairman and Chief Executive Officer

Good morning.

Jonathan Pruzan — Chief Financial Officer

Good morning.

Steven Chubak — Wolfe Research — Analyst

So, James, I wanted to start off with a question on capital. The accretion has been considerable as you noted since the pandemic started and you’re clearly significantly overcapitalized. You also noted that you plan on returning the excess possibly as early as 1Q next year, subject to regulatory approval and removal of the buyback moratorium. How should we be thinking about pace in cadence of buyback and your comfort initiating payouts in excess of 100% of earnings? And just separately, how does the dividend target evolve alongside that?

James P. Gorman — Chairman and Chief Executive Officer

Few questions tucked in there, Steve. Very artful.

Steven Chubak — Wolfe Research — Analyst

Thank you.

James P. Gorman — Chairman and Chief Executive Officer

You’re welcome. Listen, we’re overcapitalized. I mean that’s the bottom line. We are overcapitalized before we went through CCAR last time, and our SCB numbers actually were lowered by the Fed, reflecting the change in the business model. It’s something that we thought — we felt for a long time, and it’s starting to be recognized. And even if you look at the PPNR models where we continue to argue, I think entirely appropriately that financial advisor compensation is a variable not fixed expense that would come down as revenues come down. Our PPNR numbers would actually be healthier than they’re currently showing.

Eventually, I think that argument will prevail. I hope it will prevail. But even without that with the accretion from the E TRADE transaction, we’re making $2.5 billion a quarter net and we’re paying out total dividend I think about $2.2 billion, looking at Jon, maybe slightly higher. So we are clearly accreting a lot of excess capital about probably $7 billion net without doing buyback on a base where we’re 300 basis points above the minimum requirement, will always keep a buffer. I don’t know what that buffer should be, a 100 basis points probably something like that. I’m looking at CFO here to see if he disagrees with me. He is sort of shaking his hand sideways, like he is probably a little plus on the 100, I’m probably a little minus on the — oh, he is little minus. Okay, we’re all happy.

Let’s see. On buyback side, there is absolutely no reason given Morgan Stanley’s current condition, the shape of our balance sheet, our liquidity profile and the mix of the businesses, why we wouldn’t be distributing capital. Except that for right now, it’s the right thing to do for the broader communities we worked through this pandemic exercise and the Fed does its pandemic stress test, which is going on right now.

I’m highly confident we will come out of that showing we have significant excess capital. I’m hopeful, we’ll have those results before we get into next year, but obviously that’s not within my purview. Given that, I would expect us to be back doing buybacks in the first quarter. Obviously, if the economy completely tanks between now and then, or if the results are less positive than I expect them to be, then all bets are off, but that’s, you know, you’ve got to run the business as you see it likely to be in. That’s my likely scenario.

How much do we do? Yeah, you could do — by definition, you could do above 100% payout. Why not if you — otherwise we will never hit into the 300 basis points. At some point, we have to do something with this capitalized, shareholders rightfully who own the company are entitled to generate a decent return on the capital invested in the company. We have to do something with it. Buying Eaton Vance was a tremendous opportunity to use some of that. It’s going to hit our CET1, I think, about 90 basis points, 100 basis points, but we’ve accreted 90 basis points to 100 basis points in the meantime.

So we’re sort of back to where we started, but we own a new company. That’s a nice thing. So you can tell, I’m a little animated on the subject, if you look at any of the global GCPs in the US, I think it’s fair to say we are carrying the most capital surplus. And I don’t think there is any rational reason why once we get through the COVID stress test, if you will, that that would — that will perpetuate unless we get a result which is adverse, which I don’t expect.

Steven Chubak — Wolfe Research — Analyst

Thanks for all that perspective, James. And maybe just a question for Jon on the NII outlook. You beat on virtually every line item. I think NII was the lone exception. You were not alone this quarter as prepay started to accelerate even toward the end of the quarter, but just curious given the strength in loan growth that we’re cited with in Glenn’s earlier question, I want to get a sense as to how we should be thinking about the NII trajectory from here. Whether we should expect things to start to stabilize and maybe even grow as we look out to 2021?

Jonathan Pruzan — Chief Financial Officer

Yeah. Well, I think, you’re right. We did get hit with prepayments at the end of the quarter. I think absent that prepayment level, we generally came in where we thought and where we had guided you to probably a little light as we saw some contraction in deposit spreads. I think on a go-forward basis if we were just ourselves, I would say we’re pretty stable. At this point, we obviously have reinvestment risk if the investment portfolio turns over. But we’re generally offsetting that with the growth we’re seeing in the portfolio.

But as you know, we did close E TRADE. E TRADE comes with a large low cost deposit base in a very highly liquid, high quality investment portfolio. So from a quantum perspective next quarter, you’ll — or this quarter, you’ll see the dollars of NII go up as about half of the revenues generated at E TRADE were from NII. And then we are going to start optimizing their portfolio as we laid out in February, where we will give you a better sense of sort of what the sensitivities are around that, but we’re highly confident we can get the funding synergies that we outlined in February, and that contribution of NII probably ticks up, but still it’s going to be sort of again relative to others about only 25% of the wealth business, which again is a much smaller part of the overall company.

James P. Gorman — Chairman and Chief Executive Officer

Steve, just back to your capital question, I mean it’s important to note that let’s assume just mathematically, I don’t know, we are carrying 20% excess capital right now. You know 300 plus basis points on 13.2% requirement. If that’s the case, and we’re still generating ROEs of 13%, ROTCE of 15%. So, with that excess capital, we’re generating these kinds of returns. So I think shareholders would — could sensibly look through that and project what the returns would be on the capital we’re actually using to run the business. And obviously they are higher than where we are now.

Steven Chubak — Wolfe Research — Analyst

Great. Thanks for that perspective, James. Thanks for taking my questions.

James P. Gorman — Chairman and Chief Executive Officer

You’re welcome.

Operator

Thank you. Our next question comes from Brennan Hawken with UBS. Your line is now open.

Brennan Hawken — UBS — Analyst

Good morning. Thanks for taking the questions. I wanted to start with one on expenses. So at the beginning of the year, James, you provided some targets, two-year targets that focused on efficiency ratio and pre-tax margin and wealth. But I seem to recall that they were based on, this is before all the deals, so I think they were based on what I’ll refer to as legacy MS, not pejoratively but just for clarity.

So not trying to be nit-picky here, I just want to try to understand, is there a way, we’re going to be able to track your progress in your legacy business towards those targets or is the idea that now that you’ve got so many of these right strategic integrations that are continuing your transformation that’s sort of trumping the work that you had previously laid out on efficiency, and therefore it’s just more important to focus on the integration there and not the efficiency push. Just want to try to understand how to think about that.

James P. Gorman — Chairman and Chief Executive Officer

Sure, Brennan. I think there is sort of three elements for looking at this. One is what is the, as you described, the legacy business are going to generate in terms of efficiency ratio, and right now, I think, this year we’re slightly over 70%. We were less than that in Q2, we were higher in Q1 and we were right — I think right on the button this quarter. Our two-year objective was 70 to 72, so we’re meeting that. Our long-term aspiration was under 70, and we are very close to meeting that. So check the box on legacy.

Number two is, what do the new acquisitions do to our efficiency ratio. If you look at the tax margin on the E TRADE business, it’s — let’s say it was — it’s sort of in the 40%-ish range, maybe a little below that with what’s going on with net interest income. And if you look at the Eaton Vance business, it’s closer to 30%. So by definition, if you simply add one plus one, your efficiency ratio would actually be lower. But the third bucket of course is what is the integration costs, well, they don’t start on Eaton Vance until we closed that, which John said, should be Q2 of next year. We have — actually we had a small number of integration costs already in E TRADE as — in the last, a little bit and that will build and I think we put out a prediction of $800 million over three years.

I personally would like to accelerate that. We will probably identify it as a below the line number. So just for client limits and for your models we will show, you will be able to see efficiency ratio with and without it, but clearly we will talk to accountants about the right way to report that. But we’re not going to hide the ball there. We are highly confident that absent integration costs, our efficiency numbers — there is no reason why they don’t understand.

Brennan Hawken — UBS — Analyst

Okay, great. Thanks for that. And then, I know that, Jon, I think you mentioned that your plan is to lay out some more specifics around E TRADE with the fourth quarter call, which makes a lot of sense. But what’s your early read on how you’re thinking about some of these changes that are likely to happen on the back of this integration? Is the plan that the E TRADE banks hub will be folded into the — one of the Morgan Stanley banks hubs? Are you planning to integrate the BDs?

And really one of the great assets that E TRADE brings the stock plan business has sort of a different focus, more of a public plan focus. And so the strengths are very different, but offer a nice kind of yin and yang with the Solium which has a strong private offering. So how do you plan to bring those platforms together? Or is the idea that in order to fully capture the broad strength, keeping them separate is a better approach, and so it may be the full integration is not going to be realized in order to maintain those various strengths?

Jonathan Pruzan — Chief Financial Officer

Sure. I mean broadly the answer Brennan to that question is yes. But I think the way we’re thinking about it, first, we’ve got to integrate the systems. We want to capture the cost and the funding synergies that we laid out. We want to do it in a way that doesn’t disrupt the customer experience and ultimately enhances the customer experience. And then as you said, I think we believe there are significant opportunities across all three channels to generate growth and revenue growth, and whether that’s in the stock plan business, and trying to get our cash capture numbers up to the E TRADE numbers. When we did the deal they were running about 15%. They are now running north of 20%. Our numbers were dramatically lower than that. So if we can bring the combined business together and get that to a higher level closer to theirs, that’s a significant synergy.

Clearly, they are generating lots of new clients. Some of those clients are ultimately going to want to — want advice and so there are lots of opportunities across all three channels and we’ll start to see those as we get these systems integrated. As we mentioned before that we will keep the E TRADE brand for the self-directed business line, but we’re going to bring these companies together slowly. This was not a deal about costs. It was about revenue opportunities ultimately, just like the Eaton Vance deal was, and we’re going to take our time, integrate them well and bring the cultures and companies together.

James P. Gorman — Chairman and Chief Executive Officer

And to be clear, nothing has changed in our view of E TRADE, if anything it’s got better. The integration plans we’ve been working on for six months with Mike Pizzi, CEO of E TRADE has joined our operating committee. Very well-thought-through plans at great detail, we’ll stage the various businesses as you highlighted the workplace, the banks, etc. And then the actual E TRADE trading business will attain a separate identity because it has a very powerful brand in the marketplace.

So we are highly confident we’re going to get the cost synergies. It’s just — and I think we gave you that $800 million number in January and February, I guess when we did the deal, and it would be fair to say that it’s probably not where we tend to be conservative with numbers like that, so I doubt we’re going to be spending more than that and the pace of the spend will be just around with the integration plan. So it’s going exactly as we hoped it would go, but even a little better, frankly.

Operator

Thank you. Our next question comes from Mike Carrier with Bank of America. Your line is now open.

Mike Carrier — Bank of America — Analyst

Good morning and thanks for taking the questions. First, you said Institutional had very strong year and few years for that matter. And James you mentioned upfront you still see good organic growth opportunities. Just given your leading share in some of the areas, can you provide maybe a little color on just where you see some of the exact organic growth in that business and that can maybe offset some of the expected [indecipherable]?

James P. Gorman — Chairman and Chief Executive Officer

Yeah. Well, firstly, doing deals in the Institutional space is a little fortune. You’re unlikely to want to do balance sheet type deals. I don’t think anybody would be sending up balloons, if we did that. And there are obviously advisory businesses around the world that you could acquire, smaller ones, boutiques, if you like, but we haven’t found anything that really excites us yet. So if we look at the organic growth, I mean just look at fixed income, and still the gap between what our fixed income business is doing, which is phenomenal. By the way from where they’ve come from it’s truly phenomenal. And credit Sam Kellie-Smith and Ted Pick overseeing all institutional business, for that turnaround in the last couple of years is just phenomenal, but they clearly have capacity to grow in that business.

Our equities business, you know, we lost the number one mantle for the quarter, we didn’t like that. We got it back. Clearly, prime brokerage should continue to consolidate this growth across prime brokerage. Our capital markets business in Asia, particularly China-bound Asia enormous, we have an incredible franchise there. I think there are parts of banking, we could be strong room, we have some segments where we are very dominant, healthcare, tech and then some other industry groups we could get even stronger.

So, I think in DCM, we’ve made progress. I think we’re number five or six in DCM underwriting, Jon, and well four actually he is pointing to me. I think the gap there with some of our competitors, there is no particularly rational reason why there should be a gap there. I think there is just — it’s nowhere near, we’re nowhere near what we could be as a potential. The question is can we get there with the kinds of returns we want and expect from the business. So we’re quite judicious. We’re not just throwing balance sheet at it.

Look at the trading bar, I think our trading bar this quarter was $60 million a day and that was materially lower than our major competitors. So we’re quite judicious about it, but a series of small steps rather than big swings is the way I describe the institutional business, and they have delivered. I made a point of saying in ’18, they had a record ’19, and again in ’20, they are delivering. So I think there’s a lot of upside. And obviously it’s also framed by the competitive landscape and what the European banks are doing or not doing, etc. Jon, I don’t know if you want to add to that.

Jonathan Pruzan — Chief Financial Officer

Yeah. No, I think you’ve summed that up well, and I think Asia is really a bright spot for us. As I said, year-to-date, the revenue generation from that business in ISG now bigger than Europe. We see that as a real growth engine and we’ll continue to make investments there.

Mike Carrier — Bank of America — Analyst

All right. Thanks a lot. And then, just given the recent M&A whether E TRADE wallet or Eaton Vance Investment Management, I think both makes sense. Just curious on timing, is it obviously at the excess capital, or are you seeing something from like an industry dynamic, and then more importantly, both of those businesses are putting up good growth. So just what do you think that business does with these transactions obviously not over the next six months, 12 months, but maybe two years to four years?

James P. Gorman — Chairman and Chief Executive Officer

Yeah. You’re a little garbled there with the fund line, but I think the question is around the timing of those transactions. Here’s how I think about acquisitions. There are at least four things that matter. One is strategy; two is culture; three is price; and four is timing. Strategy is like the high table if you will, the Holy Grail. You’ve got to have strategic intent. It’s got to be a logical fit. It’s got to be building on something which you already have confidence in. It’s not a swing for the fences, it’s not new ground. It’s something we know well, we’re good at and that’s the perfect strategic opportunity comes when you get that and we got that with E TRADE and then with Eaton Vance.

Culture is very important, particularly in the finance industry, where a lot of deals have gone bad because of cultural — bad cultural fits including by the way in the asset management space. And there is a fairly high skepticism probably from all of you about large asset management deals. We talked through that a lot. Eaton Vance has been around 94 years. We’re the biggest distributor of their product. We know them extremely well. Parametric has been an absolute home run in our system. The cover funds and what they’ve done in sustainability space, the fixed income, combined with our fixed income business, their core equity funds.

There is so much to like about it, and about their leadership team, and I would point out that they have — they had an internal voting shareholder structure, and all 25 of their internal voting shareholders voted in favor of the deal unanimous. So it wasn’t just the Board, it was the management. So culture, I feel really good about. Price is price. You don’t buy quality assets cheaply. Timing is the thing leasing your control. And I’m sure if we didn’t do this transaction of Eaton Vance, somebody else might have. We didn’t want to do it before we had the E TRADE thing completely done.

On the other hand, we want to get moving. Its assets — quality assets don’t sit on the shelf for very long. They were interested in Morgan Stanley, we’re interested in them, so timing is just — timing is the thing you’ve got to give most on. It may not be the ultimate convenience, certainly came hot on the trail of E TRADE. We didn’t want to communicate all of a sudden, we’re trying to do an acquisition a week, we’re not. We didn’t control the timing. So we — if we got the first three right, then timing is the least important.

What it does in the COVID thing, I think is your broader timing issue with what’s going on with the economy. Listen, their business is growing. They’ve had great growth. As I said the Parametric product has done incredibly well since it was created a few years ago. They’re seeing great growth across the whole platform as is our asset management business. So we really think we’re putting together two strong growing businesses. And the investment market is not going to go away, whatever happens in the election, whatever happens politically. So I’m not worried about that over the next couple of years.

Mike Carrier — Bank of America — Analyst

Great. Thanks.

Operator

Thank you. Our next question comes from Mike Mayo with Wells Fargo Securities. Your line is now open.

Mike Mayo — Wells Fargo Securities — Analyst

Hi. Well, to coincide with your upgrade of your credit rating, congratulations. My question is on risk. In…

James P. Gorman — Chairman and Chief Executive Officer

Boy, I thought you’re about to upgrade — I thought you’re about to upgrade us Mike, when you said upgrade. You have disappointed me, man.

Mike Mayo — Wells Fargo Securities — Analyst

Well, first, 3% quarter-over-quarter loan growth is well above the industry. So just wondered about the risk related to that and how you’re getting what others are not. Second, on the E TRADE acquisition, the spread revenues for E TRADE seem like they would be a quite a bit lower. So updates on revenue thoughts with that acquisition? And then third, with Eaton Vance, $7 billion for a firm that’s earning about $360 million. You’d have to double the earnings, just to get over a 10% ROE. So in terms of risk, loan risk, E TRADE risk with the spread revenues and Eaton Vance risk with just really getting your full money to work?

James P. Gorman — Chairman and Chief Executive Officer

Well, I’ll let Jon talk about the credit risk, but I would observe that we are not in the unsecured credit world. We do not do small business lending on any scale at all. We tend to loan against people’s own portfolios. So we have collateral and we have total visibility on the consumer side. And on the institutional side, we’re very careful about what sectors we’ve been in. We’re not over-exposed to some of the more troubled sectors. And we have a lot of really good clients who have been really loyal to us, have great businesses that we want to support during this period.

So, the fact that credit is performing differently from some other institutions is completely irrelevant. I mean, it entirely depends on who you’re lending to and in what terms and conditions. So on the E TRADE business, yes with the NII obviously that business is affected by that. On the other hand, the account openings, the positive asset flows, the opportunity for us to provide those kinds of mortgage and lending products to their clients, the opportunity for us to provide the OLS [Phonetic] — put the OLS platform on their system, the fact that we’re not spending $200 million a year building out our own digital platform, there are so many positives before you even get to the workplace business, where their conversion rate as Jon said, is something like 20%-plus, ours has been about 3%.

So I just think that we — certainly we — our eye is wide open on what’s going on in interest rates in this world. I don’t expect that to be a permanent state, but it’s certainly not something that makes me shy about the attractiveness of this acquisition. The underlying benefit and flows in the business have been phenomenal. And the one thing that is actually changing people’s behavior even more than what’s going on in the last five years is the increased use of digitalization whether it’s their health services, financial services, obviously shopping, etc. So I think we couldn’t have been more blessed than we’ve got E TRADE at the time we got it.

On Eaton Vance, so Mike, I’m not that smart. One of your colleagues on the call said that even if we paid a billion dollar taxes for it, a $90 billion company, it’s like, yeah, I’m not ashamed to say it’s fully priced, but this is a quality asset. And I look at the growth rate in the asset. I don’t look at the static position. We will get expenses out of this. We will consolidate this. We will generate the revenues from it. It fills out our fixed income asset management business in a way that we couldn’t have done otherwise, and it provides us some real growth endurance, as I said with their core equities platform with Parametric, with COVID funds, the Atlanta fund, they’ve got so many businesses that work for us. They have very little international distribution. We can take them internationally.

We have trouble getting our product distributed domestically, because we don’t have a strong whole selling sales force as others do. They do. They have a world-class one. So will that deal deliver? I’m positive that deal is going to deliver. And if we overpaid by couple of $100 million, people said, we overpaid Solium by a couple $100 million. Some people said, we overpaid Smith Barney by a couple of billion dollars. So I take a very long-term view on acquisitions.

Mike Mayo — Wells Fargo Securities — Analyst

Just one more follow-up. I pulled back the lens even more, I mean over the last 10 years to 20 years, you’re right now reversing some of the actions that you took. You sold off Van Kampen, and now you go ahead and get an asset manager. You got out of the kind of the mass market, wealth management, and now you’re back with E TRADE. Can you give us kind of your big picture strategic thoughts on why the long-term reversal here?

James P. Gorman — Chairman and Chief Executive Officer

I totally disagree with what you just said. We have not had a long-term reversal. We sold Van Kampen which I regard as a mistake. I said it a couple of years later. I wish we hadn’t done it, but we did it. And I said on a call a couple of weeks ago, Martin Flanagan was listening, I regret that, but god bless him, he is a friend of mine and I wish him well. We haven’t got out of the mass market, and by the way E TRADE is a combination of a workplace business and active trader options derivative business and a direct business.

We have always provided financial services since we merged with Dean Witter in 1997 to the average investor. We happen to have a lot of very, very wealthy investors in addition, but we have millions of people with hundreds of thousands of dollars to invest not tens of millions of dollars to invest. So this is not a change in strategy at all. This is about getting scale in the businesses we want to be in.

The one thing we did differently, which I would have done differently, I’ve said repeatedly is Van Kampen. And you look at some of the other stuff we did. We got out of mortgage servicing, Saxon. We got out of shipping storage and oil storage and shipping TransMontaigne and Heidmar. We got out of this PDT business, Pete Muller’s business because it was a prop business. So we shut down FrontPoint, our hedge fund, we got out of Discover, which was a credit card business to the mass market unsecured credits, we have fundamentally — and that happened before my tenure, obviously, but fundamentally changed the profile of this company to focus on originating, distributing and managing capital for individuals, governments and institutions. That’s what we do, and this is entirely consistent with that. And Eaton Vance fits squarely in that square.

Operator

Thank you. Our next question comes from Jim Mitchell with Seaport Global. Your line is now open.

Jim Mitchell — Seaport Global — Analyst

Thanks. Good morning. Maybe just a follow-up on E TRADE. If we look at their results in the first half, as you pointed out, James, are very strong, adding 650,000 retail accounts at 14%, cash balance is up 50%. I guess two parts to the question, I guess first, on the flip side, you have lower rates, so how do you think about the accretion targets, given the growth we’ve seen versus the interest rate declines we’ve seen since you announced the deal?

And then secondly, I mean how do you — what’s driving, I mean, obviously the markets are volatile, but do you think that kind of account growth can continue and it’s not a big surprise going forward?

James P. Gorman — Chairman and Chief Executive Officer

Well, let me start and then I’m sure Jon will add. Listen, we are on day 10 or something here. And I know everybody wants to fill out your models. I’m sympathetic to that. Sharon has already told me that’s what everybody is looking for. And I’d love to be able to do that for you, but we’re not going to do that today. They have had unbelievable growth. I think their record new account number before this year was 93,000, and they are over 300,000 in the first quarter, second quarter, couple of hundred this quarter, well over it. They’ve had incredible asset flows into the business. So, will that continue? I think it will stay elevated. It won’t continue at this level.

There will certainly be net attrition because some of these accounts that were opened will close. They were smaller accounts. But they also brought in a lot of large accounts. So I think the answer is, Jim, it was slow, but they have reached. I would — I believe they have reached a new baseline above where they were previously because of all the engagement around the markets.

How their P&L then plays out based on that and based on some of the mortgage and OLS product and other stuff that we put in their system and some of the expenses that we were able to take out and the funding benefits, you know Jon can address that. But we will certainly do a full update at year-end once we have a natural quarter with them sitting inside Morgan Stanley. Jon?

Jonathan Pruzan — Chief Financial Officer

Yeah. I mean, I think, stay tuned for January, but we announced this deal in February. We told you, it would be dilutive in year one, breakeven as in year two, and accretive in year three, and we still think that that’s the general framework and we’ll give you more information in January. We’re just — we just started on this path. We still have high confidence in the funding synergies, the $400 million of cost savings and the broad outline that we outlined in February.

Jim Mitchell — Seaport Global — Analyst

All right. Thanks. Appreciate it.

Operator

Thank you. Our next question comes from Devin Ryan with JMP Securities. Your line is now open.

Devin Ryan — JMP Securities — Analyst

Okay, great. Good morning, thanks for taking the question. First one is just around the acquisitions, and I appreciate you guys have your hands full and the message is nothing big coming soon or what’s it sounds like. But if we take a step back, you’ve added many millions of new retail customers to Morgan Stanley’s ecosystem over a short period of time, whether that be Solium, E TRADE or Eaton Vance. And so if we think about products, are there any big products or services that you’re not touching yet at the firm level that could really makes sense to plug in to this broader retail consumer base or is it really now just more about cross selling existing Morgan Stanley?

James P. Gorman — Chairman and Chief Executive Officer

I think we’ve got a very full plate right now. And I think the biggest opportunity is probably putting mortgage product to high FICO score clients with good assets at E TRADE and putting the banking product through the Morgan Stanley system, the digital banking to go with our — already the two banks that we have. I think they are the two obvious ones, Devin, but I’m not seeing a specific product gap. And as always we have total open architecture. We’ll take anybody’s best product including from all our competitors because if that’s what’s right for the client, then that’s the right thing to do. So I’m not seeing a product gap.

Devin Ryan — JMP Securities — Analyst

Okay, terrific. And then just a quick follow-up. I just want to make sure I’m following what’s happening on the wealth side on the advisor headcount. So this is the first quarter of net additions in over a year, it’s the best addition quarter in five years. And I heard the comment that Morgan Stanley is a destination and also benefited from lower attrition. But is this quarter kind of a one-off in that evolution or is this something that we should maybe focus on as a shift occurring and maybe the backlog could back that up? So maybe just curious kind of what the recruiting backlog looks like and, if we should start to think about your headcount growth again on the financial advisor side?

James P. Gorman — Chairman and Chief Executive Officer

I mean, Jon may have a comment, but it’s hard to predict, but the trend is definitely our friend. And if you look at the net recruiting numbers for the last several quarters, I don’t have them on hand, but I think the gap has been closing. We’ve now turned positive. We’re at an interesting inflection point with that business, it’s got great momentum. That’s all I’ll say. In attrition, part of it Devin is that people aren’t leaving, then by definition you’re going to be growing. But, Jon…

Jonathan Pruzan — Chief Financial Officer

I think that’s right. And the pipeline for recruiting certainly in the near term is strong. We’re attracting attractive teams with good business, books of business. As James said the number of advisors, if you go back, the JV was dramatically higher, the attrition rates are quite low. And on a net basis, we are seeing sort of flat to slightly growing numbers, but more importantly, the assets and the revenues at the new advisors are bringing with them is going to be additive in future years. So it’s a really nice position to be in right now.

Devin Ryan — JMP Securities — Analyst

Yeah. Okay, terrific. Thank you.

Operator

Thank you. Our next question comes from Gerard Cassidy with RBC Capital Markets. Your line is now open.

Gerard Cassidy — RBC Capital Markets — Analyst

Thank you. Good morning, James, Good morning, Jon.

James P. Gorman — Chairman and Chief Executive Officer

Hey.

Gerard Cassidy — RBC Capital Markets — Analyst

Jon, you touched on the prime brokerage results were strong in the quarter, average balances, I think, you said increased as the markets improved, and more clients became re-levered up or engaged more. Can you share with us what’s going on with winning new clients, particularly on the geographies outside of North America? Is that also driving these numbers?

Jonathan Pruzan — Chief Financial Officer

So, a couple of things. We did have a nice quarter in PB. You’re right, balances are up from where they were. They are still below the peak levels. We have seen the long short hedge funds re-lever. Quant still haven’t re-levered as much as the volatility, and the equity market still remains reasonably high. We continue to see a nice pipeline of new launches that adds to the growth dynamic — add to the growth dynamic and it’s been pretty broad-based. So, we continue to believe if the markets remain constructive, if volatility comes down, we’ll continue to see growth in the PB balances which will drive revenue growth in the future.

Gerard Cassidy — RBC Capital Markets — Analyst

Very good. And then as a follow-up, I think, James, you talked about the strength in the institutional business. We’ve been very pleased with the numbers in 2018, ’19 and year-to-date. You cited some of the competitors overseas aren’t as strong. Is there any evidence yet that they are kind of getting back up on their feet and so they are more competitive environment as we look forward or do you think they are still struggling?

James P. Gorman — Chairman and Chief Executive Officer

Well, I don’t think, I have said that, Gerard, to be fair. I just said, there might be opportunity depending what some of the international competitive strategies do. And clearly, some of them have chosen over the last two years to shrink their balance sheets and go back to their core traditional banking businesses more. It’s hard for me to predict. I mean these things wax and wane a little bit, so I don’t want to comment on those strategy except to observe what’s happened, and that’s clearly provided opportunity for some of the US banks but that could change.

Gerard Cassidy — RBC Capital Markets — Analyst

Okay. Thank you.

James P. Gorman — Chairman and Chief Executive Officer

You’re welcome.

Operator

Thank you. Our next question comes from Andrew Lim with SocGen. Your line is now open.

Andrew Lim — SocGen — Analyst

Hi. Good morning. Thanks for taking my questions. So the question for you, James, on the M&A strategy, please. So, you talked a few weeks ago about your disappointment at MS being trading like a bank with PE ratio from 9 times to 10 times. And I can see how buying wealth management and asset management businesses might try and change investors’ perception of that. But I’d like to, sort of like discuss it from a different angle. Why isn’t it a better strategy to divest CIB? It’s not obvious to me that CIB has synergies with asset management and wealth management.

You can have the CIB trading at 9 times to 10 times, and then asset and wealth management trading at 20 times. And on top of that, you could have the bulk of the excess capital with asset and wealth management and that could be returned freely to shareholders with that restrictions from the Fed. So just wondering what your thoughts on that as a strategy to maximize shareholder value?

James P. Gorman — Chairman and Chief Executive Officer

That’s not going to happen. That’s my thought about that. We have an integrated model for a reason. We have the balance from wealth and asset management, we have the engine room, we generate, originate product in our institutional business that helps provide enormous opportunities for our clients across the other side of the house. There are so many synergies, Andrew. That’s just not — that’s not even remotely close to where we think about this business.

Operator

[Operator Closing Remarks]