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Morgan Stanley F4Q07 (Qtr End 11/30/07) Earnings Call Transcript

December 19, 2007 | about stocks: MS

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Morgan Stanley (MS)

F4Q07 (Qtr End 11/30/07) Earnings Call

December 19, 2007 11:00 am ET

Executives

Colm Kelleher - Chief Financial Officer

John Mack - Chairman and Chief Executive Officer

Analysts

Guy Moszkowski - Merrill Lynch

Glenn Shorr - UBS

Prashant Bhatia - Citigroup

Roger Freeman - Lehman Brothers

Mike Mayo - Deutsche Bank

Meredith Whitney - CIBC World Markets

William Tanona - Goldman Sachs

Steven Warden - JP Morgan

Michael Hecht - Bank of America

Douglas Sipkin - Wachovia

Presentation

Operator

Good day, ladies and gentlemen. Welcome to the Morgan Stanley conference call. The following is a live broadcast by Morgan Stanley, and is provided as a courtesy. Please note that this call is being broadcast on the Internet through the company's website at www.morganstanley.com. A replay of the call and webcast will be available through the company's website and by phone until January 19, 2007.

This presentation may contain forward-looking statements. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date on which they are made, which reflect management's current estimates, projections, expectations or beliefs, and which are subject to risks and uncertainties that may cause actual results to differ materially.

For a discussion of additional risks and uncertainties that may affect the future results of the company, please see "Forward-looking Statements" immediately preceding Part 1, Item 1; "Competition and Regulation" in Part 1, Item 1; "Risk Factors" in Part 1, Item 1A; "Legal Proceedings" in Part 1, Item 3; "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part 2, Item 7; and "Quantitative and Qualitative Disclosures about Market Risks" in Part 2, Item 7A, of the company's Annual Report on Form 10-K for the fiscal year ended November 30, 2006, "Management's Discussion and Analysis of Financial Condition and Results of Operations", and "Risk Factors" in the company's 2007 quarterly reports on Form 10-Q and other items throughout the Form 10-K, and the company's 2007 current reports on Form 8-K.

The information provided today may also include certain non-GAAP financial measures. The reconciliations of such measures to the comparable GAAP figures are included in our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on 8-K, which are available on our website, www.morganstanley.com.

Any recording, rebroadcast, or other use of this presentation in whole or in part is strictly prohibited without prior written consent of Morgan Stanley. This presentation is copyrighted and proprietary to Morgan Stanley.

At this time, I would like to turn the program over to Colm Kelleher for today's call. Please proceed.

Colm Kelleher

Thank you, operator and good morning everyone. Before I go through the details of our results, John Mack has joined me and will begin the call. John?

John Mack

Good morning, everyone. The results we announced today are embarrassing for me; for our firm. This was a result of an error in judgment incurred on one desk in our Fixed Income area, and also a failure to manage that risk appropriately.

Make no mistake, we've held people accountable. We're moving aggressively to make necessary changes and [this law shouldn't] be overshadowed the fact that the rest of the firm delivered really outstanding results for the quarter and for the year.

We had a record full year result in investment banking, equity, sales and trading, and asset management. Global Wealth Management was more than double pre-tax profit for the year. The fact is, our core business remained strong. We are moving quickly and decisively to build on that momentum.

The strength of our business and our strategy is clear in the, approximately, $5 billion long-term investment we've announced this morning from CIC, a China Investment Corp. This investment will help us further bolster Morgan Stanley's strong capital position, while also building on our deep historic ties and market leadership in China. It also will ensure we have resources necessary to pursue the growth opportunities we see in this region across all of our businesses: Institutional securities, Wealth Management, Asset Management businesses into '08 and beyond.

Before Colin take you through this quarter's results in detail, I've got a few things I'd like to say. First, to talk about the writedowns in our mortgage business; second, the strong performance across our other businesses; and third, actions we've taken to address this quarter's loss and build momentum across the rest of the firm.

So, let's start with the mortgage business. Let me give you a quick recap of what led this writedown on our subprime trading position. We had a large illiquid trade on AAUK and a deteriorating credit market. The early view is to hold the position, rather than curl the cost of the unwind, as it was believed we had adequate hedges in place.

However, the hedges did not perform adequately in extraordinary market conditions of late October and November. Subsequently, given the illiquidity or positions; we are now writing it down to these levels. We have moved aggressively to address these issues. We've been as transparent as possible about our exposure.

Indeed, back in early November, we provided you details on the net exposure of the subprime trading position in our mortgage business. We told you as of October 31, we expect to take a $3.7 billion write-down of the subprime position. We also made it clear that year-end remarks would depend on market conditions.

During the month of November, the value of that position continued to deteriorate, that led us to write down another $4.1 billion on the subprime trading position in the fourth quarter. We were also taking a writedown of $1.6 billion on other mortgage-related assets that had suffered deterioration in value as a result of dislocations in the mortgage market. Colin will take you through that later on.

Virtually, all writedowns this quarter were the result of trading about a single desk in our mortgage business. And I want to be absolutely clear as head of this firm, I take responsibility for performance.

Let's go to our other businesses. Beyond the loss of our mortgage business, almost every other business at Morgan Stanley continued to perform exceptionally well this quarter, and as I said earlier, strong for the year.

Our Investment Banking revenues were a record $5.5 billion this year, up 31% from last year. We finished rank number one in global completed M&A, and number three in global IPOs.

Our Equity sales and trading revenues were a record $8.7 billion, up 38% from last year. We had record results both in derivatives and prime brokerage, where we continue to be market leaders. Equity underwriting revenues were up 48% at a record $1.6 billion.

Our Global Wealth Management business has been dramatically reinvigorated. Revenues were up 20% from last year. We had a PBT of $1.2 billion, up a 127%, margins at 21% in the fourth quarter, the highest quarterly margins since 2000, and a major improvement from the 2% margins this business is delivering in early '06.

Our financial advisors are now the most productive in the industry, with the record annualized FA productivity of 853,000, and we had strong client inflows of $40 billion this year.

Our Asset Management business also delivered its best year ever in '07. We had record revenues of $5.5 billion, up 59% from last year. We had a record PBT of $1.5 billion, up 72%. We achieved five consecutive quarters of net customer inflows. Our asset management business has also reached a record high of $597 billion at the end of November, up nearly 35% from two years ago.

Our international business has never been stronger across Europe, Asia and the emerging markets. We achieved record international revenues of almost $16 billion this year, up 44% from 2006.

In Asia, we finished the year ranking number two in IPOs overall, and number one in China-related international IPOs. In China, we've tripled our revenues over the past year. We've secured a banking license. We are now in the process obtaining a securities license, a trust license and asset management license, which will help continue strengthen our Chinese business.

We are also building out our businesses in the Middle East as well, forming a joint venture with the Saudi Arabia securities firm, Capital Group and opening new offices in the region. Those important investments will help us increase our revenues about 90% in the Middle East since '05.

Now, let me move to kind of the actions that we’ve taken. While, we move very aggressively as you know, the issue raised by our loss in the mortgage business insure that we are well positioned to build on our businesses going forward. So, we have made some major changes. We have put in place a new senior management team. We changed Gorman and Walid Chammah as Co-Presidents, with Mitch Petrick as Global Head of Sales, and Trading and Ellyn McColgan as Head of our Wealth Management business, which we announced yesterday. I think it was in the press.

We've also made other changes to restructuring our institutional sales and trading businesses. We are further strengthening our risk management function. It will now report to Colm our CFO, and we will look to add additional talent to our risk management team. We are also restructuring our prop trading businesses. These businesses will operate under unified management reporting to Mitch.

Finally, as I mentioned earlier, we have further strengthened our balance sheet by raising approximately $5 billion in capital to the long-term passive investment made by China Investment Corp. That investment grew out of our strong relationship in China, and I believe will help strengthen our deep ties to this critical important growth market in the years ahead.

So, as we move forward, I'm confident these actions and the new leadership team we put in place will help us adjust to the changing market conditions.

The near-term outlook is challenging. The mortgage business is going to be dramatically reduced. Credit and leverage lending would be on a lower basis, as well. However, despite challenging credit markets, we see opportunities in other parts of our fixed income business, as well as, in equities and investment banking. We continue to have strong momentum in Asset Management and Global Wealth Management.

We remain bullish on Morgan Stanley's significant growth opportunities in our international and emerging businesses. The fact is, that we have a strong broad-base business. We are positive about our business mix, and we continue to believe diversification is a great strength of ours. And despite the challenging market conditions we're facing, we are optimistic about the long-term prospects for this global growth of financial services and for Morgan Stanley.

And with that, I'm going to turn it over to Colm.

Colm Kelleher

Thank you, John. We have a lot of material to cover today, and it will take some time, but I want to make sure that we provide you with all the information you need for your analysis. There will be plenty of time for questions-and-answers.

As you are aware, over the past year our trading Group decided to short the subprime market. The traders were short, the lowest transaction in subprime securities with a notional value of approximately $2 billion. The traders decided to cover the cost of the negative [count] in the short position. In doing so they went along approximately $14 billion at the Super Senior AAA or BBB subprime securities, we refer to as mezzanine.

But the credit market declined dramatically; the implied cumulative losses in the subprime market [action] to the value of the Super Senior AAA branch were [notionally] long. As a result, notwithstanding the short position, the implied loses of the notional long generated a major net loss from the position of advanced markets.

The loss was non-linear with the decline of the relevant ABX index, given the long-short structure of this particular trait. Now, when I last spoke with you November, we provided a risk management non-GAAP perspective on our US subprime exposure through October 31. On page 15 of the supplement, you can see the updated schedule through November. Our writedown reflected the impact of November increased to $7.8 billion from $3.7 billion as of October 31, while our total net exposure decreased to $1.8 billion from $6 billion over the same period.

Using consistent valuation methodology, the fair value of these positions declined from October 31 to November 30. Our valuations of these positions takes into consideration observable traits, the continued deterioration in market conditions, the decline in the ABX indices and other market developments, including updated mortgage remittance and cumulative loss data.

The decrease in the fair value of our subprime exposures has led to our first quarterly loss. The traits we observed on exposures has led to our first quarterly loss. The trends we observed were those we executed in November, as part of our effort to reduce our exposure. The ABX deterioration in the class to two senior positions, namely the BBB061 Vintage where our most significant exposure risk, was approximately 24% during November, which relates to 2005 collateral.

In addition to the $7.8 billion in subprime writedowns, we also wrote down approximately $1.2 billion in other mortgage related positions as a result of fair value declines in November, of which $400 million relates to CMBS, were trained to execute as part of our balance sheet reduction.

A $180 million in Alt-A, and other loans, where credit spreads widened and real estate deteriorated. $175 million in first and second year loans spent for securitization, while subordination changes by rating agencies and executed trades at $450 million of European non-conforming loans on credit spread widening and executed trades.

We also took a $435 million writedown on the securities available for sale portfolio in our subsidiary banks. We continue to see value in this portfolio, which is made up of exclusively of AAA rated residential mortgage-backed securities and the portfolios contains no subprime home loans, subprime residuals or CDOs.

This portfolio was re-designated as trading effective November 30. To preserve our flexibility with the portfolio until [in line] with the accounting treatment of our other trading portfolios so that any mark-to-market will flow directly through the income statement each quarter.

These factors totaling $9.4 billion in writedowns drove the fourth quarter loss $3.6 billion down from last quarter's $1.5 billion profits. The EPS impact from these writedowns was $5.80. Basic EPS from continuing operations for the quarter was a loss of $3.61 per share versus $1.45 gain the quarter last quarter.

Net revenues were negative $450 million driven by the loss of fixed income revenues reflecting the write-downs I mentioned. As John said, despite clearly disappointing results in our credit trading business with fixed income, many of our businesses produced record results and contributed to the second strongest year on record.

Let me now address other aspects of our firm-wide results, which are outlined on pages one and two in the financial supplements. Consolidated revenues for the quarter were negative $450 million, and total non-interest expense were $5.4 billion, down 6% from last quarter.

Our largest component Compensation and Benefits expense were $3.2 billion, reflecting an adjustment to the full year payout. Despite the quarter with significantly lower revenues, our compensation reflects strength across most businesses and our recognition of the competitive environment and the need to retain talent.

The full year compensation to net revenue ratio is 59%. As you know, next year’s compensation is very difficult to forecast, particularly given on certain market conditions in 2008. As of now, the best data point we can direct you to is our full year 2006 comp net revenue ratio of 47%. We will provide you with updated guidance in the first quarter.

Non-compensation expenses was $2.2 billion, which includes the $360 million reversal of the Sunbeam Coleman Reserve resulted from the recent Florida Supreme Court decision. Excluding this reversal, non-comp expense dropped 21%, driven by higher business development in professional service expenses. Our full year revenues decreased 6% from 2006.

Our effective income tax rate continuing operations for the full year was 24.5%. The decrease reflects the impact of lower earnings and lower tax rate applicable to non U.S. earnings partially offset by lower estimate domestic tax credits.

At this point, we would anticipate that next tax rates will be close to 2006 tax rate of approximately 33%. The raise depends on a number of factors including the level in geography mix of our earnings.

Now, I would like to discuss the details of our business segment results. Starting with Institutional Security which is detailed on page five of the supplement. The significant loss on fixed income sales and trading drove negative revenues of $3.4 million in this segment, down a 169% from the third quarter.

Non-interest expense of $3.1 million decreased 12%, driven by lower compensation expenses, excluding $360 million recovery the Coleman Sunbeam Reserve, non-interest expenses were down 2%.PBT was $6.5 billion loss.

Full year net revenues were $16.1 billion, down 24% from last year, yet still the second highest on record. Full year PBT decreased 89% to $817 million, and return on equity was 4%.

Page six of the supplement shows sales and trading reporting total negative revenues of $5.6 billion, reflecting the loss in our credit business within fixed income and the write-down and securities available for sale portfolio within other sales and trading. These losses were partially offset by record results in equities and recoveries related to our leverage lending business.

The credit environment impact in our sales and trading results was partially offset by a gain of approximately $455 million from the spread widening in Morgan Stanley’s credit on some of our own structured notes. Of this amount, approximately $185 million was reported in fixed income sales and trading, and $270 million in equity sales and trading. In fixed income sales and trading, we reported $7.9 billion in losses, compared to $2.2 billion in revenues last quarter, reflecting the write-down of our subprime related assets. For the year, fixed income sales and trading revenues was $650 million, down 93% from our record results in 2006.

Corporate credit and securitized credit product sales and trading, which includes our residential and commercial mortgage business reported losses of $9.2 billion, down from an approximately $260 million gain last quarter. Majority of the losses were in our U.S. subprime residential business, and the result’s partial positions that we took in the beginning of 2007. The other mortgage related markdowns were driven by the November fair value deterioration I mentioned earlier. Interest rates and currencies all were down 17% from our record third quarter, continues to perform well in this environment reflecting strong customer flow, increased volatility and the $185 million benefit from the impact of widening credit spreads on firm-issued structured notes.

Commodities decreased 84% driven by lower trading revenues across metals, oil, electricity and natural gas and the lack of structured deals this quarter. Our client flow business performed well, it was more than offset by poor positioning performance relative to opportunity in the market created by volatility of most products.

Equity sales and trading revenues of $2.5 billion were 40% higher than last quarter, that set a new quarterly record. For the year, equity sales and trading revenues were up 38% to $8.7 billion, our best year ever. Looking at the quarter, strong revenues were driven by client flow of prime brokerage businesses, positive results in our Quant trading strategies for $270 million benefit for the widening of credit spreads of firm-issued structured notes and regional strength outside the U.S. especially in Asia. Non-U.S. regions contributed well than half of this quarter's total revenue. The cash business had record revenues and strong performance across regions including record results in Europe. Derivative revenues decreased from a strong third quarter reflecting difficult market conditions with poor liquidity and even volumes.

Our quantitative strategies business recovered from losses last quarter that contributed healthy revenue gains more consistent with historical level, despite operating in a reduced risk and capital environment. Our prime brokerage business produced the second best revenue quarter ever with our average customer balances down slightly from the end of the third quarter. Outside of the U.S., the business reported record revenues. Our prime balances were down slightly towards a significant increase in client balance in October though it sustained in November consistent with the recovery in the equity markets.

For the full yea,r this business produced record revenues and client balances of each region. Other sales and trading was negative $202 million, driven by the write-down in our securities available-for-sale portfolio offset by recoveries and our leveraged acquisition pipeline reflecting the improvements in liquidity that we’ve saw in the quarter. Loans and commitments detail is on page 7 of the financial supplement. As we told you last quarter, our leverage finance business is subject to liquidity in the marketplace and this quarter we saw deals price activity began to return to the market. Total loans and commitments net of hedges declined $12.1 billion, to $55.1 billion. Commitments including both investment and non-investment grade are down 18% to $70.2 billion, through a combination of deal closings, renegotiation or deals going away.

Now, just based on our total loans and commitments, we'll continue to drive in the Q1, if capital markets remain receptive. On non-investment grade corporate lending commitments of $20 billion, this includes $12.2 billion of commitments related to our leveraged acquisition finance pipeline, which is down from $31.3 billion. Over the course of the quarter, $4.4 billion of deals were withdrawn and $14.7 billion of deals were closed. Of the deals closed, $6 billion have been funded and are included in the $10 billion of non-investment grade loans.

Moving to page six of the supplement, Investment Banking revenues were $1.4 billion, down 5% in the third quarter of '07. Advisory revenues increased 17% to a record $779 million, driven by revenue strength across all regions. Underwriting revenues were lower than last quarter in both, equity and debt underwriting. Sequentially, equity underwriting revenues were down 19% to $348 million, but up 37% from the fourth quarter of '06 with particular strength in Asia, fixed income underwriting revenues of $236 million, down 32% from the third quarter largely reflecting the decline in non-investment grade issuance as investors grappled with the deterioration in the credit environment. Partially offsetting this decline was the significantly increased demand for investment grade debt in the quarter, especially during September and October. The investment banking environment was mixed during the quarter, volumes decreased across products as uncertainty returned through the overall market in November, except an announced M&A where volumes remained healthy. We maintain leading positions in our lead table standings for the calendar year-to-date through November. We continue to meet M&A market shares and the number one rank in M&A completed at approximately 37% market share; on number two it announced with approximately 33% market share. Our rank in U.S. IPOs is number one, and we are number three in global IPOs. We are number two in U.S. equity-related issues, and number five globally.

At Bloomberg, we are number two in global IPOs, number two in Asia Pacific equity offerings, and number one in International China IPOs. In debt underwriting, our rank was number five, with a stable share of the market. Our rank in investment grade debt market is number four. Our non-investment grade rank was number nine. Full year advisory revenues increased 45% to a record $2.5 billion, 21% higher than the previous record set in 2000. Equity underwriting was up 48%, to a record $1.6 billion, and debt underwriting increased 1% to a record $1.4 billion. Our investment banking pipelines continue to be healthy.

Depending on market conditions, we remain cautiously optimistic about our M&A backlog, as there is a favorable flow of strategic activity even as we expect financial sponsor activities down in 2008. Our equity backlog is higher than the third quarter and fourth quarter of '06, with particular strength in Europe and Asia. But our non-investment grade debt backlog is down significantly, investment grade backlogs are higher as capital raising needs remain robust. Principal transactions, investment revenues were $496 million up $279 million increase versus the third quarter and full year revenues increased 35% in 2006. The increases were largely driven by higher investment gains in Bovespa Holding to the fourth quarter and Grifols SA in the full year.

As John mentioned, we are very focused on our risk management and VaR represents one of the key measures of risk. Aggregate average trading and non-trading VaR increased to $98 million from $91 million last quarter, driven predominantly by the increase in non-trading VaR. The increase in non-trading VaR primarily reflects the firm's exposure to event loans that closed during the quarter and are currently in the process of being distributed.

Aggregate average trading VaR increased modestly to $89 million from $87 million. Aggregate quarter-end trading VaR decreased to $78 million from $81 million, reflecting an active reduction in risk exposure that was offsetting the VaR model by higher realized market volatilities.

We have aggressively and thoroughly reviewed our stress test scenarios to ensure that the market moves contained in these scenarios are superior enough, in light of what's going on in the markets.

Over the past two quarters, we have repeatedly increased the magnitude of market moves contained in our stress test scenarios, reflecting the increased levels of uncertainty and realized market volatility. In the high levels of price volatility realized during this quarter, we continue to pay close attention to our stress test scenario result, one of the most meaningful risk indicators with respect to rapid and dramatic market moves.

As John mentioned, we are issuing approximately $5 billion of securities to the China Investment Corporation (CIC) that mandatorily convert into shares in August 2010. This additional equity capital will build the firm's strong capital position and enhance our ability to pursue global growth and revenue opportunities.

Mandatory convertible securities we are issuing to CIC targeted yield of 9% and the after-tax profit approximately 7% because significant portion of the yield is tax deductible. Therefore, the after-tax yield of these equity securities is only 4.75% over our common dividend yield.

In return for this excess yield of these equity securities, we retain the first 20% depreciation of our stock price. We believe that the combination of paying less than 5% annual excess yield probably two years and seven months, the return for 20% premium is attractive to our shareholders. The 20% premium will be set above a reference price to be determined shortly.

The number of shares the mandatory convertible securities will convert into is based on our stock price of conversion. A higher future stock price lowers the cost of the equity capital because the number of shares issued at conversion declines.

Given this feature and the tax deductibility of the yield on the combination of regulatory capital eligibility and high equity trading from the rating agencies, we believe this is an attractive security to add to our capital base, as we pursue growth and revenue opportunities in 2008 and beyond.

Turning to page 4 of the Supplement on our current capital position, average unallocated capital, economic capital was negative $400 million, down from $3.5 billion surplus the last quarter. The period end unallocated economic capital was a shortfall of $4.1 billion. However, the firm continues to maintain total capital level to significantly exceed regulatory requirements.

Over the course of the quarter, we assessed and assigned more economic capital requirements for our businesses, particularly institutional securities, while available capital decreased due to the write-downs. Capital requirements for institutional securities increased mainly due to increased volatility in the credit markets and rating has declined in underlying assets of certain credit businesses.

We also intend to strengthen our balance sheet and optimize deployments of capital across our businesses. Furthermore, we will maintain flexibility in our share repurchase program, while we build up our capital. During the quarter, we repurchased approximately 9.2 million shares of common stock for approximately $560 million.

Year-to-date, we have repurchased approximately 51.7 million shares of common stock for approximately $3.8 billion. Even after reflecting the write-downs and losses in our fixed income business and response to current market conditions, we reduced total assets on the balance sheets by a $133 billion to $1.1 trillion. This brought the adjusted leverage ratio down from 18.8 to 17.6.

These steps including the investment by CIC will ensure that Morgan Stanley has resources necessary to pursue growth opportunities globally across our institutional securities, wealth management and asset management businesses into 2008 and beyond.

Page 8 of the Financial Supplement describes our Global Wealth Management business. Despite the market environment in the quarter, Wealth Management produced very strong results; the fourth quarter was our best revenue quarter to the second quarter 2000.

As we announced earlier this week, Ellyn McColgan will be joining the firm to succeed James Gorman as President and Chief Operating Officer of GWM in April 2008. Ellyn brings the breadth and depth of experience that will enable us to build the momentum we have achieved in this business over the past two years.

Revenues reached $1.8 billion, up 6% from the third quarter, as the retail investor remained active during the quarter.

Commission on principal trading results was strong, which more than offset the sequential decline in investment banking revenues. Non-interest expenses of $1.4 billion were up 1% from last quarter, reflecting increases in business development expenses, the absence of the insurance recovery in the third quarter and commission-based compensation reflecting higher revenues. We continue to focus on and maintain a cost discipline. I believe that expense control can help fund our investment spending as we grow this business.

PBT of $378 million was up 32%, and our PBT margin increased to 21% from 17% in the last quarter. The return on equity of this business was 52%.

2007 was our second best year ever with strong performance across the business, reflecting higher financial advisor productivity, new and enhanced product offerings, strong client activity and focused cost discipline. The full year net revenues of $6.6 billion, were up 20% and expenses of $5.5 billion increased 9%.

PBT totaled $1.2 billion, up a 127% from 2006, and our PBT margin improved 17%. The return on equity for fiscal '07 was 41%.

On page 9 of the Supplement, you can see the strong productivity metrics. Net new assets of $10 billion represented our 7th consecutive quarter of positive client influence.

Assets in the $1 million plus household segment increased $29 billion in the quarter, increased to 72% of our total client asset base, as we continue to be effective in gathering assets in the high network segment.

Total client assets increased 3% sequentially to $758 billion, driven by both marked increases of net new assets. Fee-based assets represented 27% of the total, down from 29% last quarter. This decline largely reflects the termination on October 1st of our choice of fee in lieu of commission brokerage program.

Client assets in the Choice program primarily moved to commission-based brokerage accounts for the election of our clients, the fee-based advisory programs including Morgan Stanley Advisory, a new norm discretionary advisory account launched in August. In addition, we are developing an [internship] program that we believe will be attractive to former Choice clients.

Average production and total client assets for Global represented record levels in the quarter of $853,000 and $90 million, respectively, as our FA headcount increased to 8,429 producers.

We are achieving increased FA productivity, while growing the number of FAs. We continue to hire producers with higher production than those we lose. Our bank deposit program ended the year at $26.2 billion, exceeding our goal of $20 billion.

We launched another closed-end fund this quarter, PIMCO Income Opportunities Fund bring the total to five this year with over $4 billion in sales. While there may be pressure on this business in 2008 if U.S. enters the recession, we believe that our more protected sales force including new hires will mitigate the slowdown in retail activity.

We will continue to invest in technology and other infrastructure and continue to expand our U.S. and international Private Wealth Management business to grow our global footprint and capture the long-term growth potential of the business.

On page 10 of the Supplement, we describe our Asset Management business. The business perform well in the quarter, net revenues were $1.3 billion were down 8% for the third quarter, driven primarily by $129 million of losses in securities issued by structured investment vehicles SIVs and held by asset management.

Our total SIV exposure in our money funds as of today is $7.7 billion; of that 92% is in lower risk SIVs that are sponsored by banks, which have continued to support our SIVs. Income before tax is $294 million, down 40% from the third quarter driven by lower revenues and higher expenses including both compensation and non-compensation expenses. PBT margin was 24%, and ROE for the quarter was 18%. Looking first of revenues, our principal transaction revenues excluding the losses of securities on non-bank sponsored SIVs and held by asset management decreased 7% reflected lower revenues from real-estate investment is offset by higher alternative investment gains.

Management and admin fees, a key indicator of the positive momentum in this business increased 6% to just under $1 billion driven by asset growth in a more favorable asset mix. Non-interest expense of nearly $1 billion grew up 10% for the third quarter driven by higher compensation reflecting expenses associated with deferred compensation plans as well as increases in professional services and occupancy cost. For the full year revenues were a record $5.5 billion up 59% from 2006. PBT was $1.5 billion, PBT margin was 27% and our return on equity was 26%. This year we successfully built our management team and expanded our product array. We had a very successfully year for capital raisings. In our Private Equity Asia Fund III, we have raised $1.5 billion including $350 million of commitments from the firm. In real-estate, we’ve raised almost $15 billion in 2007 across our funds most notably measured at fixed international where we have a rate $8 billion and committed $1.6 billion of our own capital.

As you can see on page 11 of the supplement, it should be continue to show improvement in all key metrics. Assets under management and supervision increased by $20 billion to end the quarter a record $597 billion primarily due to market increases in September and October. We have $400 billion in total net inflows as $5.6 billion of inflows in non-liquidity products were partly offset by $5.2 billion of outflows in liquidity products.

Positive net flows were driven by non-U.S. channels that had $7.4 billion of inflows, the majority of which were from alternatives from real-estate products. U.S. institutional and America's intermediary channels had inflows of $800 billion and $400 billion respectively. Van Kampen and Morgan Stanley branded retail funds showed outflows of $1.4 billion and $1.6 billion during the quarter respectively. Institutional liquidity outflows were $2.9 billion compared to $12.4 billion in net inflows last quarter. This quarter’s short-term outflows were driven by an expected $5.2 billion client outflow gained in the prior quarter.

Retail liquidity outflows are $2.3 billion primarily driven by additional bank deposit programs introduced in our Global Wealth Management business. Our total net inflows of the year were $35 billion, when compared favorably to the $9.3 billion in net outflows we saw in 2006. We launched and incubated 14 new products in the fourth quarter including six alternatives, seven in equities, and one in fixed income. For the full year we launched 74 new products, 37 in alternatives, 25 in equity, and 12 in fixed income.

In a summary, we are pleased with the performance of this business. We are focused on improving our margins and our own products expansion, especially in alternatives and widening our distribution capabilities. In addition, we continue to develop our private equity and infrastructure investment management business and continue to see investment opportunities generated from the firm's franchise and geographic footprint.

Our global real estate business operates at a higher level around the world and we continue to raise new funds to take advantage of the current market dislocation. Real estate fundamentals generally remain intact, although headwinds will increase when we get the downturn, given the downturn on the economic activity on the fallback and availability of debt financing. We will continue to be focused on expanding our non-U.S. footprint in both Europe and Asia, as well as invest in our Morgan Stanley and Van Kampen brands.

On page three of the supplement, you can see the regional revenue disclosure at the firm-wide level. This year 43% of our revenues have come from the Americas, 36% from Europe, Middle East and Africa, and 21% from Asia. Year-over-year international revenues have increased 44%.

Our regional results in the second half of 2007 are skewed in favor of non-U.S. results and the majority of our trading losses is sustained in our U.S. business. If we were to exclude these losses, 55% of our revenues will be from the Americas, 29% from Europe, Middle East and Africa, and 16% from Asia. We continue to believe that the pace of international growth will exceed that of the U.S.

Next, I'd like to review with you other mortgage related assets on the balance sheet to briefly discuss the valuation methodology for each. In non-subprime residential mortgages, we have both balance sheet and net exposure in the U.S., Europe and Asia. This includes RMBS bonds, European mortgage loans and to a lesser degree residential Alt-A loans.

At end of the fourth quarter, we had $16.4 billion on our balance sheet with a total net exposure of $10.8 billion, and a write-down reflected in our income statement on $800 billion this quarter. These positions are value based on subordination changes by rating agencies and execution of trades and comparable instruments.

In CMBS, commercial whole loans we have $31.5 billion on the balance sheet at the end of the fourth quarter. During the quarter, we significantly reduced our net exposures to these positions by more than half from $36.2 at the end of the third quarter, to $17.5 million at the end of the fourth quarter. The write-down on the portfolio was $400 million, based on fair value inline with the observable market prices from our executed trades. A majority of these assets are categorized as Level 2. Our residual exposures are well diversified and approximately two-thirds are outside of the U.S. As a result of the write-downs in the quarter, the level of financial assets categorized in Level 3 has decreased. The movement of assets from Level 2 into Level 3 category was more than offset by losses in Level 3 driven by corporate and other debt and derivative contracts.

In our 10-K, and that’s in amongst position is classified within the same level, will be now included in that level. In our third quarter disclosure these positions were showed on a gross basis we’re going to actually – going to a separate column, this will be now more comparable to our peers. Within this presentation, change of total asset position in Level 3 at the end of the third quarter was, approximately, 7% of our total assets and Level 3 liabilities represents approximately 2% of total liabilities. While we're still working on the fourth quarter disclosures, we anticipate that the total Level 3 asset positions as a percentage of total assets and the total Level 3 liability positions as a percentage of total liabilities will remain approximately the same when we file our 10-K.

Now, a bit on the outlook. As I mentioned in August and again in November, we believe that the credit environment remains challenged. It may take several quarters to return to a more normal market activity levels of credit extension on liquidity provision. As we said last quarter, this affects not only trading but also customer flow and securitization. Lending standards have tightened and we are seeing a return to more traditional credit analysis. We expect many of the structured credit products to remain challenged for an extended period. However, there continues to be opportunities in other areas of fixed income including interest rate, foreign exchange, commodity products and within emerging markets.

Volatility in the equity markets does not appear to be subsiding. This creates opportunities in our cash derivatives and prime brokerage businesses. Investment banking pipelines remain healthy across advisory equities and fixed income, and we are still cautiously optimistic.

Asset Management and Global Wealth Management continue to provide strong results for the market turmoil and a positive momentum going into next year. The near term cyclical challenges do not change our view of the long-term secular growth opportunities. But we will continue to allocate resources and capital into high growth areas globally and on a risks reward basis.

Thank you for bearing with me; we are now happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions).

And our first question comes from the line of Guy Moszkowski with Merrill Lynch, go ahead.