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Morgan Stanley (NYSE:MS)
Q1 2018 Earnings Conference Call
April 18, 2018, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Sharon Yeshaya -- Head of Investor Relations

Good morning. This is Sharon Yeshaya, Head of Investor Relations. During today's presentation, we will refer to our 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

Thank you, Sharon. Good morning, everyone. Thank you for joining us. 2018 began on a very strong footing. In the first quarter, firm revenues and net income were a record -- $11.1 billion and $2.7 billion respectively. The ROE of 14.9% comfortably exceeded our targets, albeit in what is typically a seasonally strong quarter. Importantly, the quarter's performance demonstrated our inherent operating leverage in an attractive market environment. Results across all businesses were consistently strong.

Our Sales and Training businesses performed exceptionally well against a backdrop of heightened volatility and client activity. Equity Sales and Trading benefited from strong volumes across all regions. Return volatility in rates and FX markets provided clients with an opportunity and a catalyst to rebalance their portfolios. This activity, combined with the rising U.S. interest rates and changes in inflation expectations, contributed to strong fixed-income results. We remain appropriately sized to take advantage of active markets when they present themselves.

Investment Banking demonstrated sustained strength despite new-issue markets being punctuated by periods of elevated volatility. Wealth Management remained solid. For the quarter, a combination of continued advisory growth supported by secular trends and the business' scale-driven operating leverage produced record pre-tax profit of $1.2 billion. This represents an almost 20% year-on-year increase in PBT with the margin and the range we set to achieve over the next two years. At the same time, we continue to actively invest in the business, building out our digital offerings, banking products, and technology capabilities more broadly.

Investment Management again witnessed net long-term inflows over the quarter as the team continues to produce strong investment returns across both alternatives and public markets. We expect attractive returns from investment management in the years ahead, particularly as we take advantage of our global platform. In the quarter, we closed the Mesa West acquisition and made several key hires.

We've often said that wealth and investment management give us ballast, and our other businesses make up the engine that drives this firm forward in more active markets. That is exactly what we witnessed in the first quarter. For the past several years, a lot of focus has been put on the importance of the stability that wealth management has brought to our firm. This focus has been appropriate. Margins of 26.5% on revenues of $4.4 billion would have been unthinkable just three years ago. However, what has not been discussed as often is our continued commitment to strengthen the Institutional Securities businesses. In Institutional Securities alone, the dominance of Equities, the strength of Fixed Income, and the breadth of Investment Banking generated over $6 billion in revenue.

Along with the rest of the industry, we recently submitted our 2018 CCAR plan. As has been widely reported, this year's scenario is more severe than previous years. Of course, we don't have full transparency into the Fed models, but over the years, we've seen a reasonable degree of variability. Therefore, we're prepared for a range of outcomes this year. More importantly, beyond this year, the Federal Reserve has recently requested comments on several proposed rulemakings. We expect that we -- and the U.S. financial sector more broadly -- will benefit from more sensible and less complex regulation. We believe we are sufficiently capitalized and expect to maintain our attractive capital return profiles over coming years.

As we look forward, our objectives remain the same: To execute on our strategy and deliver on the medium-term goals laid out at the beginning of this year. I'm confident that given our business model, mix, and the competitive strength of our global franchise, we're very well positioned. I'll now turn it over to Jon to discuss the quarter in detail.

Jonathan Pruzan -- Chief Financial Officer

Thank you and good morning. The first quarter's results were strong across businesses and regions. Global markets were active. Our Institutional Securities businesses benefited from increased trading volumes and the return of healthy volatility across many asset classes. Our wealth and investment management businesses delivered solid results, weathering softer asset prices. Revenues were up 17% sequentially to $11.1 billion, a firm record after excluding the impact of DVA in prior periods. PBT was $3.4 billion, EPS was $1.45, ROE was 14.9%, and return on tangible common equity was 17.2%.

Total noninterest expense was $7.7 billion, up 10% year over year. The increase was driven by a combination of higher compensation expenses and execution-related costs associated with higher revenues and business volumes respectively. Continued investments into technology also contributed to the increase. Over that same period, revenue growth was 14%. In the quarter, the firm efficiency ratio was 69%, with all segments contributing to strong operating leverage. The gross-up impact of the new accounting guidance for revenue recognition was not material at the firm level. The details are more fully described in the quarterly supplement.

Now, to the businesses. Institutional Securities generated revenues of $6.1 billion. This represents a 35% sequential increase and the best performance for the segment as a whole since 2007. Investment Banking, Equities, and Fixed Income all contributed to the results. Non-compensation expenses were $1.8 billion for the quarter, a 6% increase, driven by higher execution expenses. Compensation expenses were $2.2 billion, representing a compensation-to-net-revenue ratio of 35.4%.

In Investment Banking, we generated revenues of $1.5 billion, a 5% increase over our strong fourth quarter. The results reflect the combination of increased advisory revenues and stability in underwriting. All regions demonstrated strength. Advisory revenues for the quarter were $574 million, up 10% sequentially. Announced M&A volumes have had a strong start to the year. Notably, there has been a pickup in both larger and cross-border transactions. Clients remain engaged and pipelines are healthy.

Turning to underwriting, new-issue market conditions were more challenged during periods in the quarter. Despite bouts of heightened equity volatility, rising interest rates, and wider credit spreads, results remain solid. Equity underwriting revenues of $421 million were up 1% sequentially. The market backdrop impacted our ability to convert some of our IPO backlog, but follow-on activity remained robust. Regionally, we witnessed strength in Asia and the Americas. We also saw issuers take advantage of higher volatility through increased convertible issuance.

Fixed Income underwriting revenues increased 4% sequentially to $518 million. A decrease in high-yield financing was offset by increased investment-grade issuance. This was supported in part by event-driven activity, including one large financing we provided together with our partner, MUFG. Overall, Investment Banking pipelines remain healthy and diversified across products, regions, and sectors. However, as demonstrated by recent market dynamics, future activity may be impacted by regulatory, macroeconomic, and geopolitical factors.

Our Sales and Trading businesses produced revenues of $4.4 billion, up 64% quarter over quarter. Increased market activity, strong client engagement, and more favorable bid offer spreads -- particularly during the first half of the quarter -- drove the improvement in results. In Equities, we retained our leadership position and expect to be No. 1 globally. Revenues were $2.6 billion, up 33% sequentially, on strengths across all products and all regions.

Derivatives had a very strong quarter as episodes of volatility created significant trading activity and strong client demand for hedging solutions. A combination of higher client balances and increased engagement generated a sequential rise in prime rate brokerage revenues. And, cash revenues also saw a quarter-over-quarter increase, benefiting from strong volumes globally, particularly in Europe and Asia.

Fixed-income was also strong. Revenues in the first quarter were $1.9 billion, more than doubling fourth-quarter results. While seasonal patterns were a contributing factor, the sharp rise in interest rates in the early part of the quarter, heightened volatility levels, and the rise in inflation expectations aided activity and our performance. Our macro business performance was solid, driven by improved sequential performance across rates and FX. The credit businesses performed well. Our securitized product group had one of its best quarters in close to four years, driven by strength in Europe and a more active trading backdrop. Deepening our institutional lending footprint has aided this revenue stream.

Commodity revenues were also strong. The results benefited from both an increase in flow activity and more structured transactions, which can be episodic. Fixed-income results demonstrate the operational flex in the business and the segment's ability to service clients in a range of market environments. Average trading vol for the period was $46 million, up from $38 million in the fourth quarter 2017. The increase was driven by higher market volatility and facilitation of increased client activity.

Turning to Wealth Management, revenues of $4.4 billion were down 1% quarter over quarter as continued growth in asset management was offset by the impact of mark-to-market undeferred compensation plan investments. Despite lower sequential revenues, the segment produced record pre-tax profit of $1.2 billion, resulting in a PBT margin of 26.5%. The 40 basis points of sequential margin increase and 250 basis point uplift compared to last year's first quarter demonstrates the operating leverage in this scale business. On a year-over-year basis, non-compensation expenses were flat despite an 8% growth in revenues.

Total client assets were essentially unchanged at $2.4 trillion, reflecting softness in domestic and international equity indices. Fee-based assets continue to be a source of long-term organic growth for the business, supported by both conversions from brokerage and net new asset flows into the firm. Net fee-based asset flows of $18 billion were strong. As a result, fee-based assets reached a new high of $1.1 trillion or 45% of total client assets.

Asset management revenues were $2.5 billion. Positive flows and last quarter's higher asset levels were partially offset by the effect of fewer calendar days in the quarter. Net interest income was $1.1 billion. Higher average balances and yields were offset by an increase in funding costs, driven primarily by higher rates on our deposits. Lower sweep deposit balances also impacted NII as retail clients have continued to deploy cash into the market. Cash in our clients' accounts remains at historic lows and equity allocations remain at historic highs, hovering around 54% of client assets.

On a year-over-year basis, net interest income is up 8%. This has been driven primarily by an increase in wealth management and lending in the U.S. banks. Loan balances are up $6.7 billion or 11%, with growth across both SPL and mortgage. In the quarter, loans grew by 1% to $68.3 billion. The more modest pace of sequential loan growth was driven by rising rates, steepening paydowns, and a lower level of mortgage reduction as we transition to our in-house origination platform. Retail engagement was strong in the quarter as investors actively repositioned portfolios and responded to market volatility. However, total transaction revenues of $747 million were down 5%, driven principally by the impact of mark-to-market undeferred compensation plans.

This quarter's results underscore the ability of the segment. Despite gyrations in equity markets and our pace of investment, pre-tax profit reached new highs. We continue to pursue enhancements to our digital capabilities, and we're continuously introducing new applications to the organization. Over time, we believe that these advancements will enable our advisors to provide better advice and service and broaden their client relationships.

In Investment Management, revenues were $718 million, up 13% sequentially, driven by higher asset management fees and the absence of last quarter's impairment charge. Total AUM of $469 billion was down 3% quarter over quarter, with long-term AUM of $312 billion up 2% quarter over quarter. Although we saw outflows in our liquidity business as clients managed their cash balance needs around the turn of the year, our long-term strategy saw continued positive flows. In the quarter, we also closed the Mesa West acquisition, adding private real estate credit capabilities to our platform.

Asset management fees of $326 million were up 9% sequentially on the back of higher-average AUM for the quarter. We continue to see stability in fee rates earned on our long-term assets. Investment revenues were $77 million, down by 31% relative to last quarter, impacted by lower market performance in certain private-equity-related funds. Total expenses increased by 2% quarter over quarter, largely driven by the revenue recognition gross-up related to the segment.

Turning to the balance sheet, on a sequential basis, total spot assets of $860 billion was essentially flat. As a result of higher lending commitment supporting relationship and event activity in the quarter, our standardized RWAs grew by approximately $12 billion to $389 billion. Our Basel III standardized Common Equity Tier 1 ratio is expected to decrease to 15.6%. Our supplementary leverage ratio is expected to remain relatively unchanged at 6.3%

During the fourth quarter, we purchased approximately $1.25 billion of common stock or approximately 22 million shares, and our board declared a $0.25 dividend per share. This morning, we announced a share repurchase plan with MUFG. As part of our regular repurchase program, we will make pro rata purchases directly from MUFG. This will help ensure compliance with their passivity commitments to the Federal Reserve by maintaining their ownership below 24.9%. This will not impact our strategic alliance.

Our tax rate in the first quarter was 20.9%, reflecting the reduced U.S. corporate tax rate and benefits associated with share-based payments. Our guidance for the full year remains at 22% to 25%. The vast majority of share-based award conversions took place in the first quarter. We expect the tax rate for the remaining quarters to be at the upper end of this range.

This quarter demonstrates the strength of our franchise and the benefit of our global business model. As we look forward, we remain confident that we are well-positioned to execute the medium-term strategic objectives that we laid out earlier this year. In the near term, we are aware of the fragility of market sentiment. We have emphasized the importance of open and functioning markets as it relates to our performance. This quarter's results demonstrate that increased levels of activity and client engagement are broadly beneficial to our business. With that, we will now open the line to questions.

Questions and Answers:

Sharon Yeshaya -- Head of Investor Relations

Ladies and gentlemen, if you have a question at this time, please press *1 on your telephone keypad. If your question has been answered or you wish to remove yourself from the queue, please press #. In the interest of time, we ask that you please limit yourself to one question and one follow-up question. Thank you. Our first question comes from the line of Steven Chubak of Nomura. Your line is now open.

Steven Chubak -- Nomura Securities -- Analyst

Thanks. Good morning, all. So, I was hoping to just unpack, James, your comments surrounding the recent proposed changes to the capital regime. As we think about the capital constraints that you're looking to manage longer-term, historically, you've been a bit more leverage-constrained. We now have this enhanced SLR and STB proposals that are out there, and there's some expectation that risk-based ratios could once again become a bit more binding. Based on the new proposals as outlined and your initial read, which constraints are you now more focused on in terms of what informs not just future payout capacity, but also how you're thinking about your balance sheet strategy longer-term?

James P. Gorman -- Chairman and Chief Executive Officer

There's a bunch in that, obviously. I think the first point -- just to reiterate -- is acknowledgment that this year's CCAR test relates to the economic scenarios which are driven by the 10% unemployment requirement under Dodd-Frank. When your unemployment is currently around 4% -- 4.1% in this country -- you need some very severe shocks to hit 10%. So, it's an academic approach, if you will, to achieve an outcome, which then generates models which are very severe, so this year will be interesting to see how it all plays out. We obviously believe we're well capitalized, but we can't anticipate how all these tests this year will play out.

So, what we're really focused on is 2019 ongoing, and you're right, the STB buffer comes into play. Historically, you're right. Our constraint has been our leverage ratio. I think our constraint on every test going back -- maybe not the first one, I can't remember exactly, but I'm pretty sure. And, it will remain the constraint under the traditional CCAR model. Under the SCB proposal, I think you're right. The likelihood is that the CET1 ratio will be the constraint rather than the leverage ratio. For Morgan Stanley, I don't think that's unfriendly news.

Where it comes out -- and, we're in a comment period at the moment, but the Federal Reserve has asked for responses to the multiple rule changes, and Jon may have something to add to these comments, by the way -- the Fed has asked for comments on that. Where that comes out remains to be seen, but I've always found it slightly surreal that the binding constraint would be the debt balance sheet irrespective of the content of assets that comprise that balance sheet. Having capital as a leverage ratio of cash or treasuries or other forms of government securities versus highly illiquid high-risk securities seems to me the kind of thing one would want to differentiate against.

So, I've always -- in my mind, leverage ratios should have been a secondary ratio to the core capital ratio. That's been my personal view because it leads to a very bizarre outcome that in order to -- if your constraint is leverage ratio, it might cause you to be very aggressive on the risk-based assets because frankly, they don't matter if leverage ratio is your constraint. That's clearly not an outcome that regulators here or anywhere in the world would want. So, I'm kind of welcoming the shift to the SCB model. I think if it translates to more incentive, which I think it will -- the constraint being core capital -- I think that's more sensible from a regulatory perspective and I don't think we're going to be worse off under that scenario than we are today. Whether and how much better off, I don't want to prejudge.

Steven Chubak -- Nomura Securities -- Analyst

All right, thanks, James. That's a very comprehensive response. I'll switch over to the business side, specifically Wealth Management. It's really encouraging to see continued robust fee-based flows, improvement in pre-tax profitability. Probably the one area that maybe fell a bit short of our expectation was in NII, driven in part by slower loan growth. I know you had spoken of some of the factors, including the migration of mortgage originations in-house, but how should we think about the outlook for loan growth in the coming year? Maybe against the backdrop of rising funding costs, how does that inform your outlook for the NIM trajectory from here?

Jonathan Pruzan -- Chief Financial Officer

I would say that the NII results and lending results were actually in line with our own expectations. I think what we've talked about coming into the -- throughout last year as well as coming into this year was a couple of factors that we suggested would slow down NII growth in this segment, and that's what we obviously saw this quarter. We still do believe that we'll have good loan growth, and that will be a driver of the NII growth going forward.

Last year, we grew loans by about $7 billion or $8 billion. Our portfolio is now about $70 billion, so we'll grow probably at a slower pace for the reasons you highlighted -- the transition and rising rates -- but we still think that's healthy growth on a $70 billion portfolio. We still feel like there's opportunity within our client set -- if you look at penetration numbers and whatnot -- that we'll continue to grow that line, but at a slower pace. We also told you last year that we thought that the deposit deployment strategy that we had in place was going to play out, and we were planning on diversifying our deposit and liability structure, which we obviously have done.

What we have seen -- and, we talked about this last year and again this year -- our clients are deploying more cash into the markets, and they're putting it into different types of investments. The good news is that we still capture those assets when they go into advisory accounts and other transaction-related accounts, but it has brought down our sweep accounts, and we've replaced those with higher-cost deposits, and you're seeing that on the net interest expense line item. The other point I would make quickly is that we have seen a very receptive network, if you will, to our new products, particularly around some of the CDs and savings promotions that we've been running, so we have been able to raise $10 billion-odd deposits since last summer, albeit at a higher price. So, I think this is actually playing out as we expected, and it is going to be growth, but it will be slower.

Sharon Yeshaya -- Head of Investor Relations

Thank you. Our next question comes from the line of Brennan Hawkins of UBS. Your line is now open.

Brennan Hawken -- UBS Investment Bank -- Analyst

Good morning. I just want to ask another question here on the lending and such. Jon, you highlighted the institutional lending support to FICC trading results this quarter. We certainly saw strong growth in the institutional balances here. Is some of this funding that you're doing for CDs being used to fund some of the institutional loan growth? What's the plan for how long that would stay on the balance sheet, and does this provide a pipeline for some DCM activity here over the coming quarters?

Jonathan Pruzan -- Chief Financial Officer

There's a lot of questions in there, and I would basically say yes to all of them, but let's just quickly tick off. So, if you look at our disclosures, one of the pages in the supplementary deck has the U.S. banks. You'll see -- as you mentioned -- that the institutional lending has increased. A lot of that has been in our FID-secured business or our warehousing businesses, which have been very active. There's good velocity in those facilities.

We've seen really good strength in Europe as we help finance some of our clients buy some of these portfolios that the bank has been selling, so it's been a good business for us, good velocity, good yield, and that is actually financed in the bank. You don't see that in the net interest income that we talk about in wealth management because it shows up in the ISG lines, so there is good asset sensitivity and good growth in that line item that's just embedded in some of the Fixed Income and Sales and Trading line items. So, good growth in that area. We continue to see -- or, have the ability to invest in that area and grow that business, and it's been a good source of revenue for us, stable revenues.

Brennan Hawken -- UBS Investment Bank -- Analyst

Terrific. So, the follow-up would be, then, I'd expect that at least while certainly, volatility supported some of the trading strength here this quarter, there's also some annuitized component to some of the revenue strength here in trading that sits on the balance sheet. Another component -- which you might not have touched upon, so I want to try and get at it a different way -- are the CDs being used to fund this, and are those deposit costs being borne in the NII and in wealth, but not necessarily getting the benefit of the NII, so it's just a geography issue. So, we all might focus on the wealth NII, but you really are generating the economics, it's just not pulling through that line. Thanks.

Jonathan Pruzan -- Chief Financial Officer

Yes. Again, within Fixed Income, there are lots of businesses -- macro, micro, corporate trading, commodities -- but within our SPG business, a larger percentage of that line item over time will be coming from these lending activities, and we've seen good growth in that area. Again, the primary funding sources for the bank are deposits, and they are being used -- whether that's the sweep deposit savings at the time as well as some of the other external sources that we have -- to fund the institutional part of the lending program. So, again, you are right that it is a growing part of that segment, but it's still relatively small to the overall pie. It does give us some stability, and we like the credit characteristics and the yield characteristics of that business, and we'll continue to try to grow it going forward.

Sharon Yeshaya -- Head of Investor Relations

Thank you. Our next question comes from the line of Glenn Schorr of Evercore. Your line is now open.

Glenn Schorr -- Evercore ISI -- Managing Director

Hi. Thanks very much. A question -- historically, the whole industry -- but Morgan Stanley specifically -- had big seasonality in the first quarter. I thought a chunk of that had to do with the physical commodities business, which is no longer there, but putting aside that, this was a more active first quarter in general. You talked about securitized products, but you also talked about some structured transactions and commodities. I know it's an impossible question, but should we be expecting seasonality of the past, given the higher activity levels in those specific components this quarter?

Jonathan Pruzan -- Chief Financial Officer

I'm glad you prefaced that by saying it's an impossible question, which means -- actually, I'm going to go back to Brennan's question because I realized I didn't answer the second part, and then, Glenn, I'll get back to you. On the NII comment, obviously, we transfer price across segments, so some of the benefit of those deposits is being borne in the NII of the banks clearly, and how it falls within the segments is ultimately a function of usage and activity levels.

And now to Glenn, in terms of seasonality, we did exit many of our physical commodities businesses that I would say added to the seasonality because we were generally owners of commodities and oil, and during the winter, with the weather, you saw different seasonality components to that business. It's obviously now a smaller component of it. Generally speaking, though, if you look back over five or ten years, the first quarter has generally been seasonally strong, particularly in ISG Sales and Trading, and whether that's just because people have new money to invest or they're repositioning for the year or the start of the measurement period in terms of their performance, but there generally has been real seasonality in Sales and Trading.

We clearly saw that in the first quarter this year. If you look at the wallets, at least based on some of the early data, it suggests that the Equity wallet is up, Fixed Income wallet is also up, but I think also, if you look -- certainly, quarter over quarter, year over year, Equity wallet would be up, and it looks like Fixed Income is actually quite balanced.

James P. Gorman -- Chairman and Chief Executive Officer

I'd just make an observation that yes, historically, the first quarter has been the seasonally stronger quarter across Wall Street, but you've also got to take into account what the business mix is. 10 or 12 years ago, when I started here running Wealth Management, I think our revenues in Wealth Management were at quarter over quarter, and our pre-tax at that point was around 3% or something of that order.

Obviously, we're in a very different planet now, so at $4.4 billion plus or minus a quarter and pre-tax over $1 billion, you add wealth -- the way I think about is I add Wealth and Asset Management together and say we start off every quarter with $5 billion in the bank, and then, if you think about Equities and investment banking has historically -- it's been a long time since we've had an Equities quarter below $1.5 billion and quite a long time since we've had a Banking quarter much below $1 billion. I think there have been some in the high $900 million range.

So, $2.5 billion in the bank from those -- so, every quarter begins with roughly $7.5 billion. The flex is obviously how strong the markets are, reflecting the new issue calendar, which pumps up the banking, reflecting Equity activity depending on the div/of season, what time of the year it is, and then, obviously, Fixed Income. As you correctly point out, the tail that wagged the dog for a while in Fixed Income was the big physical commodities and some of the very large multiple-structured trades we did. A lot of that has gone away, so Fixed Income won't have the huge ups that we had in 2006 and 2007, most of which we gave back, but it's unlikely to have the kinds of downs that we had before we got rid of the physical stuff and restructured the business.

So, I think the range of this firm is kind of a worst-case scenario without the market completely imploding around $7.5 billion a quarter. That was not the case ten years ago, and it was not the case five years ago, so that's what we're playing for. It's the ballast and the speed. Obviously, in a good market, a seasonally strong market, an active market -- all which we had in the first quarter -- slightly lower tax rate, slightly lower preferred that we have every other quarter, then you're going to be toward the higher ends of your ranges.

Glenn Schorr -- Evercore ISI -- Managing Director

I appreciate that. Much more than I bargained for.

Sharon Yeshaya -- Head of Investor Relations

Thank you. Our next question comes from the line of Guy Moszkowski of Autonomous. Your line is now open.

Guy Moszkowski -- Autonomous Research -- Managing Partner

Good morning. James, I think I got the gist of what you were trying to say at the outset when you talked about this year's CCAR being prepared for a range, but I think you were trying to send some messages there, and I was just hoping that you could elaborate a little bit on what you mean by that versus how you might view future CCARs.

James P. Gorman -- Chairman and Chief Executive Officer

Well, very simply, Guy -- and, I appreciate that follow-up question there -- very simply put, we have increased the dividend four years in a row and increased the buyback four years in a row. We've gone from $0.05 and $500 million to $1.00 and $5 billion. This test is a hard test. If you have to generate a 10% unemployment number -- and, unemployment is currently 4.1% -- you have to provide some pretty extraordinary shocks to hit it. Now, that's just mathematical. That doesn't -- I'm not saying people actually believe that's what's going to happen in the scenario. It's certainly much worse than what happened in the financial crisis of '08.

But, that's the reality of the Dodd-Frank legislation and the outcome that has been generated. We obviously -- the firm has not materially grown in any way that would suggest we need more capital. The firm is more profitable than it was, so it's accreting more earnings. The firm is operating at a tax rate nearly 10 points below what it was a year ago. The firm has more earnings coming out of Wealth Management, which are more stable, so on any objective assessment, you would say that...

We were approaching 100% payout last year. I think we were in the high 90s, if memory serves me. You would expect us to be paying out certainly anything that we accrete in sum. Any objective assessment would say that. I'm just saying against the backdrop of the way the particular models of this test are spinning out for 2018 -- and, I don't think this will be the case for 2019, so I want to really separate those discussions -- it's less clear.

We're pretty confident, and we'll ask for what we think we should be getting, and what our business throws off. Obviously, that's between us and the Federal Reserve until the results are outlined. But, over the years, I've seen our PP&R numbers come out at $6 billion and $400 million. That's a $5.6 billion swing. I've seen some pretty unusual results over the years, and I just can't predict exactly how it's going to play out. I'm prepared -- and, I said it very deliberately, which you picked up on -- for a range of outcomes for 2018.

Guy Moszkowski -- Autonomous Research -- Managing Partner

Okay, that's helpful clarity. Thank you. The other question I just wanted to pick up on that was something that Jonathan mentioned in his remarks was the concept of the bid offer, which was up very strongly in the early part of the quarter -- I guess across a wide range of product. I'd just be interested in a little bit more color on what you saw, where you saw it, and in terms of product and areas, and to what extent should we think that this is probably normalized already?

James P. Gorman -- Chairman and Chief Executive Officer

Before he does it, I just want to be clear: We are highly confident in this firm's capital position. If it was strong last year, it's stronger now, and that's where we stand as a firm. So, there is nothing that I'm trying to suggest or indicate that would imply that we don't feel very strongly about our capital. We were capital-sufficient last year. By definition, every dollar you accrete from then on, you would either give back to shareholders or put to good use. So, we're highly confident about that position. What I am anticipating is I've been around this trap long enough, been through enough of these tests, and seen enough variability that when you dial the scenario up to the level it got dialed up, it can lead to unintended consequences. Jon?

Jonathan Pruzan -- Chief Financial Officer

I would add -- you heard, Guy, that we repurchased $1.25 billion this quarter. We have a $5 billion authorization that James referenced, and it's our intent to use that authorization in the second quarter. In terms of the bid offer spread, any time you see heightened volatility in the equity markets around some of our market-making activities, you generally see that spread widen out, and it's really just a function of volatility. So, as the volatility changes, you'll see changes in that bid offer spread. I think it's as simple as that.

Sharon Yeshaya -- Head of Investor Relations

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

Mike Mayo -- Wells Fargo and Co. -- Analyst

Hi. This question might go in the category of "no good deed goes unpunished," but you had the biggest gap between your return on equity and your target return on equity, so the fact that you're not raising targets yet... Is it seasonal, or you don't want to extrapolate some of the results because of something you see, or because you compete away the tax benefits, or you just want to be super safe, especially after your first couple years as CEO, James? You got started, but you missed a couple targets, and now you're exceeding them, and you're exceeding them by a wide margin. So, why not increase targets?

James P. Gorman -- Chairman and Chief Executive Officer

Well, Mike, I'm glad you asked the question. Not to correct you, but I will -- actually, we had a bigger gap between our return targets and our performance, and that was when we generated 2% ROEs and had a 10% target, which if memory serves me, you reminded us of pretty frequently on these calls. So, it's a happy gap in the other direction, but seriously, this isn't all science. There are these things called the markets that operate here, and we built our business models to function well in bad markets.

If Morgan Stanley's strategy could be defined simply, it would be that we will do fine when the markets are tough and we will do well when the markets are good. There are others who might do better when the markets are good -- that's fine. What I care about is how we do when the markets are tough. So, when we put in a target range, we don't anticipate -- firstly, we would never change it after one quarter, and you wouldn't expect us to. I think we called it a medium-term range, so think about it for a couple of years. It would be kind of silly to bounce around after one quarter.

But, putting that aside, philosophically, the target range is supposed to represent a normal set of outcomes under tough market environment and good market environment. This was a very good market environment, as we said right at the outset. Not perfect -- we can definitely do better. The underwriting calendar was not phenomenal, Wealth Management transaction activity was extremely light, we had very few gains in the investment portfolio, we're managing expenses strongly, but not ruthlessly. So, there's things we could do, clearly, to drive returns higher, putting aside revenue growth, but what we're focused on is how are we going to do in a difficult market environment?

So, seasonally, just add in the extra preferred, bring the tax rate up to 23% to 25% range that Jon talked about, and the returns for this quarter probably drop from 14.9% to -- rough math -- about 14%. So, think of it as our starting basis is 14%-yeah, the high end of our target was 13%, but as I said, a very good environment. If we go to the end of this year and we are consistently above 13%, then I will come back to you, and I'm prepared to renegotiate our goals at that point.

Mike Mayo -- Wells Fargo and Co. -- Analyst

Fair enough. One follow-up on terms of environment -- now that you have $70 billion of loans, up almost 20% year over year, how do you reassure investors that these loans will stay of good quality?

Jonathan Pruzan -- Chief Financial Officer

Again, I think from the overall credit quality, there's a couple of components. One is obviously mix. A good portion of that -- the vast majority of the wealth management loans, virtually all, are secured in one way, shape, or form, whether that be by a house or bigger portfolios around the security-based lending, where we have good LTVs and good protections. On the mortgages, I think you know our portfolio has been very clean, and then, on the institutional side again, all of that lending is secured. The warehouse business has good structural protections and good haircuts. Our commercial real estate portfolio also has performed nicely in terms of its LTVs and whatnot, but again, we are in a pretty good credit environment. I would suspect at some point, we'll get into a credit cycle and you will see more losses from that portfolio, but at this point, it's been very clean, it's been a good risk-return profile with healthy yields and very strong credit characteristics.

Sharon Yeshaya -- Head of Investor Relations

Thank you. Our next question comes from the line of Gerard Cassidy of RBC. Your line is now open.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Thank you. Good morning. Jon, can you share with us your thoughts on -- you talked about the mortgage production, and moving it in-house may have contributed to some of the slower growth, but -- I know it's early, but your clients tend to be higher net worth type of clients. Have you seen any evidence yet that the SALT issue -- when it comes to state and local taxes -- and that restriction is impacting people's borrowing habits on mortgages yet?

Jonathan Pruzan -- Chief Financial Officer

To be honest, the answer is no. I know there was a lot of discussion about people moving, and particularly out of places like California and New York, but we haven't really seen any activity based on that dynamic. We did -- obviously, our provider was PHH. They've changed their business model, so we had to change ours, so we brought it in-house, and we purposely slowed down that production to make sure we have the right infrastructure and level of client service required for our clients. We still think there's opportunity to grow. As rates rise, we'll also see presumably less run-off, but again, we feel good about where we are in terms of the lending growth -- slower first quarter, but as expected.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Very good. And then, pivoting to the trading area, in Equities, obviously, you've made a meaningful commitment to technology and low-touch trading versus the traditional high-touch trading. Can you share with us how those trends are moving? Is the high-touch trading falling fast? Is it really becoming more of a low-touch trading environment, which you guys are one of the leaders in?

Jonathan Pruzan -- Chief Financial Officer

Yeah, I think there has been a multiyear trend of more electronic trading versus voice trading, and we've seen that quarter over quarter. We benefited, obviously, this quarter as we've seen that transition. The volumes have gone up dramatically, so although there are different dynamics around voice versus electronic, we've been making up a lot of it in volume, but there is clearly pressure on the voice trading part of the business.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Thank you.

Sharon Yeshaya -- Head of Investor Relations

Thank you. Our next question comes from the line of Michael Carrier of Bank of America Merrill Lynch. Your line is now open.

Michael Carrier -- Bank of America Merrill Lynch -- Managing Director

Thanks, guys. Hey, Jon, you guys generated good operating leverage in the quarter -- comp ratio lower. On the non-comp side, we expected some lip with the activity, but maybe just some color on what's being driven by activity versus what -- you guys mentioned some of the investments in Wealth Management -- what we should be expecting as more ongoing.

Jonathan Pruzan -- Chief Financial Officer

Again, I think based on our expectations and budgets, we actually were right in line with what our expectations were on the non-revenue-related items, and then we saw a clear increase in BC&E, which shows up in the BC&E line, an increase in transaction taxes, increases in U.K. bank levy, and some of the other things that would show up in the other expense line. So, we expected the increases, we had a little bit of increase in occupancy as we knew we were renegotiating some leases, we've got some expenses related to some of the planning we're doing in Brexit. So, again, all of the expected slight increases that we thought we'd have, we saw, and then the real increase in expenses was virtually all related to the Sales and Trading and revenue-related activities.

Michael Carrier -- Bank of America Merrill Lynch -- Managing Director

Okay, got it. And then, as a follow-up, on the capital ratios and the stress capital buffer, I just wanted to get your take. Given that it will be more variable or volatile going forward, do you expect some more transparency in either the calculation or the test, and if you get that, then can you better manage the current portfolio and the business to maybe navigate that better over the next years? I know it's early, but I'm trying to understand.

Jonathan Pruzan -- Chief Financial Officer

Again, I would say it's very early. I would say there have been a couple of announcements. Vice Chairman Quarles testified yesterday or the day before and made some comments. I think there is clearly a trend toward simplification, there's a trend toward more transparency, there's a trend toward more bespoke regulation based on your own individual firm risk profile, and there is an element of recalibration ten years after the fact. I think transparency for us that might lead to better stability would really be transparency around the actual scenarios.

We've seen this test get harder year after year. As James mentioned, the 10% unemployment rate, but also, every year, when we get their scenarios, and their up-front market shock, and their paths, there's always a couple things in there that surprise us and -- to be fair -- are not necessarily 100% consistent with how we see the world and what would happen in a scenario like that. So, anything around transparency around the scenarios -- and, that's one of the things that we're going to comment on, and I think Vice Chairman Quarles mentioned something about putting out the scenarios for comment -- any of that would be helpful for us to plan our business because we look at things for the longer term, and to get a surprise year after year based on the scenario does obviously inhibit some of that long-term strategy planning.

Sharon Yeshaya -- Head of Investor Relations

Thank. Our next question comes from the line of Jim Mitchell of Buckingham Research. Your line is now open.

Jim Mitchell -- Buckingham Research -- Analyst

Good morning. Just a follow-up on that -- James, as you said, you've built more stable, you think stable, revenue-producing business model, yet when we look at the stress tests, you get hit the hardest in terms of starting point to stress minimum, in terms of loss rates. It doesn't seem to jive with what you've built; therefore, you get hit hardest in the SCB even though you have plenty of capital. Is there anything you'd think about going forward that you can help with that or help yourself reduce that? Is that higher losses that they attribute to your firm? How do we think about offsets going forward, or how do you think about it?

Jonathan Pruzan -- Chief Financial Officer

I'll try to take a chance. Again, the transparency in their models -- and, one of the uncertainties this year is they are continuing this for a two-year phase-in transition on some of their PP&R models. As James mentioned, we think we've created a much more stable revenue base, yet in the stress cases that they've prepared, our PP&R has been wildly unpredictable and wildly low. Some of that this year is going to be a function -- as you know, a significant portion of our revenues and wealth comes from our fee-based flows, and if your markets are down 65% and they don't ever recover, that obviously has an impact on our business.

The other thing you should know is all these tests -- we're not allowed to make any sort of management action, so we just watch all of this go on and have no ability to react to it. So, we do have a high reduction. Also, some of that has to do with just our RWA density is lower than everyone else's, and while it intuitively means that we have less risk, it doesn't seem to benefit from the test, which is also one of the reasons why I think -- and, I think why Chairman Quarles mentioned this yesterday -- we do think that a recalibration of the GSIB methodology, particularly Method 2, would be helpful. Our derisking strategy has led to a higher GSIB buffer, which intuitively doesn't make sense, and we've got a pretty big gap between Method 1 and Method 2, so those are some of the types of things that we'd like to comment on going forward in this process.

James P. Gorman -- Chairman and Chief Executive Officer

And specifically on us, historically, we said the constraint was leverage ratio, and as the models in the Fed have done, you grow your balance sheet, then that's highly punitive. I think it's been growing 4.3% or 4.5% a year. I've said this publicly and I've said it privately: I can't anticipate a scenario where your balance sheet grows during times of financial distress and deflation of financial assets unless you're acquiring other institutions. It just is illogical, and I've seen no empirical evidence to support balance sheet growth during that time period. I think that view has started to resonate, and I think Vice Chair Quarles talked about some of that in one of his speeches recently that they're considering moving to the stress buffer model.

But, in fact, our experience -- I think the balance sheet shrink was 29% post-crisis, so under that, we would be wildly overcapitalized from a leverage ratio perspective. Now, I'm not suggesting it's appropriate to model in that regard because obviously, we took very draconian steps because we had to, and a stronger institution might take less draconian steps, and we believe we're a stronger institution now, but the bottom line is we have always had the constraint of leverage ratio. If you took away the balance sheet growth and just kept it flat, we wouldn't even be having this discussion.

Jim Mitchell -- Buckingham Research -- Analyst

Right, absolutely. Thanks for that. And then, maybe a follow-up on -- there's been chatter about the Volcker Rule. When you talk to your traders, has the uncertainty and complexity of that rule hurt them in any way? Do they feel like some greater simplicity would help a lot, or just a little? Is it more of an expense issue? I'm just trying to think through if there's any kind of material impact where the revenue and expense is from some simplicity in the Volcker Rule.

James P. Gorman -- Chairman and Chief Executive Officer

It's probably going to take too long to pull apart all the aspects of the Volcker Rule for this call, so given the time, I won't go into it. But, clearly, what Paul Volcker was trying to do was restrict deposit-taking institutions from putting their own capital at risk in proprietary trading or investing, and it morphed into something which is far more complex, requires a lot of attestations, and many people's view is it has impinged on market liquidity and moved from focus on proprietary activity to principal trading activity.

I think the regulators are obviously very aware of the industry response on this, and this is an opportunity where they're taking a hard look at it. I do not expect the Volcker Rule to be removed; I'm not sure it should be removed because I'm not sure banks should put large parts of their capital at risk in proprietary trading or proprietary investing positions. So, the essence of what Volcker was trying to do, I personally agree with. The way in which it was executed...some revision would be appropriate.

Sharon Yeshaya -- Head of Investor Relations

Thank you. Our next question comes from the line of Christian Bolu of Bernstein. Your line is now open.

Christian Bolu -- Sanford C. Bernstein -- Analyst

Good morning, James, good morning, Jonathan. Thanks for squeezing me in here. On the Wealth Management side, I just wanted to follow up on the NII question. To wrap it all up, how should we think about sequential quarter progress going forward? Should we be thinking about growth off a Q1 base? Also, if you have the brokerage deposit number for the quarter, that would be helpful also.

Jonathan Pruzan -- Chief Financial Officer

Sure. Again, the way I would describe this -- first of all, I think you've heard James talk a lot about this business being ballast, so it's not going to move quarter over quarter sequentially very much. That's why we like it a lot. It sort of grinds it out. If you look at the year-over-year comparison, the NII is up 8%, driven by very nice loan growths, and I would say going forward, we've tried to highlight in this call that the loan growth will be at a slower rate than last year. We're also off of a bigger base, and we're also not going to get the benefit of the lower betas or the actual betas below the predicted-model betas of 50%. I think we're going to start seeing the betas -- and, we already have -- creep up toward that 50% type of level.

So, again, we do expect NII growth. It will be slower than we've had over the last five years. We've tripled our loan portfolio in five years. We clearly can't continue at that clip, as we started with a lot of new products and a lot of new strategies, but we will continue to see growth, just at a slower pace.

Christian Bolu -- Sanford C. Bernstein -- Analyst

The growth is sequential or year-over-year growth? That's what I'm trying to know.

Jonathan Pruzan -- Chief Financial Officer

I'm sorry. When we talk about NII growth, we're talking year-over-year. So, if you look at -- historically, we've been growing NII year over year on average $500 million. We're clearly telling you that we're going to grow NII in '18 versus '17, but it's going to be at a slower pace.

Sharon Yeshaya -- Head of Investor Relations

Thank you. Our next question comes from the line of Kian Abouhossein of JP Morgan. Your line is now open.

Kian Abouhossein -- JPMorgan Chase -- Analyst

Securitized products -- you mentioned it's one of the best performances you have seen over the last four years, and I'm just wondering why that is because I wouldn't expect that looking at industry data. You particularly highlighted Europe in that context as well. Historically, it's a very small part -- at least, if you look at the larger data in terms of issuance revenues. I'm just wondering what is driving that for you. It looks like you're gaining market share, so I want to understand what you're doing globally, but also in Europe in particular in this area.

Jonathan Pruzan -- Chief Financial Officer

Again, I would say broadly, Fixed Income was strong. There weren't a lot of elephant-type transactions in the quarter, so it was really just small outperformance in a lot of places across the globe. In terms of SPG -- and, one of the things that we highlighted -- Europe is -- again, in our warehouse business, we've been very active supporting clients as some of the larger banks have been getting out of real estate portfolios as they continue to deleverage, and we've been providing financing for European clients. That's been a very good business for us.

Obviously, some combination of both syndicating out that exposure but also securitization activity on the back of it has been very good for us. So, again, I called out SPG just because if you look at percentages, it did sort of outshine, if you will, the other areas with FX and commodities, but it wasn't -- it was just a little bit better in a lot of different places all over the world, across products and geographies.

Sharon Yeshaya -- Head of Investor Relations

Thank you. Our last question from the line of Brian Kleinhanzl of KBW. Your line is now open.

Brian Kleinhanzl -- Keefe, Bruyette, and Woods -- Managing Director

Yeah, thanks. Just had a quick question. In the Wealth Management space, I saw that the reps were down 1% year on year. Going forward, is that just the right way to think about your advisors in that business? Is this going to be a declining base from here, or is there going to be some point we can actually see growth in advisors?

Jonathan Pruzan -- Chief Financial Officer

Generally, the attrition has been pretty low. 1% is a relatively small number given the size of the franchise with the ages and retirements, and some people still leaving. What we've seen to date this year is actually a significant slowdown in the number of people who have left. Generally, the size of the production of the people who have been leaving has been quite low. We have deemphasized recruiting. We only recruited a handful of people over the first quarter. But, I think generally speaking, flattish, and plus or minus 1% I bucket into the flattish category as how we see this in the near term as we continue to invest in our current franchise, our current FAs, and our current infrastructure.

James P. Gorman -- Chairman and Chief Executive Officer

Yeah, I'd focus on total assets and assets per advisor more than the number of advisors, but you won't see radical shifts in numbers. We're at the last question. I know there are other people on the line. I'm sorry about that. We went a little longer on some of these questions early because they were a little more dense. So, if you need to call Sharon, then please do, and we'll answer everybody's questions offline. Thank you so much.

Sharon Yeshaya -- Head of Investor Relations

Ladies and gentlemen, thank you for participating in today's conference. That concludes the program. You may all disconnect. Everyone have a great day.

Duration: 61 minutes

Call participants:

Sharon Yeshaya -- Head of Investor Relations

James P. Gorman -- Chairman and Chief Executive Officer

Jonathan Pruzan -- Chief Financial Officer

Steven Chubak -- Nomura Securities -- Analyst

Brennan Hawken -- UBS Investment Bank -- Analyst

Glenn Schorr -- Evercore ISI -- Managing Director

Guy Moszkowski -- Autonomous Research -- Managing Partner

Mike Mayo -- Wells Fargo and Co. -- Analyst

Gerard Cassidy -- RBC Capital Markets -- Analyst

Michael Carrier -- Bank of America Merrill Lynch -- Managing Director

Jim Mitchell -- Buckingham Research -- Analyst

Christian Bolu -- Sanford C. Bernstein -- Analyst

Kian Abouhossein -- JPMorgan Chase -- Analyst

Brian Kleinhanzl -- Keefe, Bruyette, and Woods -- Managing Director

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