Morgan Stanley Bucks Industry Trends, Posts Strong Q1 Results

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It is clear from the impressive performance that Morgan Stanley (NYSE:MS) reported last week that the banking giant has successfully completed the makeover it envisioned immediately after the economic downturn of 2008. [1] Spending years focusing on integrating the Smith Barney wealth management unit it acquired in several parts from Citigroup (NYSE:C), cutting costs across the board and meeting tighter regulatory requirements, Morgan Stanley now looks set to reap the rewards of a well-balanced business model. While the swelling wealth management operations give the bank a stable revenue source, the roughly similar-sized equities and debt trading desks should help overall profitability. And this is exactly what the Q1 results demonstrate.

Morgan Stanley reported a year-on-year improvement in revenues as well as net income across each of its three business divisions – institutional securities, wealth management and investment management. Notably, this even holds true for its debt trading desk, which reported a 14% improvement in revenues compared to the year-ago quarter on an adjusted basis – making Morgan Stanley the only one among the country’s biggest banks to report growth in debt trading revenues this quarter. While JPMorgan (NYSE:JPM), Citigroup and Goldman Sachs (NYSE:GS) reported declines of 10-15%, Bank of America’s (NYSE:BAC) debt trading revenues were even with those in Q1 2013.

The strong all-around performance – especially by its trading desks, which have been churning out sub-par results the last two years – coupled with bank’s recently announced plans to return about $1.8 billion to shareholders over the next four quarters, prompted us to revise our price estimate for Morgan Stanley’s stock upwards from $31 to $35.

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Trading Unit Bounces Back

Unlike its other major competitors in the U.S. – namely Goldman Sachs, JPMorgan, Citigroup and Bank of America – Morgan Stanley’s new business model relies more on equity trading operations than fixed-income operations to generate value, due to a conscious decision by the bank to scale down the latter (see Morgan Stanley Cuts Its Fixed Income Targets As Focus Shifts). This fact is evident from the chart above, which shows the higher share of its equities trading desk in its total share value. The bank had also kept its trading operations somewhat out of focus over the 2010-2012 period – choosing to concentrate its efforts on its wealth management business.

But Morgan Stanley’s decision to settle for a smaller role in the securities trading industry seems to have worked out, as the bank was able to grow trading revenues considerably in a quarter which was undoubtedly slower than the one a year ago. Also, the bank’s equities trading revenues were slightly higher than debt trading revenues yet again this quarter (roughly $1.7 billion each). This trend of strong equity trading revenues is definitely a good sign for Morgan Stanley’s overall business model in the long run.

Wealth Management Business On A Roll

Morgan Stanley’s struggle to eke out profits from its wealth management business is no secret, with the bank unable to break the trend of single-digit margin figures for two long years in 2010-2011. But it stuck to its decision to completely buy out Citigroup’s stake in the Smith Barney operations, with this being the focus of its capital plan even in 2013. Having achieved the self-imposed 17% margin target for the business well before the 2014 deadline in Q4 2012, Morgan Stanley has seen continual improvement and managed to cross the 19% mark for the first time this quarter.

It should be noted that with $1.943 trillion in client assets, Morgan Stanley’s brokerage unit could very well displace Bank of America’s Merrill Lynch unit, which had $1.947 trillion in client assets at the end of Q1, by the end of this quarter to become the country’s largest brokerage – something that is supported by the faster growth in assets for Morgan Stanley (8%) compared to Merrill Lynch (7%).

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Notes:
  1. Q1 2014 Earnings Release, Morgan Stanley Website, Apr 17 2014 []