Morgan Stanley Details 2015 Goals Alongside Lukewarm Q4 2014 Results

Morgan Stanley (NYSE:MS) posted a worse-than-expected performance for the fourth quarter of the year on Tuesday, January 20, as a poor showing by the bank’s debt trading desk and losses in its commodities trading business hit top line figures for the period. ((Q4 2014 Earnings Release, Morgan Stanley Press Releases, Jan 20 2015)) The investment bank’s results were peppered by a series of one-time items, including a $1.1 billion addition to employee-related expenses from a deferral adjustment, a $468 million accounting charge from the implementation of FVA (funding valuation adjustments) and a $284 million bill for settling a legacy mortgage-related lawsuit. Incidentally, these charges pushed Morgan Stanley’s pre-tax income figure into the red, and the bank would have reported a net loss for the period if it weren’t for a one-time $1.4 billion tax benefit.

Looking past all the non-recurring items and taking into account the fact that debt trading revenues have been hit across the industry, Morgan Stanley’s operating performance was not too bad. Most notably, the bank’s wealth management arm continues to grow in size while also improving its operating margins. The fact that Morgan Stanley’s strategic update targets a pre-tax margin of 25%for the division by the end of 2015 from the current level of 20% indicates that the bank is exploring additional avenues to boost profitability. ^[1] Also, Morgan Stanley’s decision to limit compensation expenses for its institutional securities division to less than 39% of total revenues starting this year should play an important role in the bank achieving its goal of a return on equity in excess of 10% in the near future.

As our analysis of the company includes estimates that are largely in line with the targets announced earlier this week, we maintain our $38 price estimate for Morgan Stanley’s stock. This is about 10% above the current market price.

See our full analysis of Morgan Stanley

Wealth Management Becoming Cornerstone Of Business Model

Over recent years, Morgan Stanley has relied heavily on its wealth management operations to provide a stable source of income to what used to be a volatile, trading-driven business model. The growing importance of the wealth management division is evidenced by the fact that wealth management operations now contribute almost 45% of Morgan Stanley’s total revenues compared to a share of less than 19% in 2006. Our analysis of the bank shows that these operations are responsible for just under 30% of Morgan Stanley’s total share value – making it the most valuable division for the bank, as seen in the chart above.

The growing importance of wealth management operations has been driven by a steady increase in revenues even as Morgan Stanley works to keep costs under check. Having achieved the self-imposed 17% margin target for the business well before the 2014 deadline in Q4 2012, the bank has pushed the envelope each quarter since then and managed to achieve a record margin figure of 21% in Q3 2014. Although this figure fell slightly in Q4 2014 on a reported basis, ignoring an $88 million one-time expense from an adjustment in deferred compensation, pre-tax margins were at an all-time high of 21.7% for the period.

Morgan Stanley reported record revenues of $3.8 billion for its wealth management division for Q4 2014, with the total size of client assets also swelling to a record $2.02 trillion. Thanks to a continuing reduction in the number of wealth advisors over recent quarters, Q4 2014 was also the best ever for the division in terms of two key metrics that Morgan Stanley reports: the average annualized revenue per representative and total client assets per representative.

Trading Operations Had A Forgettable Quarter

Unlike its other major competitors in the U.S., 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.

Since early 2013, Morgan Stanley’s equities trading desk has established itself as the undisputed leader in the global equities trading industry – garnering more revenues from these operations than any other bank worldwide in five of the last six quarters (except for Q4 2013). The bank’s total trading revenues for Q3 2014 were less than $1.8 billion – adjusted for debt revaluation gains – with the equities trading desk making $1.6 billion and the fixed-income desk making just $133 million. This was Morgan Stanley’s worst trading performance since Q4 2011. The re-sized FICC trading operations took a beating this time around as a sudden increase in debt market volatility over the month of December caught all investment banks off-guard, even as the precipitous fall in oil prices hit commodities trading revenues at Morgan Stanley.

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1. Q4 Strategic Update, Morgan Stanley Press Releases, Jan 20 2015 [↩]