Morgan Stanley’s Results Show A Shift In Its Business Model

Investors expressed their concerns about Morgan Stanley’s (NYSE:MS) performance figures for the quarter by sending the share price lower by more than 5% in trading on Thursday. Expectations were already high following competitor Goldman Sach’s (NYSE:GS) results, and the decline in Morgan Stanley’s DVA adjusted earnings compared to the same quarter last year triggered the sell-off. ^[1]

Morgan Stanley’s fixed-income trading unit stands out as the problem area – recording a weak performance for a quarter which saw all competitors do extremely well in the area. It was only thanks to a record performance by the bank’s wealth management business that the consolidated numbers show an improvement over those for the previous quarter.

Morgan Stanley has worked hard over recent years to increase its focus on the less volatile wealth management business while downsizing its fixed-income trading business to free up capital and to comply with stricter regulatory requirements. The overall effect of these moves has been to fundamentally change the bank’s business model from predominantly investment banking to a more balanced one – something we see as a positive.

We, hence, stick to our $24 price estimate for Morgan Stanley’s stock, which is about 20% ahead of current market prices.

See our full analysis of Morgan Stanley

Fixed Income Trading Unit Is Steadily Losing Steam

Morgan Stanley’s fixed-income trading unit was the investment bank’s biggest source of revenue prior to the economic downturn of 2008 and even over the 2009-2010 period. But over recent years, the net contribution of the business to the top-line has fallen largely because of multi-billion accounting charges related to the revaluation of its own debt (DVA) as well as due to a reduction in trading assets to comply with stricter regulatory requirements.

But once you adjust the revenues for DVA, the underlying trend becomes all the more evident as shown in the table below:

While the equities trading business has been more consistent in its performance, the fixed-income trading revenues have been extremely volatile. Considering only Q1 performances (as the trading business is quite cyclical) the fact that Morgan Stanley’s debt trading business added only $1.5 billion in Q1 2013 – 40% below the $2.6 billion generated in Q1 2012 – is not very justifiable for a period when other investment banks have reported similar or better performances compared to the same quarter last year. In fact, Morgan Stanley’s DVA-adjusted first quarter fixed-income trading revenues were the lowest since 2008.

Whereas The Morgan Stanley Wealth Management Business Is Strong

After a two-year long struggle to integrate its legacy wealth management business with Smith Barney, Morgan Stanley was able to break the trend of single-digit margin figures for the unit last quarter with an operating margin of 16.9% in Q4 2012. And by repeating the performance this quarter too, Morgan Stanley has indicated that the performance improvement was not a one-off event. Profitability in the world’s largest brokerage is here to stay.

Revenues for the recently re-branded Morgan Stanley Wealth Management business almost touched $3.5 billion in Q1 2013. Tighter non-compensation expenses helped the division’s pre-tax operating income figure reach a record $597 million – representing margins of 17.2%. The business also grew the size of client assets it manages by 6% Q-on-Q to almost $1.8 trillion while slightly reducing the number of wealth management representatives.

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1. Morgan Stanley Reports First Quarter 2013, Morgan Stanley Press Releases, Apr 18 2013 [↩]