Was Morgan Stanley Too Cautious With Its Plan To Return Almost $7 Billion To Shareholders?

Late last week, Morgan Stanley (NYSE:MS) announced plans to return as much as $6.8 billion to shareholders in the form of dividends and share repurchases over the next twelve months, after the Federal Reserve cleared the capital plan of all major U.S. financial institutions as a part of its latest round of stress tests for banks (see Fed Clears Capital Plans Of All U.S. Banks Subject To Stress Tests For The First Time In Seven Years). Although this is a sizable improvement from the banking giant’s 2016 capital plan to return $5 billion, it would appear that Morgan Stanley played it fairly safe while coming up with its current plan – especially when compared to JPMorgan and Citigroup, who are returning $27 billion and $19 billion, respectively. After all, Morgan Stanley is the best capitalized major bank globally, with a common equity tier 1 (CET1) capital ratio of 16.6% – indicating a 660 basis point buffer over the bank’s regulatory requirement of 10%. But could Morgan Stanley really have earmarked more cash to return to investors?

In our opinion, the primary reason Morgan Stanley chose a more conservative capital return plan was to ensure that it did not face any objections from the Fed this time around. It must be noted here that Morgan Stanley was the only bank to receive a conditional approval for its capital plan last year, and it likely wanted to ensure an unconditional approval in 2017. Additionally, while Morgan Stanley’s CET1 capital ratio remained strong even under the Fed’s “severely adverse” stress test scenario, the bank’s statutory leverage ratio fell to just 3.8% under this scenario – the lowest among all 34 banks that were tested. Because of this, a higher capital return plan could have very well attracted stricter scrutiny by the regulator.

The proposed plan includes a 25% hike in dividends from the current 20 cents per share to 25 cents per share beginning Q3 2017. The bank will also initiate a new share repurchase program to buy back up to $5 billion of its shares over the next twelve months. We are currently in the process of updating our price estimate for Morgan Stanley’s stock.

See our full analysis for Morgan Stanley here

Historically, Morgan Stanley focused considerably on returning cash to investors – something that was a common trend among investment banks prior to the economic downturn. Like its peers, Morgan Stanley preferred to do so not by paying out a high dividend each quarter, but by buying back shares worth billions of dollars each year. This is evident from the fact that the bank’s increase in quarterly dividends between Q1 2000 to Q1 2009 was not sizable, but by the end of this period the bank was routinely spending three times the amount it handed out as dividends to repurchase shares.

The table below puts things in perspective, as it summarizes Morgan Stanley’s capital return figures for each year since 2005. The data has been compiled using figures reported in annual reports:

The disparity in Morgan Stanley’s payouts to common shareholders before and after the economic downturn stand out clearly here. But a poor operating performance over the period was not the only factor to blame for this. The bigger reason was that Morgan Stanley was saving to acquire 100% of the Smith Barney brokerage business from Citigroup. In fact, once the bank completed the acquisition in early 2013, its plan to buy back $500 million worth of shares was approved by the Federal Reserve within a couple of months. But the real boost came in 2014, when Morgan Stanley doubled dividends to 10 cents a share and also put in place a program to repurchase shares worth $1 billion for a total payout of $1.8 billion. The bank went on to hike the proposed payout figure by almost 150% in 2015 to $4.25 billion, before returning $5 billion in its 2016 plan and now aiming for a $6.8 billion payout.

As Morgan Stanley paid 20 cents in dividends per share over the first two quarter of 2017, and proposes to pay $0.25 per share over the remaining two quarters, total dividends for the year should be 90 cents per share. This works out to total dividends of around $1.7 billion for the year, assuming the total number of shares outstanding remains constant at the current level of 1.85 billion. Also, the bank repurchased $750 million in shares over Q1 2017 and had authorization in place to repurchase an additional $500 million for Q2 2o17 – taking the total repurchase figure over the first half of the year to $1.25 billion. Taken together with $2.5 billion in proposed purchases for the rest of the year (half of the total proposed repurchases of $5 billion), this points to total share repurchases of $3.75 billion in 2017.

We represent dividend payouts and share repurchases in our analysis of Morgan Stanley in the form of an adjusted dividend payout rate, as shown in the chart below. Note that we represent this payout rate as 0% in the chart for 2012 for simplicity, as the figure was not meaningful. You can understand how a change in Morgan Stanley’s adjusted payout ratio affects its share value by making changes here.

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