Wealth Management Gains Help Morgan Stanley Side-Step Trading Woes In Q3

by Trefis Team
Morgan Stanley
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Morgan Stanley (NYSE:MS) reported an earnings beat earlier this week, with the investment banking giant’s revenues and profits for the third quarter continuing to draw on the strength of its wealth management franchise. While the period saw trading revenues across the industry fall by roughly 20-25% compared to a year ago on the back of extremely low volatility across global capital markets, the bank’s wealth management operations mitigated the impact of this on the bottom line to a large extent. Strong inflows coupled with upbeat security valuations helped client assets managed by the wealth management division reach a record high of $2.3 trillion, while the division’s interest revenues gained from the Fed’s rate hikes. Notably, Morgan Stanley achieved a 9% jump in revenues for the quarter compared to Q3 2016 while its non-interest expenses only increased by 4%. This resulted in the division’s pre-tax margin figure jumping to a high of 26.5% – comparable to wealth management margins for rival Bank of America, which has a much more diversified business model.

Morgan Stanley remains the leader in global equity trading operations, and has a strong advisory & underwriting unit with a sizable global footprint. But we believe that growth for the company will primarily be from its wealth management division, as the bank will reap the benefits of improved cross-selling capabilities and fee-earning potential from its push in the traditional loans-and-deposits space. Also, the bank’s return on equity (ROE) figure of 9.8% for YTD 2017 is commendable – especially since Morgan Stanley is the best capitalized global banking giant with a common equity tier 1 (CET1) capital ratio of 16.3% (fully-phased in), which would weigh heavily on its ROE figure. In light of the better-than-expected wealth management performance, we have increased our price estimate for Morgan Stanley’s stock upwards from $47 to $50. The new price estimate is slightly ahead of the current market price.

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The table above summarizes the factors that aided Morgan Stanley’s pre-tax profit figure for Q3 2017 compared to the figures in Q3 2016 and Q2 2017. While the bank’s sales & trading and investment banking operations had a lukewarm quarter due to industry headwinds, its wealth management and investment management units mitigated the impact on the bottom line to an extent.

As seen in the chart below, Morgan Stanley’s total investment banking operations saw a sequential decline in four of the six reported revenue streams. However, Morgan Stanley’s equity trading revenues remained the highest among all U.S. investment banks for the quarter, as the decline was seen across the industry.

Over the last few years, Morgan Stanley has relied heavily on its wealth management operations to provide a stable source of income, but the division has grown to replace its core trading operations as its most valuable unit. There have been three key factors behind strong growth in wealth management profits over recent quarters. Firstly, Morgan Stanley has put in considerable efforts to streamline the division over the years – saving it millions in recurring costs. Secondly, Morgan Stanley’s increased focus on retail banking offerings has seen its loans and deposits grow at a strong rate – simultaneously granting it access to a cheap source of funds and also providing it with an efficient cross-selling channel. And finally, an overall strong outlook for the U.S. economy has helped the division secure strong inflows.

Additionally, the bank has looked to stabilize its wealth management revenues further by focusing more on fee-based client assets rather than performance-linked ones. This is evident from the fact that fee-based client assets swelled to over $1 trillion for the first time in Q3 2017 – up from $855 billion a year ago. In fact, these assets now constitute almost 43.5% of the division’s total client assets of $2.3 billion regulatory changes – a jump from under 41% in Q3 2016. Total client assets constitute of wealth management assets under management (shown in chart below) as well as deposits, brokerages and other client assets.

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