Declines in Trading Forces Morgan Stanley to Cut Costs
Morgan Stanley (NYSE:MS) and the other banks including Bank of America (NYSE:BAC), Citigroup (NYSE:C), Goldman Sachs (NYSE:GS) and Deutsche Bank (NYSE:DB) have seen their stock prices decline steadily over the last 3 months. [1] An estimated 16% decline in Q2 trading revenues caused by a slowdown in fixed-income, currencies and commodities trading is forcing Morgan Stanley – the world’s largest brokerage firm – to resort to cost cutting to resize its business and maintain profit margins. [2]
We have a near $33 price estimate for Morgan Stanley which is roughly at a 50% premium over the current market price.
Trading and Asset Management Are MS’s Linchpins of Value
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Our analysis of the company shows that the trading and asset management businesses together contribute to 60% of its value.
Trading margins have been adversely impacted over the past few months by choppy market dynamics and increasingly strict regulations aiming to curb banks deemed “systemically important” from taking “unwarranted risks”. Morgan Stanley and other banks have already initiated steps to wind down proprietary trading units to comply with the Volker Rule. [3] Proprietary trading margins tend to be higher as banks bet on their own capital, eliminating the need to share any of the spoils. Cutting down on these businesses will pull down the overall margins for the trading business. Stricter scrutiny of capital and liquidity norms could also limit the flexibility of trading operations, further eating into the yield.
The company’s yields on debt, currency and commodities trading dropped from 3.6% in 2006 to 2.5% in 2010. We estimate that margins will creep back to 3% over our forecast period.
In the equity trading markets, the company has shown considerably better margins of around 8.4% in 2010 and we expect the margins from this line of business to remain at roughly the same level in the future.
How the Banks are Responding
Hard-pressed to maintain margins, Morgan Stanley has been forced to cut down on costs. The company plans to reduce jobs in its wealth management division, and some reports indicate that other banks will follow suit soon. Morgan Stanley is also initiating strict cost-cutting measures through which it aims to save $500 million in the first year and $1 billion in the next three years. [4].
See our complete analysis of Morgan Stanley
- Shrinking Valuations Drive Bank Payroll Cuts to Buoy Profits, Bloomberg [↩]
- Morgan Stanley Weighs Job Cuts as Barclays Capital Reduces Its Sales Posts, Bloomberg [↩]
- Goldman Sachs Said to Close Fixed-Income Prop Group, Bloomberg [↩]
- Morgan Stanley Slashing Everything: Travel, Blackberries, Jobs, And Paper, Business Insider [↩]