Tepid trading may spoil Morgan Stanley’s 1Q results
As big investment banks prepare to report first-quarter earnings this month, many analysts are lowering their forecasts in light of weaker-than-expected trading by investors in February and March.
As big investment banks prepare to report first-quarter earnings this month, many analysts are lowering their forecasts in light of weaker-than-expected trading by investors in February and March.
Eyes are turning, particularly, to Morgan Stanley, which last June became the world’s biggest retail-brokerage firm with its absorption of the Smith Barney network to form Morgan Stanley Smith Barney LLC.
Morgan Stanley acquired 51% of Smith Barney’s revenue flow for $2.7 billion from its capital-starved parent, Citigroup Inc., with an option for 100% control in 2014. For Morgan Stanley, the deal was intended in part to smooth out the contributions from volatile capital markets and proprietary trading, areas that torpedoed big banks’ results during the financial crisis of 2008 and early 2009.
Analysts in recent days have lowered their first-quarter forecast for Morgan Stanley to an average of 67 cents a share, down 13% from their expectations at the beginning of the year, according to Zacks Investment Research.
“Our previous estimates did not anticipate tepid activity in February and March,” Sanford C. Bernstein & Co. LLC analyst Brad Hintz wrote in a research report to clients March 26.
While Mr. Hintz actually raised his first-quarter earnings estimate for the firm to 54 cents, from 50 cents, he lowered his full-year estimate to $2.74 a share, from $2.81.
That is based in part on his view that retail investors will remain risk-averse and heavily invested in cash.
It is also based on his expectation that the full integration of Smith Barney into Morgan Stanley is at least 15 months away. In other words, the synergies expected to create $1.2 billion in cost savings may be a long way off.
“Large one-time expenses associated with the MSSB merger will mask much of the improvement in the retail-brokerage expense run rates over the coming year, which could make investors skeptical of the firm’s all-in bet on retail,” Mr. Hintz wrote in his report, in which he also endorsed the bank’s decision to become the leading retail-channel distributor of financial products through some 18,000 brokers.
Morgan Stanley, of course, hasn’t given up its venerable heritage in institutional markets, capital markets and proprietary trading — despite losing $960 million in 2009 and $1.3 billion in 2008 from credit-related losses in those areas.
Trading and banking revenue has bounced back, enabling the bank to repay with interest the $10 billion it borrowed from the government during the financial crisis.
Even so, analysts are keeping a watchful eye on Morgan Stanley and other big investment banks.
“The problem with an investment bank is that their risk appetite can change overnight,” said Peter Nerby, who follows banks’ creditworthiness for Moody’s Investors Service.
Indeed, Morgan Stanley last week said it will book a loss of $800 million to $1 billion in the first quarter for a soured investment in an Atlantic City, N.J., casino project.
Moody’s dropped its rating on Morgan Stanley two notches to A-2 during the financial crisis of 2008 and continues to have a “negative outlook” on it and its major rivals.
Analysts are fairly bullish, however, about the firm’s new focus on wealth management. It’s a less volatile business than trading and traditional investment banking and it consumes a lot less capital.
Nearly half of Morgan Stanley’s revenue eventually could come from retail-wealth-management activities at a handsome profit margin of almost 25%, said Mr. Hintz.
Still, it remains to be seen how successful Morgan Stanley chief executive James Gorman and Smith Barney president Charles Johnston will be in motivating their army of 18,000 brokers and branch managers. Some 700 Smith Barney advisers bolted soon after the deal was announced, many Smith Barney branch and regional managers lost their empires, and almost every week, rival wirehouses and independent firms announce hires from Morgan Stanley.
Mr. Gorman and other executives repeatedly have said they can retain and recruit the producers they want without significantly escalating recruiting wars — an assertion the firm continues to repeat.
“Attrition in our top two quintiles is at historic lows,” said Christine Pollak, a Morgan Stanley spokeswoman, referring to the top 40% of financial advisers by revenue produced. “The vast majority of FAs who do leave have below-average production.”
In the last two weeks, the firm has recruited three teams with annual revenue of more than $1 million, she said without providing details.
Morgan Stanley also is pressing legal levers to retain brokers. Last month, it sued Kevin Whitehead, who had overseen six branches and more than 100 advisers at its St. Louis complex, for jumping ship to take a similar position at Wells Fargo Advisors LLC.
The integration of the Morgan Stanley and Smith Barney platforms is on schedule to be completed in the summer of 2011, the same year that the cost synergies will be fully realized, said James Wiggins, a senior spokesman for the wealth management group.
Pretax profit margins in the unit remain stressed, averaging just 8% in the second half of 2009 after the deal closed. But Mr. Gorman said at a conference in February that they should climb to 15% this year and top 20% — the Holy Grail of all big brokerage operations — in 2011. Return on average common equity — a profitability signal monitored by investors — averaged just 4.3% in the second half of last year, down from 49% for the pre-merger retail unit in all of 2008.
That last percentage, of course, points to why Mr. Gorman is focusing so much attention on retail. Nineteen out of 30 analysts tracked by Bloomberg have the equivalent of “buy” recommendations on the stock, in part because of the potential for steady retail revenue.
“Essentially, the new Morgan Stanley will be more like a Merrill and less like a Goldman Sachs,” Mr. Hintz wrote in an e-mail.
Morgan Stanley Smith Barney ended 2010 with 18,135 advisers overseeing $1.6 trillion of client assets, superseding Merrill Lynch & Co. Inc. as the securities industry’s biggest retail brokerage.
E-mail Jed Horowitz at [email protected].
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