Fitch: Trading Drives Better Earnings for Morgan Stanley in 2Q16
The company's reported return on average equity (ROE) was 8.3% in 2Q16, up from 6.2% in the sequential quarter, but down from 9.9% in the year-ago quarter. While the ROE improvement relative to the sequential period is good, Fitch also notes that these returns remain below MS's long-term targets as well as Fitch's estimate of the company's cost of equity of between 10% to 12%.
This quarter's results generally are in line with peer banks that have reported thus far, as all have benefited from improved market conditions for trading activity within their Fixed Income, Currency, and Commodities divisions.
Net revenue in MS's Fixed Income and Commodities segment increased 49% from the sequential quarter and was down only 6% from the year-ago quarter, which notably still include the results from MS's oil merchanting business which was sold in late 2015. Improvement in this segment has been a focus more of MS over the last year, as the company had change leadership in this group and implemented efficiency measures across this platform.
Equity trading net revenue for MS was more muted, increasing 4% from the sequential quarter, but declining 8% from the year-ago quarter amid lower client activity levels and weakness in Asia. These results in equity trading are largely consistent with peer institutions that have reported thus far.
Investment banking (IB) net revenue benefited from favorable comparisons to the sequential quarter, increasing 12%, but was down relative to the year-ago quarter. The net revenue improvement relative to the sequential quarter was mixed as higher debt and underwriting net revenue more than offset a decline in advisory net revenue.
While in general the debt and equity underwriting environment in 2Q16 remains muted, it has improved relative to a very challenging 1Q16. Compared to the year-ago quarter, advisory net revenue was up 17%, while debt and equity underwriting net revenue was down 35% and 46%, respectively.
MS's wealth management business continues to generate good and stable earnings. Net revenue in the wealth management segment was up 4% relative to the sequential quarter but down modestly by 2% relative to the year ago quarter.
At the same time, the segment's pre-tax margin improved to 22.5%, up from 21% in the sequential quarter. A portion of this margin improvement was due to MS holding the line on expenses, with the compensation and benefits as a percentage of net revenues (comp ratio) in wealth management decline to 56% from 57% in both the sequential and year-ago quarters.
MS's investment management segment continues to perform satisfactorily despite continuing to experience some modest overall net outflows from its fund platform. Nevertheless, the segment's pre-tax margin remains good at 20% in 2Q16.
Fitch continues to note that MS's management is managing expenses carefully. The company's overall pre-tax margin was 28%, up from 22% in the sequential quarter, and unchanged from the year-ago quarter. While this sequential improvement was due to the better net revenue performance, MS also reduced its compensation ratio to 45% and its non-compensation ratio to 27% in 2Q16, from 30% in the sequential quarter.
The company's strong capital and liquidity positions continue to support its ratings in Fitch's opinion. MS's fully phased-in Basel III Common Equity Tier 1 (CET1) ratio under the advanced approaches improved to 15.8% in 2Q16 up from 14.5% in 1Q16, as MS continues to focus on reducing high density risk weighted assets (RWA).
MS's CET1 ratio is at the top end of peer group averages. Given the company received a conditional non-objection to its capital plan under the annual Comprehensive Capital Analysis & Review (CCAR) in late June 2016, Fitch would expect MS to begin returning more capital to shareholders.
Under the capital plan MS increased its dividend by $0.05 per quarter to $0.20 per quarter and plans to repurchase $3.5 billion of shares over the next four quarters beginning in the 3Q16. To address the conditional non-objection, MS will be required to submit an additional capital plan by the end of 2016 addressing weaknesses identified in its capital planning processes.
MS's 2Q16 fully phased-in Enhanced Supplementary Leverage Ratio improved to 6.1% in 2Q16, up from 6.0% in the sequential quarter.
Liquidity was similarly strong with the company's Global Liquidity Reserve (GLR) down just slightly to $207 billion, or 25% of total assets relative $211 billion or 26% of total assets in the sequential quarter. MS's deposit balances seasonally declined to $153 billion in 2Q16, down from $158 billion in the sequential quarter, but up from $139 billion in the year-ago quarter.
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