How This Financial institution Has Been Making ready for an Funding Banking Slowdown
Banking and Investment

How This Financial institution Has Been Making ready for an Funding Banking Slowdown

This 12 months has been one for the document books. Inflation is at its highest degree in over 40 years. The S&P 500 is off to its worst begin in over 50 years. Rates of interest are rising at their quickest tempo in 30 years. 

Firms went public at a document tempo final 12 months, however this 12 months’s market weak spot has brought on preliminary public choices (IPOs) to come back to a screeching halt. Consequently, funding banks have seen earnings from this exercise plummet.

Whereas no one might have seen this coming, Morgan Stanley (MS 1.48%) has put itself ready to climate the storm whereas different funding bankers really feel the ache from an financial slowdown. Here is what the corporate did to remodel its enterprise.

The issue with funding banking

Morgan Stanley has traditionally offered funding banking companies to firms that wish to go public via an IPO or elevate cash via a debt providing. The corporate is among the finest at what it does, and is among the prime funding banks on the earth, alongside Goldman Sachs, JPMorgan Chase, and Financial institution of America. Nonetheless, the corporate’s reliance on funding banking created a feast-or-famine scenario, the place it thrived when financial circumstances have been favorable and struggled when issues turned south.

In 2009, one 12 months earlier than present CEO James Gorman took the reigns, Morgan Stanley generated 66% of its income from its institutional securities section, which incorporates funding banking and buying and selling income. Since then, the agency has diversified its income, so 50% comes from the institutional securities section, making it much less prone to the funding banking market cycles. Here is the way it did it. 

Charts shows Morgan Stanley's revenue mix from 2009 and 2021.

Knowledge supply: Morgan Stanley. Chart by writer.

Morgan Stanley’s answer

Morgan Stanley additionally gives wealth administration companies, which embody funding recommendation and brokerage companies, together with funding administration companies, the place it gives funding merchandise for retirement plans, foundations, and endowments.

These two companies have been a smaller portion of the agency’s income till a number of years in the past, when it acquired the E*Commerce buying and selling platform and the asset supervisor Eaton Vance for a complete of $20 billion.

The acquisition of E*Commerce gave Morgan Stanley a buying and selling platform that brings in cash via transaction charges whereas rising its deposit base, permitting it to earn additional curiosity revenue. In the meantime, the acquisition of Eaton Vance provides Morgan Stanley a extra vital funding enterprise the place it collects charges on its property underneath administration (AUM). Final 12 months Morgan Stanley’s AUM grew 85% to $5.6 billion due to this acquisition. 

Professionals review a tablet in an outdoor setting.

Picture supply: Getty Photographs.

Bringing stability to its earnings

Via the primary half of this 12 months, Morgan Stanley’s funding banking income fell 46%, primarily resulting from a dramatic 70% drop in underwriting revenue. The financial institution’s different areas noticed declines too, however not practically as large.

Its wealth administration section introduced in $11.7 billion in web income, down 3% from final 12 months. Asset administration charges and web curiosity revenue grew on this section, whereas transaction charges dropped off. Its institutional administration section introduced in $2.7 billion in income, down 9% from final 12 months. Asset administration charges right here have been additionally up from final 12 months, whereas performance-based charges dropped amid weaker markets. 

Whereas each segments noticed drops in income, they weren’t practically as a lot because the funding banking portion of its income. Each income sources are unbiased of the funding banking cycle, and assist present Morgan Stanley with a extra steady income base.

Funding takeaway

Morgan Stanley’s web income via six months is down 8% from final 12 months, and web revenue is down 19%. To place this in perspective, Goldman Sachs, which depends extra on funding banking to drive earnings, noticed its web income via six months fall by 25%, whereas its web revenue fell by 45%. In the meantime, Jefferies Group, one other funding bank-heavy enterprise, noticed its web income fall by 30%, and web revenue fall by 53%. 

Morgan Stanley has been on a mission to construct a extra resilient enterprise, and we see that enjoying out in the present day. The agency presently trades at a price-to-earnings ratio (P/E) of simply 10.9, on the decrease finish of its historical past. Nonetheless, you can argue that it deserves a better valuation after remodeling its enterprise via strategic acquisitions — and it might be a superb worth inventory at this value.

Financial institution of America is an promoting companion of The Ascent, a Motley Idiot firm. JPMorgan Chase is an promoting companion of The Ascent, a Motley Idiot firm. Courtney Carlsen has positions in Morgan Stanley. The Motley Idiot has positions in and recommends Goldman Sachs and Jefferies Monetary Group Inc. The Motley Idiot has a disclosure coverage.