netrashetty
Netra Shetty
Morgan Stanley is a global financial services firm headquartered in New York City serving a diversified group of corporations, governments, financial institutions, and individuals. Morgan Stanley also operates in 36 countries around the world, with over 600 offices and a workforce of over 60,000.[1] The company reports US$779 billion as assets under its management.[2] It is headquartered in Midtown Manhattan, New York City.[3]
The corporation, formed by J.P. Morgan & Co. employees Henry S. Morgan (grandson of J.P. Morgan), Harold Stanley and others, came into existence on September 16, 1935. In its first year the company operated with a 24% market share (US$1.1 billion) in public offerings and private placements. The main areas of business for the firm today are Global Wealth Management, Institutional Securities and Investment Management.
The company found itself in the midst of a management crisis in the late 1990s[4] that resulted in a loss of a number of the firm's staff [5] and ultimately saw the firing of its then CEO Philip Purcell in 2005.
Morgan Stanley (NYSE:MS) is a U.S. bank holding company and the seventh largest global asset management firm in terms of assets under management with $522 billion.[1] Morgan Stanley advises large, institutional clients on how to structure and execute transactions, including mergers and acquisitions, and helps them with debt and equity issuance. Additionally, Morgan Stanley offers trading services and manages assets for institutions and wealthy individuals.
From 2007 to the 2nd quarter of 2009, Morgan Stanley faced significant declines in its assets and earnings, particularly due to the plunging in value of its mortgages and mortgage-backed securities, resulting in write-downs and write-offs totaling $10.8 billion in 2007. Conditions only worsened from 2008, prompting the firm to change its status to a Bank holding company on September 21, 2008, thereby allowing the company to run commercial banking operations and give its depositors insurance through Federal Deposit Insurance Corporation (FDIC). From a strategic perspective, Morgan Stanley can use deposits to reduce its leverage. However by July 22, 2009, the firm had posted three straight quarterly losses.
From the 3rd quarter of 2009 to the 2rd quarter of 2010, Morgan Stanley showed positive signs of recovery with consecutive quarters of profits with net income in 2Q2010 amounting to $1.9 billion primarily due to stable investment banking revenue which is gaining market share. However, the bank's trading performance lagging behind those of its peers, dropping 26% in 2Q2010 over 1Q2010. [2] The bank's wealth management division also suffered with %5.5 billion in net withdrawals in 2Q2010.[2]
Contents
1 Business Segments
1.1 Institutional Securities (67.2% of Net Revenue) [3]
1.1.1 Investment Banking and Corporate Lending
1.1.2 Sales and Trading Activities
1.2 Global Wealth Management (28.4% of Net Revenue)[3]
1.2.1 Morgan Stanley-Smith Barney
1.3 Asset Management (5.2% of Net Revenue)[3]
2 Trends and Forces
2.1 Impact of Basel III Rules on Big Banks
2.2 Transformation into a bank holding company helps reduce bankruptcy risk
2.3 Stress Test & the Repayment of TARP Funds
2.4 Shareholder Pressure on Employee Compensation
2.5 Macroeconomic Factors
2.5.1 Interest Rates
2.5.2 Benefits of Changes in Tax Law
2.5.3 Housing Market
2.6 Emerging Markets
2.7 Government Regulation
2.7.1 Obama's Bank Plan Restricts Banks' Profit Potential
2.7.2 Restriction of Hedge Funds, Private Equity Activities and Proprietary Trading Activities Leads to Business Restructuring
2.7.3 Barring of Swaps Could Cost Banks $85 Billion in Capital
2.7.4 New Tax Bill Protects Bank's Foreign Profits
3 Competition
4 References
In the 3rd quarter 2010, Morgan Stanley experienced a net loss of $0.07 per diluted share as revenue fell 20% with a reported income of $313 million from continuing operations. The report is a major plunge for the bank since income amounted to $936 million a year ago. Net revenues for the third quarter amounted to $6.8 billion compared to $8.5 billion a year ago. Revenues for the quarter included a negative revenue of $731 million related to MS's debt-related credit spreads (DVA), compared with a negative revenue of $878 million in the previous year.
Business Segments
Institutional Securities (67.2% of Net Revenue) [3]
Morgan Stanley's Institutional Securities group was the most profitable segment of its business plan in 2009 and the first half of 2010. Institutional Securities incorporates several different businesses including Investment Banking and Sales and Trading. The segment provides financial advisory and capital raising services primarily through wholly owned subsidiaries that include Morgan Stanley & Co Inc., Morgan Stanley & Co International plc, Morgan Stanley Japan Securities Co., Ltd and Morgan Stanley Asia Limited. The segment also conducts sales and trading activities worldwide, as principal and agent, and provide related financing services on behalf of institutional investors.
Investment Banking and Corporate Lending
Morgan Stanley's Investment banking provides corporate and institutional clients globally with advisory services on key strategic matters, such as mergers & acquisitions, divestures, joint ventures, corporate restructurings, recapitalizations, spin-offs, exchange offers and leverage buyouts and takeover defenses as well as shareholder relations. Its capital raising activities involve participating in public offerings and private placements of debt, equity and other securities worldwide. Its corporate lending activities including providing loans or lending commitments, including bridge financing, which involve providing capital on a short-term basis to a company prior to its going public or its next major private equity transaction. Overall investment banking revenue rose 14% sequentially to $1 billion. Based on industry announced but not complete M&A volumes reported by Dealogic, M&A seemed to have grown substantially during the 3rd quarter, setting up the 4th quarter and early 2011 for fairly robust advisory revenues, depending on MS's share of the mandates.
Sales and Trading Activities
Morgan Stanley conducts sale, trading, financing and market making activities on securities and futures exchanges and over-the-counter (OTC) markets around the world. Its sales and trading activities include Equity Trading, Interest Rates, Credit and Currencies, Commodities and Clients and Services. The banks is also a leader in electronic trading. Electronic trading involves using computers to conduct trades rather than involving human agents. It also carries significantly lower margins. On a core basis, trading revenue for the 3rd quarter 2010 was weaker than expected. Fixed income revenues, as reported and combined with other sales and trading amounted to $505 million. Excluding the credit valuation adjustment ($535 million loss in the 3rd quarter), FICC (Fixed-income, currencies and commodities) revenues decreased by 36% on a core basis, notably underperforming MS's competitors, which mostly experienced single digit declines. Equity revenues amounted to $925 million in the 3rd quarter of 2010. Excluding the credit valuation adjustment ($196 million), core equity revenues declined by 13% sequentially.
Global Wealth Management (28.4% of Net Revenue)[3]
This subset of Morgan Stanley focuses on providing advising services on investing and wealth planning, provides services for retirees, and offers insurance, credit, and other money lending products. It provides advising services to individuals and smaller businesses, however, its emphasis is on ultra high net worth and affluent investors. In fact, 69% of its individual clients are households with more than $1 million. In the 3rd quarter of 2010, total client assets rose to $1.6 trillion, mostly driven by the broad market rise (S&P500 increase of 11%). Flows improved with $5 billion of net asset inflows during the quarter. Revenue amounted to $3.1 billion, driven by higher than expected principal trading revenue ($386mm vs. $274mm estimate and $274mm in 2Q10). The segment’s compensation ratio declined from 64% to 61.5%, thereby increasing pre-tax margins from 6.7% to 9.1%, the segment's highest level since 3rd quarter 2009.
Morgan Stanley-Smith Barney
In January 2009, Morgan Stanley purchased Citi's Wealth Management business Smith-Barney for $2.7 billion in cash and a 51% stake of the venture.[4] The business is the world's largest wealth management business, with over 18,000 financial advisors, $1.7 trillion in client assets, $14.9 billion in pro-forma revenues, and $2.8 billion in pro-forma pre-tax profit.[5] MS Chairman and CEO John Mack stated that the move is an "important step forward in our effort to build our wealth management franchise, which will be an increasingly important and profitable part of Morgan Stanley's business."[5] In the first quarter of 2010, MS cut about 200 brokerage support staff but expanded its staff that works with high-net worth customers by adding 150 private bankers as well as 35 new securities sales and trading staff dedicated to working with the brokerage arm. MS also consolidated 136 groups of branches down to 120.[6]
Asset Management (5.2% of Net Revenue)[3]
Morgan Stanley's asset management services large institutions such as pension funds. Morgan Stanley Investment Management has nearly 1,000 investment professionals around the world and approximately $242 billion in assets under management as of Sept 30, 2010.[2] Asset management revenues for the 3rd quarter 2010 amounted to $802 million, driven by a $427 million of principle investment gain including $203 million form investments in certain consolidated real estate funds (MSREF), and $83 million of investment gains from private equity funds. In recent years this division has struggled as has seen significant asset outflows. To combat these trends the business has recently appointed new management in addition to bringing on new talent in the lower ranks. Additionally, it is pouring more resources into its Alternative Investments -typically higher risk higher return investments- and private equity offerings, two areas in which it has traditionally under invested. Morgan Stanley's alternative investments platform includes hedge funds, funds of hedge funds, funds of private equity fund and portable alpha strategies, including FrontPoint Partners LLC, a leading provide of absolute return strategies. The platform also includes minority stakes in Lansdowne Partners, Avenue Capital Groupe and Traxis Partners LP. Morgan Stanley's Merchange Banking Division includes the bank's real estate investing business, private equity funds and infrastructure investing group. Morgan Stanley typically acts as a general partner of and investment adviser to, its alternative investment and merchant banking funds. In June 1, 2010, Morgan Stanley completed its sale of its retail asset management business, including Van Kampen Investments, to Invesco in exchange for $800 million in cash and 30.9 million shares in Invesco LTD. equity. [7]
MS's annual net revenue, 2005-2009[8]
On Dec. 2, 2010, the local government of Hangzhou, China announced that it had signed a partnership with Morgan Stanley to establish the bank's China headquarters for private equity investment in the city. This agreement makes Morgan Stanley one of the first few major banks which have divested its private equity operations in the US and moved the business to China, creating an opportunity for the bank to launch a new line of yuan-denominated private equity funds in the country. [9]
Trends and Forces
Impact of Basel III Rules on Big Banks
The Basel Committee on Banking Supervision announced new regulations which ultimately will force banks to have 10.5% of total capital on hand against liabilities. The new rules are likely to affect the credit industry by imposing stricter discipline on credit cards, mortgages and other loans. Requiring banks to hold more capital on hand will limit the amount of money they can lend out, but also reduce the risk of insolvency given many loan defaults. woop
Under the new regulations, the mandatory Tier 1 capital reserve would rise from 4 percent to 4.5 percent by 2013 and reach 6 percent in 2019. Banks would also be required to keep an emergency reserve, or "conservation buffer," of 2.5 percent. Ultimately, the amount of rock-solid reserves each bank is expected to have will amount to 8.5 percent of assets. Also, the rules eliminate the ability to count deferred tax assets, some mortgage servicing rights and trust preferred securities as assets.
The potential impact of the regulations on US banks is rather limited because as of September 2010, 61 of 62 US banks with assets of more than $10 billion meet the requirements, therefore, banks such as Morgan Stanley, Goldman Sachs Group (GS), J P Morgan Chase (JPM), and Citigroup (C) will not see their businesses change with the passing of these rules.
Some major European banks, specifically Switzerland's two largest UBS and Credit Suisse, may face additional requirements because of the their immense to the Swiss economy and the possible harm a collapse would pose to the country.
The rules must still be presented to the leaders of the Group of 20 rich and developing nations at a meeting in November 2010 before they can be ratified by national governments, but the general consensus is that these rules will pass.[10]
Transformation into a bank holding company helps reduce bankruptcy risk
The risky mortgages and leveraged lending that were responsible for much of Morgan Stanley's growth since 2005 collapsed in 2007 resulting in more than $10b in losses. And, as asset prices, especially prices of mortgage-based securities started to plunge, it increased the risk that the bank would default on its debt obligations and could declare bankruptcy. In 2008, Morgan Stanley came under intense pressure to increase its equity base because of its high leverage ratio. Although investment banks typically operate at a higher leverage ratio than commercial banks, MS's was dangerously high. In September 2008, Morgan Stanley held $1 in equity for every $34 in assets, the remaining assets were supported by leverage, or borrowed money.
On September 21, 2008, Morgan Stanley became a bank holding company, which allows it to run commercial banking operations and gives its depositors insurance backed by the Federal Deposit Insurance Corporation (FDIC). Morgan Stanley has 3 million retail brokerage clients, with $36 billion in deposits, which amounted to about 4% of the firm's liabilities, which it uses to reduce its leverage and risk. This amount is a lot smaller than deposits at traditional commercial banks, whose deposits can account for 40% to 60% of liabilities.[11] Morgan Stanley has been continually expanding its retail banking services, as shown with its purchase of Citi's Wealth Management business in 2009 to create Morgan Stanley Smith Barney, the largest wealth management business in the world with $1.7 trillion in client assets.[12]
By becoming a bank holding company, Morgan Stanley has allowed itself to be placed under more oversight from the Federal Reserve than it had been in the past and expose itself to strict financial regulations which include the restriction of its proprietary trading and private equity businesses to 6% of its overall business.
Stress Test & the Repayment of TARP Funds
In February, the nation's 19 largest banks with more than $100 billion in assets were required to participate in a "stress test" -- a series of financial assessments to determine the health of the bank and if it needs additional capital.[13] The Fed's criteria for the Stress Test included measures such as, GDP, unemployment rates, and housing prices. In May 2009, the government determined that in addition to the $10 billion in Troubled Assets Relief Program (TARP) funds the government had given MS since October 2008, Morgan Stanley needed to raise additional $1.8 billion.[14] This was a relatively small amount compared to the $34 b Bank of America had to raise, and MS ranked 5th in the amount it capital it had a raise.[15]
Morgan Stanley was considered to be the first bank to repay its TARP money on June 17, 2009.[16] It raised $7.6 billion through the sale of common stock and assets.
Shareholder Pressure on Employee Compensation
Since the conclusion of the financial crisis, Morgan Stanley has repeatedly faced scrutiny, criticism and lawsuits by the public and shareholders for its employee compensation plans. On Feb. 11, 2010, the bank was sued by two institutional shareholders, the Security and Police and Fire Professionals of America Retirement Fund and the Central Laborers' Pension fund, which accused it of overpaying its employees after having been bailed out by taxpayers, setting aide 62% percent of net revenue to compensate employees in 2009,[17] a year in which the firm reported a loss of $0.93 per share.[18] The firm's primary competitor, Goldman Sachs, which sustained a profit of $8.6 billion in the first 9 months of 2009, set aside only 36% for employee compensation in 2009, thus supporting the plaintiffs' argument that MS's compensation plans are excessive and waste company assets and breach the company's duties to its shareholders.[17] Ultimately, this suit has the effect of forcing Morgan Stanley and other major financial services firms to reevaluate their compensation plans, changing the overall profitability of these firms.
Macroeconomic Factors
Interest Rates
Rising interest rates raise the cost of borrowing for all lenders, dampening the overall demand for mortgages and other home loan products. The U.S. Federal Funds Rate could help to stimulate demand for loans and lower default rates by allowing people to refinance their homes at lower rates. The Fed has been consistently lowering rates since 2007. For example, in July 2009 it was 0.5%, compared to 2% in July 2008 and 5.25% in September 2007.[19][20]
Benefits of Changes in Tax Law
Rising corporate income tax rates directly increase costs for taxes paid to the government, which decreases the amount of profits left for banks to fund investments and reinvest in operations. However, changes in tax law can also benefit banks. Newly proposed fiscal legislative reform for 2011, which will effectively increase the capital gains tax paid by private equity firms and other money managers from 15% to between 20% and 30%. This tax increase creates incentives for such firms to exit their profitable positions and move to launch initial public offerings (IPO) before the change in tax law takes effect in 2011. This is increase in IPO activity directly translates into an increase in fee for investment banks handling the private equity IPO deals.[21]
Housing Market
Investment banks, particularly those with significant mortgage securitization practices, are very sensitive to the residential real estate market. Mortgage-backed securitization (MBS) is the bundling of mortgages for sale to third parties. When the housing market goes down, the value of the underlying mortgages backing these securities falls as well. Moreover, the overall number of mortgages also decreases.
Housing loans have traditionally been a strong source of revenue for banking firms. With the current interest rate environment, owners of real estate are selling to take advantage of the high short-term rates. With low interest rates in the future, prospective home owners are staying out of the market and waiting for short-term rates to drop before looking for a loan. This over-arching attitude has weakened the housing loans business for banks, such as Morgan Stanley.
Emerging Markets
International expansion is a leading driver of investment banking and trading business. Since 2004, firms like Morgan Stanley have seen its international revenues grow at 2-5 times the pace of its US revenues. Morgan Stanley's US revenue grew at a compound annual growth rate of 3% versus 14% for international. This growth is driven by private equity, US company expansion, and the growth of capital markets in developing countries. Also, demand for access to foreign stock markets has risen; on August 25, 2008, Morgan Stanley announced that it was the first major investment bank to enter into a "swap agreement" letting foreign investors buy stock on the Saudi stock exchange.[22]
US companies often seek to expand their presences in other countries through acquisitions, leading to advisory fees for investment banks. Likewise, private equity companies are increasingly looking for international opportunities and require investment banks to take their acquisitions public. Finally, demand for capital and thus investment banking services, in developing countries like Brazil, China and India has increased exponentially over the last year and is expected to continue to grow for the foreseeable future.
In early 2011, the China Securities Regulatory Commission approved Morgan Stanley's partnership with Huaxin Securities Co to operate domestic securities businesses. The joint ventures will be able to help local clients raise money by selling stocks and bonds on local Chinese markets. Foreign companies are keen to get into China's expanding domestic securities market. The local partner will have a two-thirds share in the ventures. Morgan Stanley previously had a stake in China's first investment bank, China International Capital Corp., but sold it last year.[23]
Government Regulation
Obama's Bank Plan Restricts Banks' Profit Potential
United States President Barack Obama presented a plan on January 21, 2010 to restrict the activities of commercial banks, specifically outlawing proprietary trading and preventing commercial banks and institutions that own banks from owning, investing in or sponsoring private equity and hedge funds.[24] The Obama administration also plans to limit the ability of the largest banks to use borrowed money to fund expansion plans, which calls for an expansion of a 1994 law that forbids banks from acquiring another bank if the deal would give the bank more than 10% of the nation's insured deposits.[25]
Such legislation is intended to reduce speculative activity by financial institution in order to avoid future financial crises similar to the 2008 Financial Crisis; however, Obama's plan also has the effect of slowing economic recovery by limiting banks' ability to generate earnings as well as limiting investment in private equity deals and funds. U.S. banks make immense contributions to the buyout sector and have raised 60 funds since 2006, with a total value exceeding $80 billion. Such investments are crucial to driving economic growth and development, which will be greatly hindered with the imposition of such limits on the investment activities of major banks such as Morgan Stanley. Since U.S. banks also manage more than $180 billion in hedge funds of funds subsidiaries, any restriction on banks' management of funds would affect hundred of hedge funds worldwide, which generate profits from such funds of funds.[24]
Restriction of Hedge Funds, Private Equity Activities and Proprietary Trading Activities Leads to Business Restructuring
In compliance with the Volcker Rule, which restricts a banks' hedge fund and private equity activities to only 3% of Tier 1 capital, Morgan Stanley initiated the sale of FrontPoint, a Connecticut hedge fund it purchased in 2006 to the fund's managers for about $225 million. The managers would only be paying about half of what Morgan Stanley paid for the fund in 2006, resulting in substantial losses for the bank.[26]
In its efforts to get around US regulatory limits on private equity investment, Morgan Stanley has initiated plans to establish its private equity business in Hangzhou, China, entering into a largely untapped market for yuan-denominated private equity funds. The move is also a product of China's encouragement of private equity investment to aid economic restructuring in the country. [27]
Reuters reported that Morgan Stanley's proprietary trading unit will be spun off as an independent firm by the end of 2012. The unit, known internally as process driven trading, will be named PDT Advisers and will be run by Morgan Stanley's proprietary trading Chief, Peter Muller. During a two-year transition period, PDT Advisers will continue to manage Morgan Stanley's proprietary trading, as well as expand its business to include third-party investors.[28]
Barring of Swaps Could Cost Banks $85 Billion in Capital
On April 29th, 2010, debate on financial reform entered into the Senate with the new provision of the Senate Agriculture committee's derivatives bill that would bar swaps dealers from accessing the Federal Reserve's discount lending window or any other government guarantees. Swaps are derivative trades used by banks, financial firms and commercial companies to offset risks or hedge for or against certain outcomes. The biggest U.S. banks such as Morgan Stanley, Goldman Sachs Group (GS), and J P Morgan Chase (JPM) are the biggest swaps dealers, controlling 96% of the swaps market.[29]
The new derivatives bill forces banks to spin off most of their swaps desks and create new entities for swaps dealing activities. The cost of doing is estimated to be about $85 billion in capital. The ultimate purpose of the bill is to separate riskier trading and securities activities of investment banks from federally insured and implicitly guaranteed commercial banks.[29] Banks, however, are still allowed to trade interest rate and FX derivatives, gold and silver contracts, and cleared investment grade credit derivatives and hedge their own bets within the deposit-taking bank subsidiary.[30]
New Tax Bill Protects Bank's Foreign Profits
President Obama signed a new tax bill in December 2010 that offers a plethora of new tax breaks impacting various companies. There will be exemptions allowing banks, insurance companies and other financial firms to be protected from U.S. taxes for foreign profits until 2011, which will cost the U.S. gov is $9.2 billion. According to Washington Research Group director Anne Mathias, this will benefit multinational banks and financial firms like Citigroup, Bank of America, Goldman Sachs and Morgan Stanley and financing operations of other international companies.[31]
Competition
Global M&A market share for the first 7 months of 2010[32]
Morgan Stanley's primary competitor is Goldman Sachs Group (GS). Two the firms competed intensely as two of the premiere Investment Banks in the industry. However, since the 2007-2009 Financial crisis, both banks converted into holding banks. Despite this conversion, both banks remain close competitors. As of July 29, 2010, Morgan Stanley ranks 3rd in total number of Mergers & Acquisitions in 2010 behind Goldman Sachs Group (GS) in first and Credit Suisse in 2nd. The firm has also expected this sector to continue to grow as the economy begins to recover.[33] The firm also has strong positions in both debt and equity underwriting. It's primary competitors are Goldman, Merrill Lynch (MER) and J P Morgan Chase (JPM).
2008 metrics Goldman Sachs Morgan Stanley[34]
Gross Earnings ($B) 22,222 24,739
Pre-tax income ($M) 2,336 1,707
1-yr revenue growth (%) -51.7 -11.6
Equity origination revenue ($B) 1,353 1,045
M&A advisory revenue ($B) 2,656 1,740
Debt underwriting revenue ($B) 1,176 845
The corporation, formed by J.P. Morgan & Co. employees Henry S. Morgan (grandson of J.P. Morgan), Harold Stanley and others, came into existence on September 16, 1935. In its first year the company operated with a 24% market share (US$1.1 billion) in public offerings and private placements. The main areas of business for the firm today are Global Wealth Management, Institutional Securities and Investment Management.
The company found itself in the midst of a management crisis in the late 1990s[4] that resulted in a loss of a number of the firm's staff [5] and ultimately saw the firing of its then CEO Philip Purcell in 2005.
Morgan Stanley (NYSE:MS) is a U.S. bank holding company and the seventh largest global asset management firm in terms of assets under management with $522 billion.[1] Morgan Stanley advises large, institutional clients on how to structure and execute transactions, including mergers and acquisitions, and helps them with debt and equity issuance. Additionally, Morgan Stanley offers trading services and manages assets for institutions and wealthy individuals.
From 2007 to the 2nd quarter of 2009, Morgan Stanley faced significant declines in its assets and earnings, particularly due to the plunging in value of its mortgages and mortgage-backed securities, resulting in write-downs and write-offs totaling $10.8 billion in 2007. Conditions only worsened from 2008, prompting the firm to change its status to a Bank holding company on September 21, 2008, thereby allowing the company to run commercial banking operations and give its depositors insurance through Federal Deposit Insurance Corporation (FDIC). From a strategic perspective, Morgan Stanley can use deposits to reduce its leverage. However by July 22, 2009, the firm had posted three straight quarterly losses.
From the 3rd quarter of 2009 to the 2rd quarter of 2010, Morgan Stanley showed positive signs of recovery with consecutive quarters of profits with net income in 2Q2010 amounting to $1.9 billion primarily due to stable investment banking revenue which is gaining market share. However, the bank's trading performance lagging behind those of its peers, dropping 26% in 2Q2010 over 1Q2010. [2] The bank's wealth management division also suffered with %5.5 billion in net withdrawals in 2Q2010.[2]
Contents
1 Business Segments
1.1 Institutional Securities (67.2% of Net Revenue) [3]
1.1.1 Investment Banking and Corporate Lending
1.1.2 Sales and Trading Activities
1.2 Global Wealth Management (28.4% of Net Revenue)[3]
1.2.1 Morgan Stanley-Smith Barney
1.3 Asset Management (5.2% of Net Revenue)[3]
2 Trends and Forces
2.1 Impact of Basel III Rules on Big Banks
2.2 Transformation into a bank holding company helps reduce bankruptcy risk
2.3 Stress Test & the Repayment of TARP Funds
2.4 Shareholder Pressure on Employee Compensation
2.5 Macroeconomic Factors
2.5.1 Interest Rates
2.5.2 Benefits of Changes in Tax Law
2.5.3 Housing Market
2.6 Emerging Markets
2.7 Government Regulation
2.7.1 Obama's Bank Plan Restricts Banks' Profit Potential
2.7.2 Restriction of Hedge Funds, Private Equity Activities and Proprietary Trading Activities Leads to Business Restructuring
2.7.3 Barring of Swaps Could Cost Banks $85 Billion in Capital
2.7.4 New Tax Bill Protects Bank's Foreign Profits
3 Competition
4 References
In the 3rd quarter 2010, Morgan Stanley experienced a net loss of $0.07 per diluted share as revenue fell 20% with a reported income of $313 million from continuing operations. The report is a major plunge for the bank since income amounted to $936 million a year ago. Net revenues for the third quarter amounted to $6.8 billion compared to $8.5 billion a year ago. Revenues for the quarter included a negative revenue of $731 million related to MS's debt-related credit spreads (DVA), compared with a negative revenue of $878 million in the previous year.
Business Segments
Institutional Securities (67.2% of Net Revenue) [3]
Morgan Stanley's Institutional Securities group was the most profitable segment of its business plan in 2009 and the first half of 2010. Institutional Securities incorporates several different businesses including Investment Banking and Sales and Trading. The segment provides financial advisory and capital raising services primarily through wholly owned subsidiaries that include Morgan Stanley & Co Inc., Morgan Stanley & Co International plc, Morgan Stanley Japan Securities Co., Ltd and Morgan Stanley Asia Limited. The segment also conducts sales and trading activities worldwide, as principal and agent, and provide related financing services on behalf of institutional investors.
Investment Banking and Corporate Lending
Morgan Stanley's Investment banking provides corporate and institutional clients globally with advisory services on key strategic matters, such as mergers & acquisitions, divestures, joint ventures, corporate restructurings, recapitalizations, spin-offs, exchange offers and leverage buyouts and takeover defenses as well as shareholder relations. Its capital raising activities involve participating in public offerings and private placements of debt, equity and other securities worldwide. Its corporate lending activities including providing loans or lending commitments, including bridge financing, which involve providing capital on a short-term basis to a company prior to its going public or its next major private equity transaction. Overall investment banking revenue rose 14% sequentially to $1 billion. Based on industry announced but not complete M&A volumes reported by Dealogic, M&A seemed to have grown substantially during the 3rd quarter, setting up the 4th quarter and early 2011 for fairly robust advisory revenues, depending on MS's share of the mandates.
Sales and Trading Activities
Morgan Stanley conducts sale, trading, financing and market making activities on securities and futures exchanges and over-the-counter (OTC) markets around the world. Its sales and trading activities include Equity Trading, Interest Rates, Credit and Currencies, Commodities and Clients and Services. The banks is also a leader in electronic trading. Electronic trading involves using computers to conduct trades rather than involving human agents. It also carries significantly lower margins. On a core basis, trading revenue for the 3rd quarter 2010 was weaker than expected. Fixed income revenues, as reported and combined with other sales and trading amounted to $505 million. Excluding the credit valuation adjustment ($535 million loss in the 3rd quarter), FICC (Fixed-income, currencies and commodities) revenues decreased by 36% on a core basis, notably underperforming MS's competitors, which mostly experienced single digit declines. Equity revenues amounted to $925 million in the 3rd quarter of 2010. Excluding the credit valuation adjustment ($196 million), core equity revenues declined by 13% sequentially.
Global Wealth Management (28.4% of Net Revenue)[3]
This subset of Morgan Stanley focuses on providing advising services on investing and wealth planning, provides services for retirees, and offers insurance, credit, and other money lending products. It provides advising services to individuals and smaller businesses, however, its emphasis is on ultra high net worth and affluent investors. In fact, 69% of its individual clients are households with more than $1 million. In the 3rd quarter of 2010, total client assets rose to $1.6 trillion, mostly driven by the broad market rise (S&P500 increase of 11%). Flows improved with $5 billion of net asset inflows during the quarter. Revenue amounted to $3.1 billion, driven by higher than expected principal trading revenue ($386mm vs. $274mm estimate and $274mm in 2Q10). The segment’s compensation ratio declined from 64% to 61.5%, thereby increasing pre-tax margins from 6.7% to 9.1%, the segment's highest level since 3rd quarter 2009.
Morgan Stanley-Smith Barney
In January 2009, Morgan Stanley purchased Citi's Wealth Management business Smith-Barney for $2.7 billion in cash and a 51% stake of the venture.[4] The business is the world's largest wealth management business, with over 18,000 financial advisors, $1.7 trillion in client assets, $14.9 billion in pro-forma revenues, and $2.8 billion in pro-forma pre-tax profit.[5] MS Chairman and CEO John Mack stated that the move is an "important step forward in our effort to build our wealth management franchise, which will be an increasingly important and profitable part of Morgan Stanley's business."[5] In the first quarter of 2010, MS cut about 200 brokerage support staff but expanded its staff that works with high-net worth customers by adding 150 private bankers as well as 35 new securities sales and trading staff dedicated to working with the brokerage arm. MS also consolidated 136 groups of branches down to 120.[6]
Asset Management (5.2% of Net Revenue)[3]
Morgan Stanley's asset management services large institutions such as pension funds. Morgan Stanley Investment Management has nearly 1,000 investment professionals around the world and approximately $242 billion in assets under management as of Sept 30, 2010.[2] Asset management revenues for the 3rd quarter 2010 amounted to $802 million, driven by a $427 million of principle investment gain including $203 million form investments in certain consolidated real estate funds (MSREF), and $83 million of investment gains from private equity funds. In recent years this division has struggled as has seen significant asset outflows. To combat these trends the business has recently appointed new management in addition to bringing on new talent in the lower ranks. Additionally, it is pouring more resources into its Alternative Investments -typically higher risk higher return investments- and private equity offerings, two areas in which it has traditionally under invested. Morgan Stanley's alternative investments platform includes hedge funds, funds of hedge funds, funds of private equity fund and portable alpha strategies, including FrontPoint Partners LLC, a leading provide of absolute return strategies. The platform also includes minority stakes in Lansdowne Partners, Avenue Capital Groupe and Traxis Partners LP. Morgan Stanley's Merchange Banking Division includes the bank's real estate investing business, private equity funds and infrastructure investing group. Morgan Stanley typically acts as a general partner of and investment adviser to, its alternative investment and merchant banking funds. In June 1, 2010, Morgan Stanley completed its sale of its retail asset management business, including Van Kampen Investments, to Invesco in exchange for $800 million in cash and 30.9 million shares in Invesco LTD. equity. [7]
MS's annual net revenue, 2005-2009[8]
On Dec. 2, 2010, the local government of Hangzhou, China announced that it had signed a partnership with Morgan Stanley to establish the bank's China headquarters for private equity investment in the city. This agreement makes Morgan Stanley one of the first few major banks which have divested its private equity operations in the US and moved the business to China, creating an opportunity for the bank to launch a new line of yuan-denominated private equity funds in the country. [9]
Trends and Forces
Impact of Basel III Rules on Big Banks
The Basel Committee on Banking Supervision announced new regulations which ultimately will force banks to have 10.5% of total capital on hand against liabilities. The new rules are likely to affect the credit industry by imposing stricter discipline on credit cards, mortgages and other loans. Requiring banks to hold more capital on hand will limit the amount of money they can lend out, but also reduce the risk of insolvency given many loan defaults. woop
Under the new regulations, the mandatory Tier 1 capital reserve would rise from 4 percent to 4.5 percent by 2013 and reach 6 percent in 2019. Banks would also be required to keep an emergency reserve, or "conservation buffer," of 2.5 percent. Ultimately, the amount of rock-solid reserves each bank is expected to have will amount to 8.5 percent of assets. Also, the rules eliminate the ability to count deferred tax assets, some mortgage servicing rights and trust preferred securities as assets.
The potential impact of the regulations on US banks is rather limited because as of September 2010, 61 of 62 US banks with assets of more than $10 billion meet the requirements, therefore, banks such as Morgan Stanley, Goldman Sachs Group (GS), J P Morgan Chase (JPM), and Citigroup (C) will not see their businesses change with the passing of these rules.
Some major European banks, specifically Switzerland's two largest UBS and Credit Suisse, may face additional requirements because of the their immense to the Swiss economy and the possible harm a collapse would pose to the country.
The rules must still be presented to the leaders of the Group of 20 rich and developing nations at a meeting in November 2010 before they can be ratified by national governments, but the general consensus is that these rules will pass.[10]
Transformation into a bank holding company helps reduce bankruptcy risk
The risky mortgages and leveraged lending that were responsible for much of Morgan Stanley's growth since 2005 collapsed in 2007 resulting in more than $10b in losses. And, as asset prices, especially prices of mortgage-based securities started to plunge, it increased the risk that the bank would default on its debt obligations and could declare bankruptcy. In 2008, Morgan Stanley came under intense pressure to increase its equity base because of its high leverage ratio. Although investment banks typically operate at a higher leverage ratio than commercial banks, MS's was dangerously high. In September 2008, Morgan Stanley held $1 in equity for every $34 in assets, the remaining assets were supported by leverage, or borrowed money.
On September 21, 2008, Morgan Stanley became a bank holding company, which allows it to run commercial banking operations and gives its depositors insurance backed by the Federal Deposit Insurance Corporation (FDIC). Morgan Stanley has 3 million retail brokerage clients, with $36 billion in deposits, which amounted to about 4% of the firm's liabilities, which it uses to reduce its leverage and risk. This amount is a lot smaller than deposits at traditional commercial banks, whose deposits can account for 40% to 60% of liabilities.[11] Morgan Stanley has been continually expanding its retail banking services, as shown with its purchase of Citi's Wealth Management business in 2009 to create Morgan Stanley Smith Barney, the largest wealth management business in the world with $1.7 trillion in client assets.[12]
By becoming a bank holding company, Morgan Stanley has allowed itself to be placed under more oversight from the Federal Reserve than it had been in the past and expose itself to strict financial regulations which include the restriction of its proprietary trading and private equity businesses to 6% of its overall business.
Stress Test & the Repayment of TARP Funds
In February, the nation's 19 largest banks with more than $100 billion in assets were required to participate in a "stress test" -- a series of financial assessments to determine the health of the bank and if it needs additional capital.[13] The Fed's criteria for the Stress Test included measures such as, GDP, unemployment rates, and housing prices. In May 2009, the government determined that in addition to the $10 billion in Troubled Assets Relief Program (TARP) funds the government had given MS since October 2008, Morgan Stanley needed to raise additional $1.8 billion.[14] This was a relatively small amount compared to the $34 b Bank of America had to raise, and MS ranked 5th in the amount it capital it had a raise.[15]
Morgan Stanley was considered to be the first bank to repay its TARP money on June 17, 2009.[16] It raised $7.6 billion through the sale of common stock and assets.
Shareholder Pressure on Employee Compensation
Since the conclusion of the financial crisis, Morgan Stanley has repeatedly faced scrutiny, criticism and lawsuits by the public and shareholders for its employee compensation plans. On Feb. 11, 2010, the bank was sued by two institutional shareholders, the Security and Police and Fire Professionals of America Retirement Fund and the Central Laborers' Pension fund, which accused it of overpaying its employees after having been bailed out by taxpayers, setting aide 62% percent of net revenue to compensate employees in 2009,[17] a year in which the firm reported a loss of $0.93 per share.[18] The firm's primary competitor, Goldman Sachs, which sustained a profit of $8.6 billion in the first 9 months of 2009, set aside only 36% for employee compensation in 2009, thus supporting the plaintiffs' argument that MS's compensation plans are excessive and waste company assets and breach the company's duties to its shareholders.[17] Ultimately, this suit has the effect of forcing Morgan Stanley and other major financial services firms to reevaluate their compensation plans, changing the overall profitability of these firms.
Macroeconomic Factors
Interest Rates
Rising interest rates raise the cost of borrowing for all lenders, dampening the overall demand for mortgages and other home loan products. The U.S. Federal Funds Rate could help to stimulate demand for loans and lower default rates by allowing people to refinance their homes at lower rates. The Fed has been consistently lowering rates since 2007. For example, in July 2009 it was 0.5%, compared to 2% in July 2008 and 5.25% in September 2007.[19][20]
Benefits of Changes in Tax Law
Rising corporate income tax rates directly increase costs for taxes paid to the government, which decreases the amount of profits left for banks to fund investments and reinvest in operations. However, changes in tax law can also benefit banks. Newly proposed fiscal legislative reform for 2011, which will effectively increase the capital gains tax paid by private equity firms and other money managers from 15% to between 20% and 30%. This tax increase creates incentives for such firms to exit their profitable positions and move to launch initial public offerings (IPO) before the change in tax law takes effect in 2011. This is increase in IPO activity directly translates into an increase in fee for investment banks handling the private equity IPO deals.[21]
Housing Market
Investment banks, particularly those with significant mortgage securitization practices, are very sensitive to the residential real estate market. Mortgage-backed securitization (MBS) is the bundling of mortgages for sale to third parties. When the housing market goes down, the value of the underlying mortgages backing these securities falls as well. Moreover, the overall number of mortgages also decreases.
Housing loans have traditionally been a strong source of revenue for banking firms. With the current interest rate environment, owners of real estate are selling to take advantage of the high short-term rates. With low interest rates in the future, prospective home owners are staying out of the market and waiting for short-term rates to drop before looking for a loan. This over-arching attitude has weakened the housing loans business for banks, such as Morgan Stanley.
Emerging Markets
International expansion is a leading driver of investment banking and trading business. Since 2004, firms like Morgan Stanley have seen its international revenues grow at 2-5 times the pace of its US revenues. Morgan Stanley's US revenue grew at a compound annual growth rate of 3% versus 14% for international. This growth is driven by private equity, US company expansion, and the growth of capital markets in developing countries. Also, demand for access to foreign stock markets has risen; on August 25, 2008, Morgan Stanley announced that it was the first major investment bank to enter into a "swap agreement" letting foreign investors buy stock on the Saudi stock exchange.[22]
US companies often seek to expand their presences in other countries through acquisitions, leading to advisory fees for investment banks. Likewise, private equity companies are increasingly looking for international opportunities and require investment banks to take their acquisitions public. Finally, demand for capital and thus investment banking services, in developing countries like Brazil, China and India has increased exponentially over the last year and is expected to continue to grow for the foreseeable future.
In early 2011, the China Securities Regulatory Commission approved Morgan Stanley's partnership with Huaxin Securities Co to operate domestic securities businesses. The joint ventures will be able to help local clients raise money by selling stocks and bonds on local Chinese markets. Foreign companies are keen to get into China's expanding domestic securities market. The local partner will have a two-thirds share in the ventures. Morgan Stanley previously had a stake in China's first investment bank, China International Capital Corp., but sold it last year.[23]
Government Regulation
Obama's Bank Plan Restricts Banks' Profit Potential
United States President Barack Obama presented a plan on January 21, 2010 to restrict the activities of commercial banks, specifically outlawing proprietary trading and preventing commercial banks and institutions that own banks from owning, investing in or sponsoring private equity and hedge funds.[24] The Obama administration also plans to limit the ability of the largest banks to use borrowed money to fund expansion plans, which calls for an expansion of a 1994 law that forbids banks from acquiring another bank if the deal would give the bank more than 10% of the nation's insured deposits.[25]
Such legislation is intended to reduce speculative activity by financial institution in order to avoid future financial crises similar to the 2008 Financial Crisis; however, Obama's plan also has the effect of slowing economic recovery by limiting banks' ability to generate earnings as well as limiting investment in private equity deals and funds. U.S. banks make immense contributions to the buyout sector and have raised 60 funds since 2006, with a total value exceeding $80 billion. Such investments are crucial to driving economic growth and development, which will be greatly hindered with the imposition of such limits on the investment activities of major banks such as Morgan Stanley. Since U.S. banks also manage more than $180 billion in hedge funds of funds subsidiaries, any restriction on banks' management of funds would affect hundred of hedge funds worldwide, which generate profits from such funds of funds.[24]
Restriction of Hedge Funds, Private Equity Activities and Proprietary Trading Activities Leads to Business Restructuring
In compliance with the Volcker Rule, which restricts a banks' hedge fund and private equity activities to only 3% of Tier 1 capital, Morgan Stanley initiated the sale of FrontPoint, a Connecticut hedge fund it purchased in 2006 to the fund's managers for about $225 million. The managers would only be paying about half of what Morgan Stanley paid for the fund in 2006, resulting in substantial losses for the bank.[26]
In its efforts to get around US regulatory limits on private equity investment, Morgan Stanley has initiated plans to establish its private equity business in Hangzhou, China, entering into a largely untapped market for yuan-denominated private equity funds. The move is also a product of China's encouragement of private equity investment to aid economic restructuring in the country. [27]
Reuters reported that Morgan Stanley's proprietary trading unit will be spun off as an independent firm by the end of 2012. The unit, known internally as process driven trading, will be named PDT Advisers and will be run by Morgan Stanley's proprietary trading Chief, Peter Muller. During a two-year transition period, PDT Advisers will continue to manage Morgan Stanley's proprietary trading, as well as expand its business to include third-party investors.[28]
Barring of Swaps Could Cost Banks $85 Billion in Capital
On April 29th, 2010, debate on financial reform entered into the Senate with the new provision of the Senate Agriculture committee's derivatives bill that would bar swaps dealers from accessing the Federal Reserve's discount lending window or any other government guarantees. Swaps are derivative trades used by banks, financial firms and commercial companies to offset risks or hedge for or against certain outcomes. The biggest U.S. banks such as Morgan Stanley, Goldman Sachs Group (GS), and J P Morgan Chase (JPM) are the biggest swaps dealers, controlling 96% of the swaps market.[29]
The new derivatives bill forces banks to spin off most of their swaps desks and create new entities for swaps dealing activities. The cost of doing is estimated to be about $85 billion in capital. The ultimate purpose of the bill is to separate riskier trading and securities activities of investment banks from federally insured and implicitly guaranteed commercial banks.[29] Banks, however, are still allowed to trade interest rate and FX derivatives, gold and silver contracts, and cleared investment grade credit derivatives and hedge their own bets within the deposit-taking bank subsidiary.[30]
New Tax Bill Protects Bank's Foreign Profits
President Obama signed a new tax bill in December 2010 that offers a plethora of new tax breaks impacting various companies. There will be exemptions allowing banks, insurance companies and other financial firms to be protected from U.S. taxes for foreign profits until 2011, which will cost the U.S. gov is $9.2 billion. According to Washington Research Group director Anne Mathias, this will benefit multinational banks and financial firms like Citigroup, Bank of America, Goldman Sachs and Morgan Stanley and financing operations of other international companies.[31]
Competition
Global M&A market share for the first 7 months of 2010[32]
Morgan Stanley's primary competitor is Goldman Sachs Group (GS). Two the firms competed intensely as two of the premiere Investment Banks in the industry. However, since the 2007-2009 Financial crisis, both banks converted into holding banks. Despite this conversion, both banks remain close competitors. As of July 29, 2010, Morgan Stanley ranks 3rd in total number of Mergers & Acquisitions in 2010 behind Goldman Sachs Group (GS) in first and Credit Suisse in 2nd. The firm has also expected this sector to continue to grow as the economy begins to recover.[33] The firm also has strong positions in both debt and equity underwriting. It's primary competitors are Goldman, Merrill Lynch (MER) and J P Morgan Chase (JPM).
2008 metrics Goldman Sachs Morgan Stanley[34]
Gross Earnings ($B) 22,222 24,739
Pre-tax income ($M) 2,336 1,707
1-yr revenue growth (%) -51.7 -11.6
Equity origination revenue ($B) 1,353 1,045
M&A advisory revenue ($B) 2,656 1,740
Debt underwriting revenue ($B) 1,176 845
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