Morgan Stanley's Q2 results, which showed improved revenues for its newly-enfeebled fixed income business, struggles in equities and better M&A activity, raise more questions than answers. This is what you need to know.
Morgan Stanley’s fixed income revenues were strong in the second quarter. It’s easy to assume that this is down to the usual post-Brexit bounce. But CFO Jonathan Pruzan insisted that, while the volatility and volumes in its macro business helped bolster revenues, the quarter was generally improved. “One or two days” of spiked activity before and after the Brexit vote didn't make much difference, he added.
Morgan Stanley sold its huge oil merchanting business late last year – largely, it says, to reduce volatility in FICC revenues. It also cut 25% of its headcount in FIC, which would seemingly hurt its business should the overall environment for fixed income improve.
CEO James Gorman said today that its fixed income headcount cuts were in line with its competitors, the difference being that Morgan Stanley made did them all at once rather than in “dribs and drabs”. “Clearly, we were over-staffed at that time,” said Gorman, adding that the bank wasn't “constrained by capacity of personnel” around Brexit.
Morgan Stanley is targeting a run rate of $1bn a quarter in fixed income, or around $4bn a year. So far, it’s hit $2.1bn and is therefore on track for the year. However, questions remain as to whether the fixed income business can meet the run rate as the Brexit surge dissipates.
The idea of cutting back in FIC was to ensure less volatile revenues and help push back the banks’ return on equity to 9-11% by the end of 2017. In Q1, Gorman said he wouldn’t rule out more cuts to FICC if revenues continued to be challenged. Traders better hope Q2 performance isn’t a blip.
Project Streamline – or Morgan Stanley’s plan to strip out $1bn annually in costs by 2018 – continues. So far, it’s moved 250 employees from “high cost metro areas” to its “centres of excellence” in lower cost destinations like Hungary and Glasgow intends to shift around 1,200 people in the future. Back office jobs and tech development roles will be harder to come by in London or New York, but this is in line with a longer-term trend across the industry anyway.
It’s also using technology to “drive through efficiencies” – again through back office processes and is obviously aiming to cut compensation costs, which are down 23% year on year in its securities business. Oh, and it’s slashing “non-essential” travel, which is down 50% year on year for the first half.
Morgan Stanley’s M&A team had an exceptional quarter. Revenues are up 22% year on year for the first half to $1.1bn, even after a strong first six months of 2015. It’s not as though Morgan Stanley was a particular laggard during the good times in 2015 – its overall ranking of second place for the first half remains unchanged globally, according to the latest figures from Dealogic.
European revenues appear to be the differentiating factor. It had 7% of the revenue pot in EMEA to June 2016, according to Dealogic, and ranked third overall. At this point last year, it had 5.6% of the market and was ranked fifth. Morgan Stanley's biggest deal of the quarter was Charter Communications' $79bn purchase of Time Warner Inc.
Morgan Stanley’s fixed income division has gone from the being beating heart of the business to being a marginal player. This is part of James Gorman's strategy of creating a market leading equities business rather than trying to be all things to all men. It's worrying, therefore, that equity trading revenues are at $4.2bn for the first six months of the year – a 9% decline on 2015.
Pruzen said that cash equities were up quarter on quarter, and that revenues in both prime services and equity derivatives did OK. So, what’s happening? Morgan Stanley said that reduced volumes in Asia were to blame – revenues declined in spite of better performance in Europe and the U.S. Across the group, Asian revenues were down 31% year on year in Q2.
It would be easy to pin 46% year on year declines in equity capital markets revenues and 34% shrinkage in debt capital markets revenues on the uncertainty surrounding the EU referendum, but quarter on quarter both divisions improved.
Pruzan said Brexit was more about impact on the markets business. “As we approached the Brexit vote and clients started to realise the potential impact it would have, we saw more risk management and hedging activity. Right before and after the vote we saw heightened volatility and significant volumes. But one or two days of activity doesn’t make a quarter.”
Photo: Morgan Stanley building by Alan Wu is licensed under CC BY-SA 2.0