Morgan Stanley is the latest bank to report earnings for the first quarter. As at rival U.S. banks, the sales and trading business was strong and the M&A advisory business was weak. However, profits in Morgan Stanley's Institutional Securities unit (investment bank) fell 45% on the previous year and the return on equity in the unit was down to 6% (from 13%). In the circumstances, you might expect that Morgan Stanley would lay people off. Instead, CEO James Gorman has guaranteed jobs across the bank will be safe, and speaking today Gorman said that was absolutely the right thing to do.
Business-by-business, the performance of Morgan Stanley's investment bank relative to the first quarter of 2019 and to rival U.S. banks is shown in the first chart below.
As the chart reflects, Morgan Stanley's investment bank had an acceptable but far from great quarter relative to its U.S. rivals: it lost market share in equity capital markets (ECM) and debt capital markets (DCM), but held up elsewhere.
In equities, the bank said performance was particularly strong in the Americas and Asia. In fixed income trading, Morgan Stanley cited higher revenues in rates, foreign exchange and commodities, but declining revenues in credit products, especially in securitized products and municipal securities. The bank recorded mark-to-market losses of $610 million on loans held for sale, along with a provision of $388 million for credit losses on loans and unfunded lending commitments held for investment.
Writedowns aside, the real issue at Morgan Stanley's institutional securities unit in the first quarter was the failure of costs to fall in line with revenues. While revenues in the unit fell 6% year-on-year in Q1, costs rose by 10%. Cost stickiness reflects last week's observation by Morgan Stanley's own analysts, that only 5% to 10% of costs in investment banks can easily be cut in the short term, compared to 20% cost flexibility at the time of the last financial crisis.
Cost cutting, or not at Morgan Stanley
Morgan Stanley doesn't break out line-by-line costs for its institutional securities business. However, it does break out costs for the bank as a whole (institutional securities, wealth management, and investment management). The chart below shows where costs were cut across the bank in Q1 relative to a year earlier. Profits across Morgan Stanley fell 30% year-on-year in the first quarter.
Compensation and benefits spending across the bank fell 8% despite Gorman's jobs promise; spending on professional services (consultants) fell 13%, and spending on marketing and business development fell 6%. Spending on everything else rose.
Despite the profit squeeze, Gorman said today that guaranteeing jobs was absolutely the right move to have made, and that Morgan Stanley's shareholders will be the ultimate beneficiaries. Conserving jobs was the "one of easiest decisions I ever made," said Gorman, adding that the board unanimously agreed with him. "This is a once in a hundred year health crisis," he added, saying that the stress to Morgan Stanley employees and families is already overwhelming and would be worsened by an RiF (reduction in force) which would in itself lead to high severance costs in the short term.
Gorman said he'd received "hundreds and hundreds of emails" from employees thankful for his jobs guarantee. One Morgan Stanley employee in a support function messaged to say she'd been overwhelmed with gratitude after her husband had been laid off from a small business the night before Gorman's promise was made.
Naturally, the employment guarantee isn't likely to come for free - last quarter's decline in compensation spending suggests Morgan Stanley is already accruing smaller bonuses for 2020. However, as the year progresses, Gorman said spending in other areas is likely to fall: transaction costs and brokerage and clearing fees will drop as market chaos (hopefully) abates and as trading volumes return to normal levels.
In the meantime, at least one category of employee at Morgan Stanley isn't benefiting from unequivocal job security: Gorman also said today the bank had reduced its dependency on "contingent workers" in the first quarter. While permanent employees are safe, the implication is that contractors are being squeezed harder than usual.
Over 90% of Morgan Stanley's employees are currently working from home. Having suffered from COVID-19 himself, Gorman said he expects employees to come back to work in cycles, possibly from June onwards.
Photo by Ryoji Iwata on Unsplash
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