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Morgan Stanley (NYSE:MS) is a U.S. bank holding company and an asset manager. 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.
Many of the firm's mortgages and mortgage-backed securities have seen their values plunge, resulting in a write-downs and write-offs totaling $10.8 billion in 2007 and a $3.5 billion quarterly net loss in the fourth quarter of 2007, the first in Morgan Stanley's history. Additionally, after the bankruptcy of Lehman Brothers and the sale of Merrill Lynch (MER) to Bank of America (BAC) on September 15, 2008, Morgan Stanley's prospects as an independent firm became the subject of speculation, leading to talks of a merger or buyout.[1]
On September 21, 2008, Morgan Stanley became a bank holding company. The new status allows the company to run commercial banking operations and gives its depositors insurance through Federal Deposit Insurance Corporation (FDIC). From a strategic perspective, Morgan Stanley can use deposits to reduce its leverage. Morgan Stanley already has 3 million retail brokerage clients, with $36 billion in deposits, which amounted to about 4 percent of the firm's liabilities. This amount is a lot smaller than deposits at commercial banks, whose deposits account for 40 to 60 percent of liabilities.[2] On September 22, 2008 Morgan Stanley announced it would expand its retail banking operations and pursue consumer deposits.[3] On the same day, Mitsubishi UFJ Financial Group, Japan's largest bank, announced plans to invest $8.4 billion for a stake of 10 to 20 percent in Morgan Stanley.[4]
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. Though the exact impact of this transition on the bank's profitability is unclear, analysts believe that limitations on high-risk proprietary trading will hurt the Morgan Stanley's operating margin.[5]
[edit] Business Segments
[edit] Institutional Securities
Morgan Stanley's Institutional Securities group was the most profitable segment of its business plan in 2008. Institutional Securities incorporates several different businesses including Investment Banking and Trading. The Investment banking business advises companies on potential transaction, in the areas of valuation and deal structuring. This division also underwrites (guarantees the sale of) new debt and equity issues.
[edit] Investment Banking
Morgan Stanley's Investment banking has suffered a few set backs in the last year, due largely to the loss of talent. With the management shuffle complete and aggressive recruiting efforts well underway the expectation is that this business should prove relatively stable going forward.
[edit] Global Capital Markets
Morgan Stanley is a leader in electronic trading. Electronic trading involves using computers to conduct trades rather than involving human agents. It is in many ways more efficient than regular trading. It also carries significantly lower margins.
[edit] Global Wealth Management
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.
Morgan Stanley provides advising services to individuals and smaller businesses but emphasizes its wealthier customers. In fact, 69% of its individual clients are households with more than $1 million. Morgan Stanley's pre-tax profit margins from global wealth management have traditionally underperformed but have gained in the past few years, going from 5% in mid-2005 to 37% in 2006.[6] However, it underperformed in 2007 with just a 5% pre-tax margin due in large part to the 2007 Credit Crunch.[6]
In recent years, Morgan Stanley's retail brokerage margins have severely lagged its peers. At the end of 2005 Morgan Stanley's pre-tax margins for its GWM division stood at just 1% compared to its peers Merrill Lynch and Smith Barney whose margins exceeded 20%. As part of the recent restructuring, Morgan Stanley brought over James Gorman the former head of Merrill Lynch's Global Wealth Management Division. Gorman is largely credited with turning around Merrill's GWM division just a few years earlier. Over the last 2 years he has used some of the same strategies that were so effective in his previous role, namely culling unproductive advisors, adjusting the advisor pay scale to reward larger (more profitable) clients, and better segmenting clients (ensures that clients receive the right services based on their characteristics). By the end of 2006, GWM's pre-tax margins had risen to 12% and revenue/FA was up from $426,000 to $658,000; as of the third quarter of 2007, these figures had risen to 17% and $817,000, respectively, reflecting Morgan Stanley's continued efforts to improve performance in this segment.
[edit] Asset Management
Morgan Stanley's asset management services large institutions such as pension 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.
[edit] Trends and Forces
[edit] Interest Rates
Interest rates can have a significant impact on investment banks. In lower interest rate environments, companies are more likely to issue debt in order to pursue acquisitions or make other strategic investments, leading to higher levels of M&A and debt underwriting activity. Over the last over the last 4 years interest rates have been hovering near historic lows. Morgan Stanley's investment banking division has benefited from this trend through the early- to mid-2000s. In light of the recent collapse of the subprime mortgage industry, the U.S. Federal Reserve has cut rates from 5.25% in September, 2007, to 1.5% in October, 2008. This could help offset the economic turbulence that has hit Morgan Stanley's investment banking division over the past year.
[edit] Housing Market
Investment banks, particularly those with significant mortgage securitization practices, are very sensitive to the residential real estate market. Mortgage-backed securitization is the bundling of mortgages for sell 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. In recent years Morgan Stanley has been increasing its exposure to MBS through the acquisition of several mortgage originators, including Virginia based subprime lender Saxton Capital in December of 2006.
This acquisition came just months before the collapse of the U.S. subprime mortgage industry and subsequent housing slump. As a result of this acquisition and Morgan's holdings of subprime-backed securities, net income for fiscal year 2007 was down 57%. In August 2008, Morgan Stanley announced that it had frozen thousands of home equity credit lines due to the declining values of the properties backing them.[8]
[edit] 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.[9]
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.
[edit] Litigation and Regulation
The Securities industry is one of the most highly regulated industries in the world. Morgan Stanley faces constant litigation risk across all of its businesses. That said its Global Wealth Management business often a target of law suits. Retail investors who lose money sometimes sue the firm on variety of grounds. This is especially true of non-fee based clients.
[edit] MS purchases 100% of Citi's Smith-Barney.
On 1/13/09, Morgan Stanley purchased Citi's Wealth Management business Smith-Barney for $2.7 billion in cash and a 51% stake of the venture.[10] The business will be 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.[11] 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."[11] The move is forecast to save both firms $1.1 billion.[11] MS and C, who have seen their investment banking segments drop monumentally due to the 2008 Financial Crisis, have invested in wealth management to hedge losses from other areas.
[edit] Competition
Morgan Stanley significant strides in restructuring its Global Wealth Division but still lags behind Merrill Lynch and Citigroup among all of the relevant metrics. As James Gorman continues to whip the organization into shape, Morgan Stanley may continue see increased gains against its competitors. That said it will be an uphill battle as Morgan Stanley has the smallest advisor force of the three and attracting new clients in the private wealth industry tends to be an expensive process.
To a lesser extent the firm also competes with smaller players like Lazard (LAZ) and Jefferies Group (JEF).
[edit] Subprime Crisis and Transformation to Bank Holding Company
The higher-risk businesses of mortgages and leveraged lending have been responsible for much of Morgan Stanley's growth since 2005.
These same areas, however, are highly sensitive to conditions in the U.S. housing market, subprime lending industry, and debt markets, all of which have been contracting throughout 2007 and 2008. Morgan Stanley wrote down $10.8 billion worth of mortgage-related assets in 2007. Morgan Stanley's actual write down was lower than what investors expected after Citigroup and Merrill Lynch stunned the financial markets by announcing the extent of their exposure to subprime debt.
In September 2008, Morgan Stanley came under pressure to increase its equity base. This was because losses spurred by the 2007-2008 Credit Crisis drove down the banks equity to an extremely low level -- in September 2008, Morgan Stanley held $1 in equity for every $34 in assets, the remaining assets were supported by leverage, i.e. by borrowed money. This put its leverage ratio at 33. [12] Traditionally, investment banks have been allowed to operate at a much higher leverage ratio compared to commercial banks, for example: In September 2007, Bank of America had a leverage ratio of 11.
High level of leverage had not been a problem for Morgan Stanley prior to 2008. However, as asset prices, especially prices of mortgage-based securities started to go down, it increased the risk that the bank would default on some of its debt obligations. In September 2008, this led to speculations that the bank may go bankruptcy. Such speculations were aided by the fact that other well-known investment banks such as Lehman Brothers (LEH) and Bear Stearns Companies (BSC) became insolvent and declared bankruptcy in 2008. Merrill Lynch, another reputed bank, agreed to merge with Bank of America, on September 15 2008, in order to improve its equity base and to remain solvent. [13]
On September 21, 2008, Morgan Stanley became a bank holding company. The new status allows the company to run commercial banking operations and gives it depositors insurance through Federal Deposit Insurance Corporation (FDIC). From a strategic perspective, Morgan Stanley can use deposits to reduce its leverage. Morgan Stanley already has 3 million retail brokerage clients, with $36 billion in deposits, which amounted to about 4 percent of the firm's liabilities. This amount is a lot smaller than deposits at commercial banks, whose deposits account for 40 to 60 percent of liabilities.[14] On September 22, 2008 Morgan Stanley announced it would “pursue initiatives to expand the retail banking services it offers its retail clients and build a stable base of core deposits.”[15]
[edit] References
- ↑ Morgan Stanley board meets to weigh options | Reuters.com
- ↑ Bloomberg.com, Retrieved September 23, 2008
- ↑ Financial Express, Retrieved September 23, 2008
- ↑ Marketwatch.com, Retrieved September 24, 2008
- ↑ Wall Street Journal, retrieved September 22, 2008
- ↑ 6.0 6.1 6.2 MS 2008 10-K
- ↑ Google Finance: MS
- ↑ Morgan Stanley to freeze home-equity credit lines - Reuters.com
- ↑ Morgan Stanley says first in Saudi swap agreement | Reuters.com
- ↑ IT Business Net, "Morgan Stanley and Citi to form joint venture," 1/13/09
- ↑ 11.0 11.1 11.2 Middle East North Africa Financial Network, "Morgan Stanley and City form joint venture," 1/14/09
- ↑ The Wall Street Journal, Retrieved September 23, 2008
- ↑ Morgan Stanley board meets to weigh options | Reuters.com
- ↑ Bloomberg.com, Retrieved September 23, 2008
- ↑ Financial Express, Retrieved September 23, 2008
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