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MS AT A GLANCE

P/E ► -24.6   EV/EBITDA ► 28.8 AVG ROA ► 1.2% AVG ROE ► -4.3% AVG Debt to Equity ► 15.6 AVG Current Ratio ► 0   Interest Coverage Ratio ► 1.26 AVG

 

 

 

 

 

 

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.

Many of the firm's mortgages and mortgage-backed securities have seen their values plunge, resulting in write-downs and write-offs totaling $10.8 billion in 2007 and as of July 22, 2009, it has posted three straight quarterly losses. The significant decline of its assets prompted it to become a Bank holding company on September 21, 2008. 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. In addition, Morgan Stanley received $10b in government TARP funds and was required to raise an additional $1.8b after taking the "Stress Test" in February. Since then, has raised money through the sale of common stock and assets and was the first financial institution to repay its TARP loan in June 2009.

Business Segments

Institutional Securities (67.2% of Net Revenue) ^[2]

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.

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.

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.

Global Wealth Management (28.4% of Net Revenue)^[2]

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, but focuses on its wealthier customers. In fact, 69% of its individual clients are households with more than $1 million.

Asset Management (5.2% of Net Revenue)^[2]

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.

MS's annual net revenue, 2005-2009^[3]

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 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.^[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] The move is forecast to save both firms $1.1 billion.^[5] 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.

Trends and Forces

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.^[6] Morgan Stanley will continue to expand its retail banking operations and consumer deposits.^[7]

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.^[8]

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.^[9] 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.^[10] 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.^[11]

Morgan Stanley was considered to be the first bank to repay its TARP money on June 17, 2009.^[12] It raised $7.6 billion through the sale of common stock and assets.

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.^[13][14]

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.^[15]

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.

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.^[16] 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.^[17]

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.^[16]

Competition

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. Morgan Stanley surpassed Goldman Sachs in total number of Mergers & Acquisitions in 2009, a spot which Goldman has historically held. The firm has also expected this sector to continue to grow as the economy begins to recover.^[18] 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).

References

1. ↑ Bank of America Topples UBS as World Wealth Manager, CNBC July 6, 2009
2. ↑ ^{2.0 2.1 2.2} MS 10-K 2008 Item 6. "Selected Financial Data" p.34
3. ↑ Google Finance: MS
4. ↑ IT Business Net, "Morgan Stanley and Citi to form joint venture," 1/13/09
5. ↑ ^{5.0 5.1 5.2} Middle East North Africa Financial Network, "Morgan Stanley and City form joint venture," 1/14/09
6. ↑ Bloomberg.com, Retrieved September 23, 2008
7. ↑ Financial Express, Retrieved September 23, 2008
8. ↑ Wall Street Journal, retrieved September 22, 2008
9. ↑ Board of Governors of the Federal Reserve System, "The Supervisory Capital Assessment Program:Design and Implementation," 04/24/09
10. ↑ Time, "Does Morgan Stanley Deserve to Be Free of TARP?," Stephen Gandel, 06/11/2009
11. ↑ MSNBC "Ten of the largest U.S. banks need $75 billion," 05/08/2009
12. ↑ Market Watch "J.P. Morgan, Goldman, Morgan Stanley, others repay TARP," Alistair Barr, 06/17/2009
13. ↑ Bloomberg.com, US Rates and Funds
14. ↑ Federal Reserve Board "Open Market Operations" 16 Dec 2008
15. ↑ Morgan Stanley says first in Saudi swap agreement | Reuters.com
16. ↑ ^{16.0 16.1} Hedge Funds, Private Equity Seen Hit By Obama's Bank Plan
17. ↑ 'Volcker Rule' Socks Bank Trading, Funding For Hedge funds And Private Equity
18. ↑ Bloomberg "Morgan Stanley's Kelleher Says 'Resurgent' M&A Possible in 2010" 10 Nov 2009
19. ↑ MS 10-K 2008 Item 6. "Selected Financial Data" p.34