Amid the broader market rally of the last week, Morgan Stanley (MS, Financial) suffered a setback as it announced misses on both earnings and revenue, and shares tumbled almost 5%.
As covered elsewhere on GuruFocus, major rivals Bank of America (BAC) and Goldman Sachs (GS, Financial) had posted decent results for the previous quarter, so the market was understandably surprised by the subpar report coming out of Morgan Stanley. Is this cause for serious concern or a once-off speed bump?
A disappointing earnings report
The bank posted revenue of $8.55 billion, representing a 10% decrease year-on-year. More importantly, this badly missed analyst estimates by approximately $750 million. Earnings per share came in at 73 cents, missing consensus estimates by 16 cents.
CEO James Gorman went out of his way to emphasise that the first three quarters of 2018 had been strong, and that this miss was not going to be the start of a new trend:
“For the first nine month, Morgan Stanley performed strongly. That translated into full year results that included record revenues, record pretax profit and record net earnings. Some of those results are listed on slide three and are worth noting. That said, the last six weeks of the year in particular were obviously difficult. That combined with some idiosyncratic items that we’ll go through produced a below target ROE of 7.7% for the fourth quarter ... Importantly, we do not believe the fourth quarter is a new normal. In fact, while it’s early days, the first quarter has started on a similar path to the start of the first quarter of 2018.”
The company’s share price is down roughly 26% compared to this time last year, so clearly the market is less positive on the first nine months of performance than Gorman. That said, this quarter does seem to be an outlier in terms of how badly the bank missed analyst expectations, compared with the three previous ones. What was the driver of such a decline?
It’s all about the bonds
The biggest losses for Morgan Stanley came in fixed income trading. The firm reported FICC (fixed income, currencies and commodities) revenue of just $564 million, missing expectations of $823 million and representing a 30% year-on-year decline. Equity trading revenue also missed ($1.93 billion vs expectations of $2.01 billion), but the losses here were much smaller.
Why was this? Volatility was cited as one of the main contributing factors to the overall revenue miss, and in times of increased volatility investment banks end up holding loss-making portfolios of bonds as their clients exit the market. This does not happen to the same extent with equities, as banks tend to act as brokers and middlemen, rather than holders of stocks.
How does this compare to industry peers?
An earlier piece laid out the thesis that 2019 would not be a particularly winning year for financial stocks. Having gone through this first round of earnings, we can take a look at how the sector performed as a whole.
Without a doubt, the company posted the worst report of all the major banks. That said, every one of them -- Goldman Sachs, Citigroup (C, Financial), JPMorgan (JPM, Financial), Bank of America, and of course Morgan Stanley -- registered a marked decline in FICC revenue. What Morgan Stanley’s competitors managed to do, however, was to make up the shortfall in areas such as wealth management, mergers and acquisitions and investment banking.
So what?
So is increased volatility going to be a structural problem for all large financials, or is this an isolated instance of one bank being unable to adapt to said market turmoil in one quarter? A piece elsewhere on GuruFocus pointed out that large banks have significant exposure to sovereign bonds, making them very vulnerable to a fall in that market. Now, while that scenario is somewhat unlikely, it does paint a picture of how Morgan Stanley’s fourth quarter earnings miss could be replicated on a grander scale.
Disclosure: The author owns none of the stocks mentioned.Ă‚
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