Wednesday, May 22, 2013

Why Goldman and Morgan Stanley's Results Are Unimpressive

From The Motley Fool, Dated May, 7th 2013. 

Goldman Sachs (NYSE: GS), the largest independent investment bank in the U.S., and Morgan Stanley (NYSE: MS), the sixth-largest bank in the U.S., have recently released their quarterly results.

Goldman Sachs was able to beat both top-line and bottom-line estimates, but revenue from its biggest segment fell by 10%. Similarly, while Morgan Stanley’s earnings were also above the Wall Street expectations, the firm failed to impress investors as its fixed-income operations continue to under-perform.

The common ratios of both of these institutions have fallen under new capital-requirement rules and, according to Federal Reserve, they could come under pressure in a stressed scenario.  However, unlike Morgan Stanley, Goldman Sachs has been able to improve its return on average common shareholders' equity. 

In the first quarter of 2013, Goldman's net income increased 7.2% to approximately $2.3 billion while revenue rose 1.4% to about $10.1 billion. On the other hand, Morgan Stanley swung to a profit of $958 million as opposed to a loss of $119 million in the same quarter last year. Net revenue of $8.2 billion climbed in the quarter from $6.9 billion a year ago, showing a year-over-year increase of 17.8%.

Goldman Sachs recorded a drop of 7% in revenue from trading in currencies, commodities and fixed-income securities to $3.2 billion. As a result, total institutional client-services revenue fell 10% to $5.1 billion.

On the other hand, Morgan Stanley’s revenue from fixed-income securities plummeted by 42% to $1.5 billion. The March quarter was a difficult one for banks due to the budget impasse and the sluggish performance of Europe; but still, other banks, including Goldman, have been able to deliver relatively better results than Morgan Stanley.

Goldman's investing and lending segment delivered revenue of approximately $2.1 billion, showing an increase of 8.2% from 2012. This is the second-largest contributor to the top line behind institutional client services.

In investment banking, Goldman Sachs outperformed Morgan Stanley by posting a 35% revenue increase.

Meanwhile, Morgan Stanley’s wealth-management group reported strong earnings; its income increased by 29% from last year to $256 million as the unit’s revenue rose 5.4% to approximately $3.5 billion. Revenue in the investment- banking division, a part of wealth management, rose 15% to $1.2 billion (as shown in the graphic above).

Net revenue from its institutional-securities business, which includes advisory services as well as fixed income and commodities sales and equity sales, increased by 30% from the same quarter last year to approximately $4.1 billion. This unit swung from a net loss of $302 million in the previous quarter to a profit of $663 million.

In this quarter, institutional securities became the biggest contributor to Morgan Stanley's top and bottom lines, responsible for half of the bank’s total revenue and more than 60% of total income.

Goldman's interest income fell 6% to $925 million, while Morgan Stanley made a profit of $185 million as opposed to a loss of $59 million in the year-ago-quarter.

Net Interest Income comparison (in millions)
Goldman Sachs
Morgan Stanley

Goldman's return on equity, or ROE, rose to 12.4% from 10.7% of year ago, while Morgan Stanley’s ROE fell to 7.6% from 9.2% in the corresponding period. In the last six months, Goldman's stock has trailed Morgan Stanley, although both have risen by 14% and 24%, respectively. At the moment, Morgan Stanley’s stock is about four times more expensive than that of Goldman Sachs, which is evident in the P/E ratios of both firms. Morgan Stanley gives a lower yield and a lower ROE.

Goldman Sachs
 Morgan Stanley
Stock 6M

Capital requirements
Goldman Sachs and Morgan Stanley’s regulatory capital requirements fell in the most recent quarter following the implementation of Basel 2.5. The Tier 1 common ratio is a measure of a bank’s common equity to its assets and plays a crucial role in the stress test. If any bank wants to pay dividends or implement a buyback program then this ratio must be at least 5%.

Goldman's Tier 1 common ratio fell to 12.7% and its Tier 1 capital ratio fell to 14.4% --reflecting the revised market risk regulatory capital requirements. On Dec. 31, 2012, its common ratio was 14.5%, while its capital ratio was 16.7% under Basel 1 -- i.e. before implementation of revised market risk regulatory-capital requirements.

Similarly, Morgan Stanley’s capital ratio and common ratio declined to 13.9% and 11.5%, respectively, from a capital ratio of 16.9% and a common ratio of 13.3% a year ago. 

For both of these banks, the ratio is well above 5%. But the Fed believes that if the banks continue with their current dividends and buyback plans, then under a 2014 stressed scenario these ratios could fall to 5.8%(Goldman Sachs) and 5.7% (Morgan Stanley), thus coming dangerously close to the red line.

Besides these two banks, Feds have also warned JPMorgan Chase (NYSE: JPM), whose common equity ratio could fall to 5.6%. The three firms are required to fix the problems, while JPMorgan and Goldman Sachs are also asked to resubmit their plans to the Federal Reserve before the end of the third quarter.

Those plans will be tweaked and some minor changes are going to occur, but I am not expecting anything significant. Regulators and the banks seem to disagree mainly on estimates related to losses in an economic downturn. The banks have been more optimistic than the regulators; Goldman believes that under severe stress, it could post losses of $6.6 billion, but the Fed thinks that $20.5 billion is a better estimate.

The financial institutions also seem confident, as JPMorgan has announced, after hearing from the regulators, that it will continue with its plan to increase its dividend by 26.7% to $0.38 per share in Q2 and would buyback shares worth $6 billion in 2014. Similarly, Morgan Stanley will go ahead with its plan of purchasing the remaining shares of Smith Barney from Citigroup


In essence, by passing the stress test, even with the conditions attached, the banks have been given the green light. But the problems with current ratio and poor results from some of their biggest segments has highlighted that Morgan Stanley and Goldman Sachs  have under-performed as compared to their peers. 

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I have no business relationship with any company whose stock is mentioned in this article.