MS Morgan Stanley

Morgan Stanley tops estimates, but victory may be Pyrrhic, as earnings fall 53%

By Justin Baer and Peter Rudegeair 

Morgan Stanley became the latest big bank to beat Wall Street analysts' expectations with its quarterly earnings results.

The victory may feel a little hollow though, and not just because profits at the New York firm dropped 53%. Analysts' estimates have been falling sharply since the start of the year, lowering the bar for the banks.

J.P. Morgan Chase & Co., Citigroup Inc., Bank of America Corp. and Wells Fargo & Co. also cleared that lower hurdle, besting analysts' earnings forecasts in the past week. If Goldman Sachs Group Inc. follows suit when it reports earnings Tuesday, all six big U.S. banks will have exceeded the consensus for the first time since 2013, according to data from Thomson Reuters.

Despite numerous problems for banks this year -- difficult trading conditions, a pause in deals, stubbornly low interest rates -- bank shares rallied about 7% over the past week as investors decided things weren't as grim as analysts predicted.

Wall Street's outlook for bank earnings darkened throughout the first quarter, and estimates continued to drop even after it ended.

In Morgan Stanley's case, the firm reported a profit of 55 cents a share, easily beating the estimate of 46 cents. But that figure wouldn't have looked as good if compared with analysts' expectations as of April 1 -- 65 cents a share or a month earlier, when the expectation was about 80 cents a share.

The quarterly profit at Citigroup and Bank of America also would have fallen short of the average earnings forecasts analysts had posted at the end of March.

Of course, the idea of companies jumping over lowered expectations isn't new in any industry. Of the companies in the S&P 500, about 73% that have reported so far have beaten estimates, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.

"The good news is you beat," he said. "The bad news is that you're...short of what you did last year." At the big banks, Morgan Stanley's first-quarter profit decline of 53% followed a 27% decline at Citigroup, a 13% drop at Bank of America and a 7% decline at J.P. Morgan.

The first quarter was unusual for big banks in that the usually busy trading months of January and February were actually slow, hindered by plummeting stock prices and related volatility.

But just as executives at various banks shared updates about the tough markets, conditions were about to improve in March. The result was that analysts overshot and were too pessimistic when results were announced in April.

"There are more predictable industries out there, for sure," said Glenn Schorr, a bank analyst with Evercore ISI. "Because the financial industry is very influenced by rates, credit spreads, by market-activity levels and by regulations. And those are hard to predict."

Many bank executives are loath to give investors specific forecasts or targets on profitability. Executives from Goldman Sachs have sidestepped questions on what the firm's returns should be, arguing that too many things can go wrong.

"The perils of putting out a target is you get asked about it every time, every quarter, until you finally get there," James Gorman, Morgan Stanley's chairman and chief executive, said during a conference call with analysts.

In the first quarter, Morgan Stanley's revenue tumbled 21% to $7.79 billion, slightly shy of analyst expectations. Net income dropped to $1.13 billion from $2.39 billion a year earlier.

Mr. Gorman told analysts in January that the firm would push to boost its return on equity, an important measure of profitability, to 9% to 11% by the end of next year. In the most recent quarter, return on equity fell to 6.2% from about 14% a year earlier, highlighting that the firm has a way to go before meeting its profitability target.

Morgan Stanley executives based their target on revenue gains of 4% a year, continuing cost cuts and regulators' blessing for the firm's dividend and share-buyback plans.

"I'll give Morgan Stanley credit for stepping up and putting out it out there," said Jeff Harte, an analyst with Sandler O'Neill + Partners LP. "But they run the risk of overpromising and underdelivering for things that are out of your control."

Morgan Stanley and other big banks are muddling through a steep slump in their debt-trading business. The downturn prompted the firm to cut jobs from the unit, which has weighed down Morgan Stanley's return on equity.

Trading revenue fell 34% to $2.69 billion from $4.08 billion in the first quarter of 2015, a sharper drop than some peers.

Revenue from trading in debt, currencies and commodities fell 56% to $873 million, while revenue from equity trading dropped 10% to $2.06 billion.

In an interview, Morgan Stanley Chief Financial Officer Jonathan Pruzan said January and February were turbulent months for its trading business, but that it saw improvement in March and so far in April. "The environment is clearly better, client activity is up a bit...[but] we're going to see bouts of volatility."

The volatile markets also weakened investment-banking activity in the first quarter, hurting a division that had been a bright spot for Morgan Stanley last year.

Investment-banking revenue fell 16% to $990 million from $1.17 billion in the year-ago quarter. Fees from advising on mergers and other deals rose 25% to $591 million, while revenue on stock and bond underwriting slipped 43% to $399 million.

Revenue in Morgan Stanley's wealth-management arm was $3.67 billion, compared with $3.83 billion a year ago. In Morgan Stanley's investment-management division, revenue fell 29% to $477 million due to losses on its private-equity and real-estate funds.

Morgan Stanley's expenses fell 14% to $6.05 billion from $7.05 billion a year earlier. Costs from employee pay and benefits fell 19% to $3.68 billion, or 47% of revenue.

Write to Justin Baer at justin.baer@wsj.com and Peter Rudegeair at Peter.Rudegeair@wsj.com

(END) Dow Jones Newswires

April 19, 2016 02:47 ET (06:47 GMT)

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