Morgan Stanley Wealth Braces for Headwinds After Strong Q1

Morgan Stanley Wealth Management on Thursday reported pretax profit of $1.1 billion on $4 billion of first-quarter revenue, which would have been records aside from accounting adjustments related to deferred compensation hedging and mortgage prepayments. But company executives are not celebrating.

Interest-rate cuts and stock losses spawned by the coronavirus pandemic will devastate net interest and fee revenue for much of the remainder of the year in wealth management, they said after Morgan Stanley as a whole reported a 30% drop in earnings to $1.7 billion, or $1.01 a share, well below the consensus $1.14 estimate of analysts.

“We literally had the best quarter we ever had,” said a source familiar with the firm’s strategy, who spoke on condition of anonymity. “But that doesn’t mean it’s going to continue. Our earnings capacity for the rest of the year is definitely diminished.”

Chief Financial Officer Jonathan Pruzan said on an earnings call that the Federal Reserve’s “instantaneous shock” to interest rates went well beyond the firm’s January expectations of a 100-basis-point cut that would have reduced the firm’s 2020 net interest revenue by $640 million. The “vast majority” of that revenue is booked in wealth management, he said.

In the first quarter, net interest income in the wealth business fell 21% from a year earlier to $896 million.

Asset management revenues based on account balances at the beginning of January and February partly offset the steep subsequent market declines that are expected to devastate fees in coming months. But commissions from transaction-based accounts that Morgan Stanley and its rivals have discouraged in favor of usually more stable fee-based accounts soared.

“Clients repositioned portfolios and moved into cash and other short term securities,” Pruzan said.

Morgan Stanley Wealth Management’s transactional revenue grew by more than 15% over recent quarters, he said.

About 23% of its clients’ $2.39 billion assets as of March 31 were in cash and short-term securities, compared to about 19% in the last two quarters, while more remunerative equity allocations fell to about 50% from 55%, he said.

Morgan Stanley’s 15,400 brokers, about 95% of whom are now working from their homes, attracted $18.4 billion in net fee-based assets from clients in the quarter. (Merrill Lynch’s 14,000-plus brokers attracted $7.0 billion of new advisory assets last quarter, Bank of America said on Wednesday.)

The new-asset flow at Morgan Stanley was up 24% from what brokers gathered in the first quarter of 2019 but down 26% from last year’s fourth quarter.

Total new client assets were generated at an annualized rate surpassing the $100 billion Morgan Stanley collected last year, said the person familiar with the firm’s strategy, with money transferred from discount brokers, banks, competitor wirehouse, and accounts opened by participants in the company’s expanded corporate stock plan business.

The firm also attracted a record number of net new clients during the quarter.

“In periods of volatility, our client base looks to professionals, and they consolidate their assets,” Pruzan said on the conference call.

Chief Executive James Gorman warned that profitability goals announced in January will have to be adjusted because of the coronavirus crisis, including the 28-30% profit margin forecast for wealth management within two years. The wealth unit reported pretax margin of 26.1% for the first quarter, and said the metric would have been 27.6% excluding the impact of the deferred compensation hedging losses.

“This environment,” Gorman told analysts on the earnings call, “is anything but normal.”

But the coronavirus crisis has reinforced the wisdom of expanding wealth management to offset the volatility of Morgan Stanley’s traditional trading and investment banking calling cards.

Wealthy clients have been borrowing heavily against their investment portfolios and are taking out mortgages and other loans amid the insecurity of the pandemic, and the loan book has been performing “unbelievably well,” Gorman said.

“We know clients’ assets and liquidity levels,” he told analysts. “This was a great, tough test, and we survived it comfortably.”

Gorman disclosed last week that he has recovered from Covid-19 and said Thursday that he had not been hospitalized.

Morgan Stanley suffered an expensive setback in the early days of its brokers’ shelter-at-home experience when clients and brokers were unable to enter orders over workstations and view accounts for more than four hours on March 26.

The company traced the problem to IBM software. Morgan Stanley has already reimbursed clients for missed trading opportunities and will credit the appropriate payouts to brokers, said the person familiar with the company’s strategy.