Morgan Stanley Wealth Profit Up 9%, But Fee “Flows” Fall
Morgan Stanley’s slightly reduced force of 15,632 brokers executed its mission of selling more loans and bank products to wealthy customers in the second quarter but attracted less money to fee-based advisory accounts than in comparable quarters.
The New York investment bank, which has made a bigger bet on wealth management than its large competitors, said on Wednesday that net revenue in the division grew 4% to $4.3 billion from the year-earlier period while pretax profit was up 9% to $1.2 billion.
The wealth unit’s profit represented 37.2% of the company’s overall pretax net income in the second quarter, and 40.8% of its total revenue. Those numbers are down from wealth’s 40.0% contribution to the company’s pretax profit and 43.7% to its revenue in the second quarter of 2017.
New customer money flowing into fee-based advisory accounts fell 23% from the 2017 quarter and 16% from this year’s first quarter to $15.3 billion, while revenue from traditional commission-brokerage accounts fell to $691 million in the just-ended quarter from $766 million a year earlier.
“Retail engagement declined,” Chief Financial Officer Jon Pruzan said in a conference call with analysts, in explaining some of the “headwinds” after a strong first quarter. He and Morgan Stanley Chief Executive James Gorman described the wealth management quarter as “solid.”
Customers moved money into low-commission, short-term fixed-income products because of a flatter yield curve that benefited their returns but that cut Morgan Stanley’s commission revenue 11% from the first quarter to $442 million. They also pulled cash from deposit accounts and put less into investment accounts in order to pay taxes, he said.
Merrill Lynch gave similar explanations last week in explaining why fee-based “flows” into advisory accounts fell by more than half in the second quarter to $10.8 billion from a year earlier, despite new incentive and compensation programs to increase advisory account growth.
Large brokerage firms have been encouraging brokers and customers to move to fee-based accounts that generate revenue regardless of investors’ taste for buying and selling securities.
Despite the reduced flows, Morgan Stanley ended the second quarter with $1.08 trillion of fee-based assets, a 2% jump from the first quarter and 13% higher than a year earlier. The increase reflects modest stock-market appreciation and still significant inflows of $15.3 billion of new money. Just over 45% of Morgan Stanley’s $2.4 trillion of wealth management client assets are in fee-based accounts.
In a sign of the firm’s continuing success in selling loans and other bank products to wealthy investors, net interest income in the wealth division grew 3% from a year ago to $1 billion, the company said. Clients held $82 billion of loans and other “liability” products, up by $5 billion from June 30, 2017.
Net interest income fell slightly from the first quarter, however, because Morgan Stanley is offering above-market rates on certificates of deposit and other products to expand its bank funding, and sweeping less cash from investment accounts into low-paying bank accounts. Interest expenses grew 164% from the year-earlier quarter and 31% from the first quarter to $277 million while interest income was up 3% and 18% respectively to $1.3 billion.
Morgan Stanley ended the quarter with 15,632 brokers, a net decline of 50 from three months earlier and of 145 over the past year. Their average annualized revenue is $1.10 million, down 1% from this year’s first quarter and up 5% from last year’s second quarter.
Like Merrill Lynch and UBS Wealth Management, Morgan Stanley has retreated from expensive recruiting of experienced brokers, a strategy that has reduced “inorganic” customer growth but that Gorman said he is “very comfortable” with.
The firm in November exited the Protocol for Broker Recruiting that makes it easier for brokers to move to other firms, but the fundamental explanation for the firm’s low attrition is that dozens of large firms that used to be competitors for brokers have gone out of business over the last 25 years, Gorman said. Morgan Stanley virtually doubled its brokerage force through its purchase of Smith Barney.
“We’ve effectively absorbed the competition,” he said of Morgan Stanley and its wirehouse competitors.
The firms also have wisely ended the “competitive, crazy weekly event” of spending heavily in a no-win game of recruiting from each other, he said. On the down side, Merrill Lynch cited the end of “competitive recruiting” as a factor in the decline of assets flowing into its fee-based accounts.
Morgan Stanley Wealth’s compensation and benefits expense inched up 3% to $2.4 billion in the second quarter from $2.3 billion a year ago but was down 4% from the first quarter. As a percent of the division’s net revenue, compensation fell to 54% from 56% in the first quarter and from 55% from in this year’s first quarter. Executives said they expect to see continuing improvement as retention payments from the Smith Barney acquisition run off by January.
Overall, total wealth management expenses, excluding interest, rose 2% from a year ago and fell 1% from the first quarter to $3.17 billion. With revenue up 4% from the year-earlier period, the wealth unit’s pretax profit margin was 27%, steady with the first quarter and up from 25% a year earlier.
Net income for Morgan Stanley as a whole was $2.4 billion, or $1.30 per diluted share, compared with net income of $1.8 billion, or $0.87 per diluted share, for the same period a year ago. The company’s shares were up $1.53 or 3.1% in late morning trading following the earnings report, driven by better-than-expected investment banking and trading results.