Morgan Stanley (MS, Financial), a leading global investment bank founded in 1924, has recently released its second-quarter 2023 earnings report. The bank's operations include institutional securities, wealth management and investment management segments with over $4 trillion worth of client assets, so it is often seen as a bellwether for the investing community.
With the release of its latest earnings report on July 18, Morgan Stanley's shares closed nearly 6.5% higher, but I think this may be overly optimistic. A closer look at its earnings shows that there was both good news and bad news to consider, especially as a weak trend in the investment banking business appears to be evident.
Key highlights of the 2nd-quarter earnings report
Morgan Stanley beat Wall Street's predictions on earnings per share, reporting $1.24 compared to the $1.15 per share average estimates compiled by Refinitiv. Revenue of $13.46 billion was better than the expected $13.08 billion.
However, net profit fell 13% to $2.18 billion, or $1.24 a share, because of two key factors. One was lower trading results from a year ago, and the second was due to a round of layoffs that generated $308 million in severance costs.
“The firm delivered solid results in a challenging market environment,” CEO James Gorman commented. “The quarter started with macroeconomic uncertainties and subdued client activity, but ended with a more constructive tone.”
Morgan Stanley reported record wealth management revenue of $6.7 billion compared to $5.73 billion a year ago. On the negative side, Institutional Securities revenue fell to $5.65 billion compared to $6.19 billion a year ago, and Investment Management revenue declined to $1.28 billion versus $.1.41 billion a year ago. The wealth management business accounted for nearly 50% of total company revenue in the quarter.
Investment banking has lost its momentum in 2023
Morgan Stanley's second quarter showed that the Investment Banking and Trading businesses for banks are facing hard times in 2023. I see three main risks for Morgan Stanley and its investors at the moment: market risk, credit risk and operational risk.
Market risk is the risk that the value of Morgan Stanley's assets will decline due to changes in market conditions. This could be caused by several factors, such as changes in interest rates, currency fluctuations, or stock market volatility.
Credit risk is the risk that borrowers will default on their loans to Morgan Stanley. If this happens, Morgan Stanley could lose money on the loans.
Operational risk is the risk that something goes wrong in Morgan Stanley's operations, such as a cyber attack or a data breach. This could lead to financial losses, damage to Morgan Stanley's reputation, or regulatory fines.
Some other specific risks related to Morgan Stanley’s Investment Banking business include M&A risk, which is the risk that a deal that Morgan Stanley is advising on will fall through. This could lead to financial losses for Morgan Stanley, as well as damage to its reputation, though given its market dominance I don't think this is likely to become a real issue.
I personally think investors may be underestimating the danger of a cyber attack when it comes to the big banks. A successful cyber attack could lead to the theft of customer data and financial losses. In 2024, there will be general elections in the United States, and political instability could be a key trigger for cyber attacks to increase.
Another overlooked risk for banks is climate change as this is leading to increased flooding, storms and other natural disasters. These events could damage Morgan Stanley's lending operations by causing affected customers to default on commercial loans. This may seem like a stretch of the imagination at first glance, but insurance companies are already having trouble and even pulling out of regions highly affected by climate change, such as certain parts of California. I think it's only a matter of time before major lenders are negatively affected as well.
Fundamentals and valuation
Given the latest earnings report, I have a neutral outlook on Morgan Stanley. I agree with the GF value of $88.23, which suggests that the stock is now fairly valued.
One problem to consider with Morgan Stanley's financials is that it has been issuing net debt. Over the past three years, it issued $68.3 billion of debt, some of which has been accumulating rather than being paid back as part of the bank's normal operations.
I particularly do not like the fact that Morgan Stanley's revenue per share is in decline over the past 12 months. This combined with weak investment banking and trading business revenue may indicate tough times ahead for the stock market.
