Analysis: MS

Morgan Stanley (MS) reported strong second-quarter 2021 earnings results on Thursday, before the opening bell. On the top line, total revenue of $14.759 billion (+8 YoY) exceeded expectations of $13.971 billion, and on the bottom line, diluted earnings per share of $1.85 (-6% YoY) topped the $1.66 per share consensus.

It is also worth noting that the strong second-quarter performance has led to a record first half, as first half revenues exceeded $30 billion.

 "The Firm delivered another very strong quarter, with contributions from all of our businesses. Our Wealth and Investment Management businesses attracted $120 billion in flows and Institutional Securities generated over $7 billion in revenues. With our transformed business model providing more stable and durable earnings, we have doubled our dividend and announced a $12 billion buyback as we move to return our excess capital to shareholders. Our global franchise is very well positioned to drive further growth," said CEO James Gorman on the release.

As a reminder, the company's purchase of E*TRADE Financial and Eaton Vance affects the ability to compare current results to prior ones. E*TRADE's acquisition was completed in 4Q20 and Eaton Vance's in March of this year. E*TRADE results are reported in the Wealth Management segment while Eaton Vance results are reported in the Investment Management segment.

"Since the respective announcement of each acquisition, both businesses have performed better than we expected," said Gorman on the call. "Not only did the standard merger metrics such as synergies and funding benefits read positive, but much more importantly, we're seeing long-term business growth driven by exceptional client engagement."

Firm-Wide Metrics

Before digging into the various segment results, let's take a look at some firm-wide metrics. Morgan Stanley reported a return on tangible common equity (ROTCE) of 18.6% (or 19.0% excluding the impact of integration-related expenses), solidly above the 16.7% consensus. The firms expense ratio came in at 69% (or 68% excluding the impact of integration-related expenses), also better than the 70.3% consensus. Morgan Stanley's tangible book value per share came in at $40.12, which is down from $43.68 in the year ago period, however, largely in line with the $40.37 per share expected. The bank's common equity tier 1 ratio came in at 16.7%, in line with expectations.

On the call, Gorman acknowledged that the ROTCE performance was above the firm's longer-term 17% plus target and noted that management intends to formally revisit their goals next January.

Taking a look at capital returns, the firm returned a total of $2.939 billion via the repurchase of 34 million shares at an average price of $86.21 per share.

Institutional Securities

Moving on to the various operating segments, starting with Institutional Securities, revenues of $7.092 billion (-14% YoY) outpaced the $6.763 billion consensus "as clients remained active across Investment Banking and Equity."

Within the segment, Investment Banking revenues increase 16% YoY to $2.376 billion as advisory revenues benefited from "higher M&A completed transactions," equity underwriting revenue increased annually "driven by higher volumes in traditional IPOs partially offset by lower revenues from convertible issuance and follow-on offerings." Fixed income underwriting revenues declined from the year-ago period, mainly because of lower investment grade and noninvestment grade bond issuances, which were partially offset by strength in non-investment grade loans. In Equity, revenues advanced 8% YoY to $2.827 billion "driven by high levels of client activity with particular strength in Asia." We also saw higher prime brokerage revenues that were partially offset by declines in cash equities and derivatives due to reduced volatility and volumes vs. the year-ago period. As for Fixed Income, revenues declined 45% to $1.682 billion because of lower bid-offer spreads and volatility, as well as tighter credit spreads vs. the year-ago period. While that 45% annual decline is pretty steep, we should note that it is inline with the trend we've seen this earnings season and makes sense considering the environment we were in during the year ago period. 

On the other side of the equation, the segment reported non-interest expense, which consists of both compensation and non-compensation expense, of $4.524 billion, leading to segment net income of $1.904 billion.

Wealth Management

Moving on to Wealth Management, revenues of $6.065 billion (+30% YoY) was better than the $5.912 billion expected. Again, we remind members that the annual compare here will be impacted by the prior acquisition of E*TRADE. On the call, CFO Sharon Yeshaya commented, "The integration of E*TRADE is going well, and we continue to prioritize client experience. While early, we are encouraged by continued client engagement and excited about the potential of our pilot programs around referrals." 

Driving the segment revenues, Asset Management revenues advanced to $3.447 billion, "reflecting higher asset levels driven by market appreciation and positive fee-based flows." Transactional revenues "increased 49% [to $1.172 billion] excluding the impact of lower mark-to-market gains on investments associated with certain employee deferred compensation plans." The results also reflected "incremental revenues as a result of the E*TRADE acquisition and strong client activity." Lastly, Net Interest Income (NII) increased to $1.255 billion "driven by incremental NII as a result of the E*TRADE acquisition and higher bank lending partially offset by the impact of lower rates and an increase in mortgage securities prepayment amortization expense." 

On the other side of the equation, the segment reported non-interest expense of $4.456 billion, leading to segment net income of $1.264 billion.

Investment Management 

Lastly, looking at Investment Management, revenues of $1.702 billion (+92% YoY) was stronger than the $1.527 billion consensus. Again, we remind members that the annual compare here will be impacted by the prior acquisition of Eaton Vance. Within the segment, Asset management and related fees increased to $1.418 billion "driven by incremental revenues as a result of the Eaton Vance acquisition and higher AUM on continued strong performance and positive net flows." Performance-based income and other increased annually "primarily on higher accrued carried interest across our funds, particularly in private and equity and infrastructure." Notably, Assets Under Management (AUM) increased to $1.524 trillion which includes $13.5 billion of "positive long-term net flows across all asset classes."

On the other side of the equation, the segment reported non-interest expense of $1.272 billion, leading to segment net income of $341 million.

Other Matters 

As a reminder, Morgan Stanley previously announced a $12 billion share repurchase authorization through June 30, 2022 and a 100% dividend increase to $0.70 per common share payable on Aug. 13 to common shareholders of record on July 30.

Additionally, Yeshaya concluded her prepared remarks on the call by commenting, "The second quarter results were strong and balanced. Looking ahead, while we are cognizant of the typical summer slowdown, we are starting the third quarter from a position of strength. Investment Banking pipelines are healthy. Dialogues are active and markets are open. Wealth Management continues to retain and attract new clients, new advisers, and new assets. Investment Management should continue to benefit from the increased diversification of the platform." 

All in, this was exactly the quarter we were looking for when we initiated our position earlier this week. Management is executing on the bank's strategic transformation and we expect Wealth Management and Investment Management to continue benefiting as the E*TRADE and Eaton Vance acquisition are further integrated and leveraged into new growth opportunities. We have increased confidence in the view expressed in our initiation that as the integration of these two acquisitions continues and fee-based recurring revenues become the majority we would expect to see an expansion of the stock's price-to-earnings multiple to better reflect the more reliable revenue stream. As a result, we are increasing our price target to $105 and reiterate our One rating.

Action AlertsPLUS, which Cramer co-manages as a charitable trust, is long on MS.