Morgan Stanley Reports a Stronger than Expected Q2 Along with Optimism for the Future of the Market

Despite a lukewarm at best 2nd quarter by way of trading activity, Morgan Stanley released their earnings report for the quarter which showed signs of steady improvement for the Wall Street bank. The company’s top brass, CEO James Gorman and CFO Sharon Yeshaya, have both issued very encouraging statements regarding the direction the company is heading in as well as promise for the market to improve. It is partially due to their rhetoric, as well as some of the results of the report, that led to us seeing Morgan Stanley shares trading up near 6.5%, marking their biggest bump up since November 9, 2020, and brings their gain so far this year up to 7.2%.

Morgan Stanley, and other investment banks who rely heavily on trading and dealmaking, experienced a very tough Q2 in that market, a phenomenon that analysts have coined as a ‘dealmaking slump’. This slump marks the biggest drop in a steady decline of dealmaking going back to 2021. Total trading revenues were down 22% from a year ago, and 19% from Q1, which fell well short of analysts’ projections. Fixed income trading saw the biggest hit, falling 31% down to $1.7B from the same time last year, a time which was marked by higher interest rates from central banks which gave the firm a boost. Morgan Stanley also saw equity trading take a fall at 14% YoY to $2.5B.

Q2 proved to be a very poor quarter for the firm’s institutional securities division which not only includes trading, but also investment banking. The division reported $5.65B in net revenues, down 8% YoY though still exceeding analysts’ expectations of $5.5B. While the dealmaking slump hit the trading market the hardest, investment banking has also been affected over the last couple years. However, in its latest earnings report, Morgan Stanley posted ‘flat’ investment banking revenues just under $1.1B, barely ahead of the $1B estimate, which halted a streak of revenue falling for more than a year.

The one bright spot in the last quarter was the bank’s wealth management business, run by other co-president Andy Saperstein, a unit described by Gorman as “a pretty much unstoppable force”. The department brought in $6.7B for the quarter, a 16% increase from last year and surpassing projections of $6.5B. The most encouraging area of growth was in net new assets, which they reported accumulating $89.5B, far exceeding the $60.3B projected. The Union Bank of Switzerland’s analysts described Morgan Stanley’s inflow as “very strong”. Despite the encouraging numbers the wealth management unit reported, it was not enough to compensate for the weak quarter other areas of the bank had, with net income dipping 13% over the last year to $2.18B, amounting to $1.24 per share, just higher than the projected $1.15 per share.

While some of these numbers certainly look promising, it has primarily been the words of the Wall Street bank’s top executives that have influenced the upswing in the market. Yeshaya hesitated to refer to the recent slump as bottoming out for investment banking, referencing a better tone as the quarter wound down, and though some markets impacted trading, market conditions are stabilizing and have not yet reach capital markets, which she believes sets up the firm for success next year. The CFO is also quoted saying they have seen ‘green shoots’, a term to refer to signs of upward trends, that has proven to be a buzz term for investors.

Gorman, who announced earlier this year he plans to step down as Morgan Stanley’s CEO the middle of next year, said he believes after this past quarter the company is “overall in a better place, with a better tone”, though he does not believe that rate hikes are over yet. He also claims that it was discourse in the US over the debt ceiling that created “unnecessary” uncertainty in the market which contributed to the dealmaking slump. Gorman, Morgan Stanley’s CEO since 2010, has led the charge in expanding into wealth and assets management businesses, which are generally more stable than investment banking and trading. The CEO believes that through these markets not only can Morgan Stanley achieve its goal of $10T in assets under management but can surpass that and triple its current assets to $20T. There are currently three potential successors to Gorman which include co-presidents Pick and Saperstein, as well as Dan Simkowitz the bank’s Head of Investment Management.

Like so many matters in the market today, there are glimmers of hope pointing to impending improvement that are, in truth, too early to make a final call on now. For Morgan Stanley, while the business seems to be stabilizing, all the numbers in their Q2 earnings report do not include the $308M the bank owes for severance costs from cutting more than 3,000 jobs due to the dealmaking slump affecting the investment and trading businesses. Morgan Stanley has also said they are currently in discussions with US prosecutors concerning a probe into the company’s block-trading practices, an issue Gorman stated he would like to bring resolution to before ending his tenure. Regardless of the uncertainty still ahead, the market is reacting favorably to the news, with the Dow closing yesterday up 366.58 pts (a 1.06% increase), the highest point it has closed at since April 2022, marking the seventh consecutive session of gains, the longest streak since March 2021.

Takeaways for Internal Auditors‍

Despite the encouraging signs of improvement in Morgan Stanley's earnings report, there are several implications and lessons that internal auditors should consider in their risk assessment and evaluation of the bank's operations:

1. Risk Assessment and Monitoring: Internal auditors should closely monitor and assess the risks associated with Morgan Stanley's trading and dealmaking operations, given the recent 'dealmaking slump.' This slump indicates market volatility and challenges in generating revenues from these areas. Internal auditors must ensure that appropriate risk mitigation strategies are in place to address potential losses and fluctuations in revenue streams.
2. Compliance and Regulatory Concerns: The ongoing discussions with US prosecutors regarding the probe into the bank's block-trading practices should be a red flag for internal auditors. They must ensure that the bank's practices are in compliance with relevant regulations and internal policies. Regular audits and reviews of trading practices can help identify any potential issues and enable timely corrective actions.
3. Stress Testing and Scenario Analysis: Given the uncertainty surrounding the future market conditions, internal auditors should emphasize stress testing and scenario analysis. These risk management techniques can help the bank assess its resilience against adverse market conditions and ensure preparedness for potential downturns.
4. Diversification Strategy: The positive performance of the wealth management business should not lead to complacency. Internal auditors should encourage the bank to maintain a diversified business strategy that balances reliance on investment banking and trading with more stable segments, like wealth management. A well-diversified portfolio can better withstand market fluctuations.
5. Succession Planning and Leadership Transition: The impending departure of CEO James Gorman underscores the importance of effective succession planning. Internal auditors should evaluate the readiness of potential successors and assess how the leadership transition might impact the bank's risk management and strategic direction.
6. Severance Costs and Restructuring: The severance costs associated with job cuts are another area of concern for internal auditors. They should ensure that these costs are accurately accounted for and properly managed to avoid any financial misstatements or unexpected impacts on the bank's financial health.
7. Effective Communication and Transparency: Internal auditors should emphasize the need for clear and transparent communication between management and stakeholders. The market's positive reaction to Morgan Stanley's executive statements demonstrates the influence of leadership rhetoric on investor sentiment. However, internal auditors should ensure that such statements are balanced and based on factual data.
8. Continuous Improvement: Lastly, internal auditors should advocate for a culture of continuous improvement within the organization. This includes periodic reviews and updates of risk management processes, compliance frameworks, and internal controls to adapt to changing market conditions and regulatory requirements.

While Morgan Stanley's earnings report shows signs of steady improvement, internal auditors play a crucial role in safeguarding the bank's operations and ensuring it navigates potential risks and uncertainties effectively. By closely monitoring risks, evaluating compliance, conducting stress tests, and promoting effective communication, internal auditors can help the bank maintain its positive trajectory and build resilience in an ever-changing financial landscape.