A Tale Of Two Cities Emerged As Our Bank Holdings Reported Their Q1 2022 Results: Morgan Stanley (MS) Investment Thesis Playing Out, Wells Fargo (WFC) Slumped On Disappointing Results.
Friday, 15 Apr 2022 8:00 AM
By Mike Le
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Morgan Stanley’s big earnings beat proves management can navigate tricky markets
Morgan Stanley (MS) on Thursday reported stronger-than-expected earnings for the first quarter, thanks to the second-highest sales figure in the bank’s history.
Earnings per share of $2.02 exceeded the $1.72 expected by Wall Street analysts, while revenue hit $14.8 billion, well above the $14.2 billion expected by Wall Street analysts. Breaking down the top line one more step: non-interest revenue of $12.585 billion (down 8% year-over-year) exceeded expectations of $12.136 billion; while net interest income of $2.216 billion (down 6% over last year) exceeded the $2.077 billion consensus.
Key company metrics
Before digging into the various operating segments, let’s take a quick look at some key overall metrics:
ROTCE: 19.8% vs. 17% expected
Expense efficiency ratio: 69% (67.9% ex-integration costs) vs. 70% expected (a measure of efficiency that is calculated as total non-interest expenses divided by net revenues, lower is better on this front)
Common equity tier 1 (CET1) capital ratio: 14.5% vs. 15.7% expected (a measure of bank capital versus risk-weighted assets and a sign of the bank’s ability to endure financial stress)
Tangible book value per share (TBVPS): $39.91 vs. $40.96 expected (a measure of intrinsic liquidation value that removes intangibles such as goodwill. Think of goodwill as the value of the Morgan Stanley brand).
Results by segment
Institutional Securities net revenue of $7.657 billion far exceeded expectations of $6.224 billion thanks to strong trading revenues. Within the segment, the revenue results were as follows:
Investment Banking: $1.634 billion (down 37% year-over-year)
Equity: $3.174 billion (up 10%) vs. $2.731 billion expected
Fixed Income: $2.923 billion (“essentially unchanged”) vs. $2.25 billion expected
Investment banking nearly doubled advisory revenue on the back of higher completed M&A transactions. That was enough to more than offset a significant decline in equity underwriting revenues, due in part to market uncertainty. Equity revenue was boosted by a strong performance across businesses and geographies, particularly in Europe, the Middle East, and Africa (EMEA).
Lower credit product sales, meanwhile, were largely made up for by fixed income’s higher commodity and foreign exchange revenue. Total expenses fell 9% to $4.826 billion as compensation expenses benefited from a reduction in discretionary compensation. Non-compensation expenses were up slightly.
Wealth Management net revenue of $5.935 billion came up short versus expectations of $6.194 billion. Within the segment, the revenue results were as follows:
Asset management: $3.626 billion (up 14% year-over-year)
Transactional: $635 million (down 20%, excluding mark-to-market losses on certain employee deferred compensation plan investments)
Net interest income: $1.54 billion (up 11%)
Other: $134 million
Asset Management sales benefited from higher asset levels. Transactional sales, however, took a hit due to a decrease in client activity. Net interest income benefited from lending growth. On the expense side, total expenses fell 1.4% to $4.349 billion as a small decline in compensation expenses was partially offset by a small increase in non-compensation expenses.
On management’s conference call with investors, Gorman said the E-Trade integration “continues to go very well” and that he expects “a significant portion” of the integration to be complete by the end of the year. Morgan Stanley closed its acquisition of the discount broker in October 2020.
Investment Management net revenue of $1.335 billion missed the $1.51 billion consensus. Within the segment, the revenue results were as follows:
Asset management and related fees: $1.388 billion (up 26%)
Performance-based income and other: $53 million
Asset management and related fees benefited from incremental revenues from the Eaton Vance acquisition, which closed in March 2021. Still total assets under management (AUM) took a hit from market volatility and outflows. Total AUMs came in at $1.4 trillion, down 8%. Total expenses were up 17% as both compensation and non-compensation expenses increased as a result of the Eaton Vance acquisition.
Capital Returns
Morgan Stanley repurchased 30 million shares in the quarter at an average purchase price of $95.20 per share, resulting in a return of capital to shareholders to the tune of $2.872 billion. Furthermore, the bank’s board declared a quarterly dividend of $0.70 per share, payable on May 13, 2022, to shareholders of record on April 29, 2022.
Bottom line
This was a strong quarter from Morgan Stanley as the firm’s diversified business model allowed management to navigate a very difficult macroeconomic environment. CEO James Gorman called out a “strong and growing deposit base” and added that the recent rate hike from Federal Reserve “will have a near immediate [positive] economic impact” on the firm’s business and supports the path to realizing projected margins of more than 30%.
Wells Fargo stumbled this quarter
Wells Fargo (WFC) reported disappointing first-quarter results before the opening bell Thursday.
Total revenue of $17.59 billion, a decrease of 5% year-over-year, missed the FactSet consensus estimate of $17.80 billion. And adjusted earnings per share of $0.88, down 13.7%, beat estimates of $0.80.
Key company metrics
Before digging into the various operating segments, let’s take a quick look at some key overall metrics:
Net interest income: $9.221 billion (up 5% year-over-year) vs. $9.288 billion expected
Net interest margin: 2.16% vs. 2.12%
Non-interest income: $8.371 billion vs. $8.541 billion
Non-interest expense: $13.870 billion (down 1% year-over-year but up 5% over last quarter) vs. $13.159 billion. A very disappointing result because one of the main reasons to own WFC is for its expense reduction program, but it comes with a caveat. The year-over-year increase included a $460 million increase in operating losses primarily driven by customer remediation expenses.
ROTCE: 10%
Efficiency ratio: 79% vs. 73.8% expected
Common equity tier 1 (CET1) capital ratio: 10.5%, down from 11.4% last quarter (due to strong capital returns and $5.1 billion reduction in cumulative other comprehensive income, among other reasons) but well above the regulatory minimum of 9.1%
Period-End Loans: $911.8 billion (up 6% year-over-year, 2% increase over last quarter) vs. $892.703 billion. Third consecutive quarter of loan growth
Average deposits: $1.464 trillion (5% increase) vs. $1.479 trillion
Tangible book value per share (TBVPS): $35.13 vs. $36.49 expected
Segment results
Consumer Banking and Lending total revenue was $8.563 billion, down 1% over last year and down 2% over last quarter. Consumer and small business banking (CSBB) revenue increased 11% year-over-year primarily due to higher deposit balances, higher deposit-related fees, and an increase in debit card transaction volumes, partially offset by lower revenue from PPP loans. Within consumer lending, home lending was down 33% over last year but up 19% over last quarter. Credit card revenue increased 6% over last year, auto rose 10%, and personal lending was up slightly.
Commercial Banking total revenue was $2.327 billion, up 12% year-over-year and up 2% over last quarter. Middle market banking revenue of $1.246 billion represented an increase of 8% over the same period last year on higher deposit and loan balances as well as the impact of higher rates. Asset-based lending and leasing revenue of $1.081 billion increased 17% year-over-year driven by higher loan balances, stronger net gains from equity securities (a headwind quarter-over-quarter), and higher revenue from renewable energy investments.
Corporate and Investment Banking total revenue was $3.470 billion, down 4% year-over-year and down 1% over last quarter. Total banking revenues increased 4% year-over-year but down 5% from last quarter on lower investment banking fees resulting from lower market activity, improved Treasury management results and higher loan balances. Commercial real estate revenue increased 9% year-over-year on higher loan balances and higher revenue in the low-income housing business, partially offset by lower commercial mortgage-backed securities gain on sale margins and volumes. Markets revenue was down 18% but increased 16% from last year driven by higher trading activity across equity products and FICC.
Wealth and Investment Banking total revenue was $3.757 billion, up 6% year-over-year. Net Interest Income increased 22% year-over-year thanks to higher interest rates as well as deposit and loan balances. Non-Interest Income grew 2% on higher asset-based fees primarily due to higher market valuations, partially offset by lower activity.
Outlook for rest of 2022
One of the main reasons why we have invested in Wells Fargo is for its expense reduction outlook, so it was worrying at first to see the bank posted a much larger-than-expected expense result in the first quarter. That line item was one of the main reasons why WFC initially fell roughly 6% at the start of trading. But as we always say, you cannot trade a stock before listening to the earnings call because when management provided its view on the full year 2022, they put to ease some of the concerns about expenses this year.
After management reiterated that full year 2022 expenses are still expected to be approximately $51.5 billion, we were able to take a deep breath as it backed up our view that management’s efficiency initiatives will drive expenses lower.
On net interest income, management said on the call this will increase somewhere in the mid-teens year-over-year — a big improvement from the 8% increase they initially set in January, thanks to loan growth and the big move in rates.
Regarding the asset cap, management reiterated its view that they continue to make progress, but “setbacks” are to be expected from time to time. Although the timing of the asset cap lift remains uncertain, we believe it will happen at some point, creating a catalyst for the stock because the removal should lead to more deposit growth, stronger ROTCE performance, and a stock re-rating.
Capital returns
Wells Fargo repurchased a staggering 110.1 million shares of common stock, or $6 billion, in the quarter, reducing its share outstanding count by 2% from the fourth quarter. That brings Wells Fargo’s total repurchases since the third quarter of 2021 to $18.3 billion. Although the bank has plenty of flexibility under its stress capital framework to buy back more stock, management said on the call today to expect “significantly lower levels” of buyback activity in the second quarter.
Bottom line
This wasn’t the expected result since we believed Wells Fargo could have been a standout this quarter. After all, the bank is a major beneficiary of higher interest rates, lower expenses, and zero foreign exposure. We were disappointed by the outcome and the negative price action today.
Portfolio Action
The ugly broad market action yesterday kept the stock of Morgan Stanley (MS) from rallying after a truly blow-out quarter, while hitting Wells Fargo (WFC) on the chin for a disappointing one. We took this price action as a chance to pivot towards the company that did well on earnings: Morgan Stanley. Specifically, we sold some shares of Wells Fargo, reducing our weighting in the position, and shift the capital towards shares of Morgan Stanley. If anything is to be taken away from the last quarter, Morgan Stanley will be able to withstand capital market uncertainty because of its diversified business portfolio.
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