Brad Hintz, a respected analyst at Alliance Bernstein, says the Volker legislation's impact on financial firms is unknown at this point, but that Morgan Stanley's (Ticker: MS) turnaround is intact; its shares are a buy. In fact, Hintz says the market has oversold the shares since it has too steeply discounted its future profitability.
Here is an excerpt from his recent report: Institutional sales and trading revenue materially benefitted from a large DVA gain during the quarter. Excluding this gain, FICC declined 48% sequentially while equities fell 28% compared to Q2 '11. Investment banking revenue was expectedly weak and in-line with peer results. Retail brokerage revenue declined sequentially and fell below our estimate but GWM's PTM of 11% showed improvement and reflected cost save initiatives. Management increased its $1.0 billion expense save target for MSSB to $1.4 billion, reflecting incremental cost saves as a result of technology efficiencies, headcount reductions and compensation. The decline in asset management reflected losses related to the firm's merchant banking portfolio.
Management detailed gross exposure1 to EU periphery of $5.7 billion and France of $1.7 billion as of September 30, while net exposure to each respective region was $2.1 billion and ($286) million. This compares to tangible common equity of $53.6 billion. Prime brokerage revenue increased during the quarter and experienced no significant losses of clients amid widely rumoured liquidity concerns during the quarter. Management stated the firm meaningfully increased market share in its trading business relative to peers and Morgan Stanley repurchased debt during the quarter, underscoring its firm liquidity position to credit market participants.
Similar to peers, the firm was reluctant to speculate on the long-term implications of Volcker legislation. The difficulty regulators face, management argued, is striking the right balance between regulation of proprietary trading while not imposing on the competitive position and liquidity of the U.S. capital markets. Bernstein is also hesitant to render a conclusion regarding Volcker on U.S. firms. Nevertheless, Morgan Stanley's move to diversify its business mix by growing its retail franchise should defend profitability from onerous regulation.
MS shares are currently trading at 0.60x current tangible book value. This would imply, based on our historical valuation model incorporating forward profitability and Ke a forward ROTE of ~9%. Morgan Stanley undoubtedly faces further consolidation and structural challenges in the near term as it integrates MSSB and optimizes its fixed income trading division. However, Bernstein is convinced that the market has overly discounted long-term profitability, and we believe current valuation levels provide a convincing entry point.