Morgan Sees Weak Retail First Quarter Followed by Brighter Future

Morgan Stanley reported bad news on first quarter retail earnings today. Both pre-tax income and margins declined steeply for its brokerage business, but in a conference call this morning chief financial officer David Sidwell expressed optimism about the future of the business unit.

Morgan Stanley reported bad news on first quarter retail earnings today. Both pre-tax income and margins declined steeply for its brokerage business, but in a conference call this morning chief financial officer David Sidwell expressed optimism about the future of the business unit.

The Global Wealth Management Group, the new name of the retail business, pulled in pre-tax income of $23 million for the quarter, compared with $353 million in the first quarter of last year. Pre-tax margins fell to 2 percent, compared with 29 percent in the year ago quarter and 7 percent in the fourth quarter. A big to earnings was an $80 million compensation expense related to retirement payments to eligible employees. Excluding that cost, last year’s World Trade Center insurance settlement and lease accounting adjustment expense, pre-tax margins would have been 8 percent in the current quarter.

The picture looks even worse in comparison to retail operations at rival firms, which are earning in the double digits. At the end of the fourth quarter, the most recent earnings release available, Merrill Lynch’s retail arm turned in pre-tax profit margins of 20.2 percent, while Smith Barney reported a pre-tax profit margins of 19 percent.

But Sidwell said he thinks new retail chief James Gorman, who started five weeks ago, will be able to raise margins to these levels over the next two to three years. “We will, once he’s got a clear plan of attack, get him out in front of everyone,” Sidwell said of Gorman in answer to questioning from an analyst. “I would summarize it this way. I think he’s very clear that the foundation of this business is good. He sees nothing that says we shouldn’t be able to achieve the goals we’ve laid out: significant improvement in margins over a two to three year period. We continue to be very committed to this business, and optimistic that we will achieve the margins we talked about of 20 plus percent.”

To achieve that they’ll likely need better sales figures. Net revenues for the unit of $1.3 billion were up 4 percent from a year ago, a smaller increase than expected, said Sidwell, who attributed it in part to intense recruiting pressure in the industry for the quarter.

Morgan’s well-known problems with its sales force is a big factor. The total number of financial advisors at the firm stood at 9,000 by quarter-end, down from 9,526 at the end of the fourth quarter. Since the end of 2004, Morgan has lost 1,962 reps, almost half of which, or about 1,000, were fired last year in an attempt to get rid of low-end producers. Still, Sidwell claims that net FA losses to competitors are down, particularly at senior levels, since James Gorman took the helm of the retail brokerage business five weeks ago.

“Gorman is working hard on plan to turn the business around,” said Sidwell. “He’s working hard to stabilize and motivate the FAs.” He’s also filling product gaps, he said, and working to determine what kinds of technology investments will be necessary.

Last week, Gorman streamlined the branch structure of the retail unit, eliminating a number of intermediate management positions between himself and regional branch directors and hiring on two former Merrill executives. For more on the restructuring, check out this recent story: http://registeredrep.com/news/Gorman_Streamlines_Morgan_Brings_on_Merrill_Friends/

Despite the FA defections, the Global Wealth Management Group did manage a 10 percent rise in fee-based client assets versus a year ago, which resulted in an increase in asset management, distribution and administration fees. Total client assets sat at $633 billion for the quarter, a 2 percent increase from last year’s first quarter. Fee-based client assets now account for 29 percent of total client assets, up from 27 percent last year.

As for Morgan Stanley’s asset management arm, Sidwell said the firm is hugely committed to staying in the business. “We have some world class professionals in this business, but we recognize that we have not invested sufficiently in the fastest growing and highest margin businesses such as alternatives.” To grow that business, he said the firm will do a variety of things -- adding one to two individuals, small teams and small bolt-ons, or acquisitions. “We’re looking at a number of potential bolt-ons. We don’t need to do that necessarily through a large transformation deal. To some degree these are always high risk to do.”

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