Randomly Noted

A look at Morgan Stanley’s earnings report today is yet another example of how the not-very-sexy businesses can be good ones to be in. When people think of Wall Street, they think of investment bankers and traders. And often we hear about the larger-than-life deals and money these folks make. But the banking and trading business can be very volatile, whereas the wealth management business may not grow as steadily but is, well pretty steady.

At Morgan Stanley, the firm reported wealth management revenues in the most recent quarter were $3.1 billion. The quarter before (this year’s 2Q): $3 billion. And the year-ago 3Q was $3.0 billion.

Institutional securities had $2.8 billion of revenues in the most recent quarter. It was $4.5 billion last quarter and $5.0 billion the year before.  In a sense, Morgan has created a hedge against the volatility brought on by sales and trading by being in the wealth business.

A firm like Morgan Stanley really operates in four basic businesses – wealth management, asset management, investment banking and sales & trading. The segment that offers the most volatility in terms of earnings/sales flow from quarter to quarter in sales & trading. And that’s exactly the segment that powered Morgan Stanley to a strong earnings showing today. And which likely led CEO James Gorman during an analyst conference call to temper expectations for the rest of the year.

The strongest area for Morgan Stanley in sales & trading came from equities, where the firm had $1.415 billion in revenues, essentially flat over the quarter before. But the firm believes it took market share from its rivals. Other highlights were in commodities trading and in its prime brokerage business. Its foreign exchange business saw higher revenues on “increased client flows.” This is the part of the forex business where Morgan Stanley executes, among other things, hedging strategies for customers like companies looking to minimize forex exposure.

Morgan Stanley did not give a lot of detail or color to any of its troubled asset portfolio other than to say it had net mark-to-market losses of $277 million. It didn’t say what kind of securities led to those losses.

Aon’s $4.9 billion acquisition of Hewitt Associates today has the look and feel of deals done in another era. The deal is part cash and part stock – with the cash portion being funded in part by a “bridge loan.” Bridge loans were issued by banks with the idea that a borrowing would be temporary and refinanced as soon as possible to take the risk off the banks’ books. When markets were favorable, these bridge lending facilities were profitable. But they cost the banks money when loans couldn’t be refinanced. The bridge lenders for this deal are Credit Suisse and Morgan Stanley.

The markets seem to be satisfied that a higher offer is not forthcoming – target Hewitt’s stock is trading at $46.85, below the $48.39 value of the cash-stock deal.

There was probably a lot of high-fiving and hand clapping when the Tesla Motors IPO was priced and closed the day $6.89 higher – a remarkable feat for an IPO these days and especially given how poorly the stock market in general performed.

So, maybe I am taking the glass half full approach, but, it seems to me the underwriters really mispriced it and left a lot of money on the table. The company itself sold 11.88 million shares. If the deal had been priced closer to where it closed rather than the original $17 price this morning, the company (a novel electric car maker) would have taken in an additional $81 million or so in proceeds. And for the selling shareholders? They would have pocketed nearly $10 million more.

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Wall Street has always been associated with trading. And volatility in trading revenues can have a huge impact on the earnings of a particular firm. As the first quarter earnings reporting season comes to a close for Wall Street’s biggest banks, we thought it would make sense to see if there were any interesting trends that developed. And boy there was: fixed-income trading fueled very strong trading results across the board. As the above chart shows, fixed-income (lumped in with forex) was on a roll for the major Wall Street banks. At Morgan Stanley (MS in the above chart), fixed-income accounted for 65% of the trading revenue. At Citigroup (C), it was 82%. The others: Goldman Sachs (GS) was 75%, Bank of America (BAC) was 77% and J.P. Morgan (JPM) was 78%.

What was interesting was that some of the banks noted that volatility in the fixed-income market had declined and that spreads had narrowed. That usually spells an environment for reduced money-making opportunities. But instead, there was heavy customer order flow. Sustaining those strong trading gains will be the challenge for the banks.

In the ongoing furor about top banker pay the main combatants have been politicians, regulators, the bankers themselves and the amorphous public, the individual compenents of which care about such matters in varying degrees.

Largely forgotten have been the shareholders of these publicly traded investment and commercial banks. Surely, sky high compensation is a bigue for shareholders. When a high percentage of annual revenue goes to pay people, it’s money that otherwise belongs to the company’s owners, the shareholders. It’s a pretty direct relationship.

Now, the shareholders are starting to make noise. Maybe their representatives, the corporate boards of directors, will listen.

Aaron Lucchetti reports in today’s Wall Street Journal that the statement by the new chief executive of Morgan Stanley, James Gorman, about reducing the percentage of revenue that goes to compensation “followed prodding by some large shareholders.”

“Company officials acknowledge being questioned by investors since Morgan Stanley reported three weks ago that compensation and benefits were equal to 62% of net revenue at the New York company,” Lucchetti reported.

Good for the shareholders. Other company holders should pay attention.

Morgan Stanley reported a 4Q profit of $617 million which was a little less than expected and a decline from the previous quarter. But given that the three quarters before that showed nothing but steep losses, two back-to-back quarterly gains indicate the ship is somewhat righted.

That said, what will likely be the focus of the populist, anti-Wall Street gang in Washington and elsewhere, is not that this firm and others are healing but what they are paying their employees.

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A little more than two years ago, the largest sovereign wealth fund in the Middle East made a big investment in Citigroup – Abu Dhabi Investment Authority bought $7.5 billion of mandatory convertible securities that at the time seemed like a great deal. ADIA, as it is known, would be paid an 11% dividend for about 2 1/2  years and it would be required in March of next year to buy Citigroup stock for $31.83 a share.

With Citigroup stock around $3.50 a share today, the deal will cost ADIA dearly. So, it has filed a complaint (we are still trying to find out with whom) alleging “fraudulent misrepresentations” and wants the deal scrapped.

Unless it can be proven that Citigroup did engage in fraudulent activity (which would have huge ramifications beyond Abu Dhabi, one would have to believe), there is no reason for this deal to be torn up.

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Reading through our newswire earlier today, I came across the story of a complex merger transaction between Talbots Inc. and something called BPW Acquisition Corp.  I know the retailer has fallen on some hard times, both during and pre-recession. But they got themselves into a position to be majority owned by a three letter acquisition vehicle?

One large shareholder gets bought out and existing shareholders don’t seem to get to tender their shares in the acquisition. In fact, existing holders see their stakes diminished through dilution because the new owners get stock issued to them. So, you get to own Talbots alongside our friends at BPW.

What is going on here? Should existing holders run for the hills?

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Morgan Stanley CEO John Mack recently appeared before a group at the Wharton School of the University of Pennsylvania and recounted the events of that one week last September that nearly brought down the global financial system. For anyone interested in global finance, it is a must view (it runs a little over 26 minutes). There are some stunning details – how federal regulators were pressuring Morgan Stanley to sell itself to J.P. Morgan for $1. How Mack had a firm conversation with J.P. Morgan CEO Jamie Dimon about speaking with Mack directly on any acquisition talks, and not his subordinates. His frequent phone calls with Goldman’s Lloyd Blankfein, who told Mack he had to find a way to rescue Morgan because if it failed, his firm might be just 20 minutes behind. And how and why Mack hung up the telephone with the three most powerful regulators in the U.S. Click on the image above to see the video or click here.