Forget about the headline number showing a loss for Morgan Stanley in the first quarter. The Wall Street firm actually turned a profit in the first three months of the year – after stripping out the $1.5bn accounting hit to revenue from the price of its own debt recovering. But unlike Goldman Sachs’ results, Morgan’s number looks pretty anaemic.
Here’s how. First, add back in the $1.5bn. That's the result of an accounting rule stipulating that firms must mark to market any changes in their own liabilities - the Federal Accounting Standards Board's thinking was that if liabilities fall in value, owners of the debt hold a paper loss. That gives the issuer the chance, theoretically at least, to make a profit by buying the debt back at less than face value - so FASB decreed banks mark any such moves as a profit. Many, including Morgan Stanley, have done so at various points in the past 18 months. This quarter, though, Morgan's laibilities actually increased in value, forcing the firm to take a paper loss. Breakingviews adjusts earnings to exclude both gains and losses from this accounting rule from core earnings
Doing so for the first quarter means Morgan’s pre-tax income jumps to $600m. But shave off 30% for Uncle Sam and $401m in preferred dividend payments and the firm made just $19m for its shareholders. That equates to an annualised return on equity of just one third of a percentage point. That jumps to 1.4% if one chooses to include $331m of one-off earnings for the first quarter stemming from Morgan lowering the estimated tax rate to be paid on foreign earnings it intends to move back to the US.
ITS return may jump as business improves and writedowns diminish. But it’s a far cry from Goldman’s return of 14.5%. Why the big difference? As is so often the case between the two, it’s all down to trading. After all, Morgan’s underwriting and advisory revenues of $812m were just shy of its rival’s.
And both had losses and profits in other divisions that largely offset each other – asset management and principal investment at Goldman and wealth management and asset management at Morgan.
In fixed income trading, though, Goldman cranked out, at $6.6bn, almost three times as much as Morgan - again, after adjusting for the loss on its own liabilities.
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And Goldman’s equities revenue was more than double. Some of the latter, at least, is due to the residual effects of hedge funds taking prime brokerage business elsewhere last year – Morgan suffered more than Goldman.
But much of it is down to risk-taking. True, value-at-risk may not be the best way to assess what a firm is on the hook for. But it can be handy for general comparisons of risk-taking between firms - and Goldman’s $240m VaR is more than double Morgan Stanley’s.
Of course, it doesn’t fully explain the gulf between the two - VaR measures what’s at risk, not what profits are possible. Luck, a few outsized trading gains and even Goldman’s balance sheet, which is now 50% larger, must all be factored in.
But the huge variance in earnings stems from Morgan deciding late last year to reduce proprietary trading in favour of concentrating on trading on behalf of clients last year.
That certainly reduces risk, and the chance of taking multi-billion-dollar hits. But the price is much lower returns.
