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Morningstar | Strong 2Q Results for Morgan Stanley, but Signs of Slowing Momentum Persist

Narrow-moat-rated Morgan Stanley continued its streak of strong results during the second quarter of 2018, but signs of slowing earnings momentum (which we remarked  on after the first quarter) were also present during the period. Year-to-date results have been exceptional, with the company generating an adjusted return on equity during the first half of 13.7% (and adjusted return on tangible common equity of 15.7%). Revenue increased 13% to $22 billion during the first six months of 2018, while operating income increased 20% to $6.5 billion. Investment banking results continue to benefit from general economic confidence, as well as U.S. tax reform, with the company posting industry-leading equity trading revenue of $2.5 billion and fixed-income trading revenue of $1.4 billion during the second quarter. Despite strong results, we don't expect to make material changes to our $50 fair value estimate, believing that Morgan Stanley is fairly valued right now, with earnings momentum seeming to be slowing.

While revenue in the institutional securities segment increased 20% from the previous year, it was down 6% sequentially. Granted, that was up against a strong first quarter, but we see this quarter's revenue level as more normal. The more prominent area of concern is the change in the company's net interest income, which while up 21% year over year during the second quarter was down 7% sequentially (following on a 2% sequential decline during the first quarter of 2018). For most of the banks, we've expected to see slowing growth in net interest income due to higher deposit betas and a flattish yield curve. In Morgan Stanley's case, though, net interest income has actually declined the past couple of quarters as opposed to growing at a slower rate. This will prove problematic for wealth management margins, which ticked up again to 26.8% in the second quarter, as growth in net interest income has been a primary driver of higher margins the past several years.

Following the 2018 Comprehensive Capital Analysis and Review test results, Morgan Stanley announced that it is increasing its quarterly dividend to $0.30 from $0.25 per share. The company is also authorized to repurchase up to $4.7 billion over the next four quarters. At the moment, return on equity improvement will primarily be driven by increases in the net income portion of the return on equity equation, as the Federal Reserve isn't allowing the firm to draw down its capital base. For a more in depth take on capital returns in the banking industry and the effects of changing stress test regulations, please see our special report "New Regulatory Proposals Will Change Stress Test Landscape," published on July 8.

Morgan Stanley, along with many other retail brokerages and wealth management firms, is investing in wealth management technology. One form of wealth management technology that many of the established financial firms are launching is robo-advisory, or digital advice, offerings. We recently updated our analysis and opinion on robo-advisors in our June 2018 report "Robo-Advisor Upgrade! Installing a Program for Profitability."