In the first quarter, the strategy looked prudent: Profit and revenue soared in wealth management, even as they dipped in investment banking.
The wealth management unit generated more fees, and clients shuttled more assets to the bank. Profit margins rose and so did employees' productivity. In contrast, the company's investment banking unit brought in less revenue from trading bonds and commodities, and made less money on advising companies on mergers and acquisitions.
Overall earnings slipped 12 per cent from a year earlier — to $1.2 billion, or 61 cents a share. While that beat expectations of analysts polled by FactSet, investors weren't impressed. The stock fell $1.16, or 5.4 per cent, to close at $20.31 Thursday.
CEO James Gorman said the first quarter represented "solid momentum." He's been investing in the wealth management unit, emphasizing products like home loans, and steering the purchase of the rest of Morgan Stanley Smith Barney, the retail brokerage it owns with Citigroup.
Analysts, however, described the first quarter almost like a holding period. They said the bank was moving toward the correct positions but were disappointed by weaknesses in the investment bank. They're also anxious for the Morgan Stanley Smith Barney deal to be completed.
Gorman, the CEO since the start of 2010, is under pressure to restore Morgan Stanley's share price and measures of profitability, including its return on equity. His direction for the bank is borne from previous losses: Risky investment banking activities slammed Morgan Stanley in the financial crisis, and regulators are phasing out some of the investment bank's old sources of revenue, like trading for its own profit.
The CEO's response has been to expand the bank's work with individual investors. That business can provide a steady source of revenue even when financial markets are volatile. It also gives the bank more earnings power and access to deposits, which helps it fund lending and other initiatives.
A big part of that plan is the retail brokerage, Morgan Stanley Smith Barney. Morgan Stanley is in the process of buying out Citi's remaining 35 per cent stake. It has said it plans to do so by the end of this year, though it still needs Federal Reserve approval for part of the process.
The bank's different units are also being encouraged to work together. For example, the investment bank usually deals with companies and other institutional clients, helping them broker deals or trading on their behalf. But those corporate clients also have executives who would make prime customers for the wealth management unit, which advises individuals as well as small and medium-sized companies.
Thursday's results reinforced the shifting focus. The wealth management unit accounted for about 41 per cent of revenue, after stripping out an accounting charge. Three years ago, when Gorman took over, it accounted for 34 per cent.
Wealth management's profit margins and income tend to be more reliable and steady. Analysts said they were pleased that the wealth management unit's pre-tax profit margin was better than expected at 17 per cent. That's the highest it's been since Morgan Stanley formed the joint brokerage with Citigroup, and it's been steadily rising since 2009. The investment bank's profit margin was higher, at 20 per cent, but it's swung widely in recent years: 39 per cent three years ago, and 12 per cent two years ago.
Nomura analyst Glenn Schorr said the quarter "showed progress."
"A mixed bag at the (investment bank) isn't so bad," he wrote in a note to clients, "when wealth management is so much better (and about to be bigger)."
Barclays analyst Roger Freeman noted that the return on equity rate was down over the year — "a sign of progress yet to be made, though with important catalysts on the horizon," he wrote.
More from the earnings report:
—The economy: Executives sounded cautiously hopeful about the economy, but were far from declaring victory. In an interview with The Associated Press, Chief Financial Officer Ruth Porat said that institutional investors had been more confident in January and February, then pulled back in March amid the Cyprus bank bailout and Italy's uncertain elections. It was a trend seen with clients at Goldman Sachs, which reported first-quarter earnings Tuesday.
Porat said the market's uneven performance in recent weeks is another reminder that the recovery "may not come in a straight line," even if major economies "are clearly on firmer footing than just a year ago."
—The investment bank: The drop in revenue from advising companies on deal making grabbed analysts' attention. In some ways, it's a prime time for companies to be merging or buying other companies. With interest rates low, financing is cheap. But Porat said there's still a level of worry.
"CEOs continue to be concerned about longer term earnings outlook and they're just being very cautious in deals," she said. "The level of discussion is very good but it's just not getting to the announcement stage."
Revenue fell 14 per cent to $4.4 billion, after stripping out an accounting charge. Profit was down 30 per cent to $1.1 billion.
—Wealth management: The revenue that each representative brings in has been steadily rising, and this quarter amounted to an annualized rate of $851,000, up from $780,000 a year ago.
Overall, revenue was up 5 per cent to $3.5 billion. Profit jumped 48 per cent to $597 million.
—Expenses: Like most of its peers, Morgan Stanley has been cutting back on spending, including office space, equipment and marketing. The amount the bank spent on salaries, bonuses and benefits fell 5 per cent. Headcount was down 7 per cent, with the bank cutting about 3,900 jobs.
—Regulations: Gorman hinted that uncertainty over new regulations would be less of a drag on results. Investors have already baked in much of the effect of the new regulations into their expectations, he said. The bank's rejiggering how it makes money has also helped. "Our growth areas are those that are unlikely to be much impacted by further regulation," he said in a call with reporters. "Our path is clearer.
—By the numbers: Earnings totalled $1.2 billion, down from $1.3 billion. Per share, those earnings amounted to 61 cents, beating the forecast of 57 cents.
Revenue was $8.5 billion, down from $8.9 billion. That beat analysts' expectations of $8.3 billion.
The earnings and revenue exclude the effect of an accounting charge related to the value of the bank's debt.