Morgan Stanley has no regrets about the sorry demise of Deutsche Bank's equities business. In the call today accompanying the U.S. bank's third quarter results there was plenty of talk about "market consolidation" and "gaining share" and how, as one of the three top banks in equities sales and trading globally, Morgan Stanley is well-placed to benefit from Deutsche's disappearance.
Deutsche Bank wasn't actually mentioned by name. Instead, there was talk of 'people' who were 'stepping away' from equities and 'European peers' giving up share to U.S. banks. Deutsche was the clear elephant in the room, although Morgan Stanley CEO James Gorman might equally have been referring to Nomura (technically based in London for its international business), which withdrew from equities in 2016, or to HSBC and UBS, which are cutting costs in that business before the year ends.
“We think there will continue to be consolidation of share in that business and we think that this will be an opportunity for us,” said Morgan Stanley CFO Jon Pruzan in the call. Pruzan cited Morgan Stanley's technology investment and economies of scale as a source of the bank's competitive advantage. "It’s a strong and powerful business,” he said of the bank's equities sales and trading operation, which rests on strength in prime brokerage. "You have seen a real shift into the top three providers...We are very happy with that position."
Although Morgan Stanley is particularly proud of its equities business, which was the market leader in both the third quarter and the first nine months of the year ($6.1bn in revenues in the first nine months, versus $5.7bn at Goldman Sachs and $5bn at JPMorgan), it was the bank's fixed income traders who out-perfomed in third quarter. As the chart below shows, fixed income trading revenues were up 21% year-on-year at Morgan Stanley; only JPMorgan did better, with 25% growth. Morgan Stanley attributed the increase to, 'strong client activity in the credit and rates businesses.' It may have helped that Deutsche Bank pulled back from rates trading, too.
All that technology spending is expensive
Even as Morgan Stanley picks up market share from fallen rivals, there is however a small cloud on the horizon. The bete noir of banking analysts, Mike Mayo, called it out in today's call: costs at Morgan Stanley are increasing faster than revenues.
This applies across the bank, but it applies especially in institutional securities (which houses the investment bank). Here, revenues fell 2% year-on-year in the third quarter, while costs rose 10% on the back of a 9% increase in compensation costs and a 12% rise in non-compensation expenses. "What sort of confidence do you have that revenues will grow faster than expenses in future?," Mayo asked.
Gorman replied that he's unconcerned about the issue and said Morgan Stanley is "maniacally" focused on ensuring that revenues do indeed increase faster than expenditure in years to come.
However, Gorman also referenced Morgan Stanley's spending on technology under Rob Rooney, the head of technology and former head of EMEA. "While we are wanting to spend on some of the new technologies coming into the market we are also taking costs out of what has been a legacy system that hasn’t been terribly efficient over the last 10 years," said Gorman.
The benefits of Morgan Stanley's technology revamp will come through over time, said Gorman: "We're generating scale economics," he added. That sounds ominous for smaller players: if even the market leader can't grow revenues fast enough to cover increasing costs in the short term, bit-players in the equities market have little hope of mustering support for the kinds of technology investments required to stay in the game. Deutsche Bank might be glad that it got out when it did.
[Click on the charts to see performance by business area.]
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