During the credit boom, banks and brokers produced huge profits largely by catering to the demands of their institutional clients. While consumers demanded plenty of credit — often in the form of mortgages — it was the Wall Street securitization machine that made the most money by pooling mortgage, loans and other assets in a myriad of creative ways. In the post-bubble era, Wall Street is relying on Main Street for much of its profits, though. As big banks such as Morgan Stanley, JPMorgan Chase, Goldman Sachs and others report their first quarter results, the retail side of the financial services sector is providing strength, at least for now.
On Thursday, Morgan Stanley reported profits of $968 million, or 50 cents a share. While that was 45 percent below the level reported during the first quarter of last year, it beat the 40 cents that analysts expected for the latest period. Morgan Stanley runs Morgan Stanley Smith Barney (MSSB), the world’s largest brokerage service, and intends to buy the rest of the joint venture from partner Citigroup. Morgan Stanley’s wealth management unit, which includes MSSB, reported profits of $348 million, up from $278 million in the first quarter of 2010.
The performance of the unit reflects a shift for Morgan Stanley, which ran into trouble in proprietary trading before moving more heavily into retail. Over the last few years, those shifts coincided with a civil war inside of Morgan Stanley, culminating with the 2009 retirement announcement of John Mack as CEO, who was replaced by the current chief, James Gorman, 52.
Gorman, is a veteran of Merrill Lynch, a power in the retail side of the business. Mack, who cut his teeth in fixed income, left Morgan Stanley after Phil Purcell, the CEO of retail giant Dean Witter, took control of Morgan Stanley in a merger. Mack later returned to Morgan Stanley after Purcell was pushed out.
While fixed income trading improved, Gorman said on Thursday that the unit’s turnaround was his top priority. He shook up leadership of the group, turning it over to Ken deRegt, who replaces Jack DiMaio.
Morgan Stanley shares rose 1.7 percent on Thursday. Shares of Goldman, which lacks Morgan Stanley’s presence in the retail business, fell 1.3 percent on Tuesday, as it reported a decline in earnings.
The shift is clear. Just ask Goldman itself. “A recurring theme is continuing to play out,” says Daniel Harris, an analyst in the capital markets unit at Goldman. “Institutional activity is trailing the recovery and stability of the retail investor,” he said in an April 12 report. The retail business at firms such as Raymond James and Stifel Financial looks strong, he said.
Overall, that means that banks and brokers may be less profitable, at least for now. Return on equity is likely to be in the low teens, down from the mid-teens level of several years ago, according to Roger Freeman, analyst with Barclays. He said that firms such as Goldman won’t begin to look more attractive until the implementation of Dodd-Frank regulatory reform and Basel III global capital standards becomes clearer, allowing institutions to adjust their business to a new set of rules. While Freeman says that could happen this summer, other regulatory analysts aren’t so confident.
“What is going on now is that policymakers are trying to land 250 airplanes on the runway of Dodd Frank,” says John Taft, CEO of RBC U.S. Wealth Management, and chairman-elect of the Securities Industry and Financial Markets Association. “It is too early to tell how the regulations will be implemented or how the industry will be reshaped.
In the meantime, big banks and broker are back from the brink of extinction, but less profitable than they were. “I don’t think that the regulatory certainty hanging over the industry is going to lift this year. It is going to continue, I think, until after the 2012 election. As a result, the industry is going to struggle with lower profits for some time,” says Brett Barragate, co-leader of law firm Jones Day’s Banking and Finance practice.
