Morgan Stanley Wealth Profit Jumps 19% on Fees and Loans (Advisorhub.com)

(Updated with additional comments from company executives on a conference call.)

First-quarter profit at Morgan Stanley’s wealth management division rose 19% to a record $1.2 billion in the first quarter as the company continued to reap the benefits of emphasizing fee-based assets and lending.

Revenue at the wealth unit rose 8% to $4.4 billion from $4.1 billion a year ago, representing 39% of its parent company’s $11.1 billion in revenue for the quarter.

The division’s pretax net income from continuing operations of $3.4 billion comprised 33.9% of the company’s pretax earnings as a whole and 34.2% of its after-tax profit of $2.67 billion.

Morgan Stanley has made a bigger bet than other large competitors on wealth management through its purchase of Smith Barney from Citigroup after the financial crisis.

In a conference call on first-quarter results with analysts on Wednesday morning, Chief Executive James Gorman said the retail wealth business gives the company “ballast” and “stability” to offset riskier and potentially more profitable activities in trading and investment banking.

Morgan Stanley’s 15,682 brokers generated  “strong fee-based asset flows” from new and existing clients of $18.2 billion during the first three months of 2018, the company said. The new money was down 3% from last year’s first quarter, however, and off 13% from a record $20.9 billion of new advisory account money in the fourth quarter of 2017.

Like its competitors, Morgan Stanley has favored asset-based fee accounts over traditional commission accounts because they generate fees regardless of customer interest in trading. The percentage of total wealth client assets in fee-based accounts at Morgan Stanley jumped to 45% as of March 31 from 42% 12 months earlier, hold record-high assets of $1.06 trillion.

The wealth unit’s total client assets were up 8% year-over-year to $2.37 trillion.

Merrill Lynch on Monday reported that its flow of fee-based assets fell 17% to $24.2 billion in the first quarter, but said client assets in the accounts climbed to $2.30 trillion. Net income at Merrill and its U.S. Trust private banking cousin jumped 34% to $1.03 billion, slightly ahead of Morgan Stanley’s results.

Morgan Stanley’s bottom line also was fattened by rising interest rates and growing loans to wealthy clients. Net interest income in wealth management climbed 8% to $1.1 billion from a year ago (though it was down 1% from the fourth quarter). Loans and lending commitments to wealth clients were up 12% from a year ago and 2% from last quarter to $78.7 billion.

The firm’s retail lending portfolio, comprised largely of mortgages and portfolio-backed loans, has tripled in the past five years as Morgan Stanley sought to catch up with rivals such as Merrill Lynch, UBS Wealth Americas and Wells Fargo Advisors that are owned by banking giants. The firm has incentivized brokers to sell credit products, but Chief Financial Officer Jon Pruzan warned on the earnings call that the pace of lending and net interest income growth is bound to slow due to a shrinking number of untapped customers.

“We do expect NII growth but it will be slower than in the last five years,” Pruzan said. “We clearly cannot continue at that clip.”

Pruzan and Gorman appeared to differ on their views of traditional commission-based trading by retail customers in the first quarter. The CFO said that investors were actively repositioning portfolios amid the volatile market period, but Gorman said transactional activities were “extremely light.”

The company booked retail commissions of $747 million, down from $823 million in the year-earlier quarter, but attributed much of the decline to losses on investments related to brokers’ deferred compensation plans. The company had gains on the deferred-comp investments in 2017’s first quarter.

Morgan Stanley cut its recruiting budget for experienced brokers last year, and the company ended the first quarter with 95 fewer brokers than the 15,777 it had 12 months earlier. Headcount dropped a net 30 during the first quarter, but Pruzan said the production of lost brokers was generally “quite low.”

Merrill’s broker headcount fell by a net 124 during the first quarter to 14,829, while Wells Fargo Advisors last week said its brokerage force bled a net 155 brokers in the first three months of the year to 14,399.

Average annualized revenue of all brokers at Morgan Stanley climbed to $1.12 million based on first-quarter production, up from $1.03 million a year ago.

Compensation expenses at the wealth division inched up to $2.5 billion in the first quarter from $2.3 billion a year ago because of the higher production, Morgan Stanley said. Non-compensation expenses were “essentially unchanged” from a year ago at $764 million.

Wealth management notched a 26.5% profit margin for the quarter, up from 24% in the first quarter of 2018.

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