Analysis - Morgan Stanley investors await Fed's buyback blessing
NEW YORK (Reuters) - Morgan Stanley (MS.N) shareholders will find out this week whether the U.S. Federal Reserve will allow the bank to start returning capital to shareholders in a meaningful way for the first time since the financial crisis.
But even if the Wall Street bank gets the Fed's blessing to buy back more shares and potentially raise its dividend, it is unlikely to hit a shareholder return target Chief Executive James Gorman set out for this year, analysts and investors said.
The target, called return on equity (ROE), measures how much profit a bank makes using shareholder funds. An ROE of at least 10 percent would show that Morgan Stanley can earn enough to pay for new capital and signal that the bank is past the restructuring it needed to make after the financial crisis. Morgan Stanley's annual return on equity has languished below 10 percent since 2006.
If the bank cannot jump that hurdle in the near term, which could be done by boosting profits, buying back shares, or both, shareholders may get impatient and demand that management outline a bolder strategy to boost profits.
"They should be generating double-digit ROEs, and if they aren't, what are they going to do about it?" said Mike Mayo, a longtime bank analyst at CLSA. He raised a similar question at Morgan Stanley's annual meeting last year, prompting Gorman to say the bank would meet the 10 percent target some time in 2014.
STRESS TEST PASSED
Last week, the Fed said Morgan Stanley passed its annual stress test, a requirement of the Dodd-Frank financial reform legislation that examines how well big banks' balance sheets would hold up in hypothetical crises.
As part of the test, banks submitted capital plans, including how much they would like to spend buying back stock and paying out dividends. On Wednesday, the Fed will say whether those plans have been approved, and how much each bank can spend.
Morgan Stanley, the sixth largest U.S. bank by assets, has been paying only a nominal dividend since the financial crisis and has not had a meaningful stock buyback program since 2006.
Gorman recently referred to Morgan Stanley's 5-cent quarterly dividend as "distressed," even though he said the bank is in a position of financial strength. Bank of America Corp (BAC.N) and Citigroup Inc (C.N) pay lower quarterly dividends of a penny, while Goldman Sachs Group Inc (GS.N) pays 55 cents, JPMorgan Chase & Co (JPM.N) pays 38 cents and Wells Fargo & Co (WFC.N) pays 30 cents. All of those banks bought back more stock than Morgan Stanley last year in dollar terms.
Morgan Stanley has paid little cash back to investors because it had a bigger priority: funding its purchase of the Smith Barney brokerage business from Citigroup, a deal executed over four and a half years that was finished in June and ultimately cost Morgan Stanley $11.7 billion (7.0 billion pounds).
"We have been, for the last couple of years, quite conservative and deliberately so," Gorman said in a recent interview with Fox Business Network. But, he added, now that the bank has clearly recovered from the crisis, he wants capital returns to reflect that strength.
Morgan Stanley declined to comment about its proposed buyback and dividend plans or the implications for ROE.
Despite some concerns of ROE, the stock was among the best performers in the financial sector last year, up 64 percent in 2013, and shares have more than doubled since their post-crisis low of $12.36 in 2012. Shares are up 3.4 percent year-to-date, closing at $32.44 on Monday.
Some investors and analysts say it is less important that Morgan Stanley hits Gorman's return-on-equity goal this year than that its returns are moving in the right direction.
"They've had to get their balance sheet back in order, and now it's time to start sending some of that money toward shareholders," said Michael Cuggino, president and portfolio manager of the Permanent Portfolio Family of Funds, which owns Morgan Stanley shares. "But they don't have 100 percent control when it comes to meeting their ROE targets. It gets back to the question of, 'What does the Fed have to say?'"
WAITING FOR THE FED
How much the Fed will allow Morgan Stanley to spend on buybacks will affect how fast it can hit the 10 percent target, which would be more than double the 4.3 percent ROE it delivered in 2013.
Morgan Stanley's returns were weighed down by one-time litigation costs, an accounting charge and the cost of the Smith Barney purchase. This year's profits are expected to be helped by higher earnings from that business as well as a reduction of fixed-income trading assets that are costly under new regulations.
Although analysts expect Morgan Stanley's profits to jump 62 percent this year, many still describe Gorman's 2014 goal as aggressive.
It would require Morgan Stanley to exceed analysts' earnings expectations by a substantial amount, or buy back more stock than analysts expect the Fed to allow.
Morgan Stanley started buying back stock last year for the first time since 2006. It announced a $500 million repurchase program in July, and used $350 million worth of that authorization before year-end.
Even with those repurchases, Morgan Stanley's outstanding share count increased by 2 percent last year because of shares issued as part of compensation. By comparison, its chief rival Goldman Sachs has spent $21 billion repurchasing shares since 2010, reducing outstanding stock by 15 percent, and has increased its dividend twice.
Analysts are estimating that Morgan Stanley will buy back about $700 million worth of stock this year on a net basis, on average, according to ISI Group. The bank would need to buy back nearly 20 times that amount to hit a 10 percent ROE target, based on the average analyst earnings estimate.
Instead, analysts are forecasting a return-on-equity of 7.5 percent this year, on average, according to Thomson Reuters data. Next year, analysts estimate Morgan Stanley will reach an ROE of 8.6 percent, on average. Analysts do not expect the bank to hit 10 percent on a quarterly or annual basis in either year.
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