Executives of Goldman Sachs and Morgan Stanley, America’s two largest former investment banks, announced positive earnings on Thursday yet seemed at a loss to explain or predict the path of the economic recovery.
“My crystal ball barely works for a week,” Goldman’s chief financial officer, Harvey Schwartz, told an analyst who asked about the bank’s outlook in the stock business. “I don't think it will work for three to five years. I wish I had one that did.”
Schwartz cited two consistent themes in the banking business: doubt over the strength of the economic recovery as nearly every region in the world reported mixed economic data; and uncertainty over the influence of central banks, like the Federal Reserve, who are in various stages of either increasing or decreasing stimulus.
Analysts asked both Goldman Sachs and Morgan Stanley about their relationships with banking regulators, in particular the Federal Reserve. Six years after the mortgage blowup of 2008, the banks still have to prove that they hold enough capital to stand on their own in a crisis without government intervention.
The Fed recently stress-tested the banks to see if they could survive another financial crisis. Both banks passed, but Morgan Stanley – which its CEO said “was flying too close to the sun” during the last financial crisis – did so with flying colors and won the right to use some cash to double its quarterly dividend and buy back stock. The Fed forced Goldman Sachs to pare back the amount it had hoped to offer to shareholders.
Goldman Sachs also detailed its efforts to comply with the Volcker Rule, part of the Dodd-Frank reform act that requires banks to divest all the businesses in which they invest their own money. The effort has proven thorny, because many banks traditionally invest their money along with that of their clients. Schwartz said Goldman would have to sell off roughly $9bn of investments to meet the Volcker guidelines, but the bank doesn’t have to comply until 2018.
Still, Goldman seemed defiant about the creep of greater regulation.
“In no way, shape or form are we going to let the regulatory guidelines or constraints change our risk-taking philosophy,” Schwartz said in the earnings conference call today.
Goldman and Morgan Stanley, longtime rivals and the two biggest investment banks to survive the financial crisis, are usually neck-and-neck, but their results varied sharply in the first quarter. It is an unusual departure for Wall Street banks to turn in contradictory views on key businesses.
Overall, the numbers looked good: Morgan Stanley grew its revenue by 4% to $8.9bn, but was a bigger winner in its net income, boosting that 18% to $1.5bn. It did well in commodities, mortgages, bonds and investment banking – the business of advising companies – in which the bank’s fees grew 20% compared to the same time last year. Morgan Stanley stumbled slightly in wealth management, in which the firm advises individuals on their money. Wealth management revenues fell 3% compared to the last three months of the fourth quarter, to $3.6bn.
Morgan Stanley CFO Ruth Porat explained the drop by saying, “we are under-penetrating our clients”, meaning that the bank is not selling its customers as many investment products as it would like. One bright spot, she said, is lending, “as [financial advisers] work with the lending product, they further penetrate their client base,” Porat said.
Goldman Sachs announced earnings of $2.3bn on revenues that declined 8% compared to last year, coming in at $9bn. It also did well in investment banking – CFO Harvey Schwartz boasted of the best performance since 2007 – but showed weakness in bond trading, which accounts for one-third of its overall business.
One of the biggest divergences was in fixed-income trading, which includes Treasury and corporate bonds and is very sensitive to interest rates set by the Federal Reserve. It was the strongest business for banks for years before the financial crisis.
Every bank except Morgan Stanley and Bank of America saw sharp downturns in fixed-income in the first three months of the year. Goldman Sachs’ revenues in the business dropped by 11%, while Citigroup’s fell 18% and JP Morgan’s fell the most, with a 21% drop.
In February, Goldman backed away from its effort to create an electronic bond-trading platform that would work much like a stock exchange. The Financial Times reported that traders were nervous Goldman would collect their information.
Morgan Stanley’s compensation ratio was 48.9% in the first quarter of 2014 and this was above our 47.0% forecast and up from 48.2% a year ago. Non-compensation expenses were $2.32bn and this was better than our $2.61bn forecast as professional declined sequentially and other expense was down as well.
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