Wall Street Seeing Goldman in Rare Reversal With Morgan Stanley
Jan. 19 (Bloomberg) -- Goldman Sachs Group Inc., whose record earnings in the first nine months of last year fueled public outrage, will probably hit a profit plateau in 2010, just as Morgan Stanley rebounds from its worst year ever.
The diverging outlooks for earnings growth have started showing in the stock prices, with Morgan Stanley gaining 2.6 percent this year and Goldman Sachs dropping 2.2 percent. Analysts at Credit Suisse Group AG, UBS AG and Macquarie Group Ltd. began recommending investors buy Morgan Stanley this month.
“It makes sense that Morgan’s rebounding, they’re coming from a lower level,” said Ralph Cole, a senior vice president in research at Ferguson Wellman Inc. in Portland, Oregon, which manages about $2.5 billion and owns both Goldman Sachs and Morgan Stanley stock. Goldman Sachs “is trying to continue to move forward off a very large base, and that makes it very difficult for them.”
Goldman Sachs and Morgan Stanley, the two biggest U.S. securities firms before becoming bank holding companies in 2008, continue their traditional rivalry, especially in merger advice and derivatives. When the two New York-based companies report fourth-quarter earnings later this week, Goldman Sachs is still expected by analysts to outshine Morgan Stanley.
Goldman Sachs, headed by Chief Executive Officer Lloyd Blankfein, 55, will probably report $3.2 billion of fourth- quarter net income, or $5.24 per share, according to the average estimate of 13 analysts surveyed by Bloomberg. Morgan Stanley is expected to earn $647 million, or 43 cents a share, according to the average of 10 analysts’ estimates.
‘Turning Point’
This year may be a different story. Goldman Sachs’s earnings are seen dropping to $11 billion from $11.2 billion in 2009, while Morgan Stanley’s are expected to surge to $5.21 billion from a loss of $521 million in 2009, estimates show.
If analysts are correct, 2010 will be the first year in a decade that Morgan Stanley’s annual net income grows faster than Goldman Sachs’s. The last time was in 2000, when Morgan Stanley’s profit climbed 14 percent compared with a 13 percent gain at Goldman Sachs. Still, Morgan Stanley’s earnings are expected to remain lower than those of Goldman Sachs, which has been the case since 2003.
“Most of Morgan Stanley’s businesses, with the exception of the investment banking franchise, have been underperforming,” Glenn Schorr, an analyst at UBS in New York, wrote in a Jan. 4 note to investors that upgraded the stock to “buy.” “We think Morgan Stanley is heading in the right direction and nearing a turning point.”
Lucas van Praag, a spokesman for Goldman Sachs, and Mark Lake, a spokesman for Morgan Stanley, declined to comment on their firms’ earnings outlooks.
Goldman Sachs Revenue
Throughout 2009, Goldman Sachs dominated the securities industry in generating revenue from trading equities, fixed- income products, currencies and commodities as markets recovered from the 2008 meltdown. Goldman Sachs’s trading revenue totaled $27.3 billion for the first nine months of 2009, double what it was for the same period a year earlier. That pace can’t be sustained in 2010, analysts and investors say.
“All the easy money’s been made,” said Peter Sorrentino, a senior portfolio manager at Huntington Asset Advisors in Cincinnati, which manages $13.8 billion, including shares of Goldman Sachs. “Their earnings will level out.”
Goldman Sachs’s record trading revenue coincided with a jump in risk-taking early in the year. The firm’s value-at-risk, the amount the bank estimates it could lose from trading in a day, surged to $240 million in the first quarter, up 22 percent from the prior quarter and more than twice what Morgan Stanley stood to lose.
Morgan Stanley Payoff
Morgan Stanley may begin to see the payoff in having changed its business model. It is relying less on trading and more on fee-generating businesses such as providing financial advice to individuals, which the firm calls global wealth management, as well as asset management. In June, the company paid $2.75 billion to win control of a joint venture with Citigroup Inc.’s Smith Barney that includes more than 18,000 financial advisers, the biggest brokerage force in the U.S.
James Gorman, 51, succeeded Chairman John Mack as CEO at the start of this year, replacing an executive who spent decades in investment banking with a manager whose main experience at securities firms has been leading wealth management at Merrill Lynch & Co. and Morgan Stanley. At Goldman Sachs, Blankfein and President Gary Cohn have backgrounds in commodities and fixed- income trading.
‘More Upside’
“Usually if you can identify a name like a Morgan Stanley that is improving and is integrating some new operations, that could mean more upside” in the stock, said Cole of Ferguson Wellman. “There are just probably more risks associated with that than with Goldman being Goldman.”
That uncertainty is reflected in analysts’ recommendations. Seventeen analysts recommend buying Morgan Stanley compared with 10 who have a neutral stance and two who say investors should sell, according to data compiled by Bloomberg. By contrast, 20 analysts have buy recommendations on Goldman Sachs shares compared with seven who have a hold stance. None are telling investors to sell.
Morgan Stanley’s trading revenue lagged behind Goldman Sachs’s in 2009, in part because the firm was required to take accounting losses related to a decline in its own credit risk. The company also booked commercial real estate losses and integration costs associated with Smith Barney.
Accounting Writedowns
Morgan Stanley’s revenue from its fixed-income business was $6.87 billion for the first nine months of last year, damped by $4.9 billion in writedowns on the firm’s liabilities as credit spreads narrowed. A year earlier, the $21.4 billion in trading revenue was bolstered by $11.8 billion in gains booked on liabilities because the firm’s credit spreads widened.
The accounting writedowns on the Morgan Stanley’s bonds, known as debt-valuation adjustments, aren’t likely to be repeated in 2010, and the firm has been hiring new sales and trading employees to boost results in that area. Most of the real estate writedowns are finished and the Smith Barney joint venture will start to produce earnings gains, analysts say.
“We see stabilization and payoff from investment spending initiatives within the institutional securities franchise and the realization of global wealth management integration,” Howard Chen, an analyst at Credit Suisse in New York, wrote in a note to investors on Jan. 4.
Fixed-Income Trading
In the fourth quarter, both Goldman Sachs and Morgan Stanley are likely to show weak fixed-income trading revenue, analysts say. JPMorgan Chase & Co., the second-biggest U.S. bank, reported last week that its revenue from that business slid 45 percent from the third quarter, hitting the lowest level of the year. JPMorgan’s $2.7 billion in trading revenue was 26 percent lower than estimated by Jeff Harte, an analyst at Sandler O’Neill & Partners in Chicago.
“This suggests an even more difficult fixed-income trading environment than anticipated and may foreshadow revenue shortfalls for peers,” Harte wrote in a note to investors on Jan. 15.
Michael Cavanagh, JPMorgan’s chief financial officer, said in a conference call last week that the decline reflected fewer trades by clients and a reduction in the risk premium, or credit spread, that investors required to buy securities.
Goldman Sachs can offset some of the drop in trading revenue by slashing the amount the firm sets aside for compensation and benefits. Paying employees is the company’s biggest single expense, as well as the source of much of the popular anger at Goldman Sachs after it set aside a near-record $16.7 billion for compensation in the first nine months of 2009, or enough to give each worker $527,192.
‘Obscene’ Bonuses
The payouts have drawn criticism because Goldman Sachs, Morgan Stanley and their rivals have all benefited from government spending to stabilize the financial system since 2008. While Goldman Sachs and Morgan Stanley have repaid with interest the funds they received from the U.S. Treasury, both have won other forms of support such as debt guarantees and the ability to borrow cheaply from the Federal Reserve.
The U.K. government has levied a 50 percent tax on year-end bonuses that banks pay employees for 2009. Last week, calling bank bonuses “obscene,” President Barack Obama announced a plan to charge the biggest financial companies a fee based on their total liabilities. The fee, which would be in effect for at least 10 years, is designed to recoup $117 billion of taxpayer money, an amount equal to what the government expects to lose on the Troubled Asset Relief Program established in 2008 to help the banks.
‘Lightning Rod’
Compensation “is such a lightning rod,” said Huntington’s Sorrentino. “If this becomes all people are talking about, there are probably other places we can put our money with a lot less grief.”
Credit Suisse’s Chen expects Goldman Sachs to set aside 25.1 percent of revenue for compensation in the last quarter of 2009, down from 47 percent in the first nine months. That will boost earnings and reduce the full-year compensation-to-revenue ratio to the lowest since Goldman Sachs went public in 1999.
JPMorgan employed a similar tactic in the fourth quarter, cutting compensation at the investment bank by 80 percent from the third quarter as revenue slid 34 percent, enabling net income to drop just 1 percent from the prior quarter.
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