Morgan Stanley reported mixed earnings for the third quarter. RBC Markets Analyst Gerard Cassidy joins the On the Move panel to discuss.
JULIE HYMAN: And let's turn to the big banks and Morgan Stanley specifically, because that company reported this morning it came in ahead of estimates. Profit was up by 25%. Trading revenue was largely to thank for how the company did. Remember, Morgan Stanley has also been making a lot of acquisitions, although that wasn't shown yet in this quarter.
Gerard Cassidy is joining us now. He's RBC Capital Markets Analyst. He's with us on the phone. So Gerard, when you look at what looks like really a turnaround that we've seen in Morgan Stanley, right, and James Gorman, the CEO, bringing the business back, particularly the trading business back, is it a sustainable recovery that we've seen in that business?
GERARD CASSIDY: That's actually the key question many investors are asking, because clearly, when you turn back the clock and you look at Morgan Stanley back during the financial crisis, it was heavily weighted to the institutional business. And under their CEO, James Gorman, is diversified into the wealth management area with the acquisition of the Smith Barney broker dealer from Citigroup back in the 2009, 2011 time period. And of course, he closed just at the beginning of this month on e-trade.
He announced the Eaton Vance acquisition recently, and so he's really diversified the revenues from just investment institutional trading businesses and investment banking to a broad mix of now wealth management and asset management. And if you look at the revenues this quarter, approximately 51, 52% of revenues came from the wealth management and the asset management business, which was not the case, of course, 10 years ago. So it has definitely moved in the direction for more sustainability, more annuity like revenues, but it is still all in the investment industry, and that makes it a little more volatile, and I think that's what you're seeing today. Even though they were great numbers, there is that concern about volatility.
ADAM SHAPIRO: But when you ask this question of sustainability, we had a guest on yesterday talking about Goldman Sachs, which is making that move and has potential upside with Marcus and digital banking. With Morgan Stanley, there is a threat, is there not, to what you've just described as their revenue picture, especially if Democrats get a sweep of Congress as well as the White House and start to enact legislation that might clamp down on trading as well as taxing trades. I mean, those issues are front and center, are they not?
GERARD CASSIDY: No, no, no, I think you're bringing up some very valid points, and the Goldman diversification has been lagged and is way behind, of course, Morgan Stanley, and part of the fact that that, in our opinion, was Lloyd Blankfein, the former CEO, was a trader, you know, came up through the trading ranks, and I think that was just the strategic goals that he had were not diversification like you're seeing under David Solomon, and they're trying to become more like a JPMorgan Chase, a universal bank. Coming back to your comments about if there's a blue wave and the Democrats sweep, there is definitely going to be tax increases. We know that Candidate Biden has put them into his platform-- Corporate taxes are going up, personal taxes going up, and there's talk, as you point out, for a financial transactions tax, which could affect them.
But I think it's a little too early for the stocks, you know, to be trading just on that, because we don't know what the election is going to bring. I know that polls look like Biden will win, but we saw that also in 2016, so nobody is really certain how it's going to play out. But there is uncertainty out there, which adds to volatility. I don't disagree with you.
BRIAN CHEUNG: Hey, Gerard. Brian Cheung here. So it does seem like the big story for the banks when it comes to their bread and butter businesses, again, interest income, it does seem like it was pretty bad this quarter but that the color coming from the CFO offices on the calls this week, you know, suggests that maybe they've reached a trough for this quarter with the kind of full impact of the Fed's rate cuts being digested. Do you see that as the case, and how do you feel their economic outlooks, I guess in the future, kind of model out really whether or not we should expect to see a true trough in net interest income for this quarter?
GERARD CASSIDY: No, it's a really, you know, good question, and you're getting to the heart of the matter with the commercial banks, because it was a tale of two cities this quarter so far. We're not completely through the earnings season, of course, but all the major banks have reported, and I would say that the improvement in credit expectations was very positive. So the cost for credit, bad credit that is, dropped meaningfully relative to the second and first quarters, so that was very positive for the banks. On the other hand, however, the net interest revenue, their real structural business lending, continues to feel the pressure of the low rate environment. And some of the CFOs and CEOs indicated that that net interest revenue appears to be bottoming, and there should be some improvement in it next year.
What we would need to see for it to improve is a stronger economy, of course, because that would drive organic loan growth. The loan growth today is basically flat to negative. Organic growth, not those PPP loans, which is the Paycheck Protection Program loans, which are the government guaranteed loans, but organic growth is flat to negative. So if we see a pickup in loan growth for 2021 and if the economy does pick up some momentum and inflation starts to creep up and you get a steepening in the yield curve, that would also help. So if investors see that on the horizon, then they should put themselves in the camp that we are bottoming on net interest revenue, which is a critical component of total revenue because of a possibility of a steepening curve and stronger loan demand in 2021.
JULIA LA ROCHE: Gerard, it's Julia La Roche. I want to bring up Goldman Sachs again. One of the things that kept on coming up on the earnings conference call was a recent report, it was from Reuters, about how the company or the bank might have to change some of its targets that it set out at its first investor day actually earlier this year in January. And you know, one of things David Solomon brought up was, look, these are three year medium term goals.
He also characterized that report as, I think he said it was inaccurate. I don't know the exact language that he used per se, but he also talked about maybe finding new opportunities. From an analyst perspective, how do you kind of look at Goldman and those targets that were set out? And I would just be curious to kind of get your take on it.
GERARD CASSIDY: I think it's kind of early for them to change targets, because obviously their investor day was less than 12 months ago, obviously before the pandemic. And so I think to jump to the conclusion that they are going to reset them appears to be premature. And second, you know, we all know next year, eventually the pandemic will run its course, even as tragic as it has been, the economy should improve under that kind of scenario, and that obviously should be beneficial to Goldman.
But Goldman can also use other types of strategies that they've pointed out at Investment Day to build up this profitability in these targets, including additional acquisitions. So they were long term, or you know, I would say intermediate to long term targets, and with less than a year since giving them to throwing the hat and reset them seems rather surprising that you normally don't see that. And so if we're two or three years away from when they were set and they're nowhere near reaching them, that's a different story.
And Citigroup is a good example. They set theirs back I think it was 2017 and acknowledged the start of this year they were not going to reach them. So I would side with the company on this that they haven't reset them. They need to see the economy continue to improve like the others. And if they are able to acquire other types of companies to complement their businesses, that too could help profitability.