Morgan Stanley investors await Fed buyback grace

Morgan Stanley has been paying only a nominal dividend since the financial crisis and has not had a meaningful stock buyback programme since 2006.

Reuters/New York

Morgan Stanley shareholders will find out this week whether the US 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% 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% 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% target some time in 2014.

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 US 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 quarterly dividend as “distressed,” even though he said the bank is in a position of financial strength. Bank of America Corp and Citigroup pay lower quarterly dividends of a penny, while Goldman Sachs Group pays 55 cents, JPMorgan Chase & Co pays 38 cents and Wells Fargo & Co 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 $11.7bn.

“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% in 2013, and shares have more than doubled since their post-crisis low of $12.36 in 2012. Shares are up 3.4% 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% control when it comes to meeting their ROE targets. It gets back to the question of, ‘What does the Fed have to say?’”