Goldman Sachs Discusses Morgan Stanley, Mitsubishi Financial Deal

Goldman Sachs is out with a research report on Morgan Stanley MS as the company announced it had completed the conversion of Mitsubishi Financial Group's preferred securities into common stock, which will result in a $1.7 bn non-cash charge to 2Q11 earnings. It has a Neutral rating and a $26 price target on shares. In a note to clients, Goldman writes, "With 2Q results likely weak owing to the environment, the ability to include the conversion charge in 2Q11 will start 3Q11 off with an ability to improve results, which we now estimate will lead to a 2Q operating ROE of just 5%. The acceleration also eliminates the 2Q dividend payment of $196 mn, which is additive to our prior BVPS estimated. With the conversion behind it, Morgan Stanley can again focus explicitly on the environment, which has been challenging owing to muted volume, slowing issuance, choppy equity markets, and a lack of client engagement. We now model FICC (ex DVA) down 30% qoq and equity down 14%, yet MS remains somewhat inflexible on compensation, given its headcount expansion, thus the 54% compensation ratio is higher than the 51% in 1Q excluding DVA/MUFG loss. In addition, higher GWM expenses drive margins to 8% in 2Q." Shares of MS closed at $26.00 yesterday.