Why Morgan Stanley (MS) Shouldn’t Pay Its Shareholders

Last week’s release from the Federal Reserve from part one of its Comprehensive Capital Analysis and Review (aka, stress tests) was a big day for the nation’s banks. But tomorrow may be even bigger for bank investors. Most are anticipating signs of increased dividends or share buybacks, but Morgan Stanley (NYSE:MS) investors may be waiting a bit longer.

Morgan StanleyA quick recap
Morgan Stanley (NYSE:MS)‘s results last week weren’t bad, but also not the greatest. Though the bank had an admirable 13.9% Tier 1 common ratio, the Fed’s stressed scenario reduced the ratio by a huge 8.2%. Because Morgan Stanley (NYSE:MS) and its compatriot Goldman Sachs Group, Inc. (NYSE:GS) operations are vastly different from the large depository institutions with trading arms, like Bank of America Corp (NYSE:BAC) and JPMorgan Chase & Co. (NYSE:JPM), the Fed’s stress test produced harsher effects for the investment banks.

But despite the larger effects, Morgan Stanley (NYSE:MS) passed the first round of tests, and may have some wiggle room in the second round.

Source:  Dodd-Frank Act Stress Test 2013: Supervisory Stress Test Methodology and Results.

Should Morgan Stanley ask for a dividend increase or share buyback?
In short, no. While the bank does have some room before it’s Tier 1 common capital ratio reaches the Fed’s 5% minimum, any dividend increase or share buyback would not be substantial enough to make a big difference for its investors. With its current payout of 0.2%, Morgan Stanley will have no problem getting its current dividend approved by the Fed, and though that may not be appreciated by investors now, it has another opportunity to use its capital for another purpose that can potentially add much more value.

Taking a cue from last year’s capital plan, Morgan Stanley should avoid increasing its dividend or initiating share buyback programs in favor of escalating its acquisition of Morgan Stanley Smith Barney. The joint venture with Citigroup Inc. (NYSE:C) has already bolstered Morgan Stanley (NYSE:MS)’s operations with increased exposure to wealth management. The bank currently has an agreement with Citi that it will purchase the remaining 35% stake in Smith Barney by 2015.

Not only has the purchase of Smith Barney provided increased revenue to Morgan Stanley, but the acquisition price is heavily favoring the purchaser — giving ample opportunity for MS to realize increased gains from the purchase.