Last year, strong financial conditions and a high appetite for risk from investors set the stage for a record year for companies going public. This year has been a different story. Market weakness has made many private companies hesitant about going public, and initial public offerings (IPOs) have plunged.

Investment bankers have felt the pain from this, and one of the top investment banks in the world, Morgan Stanley (MS 1.05%), painted a picture of how much of a drag this had on earnings on Thursday. Here's what we learned about the current state of the IPO market and what to expect moving forward.

Morgan Stanley's earnings drop

Morgan Stanley's revenue fell $1.6 billion, or 11%, from last year, while its net income decreased $1 billion, or 32% from last year. Weakness in its investment banking segment led to the drop, where revenue fell by $1.4 billion from last year.

The company struggled as fewer mergers and acquisitions were completed, and advisory revenue fell 10%. Fewer companies looked to issue bonds, too, amid rising interest rates, and Morgan Stanley's fixed income underwriting revenue was down 49%.

However, the weakest area by far was equity underwriting, as fewer companies went public through initial public offerings (IPOs). Morgan Stanley brought in $148 million from equity underwriting, an 86% collapse from last year.  

IPOs were down over 90%

IPO activity was on fire last year, as 1,073 companies went public, raising $317 billion, according to data from FactSet Research Systems. IPOs have come to a screeching halt this year, with only 92 companies going public and raising $9 billion. Companies have hesitated to go public this year into a stock market off to its worst first-half start in over 50 years.

A chart shows the U.S. IPO activity over the last 13 years.

Image source: FactSet Research Systems.

The slow start in stocks is due to inflationary pressure that we haven't seen in over 40 years and the Federal Reserve's response to it. The Fed has taken a serious stance on inflation and is using its primary tool -- interest rates -- to cool it down. Since March, the Fed has raised interest rates three times for a total boost of 1.5% and could increase them another 0.75% at its meeting at the end of this month.  

The Fed believes rising rates could slow demand to bring down inflation; however, rising interest rates have ripple effects across the economy and are the primary cause of this year's volatility in markets. With all of this uncertainty about the economy, companies like Justworks, a payroll software vendor, and Fresh Market, the grocery chain, have pulled their IPO filings altogether.  

Zopa, a digital bank in Britain, had plans to go public in 2022, but CEO Jaidev Janardana told CNBC, "the markets are not there -- not for fin, not for tech. We will just have to wait for when the markets are in the right place. You only want to do an IPO once, so we want to make sure that we pick the right moment."  

Investor takeaway

Investment banking is a cyclical business vulnerable to economic conditions, and these companies can see earnings fluctuate drastically. While Morgan Stanley has felt the pain, its diversified revenue streams have helped it weather this earnings volatility better than investment bank-heavy businesses like Jefferies Group and Goldman Sachs.

Investment bankers have said their deal pipelines remain strong. According to FactSet, 159 companies that have filed to go public since 2021 are still waiting for their moment. However, investment banks will continue to face near-term headwinds to their business until market conditions improve and private companies show more confidence in going public.