HEARD ON THE STREET
July 19, 2012, 2:41 p.m. ET
Morgan Stanley Plays Beat the Clock
By DAVID REILLY
Is Morgan Stanley MS -5.42% shrinking to fit or trying to manage what will prove an inexorable decline?
That is the question for investors smarting from the firm's second-quarter results. Although Morgan returned to profitability, performance in its main trading business was dismal. And its woeful 3.7% return on equity made the 5.4% return at Goldman Sachs look fat.
.
.
The most pressing issue is the fixed-income trading business. Revenue was down 70% from the prior quarter, excluding accounting adjustments related to the value of Morgan's own debt. That came against the backdrop of tough markets and a challenging economy.
.
But the results, markedly worse than those of competitors, also reflected Morgan's recent two-notch downgrade by Moody's Investors Service and uncertainty around it. While the rating cut was less than initially feared, the result suggested customers pulled back.
Morgan finance chief Ruth Porat said on the firm's earnings call that with the ratings issue decided, the trading business is "seeing real relief and clients have re-engaged."
.
To what extent has yet to be seen. The risk is that Morgan will see a lasting migration of business to higher-rated peers, especially when it comes to derivatives. Although Morgan wants to move derivatives into its banking subsidiary—that unit has a higher rating than Morgan's holding company—it hasn't gotten regulatory permission to do so.
In response to the poor results, Morgan chief James Gorman said the firm would shrink risk-weighted assets in its trading business. He said that by the end of 2013 those would be reduced by 25% from third-quarter 2011 levels and that they are already down 15%. Overall firm assets have fallen about 5% since the third quarter to $753 billion.
This represents an accelerated attempt to right-size and refocus the trading businesses on less-capital intensive activities. Alongside this are continued efforts to reduce expenses, even while trying to gain market share in core trading activities.
.
Pressures on trading revenues from macro conditions pose a challenge to this effort. Morgan is reluctant to slash compensation drastically. Yet with a smaller revenue base than, say, Goldman, this leaves it with a higher ratio of compensation to net revenue, pressuring returns.
.
That ratio was 49% in the second quarter for the firm's institutional securities group, versus 44% at Goldman. That doesn't please shareholders, who see employees taking a bigger slice of a shrinking pie.
.
The unequal division of spoils can only go on for so long. Mr. Gorman's bet is to streamline and reorient Morgan's businesses in anticipation of global markets and economic conditions normalizing. With the shares trading at less than 50% of tangible book value, great gains could be had if this plays out.
.
The danger is that investor patience grows even thinner in the face of Morgan's inability to show consistent improvement. At this valuation, given that the bulk of Morgan's balance sheet is trading assets, the firm is theoretically worth more dead than alive.
.
In that sense, Mr. Gorman is more than ever in a race against time to prove that Morgan makes sense as a stand-alone, publicly traded investment firm.
.
Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved
0 comments:
Publicar un comentario