LEADER'S VISION FOR BIG BANK IS SHOWING SOME SUCCESS
c.2013 New York Times News Service
Thunderclouds were gathering in April when James P. Gorman, Morgan Stanley’s chief executive, went for a run on the beach on Amelia Island in Florida after attending a closed-door meeting of the bank’s top stockbrokers. After just a few miles, the storm began to pick up speed, prompting Gorman to turn around and head for safety.
Gorman did not get soaked, and his company has become better at avoiding the sort of squalls that have battered the bank in recent years. Morgan Stanley’s stock is up 59 percent this year. Last month, the bank reported strong third-quarter earnings that reflected the results of Gorman’s three-year effort to reduce risk-taking and to expand into the safer business of advising people on how to manage their wealth.
“I felt for a long time that path was clear, but it was disputed and we were doubted many times,” Gorman said recently.
Morgan Stanley was known for years for its swagger and its willingness to take big trading risks. Nevertheless, it was unable to pull back in time in during the financial crisis and sustained significant losses, forcing it to take a $9 billion lifeline in 2008 from a foreign bank. That prompted Gorman to change course.
The transformation has not been easy, and Gorman still has some naysayers. Despite the strong third-quarter results, Morgan Stanley produced a return on equity of just 6.2 percent in the quarter, excluding a charge related to its credit spreads. Simply to cover its debt expenses and other capital costs, Morgan Stanley must achieve a return on equity closer to 10 percent. Gorman said he hoped the bank would hit that number by 2015.
“Last quarter, the stock market was zooming, they did well in divisions like equities, investment banking and wealth management, and despite it all, it added up to a return on equity of just 6 percent,” said Glenn Schorr, an analyst with International Strategy and Investment. “So yes, they have made a lot of progress, but there is still a lot of work to be done.”
The bank’s fixed-income department continues to be a source of some frustration. This unit, which has posted some memorable bond-trading losses, has been shedding risky assets and taking fewer gambles. Still, in the first half of 2013, Glenn Hadden, a prominent interest-rate trader at the bank who has had some successes in the past, racked up losses of more than $200 million, according to people briefed on the matter who spoke on the condition that they not be named because they were not authorized to speak on the record. Hadden, through a company spokesman, and Morgan Stanley declined to comment.
Mike Mayo, an analyst at CLSA, says the good news about the new strategy is these kinds of losses are becoming increasingly rare, and when they do happen, they are “containable.”
One bright spot for the bank is wealth management, where it has been investing much of its effort. That department, run by Gregory Fleming, a former Merrill Lynch president, houses the combined brokerage forces of Morgan Stanley and Citigroup. In the depths of the financial crisis, Morgan Stanley’s wealth-management unit formed a joint venture with Citigroup. This year, Morgan Stanley bought Citigroup’s stake, giving it more than 16,517 brokers worldwide.
Morgan Stanley initially struggled to absorb the unit, and it often had trouble with technology issues. Still, Fleming seems to have largely overcome those obstacles. His division posted a pretax profit margin of 19 percent in the third quarter, ahead of expectations and well ahead of results in the period a year earlier.
Gorman said that while Morgan Stanley had no immediate plans to add more financial advisers, the company was putting a greater emphasis on what it offered to its wealthy clients. Brokers who deal with the bank’s wealthiest clients say Fleming upgraded the trading desk they deal with and is expanding the products sold to top clients.
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Culturally, one of the biggest challenges with the expansion into wealth management was getting Morgan Stanley’s bankers, traders and financial advisers to work together. Bankers are paid to structure mergers, and the executives they deal with often need financial advisers to manage their money. In theory, banking and retail brokerage businesses are supposed to complement each other, with one bringing the other business. But on Wall Street, it rarely works this way, because bankers tend to look down on brokers, whom they see as rather mundane.
Fleming has been trying to change this attitude. It doesn’t hurt that wealth management, not banking, drives the company’s earnings these days. Wealth management now generates almost 45 percent of Morgan Stanley’s revenue, compared with 23 percent in 2007.
“As a banker, you like wealth management a whole lot more when it is responsible for lifting the entire firm’s stock price at a place where people are paid largely in stock,” Mayo said.
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Fleming, a former banker, has moved senior bankers, some of whom he worked with at Merrill Lynch, into wealth management to work with the company’s brokers.
“I recently brought in a possible deal, and someone in banking actually returned my call,” said one Morgan Stanley broker, who spoke on the condition of anonymity because of a firm policy against speaking to the media. “It’s harder for the firm’s bankers to call us idiots when we are driving the firm’s earnings.”
Morgan Stanley’s deal to buy the remaining Citigroup stake will also provide the company with billions of dollars in customer deposits that it plans to use to increase lending to corporations and even individual retail clients. This will include loans for residential mortgages.
The bank has $82 billion in customer deposits and expects that number to grow to about $138 billion by mid-2015.
Morgan Stanley can make a lot of money off the spread on these funds — the difference between what it pays its customers who own the deposits and what it can lend those deposits for.
Right now, the bank is earning less than 1 percent on these deposits. Mayo, the CLSA analyst, said Morgan Stanley’s plan could generate an additional $650 million in revenue a year on these deposits, assuming it can earn a spread of 1.7 percent, which is healthy but still lower than Bank of America’s, which is 2.4 percent, he said. This so-called spread revenue makes up just 13 percent of the wealth management division’s revenue, compared with 34 percent at Bank of America, Mayo said.
“Morgan Stanley is on the cusp of achieving its greatest benefits in wealth management,” Mayo wrote in a recent report.
Still, lending is not without risk, and this strategy has raised some eyebrows on Wall Street.
“We will be prudent and conservative,” Gorman said. “Our intent is not to be on the leading edge of risk.”